Controls for Payroll (#14)

In this episode, we discuss the controls associated with payroll. This is an area in which fraud is more likely to occur because of such activities as buddy punching and the use of ghost employees, so controls are unusually necessary. Key points made in the podcast are noted within the following general classifications:

Manual System Controls

• Verify that all time cards have been received from employees by matching them to the employee list

• Verify all hours worked, and especially overtime, with supervisors

• Gain proper approval for all pay rate changes

• Have a second person verify all payroll calculations

• Have recipients sign for their paychecks, to ensure that payments are not going to ghost employees

• Compare cashed paychecks to the list of distributed checks, to see if additional checks were issued

• Compare the addresses on employee checks, to see if more than one check is going to the same address

• Look for double endorsements on checks, which are an indicator of ghost employee arrangements

Cash Payment Controls

• Have recipients sign for the amount of cash issued to them

• Use a bill and coin requisition form, with approvals, to request the cash to be used for payments to employees

Computerized System Controls

• Use a smart time clock to eliminate the need for manual approvals

• Have supervisors manually override the smart clock to allow overtime selectively

• Install biometric clocks to eliminate buddy punching

• Install a surveillance camera over the time clock to foil buddy punchers

• Review the payroll register for errors

• Use variance reports to detect incorrect payments

• Review self-service entries by employees and managers for errors

• Install limit checks on self-service screens to control the date entry process

• Email all payroll changes made back to the people requesting changes, to ensure that the changes match their intentions

• Install extra controls over direct deposit change transactions

• Do not use deposit slips for direct deposit information (use a cancelled check instead)

• Look for duplicate pay-to bank accounts, which can indicate ghost employee transactions

• Limit access to the employee master file, and keep a log of changes to it

• Compare the company phone list to the payroll register, to see if anyone was excluded from a payroll, or if ghost employee payments are being made

Related Courses

Accounting Controls Guidebook

How to Audit Payroll

Optimal Accounting for Payroll

Payroll Management

Controls for Accounts Payable (#13)

In this episode, we discuss the controls associated with accounts payable. There are many possible controls that may be used, but the accountant needs to be aware that employing all of them could seriously reduce the overall efficiency of the department. Key points made in the podcast are noted within the following general classifications:

Manual Controls

• Install three-way matching for larger expenditures

• Institute a duplicate invoice search

• Store unpaid invoices by date, to ensure that those items to which early payment discounts apply will be paid on time

• Roll out negative approvals, to streamline the invoice approval process

• Store blank check stock in a locked location, to prevent theft

• Restrict access to the signature plate

• Maintain a log of all checks that have already been used, to spot illicit removals

• Review supporting documents before signing checks

• Limit the number of check signers to a small number of rigorous signers

• Never sign blank checks

• Perforate cancelled checks, to keep them from being submitted for payment

Computerized Controls

• Conduct automated three-way matching

• Automatically scan for duplicate invoices

• Lock down access to the supplier master file, so that no one can alter pay-to addresses

• Track changes that have been made to the supplier master file

• Adopt a standard naming convention for suppliers in the supplier master file, to prevent the creation of duplicate supplier records

• Scan the supplier master file for duplicate supplier records

• Compare supplier to employee addresses to see if there are any matches

• Install the positive pay system

Electronic Payments

• Install an ACH debit filter to restrict deductions from a bank account

• Minimize the amount of cash in the checking account to cover just current liabilities, to minimize the risk of large additional charges being made against the account

• Install password access to the electronic payment software

• Have the bank call the CFO or controller for verbal approval of large electronic payments

• Review repetitive payments on a regular basis, to ensure that they are still valid

Related Courses

Accounting Controls Guidebook

Accounting Information Systems

Optimal Accounting for Payables

Payables Management

Collection and Cash Receipt Controls (#12)

In this episode, we discuss the controls associated with collections, cash receipts, and petty cash. The main concept is to avoid cash-related controls by keeping cash off the premises, usually by encouraging the use of ACH payments or payments into a bank lockbox. Key points made in the podcast are:

Collection Controls

• The collections staff is not allowed to handle cash receipts, since this presents a temptation to steal the cash and use credit memos to cover up the theft

• The collections staff can only create credit memos without approvals that are relatively small; all others require management approval

• Management approval is required to assign invoices to a collection agency, because of the significant collection fees charged

Cash Receipts Controls

• Two people open the mail, to reduce cash and check pilferage

• The mailroom staff creates a list of all cash and checks received, of which it retains a copy

• The mailroom staff endorses all received checks as being for deposit only

• The cash receipts clerk matches all checks entered into the accounting system to the list provided by the mailroom, to look for anomalies

• Compare the bank deposit slip to the cash receipts journal, to see if the courier removed any cash or checks

• Force the cash receipts clerk to take vacations, which may uncover instances of lapping fraud

• The cash register clerk gives a receipt to every paying customer, so the customer can compare the receipt to the amount paid

Petty Cash Controls

• Don’t use petty cash at all

• Assign responsibility for the petty cash box

• Document all disbursements from the petty cash box

• Audit the petty cash box

• Place a contact switch under the petty cash box, so that an alarm will sound if the box is taken

Related Courses

Accounting Controls Guidebook

Accounting Information Systems

Credit and Collection Guidebook

Optimal Accounting for Cash

Controls for Billing (#11)

In this episode, we discuss the controls associated with billing. The key points made in the podcast are divided into three parts, which are for manual systems, computerized systems, and general controls.

Manual Billing Controls

• Verify prices being billed against a standard price list

• Proofread larger invoices prior to mailing, to minimize errors

• Have the originating salesperson verify invoices, to spot errors

• Verify any unusual payment terms

• Verify the applicable sales taxes being charged

• Stamp each envelope with “address correction requested”

Computerized Billing Controls

• Print and review the invoice preview report to ensure that all items to be billed are accurate

• Reduce access to the billing software, to minimize the risk of fraudulent billings

Controls for All Types of Billing Systems

• Segregate the billing and collection duties, to keep anyone from falsely issuing a billing and then collecting the related funds

• Compare contract prices to what is being used for the prices on the most recent invoices

• Monitor customer complaints regarding invoices

• Issue month-end statements to customers, to see if they can spot any errors

• Compare the quantities shipped to the quantities invoiced

• Clean up the invoice format to make it easier for customers to read

• When entering an invoice into a customer’s online payment system, print the confirmation page to verify that it was entered

• Segregate credit memo creation from the cash receipts function

• Require approvals for the creation of larger credit memos

• Charge credit memos against salesperson commissions, so that they have an incentive to investigate the memos

• Audit a selection of credit memos

Related Courses

Accounting Controls Guidebook

Accounting Information Systems

Credit and Collections Guidebook

Controls for Shipping (#10)

In this episode, we discuss the controls associated with shipping. This process begins with a verification that customer credit has been approved, proceeds to picking from stock, and ends with packages being prepared for delivery to customers. Key points made in the podcast are noted below.

The primary goals of the shipping function are that you ship exactly what customers ordered – and nothing else, and that you absolutely, positively make sure that you bill them for whatever was delivered.  Our controls need to support these two goals.

Controls Over Deliveries

There’re several controls that can help us with the delivery goal that I just mentioned.  First, let’s make sure that nothing is shipped that should not be shipped.  An obvious control is to verify that the sales order has been stamped or flagged by the credit manager, which signifies that the credit department is OK with the order.  If the shipping department uses a common database with the credit department, then simply printing the daily shipping list should automatically exclude any orders for which credit has not been approved.  And, you could back this up with a standard policy which states that no orders are released without the prior approval of the credit manager.  If properly enforced, that policy is sometimes useful for putting the fear of God into the shipping manager.

There can also be an occasional audit to compare credit authorizations to what was actually shipped, just to make sure that this control works.

A second control is that, as soon as the picked items arrive in the shipping area, compare the sales order to the picked items to make sure that they match.  If some items were not in stock, then you complete a three-part backorder request form for the missing items. 

One copy goes to the order entry staff for follow-up with the customer, while another copy goes to either the purchasing department or production scheduling department to either order or create the missing items, and the shipping manager retains the final copy, along with the sales order.

A third control to support this goal is to investigate the reasons for product returns from customers, since these returns may include items that were incorrectly shipped.

Controls Over Billing of Shipped Goods

Now, we turn to the goal of making sure that all shipped items are billed.  This goal is near and dear to the heart of every accountant, since it’s highly embarrassing to not issue an invoice for a shipment.  The main control for this goal is the proper use of a bill of lading.  When an order is shipped, the shipping staff prepares a three-part bill of lading.  One copy goes with the shipment, one stays in the shipping department, and one copy – this is the important one—goes to the accounting staff.  The accounting staff uses this bill of lading as a trigger to create an invoice, which we’ll get to in the next podcast.

Another control is to complete a daily shipping log that contains a summary of every shipment sent out.  The accounting staff can compare this log to what they actually invoiced to see if any shipments were missed.  If the shipping department is fully computerized, then the shipping software should create this log automatically.

A special situation arises when a company is not actually shipping anything itself – instead, a supplier is sending the goods straight to the customer -- this is called drop shipping.  The company sends a copy of the sales order to the supplier, who sends a copy of its bill of lading to the company when it delivers a shipment to the customer.  In short, this is like having a long-range shipping dock.  The primary dangers are that the supplier never receives the customer’s order (and so never ships it), or that it ships the order but never sends a proof of shipment to the company’s accounting staff.  We guard against both the first and second risk by investigating old open customer orders for which we’ve never issued an invoice to the customer. 

These are an excellent indicator of problems somewhere in the drop shipping process, though of course they could just mean that the supplier has not gotten around to making a shipment yet.  Another control is to match the supplier’s billings to the company to the company’s invoices to the customer.  If the supplier’s invoices contain items not in the company’s invoices, then the company has missed an invoicing opportunity somewhere.

Another special situation is when a customer uses an evaluated receipts system.  This is when they pay their suppliers based on what they receive, not what they’re invoiced for.  In fact, they don’t want to receive an invoice at all.  Instead, these customers usually want to have a special label printed and attached to any deliveries sent to them.

These labels always include the customer’s authorizing purchase order number, and probably some additional information about the contents of the shipment.  If the label is not attached, then the company isn’t paid.  Consequently, a double check of the label before these shipments are sent out is a very useful control.  Also, if each label contains a unique identifying number, then the shipping manager can run a report from the computer system that shows which unique label was attached to each delivery.  If there’s no unique number listed on the report, then you know that a label was not printed.

Here’s my view of shipping controls: it’s best to use an integrated computer system to the greatest extent possible, since this area will otherwise be overloaded with paperwork, and that interferes with the efficiency of the department.  By using computers, the shipping staff can easily verify credit approvals, print labels and bills of lading, and electronically issue shipping notifications to the billing department.  Without computers, the process is much slower and more likely to suffer from errors.

Related Courses

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Controls for Production (#9)

In this episode, we discuss the controls associated with production. A major concern in this area is that the production staff is in the business of manufacturing goods, so any controls imposed on them will reduce their production efficiency. Consequently, controls generally need to be built into the production system, with little user interaction, or require the services of a separate group of people from those engaged in production. Key points made in the podcast are noted below.

The Need to Minimize Controls

Today’s topic is controls for production. Now, production employees are in the business of building products, so if you ask them to do anything else, like fill out forms or count things, they’ll be distracted.  The result is that the controls are performed poorly, and because the employees are distracted, this may also have a negative impact on their regular production work.  Therefore, it’s best to install production controls that don’t bother the production staff.  This can mean that control work is only done by non-production employees, or that controls are installed in processes around the production area, but not within it.

What to Control in Production

What are we controlling in production?  We want to make sure that the right orders are being produced, and that the materials and staff are available to manufacture those orders. To ensure that the right order is produced, the standard control is to issue work orders from a master production schedule, which is maintained by the production planning staff.  A production routing instruction sheet will be attached to the initial parts kit when it departs the warehouse, and the materials handler will shift it from work station to work station in accordance with the work sequence listed on the routing instruction.

The production planning staff monitors the flow of orders through the production process.  Though there are some automated methods available to conduct the monitoring, the most common approach is to have the production planners tour the plant and manually verify the status of each order.  Conversely, the automated approaches are to either have each workstation operator log in the arrival and departure of each production job on a computer monitor, or RFID tags can be attached to each order, and monitored based on the signals the tags emit.  The use of RFID tags is still exploratory, so I don’t recommend that approach until the technology has settled down a bit more.

Ideally, all the parts are used, production is completed, and the resulting finished goods are returned to the warehouse. 

Unfortunately, it’s not quite that simple.  We’re still going to have problems ensuring that the correct materials and staff are available to produce those goods.

One problem at the beginning of the production process is that the picking staff in the warehouse may not have properly picked all of the parts.  To detect this, a logical control is to have the materials handler compare the picked parts to the parts listed on the pick list, to make sure that they match.

Next, what if the warehouse staff picked exactly what was listed on the pick list, but it was not what the production staff really needed?  This problem is caused by an incorrect bill of materials.  There are several ways to control this issue.  First, lock down access to the bill of material file in the computer system, so that only authorized people can access it.  Second, audit the bills of material, and have all problems corrected.  The target bill of material accuracy level, by the way, should be at least 98%.  And third, investigate whenever the production staff has to request extra parts from the warehouse, or if they return unused parts to it – both are indicators of an incorrect bill of materials.

A different problem that can occur anywhere in the production process is that the routing document is incorrect, and doesn’t properly include all production work steps.  This is important, since the problem jobs must be jammed into the backlog of work stations that are not even expecting the work, which can cause some major backlogs.  To fix this problem, audit the labor routing records, and shoot for a target accuracy level of at least 95%. 

Also, as was the case for bills of material, always lock down access to the labor routing records in the computer, so that only an authorized person can access them.

Yet another problem is the occasional production of scrap.  An allowance for scrap is sometimes included in the bill of materials, but if the allowance is too small, then the job will run out of materials before the required number of units have been completed.  There are several ways to ensure that scrap levels are correctly recorded.

One is to have the production staff fill out a form that itemizes how much of which item was scrapped.  Then a data entry person collects the forms and enters the scrap information into the computer.

It also helps to prenumber the scrap forms and track down any missing forms.  However, as I mentioned earlier, you generally want to keep paperwork away from the production staff.  Also, they have a tendency not to report scrap, because they don’t want to be held responsible for making the scrap.  So, we need some alternative ways to collect scrap information.  One is to have the production staff dump all scrap into collection bins, and then a data entry person adds it all up at the end of the shift and records the amount of scrap.  A less organized approach is to periodically sweep through the production area and collect any scrap or finished goods that are left lying around, and then record this information.

There are other issues that need controls, such as labeling goods for rework, or pulling inventory out of production for a quality review, but you get the general idea that unusual transactions that remove materials from the production flow must be reported as fast as possible.

Material Requirements Planning as a Control

For those of you with some experience in manufacturing, the production flow that I’ve been talking about is based on a material requirements planning system, or MRP for short.  An MRP system is a push system, whereby a production schedule plans out how many units will be produced, and what materials will be required to produce it, and then controls the entire process of ordering materials and shepherding them through the manufacturing process.

Now, the problem with an MRP system is that it requires massive amounts of accurate information in order to correctly plan the production process.  To ensure that the MRP system works, there need to be lots of controls to verify that the data entering the system does not screw up the works.

Just-in-Time Systems and Production Controls

A way to reduce the number of controls is to use a just-in-time system.  This approach is based on the pull concept, which is that finished goods are only manufactured when there is actual demand for it.  A signaling device called a kanban is used to notify upstream workstations of the quantity needed, and those workstations produce until the order represented by the kanban has been filled.  Then they stop working.  Some other features of a just-in-time system include very small lot sizes, short lead times, frequent supplier deliveries, and a strong focus on reducing equipment setup times.

The just-in-time system is very attractive from a controls perspective. 

First of all, lot sizes tend to be quite small, so scrap is discovered by the downstream workstation almost at once, before the upstream workstation has had much time to create more of it.  This means that scrap levels will be minimal, and so there’s not much need for a control to count scrap.

Second, there’s little need to count incoming inventory, either from the warehouse or from an upstream workstation, because it’s usually slotted into bays in a standard-sized container that’s easy to count with just a glance.  So, this eliminates the need for a quantity verification control.

Third, work-in-process inventory doesn’t stay in the manufacturing area for very long, so there’s no need to track inventory as it moves from workstation to workstation within the production area.  Instead, just count the amount of finished goods as they come out of the production area.

The main area in which controls are needed for a just-in-time system involves suppliers.  They’ll be making lots of small-quantity deliveries, possibly several per day, and it’s not efficient for the receiving staff to inspect and log in each receipt.  Instead, the location of controls need to shift upstream to the supplier itself, where the company’s industrial engineering staff pre-certifies the ability of each supplier to deliver the right quantities, on time, with good quality, and directly to the production area.  This may also call for the use of a supplier performance scoring system.

In short, a just-in-time manufacturing system requires far less control than a traditional MRP system.

Parting Thoughts

Here’s my view of production controls:  The overriding concern in production is to stay out of the way of the production staff.  Their job is to manufacture goods.  This means that any attempt to have them fill out forms, conduct counts, or do anything even remotely associated with a control will almost certainly reduce their level of efficiency.  Unfortunately, an MRP system requires a lot of paperwork – it needs to be notified of any transactions that are even remotely out of the ordinary.  On the other hand, a just-in-time system is designed to be essentially self-controlling.  And that means that discrete control functions are minimized, and the production staff can get on with the business of production.  Obviously, I like the control environment for just-in-time manufacturing.

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Inventory Management

Controls for Inventory (#8)

In this episode, we discuss the controls associated with inventory. This is a massive area that encompasses many controls, so we split them up in the episode into controls for inventory storage, inventory costing, and inventory handling. The point is made that inventory is really a liability, since it puts the company at risk of inventory obsolescence, requires significant resources to track, and involves a large working capital investment.

Inventory Storage Controls

• Fence in the warehouse and lock the gate in order to minimize pilferage

• Restrict warehouse access to authorized personnel

• Tie the pay of the warehouse staff to inventory record accuracy

• Be orderly in regard to how inventory is bagged, boxed, and stored

• Implement cycle counting, including investigations of any errors found

• Conduct a weekly audit of inventory record accuracy, post the results in the warehouse, and pay bonuses based on it

Inventory Costing Controls

• Schedule a periodic obsolete inventory review

• Run the “where used” report to see if any on-hand inventory is not being used on products

• Conduct a quarterly lower of cost or market review, to spot valuation problems early

• Lock down access to the bill of materials and labor routing records, to keep them accurate

• Track the identifications of anyone who alters inventory records

• Monitor the period-end cutoff of inventory counts, using an on-site person

• Compare monthly overhead charges on a trend line to spot anomalies

• Conduct a periodic detailed analysis of the cost of goods sold to search for unusual entries

• Run a report that shows any inventory items with negative unit balances

• Run an extended inventory valuation report and look for unusually high or low values

• Compare per-unit costs on a trend line to spot anomalies

Inventory Handling Controls

• Enforce rapid data entry for inventory moves

• Update the bill of material records as soon as changes are made to product designs

• Always pick from inventory using a copy of the original customer order, to ensure that picks match what was actually ordered

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Controls for Receiving (#7)

In this episode, we discuss the controls associated with the receiving function. This is a key area, since received goods need to be logged into the system properly in order to notify everyone that they are available for use. In addition, proper receiving assists the payables department in processing payments to suppliers. Key points in the podcast are noted below.

The Segregation of Duties

The first order of business is to make sure that the purchasing and receiving functions are segregated.  Otherwise, someone in purchasing can order something, run down to the receiving dock to pick it up, and then take it home – which means that the company pays for it, and no one realizes that fraud has just been committed.  So, by having a different person receive goods, the company can be sure that the received items are properly stored or dispositioned within the company – and not taken home.

The Receiving Process Flow

Besides the splitting of duties, there’s also a strict process flow used by the receiving function to ensure that there is a proper level of control.  The first step in the process is when the purchasing department sends a copy of each issued purchase order to the receiving department.  The receiving staff files all unreceived purchase orders by supplier name, which makes them easier to locate later on.

When a delivery arrives at the receiving dock, the staff uses the purchase order number marked on the shipment to reference the purchase order document.  The staff then uses a standard receiving inspection checklist to review the delivery.  This checklist can include such items as inspecting the shipping container for damage, proper labeling, product quality, quantity, and the date and time of delivery.  They should initial each item on the checklist as they complete it, and make note of any problems.  If there are problems, they usually contact the buyer who issued the purchase order for further instructions, which may involve storing the goods to one side for further review.

If the shipment has not been authorized by a purchase order, then the receiving staff should be authorized to reject the delivery.  However, since this may cause all kinds of problems with rush deliveries that were authorized with a verbal purchase order, the receiving manager may spend some time trying to track down the recipient before rejecting the delivery.

In any case, the receiving department should always charge the buyer’s department a stiff inter-departmental charge for this service, since buying without a purchase order is a clear control breach, and is also a pain for the receiving staff to deal with.

If the shipment is acceptable, the receiving staff must identify and tag every item received with the correct part number, and then enter the part number and quantity received into the computer system.  From the perspective of the materials manager, who needs to know what materials are in stock for production, this is the single most important control in the receiving process.  It’s just not acceptable to put items on the shelf without first identifying and recording them.  Even if the receiving manager claims that there’s too much material clogging the receiving area and he or she has got to move it into warehouse storage, the answer is always the same – tagging and logging come before storage.  If necessary, the receiving staff can be supplemented with more employees to eliminate the work backlog.  Under no circumstances can unrecorded inventory be stored in the warehouse, since it’s extremely difficult to locate it again.  There.  I think I’ve beaten that control point to death.

To continue a bit further with this concept, a key control is to make sure that all data entry happens as soon as possible.  The best approach is to have suppliers attach bar coded identification tags to all deliveries, so the receiving staff simply scans the bar codes into the computer system and their data entry work is done.

If the receiving system is still paper based and there’s no computer in sight, then a different approach is needed.  Receiving employees are not always hired for their data entry skills, so it may make sense to have a data entry clerk whose primary task is logging in receipts.  This may call for manual entries to inventory card files, which – though primitive – are still in use.  If so, the clerk should also complete a receiving log, which is a daily summary of all receipts.  This log should include the date, the name of the supplier, third party delivery firm (if there is one), and the contents of each delivery at a summary level.  If the receiving department enters this information into a computer system, then there is no need to maintain a separate receiving log, since the computer can automatically generate the report.

Why bother with a receiving log? It provides a good summary of daily receipts, which can be used by the accounts payable staff at month-end when it is trying to determine if there are any receipts in inventory for which it has not yet received a supplier invoice.  If there are, then it uses the receiving log to assist in creating an expense accrual for the missing invoices.  Of course, a fully integrated enterprise resources planning system will automatically locate any receipts for which there are no supplier invoices, and take the additional step of figuring out the price of these items from the related purchase order – this gives the accounts payable staff all the information they need to create a month-end expense accrual without ever bothering to look at the receiving log.  Unfortunately, ERP systems cost a few million dollars, so most of us use other approaches to calculate the month-end payables accrual.

The final step in the receiving process is for the receiving staff to make a copy of the bill of lading, keep the copy for future reference, and forward the original to the accounts payable staff, who will match it to the supplier’s invoice and an authorizing purchase order before paying the invoice.

That’s it for the basic receiving process.  However, receiving is also subject to a number of variations that are common enough to address as well.

Customer-Owned Inventory

One special case arises when a shipment contains customer-owned inventory. This happens when customers want to have some of their parts included in a custom-designed product.  It can also happen when suppliers send consignment goods to the company that are to be sold by the company.  In either case, the company does not own the goods, and should not record them as company-owned inventory, since this would greatly inflate the value of its inventory, thereby also falsely increasing its reported profit.

The best fix for this issue is to have the purchasing staff assign a special purchase order number to each incoming item that the company is not actually purchasing – perhaps it begins with an unusual letter, such as “Q”, that tells the receiving staff not to assign a part number to the order that is also used by a company-owned part, thereby avoiding the accidental assignment of a cost to the item.  In addition, the unique purchase order code tells the receiving staff to put the inventory away in an area assigned to customer-owned or consignment goods, which is another way to ensure that this inventory is properly segregated and therefore not counted as company-owned inventory. 

Yet another control over this issue is to put a special identification tag on each item, perhaps color coded, so there is no way an inventory counter will later identify it as being company-owned.

Customer Returns

Here is another special case, and one that’s even more common.  What if customers return goods to the company?  How does the receiving department accept it, or should it accept these returns?

The answer is that it should not accept returns without a formal authorization from the customer service department.  I have had an interesting experience in this area where unrestricted returns almost bankrupted a software company that I worked for early in my career.  Our sales were to large retailers, who realized that we had no returns policy, and immediately commenced shipping back massive quantities of a few poor-selling products.  We hired a CFO who soon realized that this was a make-or-break problem.  He had the receiving department reject all product returns unless they included a return authorization number – each of which was issued by him – personally.  And I can assure you that he did not issue very many.  The sales agreement with the retailers did not allow them to return unsold products, so he solved the problem with this control.

Returning from the example, the receiving staff obviously needs to have an up-to-date list of all return authorization numbers that have been granted, including – and this is important – the exact quantity and types of items for which a return is being granted.  Otherwise, customers have a bad habit of returning more than was authorized, and may continue to do so for some time.

Cross-Docking

Let’s cover another common receiving situation, which is cross-docking.  This is when items are delivered into a warehouse receiving bay and immediately shifted to another outbound truck, where they are shipped out again.  Cross-docking almost certainly involves a high-volume environment where the materials handling staff has no time for transaction data entry.  If materials handlers are still required to do data entry, they will almost certainly make mistakes.  To avoid this issue, there are three possible controls for keeping data entry out of their hands.

One solution is to require complete bar coding of all incoming loads, so each pallet can be scanned as it leaves one trailer and enters another. 

This approach requires a great deal of coordination with suppliers, but is certainly a common approach.

A second option is to have suppliers send an advance shipping notice to the company, detailing the exact contents of each truckload.  As long as this information is accurate, the receiving staff simply logs in the identifying trailer number, the computer matches the trailer number to the advance shipping notice, and presto!  The entire truckload is automatically entered into the company’s warehouse management system.  This is very nice, but it does require accurate advance shipping notices from the supplier.

A third option is more old-fashioned, which is to have the materials handlers do nothing but handle materials, and assign full-time warehouse clerks to the entry of all incoming and outgoing transactions.  This approach tends to result in the most errors, but also requires minimal automation.

Deliveries to the Production Line

And finally, here is one more special case – what if the company has no receiving function at all, and instead allows suppliers to deliver goods directly to the production line?  This scenario almost never arises unless a company is using a just-in-time manufacturing process where inventory levels are kept so low that all arriving deliveries are used immediately in the production process.  The key control is for the company’s engineering staff to visit each supplier location and certify the accuracy of their deliveries.  If they pass, then they are allowed to make deliveries without going through the receiving process.  A secondary control that is built into the system is that the company’s production process will shut down if parts are NOT delivered, while excess deliveries will be immediately obvious, because they will be piled up on the shop floor.  A third control is to have an ongoing supplier report card system set up that tracks on-time delivery, as well as the quality and quantity of deliveries.  If a supplier’s score drops too low, then they receive a re-certification visit from the engineering staff.

Parting Thoughts

Here is my interpretation of receiving:  Inspections tend to be haphazard when a large number of deliveries are received at once, since the receiving manager is more concerned with getting deliveries properly identified and stored as soon as possible.  Consequently, it’s better to rely upon other means of determining delivery problems, such as supplier pre-certification, than to rely upon the receiving staff to do inspections.  Also, there can be a real problem with the transfer of receiving information to the accounts payable staff, with some paperwork never reaching the payables department at all, or very late.  When I eventually reach the payables control lecture, I’ll talk about methods for automating and even eliminating this transfer of information.

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Accounting Information Systems

Controls for Expense Reports (#6)

In this episode, we discuss the controls associated with expense reports. These reports have historically been reviewed by the accounting staff in detail, even though few errors are ever found. There are more streamlined ways to deal with expense reports, as discussed in this episode. Key points in the podcast are noted below.

How Expense Reports Have Been Handled

Expense reports are the summarization of a variety of expenses paid for by employees, and for which they want reimbursement.  The trouble is that none of the items paid for by the employees were initially approved by an authorized person, so the company is faced with the problem of sorting through the mess to figure out which expenses are valid, and which will be rejected.

The old fashioned control approach to expense reports is to review 100% of the receipts submitted, in excruciating detail, then go back and forth with employees and supervisors about what expenses will be allowed or rejected, and eventually reimburse an amount that is suspiciously close to the total amount shown on the original expense reports.  In other words, after all that review work, most companies pay the full amount of every expense report submitted.

There has to be a better way to control expense reports.  There is.  Actually, there are several approaches.

The Partial Expense Report Review

First -- a much less expensive alternative to the full report review is the partial review.  This means that only a few expense reports are fully reviewed, but if errors or possible cases of fraud are found, then the person submitting the expense report will be subjected to a full review from that point forward.  Even better, it makes sense to review their expense reports for the past few years to see if there’s been an ongoing problem.  In addition, it’s very useful to inform all employees that expense reports are being spot checked, which should prove to be a sufficient deterrent for most people to submit accurate expense reports.

Have the Company Directly Pay for More Expenses

Another approach is to keep as many expenses as possible from appearing on employee expense reports; since the largest expense item is almost always reimbursement for travel expenses, it makes a great deal of sense to route all travel through a booking person within the company, who can coordinate the approval of employee travel before any bookings are made.

Of course, the company pays for all travel directly, rather than through employee expense reports.  The result is that inappropriate travel can be stopped before it occurs, while the total dollar amount of expense reports submitted declines drastically.  The problem here is that many people like to make their own travel arrangements, and will resent having the company do it for them.

Use an Automated Expense Reporting System

Yet another approach is to create or purchase an automated expense reporting system, into which employees enter their expense information.  This approach avoids the use of manual or spreadsheet-based reports, which tend to be full of errors, while also allowing for the imposition of travel policies at the point of data entry.  These rules keep employees from entering expenses that’re not allowed under company travel rules. Examples of such software packages are those produced by Concur and Extensity.

Create a Travel Policy

Another approach to expense report controls is the travel policy – this policy defines exactly what expenses are allowable and (more importantly) not allowable, as well as the penalties to be imposed for breaking the rules.

Parting Thoughts

Here is my interpretation of employee expense reports:  Conducting a 100% review of all expense reports is wildly inefficient, and rarely even begins to pay back the cost to review them.  Consequently, an occasional audit will be sufficient.  Furthermore, it’ll quickly become apparent which employees are causing reporting problems, and which ones submit such squeaky clean expense reports that they can safely be ignored.  Also, requiring centralized bookings will not only improve controls, but also presents the opportunity for lowering travel costs by centralizing with a small number of travel suppliers.  Keeping tight control over whether travel occurs at all is the best way to control expense reports, since this can save thousands of dollars by preventing a trip entirely.  Conversely, most other expense report controls are more focused on saving just a few dollars here and there.

Also, smaller companies can get by just fine with expense reports that are submitted on spreadsheets, despite the occasional errors that will creep into these reports.  On the other hand, companies dealing with hundreds or thousands of expense reports will find that more automated expense reporting systems will be cost effective.

Finally, travel policies should certainly be issued on a regular basis, but in reality few people look at them, so they’re most useful as a partial deterrent.

Related Courses

Accounting Information Systems

Expense Report Best Practices

Payables Management

Controls for Purchase Orders (#5)

In this episode, we discuss the controls associated with purchase orders. Purchase orders are an excellent control over purchases, though they are time-consuming to produce, and so are usually confined to more-expensive purchases. Key points in the podcast are noted below.

Why We Use Purchase Orders

I’ll start with a question: Why do we need purchase orders?  Because it is useful to have someone with a considerable knowledge of product prices and ordering systems who can channel a company’s flow of purchases, rather than having every employee buying anything they want.  The result should be lower prices and purchases from a relatively small group of qualified suppliers.

Primary Purchase Order Controls

There are four primary controls involving purchase orders. First is the mandatory purchase order authorization.  This means that the purchasing staff must issue a purchase order for every purchase made by a company.  By doing so, someone trained in buying is reviewing every purchase made.  However, since purchase orders are very labor intensive to create, we need to devise several ways to reduce the burden on the purchasing staff.  One is to allow small purchases, which inherently don’t require much oversight, by using procurement cards instead of purchase orders – I covered the controls for them in Episode 4.  Another approach is to issue a blanket purchase order that covers all purchases for a specific item or commodity group for a relatively long period of time.  Yet another alternative is to pre-approve certain suppliers for purchases, and allow employees to requisition items directly from those suppliers by using electronic catalogs.

This brings us to the second primary control.  The purchasing staff should not be put in the position of authorizing a purchase, since they are not responsible for the expenses of each department whose employees want them to create a purchase order.  Instead, we require employees to complete a purchase requisition form, which must be approved by their department manager.  By doing so, the department manager is taking responsibility for each purchase, and understands that the cost of this purchase will be charged against his or her department’s budget.

The next primary control is to reject deliveries if there is no purchase order.  After all, employees will purchase by the easiest and quickest means possible, and purchase orders are neither quick nor easy.

To ensure that they follow the purchasing rules, the receiving staff must reject deliveries if there is no authorizing purchase order number.  This causes all kinds of grief if an item is rejected that is also desperately needed somewhere in the company, so a common alternative is to set such receipts aside for a short time while authorization can be affirmed.  More on this issue in a moment.

The final primary control is to match supplier invoices to authorizing purchase orders.  This will be dealt with in greater detail when I get to controls for the accounts payable function, but, in short, the accounts payable staff should match all supplier invoices to the quantities and prices listed on the authorizing purchase orders, and follow up on anything that does not match.

Secondary Purchase Order Controls

There are also a number of secondary controls for the purchasing function.

As I just noted, it may not be prudent to reject an unauthorized delivery, but having the receiving staff spend time tracking down who ordered the item outside of the normal purchasing rules is essentially enabling the person who broke the rules.  There needs to be a penalty for this type of behavior.  A good one is to charge that person’s department a stiff inter-company fee, such as $1,000 per incident, which should get the department manager’s attention, and keep this situation from arising again.

Here is another secondary control.  If the purchasing system is a manual one that uses paper purchase orders, those purchase orders are the equivalent of gold – steal a few and you can authorize all kinds of purchases.  To prevent this, prenumber the purchase orders, lock them up, and track the numbers to ensure that none are missing.

If the purchasing system uses a computer, then access to the purchasing database can also result in the unauthorized issuance of purchase orders.  In this case, be sure to use password control to restrict unauthorized access to the database.  This should also include the immediate cancellation of database access privileges for all employees who are leaving the company.

Whether purchase orders are created manually or through a computer, a useful control is to periodically examine all old open purchase orders.  They may contain authorizations to purchase a few residual items that were never received, or may relate to entire orders that were never received.  In either case, some investigation may reveal that these orders are no longer needed, so they can be cancelled.

And finally, the internal audit staff can also provide control over the purchasing process.  For example, they can review purchases made by the purchasing staff to see if prices are unusually high; this may be a sign that a purchasing person is being paid a kickback by a supplier in exchange for ordering items at an excessively high price.

A separate controls issue is the use of a computerized materials management system.  These systems can automatically issue purchase orders based on projected production requirements.  Such systems remove a considerable burden from the purchasing staff, but there is a risk that the system will issue incorrect purchase orders, usually caused by incorrect information somewhere in the production database.  As a control over this problem, it is customary for the purchasing staff to either review all automatically-generated purchase orders before flagging them for release, or at least review any orders involving unusual items or quantities.

Parting Thoughts

Here is my interpretation of purchase orders and related controls:  They’re a strong control over purchases, but they are not necessary in several situations, where are as follows:

The expenses of a service-intensive company mostly relate to payroll, so the minor amount of other expenditures may not call for the use of purchase orders.

Purchase orders are a pain to create, so it is best to avoid them for small dollar purchases by using procurement cards instead.  Similarly, any cost of goods sold purchases should be requisitioned by a materials management system.  Therefore, only purchases falling out of these two areas should involve manually-created purchase orders.

Conversely, if a signature plate is used instead of a check signer, then the only real control over purchases is the purchasing department, which should insist on the use of purchase orders, subject to the restrictions I’ve just noted.

Related Courses

Accounting Controls Guidebook

Accounting Information Systems

Purchasing Guidebook

Controls for Procurement Cards (#4)

In this episode, we discuss the controls associated with procurement cards (also known as credit cards). These cards are a great way to minimize the use of purchase orders, so it is useful to not impose too many controls on them; a reduced volume of controls will tend to encourage their use. Nonetheless, some controls are required, as noted in the following discussion.

Purchasing is really accomplished using two alternative methods.  You can go out and buy materials on a credit card, or in this case we’re calling it a procurement card, or you can order it through purchase orders.  So in this episode, I’m talking about procurement cards, and in the next episode, I’ll be talking about purchase order controls.

How Procurement Cards are Used

Now the procurement card is a credit card that’s used to buy small-dollar items without prior authorization.  They’re a very good technique for reducing the amount of paperwork in the purchasing department, and in terms of volume, it can be used in up to about a quarter of all purchasing transactions.  The dividing line for where you use procurement cards versus purchase orders is rather vague.  It can be just a few hundred dollars, or it can be tens of thousands of dollars, and the decision really lies with the purchasing manager, who needs to decide which dollar limit is the most cost-effective.

The intent behind procurement cards is to avoid as much paperwork as possible.  So similarly, you really want to reduce the amount of control over procurement cards to the extent practicable, which is going to depend upon the extent of use of those cards.  Because if you put too many controls on it, people will begin to say that it’s actually easier to use purchase orders.  Though frankly, given the amount of bureaucracy surrounding purchase orders, that might take a bit of doing.

Primary Procurement Card Controls

Nonetheless, as I go through these control points, please keep in mind that you don’t have to install all of them. 

These controls fall into two categories.  The primary controls for buying with a procurement card are as follows:

First of all, make anyone using a procurement card enter each receipt they make into a purchasing card transaction log, because they could lose the receipts.

Then, when the monthly card statement comes in, make them reconcile that transaction log to the card statement, to ensure that all items purchased and listed on that card statement are correct. 

If they have a missing receipt, have them fill out a missing receipt form.  This in particular should be reviewed by a supervisor, because this is a fundamental area in which someone could commit fraud by “accidentally” losing a receipt – and then buying something for personal use.

This missing receipt form should identify the item on the monthly statement, and identify what it is.  The supervisor should sign off to certify that this is a legitimate business expense on behalf of the company.

Now if someone using a procurement card also elects to contest an item, then they should fill out a line item rejection form – which can also be monitored by the procurement card manager.  This form identifies which line item is being disputed, and why.  Such as, it wasn’t an authorized purchase, it was already billed by the supplier, they didn’t receive it, and so on.

And then assemble everything – the receipts, the transaction log, the missing receipt form, item rejection form, the monthly statement, and give it to a supervisor for approval.

After being approved, this then goes to the accounts payable staff for payment.

Given the number of items in this primary control group, involving reconciliations and assembling forms, and cross-verifying information, it doesn’t hurt to make people use a standard reconciliation checklist, and sign off on the checklist when they’re done – just to make sure that everything has been completed. 

All of this may seem like a lot of work.  And if you only have one or two procurement cards, it may not be necessary.  However, if you’re dealing with dozens, or conceivably hundreds of procurement cards, then these are really very fundamental controls that are needed to maintain an adequate level of control over the process.

Secondary Procurement Card Controls

In addition to those basic controls, there are a number of secondary controls for using procurement cards.  And as I mentioned earlier, you don’t need to install all of them, because keep in mind that you want an efficient procurement card program, as well as a sufficient level of control, so this is really a balance.

The first one is to have a procurement card orientation meeting, after which you hand out cards to those who are designated as recipients.  By having this meeting, you can run them through all of the policies involving those cards to make sure that everyone clearly understands what is expected of them.

Another control – and an obvious one, and which many people use, is to restrict purchasing by dollar amounts per day, grand total amounts per month, types of purchases, various limitations along those lines, and that will vary by the types of restrictions available through the bank that’s offering the card.

Another control is, the program manager – this is the person who’s in charge of the entire procurement card program – is the only one allowed to approve changes in spending limits.  You can’t simply have a local manager call the bank and demand a higher spending limit.

And if there are really high spending limits, then the change approval authority should be bumped up to an even higher level – possibly vice president level.

Another control is to prohibit any cash advances on procurement cards, thereby locking down anyone’s ability to take cash directly out of the till.

Another control is to have users sign an agreement, which itemizes any sanctions to be imposed on them if they misuse the cards.  Now there may not even be a good legal basis for going after people if they misuse cards, but by signing this agreement, it does set an expectation with the card users.

Another control is to track card expenditures on a trend line.  By person.  What this does, is you can see if there’s any unusual blip in a person’s expenditure pattern, which may indicate some kind of fraudulent use.

Another control is to investigate any purchases made for cost of goods sold items.  The reason this one is important – actually very important to the engineering department in particular – is that if a company already has an automatic purchasing system, such as a material requirements planning system, or MRP system, the MRP system itself should be issuing all purchase orders as needed.  So if there’s a sudden need to buy something on a rush basis with a procurement card instead, this probably means that there’s an error somewhere in the supporting bill of materials database for the MRP system, which someone should investigate and correct, so that it doesn’t happen again in the future.

The Procurement Card Program Manager

Now let’s talk a bit more about this program manager.  This is someone who has a number of responsibilities related to the procurement card program, which could involve a great deal of purchasing dollars.  One item they do is to investigate anyone requesting a card.  This could involve background checks, and potentially even bonding, though it’s rarely used in this instance.  Another job function for the program manager is to monitor disputed charges.  If there are many procurement card users, it’s very likely that those disputing a few charges here and there will forget about them or not have to follow up on them, whereas a single person in charge of monitoring all of these charges can do so fairly efficiently.

This person can also monitor card usage for unusual expenses, and they can also monitor orders for replacement cards that were lost or stolen to make sure that the replacements come in in a timely manner.

Also, they’re responsible for retrieving cards from departing employees and canceling those cards.

And another control to think about is that the program manager is probably the one ordering procurement cards from the bank, but perhaps someone else should be assigned the role of receiving those cards.  This ensures that extra cards are not acquired and then used for incorrect purposes.

Procurement Card Policies

And finally, there are a number of policies related to procurement cards, and it makes sense to go over these at the procurement card orientation meeting.  Some of them may seem painfully obvious, but nonetheless it does make sense to go over them, and also issue to all card users a document that itemizes the policies.

Certainly one policy is that cards are never for personal use.  Another policy can state the limits on card spending, while another policy is to not split a large purchase into smaller dollar amounts in order to stay under a purchasing limit – and that one happens all the time.

Also, the procurement card is not to be used for capital purchases.  Capital purchases generally involve a whole different acquisition program that follows a very different set of approvals, and so should not be acquired with these cards.

Also, the procurement card is not to be shared with anyone.  After all, only one person was authorized to use it, and only one person was investigated to ensure that that person was appropriate for the use of the card.  You share it with someone else, and suddenly all of those controls have been circumvented.

Also, be timely in completing monthly reconciliations.  The accounts payable staff will love you if you do this.  One of the biggest problems with procurement card programs is getting the card users to submit their monthly reconciliations in a timely manner.

Another policy is to be timely in reporting lost cards, so the old cards can be cancelled as soon as possible, which reduces the company’s risk of having things purchased without authorization.

One more item.  Do not receive cash back for credits.  All credits must be run back through the card.  You don’t want employees accessing cash through their cards for any reason whatsoever.

Related Courses

Accounting Controls Guidebook

Accounting Information Systems

Purchasing Guidebook

Controls for the Credit Department (#3)

In this episode, we discuss the controls associated with both a manual and computerized credit department. The main control points and related topics noted in the episode are noted below.

These controls can be dealt with in terms of increasing levels of sophistication.  At the lowest level of control usage, you don’t really need the credit department at all, because the whole thing is a gigantic control.  Very small companies usually exclude it from the order process flow, so they automatically accept orders from all customers, and don’t worry much about bad debts.

Credit Applications

However, after a while a business starts to see a few bad debts.  And when that happens, the typical reaction is to issue a credit application if orders are fairly large, and to not bother with a credit application if orders are relatively small.  When this happens, employees will just go to the local office supply store to buy a block of standard credit application forms and that’s what they give to customers.

Approval Stamps

Now that’s not a sufficient control, because what you also need is a credit approval stamp.  Someone needs to review completed credit applications, decide whether or not to grant credit, and if so, then stamp a copy of the sales order –you may recall the sales order from an earlier episode.  The credit department keeps one copy of the stamped sales order, and sends another copy to the shipping department.  The shipping manager is not allowed to ship anything unless that credit approval stamp appears on the sales order.

If anyone tries to add a fake approval stamp to the sales order, well, the credit department has kept another copy of the sales order.  And, if a question arises about a sales order, then they can pull it out and compare it to the sales order copy being held by the shipping manager. To make sure that this control works, the sales orders held by both the credit department and shipping department should be locked up, which makes it very difficult for someone to illicitly stamp both copies.

And finally, at this very elementary stage of control, you need one policy, which is – don’t ship anything unless there’s a credit approval stamp on the sales order.  This policy needs to be drilled into the shipping manager.

Credit Policy

Now, moving up to a bit larger order volume, you need to develop more standardized rules for which credit applications are accepted, and which ones are rejected.  This requires a very formalized credit policy, which needs to contain several key items.  First, it should outline a collection goal.  For example, it could say that bad debts can be no more than 2% of sales.  Or, perhaps from an efficiency perspective, it specifies how many collections employees are allowed per thousand customers, or perhaps it lays out a collection target, such as the number of days sales outstanding.  Whatever this goal might be, it needs to specify the performance expected of the credit department, and itemize precisely how credit is to be granted, so there’ll no longer be any variation involved in determining who gets credit, or not, and how much credit is granted.

In addition, they need to have a supporting policy, which mandates a review of the main credit policy at least once a year.  This supporting policy is intended to compare the existing credit policy to the company’s current financial and operating position – such as its product margins, strategic direction, general economic conditions, the actions of competitors, and so on.

The reason you need this review is that, for example -- a company may have an innovative product with a high profit margin, and since the profit is so large, they can afford to grant easy credit, and if there are bad debts, they can be easily absorbed.  But over time, pricing pressure from competitors may shrink those margins, and that means a much tighter credit policy is necessary to meet the changing conditions.

Procedure Training

Another control you need with this increased order volume is regular staff training in credit procedures, with the intent being to standardize credit granting as much as possible, so there’s no variation by person.

Credit Application Analysis

And a final, fairly minor procedural item, though one that’s quite necessary, is to investigate unanswered questions on the credit application.  Early on, when credit applications are being used mostly as an afterthought, this tended to be ignored.  But now, with higher transaction volume, you want to lock down the process, and so – in addition to the policies and procedures and training, you have to make sure that the credit applications are totally completed, every single time.

Credit Limits

Now, let’s add a level of complexity to the credit function, and add computers to the mix.  This happens when transaction volume increases to the point where credit can no longer be handled manually.  The first control should be built into the accounting software, which is a field for a credit limit.  If you fill this in for every customer, then the computer system will tell you whenever a customer is exceeding its credit limit.

Also, there’s no longer a need for a credit stamp on the sales order – this is partially because there’s no longer a sales order, because it’s been automated.  It’s also because there should now be a credit approval flag in the system.  To set a credit approval flag, any person with the proper password can enter the accounting software and flag a specific order as being approved for payment.  And if it is flagged, then that order should now appear on the daily shipping report, since that report should only list orders ready for shipment if their credit flags have been set.

If the credit flag has not yet been set for an order, then that order won’t even appear on the shipping report, so the shipping manager won’t ship it.

Additional Credit Controls

Besides these basic credit controls, there are a few others to consider.  You shouldn’t necessarily install them all, since that could become burdensome, but they are things to think about if you want to create tighter controls for a computerized credit system.

First, you can create a report that itemizes all customers that comprise the top 20% of your sales.  And since that’s where most of your credit risk is concentrated, that’s where you might want to conduct a new credit review for every customer, every single year.

Another control is to review credit levels if a customer skips payments.  This is a very difficult thing to spot with a manual system, but it’s very easy to notice with a computer system.

Another possibility is to review credit levels for all customers issuing NSF checks, which is not sufficient funds checks, and in this case – again – very easy to spot with a computer report.

Another option is to review credit levels if a customer stops taking early payment discounts.

So there are a few extra controls to consider.

Now, an additional level of sophistication with a computer system is to use it to access credit information over the Internet.  I personally use Dun & Bradstreet’s Business Information Reports.  And you can also have a credit rating agency notify you by e-mail when a customer’s credit rating drops, or when some other credit-related issue arises.

If you want to use a bit more technology, consider either posting your credit application on your web site, or e-mailing it to customers.  Better yet, set up an electronic form on your website, so they can enter credit information directly into your computer system.

If you really want to get fancy, and spend a great deal of money on programming, you can set up automated rules-based decision tables to evaluate incoming customer orders.  These tables can be very sophisticated, but on a basic level, what you’re looking for is something that will scan incoming order and if it’s from an existing customer, then it’ll continue with additional processing.  If not, it’ll shunt the information off to a real person for manual review.  However, if it is from an existing customer, and if there’s been an order within the past few months, the system will continue with its automated review.  If not, and the customer has not placed an order in quite some time, then it can be shunted off again to a real person.

And then, finally, for that limited subset of customers falling within the first two criteria, it can automatically flag them as being approved if it fits within a specific credit limit – perhaps anything under a few thousand dollars.

That’s a really simple rules-based decision system.  These systems can become very complicated, and should they be – if you have a lot of customers, and you can’t possibly review them all manually.  You’ve simply got to find a way to let the computer system help you out, and a decision table is a good way to do that.

Related Courses

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Controls for Order Entry, Part 2 (#2)

In this episode, we cover the full range of controls associated with a computerized order entry function, mostly dealing with controls for electronic customer orders. The main control areas noted in the episode are noted below.

Initial Order Approval

To begin, you can get a verbal or written purchase order from a customer, and you manually enter it into your accounting computer system.  In this case, you still need to verify if an approved buyer has given you the order.  This control is usually skipped for old customers, but if the customer is a new one, this might be a useful control step.

Data Entry Review

The next control is one to ensure that the information on the customer order is the same information that was input into the computer system – in this case, you’re guarding against data entry errors.  This may sound like an archaic control, but it’s necessary if you have new or poorly trained order entry staff, or if customer orders are extremely complicated.

Once the order is in the computer, the computer can automatically match the order quantity to your inventory records, so you can tell the customer if you have enough inventory on hand to fulfill the order.  The problem for many companies is that the inventory records may be inaccurate, which leads to incorrect delivery promises to customers.  Fixing that problem calls for some inventory controls, which we’ll get to in a later episode.

Match Order to Prices

Another control is to link the computerized order to your on-line price books, so that the computer tells you if the price being entered is incorrect.  Unfortunately, there may be special pricing deals that cannot be monitored automatically with a price book.  In that case, you still need a manual control to review these prices with the sales manager.

Issue Confirmation

With a computerized order entry system, there’s no longer a need to generate a five-part sales order, as was the case with a manual order entry system.  Instead, order information is distributed throughout the company through the computer system.  However, you still need to send a confirmation back to the customer, which could be a printout or an e-mail notification.  In either case, the order entry system should be able to provide this notification for you.

Additional Scenarios

Now, what if there’s an up-front credit card payment that occurs at the same time as the order placement?  This usually happens when a customer places an order through your web site store.  For this type of order, you can skip several controls.  First, there’s no need to verify that the customer exists, because the buyer just paid you up front, which eliminates your credit risk.  Second, there’s no need to conduct any price matching, because they’re paying based on the prices you posted on your web site, so there’s no way the prices could be inaccurate.

Another type of order is when electronic orders are coming in, such as an electronic data interchange transaction.  These orders usually drop directly into your accounting system, so there is no data entry, and therefore no need for a data entry control point.  Also, there’s usually no need to verify the buyer, because electronic orders normally come from very long-term business partners, and the arrangement between the two companies is so tight that you know who’s authorizing these orders.  In many cases, the order placement by the customer is coming straight from the purchasing module of their computer system, so there’s no buyer involved at all.

You may want to insert a control point here if the order is unusually large, because it’s possible that the computer system at the other end incorrectly created a really large order.  This control is usually just a flag or report that appears when a maximum order quantity level is exceeded.

A control you do want here is a confirming electronic message going back to the customer.  This is a standard feature for electronic data interchange transactions, and this tells the customer that their order information has arrived at your computer.

Also, price verification is probably unnecessary, because electronic orders are usually based on very large, long-term, master purchase order arrangements where both parties know exactly what the prices are.  If you want to be careful – sure – you can always match it up against your pricing file on a spot check basis.  But, it probably is not necessary.

Evaluated Receipts Controls

Finally, what about order entry if you’re in an evaluated receipts situation?  Evaluated receipts is relatively uncommon, unless you’re in a fairly large company, or if you’re dealing with a large company that has such a system.  Evaluated receipts is when the customer issues you a purchase order, you put the purchase order number on the delivery going to that customer, and then when it arrives at the customer, they enter that purchase order number into their computer system, and the purchase order number is automatically matched up against the original order in their system – and they pay you based on that information.  They don’t need an invoice at all.  So in this case, an additional control is to set a flag in the order entry system when the customer order is received, which is to not print the invoice and also to trigger the creation of a special shipping tag which itemizes in a bar coded format the purchase order number, and any additional information required by the customer.

This may also call for a periodic audit review to verify that evaluated receipts customers have that flag set up in their customer master file records.

Comparison to Controls for Manual Systems

Now, if you compare the controls I’ve itemized for computerized order entry systems to the ones I described in the last podcast for a manual system, you’ll find that some controls are no longer needed.  One is that you don’t need any pre-numbered sales orders, since there are no longer any sales orders.  Also, there’s no need to lock up any unused sales orders, for the same reason.

On the other hand, computerized systems also require some new controls that you never see in a manual system.  One is password access.  It’s useful to have order entry people log into the system with a unique code, so that you can track which ones are committing the largest number of data entry errors.  Another control is to add data entry validation routines to the computer system, so that the computer will reject incorrect entries being made by your data entry staff.  Validation is good for spotting incorrect prices, addresses, or unit quantities.

A fancier control is to use workflow management software to route any unusual billing terms to a manager who has to approve them before the order can be processed.  However, that requires additional software that is not normally found in an order entry system.

Order Entry Policies

Some policies are also needed.  One is to verify customer existence if an order is placed that exceeds a specific dollar amount.  Another policy is that special price discounts must be approved by management if the discount exceeds a certain level.

Related Courses

Accounting Controls Guidebook

Accounting Information Systems

Controls for Order Entry, Part 1 (#1)

In this episode, we cover the full range of controls associated with a manually-operated order entry function, dealing with controls for both verbal and written customer orders. The main control areas noted in the episode are noted below.

Verbal Order Controls

First off, a customer order can come in either verbally, perhaps over the telephone, or as a purchase order.  Now, if you get a verbal order, you immediately have a problem, which is – is this an order that’s for real, or is someone perhaps calling in with an order that is incorrect or unauthorized?  And what if you then ship it, and then you’re stuck with not being paid, because you didn’t verify up front that it’s a real order.  So you need an up front control, which is verifying that the order is correct.  This control usually means that you have to call them back, or request something on paper that’s signed by an authorized manager.

Purchase Order Controls

The second type of order that can come in is the purchase order, which is usually signed by someone whom you presume to be an authorized person.  In this case, you have the same problem. Yes, it’s now on paper, so the information on it is more likely to be accurate.  But on the other hand, how do you know that it’s really coming from the company that it says it’s coming from?  So this one again can involve a control, which is verifying that the person who signed off on it is in fact an approved buyer.  This is easy enough if the customer is a long-term one, and you know the person who placed the order.  But if the order is a large one, and especially if it’s from a new customer, you’ll have to make additional inquiries.

Price Controls

Now, once you’ve figured out that the order is a real one, you still have some additional problems, each of which needs a control.  One issue is the price, either what was quoted to them or which they specified in a purchase order.—is that the correct price?  It may very well not be the correct price.  There are a number of issues here, such as, did they place such a large order that they’re entitled to special price breaks, and if so, is the person who took that order using the most up-to-date information about special pricing deals.  If not, this needs another control to verify that the pricing is correct.

To take the concept one step further, this may also require verification of freight charges, taxes, and possibly shipping insurance.

Credit Limit Controls

So there you are already with a bunch of controls, and you haven’t even written down the order or sent it elsewhere within the company.  So… let’s keep going.  What if a customer has exceeded its credit limit?  Well, the person taking the order has to review the open accounts receivable report to see if the limit has been exceeded.  Though, keep in mind that it’s not so easy to keep track of open receivables in a paper-based environment, because it’s so difficult and time-consuming to summarize all of the open invoices and cash receipts in one place.

If the credit limit has been exceeded, then the order entry person has to get back to the customer and tell them they can only order up to that limit, or they have to pay down their existing receivable balance with the company before they can order anything else.  So there you have another control.

Stock Checking Controls

In some cases, the customer expects to have something shipped to them right away, and that may not happen because you don’t have the inventory on hand.  So, another control needed to make sure that the order is processed properly is to go to the warehouse and make sure that you have it in stock.  Or, alternatively, that it’s within a day or two of either being received from a supplier or being manufactured in-house.

And if any of these issues I’ve already described cause problems, this requires a feedback loop back to the customer to ensure that they agree with any revisions in the contents or terms or timing of the order.

The main point of the controls so far are to make sure that the terms of the order are accurate, though it’s also possible that you may spot a shell company that’s trying to get goods delivered to it that it has no intention of paying for.  Yes, this would be a case of fraud.  Nonetheless, the main issue with these controls is to ensure that incoming orders are as clean as possible.

The Sales Order

At this point, we can move on to another transaction step, which is creating a sales order.  Now, a sales order usually comes in five parts in a paper-based environment.  One of them the order entry staff will keep on file, just in case something goes wrong later in the process, and they want to refer back to the original document.

So, one copy is stripped off and put away in a filing cabinet.  Another copy usually goes to the customer, and that’s because the customer wants to know that what it orders is what it eventually receives.

Two copies go to the credit department.  Now, one of those copies will be stamped by the credit staff – if they approve of the order – and then will be sent to the shipping department, which uses that as authorization to ship to the customer.  The credit department will retain the other copy, so they can verify, if necessary, that what was later shipped was what they authorized for shipment.

The fifth copy goes to the billing staff.  This is not always used, because some companies feel that the billing staff should just wait for a copy to be forwarded to them from the shipping department after a product ships.  However, it might make sense to exercise a bit more control by having the billing department track what’s supposedly going to be shipped.  This can be a good way to make sure that every shipment is eventually billed.  Otherwise, it’s more likely that some items will be shipped, but the paperwork never arrives in the billing department, and an invoice is never created.

So the billing staff is essentially being proactive in using this documentation to ensure that they do eventually bill what was ordered.

So there you have five copies of the sales order floating around the company, each one of which has to be tracked to some degree.  The customer will use its copy to ensure that what shows up at the door is what was ordered.  The credit department wants to make sure that what the company ships is what it authorized. – so they may run a cross-check later on to ensure that that happens.  The order entry department may, at some point in the future, want to verify that what was shipped is what was ordered, especially if they’re looking at any remainder items that need to be back ordered.  And the fifth copy of the sales order is used by the billing department to anticipate and monitor shipping documentation coming to them from the shipping department to ensure that none of it is lost.

That covers the initial orders required for a paper-based order entry system – but, there are a few more that could be added onto this.

One of them is to lock up your blank sales orders.  Why do that?  If someone from outside the company, or someone on the inside with access to the forms storage area, were to steal a sales order, they could circumvent some of the order entry systems, such as filling out the sales order, and stamping it with a fake credit approval stamp, and send it to the shipping department.  The product then ships, the company sends an invoice to a fake customer, and it never gets paid.  So this is one of the more convoluted ways to steal goods from a company.

Another control is to track sales order numbers.  Sales orders are frequently pre-numbered.  By doing so, it is much easier to locate documents, or alternatively, to figure out if documents are missing.

Product Return Controls

Another order entry control is to investigate product returns.  If something comes back from a customer that was technically never shipped or never listed anywhere on a sales order, then one should be suspicious – probably very suspicious – and start doing a Sherlock Holmes routine to figure out what happened.

Unshipped Remainder Controls

Another control is to track unshipped remainders.  What this means is that you compare the amount invoiced to customers against the amount they initially ordered.  Occasionally, you’ll find some small quantities that were never shipped, and the customers may still be waiting for them.  So this is a possible source of small revenue increases if you were to track down each remainder, call the customer, see if they still want it, see if you have it in stock, and then ship it.  So this is a control that increases your revenue.

Order Entry Policies

There are also a couple of policies to consider.  An obvious one is that someone from management should formally approve of any price changes from the standard corporate price list.  There should also be a recurring internal audit procedure to verify that price changes have been properly approved by management.

Another policy is to look for extended return rights granted to customers. – usually right on the sales order – and if there are some, this could indicate an aggressive sales approach called channel stuffing.  This means that you’re pushing more product onto customers than they really need, and the evidence of this is that you’re allowing them a number of months in which to return the goods if they don’t actual sell or use them.

Channel stuffing is usually started by management, because they’re trying to meet some rather difficult sales targets.  Because management is causing it, they may also be trying to hide it.  An internal audit procedure is needed to look for it.

Here’s another policy.  You should cross-check the existence of customers when their orders are over a certain dollar size.  Unfortunately, some customers who are intentionally trying to defraud the company will try to figure out what that policy is, and then place orders just beneath it.  But nonetheless, it does help to have a policy that requires someone to run a Dun & Bradstreet credit report, just to see if the customer has been around for a while, and that they seem to be a valid business, so that you can expect to be paid.

Related Courses

Accounting Controls Guidebook

Accounting Information Systems