Accounting: The Language of Business (Part 20)

“There’s no accounting for the mysteries of the human heart.” —Susan Elizabeth Phillips

Accounting Systems and Internal Controls (Part A)

by

Charles Lamson

Controls are a part of your everyday life. At one extreme, laws are used to govern your behavior. For example, the speed limit is a control on your driving, designed for traffic safety. In addition, you are also affected by many non-legal controls. For example, you can keep credit card receipts in order to compare your transactions to the monthly credit card statement. Comparing receipts to the monthly statement is a control designed to catch mistakes made by the credit card company. In addition, banks give you a personal identification number (PIN) as a control against unauthorized access to your cash if you lose your automated teller machine (ATM) card. Dairies use freshness dating on their milk containers as a control to prevent the purchase or sale of soured milk. As you can see, you use and encounter controls every day.

Just as there are many examples of controls throughout society, businesses must also implement controls to help guide the behavior of their employees toward business objectives. For example, some businesses require you to punch a time card when you enter and leave the work place. This is a control used to verify that you get paid for the actual hours you worked.

In the next several posts, we will discuss controls that can be included in accounting systems to provide reasonable assurance that the financial statements are reliable. We will apply the principles of accounting systems design to manual systems as well as computerized accounting systems.

Basic Accounting Systems

In the previous posts, we developed an accounting system for NetSolutions. An accounting system is the methods and procedures for collecting, classifying, summarizing, and reporting a business's financial and operating information. The accounting system for most businesses, however, is more complex than NetSolutions'. Accounting systems for large businesses must be able to collect, accumulate, and report many types of transactions. For example, American Airlines' accounting system collects and maintains information on ticket reservations, credit card collections, aircraft maintenance, employee hours, frequent flyer mileage balances, fuel consumption, and travel agent commissions, just to name a few. As you might expect, American Airlines' accounting system has evolved as the company has grown.

Accounting systems evolve through a three-step process as the business grows and changes. The first step in this process is analysis, which consists of (1) identifying the needs of those who use the business's financial information and (2) determining how the system should provide this information. For NetSolutions, we determine that Chris Clark would need financial statements for the new business. In the second step, the system is designed so that it will meet the user's needs. For NetSolutions, a very basic manual system was designed. This system included a chart of accounts, a two-column journal, and a general ledger. Finally, the system is implemented and used. For NetSolutions, the system was used to record transactions and prepare financial statements.

Once a system has been implemented, feedback, or input, from the users of the information can be used to analyze and improve the system. For example, in later posts we will see that NetSolutions will expand its chart of accounts as it becomes a more complex business.

Internal controls and information processing methods are essential in an accounting system. Internal controls are the policies and procedures that protect assets from misuse, ensure that business information is accurate, and ensure that laws and regulations are being followed. Processing methods are the means by which the system collects, summarizes, and reports accounting information. These methods may be either manual or computerized. In the next few posts, we will discuss internal controls, manual accounting systems that use special journals, and computerized accounting systems. 

*WARREN, REEVE, & FESS, 2005, ACCOUNTING, 21ST ED., PP. 183-185*

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