CHAPTER 9

ERRORS AND IRREGULARITIES IN THE TRANSACTION CYCLES OF THE

BUSINESS ENTITY / INTERNAL CONTROL AFFECTING ASSETS

Objectives:
Understand errors and frauds that may be committed in the business processes.
Describe the internal control over the major components of assets of a business enterprise

While businesses in different individuals can have striking

different characteristics most have some fundamental conceptual
characteristics are practices in common. The three basic business
transaction cycles include:
1. Sales and Collections Cycle
2. Acquisitions and Payments Cycle
3. Payroll and Personnel Cycle

Sales and Collections Cycle

1. Errors in recording sales and collections transactions
2. Frauds in sales and collections
a. Fraudulent financial reporting

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 b. Misappropriation of assets: Withholding cash receipts
1. Skimming – refers to act of withholding cash receipts without
recording them
2. Lapping – is used to conceal the fact that cash has been
abstracted; the shortage in one customer’s account is covered
with a subsequent payment made by another customer.
3. Kiting – is another technique used to cover cash shortage or
tp inflate cash balance

Acquisitions and Payment Cycle

1. Errors in the Acquisitions and Payment Cycle
The following may occur in the acquisitions and payments cycle:
a. Failing to record a purchase in the proper period
b. Recording goods accepted on consignment as a purchase
c. Misclassifying purchases of assets and expenses
d. Failing to record a cash payment
e. Recording a payment twice
f. Failing to record prepaid expenses as assets
2. Frauds in the Acquisitions and Payment Cycle
a. Paying for fictitious purchases
b. Receiving kickbacks
c. Purchasing goods for personal use

Payroll and Personnel Cycle

1. Errors
The most errors that can occur in the payroll and personnel cycle
are
a. Paying employees at the wrong rate
b. Paying employees for more hours than they worked
c. Charging payroll expense to the wrong accounts

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 d. Keeping terminated employees on the payroll

2. Frauds involving payroll

The major payroll related frauds include
a. Fictitious employees
b. Excess payments to employees
c. Failure to record payroll
d. Inappropriate assignment of labor costs to inventory

INTERNAL CONTROL AFFECTING ASSETS

Most of the processes relating to cash handling are the responsibility of

the finance department, under the direction of the treasurer. These
processes include handling and depositing cash receipts, signing
checks; investing idle cash; and maintaining custody of cash,
marketable securities, and other negotiable assets.

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These guidelines for achieving internal control over cash may be
summarized as follows:
1. Do not permit any one employee to handle a transaction from
beginning to end
2. Separate cash handling from record keeping.
3. Centralize receiving of cash to the extent practical.
4. Record cash receipts on a timely basis.
5. Encourage customers to obtain receipts and observe cash register
totals.
6. Deposit cash receipts daily.
7. Make all disbursements by check or electronic fund transfer, with the
exception of small expenditures from petty cash.
8. Have monthly bank reconciliation prepared by employees not
responsible for the issuance of checks or custody of cash.
9. Monitor cash receipts and disbursements by comparing recorded
amounts to forecasted amounts and investigating variances from
forecasted amounts.

Internal Control Over Financial Investments

The major elements of adequate internal control over financial
investments include the following:
1. Formal investment policies that limit the nature if investments in
securities and other financial instruments.
2. An investment committee of the board of directors that authorizes
and reviews financial investment activities for compliance with
investment policies.
3. Separation of duties between the executive authorizing purchases
and sales of securities and derivative instruments, the custodian of
the securities, and the person maintaining the records of
investments.

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4. Complete detailed records of all securities and derivative
instruments owned and the related provisions and terms.
5. Registration of securities in the name of the company.
6. Periodic physical inspection of securities on hand by an internal
auditor or an official having no responsibility for the authorization,
custody, or record keeping of investments.
7. Determination of appropriate accounting for complex financial
instruments by competent personnel.

Internal Control Over Receivables

Accounts receivables include not only claims against customers arising

from the sale of goods or services, but also a variety of miscellaneous
claims such as loans to officers or employees, loans to subsidiaries,
claims against various other films, claims for tax refunds and
advantages to suppliers.
Sources and Nature of Notes Receivables
Notes receivable are written promises to pay certain amounts at future
dates.

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Internal control of Accounts Receivable and Revenue
To understand internal control over accounts receivable and revenue,
one must consider the various components including the control
environment, risk assessment, monitoring, the (accounting) information
and communication system, and control activities

Control Environment
Because of the risk of intentional misstatement of revenues, the control
environment is very important to effective internal control over revenue
and receivables.

Internal Control Over Inventories and Cost of Goods Sold

The interrelationship of inventories and cost of goods sold makes it
logical for the two topics to be considered together.

Sources and Nature of Inventories and Cost of Goods Sold

The term inventories are used in this chapter to include:
1. Goods on hand ready for sale, whether the merchandise of a trading
concern or the finished goods of a manufacturer.
2. Goods in the process of production; and
3. Goods to be consumed directly or indirectly in production, such as
raw materials, purchased parts and supplies.

Internal Control Over Property, Plant and Equipment

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The term property, plant and equipment includes all tangible assets
with a service life or more than one year that are used in the operation
of the business and are not acquired for the purpose of resale. Three
major subgroups of such assets are generally recognized:
1. Land, such as properly used in the operation of the business, has
the significant characteristic of not being subject to depreciation.
2. Building, machinery, equipment and land improvements, such as
fences and parking lots, have limited service lives and are subject to
depreciation.
3. Natural resources (wasting assets), such as oil wells, coal mines,
and tracts of timber, are subject to depletion as the natural
resources rare extracted or removed.

For further discussion refer to the link provided: Errors and Irregularities in Transaction Cycle
Reference Book:
https://www.youtube.com/watch?v=pDiTJqwdTuM
For further discussion refer to the link provided: Acquisitions and Payment Cycle
Corporate Governance, Business Ethics, Risk
https://www.youtube.com/watch?v=YRmnLYj-k3o

Management and Internal Control (2019-2020

For further discussion refer to the link provided: Internal Control Over Receivables
https://www.youtube.com/watch?v=KOHDnyHZ7Bk
Edition)
By: Ma. Elenita Balatbat Cabrera, BBA, MBA, CPA,
CMA