CHAPTER 12 SUMMARY

 Introduction to Administrative Processes. Administrative processes are transactions and activities that either are
specifically authorized by top managers or are used by managers to perform administrative functions. Raising capital
funds or investment of excess funds are unlike the processes described in the previous chapters because they are not
regular, recurring, or high-volume processes; rather, they occur only when the need arises. Moreover, the nature of
these processes usually dictates that specific authorization for each transaction is necessary. On the other hand, the
general ledger and reporting processes provide feedback to owners and managers and assist these groups in the
administration of the organization.

 Source of Capital Processes. Capital is the funds used to acquire the long-term, capital assets which are required to
run the business. Capital usually comes from long-term debt or equity. Long-term debt is typically loans or bonds
payable, while equity is the issuance of common or preferred stock. The transactions and resulting processes related
to loans, bonds payable, and stock issuances should be executed only upon authorization from top management or
the board of directors as a result of a desire to accomplish organizational goals that require substantial funds.

Source of capital processes are concerned with the authorization and execution of raising capital, as well as the
related accounting. Top managers, as administrators of the business, are responsible for the authorization, control,
and use of capital. Thus, there is inherent control. The fact that these processes cannot occur without specific
authorization and oversight by top management is a strong internal control.

 Investment Processes. Investment processes authorize, execute, manage, and properly account for investments of
excess funds. The stewardship obligation suggests that if funds on hand exceed the company’s operating needs, then
they should be invested where they can earn a return. The most frequently used methods of investing funds include
the purchase of marketable securities such as stocks and bonds, or the repurchase of the company’s outstanding
common stock.

Regardless of how excess funds are invested, administrative processes are needed to carry out the investment and
account for it. Top management must monitor the funds available and compare the future need for funds that are
available. Sophisticated IT systems can automate much of the investment processes, including cash forecasting and
notifying management when excess funds exist.

 Risks and Controls in Capital and Investment Processes. For both source of capital processes and investment
processes, the important control is the specific authorization and oversight by top management. The very close
supervision of these transactions helps prevent risks of theft or misuse of the cash related to capital and investment
processes. In addition, the cash involved in these transactions is likely to be transferred electronically so that
company employees are not handling large sums of money. Accordingly, if fraud is a factor, it is much more likely to
be conducted by management than by employees. Additional internal controls are necessary to address this risk.

 General Ledger Processes. The general ledger contains data that originated in each of the processes described in
previous chapters as well as the capital and investment processes described in this chapter. As business events occur,
any regular, recurring transaction will be recorded in a special journal and subsidiary ledger; whereas, non-routine
transactions are recorded in the general journal. All transactions, however, are ultimately posted to the general
ledger. The accounting cycle encompasses all of the processes necessary to record a transaction from its origin to its
eventual posting to the general ledger.

Transaction recording in special journals and subsidiary ledgers takes place at the time the transaction occurs. Thus,
the special journals and subsidiary ledgers are updated as the processes for those journals occur. Only the posting to
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 the general ledger occurs at a later time. Accordingly, at the time the general ledger processes occur, the transactions
have already been recorded in special journals and subsidiary ledgers.

 Risks and Controls in General Ledger Processes. The following are common internal control procedures associated
with general ledger processes:
○ Authorization of Transactions. Summaries of special journals and subsidiary ledgers should not occur without
being authorized by a designated person. In manual systems and less complex computerized systems, the
authorization to post is vested in the journal voucher. In computerized environments, controlled access to the
general ledger module will limit the capability of general ledger postings to selected employees. However,
integrated and/or online computer systems often update the general ledger automatically when individual
transactions are entered, thus placing responsibility for general ledger authorization in the hands of lower-level
employees or even external users such as customers and vendors. User IDs and passwords are very important
controls in these cases. In all types of accounting systems, management must establish the method of
authorization it desires.
○ Segregation of Duties. Employees who post journal vouchers have record keeping responsibility; therefore, in
order to maintain proper segregation of duties, they should not perform authorization or custody functions such
as approving journal vouchers or handling capital funds. In addition, manual general ledger record keeping
functions should be separate from special journal and subsidiary ledger tasks. In computerized systems where
the accounting software posts to the general ledger automatically as transactions are processed, segregation is
not likely because there are no employee functions within the general ledger system. However, incompatible
duties in processes that eventually post to the general ledger should still be segregated. Segregation can be built
into employees’ user profiles.
○ Adequate Records and Documents. A well-defined chart of accounts is necessary for adequate record keeping
within the general ledger processes. To reduce the chance of misclassified transactions being posted to the
wrong account, the chart of accounts must be designed in a way that minimizes confusion about the types of
transactions that should be recorded in each account. In addition, an audit trail is necessary for tracing
transactions through the accounting cycle. The audit trail may consist of electronic images in files, or it may be
made up of paper documents and computer files.
○ Security of the General Ledger and Documents. In manual systems, the general ledger and supporting
documents must be protected from unauthorized access. IT accounting systems protect record access
electronically through the use of user IDs, passwords, and resource authority tables.
○ Independent Checks and Reconciliations. In manual systems, the reconciliation of special journals and
subsidiary ledgers to the general ledger control accounts is an independent check on the accuracy of recording
routine transactions. Managers should also conduct periodic reviews of the general ledger reports for accuracy
and completeness. In an IT system, reports should be printed and cross-checked against each other for
consistency.

 Reporting as an Output of the General Ledger Processes. The information in the general ledger provides important
feedback for managers as well as for external parties such as investors and creditors.
○ External Reporting. All amounts reported in the basic financial statements are derived from general ledger
account balances. Usually, accounts are combined and summarized when reported in general purpose financial
statements because external users do not need detailed balance information on every account. IT accounting
systems are programmed to combine accounts when the system processes the financial statements.

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 ○ Internal Reporting. Internal reports tend to vary greatly, as they are tailored to the specific needs of each
management level and function. The type of report depends upon the following factors:
 Type of business organization. Manufacturing entities, retail firms, service firms, not-for-profit organizations,
and other business organizations will each need different types of internal reports to effectively manage
their business.
 Underlying function. Managers in the areas of operations, sales, procurement, etc. will each need varying
types of financial and non-financial data.
 Time horizon. Unit measures and physical counts are likely to be used in day-to-day management; whereas,
reports generated from general ledger information are likely to be used for a time horizon of one month or
longer.

 Ethical Issues Related to Administrative Processes and Reporting. Unethical behavior that may occur in
administrative processing is likely to be the result of management fraud. This is because employees typically do not
have any opportunity to commit fraud within these processes, as they usually do not have access to the related
assets and documents or they are limited by the small number of transactions that take place. Also, administrative
processes are tightly controlled and supervised by top management, as they tend to require specific authorization.
o Unethical Management Behavior in Capital Sources and Investing. When raising capital, it is imperative that
investors and creditors be given honest and complete information. Management may sometimes try to hide
negative information when borrowing funds or selling stock so as coerce investors or creditors into making
decisions in the company’s favor.
o Internal Reporting Ethical Issues. The manner in which management uses internal reports can set either a
proper ethical tone or an improper one. When management places heavy emphasis on profitability, the result
may be unethical behavior such as manipulating numbers in order to show a higher profit. To set a proper ethical
tone, top management should measure several factors of managerial performance without over-emphasizing
profitability or cost cutting. Many companies use a balanced scorecard approach to internal reporting, whereby
measures of performance are based upon such factors as financial success, customer satisfaction, internal
efficiencies, and learning/growth. When companies use several measures, including non-financial measures,
there is less pressure on management to focus only on the financial statement numbers. As a result, unethical
behavior is less likely to occur.

 Corporate Governance in Administrative Processes and Reporting. The processes described in this chapter are part
of a corporate governance structure. When management designs and implements administrative processes, it
assigns responsibility for executing the related capital, investment, and general ledger functions to various
employees. It must be mindful of the risks of stolen or misused capital, alteration of documents or reports, and other
frauds in this process. Accordingly, it must also implement and monitor internal controls to minimize these risks. As
management considers these assignments and monitors the underlying processes and controls, it is carrying out its
corporate governance functions of proper management oversight and internal controls and compliance.

Since financing and investing transactions that are included in the administrative processes are concerned with
proper use of cash, and since cash is particularly susceptible to theft, financial stewardship is especially important.
Establishing and monitoring budgets are one method of exercising financial stewardship over administrative
processes and financial reporting. When management sets an appropriate tone at the top by consistently
demonstrating and encouraging ethical conduct, it is more likely that a stronger system of corporate governance will
result.

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 11.(SO 1) What characteristics of administrative processes are different from the
characteristics of revenue, expenditure, or conversion processes?

The characteristics of administrative processes that are different from revenue, expenditure, or conversion processes are
the frequency of occurrence and the extent of management authorization. Whereas revenue, expenditure, and
conversion processes typically occur on a regular, recurring basis (usually daily), administrative processes occur on a non-
regular basis, either as the need arises or on a periodic basis. Therefore, revenue, expenditure, and conversion processes
usually involve established procedures and controls that allow these processes to occur without intervention or specific
authorization by management. Administrative processes, on the other hand, typically require that specific authorization
for each transaction would be necessary.

30. (SO 7) Does the general ledger provide all information necessary for internal reports?

The general ledger does not provide all information necessary for internal reports. Internal reports often rely on
information from various parts of the organization. For instance, manufacturing, retail, service, and charitable
organizations would each use different types of information to manage the details of their revenue and expenditure
processes. In each of these scenarios, non-financial information is often useful to managers in order to supplement the
financial information derived from the general ledger. In addition, there may be detailed financial and non-financial
information in an organization’s accounting system that is useful for internal reporting purposes but may not be readily
apparent in the general ledger. In addition, internal reports may contain past or future information that is not included in
the current period’s general ledger.

45. Putnam Sound, Inc. internal control weaknesses.

Weakness 1: Steve prepares and posts journal vouchers. Journal vouchers should be prepared by the personnel in the
other processes of revenue, expenditures, payroll, and conversion. Those journal vouchers should be forwarded to Steve
for posting.
Weakness 2: The journal vouchers are not prenumbered. Journal vouchers should be prenumbered and the sequence
should be accounted for. Any missing numbers in sequence should be reconciled or explained.
Weakness 3: Journal vouchers are frequently voided or revised. While it may not be possible to completely eliminate
such errors, voided and revised journal vouchers should occur rarely.
Weakness 4: Journal vouchers are posted biweekly. Ideally, they should be posted more frequently, and at least weekly.
Weakness 5: The voucher log is chronological. It should be in order of the prenumbered sequence.
Weakness 6: Steve reconciles the subsidiary accounts to the control accounts in the general ledger. Reconciliation is a
good internal control, but ideally, someone other than Steve should do this reconciliation.
Weakness 7; The general journal reconciliation occurs bimonthly. It should be reconciled at the end of each month.

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