Management and Administration of Accounts Receivable - Part 4, Internal Controls
This is the 4th article in a series about Management and Administration of Accounts Receivable. This material is adapted from The Automated Accounting Systems and Procedures Handbook (John Wiley, New York 1991) Chapter 5.
SYSTEM ACCESS
Only system users who require access to certain functions of the system should be allowed such access. The system security should enforce this restricted access for different system functions such as transaction processing, file maintenance, and inquiry. Usually this is enforced via user ID. As an example, the following restrictions may be included:
| Function | Access Authorized For |
Cash receipts entry
Account deletion
New customer set-up
Write-offs
Credit limit and terms maintenance
Controller | Cash receipts accountants
Sales staff
Sales staff
Collections
Credit analysts
All functions |
In more sophisticated systems, it is possible to further restrict access within a function, allowing specific individuals to work only within a certain company defined to the system. For example, this feature might be used to restrict each of three collectors to working within a particular range of accounts. Some systems also restrict access to selected online terminals. This way those terminals located in the credit and accounting departments are the only ones that can access assigned system functions.
DIRECT CASH RECEIPTS
Accounts receivable system controls and manual procedures should help support the flow of correct information into the accounts receivable master file. Although this could include adjustments and invoice transactions, in most cases (direct) cash receipts constitute the largest volume of manually processed financial activity within the accounts receivable system. 1
Data Accuracy and On-Line Editing. System edits validate the accuracy of key input fields for direct cash receipts. Any mandatory edits can be considered a control mechanism since they help ensure the accuracy of key data fields for each transaction.
On-line editing is important for the cash receipts operator because it provides immediate feedback when a mistake is made. Most on-line editing involves a test against a master file or table to validate a data field’s accuracy.
Older batch-oriented systems allowed operators to key in information (originally on punched cards) and later produce a batch edit report showing errors made. Using a different approach, some earlier systems used a check digit in the customer account number to help ensure its accurate data entry. This procedure was helpful only when validation against the customer master file was impractical or impossible. In modern systems neither of these editing features is necessary.
Most systems edit for data accuracy customer number, transaction code, terms code, “apply to” number, and deduction reason code. Most of this editing occurs by validation against stored information. However, several important edits are provided by means other than just straight master file validation:
1. Transaction Date Editing. The system may verify the reasonableness of the transaction’s date (e.g., months are numbered 1 to 12, etc.). The system may also verify that the accounting period referred to in the date is still open and has not been closed. Transaction date editing helps provide assurance that transaction dates are reasonably accurate and, in turn, that transactions are reported in their proper accounting periods.
2. Batch Totals. Nearly all systems use a batch total to verify the amount and number of transactions submitted through batch entry. Batch entry procedures, described in detail in Chapter 3, help ensure that transaction amounts are accurately transcribed into the system form their source (paper document, bank processing center, etc.). Usually this is the only remnant of batch editing left from systems of older design.
3. Reasonableness Test. It may be appropriate for the system to test the reasonableness of a transaction’s amount before allowing further processing. This can be useful in special balance forward situations, such as mail order, where the amount of a cash receipt transaction should rarely exceed a certain level. For example, a warning can prompt the operator when a transaction has been entered that exceeds $999.99.
Controls over Cash Receipts Handling. Everyone seems to agree on the need to control cash receipts processing. Cash receipts is a likely area for fraud. Also, internally generated errors that require customer involvement to correct can significantly erode customer goodwill.
The controls mentioned here are quite common. To carry out many of these procedures, clerical staff performing the work can observe rotation of duties and forced vacation. These practices not only cross-train, but they help prevent one-man fraud operations.
1. Endorsement. Procedures should require that checks become restrictively endorsed as soon as possible. This reduces the chance that unendorsed checks pass through too many hands. Restrictive endorsement means that the checks are endorsed with a stamp that indicates
- That the check is for deposit only.
- The name on the account.
- The account number and bank name into which the check must be deposited.
2. Review of Payment and Remittance. The cash receipts clerk handling the mail must review each cash receipt to ensure that
- The remittance advice matches the amount enclosed.
- The check is signed.
- The check is properly completed.
Any cash receipts that do not pass these simple tests must be separated from the mainstream of processing and appropriately researched and resolved. For example, if the payment amount and remittance totals do not match, it may be appropriate to call the customer so that the check can be applied as intended.
3. Cash Control. Naturally it is desirable to encourage customers to use checks or money orders and discourage the use of cash. This avoids the employees’ handling of cash and the extra controls that may be required in this case. Checks and money orders also provides an audit trail of the transaction through the customer’s canceled check and the bank’s microfilming of deposits.
However, if a business receives cash directly, as often occurs in balance forward environments, steps must be taken to provide for the safe handling and processing of the cash. Dual control over the handling and mail opening will help accomplish this. Having at least two people present when opening the mail and when handling cash reduces the likelihood that one individual will pilfer any cash. With large amounts of cash, dual control may be necessary in accompanying the cash all the way to the bank.
A cash ticket (Figure 5-7) creates a record of cash received so that the actual cash may be secured immediately. The cash ticket also provides a historical record indicating that no check exists for this remittance. Totaling the cash tickets can help prove that the total cash received was in fact deposited.
Figure 5-7 Cash Ticket
4. Controlling Undeposited Cash Receipts. All cash receipts are generally held for some period of time before they are brought to the bank for deposit. In fact, companies that receive smaller amounts of receipts may hold them overnight, making only one or two bank deposits per week. Whenever the accountant is not present, the cash receipts should be locked up, and kept away from unauthorized personnel. For overnight safekeeping, some businesses use dual control—two locks with each key held by a different person.
5. Reconciliation of Deposit to the Cash Receipts Journal. This is a key control procedure that ties together two different ends of the cash receipts process. Specifically, it helps ensure that the amount of cash receipts reported by the bank matches the amount of cash receipts posted to the customer accounts. To accomplish this, an accountant must match the cash receipts register to the bank statement (not the deposit slip since errors can still occur between the deposit slip and the bank statement) and reconcile any differences. This may be a weekly or monthly procedure depending on the frequency of out-of-balance situations and the time spent to resolve them. Segregation of duties is important with this procedure—if the person performing this reconciliation also deposits the cash receipts, then he can easily cover up misappropriated deposits.
LOCKBOX CASH RECEIPTS
Cash that enters the accounts receivable system through a bank lockbox passes through a different set of controls that ensures accuracy and completeness. Many of these controls involve the financial institution’s effort and participation. They are usually open to discussing their control environment with customers. Some financial institutions have a report, called a third party review, that attests to the controls in place for certain customer-processing functions, such as lockbox services. If a third party review is available, the bank may provide a copy of this report, on request.
Data Accuracy. Because they lack master file information and batch totals for verifying information keypunched, financial institutions usually double keypunch each transaction, using a second person to verify what the first already completed. This control exists for all data elements that they keypunch as part of the lockbox service—customer number, invoice number, amount, etc.
Controls over Cash Receipts Transmission. When a data tape is used to transfer cash receipts, the sender must be able to retransmit the file should this be necessary. Some purists might say that saving a back-up file copy for retransmission is a protection mechanism and not a true control since it technically does not ensure the accuracy of transmitted cash receipts information. The following controls, however, do contribute to transmission accuracy:
1. Control Records. For its part, the financial institution will send an electronic file that includes control records. Standard file formats by the ACH and the Bank Administration Institute use several different kinds of control records with a single transmission, including control records for individual batches that comprise the transmission and a control records for the entire transmission. The accounts receivable system recomputes these control totals and accepts the transmission when computed totals match the control records sent. Usually the results of this test are reported by the system. The accounts receivable department can use this information in balancing the activity for the period (Figure 5-8).
2. Hash total. Some systems compute use a hash total, which is an otherwise meaningless arithmetic total of numeric data, such as invoice number. Like a control total, the hash total can help ensure that key data fields are accurately received from an outside source.
3. Data Communications Error Checking. In addition to control records, all modern electronic data communications use a second set of controls to help ensure transmission accuracy between computer systems. These controls make certain that nothing is lost or distorted through the transmission media (telephone lines, satellite, etc.). Most often a parity test and a cyclical redundancy check are performed by the data communications software on each of the two computers involved in the exchange. Because data that fail either of these tests are retransmitted until both tests succeed, the execution of these tests is invisible to everyone but a communications specialist. That is, all the user ever sees are the results of a successful transfer.
1 Memo transactions usually share many of the same controls as direct cash receipts. Controls over the accuracy of invoices generally fall outside the realm of the accounts receivable function and are more of an issue for other areas— pricing, order processing, shipping, etc.
Next Month: Internal Controls, continued
| About this article and the author: |
Doug Potter is the owner of The Newport Consulting Group a professional management consulting organization that provides clients with information systems planning, selection, and implementation services. He can be reached at dpotter@newportconsulting.com or through his Web site, http://www.newportconsulting.com.
Note: The contents of this article were excerpted from Mr. Potters book "Automated Accounting Systems and Procedures Handbook" Copyright 1991 by Douglas A. Potter, published by John Wiley & Sons, Inc. New York
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