To explain the above types of controls we will constantly refer to purchase of raw materials.
Organization: The enterprise should create proper departments that will achieve an efficient and orderly working environment. In the areas of purchases one would expect the organization to have a stores department which is charged with the responsibility of monitoring stock levels so that when the stock of raw materials reaches the reorder level they will raise a requisition for new supplies. We would expect that a clerk in the stores department has been charged with this responsibility and that he does his job. He knows what is expected of him, he knows whom he reports to, he knows whom he can delegate his work to and he knows the limits of his authority. We would also expect a purchasing department charged with the responsibility of receiving the requisition from the stores. Their function is once they received the requisition they will examine it for necessity and they will select the most appropriate supplier who has been approved by the entity. They will raise the LPO, check the details on the LPO, get it approved, and despatch it to the supplier. You should note that organization relates to having proper departments within the company and within those departments to have individuals with clearly specified job descriptions.
Segregation of duties: For every transaction, we can identify the following stages: initiation, authorization, execution, custody of the resultant assets and the recording of the whole process. As much as possible, these stages should be separated as far as the individuals who carry them out are concerned. In the case of raw materials, the initiation began in the stores department when the goods were requested. Part of the execution is carried out by the purchasing department when they examine the requisition and raise the LPO. Authorization of the LPO will have to be done by an independent person. We can already see that two departments have been involved, the stores and the purchasing department. These controls cover what used to be originally called internal check. This archaic term used to refer to a situation whereby the work of one person was subject to independent review by another person or was complimentary to the work of another person. It also covers rotation of duties whereby no one person is kept in the same position for an indefinitely long period of time. It includes the requirement that people should take regular leave so that other people can have the opportunity to carry out their functions.
Physical: The store-man should know the condition under which the raw materials should be stored to ensure that they do not deteriorate. He has also to ensure that the raw materials are securely kept in a warehouse that is well protected so that no one can just walk in and steal the raw materials. We will also expect the organization to have raw materials requisition notes so that they have to be properly authorised for raw materials to be moved from the warehouse to the production section.
Authorization and approval: As we saw under organization the purchasing department will raise the LPO; the LPO commits the organization to use its resources. These commitments require to be approved at the appropriate levels hence you will find that before the LPO becomes a valid contract, it must be approved in accordance with the approved delegation of authority. The reason for this is that as it forms a basis of a contract between the organization and the supplier it needs to be checked for grammatical mistakes and the commitment of funds.
Arithmetical and accounting: Transactions have to be recorded in monetary terms, or where necessary in physical quantities. The entity must therefore have adequate records to record all transactions and adequate documents to provide evidence and an audit trail of the transactions from authorization up to recording. In the case of our raw materials, we would therefore expect that when the raw material arrives at the warehouse, somebody should check it for quantity and quality to ensure that what we are receiving is what we ordered, these would mean comparing with the orders. A document must be raised to acknowledge receipt of the goods and the checking of their quality and quantity with the orders. A copy of the document acknowledging receipt should be sent to the accounts department for them to be able to match it with the suppliers invoice when it is received to ensure that we are being charged for goods that we ordered and received. The suppliers invoice will have to be entered into the purchases day book, the purchases ledger and into the creditors control account.
Personnel: Personnel controls are neglected in many organizations much to the regret of the organization concerned. Personnel involves allocating the human resources in the most efficient and cost effective manner. Every individual should be given a job that he is competent of doing, he should be properly remunerated for that job, he should be motivated to do the job, he should see a clear career path. Also the integrity of the staff involved has to be established. This involves obtaining references of key staff before the organization engages them and constant counselling to ensure that they have not lost their integrity. When the raw material reaches the warehouse, we would expect that the store man knows exactly what kind of material it is, how it should be stored to protect it from deterioration and how it should be used. We would expect that he could see potential for development within the organization and that his salary or remuneration is commensurate with his responsibilities.
Supervision: Everybody's work should be subject to supervision. So the clerk who raises the requisition in the stores has his superior supervising his activities to ensure that he does not just raise requisitions without confirming that in fact the reorder level has been reached.
Management controls: These are exercised by management by ensuring compliance with the broad policy's of the organization. In the case we are looking at, we can envisage the managing director being given a schedule of purchases for the whole month, he then reviews this schedule and tries to determine whether the material we bought was in the quantity and amount that the organization should be using, whether we are within budget and whether we are being profitable or not.
The aim of a system of internal control we said was to minimise the incidents of errors and irregularities. So as we move on to the practice of internal control we will be considering the potential errors and irregularities that can occur and the measures the organization takes to ensure that they do not occur and if they occur they are detected within reasonable time so that future occurrences are prevented.