Evaluation of Internal Control Systems: Adam & Co. - HA2042, T2 2019

This case study analyzes the internal control systems of Adam & Co., evaluating the purchasing, cash disbursements, and payroll departments. The assessment reveals significant weaknesses, including the purchasing clerk's autonomy, the cash disbursement clerk's inappropriate responsibilities, and the payroll department's lack of segregation of duties. The study highlights risks such as potential fraud and financial mismanagement due to these control failures. Recommendations are provided to strengthen internal controls, such as implementing a requisition process in purchasing, centralizing check writing, and separating payroll functions. The conclusion emphasizes the need for improved supervision and evaluation of employee duties to safeguard against financial losses and ensure organizational goals are met. The assignment follows the guidelines provided by Holmes Institute for the HA2042 Accounting Information Systems course.

CONTENTS
Executive Summary……………………………………………………..2
Introduction………………………………………………………………2
Purchase System………………………………………………………..3
Cash Disbursement System…………………………………………….5
Payroll System…………………………………………………………….6
Conclusion………………………………………………………………..
References………………………………………………………………..9
Page 1

EXECUTIVE SUMMARY
Adam & Co have very weak internal control systems. After a careful review, it is evident
that the company is exposed to great risks of losing money through the exploitation of
the existing loopholes by errant staff.
The entire internal control system requires a major haul so as to remove the
weaknesses inherent in the current set up. In almost all the departments clerks have
been left to make inventory orders or disburse payments without approval or even
knowledge of the accounts department and other relevant departments.
In the purchasing department where the clerk raises a purchase order and sends it
directly to the vendors without reference to anyone, it is recommended that a system be
put in place which allows the purchasing clerk to generate purchase orders finally after
a rigorous requisition process has been followed. It is also observed that it is not the
work of the cash disbursements clerk to update accounts payable subsidiary ledger and
the accounts payable control account. The purchasing clerk’s work is to write checks,
update the check register and raise journal vouchers after checks have been
processed.
The payroll department suffers from the same malady as the others. Payroll checks
should not be written by the payroll clerks. For sound internal control, check writing
must be centralized to be written by the company’s cash disbursements clerk only.
INTRODUCTION
This is an evaluation of the internal control systems of Adam & co. The purpose of this
review is to evaluate the soundness of the current internal control systems in place and
make recommendations.
Evaluations have been done on the purchase system, cash disbursements and payroll
system and recommendations have been made on the changes and improvements that
need to be put in place to correct the situation.
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Purchase System
Shortcomings
The current purchase system in place has serious shortcomings which require urgent
attention. The system gives the purchasing clerk all the authority to make purchases
without reference to anyone else. From the analysis made of the purchasing process of
this organization, there is an important internal control tool which is missing- a
requisition form from the department which needs supplies. Currently, the department
which requires the materials or the supplies is not involved at all while the accounts
department only gets to know that there were purchases made at the time when it is
required to pay the vendor.
Risks
The purchase system as it is currently has weak internal control mechanism and it is
open to abuse. The purchasing clerk might exploit this loophole and engage in fraud by
ordering goods for personal use.
To ensure that fraud is prevented the purchasing department in its entirety must
participate and supervise the whole process of ordering goods, supplies, and materials
for the organization. SIPMM (2018) emphasizes the need for coordination between the
company’s administration and the purchasing department.
Recommendation
There must be a requisition form emanating from the department where the goods
required will be used. Procurify (2018) underscores the critical value of a requisition to
the purchasing cycle. A department expresses the need for goods using an official
purchase requisition form which goes through approval processes before landing in the
hands of the purchasing clerk. With this system in place, the purchasing department is
precluded from making orders directly from the vendors and enables the organization to
have internal control over the whole process of requisitioning purchases.
Example
As an example, the IT requires reams of printing paper. The person in charge, upon
noticing that the supplies are low, will make an official request for the items by filling out
the requisition form. The form is approved by the head of the department and forwarded
to the purchasing department where it is scrutinized, approved and a purchase order
generated and sent to the vendor. A copy of the purchase order is forwarded to the
accounts payable section of the accounts department, a blind copy is sent to the
receiving department and the last copy is kept in the purchase order file.
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In this scenario, the supplies order is made on the strength of a formal, scrutinized and
approved document whose copies are spread among relevant departments but not at
the whims of a single purchase clerk as the case is at the moment in this organization.
Centralized Purchase System
A centralized purchase system would appropriately serve the company well. In this
system, a department based in the office controls all the purchasing made by the
company regardless of the location, Precoro (2018). The management also is centrally
placed and it is able to make a large volume of goods at favorable prices because of its
ability to negotiate.
Inventory control is made more efficient when it is managed centrally resulting in low
staff costs and decreased overheads. Purchasing and Procurement Center (2017) says
a centralized purchase system has more advantages than a decentralized one
especially if the company does not have too many branches which are too far apart.
Among the advantages of a centralized purchase system is:
 Overheads associated with purchasing are fewer
 Allows for big volumes of purchases resulting in good prices and bigger
discounts
 Purchase records can be kept and accessed in one place, Purchase Control
(2018)
 Inventory management is made easier.
Raises a requisition for supplies, approved
Requisition form forwarded
Prepares purchases order
Copies of Purchase Order
The receiving department
I is given blank copy of PO
Needy Department
Purchasing
Department
Vendor Accounts Payable
Dep
Receiving Dep
Page 4

Cash Disbursements System
Cash disbursement, according to bizfluent (2016) is a recurring procedure in every
business. It is a process where cash is released to purchase items, goods and various
materials for the company. Any organization relies on its accounting department for
decision making and approvals.
Disbursement is a cycle with a point where it starts, My Accounting Course (2019).
Generally, the cash disbursement cycle begins at the purchasing department where
orders are placed, and depending on the availability of cash, the accounting department
approves. Upon receiving the order the vendor supplies it and it is booked in at the
receiving department. The department of accounting processes the invoice and
disburses cash to the vendor.
The shortcomings at Adam & Co.
The cash disbursements clerk has been given responsibilities which do not belong to
that office. For internal control purposes, it is not right to allow the cash disbursements
clerk to access and update accounts payable subsidiary ledger and the accounts
payable control account. The work of the cash disbursements clerk, upon receiving
documents authorizing payment from accounts payable department, is to prepare a
check, update the check register and prepare journal voucher which, upon approval,
forwards it to the general ledger section of the accounts department.
Risks
The cash disbursements system in this organization is wanting and it is open to abuse
and fraud. The cash disbursements clerk may decide to pay anyone and then alter the
accounts books to cover the fraudulent activity.
Recommendation
A sound cash disbursements system with tight internal controls starts at the Accounts
Payable section. Chron (2019) ably amplifies the valuable role which controls play in
safeguarding cash. Items that are due for payment are identified by the accounts
payable department. Then a voucher is raised by the department, approved and sent to
the disbursements department. When the disbursements clerk receives it he or she
scrutinizes it for accuracy and if complete.
The clerk then prepares a check and notes its number, amount, voucher number and
other data and records them in the check register which is also known as cash
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disbursements journal. The clerk also prepares a journal voucher to capture this
transaction and sends it to the general ledger section for posting.
The journal voucher shows the updated cash balances and reduction of debt as a result
of this transaction. The disbursements clerk then writes the check number on the
payment voucher and returns it with its attachments to accounts payable section where
it is used to update the accounts payable subsidiary account.
Accounts payable department initiates
Payment by raising a payment voucher
Upon approval it is forwarded
Scrutinized, check written
Journal voucher prepared
Forwarded for posting
The payroll System
The balance small business (2019) defines a payroll as a series of actions carried out
by a company for its employees which culminates in the payment of wages. A payroll
has some parts and definition:
 Physical or electronic calculation and the handing out of checks
 Records of employees showing wages, bonuses, deductions, and other details
 A payroll is the record of total wages earned by all employees of a company in a
financial year.
After an employee’s wages have been calculated, it is a legal requirement for the
employer to withhold taxes and other deductions from each employee. After the wages
are paid out the employer must segregate the amounts deducted from employees’
wages for later disbursement to various agencies. Every employee has his or her own
record showing the amount of wages earned in each period, Cloudpay (2018). A
control record showing details of wage payments for every employee is known as
payroll register.
Accounts Payable Dep
Disbursements Dep
General ledger Section
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Shortcomings
The payroll system at Adam’s & co lacks sound internal control checks and it can be
abused. The payroll department has been given all the authority and the final say in the
approval and payment of wages. The authority to pay should come from the accounts
department, and the person writing checks is the cash disbursements clerk, not the
payroll clerk. It is also wrong for the payroll clerk to send the payroll register to the
Accounts Payable department after checks have been written and distributed.
Risks
Without the involvement of the accounts department in the approval and processing of
payroll payments, there is a danger for the payroll staff to collude and make payments
to themselves in the name of non-existent workers. This situation is made even more
likely to happen because the payroll clerk initiates and completes the process of writing
and issuing checks without any supervision.
Recommendation
For good internal control, the payroll department should process the raw data and
forward the payroll register to Accounts Payable where it is scrutinized and approved for
payment. Fitsmallbusiness (2019) suggests the use of a payroll system software to
simplify the process.
The cash disbursements clerk then writes checks and distributes them. The accounts
payable department will also deduct workers taxes and other statutory deductions and
forward them to relevant authorities.
Processes wages data
Prepares payroll register
Scrutinizes payroll register, approves
Writes checks for workers
Payroll Department
Accounts Payable Dep
Cash Disbursements
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CONCLUSION
Adam & co are operating with very weak internal control systems which expose the
company to fraudulent activities.
In the three departments of purchasing, cash disbursements and payroll loopholes exist
which could easily be exploited by some staff to defraud the company.
In each of those departments changes that will strengthen the control function are
recommended. All clerks should be stripped of the authority they now have of making
purchase orders or writing and issuing checks without following the requisition process.
Payroll clerks should cease from writing and issuing checks. All checks should be
written and issued from cash disbursements department only.
The company also, as a matter of urgency, should put in place a control system which
ensures that employees are supervised and evaluated on the duties they were assigned
because a company without such controls, according to iedunote (2015) might not
achieve its goals.
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REFERENCES
Bizfluent (2017) Objectives of accounting information system [online]. Available from:
https://bizfluent.com/list-6818819-objectives-accounting-information-systems.html
[Accessed on 18 September 2019]
Chron (2019) What is a cash disbursement system? [online]. Available from:
https://smallbusiness.chron.com/cash-disbursement-system-47911.html [Accessed 17
[September 2019].
Cloudpay (2018) The strategic importance of payroll [online]. Available from:
https://www.cloudpay.net/resources/the-strategic-importance-of-payroll/ [Accessed on
18 September 2019).
FitSmallBusiness (2019) Payroll processing: what happens during the payroll process
[online]. Available from: https://fitsmallbusiness.com/payroll-processing/
iEdunote (2015) Internal controlsystem:5 components of internal control system [online].
Available from: https://iedunote.com/internal-control-system [Accessed 17 September
2019].
My Accounting Course (2019) What is a cash disbursement [online]. Available from:
https://www.myaccountingcourse.com/accounting-dictionary/cash-disbursement
[Accessed on 18September 2018].
Precoro (2018) What is centralized purchasing [online]. Available from:
https://blog.precoro.com/en/2017/01/what-is-centralized-purchasing/ [ Accessed on 18
September 2019]/
Purchase Control (2018) Centralized vs decentralized purchasing [online]. Available
from: https://www.purchasecontrol.com/blog/centralized-vs-decentralized-purchasing/
[Accessed on 18September 2019].
Purchasing Procurement Center (2017) Centralized purchasing-good or bad [online].
Available from: https://www.purchasing-procurement-center.com/centralized-
purchasing.html [Accessed on 18 September 2019].
Procurify (2018) What is a purchase requisition and why it is important for your business
[online]. Available from: https://blog.procurify.com/2018/01/30/purchase-requisition-
important-business/ [Accessed 17September 2019].
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SIPMM (2018) Key Performance Indicators for Evaluating Purchasing Performance
[online]. Available from: https://sipmm.edu.sg/key-performance-indicators-evaluating-
purchasing-performance/ [Accessed on 16 September 2019].
The balance small business (2019) What is the definition of payroll [online]. Available
from: https://www.thebalancesmb.com/what-is-payroll-398399 [Accessed on 18
September 2019]
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