CHAPTER 2 THEORETICAL FOUNDATIONS

Transcription

1 CHAPTER 2 THEORETICAL FOUNDATIONS This chapter covered the theoretical foundation used in the analysis and implementation process of this thesis. The main terms and concepts that are covered in this section are the Accounting Information System (AIS) and the Inventory Cycle (IC), with the explanation on the specifically related Internal Control (IC) and the Flowchart as the supporting instruments. 2.1 ISO 9001 ISO (The International Organization for Standardization) is a worldwide federation of national standards bodies (ISO member bodies). The work of preparing International Standards is normally carried out through ISO technical committees. Each member body interested in a subject for whom a technical committee has been established has the right to be represented on that committee. International organizations, governmental and non-governmental, in liaison with ISO, also take part in the work. ISO collaborated closely with the International Electronical Commission (IEC) in all matters of electro technical standardization. (The British Standard, 2000) History of ISO 9001 The International Organization for Standardization (ISO) was founded Based in Geneva, Switzerland, it created the first international standards for 7

2 8 manufacturing, trade and communications. ISO 9001 was initially published in 1987 and specifies, in broad terms, the necessary components of a quality management system and, in detail, the basic requirements of the quality function for all industries. Today, more than 90 countries are members with the U.S. representative being the American National Standards Institute (ANSI). There are over 500,000 ISO 9001 certified companies around the world (including more than 50,000 in North America), all demonstrating a commitment to continual improvement in quality. The most recent change to the ISO 9001 standard is ISO 9001:2000. This new standard is now in place and includes improvements in three key areas: 1. Creating a common structure based upon a process model 2. Creating a method to demonstrate continual improvement and customer satisfaction 3. Developing metrics to determine how effectively internal processes are working with a focus on improving results The benefits and the results of ISO 9001 To implement ISO 9001:2000 in an organization, it will make the organizations one of the fastest and most effective ways to implement ISO 9001 is to use The USI 9001 Store Documentation and Training Package. By using this package it will implement a professionally designed Quality Management System in the

3 most cost effective manner available (International Organization for Standardization, 2008). 9 Over 350,000 companies world are registered to ISO 9000, the benefits they find include (International Organization for Standardization, 2008) are improved consistency of service and product performance, higher customer satisfaction levels, improved customer perception, improved productivity and efficiency, cost reductions, improved communications, morale and job satisfaction and competitive advantage and increased marketing and sales opportunities Implementing ISO 9001:2000 Here are the steps to implementation (from International Organization for Standardization, 2008): 1. The project manager prepared a project plan 2. Management identifies an ISO Steering Team 3. Project manager and others conducted a Gap Analysis 4. The ISO Steering Team identified Task Team members The steering team is a team led by top management that will coordinate and lead the implementation project. The task team will be lead by a member of the steering team. They will set-up for each Quality System Procedure that needs to be developed. The next steps to implementations are: 1. Train employees on the basics of ISO 9001:2000

4 10 2. Task teams hold team meetings to: Review procedure templates and current process Review Gap Analysis results Edit procedure template for your organization Submit the edited procedure to the ISO Steering Team for approval Take any necessary action to implement the new procedure 3. The ISO steering team will review the procedures; they will approve or suggest changes 4. Internal auditors are trained for the internal audit program 5. The new Quality System procedures are used for several months while records are collected and improvements made 6. The Registrar conducts an audit of the system

5 Table 2.1 TUV America Inc. IDEAL Process Four Phase ISO 9001 Certification ISO 9001:2000 Inventory Control The people at ISO understand that to have a customer focus, the company need to focus on their inventory. First the company needs to control their processing process to ensure that the company orders the correct parts. Once the parts come into the facility through the receiving area, they must be controlled. Below will explain more about the inventory control process covers any inventory from the point it enters the facility as part (including customer supplied good, raw goods, sub-assembles or finished goods) and leaves the facility as part of customer fulfillment (ISO 9000 Resources, 2007).

6 The ISO 9001:2000 standard requires that certified companies address the following areas (ISO 9000 Resources, 2007): 12 Segregate good and bad parts Using incoming inspection, in-process testing and non-conforming materials management the company must separate conforming and nonconforming parts. Non-conforming materials should be managed using the standard non-conforming materials procedures while conform materials are managed using the standard inventory procedure. Assure that only good parts are used The company must have system in place to assure that non-conforming parts are not used in production. Non-conforming part must be identified as non-conforming and protected from accidental use. This is managed using the Non-conforming materials (NCM) procedure. Unique identification of every part The engineering design process should create unique part number for every component and assembly. These part numbers should be clearly labeled on the parts or part storage areas.

7 13 Identification of every parts status As parts are tested and measured, their status should be obvious. This is simple for non-conforming materials that are tagged as bad parts. The most vulnerable area is where parts are in-process and may have failed testing but are not yet tagged. If a second operator starts working on a set of parts, it must be obvious that the parts are good. Proper handling of parts and assemblies All inventories must be handled to reduce damage to the parts or assemblies. This can include the installation of special Electro Static Discharge (ESD) equipment to in electronic assembly areas. It also includes boxing and packaging of finished assemblies to ensure that they arrive at the customer without damage. Protection of inventory This is much harder than it sounds. Many parts have special requirements that must be covered in your inventory control system and procedure. The following parts should be addressed in the inventory control procedure o Item with special handling issues like ESD sensitive component or fragile component.

8 14 Stock with a shelf life Item with a defined shelf life should be labeled in a clear way so that the item is not used past the expiration date. This should be part of the incoming inspection procedures. Part should not be put into stock (placed on the shelves) until they have been labeled according to their special needs. Labels, adhesives are glues are a good example of parts that requires special attention. Some electronic components (batteries solder) also have a shelf-life. All inventories should be rotated. Stock must be rotated to make sure that the older stock is used first. This is called First-In First-Out or FIFO. 2.2 Internal Control Definition of Internal Control The early definition of internal control was developed by America Institute of Certified Public Accountants (AICPA). The definition was included in the Statement on Auditing Standards (SAS No. 1). SAS No. 1 defines internal control as: Internal control comprises the plan of organization and all of the coordinate methods and measure adopted with a business to safeguard its assets, check the accuracy and reliability of its accounting data, promote operational efficiency, and encourage adherence to prescribed managerial policies.

9 15 Along with time, the standards and definition of internal control is developing. During 1970s and 1980s, AICPA was criticized that their standards did not provide adequate guidance to either external auditors or the users of these reports. This problem was called external gap, in that public accounting standards did not meet the expectations of investors. To conquer this problem, AICPA released a whole new series of auditing standards that better defined many problems areas facing external auditors. One of these, SAS No. 55, defined internal control from the perspective of the external auditors and defined internal control in terms of three elements: the control environment, the accounting system, and the control procedures Internal Control Objectives According to Arens et al. (2006, p.270), management typically has three broad objectives in designing an effective internal control system: 1. Reliability of financial reporting Management had both a legal and professional responsibility to be sure that the information is fairly presented in accordance with reporting requirements such as GAAP. The objective of effective internal control over financial reporting is to fulfill these financial reporting responsibilities. 2. Efficiency and effectiveness of operations Controls within an organization are meant to encourage efficient and effective use of its resources to optimize the company s goals. An

10 16 important objective of these controls is accurate financial and nonfinancial information about the entity s operations for decision making. 3. Compliance with laws and regulations Section 404 requires all public companies to issue a report about the operating effectiveness of internal control over financial reporting. In addition to the legal provisions of Section 404, public, nonpublic, and not-for-profit organizations are required to follow many laws and regulations. Some relate to accounting only indirectly, such as environmental; protections and civil right laws. Others are closely related to accounting, such as income tax regulations and fraud General Characteristic of a Good Internal Control As stated by Gay and Simnett (2006, p. 341), general characteristics of satisfactory internal control are: 1. There should be controls to monitor and minimize business risks 2. There should be proper segregation of responsibilities. 3. The internal control should have a system of authorization, recording and other procedures adequate to provide accounting control of assets, liabilities, revenues, and expenses. 4. There should be sound business practices in performance of duties and functions by each department. 5. Internal procedures should ensure that persons have capabilities commensurate with their responsibilities.

11 17 As for computerized system, a good internal control in a computerized system should include; segregation of duties, reconciliation, authorization, access restriction, monitoring and supervision, business interruption recovery and knowledge and training Internal Control Documentation According to Gill et al (1999, p ), documenting and understanding of internal control structure is required in all audits. Documentation in the working papers may take several forms, such as: 1. Flow charts A flow chart is a diagram of the client s documents and their sequential flow in the organization (Arens et al 2005 p.295). Detailed flow charts should display adequately the following essential components: All operations performed in processing the class of transactions The method of processing (manual or computerized) The extent of segregation of duties (by identifying each operation with a functional area, department or individual) The source, flow and disposition of the documents, records and reports, involved in processing 2. Narrative memoranda A narrative memoranda (narrative) is a written description that reflects the auditor s consideration of the internal control structure. It may be

12 18 used to supplement other forms of documentation by summarizing the auditor s overall understanding of the control structure, the individual components of the control structure, or specific control policies or procedures. A proper narration of an accounting system and related controls should include these four characteristics (Arens et al 2005 p.285): The origin of every document and record in the system All processing that takes place The disposition of every document and record in the system An indication of the controls relevant to the assessment of control risk 2.3 Inventory Cycle Definition of Inventory The definition of inventory according to enterprenue.com 2008 is: An itemized list or catalog of the stock of a business There's more to inventory control than simply buying new products. It is essential to know what to buy, when to buy it and how much to buy. Also the company need to track your inventory--whether manually or by computer--and use that knowledge to hone the purchasing process. The business's basic stock should provide a reasonable assortment of products and should be big enough to cover the normal sales demands of your business. When calculating basic stock the company must also factor in lead time--the length of time between reordering

13 19 and receiving a product. For instance, if the lead time is four weeks and a particular product line sells 10 units a week, then the company must reorder before the basic inventory level falls below 40 units. If the company don't reorder until it is actually need the stock, the company will be without the product for four weeks Inventory System Segregation of Duties Segregation of inventory control from the warehouse Within the purchases subsystem, the primary physical asset is inventory. Inventory control keeps the detailed records of the asset, while the warehouse has custody. At any point, an auditor should be able to reconcile inventory records to the physical inventory (Hall, 2007). Segregation of the General Ledger and Accounts Payable from Cash Disbursement The asset subject to exposure in the cash disbursements subsystem is cash. The records controlling this asset are the accounts payable subsidiary ledger and the cash account in the general ledger. An individual with the combined responsibilities of writing checks, posting to the cash account, and maintaining accounts payable could perpetrate fraud against the firm (Hall, 2007).

14 20 Supervision Inspection of Assets When goods arrive from the supplier, receiving clerks must inspect items for proper quantities and condition (damage, spoilage and so on). For this reason, the receiving clerk receives a blind copy of the original purchase order from purchasing. A blind purchase order has all the relevant information about the goods being received expect for the quantities and prices. To obtain quantities information, which is needed for the receiving report, the receiving personnel are forced to physically count and inspect the goods. If receiving clerks were provided with quantity information via an open purchase order, they may be tempted to transfer this information to the receiving report without performing a physical count. Inspecting and counting the items received protects the firm form incomplete orders and damaged goods. Supervision is critical at this point to ensure that the clerks properly carry out these important duties. Incoming goods are often accompanied by a packing slip containing quantity information that could be used to circumvent the inspection process. A supervisor should take custody of the packing slip while receiving clerks count and inspect the goods (Hall, 2007). Theft of Assets Receiving departments are sometimes hectic and cluttered during busy periods. In this environment, incoming inventories are exposed to theft until they are securely placed in the warehouse. Improper inspection procedures coupled with

15 inadequate supervision can create a situation that is conducive to the theft of inventories in transit (Hall, 2007). 21 Access Controls Direct Access In the expenditure cycle, a firm must control access to physical assets such as cash and inventory. These control concerns are essentially the same as in the revenue cycle. Direct access controls include locks, alarms, and restricted access to areas that contain inventories and cash (Hall, 2007). Indirect Access A firm must limit access to documents that control its physical assets. For example, an individual with access to purchase requisition, purchase orders, and receiving reports has the ingredients to construct a fraudulent purchase transaction. With the proper supporting documents, a fraudulent transaction can be made to look legitimate to the system and could be paid (Hall, 2007).