1. What are the two basic requirements of an internal control system? 4. Explain
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Question
1. What are the two basic requirements of an internal control system?
4. Explain what separation of record-keeping from control of assets means and why you would use it.
5. Explain how lapping works.
8. List and briefly discuss appropriate procedures for control over product storage and explain how perpetual inventory cards can be used in control.
9. Explain the difference between standard and actual food cost.
How is the actual food cost computed?
How is standard food cost computed?
10. If the actual food cost percentage is greater than the standard food cost, what might be the reasons for the difference?
11. Explain why the contribution margin of menu item is more relevant to profitability than the food cost percentage.
Explanation / Answer
Answer 1.
In order to maintain an adequate system of internal control, there are many requirements. Two of them are as follows:
a. Risk Assessment: It involves identifying the areas in which the greatest threat or risk exist. This will ensure that the greatest risks receive more attention, effort and level of control. Eg. Cash transactions involve a higher degree of risk.
b. Monitoring and Reviewing: The system of internal control should be periodically reviewed. This will ensure that the internal control activities have not become obsolete. Moreover, the internal control system can be modified accordingly to remain applicable for the current state of risks.
Answer 4.
Meaning of separation of record-keeping from control of assets:
Also called Segregation of duties, it is an important concept in placing internal controls over a company’s assets. Segregation of duties involves separating the three main functions namely having custody of assets, being able to authorize the use of assets and recordkeeping of assets and having them conducted by different employees.
Eg. The internal control of cash can be improved if cash handling duties are separated from the record keeping duties. This will reduce the likelihood of theft of cash.
Reasons for segregation of duties ie. why you would use it:
1. It ensures that there is continuous oversight and review to identify the errors
2. It helps to prevent fraud or theft because it requires two dishonest people to collude in order to hide a transaction
Answer 5.
Lapping is a fraudulent scheme which accountants use to handle shortages in accounts receivable payments from customers. These shortages are the result of theft and mismanagement of cash receipts.
Herein, the accountant uses payments received from one customer to count towards another customer's account. This method involves taking the first receivable collected and using it to cover the theft. Once the second receivable is collected, it is accounted to the first, the third receivable to the second, and so on. Thus, this type of fraud can be conducted in perpetuity since newer payments are continually being used to pay for older debts.
Eg. Customer ABC pays $100 toward her account. The cashier steals that money. Customer XYZ pays $175 towards his account. The cashier credits $100 toward Customer ABC, while waiting for another $75 to come in to credit Customer XYZ. This process continues for all customers till the end.
Answer 8.
Part a
Appropriate procedures for control over product storage:
Products should be stored in such a manner that their safety and maintenance remains a high priority. The procedures should ensure that there is least breakage, damage, deliveries left out on the floor and product theft.
• All warehousing software runs on data, therefore product and storage location data must be kept current and accurate. Companies should maintain all information on a single system of record and keep it current and accurate.
• Optimizing storage locations and layouts to fit product without the need to restack repeatedly. This will ensure that products are stored in an organized manner enabling the company to be able to exercise better checks and controls.
• Special storage areas may be used to segregate items with fire risk or high-value product might require caged or controlled-access storage.
• Minimizing the travel time by placing a product in high demand closer to its next point of use. The difficulty of retrieval makes product storage controls difficult.
• Companies should integrate the capability of tracking products by lot or serial number in their warehouse and shipping processes and use the system of record to manage the lot and serial-number data.
Part b
A perpetual inventory system updates the inventory in real time when purchases are made or inventory is sold. It comprises of (i) bin card, for quantitative perpetual inventory; (ii) stores ledger for quantitative and valued perpetual inventory; & (iii) continuous stock taking for physical perpetual inventory. Thus, it helps in maintaining better inventory controls in the following manner:
1. It provides the ability to run reports that can immediately identify inventory items that are running low. Thus, it prevents being out-of-stock. It becomes possible to keep the stock within the prescribed limits.
2. It helps to compare the inventory balance in the system with the month/ year-end count and allows investigating any discrepancies like theft, shrinkage or even counting errors. Thus, detection & adjustment of discrepancies can be readily made.
3. Since stocks are kept within the limits, the chances of bottlenecks in supply for production, loss due to deterioration, obsolescence etc., are minimized.
4. Timely stock replenishment is possible because as soon as the stock reaches the ordering level, initiative for purchase is taken.
5. Under the perpetual inventory system, the inventory levels are always correct and the inventory turnover ratio can be calculated correctly. It can tell whether sales are slowing down or whether individual products are no longer selling quickly.
NOTE: 4 questions answered
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