Internal Control and Accounting Analysis of ABC Limited: Analysis of Weaknesses and Recommendations
The report was prepared to cover the requirements of the AAT ICAS unit. The AAT ICAS refers to an Internal Control and Accounting System where the report serves as investigation of the weakness area of the business control and makes the recommendation to fix this problem. The following report reviews the restaurant business particular in payroll area.
The report reviews the accounting system of ABC Limited and makes recommendations.
The report was carried out via observation. A certain business was chosen; the researcher asked permission of the manager of the business and spent three days, one in each restaurant observing the premises and the workers at their work. The researcher acted as inconspicuous observer. She also interviewed the different workers in an informal manner regarding the tenor and quality of their work. She conducted background research on the history and work of the restaurant, as well as on tasks associated with a restaurant. Finally, she prepared a survey of 10 items, Likert style that questioned accountant and managers on their economical operations and accounting strategies. All workers were informed about the research before being asked to complete questionnaire and results of survey were handed back to manager for approval and confirmation.
Executive Summary
The following report is about ABC Limited a thriving restaurant chain that is located in London and specializes in pan Asian cuisine. There are three restaurants, (Restaurant A, Restaurant B. And Restaurant C), in London. There are around ten staffs in each restaurant. The main head office is on the first floor of Restaurant B. The average turnover for Restaurant A, B and C. are £ 1040000, £780000 and £52000 respectively. Strengths are that the corporation is relatively simple which can engender change in afar easier, less complex way. Weaknesses are that there are grave holes in the internal accounting system. Recommendations for weaknesses include training for staff and for managers as well as certain amendments in internal accounting system.
The company can expect greater profit and reduced seepage of money as well as wastage of time.
1. Introduction:
1.1 Overview of the business
ABC Limited is a restaurant group, which provides delicious pan Asian cuisine to the customers in London. There are three restaurants, (Restaurant A, Restaurant B. And Restaurant C), in London. There are around ten staffs in each restaurant. The main head office is on the first floor of Restaurant B. The average turnover for Restaurant A, B and C. are £ 1040000, £780000 and £52000 respectively.
The internal major stakeholders work for the business directly and are affected by wages and job stability. The director obviously wants the restaurant to profit and become a business success. Workers want the business to be successful too so that then they can receive bonuses and maintain a stable, lucrative job.
The internal major stakeholders are as follow.
1. Director
2. Management
3. Employee
The external major stakeholders are involved with the company but are not employed directly by the company. The customers, for instance, are interested in prices and quality of the product. Suppliers are interested in the success and stability of the company so that they can ensure that they will have a customer in the future. The government is interested in the company’s pay taxes and the quality as well as amount of the people that they staff.
The external major stakeholders are as follows.
1. Customers
2. Suppliers
3. Media
4. HMRC
5. Companies House
The business relationship is critical to the success of the business because a business can only work with each of these components in place and interconnected. As noted, the business needs management to direct it. It needs customers to sell to and to enable it to continue. A business too needs people to invest in it and enable it to have a start-off particularly in the beginning when the business needs to have enough money to succeed and with which to buy the necessary equipment and hire the necessary people. It needs banks to provide it with loans; but these may be insufficient or banks may be reluctant. Angel investors are, therefore, another solution. These are people who are willing to risk a portion of their money in order to give the business a try.
Suppliers are needed in order to supply the company with the needed resources and goods. So, for instance, ABC Limited being a restaurant group would need suppliers to supply it with food products, dishware, tableware, and so forth at reasonable prices in order that they can conduct their business and satisfy their customers as per their guarantees. The media, meanwhile, helps promote the company. The company, particularly a start-up one needs publicity, particularly if it has to make its niche in an already glutted market. It can rely on the media to give it this publicity and to sustain this publicity. The media can help it attract clients.
Meanwhile the HMRC (i.e. Human Resource Management Consultants) not only helps the company hire its workers and staff (such as waiters / waitresses, cooks, accountants, cashiers etc.) that will staff the restaurants and help conduct its business but this division also ensures that smooth communication exists between staff and management so that each is able to communicate with one another in a feasible and facilitative manner so that the business outcome is achieved.
Finally Companies House, which is the United Kingdom Registrar of Companies, approves of ABC Limited, sees that it fulfills all the requirements of the Registry and includes them on their list of credible and credentialed businesses. Again, the loop continues in that customers, workers, and media acknowledge the business as a government approved enterprise.
In this way, both internal and external divisions are linked and mutually serving and dependent in that both categories fold back on one another and work superbly with one another (or rather they should) so that the objective, vision and mission of ABC Limited is realized and that the business can become a successful venture enterprise.
2. Overview of the Accounting Function under Review
The payroll department will be the department to be reviewed.
The restaurant is headed by Mr. Chan. As a small company limited, ABC Limited has one company accountant, Mr. Lee, who records the payroll, sales ledger, purchases ledger, and petty cash accounts on a daily basis. Although Mr. Lee does not possess accounting qualifications, he does have some basic knowledge of accounts.
ABC Limited asks the DD Accountancy Firm to act as professional accountants for the company in order to audit their firm, to prepare their yearend accounts and financial statements, and to submit their VAT Return and Annual Return. The DD Accountancy Firm is a Chartered Certified Accountancy Firm and providing professional accountancy services to the clients.
All Restaurant Managers of each of the three ABC Limited restaurants have to send a daily sales report to Mr. Lee through email at the end of every night shift. All the invoices received by the suppliers are kept in the file and have to be paid every 10th day of the month. For example, all the invoices for the month of April have to be paid on the 10th of May. Mr. Lee sends all the invoices to DD Accountancy Firm on a quarterly basis in order to submit his VAT Return.
The working hour record sheets for the staffs have been sent to Mr. Lee on Wednesday of every 2 weeks and who then processes the required payroll. Mr. Lee, consequently, reports to the director who checks all the payments. If the director agrees with the conditions of the payment, Mr. Lee prepares the pay packets for the staff and keeps it in his drawer. The staff salaries have been paid by cash.
Within the company, ABC Limited uses two main types of software. These are Microsoft Excel and Microsoft Word 2010. The company use Excel to keep inventory levels up-to-date. Microsoft Word is also used to produce a template for invoices
Mr. Lee and company have access to involuntary invoices. They are limited. He can also create spreadsheets.
3. Financial Statements
The organization produces three types of financial statements:
Firstly, they produce the income statement. The income statement provides information on the operation of the company, which reports on the company’s income, expenses, and profits over the year.
Secondly, they produce a statement of financial position. The statement of financial position reports on a company’s assets, liabilities, and ownership equity at a given point in time.
Finally, they produce a cash flow statement. The cash flow statement reports on a company’s cash flow activities, particularly its operating, investing and financing activities.
The company produces these financial statements to create a set of accounts which can then be used for multiple purposes. For example owners and managers use these financial statements to make important decisions relating to actions to increase profit or reduce the cost of sales. Also HMRC will need these financial statements as they will need to determine the accuracy of taxes and other duties declared and paid by a company.
4. Regulations
The company has Food & Safety regulations, Health & Safety regulations and Licensing laws for serving alcohol on premise. There is the Food Law Code of Practice (see Food Standards Agency http://www.food.gov.uk/enforcement/foodlaw/foodlawcop/) and the Food Hygiene Regulations Act (2006). These are the main Restaurant Licensing Laws (or regulations specific to the industry).
It also has to adhere to the requirements of the United Kingdom company law which regulates corporations that have been formed under the Companies Act 2006. Company Law or corporate law can be broken down into two categories:
1. Corporate governance which concerns the rights and duties of ABC Limited amongst its shareholders, employees, creditors and directors
2. Corporate finance which concerns the money raising options of managers and stakeholders of ABC Limited. They have two options: a) Equity finance which is really the traditional method of issuing shares to build up a company’s capital. (b) Debt finance — which involves getting loans usually for a fixed annual interest. (Kraakman et al., 2009).
Aside from that, of course, ABC Ltd. Also has to comply with the UK Generally Accepted Accounting Principles (GAAP) which regulates both accounting standards and UK company law and states how company accounts must be prepared in the United Kingdom.
The FRSSE (Financial Reporting Standard for Smaller Entities) is particularly relevant for the ABC Limited — a small restaurant — which would likely follow these regulations more that it would those of the SOX which is for larger entities.
ABC too has to have an accounting system which accurately illustrates both its internal and external system. Externally, it serves for tax reasons and for bank officials who have been approached for a loan as well as to show its stakeholders accounts of its business and to help it regulate its own internal and external operations. The external audit too serves as record of the company’s accountability and integrity. As regards tax, it is accountable to HMRC which is the Tax Office (H M. Revenue & Customs).
Internally, the audit helps in terms of data protection by seeing whether it loses data or needs to protect its data better. The internal purpose also helps the company assess possible seepage of money from business due to internal fraud such as employees stealing, or wasting proceeds from Company. Studies show that internal business fraud losses average 6% of all U.S. business revenue a year. This is a lot of money for a company to lose!
The company too has to follow the anti-discrimination law in its hiring, treatment of, and compensation towards its workers. The main requirements are in the Employment Equality Regulations which emphasizes fair treatment to all regardless of sexual orientation, religion or belief and age. The Equality Act 2010 and Disability Discrimination Act 2005is an elaboration. The company has to hire and retain workers based on merit rather than on external conditions.
The company pays the staffs to meet minimum wages according to their ages and follows the Race & Equality Act.
In this case, there would be no audit as the company income is less than £6.5 million and gross assets are less than £3.2 million. It is therefore more likely that the company would abide by the FRSSE (Financial Reporting Standard for Smaller Entities) rather than the Sarbanes-Oxley. The spirit of the regulations is, however, similar.
* see question
The Sarbanes-Oxley (SOX) refers to the bylaws passed in 2002 that ensure that accountants keep to six key articles (their responsibilities; the public interest; Integrity; Objectivity and Independence; Due Care; and Scope and Nature of Services i.e. that services should be provided with competence and diligence and practitioners should be devoid of objectivity).
Transgression of the SOX can be severely punished with accountant losing his job, being fined and receiving imprisonment.
As control to the 6 Articles, the SOX deals with issues of auditor independence (where auditor has to be objective and detached from personal interests), corporate governance, internal control assessment (where an outside body evaluates audit in order to ensure objectivity), and enhanced financial disclosure (where extra laws have been added regulating aspects of financial statements that have to be disclosed in order that it is the public who is best served in all issues rather than the corporate firm or the accountant.) (Investopedia )
ABC Limited often checks the government website to monitor for changes, and changes are implemented by the company informing the staff at the meeting and making sure that changes are in effect from a certain date.
ABC Limited uses the Performance measurement appraisal in order to evaluate the performance of its company in various factors and in order to see whether programs, investments, and acquisitions are yielding their desired outcome. It also measures its performance against the Key Performance Indicators (KPIs) that measure economic, environmental and social performance. The dimensions of their performance analysis are divided into two sectors:
1. What — the business results
2. How — how personnel accomplish their tasks
The objectives of the annual Performance appraisal are in order to determine the steps that should be taken the following year to develop their goals and to review outcome of their goals during the past year.
ABC Limited uses this appraisal to credit and reward commendable conduct and to coach restaurant managers so that they can maximize performance the coming year.
The performance management system is itself a consistent process of daily, weekly, monthly, and annual reviews broken into smaller and larger segments depending on whether it is done at the end of a term or year, or as a regular event (Ballou et al., 2009)
SWOT Analysis
Strengths
The company has a small business management which holds communication in place and enables commination to be direct and as error-free as possible between the three restaurants. It also has a simple way of managing its accounting operations which reduces error. The relative smallness of the company makes workers potentially feel more wanted, can be attractive for clients and stakeholders, and can help company run their affairs in a less complex, therefore, more direct, faster, and error-free way.
Weaknesses
The company’s accounting system seems somewhat insecure in that petty cash can be easily pilfered from Mr. Lee’s drawers
Moreover, there seems to be insufficient controls in place or insufficient controls to check that workers and managers do their work effectively.
The company can also benefit from a computer / data network.
Opportunities
This is the age of technical breakthroughs and proliferation of technology which makes it cheap. The company can invest in technology to publicize their place. They can also set up an online system to attract people to their place online, and set up a software system (such as SAP) to guide their accounting.
There are also always opportunities for restaurants in Britain, as long as they fill a desired spot and provide corresponding price and quality.
Threats
The hash of business scandals in England during the last two decades has made government all the more stringent regarding integrity of businesses. Added to that is the current concern over healthy food and over other food concerns such as organic specification, vegetarianism, and other dietary concerns that have become much more scrupulous in recent years. Safety of place and regard for worker’s welfare has also become more pronounced. All of these cut into the expenses of ABC Limited and can be threatening to its enterprise in terms of its profit-making capabilities.
Brittan too has a glut of restaurants.
See Appendix, fig. 2 for Table.
5 Review of the ABC Limited system
5.1 System requirements
All the stocks are controlled by an Excel spread sheet which makes it easy to add up the figures, to control the cash flow and to export to external accountants who can then prepare the year end accounts. Anyone from management can access the spread sheet easily to get the information when Mr. Lee is away from the office. On the other hand, anyone too can change the data easily by mistake.
As regards the hardware and software, all the computers are standalone basic with windows 7. The computers are operated with Microsoft Office 2010 and Norton Anti-Virus to protect the computers from the risks. There is an alternative, which is a quick and simple way of producing invoices, with either software called Sage Line 50 or QuickBooks. QuickBooks is a relatively cheap (£143) and has all the tools to create and raise invoices, or there is Sage Line 50, which is more expensive (£714); however this includes a tool that is able to control stock levels as well.
The staff are fully competent in using excel spread sheet.
The business has created the following contingency plans: As the computers are standalone basic, the company keeps a hard copy of the records, too. The company is also linked to the job agency to get the temporary staff on short notice for big party or lack of staff due to the sickness.
The system is used to its full potential.
5. WEAKNESSES
The weaknesses of the accounting system are tabulated in the Appendix (fig. 3).
To summarize: There is insufficient security in regards to the handling, filing and distribution of pay packets. Anyone could just pick up their pay pack as the office has no lock. There is a high risk of potential fraud since anyone could pick up someone else pay packet and the company would lose money unnecessarily. This would also lead to wastage of hours in dealing with this problem.
Secondly, the payroll is inadequately qualified for the role. Mr. Lee has admitted he is the only employee who knows basic knowledge of Payroll system. When he was on holiday, there was no one to step in and solve the problems. If Mr. Lee prepared the payroll in advance, there would be a lot of adjustments to be made which could lead to further errors. These errors will result in incorrect income statement figures, leading to misstated accounts. This means tax calculations will be incorrect resulting in fines from HMRC and late payment fines.
Thirdly, there is a lack of recording regarding responsibility of salesperson for their particular commissions. This, technically, could be an unlimited cost, because if sales people catch on to this fact they may engage in fraudulent behavior.
Finally, there is no control of work.
In total, the company can lose a lot of money.
Potential Fraud
The petty cash control is at high risk since anyone can open the tills with large amount of cash inside. Cash might be missing. The company as yet has no fraud detection policies/procedures in place.
As prevention, CCTV should be used near the tills, and cash receipts should be recorded regularly. The tills should be opened with manager’s personal password and all the cash payment should be taken by the managers. The managers, too, should change the personal password periodically. All the managers need to check X-reading which shows end of shift sales before the next shift starts.
The only way the fraud can be detected if it already happened is from he company’s financial statement which statement also serves as ‘internal audit’ in that it assesses possible seepage of money from company due to internal fraud such as employees stealing, or wasting proceeds from Company.
In order to ensure that they are compliant with legislation, ABC Limited uses working regulations of maximum 48 hours and minimum wages of £6.19 for the adults. The performance appraisal that was described before can be put in place to serve as control for compliance.
6. Recommendations
The recommendations of the accounting system are tabulated in the Appendix (fig. 4).
To summarize: Pay packets should be electronically sent out to each employee, and the money deposited into the bank accounts by BACS on a monthly basis. Mr. Lee therefore would just need to calculate wages only once a month. This would simplify the system and minimize possible errors. Mr. Lee and General Manager too should receive a day of general training. This would greatly decrease errors, as no one would be able to pick up other peoples pay packets.
As the payroll, too, would run once a month instead of bi-weekly basic, Mr. Lee would have more time to concentrate on other accounts duties.
Staff will be trained in using Sage Roll greatly decreasing the number of mistakes. In fact, the company could be saved approx. £505; if not more depending on how many times the mistake may have occurred. Clock cards system should be implemented. This would ensure honesty of performance aside from saving company many hours of wages, potentially in excess of £1,500 per year. Finally, payroll should be processed using Sage Payroll software which is better recognized by HMRC. This would enable figures to be more elaborate.
For elaboration on recommendations, as well as details of cost and implementation see Fig. 4 in Appendix.
APPENDIX
Fig. 1. Accounts Department of ABC Limited
ABC Limited
Mr. Chan
Director
Mr. Lee
Company Accountant
Restaurant C
Manager
Restaurant B
Manager
Restaurant A
Manager
Fig. 2 SWOT
Strengths
Weaknesses
relative smallness of the company makes workers potentially feel more wanted, can be attractive for clients and stakeholders, and can help company run their affairs in a less complex, therefore, more direct, faster, and error-free way.
The company’s accounting system seems somewhat insecure in that petty cash can be easily pilfered from Mr. Lee’s drawers
There seems to be insufficient controls in place or insufficient controls to check that workers and managers do their work effectively.
The company can also benefit from a computer / data network.
Opportunities
Threats
This is the age of technical breakthroughs and proliferation of technology which makes it cheap. The company can invest in technology to publicize their place. They can also set up an online system to attract people to their place online, and set up a software system (such as SAP) to guide their accounting.
There are also always opportunities for restaurants in Britain
The hash of business scandals in England during the last two decades has made government all the more stringent regarding integrity of businesses. Added to that is the current concern over healthy food and over other food concerns such as organic specification, vegetarianism, and other dietary concerns that have become much more scrupulous in recent years. Safety of place and regard for worker’s welfare has also become more pronounced.
Fig. 3. Weaknesses of accounting system of ABC Limited
Weakness
Implication
Pay packets: There is not enough security with the handling, filing and distribution of pay packets. Anyone could just pick up their pay pack without any questions about it as the office has no lock
High risk of potential fraud, anyone could pick up someone else pay packet and the company would lose money unnecessarily. This would also lead on an unnecessary waste of hours dealing with this problem.
DR Wages £45
CR Bank £45
Payroll aren’t qualified enough for the role: Mr. Lee has admitted he is the only employee who knows basic knowledge of Payroll system, When he was on holiday, there was no one to step in and solve the problems. If Mr. Lee prepared the payroll in advance, there would be a lot of adjustments to be made; this could also lead to more errors.
Therefore because of these errors, there will be incorrect income statement figures, leading to misstated accounts. This means tax calculations will be incorrect leading fines from HMRC and late payment fines as well.
DR Fines £600
CR Bank £600
Sales commission: No recording of which salesperson is responsible for what commission.
DR Wages £2,000
CR Bank £2,000
This, technically, could be an unlimited cost, because if sales people catch on to the fact they can get away with it then they will continue to participate in this fraudulent behavior.
This could be potentially added up to lot of money being paid out. Aside from which, no one is checking his work.
Fig. 4 Recommendations
the solution
Benefit
Cost
Implementation
Pay packets should be electronically sent out to each employee, and the money deposited into the bank accounts by BACS on a monthly basis.
Mr. Lee therefore would just need to calculate wages only once a month. This would simplify the system and minimize possible errors
Initially there would be an email sent round to all staff that these changes will be implemented from a certain date, and then they should all be given a work email address if they already haven’t got one, and then the e-pay slips would be sent directly to this email address.
Training: Approximately 1 day of training for Mr. Lee and General Manager
There would be a huge decrease in errors, as no one would be able to pick up other peoples pay packets.
As the payroll would run once a month instead of bi-weekly basic, Mr. Lee would have more time to concentrate on other accounts duties.
£180 approx.
Both Mr. Lee and GM would be informed. Coach would be hired. Training would be evaluated.
Staff will be trained in using Sage Roll
This would decrease the number of mistakes, and time making adjustments to correct errors would be reduced and cost effective. The company could be saved approx. £505, plus more depending on how many times the mistake may have occurred. The benefit of this would be the exclusion of errors in the future.
The course would cost £1,525 plus books at £90 for each person, but to save costs he could study distance learning course which costs £780 including books for each person.
Employees would be put on an AAT level 2 course. Therefore, as well as receiving basic double entry lessons, there is a unit that teaches specifically about Sage and Payroll so would be useful for the employer as less mistakes would be made.
Clock cards system should be implemented. All staff would have a card that lets them in and out of the building, which notifies a system that record who it is and when they entered and left the building.
The benefit would be that no longer would staff be able to lie that they had done XX hours of overtime. This would save many hours of wages, potentially in excess of £1,500 per year as the system would not have to replaced or maintained often.
To implement this system for such a small company cost £540 (£180×3) for all the restaurants. Training would be needed for maximum of 30 minutes of time for all 30 members of staff. This approximately totals £120.
Training would take place for 10 minutes for each restaurant, explaining to staff when this will come into effect and how to use the swipe cards. An email would then be sent out reminding a staff of the upcoming change of policy.
Instead of payroll being processed by Excel spread sheet, payroll should be processed within the company using Sage Payroll software which is better recognized by HMRC.
The figures would be more accurate.
Sage 50 Payroll Professional software costs £726. And the staff can learn by using self-study workbook packages for only £150.
No immediate action required. The company should encourage Mr. Lee to learn sage payroll software as soon as possible. So that the company could use the software very soon.
References
AICPA (2011) Code of Professional Conduct
and Bylaws
http://www.aicpa.org/research/standards/codeofconduct/downloadabledocuments/2011june1codeofprofessionalconduct.pdf
Ballou, Brian, Heitger, Dan L., and Schultz, Thomas D., (2009). Measuring the costs of responding to business risks. Management Accounting Quarterly. http://findarticles.com/p/articles/mi_m0OOL/is_2_10/ai_n31641694/?tag= rbxcra.2.a.44 DeBusk, G.K., & DeBusk, C. (2011). Has you accounting department evolved?: Accounting and the use of lean six sigma. Cost Management.. Vol. 25, Iss. 3; pg. 15. http://proquest.umi.com/pqdweb?index=8&did=2390884621&SrchMode=1&sid=8&Fmt=4&VInst=PROD&VType=PQD&RQT=309&VName=PQD&TS=1315215394&clientId=29440
Gjerde, Kathy A. Paulson & Hughes, Susan B. (2007). Tracking performance: when less is more Management Accounting Quarterly. http://findarticles.com/p/articles/mi_m0OOL/is_1_9/ai_n31141879/?tag=co ntent;col1.
Investopedia Definition of ‘Sarbanes-Oxley Act
http://www.investopedia.com/terms/s/sarbanesoxleyact.asp#axzz2FJsI2Jnz
Webster WH (2003) Accounting for managers New York: McGraw-Hill
Wild, JJ, Shaw, KW., & Chiappetta, B (2009) financial and managerial accounting McGraw Hill
R Kraakman, J Armour, PL Davies, L Enriques, H Hansmann, G Hertig, K Hopt, H Kanda and E. Rock, The Anatomy of Corporate Law (2nd edn OUP 2009)
D Kershaw, Company Law in Context (OUP, Oxford 2009)
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