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Chic Paints Ltd

‘’This is a report analysing the internal controls in place and evaluating the accounting system’’

Student Name: William Jordan

AAT Number: 20009737

I testify that the following report is my own unaided work and a true reflection of the organisation.

Signed: Dated:

Page | 2Table of Contents1. Terms of Reference.....................................................................................................................3

2. Executive Summary.....................................................................................................................4

3. Methodology..................................................................................................................................5

4. Introduction to the Organisation..............................................................................................6

4.1 History........................................................................................................................................6

4.2 System Overview.....................................................................................................................6

4.3 External Standards and Regulations.....................................................................................6

4.4 Significant Stakeholders of the Company.............................................................................7

5. Information on the Accounts Personnel and Department ...............................................7

6. Review of the Accounting System...........................................................................................8

5.1 Training......................................................................................................................................8

5.2 Working Methods and Practices.............................................................................................8

5.3 Record Keeping Systems........................................................................................................9

7. Ethical Evaluation of the Accounting System.......................................................................9

9. Internal Controls and Analysis of Fraud...............................................................................10

9.1 Internal Systems of Control...................................................................................................10

9.2 Analysis of Fraud....................................................................................................................11

10. Recommendations to Improve..............................................................................................11

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1. Terms of Reference

This report examines the accounting system that is currently utilised by Chic Paints with respect to constructing recommendations to develop and evolve the system and the controls in place to safeguard it, as well as to moderate the system’s exposure to fraud.

Primarily, this report will investigate the systems in place at Chic Paints, but as well as this the report will give an overall insight into the company and how imperative the system’s information is to the company as a whole. Furthermore, significant stakeholders, both internal and external, are very important to companies so this report will look into the requirements of them. Recommendations will also be discussed to make improvements to the ethical and sustainability issues.

The costs and benefits are imperative to making recommendations on making improvements with a company’s internal systems, so these will be analysed along with the potential risks to Chic Paints in terms of fraud.

The aim of this report is to complete the learning outcome required to complete the Internal Controls and Evaluating Accounting Systems Paper in accordance with AAT Level 4 Diploma in Accounting.

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2. Executive Summary

This report evaluates the accounting system of Chic Paints Ltd and the internal controls with recommendations on how these can be developed and improved to safeguard the company. By improving the internal controls this can help provide provision to the accounting role by diminishing the threat of fraud and safeguarding the operations used within the accounting function to work appropriately, efficiently and also so that the controls are adaptable to changes within the environment and industry that Chic Paints Ltd operates in. The fundamental outcome from this report is that the company invests in a more reliable sophisticated accounting software package rather than the Microsoft package currently being used which is simply does not safeguard the company. In addition to this, training should also be funded so all staff comprehend the system sufficiently enough to improve the company’s internal controls.

By realising the improvements and recommendations advised in this report, Chic Paints should see many positive influential changes to the whole accounting function. Not only will the reporting of the company’s finances become much more user friendly to staff, the ability to improve the working capital cycle will also make the company much more liquid as the new system will improve the credit control system which increases cash inflow. Staff morale will also increase as employees become more engaged with the company through training courses which adds to Chic Paints intangible assets and also possibly most importantly, the improved internal controls will minimise the risk of fraud.

The company still refrains from using BACS payments as much as possible for both suppliers and wages so a further recommendation in this report is that the new system must integrate the ease of use of BACS payments to pay all staff and suppliers where possible, curtailing the reliance on cash and cheque payments which are often the main cause of fraud, and paying immediately into suppliers and staff bank accounts in turn improving controls.

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3. Methodology

To enable research and gather information to structure this report many source where used, these sources can be see below.

To research around improving internal control and systems many reference books and online content was reviewed.

To discover the efficiency of the accounts department within Chic Paints, staff from other departments where asked several questions via a questionnaire to see what issues have arisen from the current accounting function and find out ways to improve this.

As a result of the questionnaire, by basing the results over a substantial period of time, more accurate results could be produced ultimately meaning a thorough review of the company’s strengths, weaknesses, opportunities and threats.

Integrity, objectivity, confidentiality and professional behaviour are all main principles behind a company’s ethical values and these were used to analyse the company’s ethical accounting systems and controls.

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4. Introduction to the Organisation

4.1 History

Chic Paints Ltd is a large manufacturing company which now focuses on producing in the niche market of specialist paints for cars, boats and industrial machinery. It is a limited company which underwent a management buyout six years ago. Strategic plans have meant a massive shift in philosophy where previously the company manufactured many products as a conglomerate including household paints which resulted in huge competition from competitors and resulting in low profit margins.

Due to a change in philosophy, six years on from the management buyout, the company’s turnover has progressively declined 40% from £200 million to £120 million, but on the contrary, the gross profit margins have risen from roughly 12% to around 30%. Staffing levels have also been cut 30% from approximately 500 employees to 350 and the company has seen a rise 25% in its net assets from £20 million to £25 million.

4.2 System Overview

The accounts system currently being used by the company is a centralised system. There are eight computers in the accounts department with every full time employee having their own personal computer, and part time employees having to share PC’s.

The main accounts system used by the accounts department is Microsoft Office 2010 Excel spreadsheets, which allows the staff to record and accounts for all the transactions which take place. On top of this, the accounts department incorporate an inventory control system which monitors the receipts of goods into the company’s warehouse and issues out to the various production capacities.

Furthermore, with the company being manufacturing based, costing systems are implemented to help the company review monthly figures. A stand-alone full absorption costing system was installed three years ago, along with a more traditional standard costing and variance analysis system.

A Sage 50 payroll system is also used by the company.

4.3 External Standards and Regulations

The Companies Act 2006 – The Company must abide by this rule which sets the standards for the preparation of the financial statements.

UK Accounting Standards – These provide more distinguished standards for the company to follow in order to prepare the financial statements.

International Accounting Standards and International Financial Reporting Standards are also regulations which are mandatory for the company to accept.

The Data Protection Act safeguards the company’s use of personal information whether it is customers, suppliers and employees. The systems used by Chic Paints must be capable of storing this sensitive information confidentially and not misused otherwise various fines and penalties will be charged to the company.

Late Payment Law means the company must not deploy procedures to defer payments to creditors beyond acceptable periods.

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4.4 Significant Stakeholders of the Company

Internal stakeholders are groups that are a part of Chic Paints or staff who work specifically for the company, such as employees, directors, and shareholders. Employees have a high interest to receive high wages but also to be motivated in their job and most importantly to have security in their jobs. Shareholders are concerned with the company maximizing the profit that the company produces as this means they will be able to receive a substantial rate of return on their investments through dividends.

External stakeholders are organisations separate from the company or people who are not directly working within the company but are influenced in one way or another from the results of the company, such as customers, suppliers, creditors, community, and the government. The government wants the company to pay its taxes correctly and on time, employ more staff in order to improve the Governments income tax it can receive and also to reduce unemployment figures, abide by all government legislation changes, and honestly account for its financial state. Although the company does not sell to the general public, the manufacturing and repair companies have an interest with the business to create superior specialised paints at much more affordable prices. They will want the company to issue respectable credit terms, financial information such as monthly statements, price lists and changes in paint prices and also how much of a credit limit they will receive before the account is put on stop. Suppliers have a vested interest to make sure that the company want to remain buying their goods and services and they are paid on the agreed credit terms, the main suppliers of Chic Paints are producers of paint pots for the paint to go into.

5. Information on the Accounts Personnel and Department

There are several members of staff that are employed by Chic Paints Ltd. There is the Finance Director, Dave Whistler, who has a 25 per cent stake in the company and is responsible for the end of year reports and also the statutory accounts. In addition to this he is also employed for all accounting, finance and legal issues. Despite this, he believes in using delegation practices to control the accounting department, and as such many of these issues are delegated to the Chief Accountant, Hazel.

The responsibilities undertaken by Hazel are predominantly the day to day running of the department, by supervising the entire accounts clerk employed by the company. She also produces monthly management accounts, which are signed off by the Finance Director, and consequently reviews the variances which are then discussed with the various other departmental managers. She produces the annual budget for the company, but this is created on a bottom up basis with the departmental managers having an input which can mean bias in the budgets with conflicting interests from manager to manager. Finally her other major role is to ensure that the company has a good working capital cycle and that it is maintained to the level set by Dave Whistler.

There are five members of staff which report to Hazel. The accounts payable clerk, who enters all the supplier invoices and credit notes on the payable ledger and reconciles supplier statements in order to control creditor payments. The accounts receivable clerk, who raises sales invoices and credit notes, chasing debtor’s that become overdue on the sales ledger but due to weak systems this has to be exported to a spreadsheet, and setting the credit limits and checks on potential new customers as this has been delegated by the Finance Director. The general ledger clerk who enters all the necessary data straight to the general ledger, he also produces all the monthly provisions, prepayments, accruals and inventory provisions to the Chief Accountant, as well as maintaining the cashbook and petty cash. The costing technician, who costs all products and declares the minimum selling prices for the sales team based on the costs. Finally, the payroll clerk, who runs the monthly payroll for salary paid staff and weekly payroll for hourly paid staff and also for issuing the mandatory HMRC tax forms.

See Appendix 1 for a diagram of how the companies accounts department is structured.

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6. Review of the Accounting System

This report will study the systems deployed by CPL in the accounts department and how weaknesses and threats can be improved by using a SWOT analysis. This piece of the report will investigate the system in place, and take into account the financial information that the stakeholders of the company require from the current accounting system, and whether or not the current system is meeting these requirements of the stakeholders, and the rest of the employees of the company.

5.1 Training

In respect to the SWOT analysis in Appendix 2, the main points in regards to weaknesses are;

Some staff do not having any relevant formal qualifications for the job they are doing, such as the receivable clerk, and as a result control procedures within the sales ledger side of the accounts seem to be failing, on top of this staff may not feel quite as motivated to do their job and as such this may lead to a lack of accountability within the accounts department.

A lack of expert cover due to not training all staff to cover jobs in the accounts receivable department means that when other staff members help out it becomes a slow procedure due to lack of experience on the systems being used and consequently this is causing unnecessary overtime expenses and also staff that cover the work are then not being able to complete their own workload on time.

The staff within the accounting department lack specific training qualifications for the systems that are used specifically the main financial accounting system which operates using Microsoft Office spreadsheets to record all transactions; this increases the risk of mistakes and errors.

5.2 Working Methods and Practices

The systems in regards to IT in Chic Paint’s accounts department consist of eight computers which mainly run on a stand-alone basis running independently from each other and each full time accounts personnel having their own personal computer. The accounting system uses Microsoft Excel spreadsheets which includes an inventory control system. Sage Payroll is used to maintain the payroll system.

Weaknesses in the working methods and practices within the systems at Chic Paints which can be seen in the SWOT analysis from Appendix 2 are;

Over worked credit controller due to too much time being spent on ledger work means a lack of time to do credit control procedures and that overdue customer accounts are not being managed efficiently enough and this will cause serious cash flows problems in the future as many companies may not pay their debts until they are chased for payment, this is a distinct lack of communication as there is no control over when staff are becoming overloaded with work.

The system are supposed to be backed up every day, however, the company loses ledger work as these methods are not being put into practice often enough this was realised when the company suffered a power cut.

With the company using manual systems for doing all transactions within the accounts department this is very inefficient and could potentially lead to mistakes, even more so when staff are either absent or need to be covered due to simply having too much work to do.

Despite the current systems using moderately user friendly software such as Microsoft Office, this can be very time consuming due to a lack of integration with the rest of the systems and as such work becomes very delayed and due to the this system having no extensive controls this increase the risk of major mistakes in the accounts

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The need for overtime in the accounts department shows that the current systems like any sort of contingencies when work suddenly increase, this is due to a lack of control in the planning of the work.

5.3 Record Keeping Systems

Detailed in the SWOT analysis in Appendix 2 are the main weaknesses of the record keeping systems and the points include;

The heavy dependence on the cheaper Microsoft Office software for all transactions means that mistakes could go completely unnoticed and many staff within the accounts department seems to lack the relevant skills to become competent with this system

Unusual records were found within the general ledger which were not authorised by the required staff, so there is a distinct lack of security and control over the accessibility of the systems, this could have gone completely unnoticed and as such the main hub of the financial data would have material misstatements

The inventory records in the system were overstated to that of the physical stock; this could have led to the company’s profits being distorted.

Due to staff being over worked many transactions affecting the ledgers are not completed on time, this could lead to mistakes as staff may rush to catch up with work and not take care when recording these transactions

7. Ethical Evaluation of the Accounting System

In this report is a review of the potential breaches of the accounting system and as a result best practice recommendations have been made in order to reduce the risks of this happening. The findings can be found in Appendix 4. The main points that can be summarised from the findings are;

Supplier payments are being delayed at the time when management accounts are due to be issued to various stakeholders and as a result this window dresses the accounts by improving the company’s bank balance and making the company seem more liquid and ultimately more attractive to potential investors, this is a breach of integrity in the ethics code of practice.

Due to a worsening situation in the company’s debtors days the credit control procedure has being extremely tightened and clients are being hassled for payment after just ten days overdue, and with a very loyal regular customer base this is not offering a professional service especially when in an economic recession and customers may leave the company.

Despite procedures in place in the payroll system to only give pay packets to the specific individual, due to a high work load and ease of use, the payroll clerk has decided to make her life easier by giving pay packets to other members of staff to give to the relevant person, this is a breach of ethics as it is a conflict of interest in business relations.

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8. Sustainability Review of the Accounting System

Detailed in Appendix 5 is a review of the sustainability findings of the Accounting System. The main focal points of this are;

The mission statement of Chic Paints Ltd says that it will attempt whenever possible and feasible to focus on sustainability by acting in an environmentally friendly way by using recyclable materials in all products, but despite this there does not seem to be any sort of company procedures and policies for employees to adhere to and as such this does not reflect the true internal systems in place. As such this needs looking into to enable all employees to be able to bring this statement into fruition. Recycling paper, ink cartridges and plastics as well as turning off all unused electronic devices are all ways in which the company can become more sustainable.

The company is currently operating in a supplier market where new biodegradable materials are becoming available at a slight premium of 20 per cent more than the products currently used. Although it is understandable that they did not follow this up with a purchase due to the need of reflecting this in the selling price, it is important that in the future the company does it’s upmost to purchase these materials when possible.

The company agreed to sponsor Ashton Wanderers by paying for a full team kit, however due to the team’s poor performance they decided to pull out of the sponsorship. This is a major social responsibility issue because local sports teams are at the heart of societies and by not funded the team this could have a negative impact on the income to the team.

9. Internal Controls and Analysis of Fraud

9.1 Internal Systems of Control

The internal controls set up at Chic Paints have been created to be adhered to at all times; the policies set out are very strict and formal, but despite this, many staff have evolved to work around these policies.

The SWOT analysis in Appendix 2 details the weaknesses of the internal controls and fraud. These points predominantly focussed on;

Credit control - The Company only uses a credit reference agency to get reference on a company but despite one reference being referred it was found that the credit controller issued the credit limit at two thirds higher due to controls allowing this to be done. Only having one control in respect to credit control is very risky to potential debts.

Access – A complete lack of control managed to lead to an unauthorised member of staff accessed the general ledger due to the system not having a list of authorised access users set up, all accounts staff without knowledge of this had access to the general ledger.

Authorisation – A lack of strong authorisation process means that despite all cheques requiring countersignatures from a director, the Chief Accountant often has problems persuading them to counter sign the cheques, this leads to cheques becoming left unsigned for a period of time.

Cash – There is a distinct limitation on controls in respect to cash in the company as around a quarter of the hourly paid production workers are still being paid in cash despite the remainder being set up to be paid directly in their bank accounts via BACS. Large amounts of cash are withdrawn from the bank the previous day to pay wages meaning cash is kept on the premises overnight.

Debt recovery – Debt collection procedures are generally not followed up further than phone calls, emails and letters due to prioritisation on ledger work, this often leads to debts building up over time and even not recovered.

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9.2 Analysis of Fraud

There is a wide range of potential frauds that may become apparent amongst the internal systems that are implemented at Chic Paints and ultimately procedures must be put in place in order to prevent these from occurring.

The SWOT analysis in Appendix 2 details the weaknesses involving potential fraud as;

Many members of staff are still being paid wages in cash and this will increase the risk of theft of money if another employee manages to get hold of the pay packet. Also, if the company continues to pay staff wages with cash, this could potentially lead to discrepancies between how much money has been paid physically and the amount shown on the Sage Payroll and this is likely to happen either by mistake or by staff coming to a secret agreement. Furthermore, there is a lack of control in the payroll system as the company gives Sage 50 access to the human resource department; this is risky because it is possible for an imaginary employee to be set up and consequently another employee could set up their own bank details in order to receive payment when wages are processed. The main accounting system is not integrated with the payroll system and as such this requires journal entries to transfer the payroll costs, as a result, this could mean that journal entries are not correct and if no reconciliation is completed between the system it may mean more wages could be paid to what has been journaled to the wage nominals.

All these possible frauds, the controls implemented and the recommendations to solve these issues are detailed in the fraud matrix in Appendix 3. The level of risk is also detailed in this.

10. Recommendations to Improve

In order to eradicate the weaknesses identified in the SWOT analysis in Appendix 2 there are numerous recommendations that can be applied.

First and foremost the first recommendation is to sacrifice speed and low costs and purchase a more refined integrated accounting package. For this to come to fruition the account department will require an IT specialist to re network all the eight computers in the department so that they can all run and access the same shared files, password protected. This would eliminate the reliance on spreadsheets, journals from the payroll system and manual calculations. This is beneficial as the company would have direct integrated accounting records. Consequently by doing this the accounts staff should become very engaged and thrive at the opportunity to learn new skills whilst learning the new system in place via training courses, ultimately boosting staff morale and motivation.

Too few employees in the accounts department have formal accounting qualifications and as such the company should allow staff to attend courses in order to complete these relevant qualifications, by doing this staff will be more motivated to learn in their workplace and will also feel value by the company. Not only this but by studying these technical courses it will teach the staff how to implement and understand the importance of internal controls and this eventually will benefit the company with improve appropriate controls.

Staff meetings should become a regular occurrence, this is because it would allow all accounts staff to analyse and plan how to work more effectively in the future, figuring out and discussing who can cover who in terms of absences and work overload will mean all jobs which are a priority will be completed within the required deadlines. Ultimately this should improve staff morale and in turn improve efficiency as they will have the comfort of knowing if they have too much work to do then the workload can be shared.

With the introduction of the new integrated accounting software it should become a priority to retrieve all suppliers and employees bank details to enable as many BACS payments as possible for both wages and payment runs, by implemented this, cash, apart from in petty cash, should become more or less not existent in the company and ultimately this is going to benefit Chic Paints as it will massively reduce the risk of fraudulent activities in the company.

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The company must put more emphasis on doing more credit checks on new customers before they are granted a credit limit, this can be done by asking new customers for credit references, once these have been provided the credit controller must ring these reference up to learn the new customers credit history. This will consequently benefit the company as will be mean the company reduces it chances of bad debts as credit will only be offered to customers who have a good credit history and are more than likely to pay their accounts on time.

The company has an ethical issue in that the payments to suppliers are delayed at the quarter end to improve the company’s position at the bank. By introducing the integrated accounting system this will enable the accounts department to produce enhanced financial reports. In terms of eliminating this ethical issue, by been able to produce cash flow forecasts this will mean the accounts department can plan what money is coming in from debtors and also out to creditors. This will be beneficial as the company can chase debtors easier with the use of an aged debtors list and also pay creditors on time by using an aged creditors list and stop making suppliers very unhappy.

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Appendix 1 - Structure of Hierarchy

Dave WhistlerFinance Director

Hazel Richmond

Chief Accountant

Imran PatelAccounts

Payable Clerk

Xu HinAccounts

Receivable ClerkCredit

Controller

Dan HickmanGeneral Ledger

Clerk

John Thatcher Costing

Technician

Susie James Payroll Clerk

Alan Turner Accounting

Systems Technician

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Appendix 2 - SWOT Analysis

Strengths

Most customers pay by BACS Credit scoring organisation used to grant credit All credit notes are first approved by sales managers Credit control procedures are in place Trial period offered to customers before issuing credit terms Approved list of suppliers BACS payments require authorisation

Weaknesses

Some accounts staff have no accounting qualifications Lack of cover in the department for absences No system training is in place Account receivable clerk overworked Despite procedures, computers not backed up sufficiently Manual spreadsheet system Main system not integrated – time consuming Hard to detect errors in spreadsheet transactions Security settings not set up correctly on general ledger Inventory overstated to actual inventory Basic credit check done with an agency Persuasion needed to get cheques countersigned Some wages still paid cash Basic debt collection Payroll not integrated to main accounting system Two separate departments have access to payroll records

Opportunities

Accounts receivable clerk interested in completing formal qualifications which will help improve internal controls with more technical knowledge

The company is able to perhaps train accounts clerks to do each other jobs, this would cover any potential problems arising from absences

Large proportion of the company’s customer are regular so should be fairly confident of a low debtors days period in the future to help the company’s cash flow

Threats

Sales invoices are only produced when a goods dispatched note is realised, so if goods go out to a customer without a dispatch note not invoice would be produced

Spreadsheets being used for transactions poses a threat because errors can easily be made such as accidently deleting values from the accounts

Use of a debt collection agency when debts are more than 3 months old is likely to alienate large customers and poses the risk of them moving their custom elsewhere.

Not backing up data regularly will lead to the company losing vital data if power goes.

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Appendix 3 – Fraud Matrix

POTENTIAL FRAUD CURRENT CONTROL RISK TO COMPANY RECOMMENDATIONSome employees are still being paid cash

Cash locked in the accounts office safe

High Attempt to retrieve all employees bank details

Discrepancies between cash paid and amount stated on system due to staff agreements

Nothing of note – there seems to be no other member of staff checking the amounts distributed

High Always double check wages using two staff or pay by BACS

Payroll access to HRM department could lead to set up of counterfeit employees or bank details

Nothing of note – Needed for use of maintaining employees records

Medium Unannounced internal auditing of the records regularly will deter any risk of this happening

No integration between main accounting system and payroll system could lead to deliberate errors in the journal entries

Journal are posted to the main system to transfer the payroll runs

Medium Directors or Chief Accountant should do regular reconciliations to prove the physical wages paid tally up to what has been journaled to the wages nominal code

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Appendix 4 – Ethical Review of the Accounting System

CURRENT PRACTICE PRINCIPLE BREACHED RECOMMENDED PRACTICE

A director has instructed that debts that become more than ten days overdue are to be chased even with businesses struggling in a recession

Professional competence and due care

You must maintain professional knowledge and skill to ensure that a client or employer receives competent professional service and by chasing debts that are ten day’s overdue this is not professional to clients

Try to negotiate tighter credit terms with customers, or possibly reduce credit limits

A director has asked for suppliers not to be paid at the quarter end in order to reduce the company’s overdraft

Integrity

Delaying supplier payments in order to falsify management accounts to make them look more liquid is not honest. Integrity is followed by a member by being straightforward and honest in all professional and business relations

Payments should be made when due in order to allow accounts to be prepared in a true and fair light

The payroll clerk is not following procedure to only allow personal collection of one’s own pay packet in order to make it easier for her working day

Objectivity

You must not compromise professional or business judgment because of bias, conflict of interest or the undue influence of others and the payroll clerk is giving pay packets to staff other than the relevant person

Pay packets should be kept in a locked safe or locked draw until the relevant member of staff collects their pay packet themselves

Other members of staff collecting pay packets

Confidentiality

To respect the confidentiality of information acquired as a result of professional and business relationships and, therefore, not disclose any such information to third parties without proper and specific authority, by releasing pay packets to staff this is giving strict confidential information away such as a national insurance number on the payslip

Pay packets should be issued to the individual who is receiving the pay directly regardless of past controls and procedures.

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Appendix 5 – Sustainability Review of the Accounting System

Sustainability issue Observation Recommendations

Corporate social responsibility/environmental

Chic Paint’s mission statement declares that ‘it aims to reduce impact on the environment when possible and to use recyclable materials when feasible’

There appears to be no policies or procedures for staff to follow in terms of keeping to this statement, turning electronic devices off when not in use and recycling all plastics and ink cartridges are all ways the company could adhere to this

Environmental Despite only costing 20 per cent more the company failed to act on buying biodegradable paint pots

When the opportunity arises the company should do it’s upmost to purchase these new products possibly by trying to negotiate bulk trade discounts

Corporate social responsibility The company withdrew their sponsorship of a local football team due to poor performance

The company has a social responsibility to the football team and could be seen as charitable giving, the company should continue to sponsor this until it becomes unfeasible as it could make a big difference to sports in the area.