Accounting System Implemented at Chic Paints Limited

¶ … Accounting System Implemented at Chic Paints Limited

Report submitted in order to fulfil the requirements of AAT Accounting Qualification

Internal Controls and Fraud

Accounting System Review

Weaknesses in the Existing System and Recommendations

Cost and Benefit Analysis

Mapping of report to outcomes and criteria

The purpose of this report is to present the findings of the evaluation of existing accounting system implemented at Chic Paints Limited. Chic Paints Limited hired me as an Accounting Technician of the Company to review the accounting systems of the company and report on the operating effectiveness of the internal controls, and this report explains it.

The report also discusses the results of the evaluation of existing accounting systems implemented at Chic Paints Limited on the basis of the AAT code of Ethics and Sustainability requirements. The report also identifies and presents the weaknesses in the existing accounting system along with the effects of the identified weaknesses.

1.3 Recommendations for improvement in the current system is another significant part of the report which also identifies methods for eradication of identified weaknesses. Thus, the objectives of this reports are:

Explanation and review of the existing accounting system at Chic Paints Limited;

Identification of weaknesses in the system and effect of those on the organisation; and Recommending methods and steps for improvement in the existing system.

2. Executive Summary

By conducting a proper analysis and evaluation of the entire accounting function, policies and procedures of Chic Paints Limited, following system weaknesses came to light:

Absence of controls over payments to creditors and identification of unrecorded invoices,

Absence of controls over credit controlling and recovery,

Absence of a strongly and properly integrated ERP system,

Absence of central network and automated computer system,

Absence of integrity and honesty in the employees,

Absence of proper reconciliation processes,

Lack of training and development of employees,

Major control weakness in the payroll disbursement system, and Lack of staff.

3. Introduction

3.1 Chic Paint Limited, a company formed as a result of the management buyout in the year 2007, when Ashstead Plc. placed its wholly owned subsidiary for sale. The directors of the Chic Paints Limited, who had an extenxive experience of managing the company, bought it. The directors, who are also the owners of the company, overlook all the operations of the company.

3.2 From separation from Ashstead Plc. To date, that is in the year 2013, there has been a single change in the composition of Board of Directors. The change was that Dave Whistler replaced Jane Yip, as Finance Director of the company, in around March 2013. Moreover, two directors have shown the intention to sell their holdings in the company and retire, Ruth Jones and Ahmed Khan. The other directors have identified prospective investors having specialized skills to manage the areas under those directors regime.

3.3 The existing composition of Board of Directors of Chic Paint Limited along with their percentage shareholding and area of operation / specialization in the company is:

Name of Director

Percentage Shareholding

Area of Operation

Greg Pearce

25

Managing Director

Dave Whistler

25

Finance Director

Ruth Jones

20

Sales Director

Ahmed Khan

15

Production Director

Susan Mather

15

HRM Director

3.4 The major objective of the company as reflected through its mission statement is the production and supply of quality paints as per the international safety and quality standards. The company also aims at using the best available technology for the manufacture of paints and other allied products. Moreover, the company also aims at maintaining all the ethical standards and comply with business ethics in dealing with all the stakeholders. The company also aims at ensuring sustainable business operations that contribute to a safe environment and developed society.

3.5 The major stakeholders of the company are the directors of the company, its customers, suppliers, law making bodies and agencies, bankers, employees, society and government. Chic Paints Limited is required to prepare proper management accounts for the benefit of the owners of the company that is the existing Board of Directors. Board of Directors needs this information to make further decisions about the operations of the company and improve its financial position. Moreover, law making agencies and government require the annual financial statements of the company to impose taxes and other levies. The prospective investors of the company also require its financial statements showing profits and current financial position of the company. The financial position of the company is also of import to the suppliers, supplying goods on credit. Suppliers require the financial statements of the company to determine their recovery from the company. Customers need the financial position of the company to ensure that the company is a going concern and will continue its operations for future supply of paints to them. (Mtetwa, 2013)

3.6 Employees also need to ascertain their job security, and for that purpose they need the financial statements of the company. Moreover, working in a company with strong financial position is a matter of pride for employees and they like to show it off to their acquaintances. (Mtetwa, 2013) Further, the company is also liable to the environment and society on the whole. Thus, Chic Paints Limited should comply with environmental and other social laws and the company should also contribute to the society in the form of donations as a percentage of profits.

3.7 Chic Paints Limited is required to follow a number of laws and regulations. The following laws and legal requirements are applicable on the company:

State laws;

Corporate laws and code of corporate governance;

Taxation requirements;

Requirements of the SEC;

Environmental laws and regulations;

The requirements of International Auditing and Assurance Setting Board (IAASB);

Code of Ethics and Sustainability requirements imposed by AAT; and International Financial Reporting Framework requirements.

3.8 All these legal and regulatory requirements bind the company and any change in one or more requirements will require the company to change its accounting systems. These changes will also require the company to change the relevant statements and reports to comply with the legal and other requirements. Moreover, Chic Paints Limited is also bound by the nature of business and corporate culture in formulating its accounting systems and procedures. The company uses simple reporting system as it is more cost effective and easily understood company wide

3.9 The accounting function of the company, explained in detail in the next part of the report, serves as a support function. Accounting function of the company is mainly responsible for arranging the funds for the company to be utilised properly in various capital and revenue expenditure. The reports and statements produced by the accounting function play a vital role in setting various corporate level strategies. The accounting function of the company determines and sets the bargaining power of the company. This function is responsible for identifying the best possible price of the products manufactured by the company and acceptable prices for the raw material required for manufacturing of those products.

3.10 Accounting function at Chic Paints Limited also monitors the credit and receivable. The accounting officers and clerks are also responsible for compliance with budgetary requirements. The accounting function of the company is also responsible for the approval of capital expenditure. Hence, it can be said that revenue and expenses of the entire company is governed by the accounting department. Furthermore, accounting department also ensure that all other department comply with legal requirements since they are responsible for legal and regulatory compliances.

3.11 The users of the financial information will be highly affected by any change in the reporting and recording requirements. The users will be affected more by changes in the system if such changes require non-disclosure of information important for such users. Each of the users of financial statements of Chic Paints Limited requires a set of information and any deduction or loss of information will be a point of concern for each user. Moreover, it is highly likely that the changes in requirements enhance the information provided to the users.

4. Internal Controls and Fraud

4.1 Lack of effective internal controls will lead to the chances of frauds and misappropriation in the company. Since, Chic Paints Limited is a small company having around 350 employees and fully owned by the Board of Directors, the management of the company is fully responsible to implement a culture of strong internal controls. (Perry, 2011)

4.2 The company will surely face the chances of fraud and misrepresentation if the employees or management of the company surpass the ethical and professional requirements and internal control mechanism of the company. Management's unethical ways and greed also let to fraud in any organisation. Furthermore, in certain areas of operation there exists an inherent risk of fraud and thus the Board of Directors and management should monitor those areas on a regular basis. The areas that are most inherent to fraud risk are management override of control and cash. At Chic Paints Limited, areas such as accounting function or purchases division are solely in the control of chief accountant and purchase manager / deputy manager respectively, lack of monitoring from directors gives a chance of deliberate misappropriation to the management and hence, will result in fraud. (Fraudiscovery.com, 2013)

4.3 In order to detect fraud cases at Chic Paints Limited, the Board of Directors and management of the company should be vigilant and alert. Any transaction or attempt by any employee, director or management that is unusual or out of ordinary should be investigated properly. The directors / management of Chic Paints Limited should also design surprise checks and procedures including inventory count, assets check, personal computers analysis, etc. To detect any out of ordinary activity or fraud attempt by employees. Proper reconciliation controls and checks detect fraud. Thus, directors / management of Chic Paints Limited should check and review all the reconciliations especially bank reconciliations and investigate the reconciling items that are huge or unusual. (Fraudiscovery.com, 2013)

4.4 The directors and management of the company should also be beware of unauthorised customers or suppliers. The purchasing and selling price should also be monitored as fraudulent activities are recognised by low selling price and high purchase cost. Fraud is also deducted by excessive payments to a single supplier. Directors should also keep their eyes open to huge write-offs that are not required in the normal course of business. Increase inventory loss and damages are also one of the situations that might be an indicator of fraud in an organisation. (Fraudiscovery.com, 2013)

4.5 It is extremely important for a company to design and implement a system of sound internal controls in all the business processes of the company. A sound internal control system will ensure that the fraud is prevented and detected in a timely manner. The design and implementation of a sound internal control system will also ensure that all the operations and functions of the company are operating effectively without any fraud and misappropriation. (Griffin, 2013) Moreover, in small companies like Chic Paints Limited proper segregation of duties cannot be maintained because of a small number of employees. Thus, such companies need a set of other requirements to establish a strong internal control system.

4.6 Internal controls refer to the policies and procedures implemented by the companies for the purpose of prevention and detection of fraud in an organisation. A good internal control system in small organisations like Chic Paints Limited requires the presence of six major components. (Griffin, 2013)

4.7 Effective and strong internal control system require the management to be ethical, honest, professional and committed. It is very important for the entity's board to play a vital role in entity's operations. (Perry, 2011)

4.8 The management should also perform key controls in the organisation to build a strong control system. Direct involvement of chief accountant in various day-to-day matters, as well as, review of the accounting system at Chic Paints Limited shows that the top management is involved in day-to-day matters. However, the finance director should also take more involvement in the day-to-day operations. (Perry, 2011)

4.9 A strong IT system is essential for the formation of strong internal control environment. Although Chic Paints Limited has implemented IT policies, the IT system implemented there is not strong enough to prevent errors. There is a dire need for the company to improvise the IT system and implement central network-based controls. (Perry, 2011)

4.10 The activities and procedures included in the internal control system of the entity should be designed as per the size and nature of the company. Tailor made internal control procedures will ensure that the internal control system at Chic Paints Limited is more effective and efficient. Moreover, there should be frequent communication between the management and accounting personnel regarding the internal control procedures implemented at the company. (Perry, 2011)

4.11 Design and implementation strong internal control system in the accounting function of Chic Paints Limited will lead to a competent and effective accounting function. Such a department will ensure that proper controls are maintained on all other functions of the company. The finances and credit of the company will be properly managed and controlled. With the help of strong internal controls, the company can easily comply with all the legal and regulatory requirements. Moreover, strong internal control system means that the management and governance of the company is ethical and morally strong. Stable internal control systems also guarantee compliance with ethical and sustainability requirements of the AAT.

4.12

5. Accounting System Review

5.1 Currently the accounting function of the company is led by the Finance Director Dave Whistler who is an FCMA and BA (Hons). Finance director is involved in the development of financial strategies of the company in line with the corporate strategy and goals. Major responsibilities of the finance functions are delegated to the Chief Accountant, Hazel Richmond (AAT and ACCA) having an experience of managing the accounting function of the company since last four years. There is a total of 6 other officers and clerks reporting to the Chief Accountant responsible for recording in the general ledger, maintaining accounts payables, receivables, payroll and credit of the company. I am also a member of the team and assist the chief accountant in variance analysis and review of the systems. The chief accountant is herself responsible for the preparation of management accounts and other financial statements. Both the Finance Director and the Chief Accountant possess required information and knowledge and sufficient educational skills. Moreover, the experience of both individuals is quite suitable for the position they hold. Thus, it can be said that the top level members of the accounting function are professionally sound and competent.

5.2 The existing accounting system implemented at the company is a simple excel-based system. Chic Paints Limited had a specialized tailor made system before its buying out, however, the company's management shifted to Microsoft excel spreadsheets for maintaining and keeping all books of accounts. This shift to Microsoft excel spreadsheets was an intermediary step taken by the management, however, there has been no change in the system even after six years of operation as a separate entity other than up gradation to Microsoft office 2013.

5.3 The company maintains around forty two personal computers on a standalone basis, and there is no shared network in the company. Permanent employees have a dedicated computer while part-time employees share personal computers. Eight of the forty eight personal computers are used by the accounts department of the company. The company owns forty user licenses for Microsoft office 2013 and the computers used by the company were purchased three years back.

5.4 Various segregated accounting systems are maintained and operated by the company. At the end of the reporting period, reports, from each of the system, are used to update the general ledger and prepare management accounts. These systems comprise of:

Excel based inventory management and control system to record goods received in and issued from the warehouse;

A proprietary off the shelf accounting system for maintaining a general ledger accounts receivable ledger and accounts payables ledger on the basis of spreadsheets.;

The company uses a proprietary software based absorption costing system installed three years ago;

Standard costing system for comparing actual figures with standards and reporting variances;

To record and disburse employee expenses and salaries, the company uses a payroll system based on SAGE. This was installed three years back;

The company uses a computer aided management software to control the company's production and manufacturing.

5.5 The IT policy of the company was formulated in the supervision of the new finance director and requires the use of licensed software in all the PCs. Prior permission by the line manager is required for installing any software on staff's personal computers. Unauthorized access to the office computers and downloading data on unauthorized devices is not permitted. In order to prohibit unauthorized use, the personal computers shall be password protected. Only the users and their line managers should know the passwords of their computers. Only business and work related use of PCs is authorized provided that the users use internet and network within the limitation of relevant laws and legislation. The policy also requires that all the systems should be backed up twice a day.

5.6 The current business and accounting policies adopted by the company's management are:

Purchasing manager and deputy purchasing manager are responsible for selection, vetting and approval of all the suppliers of the company. Purchases are made from suppliers selected by the company's purchase department under medium term contracts. The accounts payable clerk checks the financial stability of new suppliers. This ensures that the skills and expertise of purchasing staff and accounting staff is used for evaluation of the new suppliers.

There are approximately around thirty suppliers with whom the company is dealing currently. All the supplies made to the company are on thirty to sixty days open credit. The existing medium term contracts ensure that the prices of the major suppliers do not fluctuate much. This is an effective step that ensures that the prices of supplies are locked and also gives a room for proper quality check and rejections of faulty supplies.

All the transactions relating to the purchase of materials are recorded in the computerized inventory system of the company. At the time of placing the order, an entry is made in the system. On receiving the goods (verified through goods receipt note GRN) the warehouse staff check the details of the GRN and match those with the system details. Moreover, the staff also checks the physical condition of the received goods. On being satisfied that the details of the order match with the details in GRN and the received materials are of satisfactory quality the warehouse officers record the quantity of goods received and note down the discrepancies. This step ensures a three way checking and is an internal control imposed on the quantity and quality of materials received.

A copy of GRN is sent to purchasing manager / deputy purchasing manager who also receives the suppliers' invoice. After receiving the invoice purchase manager / deputy purchase manager check the quantities and other details of invoice with that of the GRN. They also ensure the invoiced prices are as per the agreed terms and conditions. On being satisfied with the invoiced quantities and prices, they forward the invoices to accounts payable clerk for payment purposes. This is also a valid control implemented by the company as it ensures that only those invoices are processed which are correct in nature and duties are properly segregated.

On receiving the invoices accounts, payable clerk makes entry in the accounts payable ledger. On a monthly basis aging of creditors is generated, from the accounts payable system, to identify the creditors due for payments and make their payments. The payments are made after the cash position is reviewed by the Chief Accountant. If the company's cash position does not allow payments to be made, payments are delayed, and suppliers are not usually told the real reason for the delay.

On approval, the payments through BACS are made by the cash book in charge and are signed by two of the authorised signatories. In the majority of the cases, BACS are signed by the Chief Accountant and the Finance Director. This is a highly appropriate procedure as chief accountant has full knowledge of the company's expenditure and unusual transactions can easily be detected through this step.

The sales director along with a sales force of four sales agents is responsible for identification and addition of new customers. The sales teams is also responsible for dealing with the existing customers. This makes it quite easy for customers to communicate with the company and form good relationships.

On identification of new customer, only cash sales are made to that customer for a period of one month. The evaluation of a customer for granting credit limit is done by credit controller and accounts officer along with an outsourced credit agency. The credit controller can grant a maximum credit limit of £25,000 or can recommend a higher limit to finance director. The credit limit will be applied for one month trial period.

As per the existing company policy, the increase is credit limits is recommended by sales manager and approved by the finance director or managing director.

For the invoicing purposes the accounts receivable clerk and credit controller of the company use the list of dispatches. The invoices are sent to customers and payments are received via BACS in the majority of cases and cheques in a few cases. Cheques are received via post and submitted into bank accounts by accounts receivable clerk and credit controller.

Debtors aging report is prepared on a monthly basis. One month due accounts are reviewed by sales manager while two months due accounts are reviewed by the sales manager and sales directors. The accounts receivable clerk chases the late payments by calls, emails and letters.

Two different payroll systems are run side by side. One for hourly workers and other for permanent employees. Majority of hourly staff is paid by cash and remaining by cheques. The permanent employees are paid by BACS. Payments to hourly staff are made on a weekly basis. As per the company policy cash payments are made to the person entitled to receive payments. However, payroll clerk disregards this policy.

Payroll for permanent staff is run on monthly basis. After finalisation of both payrolls the payment for income tax is made by the GL clerk.

5.7 AAT sustainability requirements impose the regulations on the companies to protect their environment and society. Chic Paints Limited manufactures paint and thus there are chances that the company might damage the environment it operates in through is manufacturing process. The company is bound by all the environmental laws and regulations. The company is also required to make contributions to the society in the form of donations. The company has a responsibility towards its stakeholders and hiding information from them, using policies of credit to window dress the accounts show that the company is not fulfilling its responsibilities towards the stakeholders. (Aat.org.uk, 2013)

5.8 AAT code of ethics requires the professional accountants to demonstrate the characteristics of 'integrity, objectivity, professional competence and due care, confidentiality and professional behaviour'. A few of the instances like disregard of company policy by payroll clerk, window dressing of accounts, delay in payments to the suppliers, avoiding the credit collection and not giving the routine matter their required importance show that the accounting staff do not comply with the principle of ethics. There is a requirement for the company to arrange proper trainings to make the staff familiar with the requirements of AAT code of Ethics. (AAT London, 2011)

6. Weaknesses in the Existing System and Recommendations

6.1 Although the existing systems implemented in the company are cost effective and easy to use, but makes overall accounting operations and reporting procedures quite complex. Since the reports generated by all the systems are not linked, entries made in one system need to be updated manually on other system. The manual updating not only requires more time but also effects the performance. Moreover, because of manual data entries chances of omissions and misstatements increase.

6.2 There is an absence of a complete tailor made ERP in the company instead various systems are used for recording purposes. Various reports coming from different systems are used to update the general ledger, accounts payable and accounts receivable ledgers. Moreover having a different system for each accounts area which is also run by a different clerk without any specific monitoring and control leads to the chances of fraud and misappropriation of assets. There are chances of omission and mistakes while updating the GL and other subsidiary ledgers because of segregated and disseminated systems and manual updating of data from various system reports to the general ledger and subsidiary ledger's accounting system. The company should have a complete ERP package so that all the accounting and business heads are linked and proper system-based controls can be implemented.

6.3 The designed IT policy, outlines few very important IT-based controls. However, the existing hardware and network setup of the company do not permit those controls to be exercised, and there is a noncompliance with the policies. These non-compliances include:

Company has forty eight PCs and Forty user licenses of Microsoft Office, thus use of the licensed software in every PC is not possible;

Since the computers are not connected via a central network or server it is very difficult, and time consuming to take data backup twice a day; and The control on permitted use of internet and network cannot be properly monitored in the absence of a central network or server.

6.4 Although the IT policy of the company requires every user to have a unique password that should not be shared. There are no controls in place to ensure that. It is a major weakness in the internal controls. The management should review the systems for passwords and checks at least once a quarter. Moreover, there should be a system-based prompt for change of password.