Accounting Policies and Procedures Guide 2013 Edition

Accounting Policies and Procedures Guide Table of Contents TAB DESCRIPTION PAGE 100 INTRODUCTION TO SMALL BUSINESS ACCOUNTING... 1-1 200 OVERVIEW OF THE ACCOUNTING PROCESS... 2-1 300 PROCESSING SALES AND RECEIPTS... 3-1 400 PROCESSING PURCHASES AND PAYMENTS... 4-1 500 PROCESSING PAYROLLS... 5-1 600 MAKING ACCOUNTING ADJUSTMENTS... 6-1 700 MAINTAINING THE GENERAL LEDGER... 7-1 800 PREPARING FINANCIAL REPORTS... 8-1 iii

Introduction to Small Business Accounting 1 Table of Contents Section Description Page 100 INTRODUCTION... 1-1 105 WHO ARE THE ACCOUNTING STAFF?... 1-1 110 WHAT DOES THE GUIDE COVER?... 1-2 115 HOW SHOULD THE GUIDE BE USED?... 1-3 TOC 1-1

TOC 1-2 Introduction to Small Business Accounting

Introduction to Small Business Accounting 1 o o o WHO ARE THE ACCOUNTING STAFF? WHAT DOES THE GUIDE COVER? HOW SHOULD THE GUIDE BE USED? 100 INTRODUCTION 100.01 Accounting staff are vital to the success of accounting departments of small to midsized companies. Yet, minimal guidance and few tools exist to help the typical staff persons perform their duties. In most cases, employees are forced to develop their skills by trial and error and constant on-the-job training, otherwise referred to as the school of hard knocks. This approach generally leads to periods of frustration before staff persons finally become proficient in their job. 100.02 This Guide provides the practical guidance to help fill this void. It provides how-to guidance and numerous practice aids (workpapers, forms, and checklists) to help staff persons master the various accounting tasks in small to mid-sized companies. The Guide focuses not only on the day-to-day processing of accounting transactions (such as sales and receipts, purchases and disbursements, and payroll) but also on monthly, quarterly, and annual tasks such as general ledger closings. 100.03 This chapter introduces the Guide by answering the following three questions: Who Are the Accounting Staff? What Does the Guide Cover? How Should the Guide Be Used? 105 WHO ARE THE ACCOUNTING STAFF? 105.01 In a small to mid-sized company, the accounting staff represents those persons handling the accounting department s day-to-day activities. The term generally encompasses all accounting department personnel below the controller level, including data entry personnel, accounting clerks, and degreed and nondegreed accountants. In companies with small accounting staffs, the controller s or head bookkeeper s duties also frequently fall under the umbrella of the accounting staff s role. The accounting staff individuals are crucial to properly carrying out the traditional accounting functions of the department. 110 WHAT DOES THE GUIDE COVER? 110.01 This Guide covers the full range of the accounting staff s duties in the typical small to mid sized company. It provides guidance on how to process the day-to-day transactions, close the general ledger, and prepare financial reports. The following presents an overview of each of the chapters. 1-1

Introduction to Small Business Accounting Chapter 2: Overview of the Accounting Process. This chapter summarizes the key elements of the accounting process. It discusses the types of source documents, the day-to-day transaction processing covered in Chapters 3 through 5, and basic internal controls. This chapter is intended to give accounting staff a big picture of the accounting process before jumping into the more detailed discussion in the rest of the Guide. Chapter 3: Processing Sales and Receipts. This chapter discusses the various steps required to process sales invoices and cash receipts. The cash receipts discussion addresses processing of both mail receipts and over-the-counter receipts. The chapter also covers various period-end activities, such as reconciling the bank accounts and the subsidiary ledger. Chapter 4: Processing Purchases and Payments. This chapter provides detailed guidance on processing vendor invoices, recording the invoices in the accounting system, making the payments, and performing period-end reconciliation and cutoff procedures. The chapter addresses common problem areas, such as obtaining invoices from the various departments, obtaining payment approvals, dealing with 1099 forms, and assigning proper general ledger account codes. Chapter 5: Processing Payrolls. This chapter begins by providing guidance on obtaining key payroll information and computing wages. It then covers the steps required to process each period s payroll. The last three sections address specific monthly, quarterly, and annual payroll activities (including filing payroll tax reports) that must be completed. Chapter 6: Making Accounting Adjustments. The previous three chapters cover the processing of day-to-day transactions. This chapter provides guidance on preparing common period-end journal entries needed to put the accounting records on a GAAP (generally accepted accounting principles) basis. It illustrates and explains the debits and credits relating to recording cost of sales, making accrual entries, adjusting asset valuations, recording depreciation expense, and various other entries. Chapter 7: Maintaining the General Ledger. This chapter builds on the previous four chapters. After day-to-day transactions (Chapters 3 through 5) and various adjustments (Chapter 4) have been posted to the general ledger, accounting personnel are ready to complete the general ledger closeout. It shows how to prepare key general ledger supporting workpapers, review the general ledger, and protect and store files and records. Chapter 8: Preparing Financial Reports. This chapter provides guidance on generating the basic monthly financial statements and modifying the format and presentation of the financial statements. It also shows how to prepare selected other management reports, such as the owner s weekly flash report and the weekly cash flow report. 1-2

115 HOW SHOULD THE GUIDE BE USED? 115.01 This Guide contains in-depth guidance on all key aspects of the accounting department. Because of the breadth of the materials and level of detail, it will generally not be read from cover to cover. Instead, it will most often be used on an as-needed basis as situations arise. As such, the Guide should be kept in an area within the accounting department that is visible and accessible by all accounting staff. Some common expected uses for the Guide include the following: Addressing day-to-day questions. The Guide will frequently be used as a reference tool to answer accounting staff questions as they arise. For example, the accounts receivable staff person may need answers on how to handle exceptions encountered while processing cash remittances or auditing the daily cash register report. The accounting manager may have questions on when and how to file various government reports, such as payroll tax returns and sales tax returns. The detailed table of contents in each chapter allows easy answers to accounting staff questions. Improving key functions. The Guide may also be used to improve key functions within the accounting department. The staff person responsible for certain functions, such as processing vendor invoices or closing the general ledger, would simply read the related chapter topic and compare the guidance with the company s existing procedures. Any proposed recommendations should then be brought to the controller s attention. Cross training the accounting staff. The controller may use the Guide to cross train staff to handle additional areas. This cross training will make it easier for staff to take scheduled or unscheduled time off since one or more other staff persons can help out temporarily. Training new staff. The Guide may be used to help select and train staff that are new to a particular function within the accounting department. The guidance will ensure the staff person receives a proper foundation. Once the basic foundation is set, the new person will better understand why and how to carry out the company s policies and procedures in that area. Learning new skills. Accounting staff sometimes become bored and complacent because they work year after year in a single area with little challenge or opportunities for improvement. The Guide can help those individuals expand their accounting skills to prepare them for handling new accounting opportunities within the company. Each of the above uses for the Guide will eventually make the accounting staff as a whole more knowledgeable and confident concerning the operations of all aspects of the accounting department. 1-3

1-4 Introduction to Small Business Accounting

Overview of the Accounting Process 2 Table of Contents Section Description Page 200 INTRODUCTION... 2-1 205 TYPES OF FINANCIAL RECORDS... 2-1.03 Source Documents... 2-3.04 Summary Journals... 2-3.08 Subsidiary Ledgers... 2-4.10 General Ledger... 2-5.13 Financial Statements... 2-5 210 PRIMARY ACCOUNTING PROCESSES... 2-5.02 Sales, Accounts Receivable, and Cash Receipts... 2-6.04 Purchasing, Accounts Payable, and Cash Disbursements... 2-6.06 Payrolls... 2-7.08 Inventories and Cost of Sales... 2-8.11 Fixed Assets and Depreciation... 2-9.13 General Ledger and Financial Statements... 2-10 215 BASIC INTERNAL ACCOUNTING CONTROLS... 2-11.03 Segregation of Duties... 2-11.06 Restricted Access... 2-11.08 Document Controls... 2-12.10 Processing Controls... 2-12.11 Reconciliation Controls... 2-13 220 BOOKKEEPING SKILLS EVALUATION... 2-13.04 Reference Checking... 2-13.06 Pre-employment Testing... 2-14 225 SUMMARY... 2-14 TOC 2-1

TOC 2-2 Overview of the Accounting Process

Overview of the Accounting Process 2 o o o o TYPES OF FINANCIAL RECORDS PRIMARY ACCOUNTING PROCESSES BASIC INTERNAL ACCOUNTING CONTROLS BOOKKEEPING SKILLS EVALUATION 200 INTRODUCTION 200.01 Understanding the overall accounting process is often crucial to the success of any small business accounting function. For full-charge bookkeepers and accounting staff who work with multiple accounting areas, getting a big picture understanding is essential. Even accounting staff who work primarily in one or two areas, such as accounts receivable or inventory, should have a basic idea of how their area interacts with others. 200.02 This chapter provides a broad overview of the small business accounting process. The following sections are covered: Types of Financial Records. Section 205 briefly discusses the five types of financial records (source documents, summary journals, subsidiary ledgers, general ledger, and financial statements) used in most small businesses. Primary Accounting Processes. Section 210 covers the six accounting processes found in most small businesses, consisting of (1) purchasing, accounts payable, and cash disbursements; (2) sales, accounts receivable, and cash receipts; (3) payroll; (4) inventories and costs of sales; (5) fixed assets and depreciation; and (6) general ledger and financial statements. Basic Internal Accounting Controls. Section 215 provides a brief overview of the basic small business internal accounting controls. Bookkeeping Skills Evaluation. Section 220 provides guidance to help accounting managers and supervisors evaluate basic bookkeeping skills before making a hiring decision. 205 TYPES OF FINANCIAL RECORDS 205.01 The accounting system in each company is responsible for distilling the hundreds or thousands of monthly transactions into a manageable format (i.e., the month-end general ledger and financial statements). The monthly financial transactions in most small businesses start with one or more source documents (such as invoices, cash receipts, and time cards), which are 2-1

Overview of the Accounting Process summarized throughout the month and posted to specified general ledger accounts. The ending monthly general ledger balances are then used to generate the company s financial statements. 205.02 Exhibit 2-1 presents an inverted pyramid to show how the various source documents and other financial records are processed throughout each period to produce the company s month-end financial information. The following paragraphs briefly discuss the types of financial records shown in Exhibit 2-1 and the accounting department s involvement with the records. Exhibit 2-1 Flow of Basic Accounting Records 2-2

Source Documents 205.03 Each accounting transaction begins with some type of source document, which differs depending on the type of transaction. The source documents that account for most financial transactions include: Purchases. Vendor invoices and supporting documentation, such as purchase orders, packing slips, and receiving reports, are the primary source documents for purchases of inventory and various other goods and services. Sales. Customer sales invoices and supporting documentation, such as sales orders and shipping documents, are the primary source documents for recording sales transactions for companies other than retailers. Cash register tapes, cash receipt forms, and daily cash-register reports are the primary source documents for most small retail businesses. Cash receipts. Remittance advices and deposit slips are the primary source documents for recording cash received from customers on credit sales. For retailers and other companies that do not extend credit to customers, the cash receipt source document also serves as the sales document. Cash disbursements. Company checks (accompanied by previously approved vendor invoices and other documents supporting the purchase) are the primary supporting document for recording cash disbursements. Payroll. Time cards, time reports, or other documents showing time worked by employees are the primary supporting documents for recording payroll costs. Payroll checks are the primary documents supporting the payment of payroll costs. Whenever possible, appropriate controls (such as using prenumbered source documents) should exist to help ensure that all transactions are captured and recorded. Section 215 briefly discusses some basic internal controls that small businesses should consider. Summary Journals 205.04 Once individual transactions have been captured on source documents, the accounting system summarizes them by transaction type and general ledger accounts using a chart of accounts and summary journals. The company s chart of accounts identifies specific general ledger account numbers for recording the various financial transactions. Once transactions have been coded with the appropriate general ledger account numbers, the amounts are grouped together for general ledger posting using summary journals. 205.05 Each of the basic types of source documents discussed previously usually has a separate summary journal. Thus, summary journals generally include: a. Purchases journal. b. Sales journal. 2-3

Overview of the Accounting Process c. Cash receipts journal. d. Cash disbursements journal. e. Payroll journal. 205.06 Each of the journals generally include individual transaction amounts or quantities (and selected other key source document information) and an aggregate general ledger posting amount. Depending on the type of accounting system, the summary journal information may be presented in a single report or more than one report. For example, some systems present detailed source document information (such as customer name, customer number, amount received, and date) in a detailed batch-level report. The system then summarizes the information for each batch and transfers it to a separate report for posting to the general ledger. 205.07 Thus, summary journals not only provide a trail showing amounts posted to the general ledger, but they also show the detailed components making up each general ledger posting. This detail makes it easier for accounting personnel to locate original source documents when questions arise at a later date. Subsidiary Ledgers 205.08 As the system posts summary journal totals to the general ledger, most systems also generate subsidiary ledgers for selected balance sheet accounts, such as accounts receivable, inventory, property and equipment, and accounts payable. These subsidiary ledgers show the composition of ending general ledger account balances as follows: a. Accounts receivable. The accounts receivable subsidiary ledger (often called the aged trial balance ) typically shows the balance owed by customer. Amounts owed are typically divided into a current column and several past due columns. b. Inventory. The inventory subsidiary ledger typically lists the quantity, unit cost, and extended cost of each inventory part number. (Because of the time required to maintain an inventory subsidiary ledger, some smaller companies do not maintain an ongoing subsidiary ledger. Instead, they periodically prepare an inventory listing by counting the inventory on-hand.) c. Property and equipment. The property and equipment subsidiary ledger shows the ending asset and accumulated depreciation balances for each fixed asset. The subsidiary ledger may also show the current depreciation charge for each asset. d. Accounts payable. The accounts payable subsidiary ledger lists the balance due each vendor by invoice. Depending on the system, the ledger may also be segregated by the payment due date. 205.09 Subsidiary ledgers are the key financial records used for managing each of these balance sheet accounts on a day-to-day basis. Thus, it is crucial that accounting staff persons post individual transactions accurately and on a timely basis to ensure that the subsidiary ledgers remain useful and in agreement with the related general ledger balances. 2-4

General Ledger 205.10 As mentioned previously, summary journals group amounts by general ledger accounts so the system can post and update the general ledger. Accounting personnel also update the general ledger by preparing manual journal entries for transactions (such as prepaid amortization or period-end accruals) that are not accumulated and posted automatically through summary journals. 205.11 The general ledger lists the period-end balance for each general ledger account. Depending on the type of general ledger system, it may also show month-to-date or year-todate activity totals posted to each general ledger account. 205.12 General ledger accounts are comprised of assets, liabilities, and equity accounts (called balance sheet accounts) and revenue and expense accounts (called income statement accounts). For the general ledger to be in balance, the period s total debits must equal the total credits. Also, the revenues less expenses must equal the net income added to retained earnings. Financial Statements 205.13 Financial statements simply represent a further summarization and grouping of period-end general ledger amounts into designated financial statement captions (such as cash, trade receivables, inventories, trade payables, revenues, and cost of sales). The accounting software s report writer package defines which general ledger accounts are grouped into which financial statement captions. 205.14 Common financial statements include a balance sheet, income statement, and statement of cash flows. The balance sheet and income statement are taken directly from the corresponding general ledger accounts. The cash flow statement is typically derived from the balance sheet and income statement. 210 PRIMARY ACCOUNTING PROCESSES 210.01 Accounting activities generally fall into one of several natural accounting processes (or cycles). Accounting personnel may be responsible for all or only a part of a cycle. In either case, it is important that they have at least a basic understanding of the complete cycle. Primary cycles include: Sales, accounts receivable, and cash receipts. Purchasing, accounts payable, and cash disbursements. Payrolls. Inventory and cost of sales. Fixed assets and depreciation. General ledger and financial statements. 2-5

Overview of the Accounting Process Each cycle is briefly discussed below. Sales, Accounts Receivable, and Cash Receipts 210.02 This process or cycle consists of selling goods or services and receiving payment from customers. The accounting department s role in this process generally consists of the following activities: Data entry (invoices). Entering the sales invoices (including any debit or credit memos) into the accounting system to produce the sales journal. General ledger posting (invoices). Posting the sales journal to the aged trial balance and the applicable general ledger accounts (debit to accounts receivable and credit to sales). Data entry (customer remittances). Applying customer payments against applicable open sales invoices to produce the cash receipts journal. General ledger posting (remittances). Posting the cash receipts journal to the aged trial balance and the appropriate general ledger accounts (debit cash and credit accounts receivable). Reconciliation. Keeping the aged trial balance in balance with the ending general ledger balance. Account maintenance. Setting up new customer accounts and credit limits and deleting/changing existing accounts. Chapter 3, Processing Sales and Receipts, discusses this process in more detail. 210.03 A crucial part of this process is ensuring that invoices, remittances, and any adjustments are posted accurately and on a timely basis. If the timing is delayed or transactions are posted inaccurately, the aged trial balance will become unreliable for managing receivables, customer complaints will become common place, and financial statement accuracy could diminish. Purchasing, Accounts Payable, and Cash Disbursements 210.04 This process or cycle consists of the purchase of goods or services and the subsequent payment of those goods or services. The accounting department s role in this process generally consists of: Account coding. Ensuring that vendor invoices have been coded with the appropriate general ledger account numbers based on the approved chart of accounts. Proper account coding requires accounting personnel to have a strong understanding of the company s chart of accounts. 2-6

Data entry (invoices). Entering the vendor invoice amounts (including any debit or credit memos) into the accounting system to produce the purchases journal. General ledger posting (invoices). Posting the purchases journal to the accounts payable subsidiary ledger and the various general ledger accounts. For instance, recording a debit to the appropriate asset (inventory or fixed asset) or expense accounts and a credit to accounts payable. Check preparation. Selecting invoices to pay and preparing checks for paying specific vendor purchases to produce the cash disbursements journal. General ledger posting (checks). Posting the cash disbursements journal to the accounts payable subsidiary ledger and the general ledger (debit to accounts payable and credit to cash). Reconciliation. Keeping the accounts payable subsidiary ledger in balance with the ending general ledger balance. Account maintenance. Setting up new vendor accounts and deleting old accounts. Chapter 4, Processing Purchases and Payments, provides in-depth discussion of this process. 210.05 Ensuring that vendor invoices have been recorded accurately and coded with the appropriate general ledger account numbers are crucial steps in this process. Any undetected errors at this stage could affect vendor payments, financial statement accuracy, and tax return amounts. Thus, accounting personnel should exercise great care at this stage and follow established internal controls (see Section 215). Payrolls 210.06 The payroll process consists of processing payrolls and remitting amounts due to employees, government, and others (health insurers, retirement plan trustees, etc.). The accounting department s role in this process generally consists of the following activities: Time cards processing. Checking mathematical accuracy of time cards. Data entry. Entering time distribution by employee, including hours worked, time off, and overtime hours into the accounting system to produce the payroll journal. General ledger posting (payroll). Posting the payroll journal to the general ledger. For example, debit compensation expense and credit liability accounts for net payroll and payroll taxes. Check preparation. Preparing and distributing employee payroll checks to produce the payroll check register. 2-7

Overview of the Accounting Process General ledger posting. Posting the payroll check register to the general ledger. For example, debit liability accounts and credit cash. Tax reports preparation and deposits. Preparing payroll tax reports and making required tax deposits to state and federal agencies. Account maintenance. Setting up new employees, deleting terminated employees, changing pay rates and tax rates, revising employee withholding amounts, etc. Chapter 5, Processing Payrolls, covers all aspects of this process in great detail. 210.07 Preparing timely and accurate paychecks is obviously important to accounting personnel, since to do otherwise will often bring an immediate response from affected employees. Also, failing to file accurate and timely payroll tax reports subjects the company and key employees (possibly even some supervisory accounting personnel) to tax penalties. Inventories and Cost of Sales 210.08 The inventory and cost of sales process consists of properly accounting for incoming and outgoing inventory. The extent of the accounting department s involvement in this area varies greatly with the nature of the company s business (retailer, wholesaler, or manufacturer) and the type of inventory accounting system. In many small businesses, CPAs (both internal and external) are heavily involved in this area because of its complexity and importance to the business s success. 210.09 The accounting department s role in this process generally includes: Data entry (purchases). Entering inventory purchases is typically done as part of the purchasing process discussed in Paragraphs 210.04-.05. In addition, posting the purchases journal typically updates the inventory subsidiary ledger if one is maintained. Cost of sales. As mentioned above, the method used to record cost of sales varies greatly among small businesses. If a separate inventory subsidiary ledger is maintained, cost of sales is often automatically recorded by the accounting system (as part of the sales and accounts receivable process) when customer sales are posted. If a separate subsidiary ledger is not maintained, cost of sales is often recorded with a manual journal entry at month end by applying an estimated cost of sales percentage to sales for that month. In any event, accounting personnel should ensure that all recorded sales have a matching recorded cost in the same period. Inventory transfers. Adjusting the detailed inventory records (if any) and the general ledger for transfers of inventory between locations or the disposal of excess, obsolete, or damaged inventory. Reconciliation. Keeping the inventory subsidiary ledger in balance with the ending general ledger balance. 2-8

Account maintenance. Setting up new inventory parts in the system and changing part numbers of existing inventory items. 210.10 Accounting for inventories and cost of sales is a complex area that varies greatly from one company to the next. Because most accounting staff personnel have minimal involvement in this area, this Guide does not provide in-depth discussion of this process. Accounting staff persons are encouraged to seek the advice and help of the controller or outside CPAs when dealing with inventory and cost of sales accounting issues. Fixed Assets and Depreciation 210.11 The fixed assets and depreciation process consists of recording fixed asset additions and deletions and related depreciation. The accounting department s role in this process generally includes: Purchases. Recording fixed asset purchases in the general ledger is typically done as part of the purchasing and cash disbursement cycle discussed in Paragraphs 210.04-.05. Purchases are usually posted to the general ledger by debiting the appropriate fixed asset account and crediting accounts payable. Subsidiary fixed assets ledger. If the company s fixed asset system is integrated with the company s accounting system, the fixed asset subsidiary ledger is generally updated at the same time fixed asset purchases are posted to the general ledger. Otherwise, additions and retirements typically must be reentered into a separate stand-alone fixed asset/depreciation system. Depreciation. Calculating and recording depreciation for each asset is typically done by using an automated fixed assets/depreciation system. However, companies with relatively few fixed assets sometimes use manual or automated spreadsheets to track fixed assets and related depreciation. In addition, those companies make a manual journal entry to record the depreciation provision. Companies generally must make separate depreciation calculations for tax purposes. Retirements. Recording fixed asset retirements (sales, trade-ins, or disposals) is typically posted to the general ledger via a manual journal entry. Although this Guide does not contain a separate chapter on fixed assets, aspects of the fixed asset process are covered in various chapters throughout the Guide. 210.12 Accounting personnel have two primary challenges in the fixed assets and depreciation area. They must ensure that the subsidiary fixed assets ledger stays in balance with the general ledger control account and that depreciation calculations comply with financial statement rules and ever-changing tax requirements. 2-9

Overview of the Accounting Process General Ledger and Financial Statements 210.13 The general ledger process consists of posting the period s transactions to the general ledger and preparing financial statements. The accounting department s role in this process generally includes the following activities: Posting summary journal entries. Entries from summary journals (purchases, sales, cash receipts, cash disbursements, payroll, etc.) are typically posted by the system throughout the month as batches of transactions are processed. Preparing manual Journal entries. Preparing and posting manual journal entries varies depending on the type of entry. The entries may be either recurring journal entries that must be made each month or adjusting journal entries that are made as needed to correct any errors that are detected. Generating the trial balance. The trial balance is simply a numerical listing of all general ledger accounts in account number order. Accounting personnel generate the general ledger trial balance to ensure total debits equal total credits. Reconciling subsidiary ledgers and supporting workpapers. As discussed previously, comparing general ledger control accounts with subsidiary ledgers (accounts receivable, inventory, property and equipment, and accounts payable) and any supporting workpapers (bank reconciliation, investment schedule, prepaid expense schedule, etc.) is crucial to ensuring the accuracy of the general ledger. Accounting persons should investigate out-of-balance situations and prepare adjusting journal entries when needed. Closing out. Closing out the general ledger involves making an entry to zero out all income statement accounts for the period (month or year) and posting the offsetting entry to the balance sheet s retained earnings account. After making this entry, the balance sheet should be in balance (in other words, assets should equal liabilities plus equity). Producing the financial statements. Producing the financial statements is done after the general ledger has been prepared and is in balance. As mentioned in Paragraph 205.14, computer-generated financial statements typically include a balance sheet and an income statement. Chapter 7, Maintaining the General Ledger, and Chapter 8, Preparing Financial Reports, provide in-depth discussion of the general ledger and financial statement process. 210.14 Accounting personnel s main concern in preparing the general ledger and financial statements is ensuring that all entries have been accurately posted. A careful review of the trial balance and preliminary general ledger and a comparison to subsidiary ledgers and supporting workpapers will often reveal additional adjusting journal entries that are needed to correct errors. 2-10

215 BASIC INTERNAL ACCOUNTING CONTROLS 215.01 Although accounting staff persons are typically not directly involved with ensuring appropriate internal accounting controls exist, a basic understanding of small business controls is helpful in carrying out day-to-day duties. This knowledge will also help accounting staff persons better understand why they are asked to perform certain procedures. 215.02 This section discusses the following general categories of internal accounting controls: Segregation of duties. Restricted access. Document controls. Processing controls. Reconciliation controls. Segregation of Duties 215.03 Segregation of duties involves allocating bookkeeping tasks among personnel so that one individual does not have the ability to make an accounting error (either intentionally or unintentionally) and also cover it up. 215.04 The principle of segregation of duties implies that the person with physical access to cash or other moveable assets (investments or inventory) should not also be involved with the related recordkeeping. For example, the person opening the mail and depositing customer remittances should not also be responsible for maintaining the accounts receivable subsidiary ledger. In addition, the person responsible for writing checks should not also have responsibility for maintaining the accounts payable subsidiary ledger. Whenever possible, bank accounts should be reconciled by someone with no other cash receipt or disbursement functions. 215.05 Unfortunately, the limited number of accounting personnel in most small businesses often makes it difficult to adequately segregate incompatible duties. In this situation, the services of other nonaccounting personnel, such as the receptionist or even the business owner, can sometimes be used in a limited capacity to provide some segregation. Also, a closer involvement in the day-to-day affairs by the small business owner and controller often partially compensates for a lack of segregation of duties. Restricted Access 215.06 Restricted access is a control category closely related to segregation of duties. Not only should bookkeeping duties be segregated whenever possible, but physical access to valuable and moveable assets should be restricted to only authorized personnel. 215.07 For example, access to warehouse and other inventory should be restricted to only those people with responsibility for maintaining inventory. In almost all instances, salespersons should not have access to inventory locations. Also, inventory should not be shipped from the warehouse unless accompanied by appropriate shipping documents. In addition, unused checks and petty cash should be kept in a locked filing cabinet in a secured area. 2-11

Overview of the Accounting Process Document Controls 215.08 Since source documents initiate the recording of transactions, it is essential that adequate controls exist to ensure that the accounting system captures all source documents. Source document controls principally include using prenumbering documents and accounting for the numerical sequence of those documents. 215.09 Common prenumbered source documents include company checks, receiving reports, purchase orders, sales invoices, debit and credit memos, shipping documents, and customer receipts for over the counter sales. For retail businesses, a cash register is another basic tool for controlling cash receipt source documents and currency. Processing Controls 215.10 Once documents enter the accounting system, processing controls help ensure that the documents are processed accurately. Common processing controls include: Batch controls. Preparing batch control totals of key source document amounts to ensure the amounts are entered into the accounting system accurately. For example, accounting persons may run an adding machine tape of total remittances received from customers for the day. After entering the remittances into the accounts receivable system, they compare the adding machine tape total to the total generated by the system to ensure all remittances were accurately entered. Source document matching. Comparing information on the various source documents to ensure they match. For example, this control might include comparing quantities and part numbers on the receiving reports/packing slips and purchase orders with the vendor invoice, and comparing unit prices on the purchase order with the vendor invoice. For customer shipments, this control might include comparing quantities and part numbers on sales orders and shipping documents with customer invoices, and comparing prices on sales orders and price lists with customer invoices. Clerical accuracy of documents. Checking the mathematical accuracy of financial data on key source documents, such as vendor invoices, customer invoices, and time cards. For example, accounting personnel may recalculate the extended prices on invoices by multiplying the quantity by the unit price. General ledger account code checking. Checking to ensure that amounts on source documents (such as vendor invoices) were coded with the appropriate general ledger account numbers before entering them into the accounting system. Processing controls are designed to catch errors before they are posted to the general ledger. 2-12

Reconciliation Controls 215.11 Reconciliations consist of reconciling selected general ledger control accounts to subsidiary ledgers. Thus, in contrast to processing controls, they are designed to detect errors after transactions have been posted and the general ledger has been run. 215.12 Accounting persons commonly reconcile accounts receivable, property and equipment, and accounts payable subsidiary ledgers. Inventory is also commonly reconciled if the company maintains a perpetual inventory subsidiary ledger. Monthly reconciliations of bank accounts are also essential controls over cash balances. 220 BOOKKEEPING SKILLS EVALUATION 220.01 Knowledge and ability are key factors to assess when hiring accounting personnel. If the company is primarily looking for a data entry person, that person s bookkeeping knowledge may be less important. However, if a company is seeking a full-charge bookkeeper, that individual must grasp all aspects of the bookkeeping function. Properly matching the company s needs with the applicant s skills will greatly improve the success of the hiring process. 220.02 Applicants are identified through various sources, including referrals from employees, customers, suppliers, and business associates; unsolicited applications; employment agencies; and advertisements. The sources used depend on how quickly the position must be filled and the company s past success in attracting applicants. 220.03 Once applicants have been screened and interviewed, their past experience and skills, as presented on their resumes and disclosed during the interview process, should be verified. Two common techniques for verifying and evaluating skill levels include: Reference checking. Pre-employment testing. Each technique is briefly discussed below. Reference Checking 220.04 Applicants will typically provide a list of personal references and former employers that the company may contact. Although references may appear to be good sources of information about an applicant, the company should remember that: Personal references are hand-picked by the applicant. Thus, the company should expect to hear mainly positive comments about the applicant. Many federal and state employment laws have been enacted to protect the rights of present and former employees. Often, employers are hesitant to provide candid information about former employees because of fear of a possible employment lawsuit. 2-13

Overview of the Accounting Process 220.05 Information requested from former employers should concentrate on the applicant s work duties and performance, attendance record, dependability, cooperation, and other jobrelated matters. The information should confirm what has already been provided by the applicant. Pre-employment Testing 220.06 To more objectively assess an applicant s abilities, some companies require applicants to take a skills test. If such tests are used, they should be given to all applicants and be relevant to the specific job. In other words, the skills tests should assess only those abilities that the applicants will need for the position. 220.07 If the company is primarily looking for someone with strong data entry skills, most state-sponsored employment commission agencies administer data-entry tests for a reasonable fee. 225 SUMMARY 225.01 To perform to the best of their abilities and to receive increased responsibility, accounting staff persons should have a good understanding of the entire bookkeeping process. Otherwise, expanded duties and advancement within the department often will be delayed. 225.02 Getting a big picture understanding of the bookkeeping process involves understanding how the various financial records interact within the accounting system. Key financial records include various source documents, summary journals, subsidiary ledgers, general ledger and financial statements. The accounting system starts with numerous source documents and continually processes and groups these transactions to ultimately produce month-end financial reports. 225.03 Each accounting transaction generally falls into one of a handful of accounting processes or cycles. Common accounting processes and cycles include purchasing, accounts payable, and cash disbursements; sales, accounts receivable, and cash receipts; payrolls; inventory and costs of sales; fixed assets and depreciation; and general ledger and financial statements. Although the general steps performed in each of these processes may appear similar on the surface, the specific procedures performed are generally quite different. There are also certain aspects of each process that are more crucial than others. 225.04 Although accounting staff persons may not have direct responsibility for internal accounting controls, a basic understanding of controls is helpful for understanding why accounting procedures are performed in a certain way. This knowledge can also help controllers improve the company s control environment when circumstances permit. The controls generally fall into one of the following categories: segregation of duties, restricted access controls, document controls, processing controls, and reconciliation controls. 225.05 Finally, small businesses should ensure that applicants for bookkeeping positions have the skills and experience needed for the position. Two common techniques for verifying and evaluating disclosed skills include reference checking and bookkeeping skills tests. 2-14

Processing Sales and Receipts 3 Table of Contents Section Description Page 300 INTRODUCTION... 3-1 305 SYSTEM CONSIDERATIONS... 3-2.03 Credit Sales: Open Item vs. Balance Forward Systems... 3-2.07 Order-entry System... 3-3.08 Retailers: Point of Sale (POS) System... 3-3 310 PROCESSING MAIL RECEIPTS... 3-4.03 Opening the Mail... 3-4.04 Making the Deposit... 3-5.05 Applying Remittances to Customer Accounts... 3-5.06 Batch Daily Remittances before Processing... 3-5.09 Apply Remittances to Customer Accounts Accurately... 3-6.10 Enter Batches in a Batch Control Log... 3-6.11 Handling Remittance Exceptions... 3-7.12 Cash Discounts Taken... 3-7.14 Unauthorized Deductions Taken... 3-7.16 Unmatched Remittances... 3-7.17 Unidentified Remittances... 3-8.18 Deposits or Advance Payments... 3-8.19 Overpayments... 3-8.20 Small Dollar Differences... 3-8.21 Returned Checks... 3-8.24 Reducing Future Remittance Exceptions... 3-9.27 Processing Debit or Credit Memos... 3-9.29 Posting Receipts to General and Subsidiary Ledgers... 3-9.30 Consider Backing up Files before Posting... 3-9.32 Post Each Batch Promptly... 3-10.33 Compare Cash Receipts Summary Journal to Batch Control Log... 3-10.34 Filing Remittance Documents... 3-10 315 PROCESSING OVER-THE-COUNTER RECEIPTS... 3-10.03 Making the Store Deposit... 3-11.06 Auditing the Daily Cash-register Report (DCR)... 3-11.07 Sample DCR... 3-11.09 DCR Audit Procedures... 3-13.10 Recording Store Receipts in the General Ledger... 3-13.13 Handling Credit Card Sales... 3-15.15 Reconciling Deposited Credit Card Sales... 3-15 3-1

Processing Sales and Receipts 3 Table of Contents (Continued) Section Description Page 315.16 Reconciling Electronically-transmitted Credit Card Sales... 3-15.19 Recording Chargebacks and Fees... 3-16.20 Filing the Retail Cash Receipt Documents... 3-16 320 PROCESSING SALES INVOICES... 3-17.04 Entering Sales Orders... 3-17.05 Batch Processing... 3-17.08 Online, Order-entry Processing... 3-18.09 Posting Sales Invoices... 3-18.10 Batch Processing... 3-18.11 Online, Order-entry Processing... 3-18.12 Filing the Sales Documents... 3-18 325 COMPLETING PERIOD-END ACTIVITIES... 3-19.02 Reconciling the Bank Accounts... 3-19.03 Who Should Perform the Bank Reconciliation and When?... 3-19.05 How to Reconcile the Bank Statement... 3-19.08 Reconciling the Subsidiary Ledger to the General Ledger... 3-22.10 Reviewing the Accounts Receivable Aged Trial Balance... 3-22.11 Making a Proper Period-end Cutoff... 3-22 330 SUMMARY Appendix 3A Cash Receipts Batch Cover Sheet... 3-27 3B Cash Receipts Batch Control Log... 3-29 3C Cash Remittance Exception Log... 3-31 3D Daily Cash-register Report (DCR) Form... 3-33 3E DCR Audit Checklist... 3-37 3F Sales Invoices Batch Cover Sheet... 3-39 3G Sales Invoices Batch Control Log... 3-41 3H Bank Reconciliation Form... 3-43 3I Period-end Sales Cutoff and Reconciliation Form... 3-45 TOC 3-2

Processing Sales and Receipts 3 o o o o o SYSTEM CONSIDERATIONS PROCESSING MAIL RECEIPTS PROCESSING OVER-THE-COUNTER RECEIPTS PROCESSING SALES INVOICES COMPLETING PERIOD-END ACTIVITIES 300 INTRODUCTION 300.01 Processing cash receipts, and to a lesser extent sales invoices, are major activities of most small business accounting departments. Not only must accounting personnel handle and deposit incoming cash promptly, but they must also process it accurately to effectively manage the company s cash flows and maintain good customer relations. 300.02 This chapter provides accounting personnel step-by-step guidance for processing cash receipt and sales transactions, both in a traditional small business that extends trade credit and in a small retail business that receives cash over the counter. The chapter assumes the small business s accounting function is computerized. 300.03 The guidance in this chapter is useful to full-charge bookkeepers as well as accounting personnel involved in selected accounting and bookkeeping areas. The chapter helps existing cash receipts personnel fine-tune their processing activities and provides newly-hired or crosstrained employees with a solid foundation for processing cash receipts. 300.04 The chapter includes the following major sections: System Considerations. Section 305 briefly discusses three aspects of accounting systems the type of accounts receivable subsidiary ledger, an order-entry system, and a retailer s point of sale system that impact how cash receipts are processed. Processing Mail Receipts. Section 310 covers the processing of customer remittances received through the mail. The section includes opening the mail, making the deposit, applying remittances to customer accounts, handling remittance exceptions and credit memos, posting the transactions, and filing the documents. Processing Over-the-counter Receipts. Section 315 covers the processing of a retail business s over-the-counter receipts. It includes making the deposit, auditing the daily cash-register report (DCR), handling credit card sales, and filing the documents. 3-1

Processing Sales and Receipts Processing Sales Invoices. Section 320 provides a brief overview of sales invoice processing for those small business accounting departments that have responsibilities in this area. However, this function is now frequently handled by order entry personnel outside the accounting department. Completing Period-end Activities. Section 325 discusses activities that are performed after each month end in preparation for closing the general ledger and preparing financial statements. Activities include reconciling the bank account and accounts receivable subsidiary ledger, reviewing the aged trial balance, and properly cutting off or ending month-end transactions. 305 SYSTEM CONSIDERATIONS 305.01 As mentioned previously, the chapter assumes that accounting personnel using this Guide are working with a basic computerized accounting system. However, even though a company is computerized, the nature of a business s activities will sometimes dictate system variations unique to that type of business. Those system variations often impact how cash receipt transactions are processed. 305.02 Three system variations that are covered in this section include: Credit sales: open item vs. balance forward systems. Order-entry system. Retailers: point of sale system. The first two generally apply to traditional businesses that extend trade credit, and the last type applies to retailers. Credit Sales: Open Item vs. Balance Forward Systems 305.03 Most accounting systems offer businesses two options for tracking unpaid customer invoices: the open item method (which is generally more costly to maintain) or the balance forward method. a. Open item method. The open item method tracks all open items for each customer. Invoices are the primary method used to notify and bill customers for purchases. b. Balance forward method. The balance forward method keeps details of only the current period s activity and groups all other open items into a single beginning balance amount. Statements are the primary method used to notify customers of purchases. 305.04 Small businesses that recurrently sell goods (rather than services) to commercial customers typically use the open item method since commercial customers generally record and pay for purchases using invoices (as opposed to statements). Retailers and other 3-2