Accounting transactions and associated information are recorded in accounting systems (you may have heard of common ones for small businesses like MYOB, Quickbooks and Xero) or enterprise wide information systems (such as SAP). The accounting system is the backbone of any business entity, whether it is profit seeking, a government organisation or a not for profit.
It is the responsibility of management to link the accounting system with other functional areas of the business and ensure that there is communication among employees, managers, customers, suppliers, and all other internal and external users of financial information. With a proper understanding of internal controls, management can design an internal control system that promotes a positive business environment that can most effectively serve its customers.
For example, a customer enters a retail store to purchase a pair of jeans. As the salesperson enters the jeans into the point-of-sale system, the following events occur internally:
- A sale is recorded in the company’s accounting records, which increases revenue. If the transaction occurred by credit card, the bank typically transfers the funds into the store’s bank account in a timely manner.
- The pair of jeans is removed from the inventory of the store where the purchase was made.
- A new pair of jeans is ordered from the distribution center to replace what was purchased from the store’s inventory.
- The distribution center orders a new pair of jeans from the factory to replace its inventory.
- Marketing professionals can monitor over time the trend and volume of jeans sold in a specific size. If an increase or decrease in sales volume of a specific size is noted, store inventory levels can be adjusted.
- The company can see in real time the exact inventory levels of all products in all stores at all times, and this can ensure the best customer access to products.
Because many systems are linked through technology that drives decisions made by many stakeholders inside and outside of the business, internal controls are needed to protect the integrity and ensure the flow of information. An internal control system also assists all stakeholders of a business to develop an understanding of the business and provide assurance that all assets are being used efficiently and accurately. It supports owners and shareholders in their desire to keep management accountable for their actions.