INTERNAL CONTROL OVER ACCOUNTS PAYABLE

The term accounts payable (often referred to as vouchers payable for a voucher
system) is used to describe short-term obligations arising from the purchase of goods
and services in the ordinary course of business. Typical transactions creating accounts
payable include the acquisition on credit of merchandise, raw materials, plant assets
and office supplies.

Other sources of accounts payable include the receipt of services, such as legal and
accounting services, advertising, repairs and utilities. Interest- bearing obligations should
not be included in accounts payable but shown separately as bonds, notes,
mortgages, or installment contracts.
Invoices and statements from supplies usually evidence accounts payable arising from
the purchase of goods or services and most other liabilities. However, accrued liabilities
(sometimes called accrued expenses) generally accumulate over time, and
management must make accounting estimates of the year-end liability. Such estimates
are often necessary for salaries, pensions, interest, rent, taxes and similar items.

In thinking about internal control over accounts payable, it is important to recognize

that the accounts payable of one company are the accounts receivable of other
companies. It follows that there is little danger of errors being overlooked permanently
since the client's creditors will generally maintain complete records of their receivables
and will inform the client if payment is not received. This feature also aids auditors in the
discovery of fraud, since the perpetrator must be able to obtain and respond to the
demands for payment. Some companies, therefore, may choose to minimize their
record keeping of liabilities and to rely on creditors to call attention to any delay in
making payment. This viewpoint is not an endorsement of inaccurate or incomplete
records of accounts payable, but merely recognition that the self-interest of creditors
constitutes an effective control in accounting for payables that is not present in the
case of accounts receivable.
INTERNAL CONTROL OVER OTHER DEBTS

Business corporations obtain substantial amounts of their financial resources by incurring

debt and issuing capital stock. The acquisition and repayment of capital is sometimes
referred to as the financing cycle. This transaction cycle includes the sequence of
procedures for authorizing, executing, and recording transactions that involve bank
loans, mortgages, bonds payable, and capital stock as well as the payment of interest
and dividends.

Internal Control over Debt

Authorization by the Board of Directors

Effective internal control over debt begins with the authorization to incur the debt. The
bylaws of a corporation usually require that the board of directors approve borrowing.
The treasurer of the corporation will prepare a report on any proposed financing,
explaining the need for funds, the estimated effect of borrowing upon future earnings,
the estimated financial position of the company in comparison with others in the
industry both before and after the borrowing, and alternative methods of raising the
funds. Authorization by the board of directors will include review and approval of such
matters as the choice of a bank or trustee, the type of security, registration with the SEC,
agreements with investment bankers, compliance with requirements of the state of
incorporation, and listing of bonds on a securities exchange. After the issuance of long-
term debt, the board of directors should receive a report stating the net amount
received and its disposition as, for example, acquisition of plant assets, addition to
working capital, or other purposes.

Use of an Independent Trustee

Bond issues are always for large amounts-usually many millions of pesos. Therefore, only
relatively large companies issue bonds: small companies obtain long-term capital
through mortgage loans or other sources. Any company large enough to issue bonds
and able to find a ready market for the securities will almost always utilize the services of
a large bank as an independent trustee.
The trustee is charged with the protection of the creditors' interests and with monitoring
the issuing company's compliance with the provisions of the indenture. The trustee also
maintains detailed records of the names and addresses of the registered owners of the
bonds, cancels old bond certificates and issues new ones when bonds change
ownership, follows procedures to prevent over issuance of bond certificates, distribute
interest payments, and distributes principal payments when then bonds mature. Use of
an independent trustee largely solves the problem of internal control over bonds
payable. Internal control is strengthened by the fact that the trustee does not have
access to the issuing company's assets or accounting records and the fact that the
trustee is a large financial institution with legal responsibility for its actions.

Interest Payments on Bonds and Notes Payable

Many corporations assign the entire task of paying interest to the trustee for either
bearer bonds or registered bonds. Highly effective control is then achieved, since the
company will issue a single check for the full amount of the semiannual interest
payment on the entire bond issue.

INTERNAL CONTROL OVER OWNERS' EQUITY

The three principal elements of strong internal control over share capital and dividends:

1. the proper authorization of transactions by the board of directors and corporate

office,

2. the segregation of duties in handling these transactions (preferably the use

payments), and

3. the maintenance of adequate records.

Internal Control on Equity

Control of Share Capital Transactions by the Board of Directors

All changes in share capital accounts should receive formal advance approval by the
board of directors. The board of directors must determine the number of shares to be
issued and the price per share; if an installment plan of payment is to be used, the
board must prescribe the terms. If plant and equipment, services, or any consideration
other than cash is to be accepted in payment for shares, the board of directors must
establish the valuation on the noncash assets received. Transfers from retained earnings
to the Share Capital and Paid-in Capital accounts, as in the case of stock dividends,
are initiated by action of the board. In addition, stock splits and changes in par or
stated value of shares require formal authorization by the board.

Authority for all dividend actions rests with the directors. The declaration of a dividend
must specify not only the amount per share but also the date of record and the date of
payment.

Independent Registrar and Stock Transfer Agent

In appraising internal control over share capital, the first question that the auditors
consider is whether the corporation employs the services of an independent share
registrar and a share transfer agent or handles its own capital share transactions.
Internal control is far stronger when the services of an independent share registrar and a
stock transfer agent are utilized because the banks or trust companies acting in these
capacities will have the experience, the specialized facilities, and the trained personnel
to perform the work in an expert manner. Moreover, by placing the responsibility for
handling share capital certificates in separate and independent organizations, the
corporation achieves to the fullest extent the internal control concept of separation of
duties.

Internal Control over Dividends

The nature of internal control over the payment of dividends, as in the case of stock
issuance, depends primarily upon whether the company performs the function of
dividend payment itself or utilizes the services of an independent dividend-paying
agent. If an independent dividend-paying agent is used, the corporation will provide
the agent with a certified copy of the dividend declaration and a check for the full
amount of the dividend. The bank or trust company serving as stock transfer is usually
appointed to distribute the dividend, since it maintains the detailed records of
shareholders. The agent issues dividend checks to the individual shareholders and sends
the corporation a list of the payments made. The use of an independent fiscal agent is
to be recommended from the stand-point of internal control, for it materially reduces
the possibility of fraud or error arising in connection with the distribution of dividends.

In a small corporation that does not use the services of a dividend-paying agent, the
responsibility for payment of dividends is usually lodged with the treasurer and the
secretary. After declaration of a dividend by the board of directors, the secretary
prepares a list of shareholders as of the date of record, the number of shares held by
each, and the amount of the dividend each is to receive. The total of these individual
amounts is proved by multiplying the dividend per share by the total number of
outstanding shares.

Dividend checks controlled by serial numbers are dawn payable to individual

stockholders in the amount shown on the list described above. If the shareholders
ledger is maintained on a computer master file, the dividend checks may be prepared
by the computer directly from this record. The stockholder list and dividend checks are
submitted to the treasurer for approval and signature. The checks should be reconciled
by the treasurer with the total of shares outstanding and mailed without again coming
under control of the officer who prepared them.

Cash in the amount of the total dividend is then transferred from the general bank
account to a separate dividend bank account. As the individual dividend checks are
paid from this account and returned by the bank, they should be matched with the
check stubs or marked paid in the dividend check register. A list of outstanding checks
be prepared monthly from the open stubs or open items in the checks register. This list
should agree in total with the balance remaining in the dividend bank account.
Companies with numerous shareholders prepare dividend checks in machine-readable
form, so that the computer may perform the reconciliation of outstanding checks.