Monday, 16 December 2013

Internal Control Systems (PAPAMOSS)

By Chan Hoi Leong, Researcher
Topic: Education
Area of discussion: Auditing
Chapter: Internal Control Systems (PAPAMOSS)

The primary objective of this posting is to critically discuss and explain each element of PAPAMOSS in detail, with some practical examples given to facilitate a clearer understanding. I noticed that there are lack of detailed notes available online nor in books about this topic, so I decided to do some researches and write about this PAPAMOSS’s concept. By the way, this topic is examinable in ACCA examinations (e.g. P1 & P8). Seriously, I hope that this posting can help you to understand the concept better. Kindly share this information with your friends, if you find that this is useful. In addition, if you have any comments which can improve the content of this posting, please do leave a message below.

Internal control systems

                As defined in Paragraph 4(c) of ISA 315, internal control is “the process designed, implemented and maintained by those charged with governance, management and other personnel to provide reasonable assurance about the achievement of an entity’s objectives with regard to reliability of financial reporting, effectiveness and efficiency of operations, and compliance with applicable laws and regulations.”

                     It includes all the policies and procedures (internal controls) adopted by the directors and management of an entity in order to achieve their goals of ensuring, as far as practicable, the orderly and efficient conduct of its business, including: adherence to management policies; safeguarding of assets; prevention and detection of fraud and error; ensuring the accuracy and completeness of the accounting records; and timely preparation of reliable financial statements (Kan, 2013; Kwok, 2005). Auditors generally seek to rely on the internal controls within an entity to reduce the amount of testing on final balances.

              Interestingly, the eight features of an internal control system are popularly known through these two mnemonics words, namely “PAPAMOSS” or “SOAPSPAM”. The eight features are:

Physical control:

This is mainly concerned with the custody and protection of assets such as cash and inventories. It involves tight security measures and procedures to ensure that only authorised personnel have access to the records and assets. For examples, the installation of fences, gates, doors as well as the use of locks and keys.

Authorisation and approval control:

No transactions should be carried out and no documents should be processed, without the approval or permission from an appropriate and responsible person. Approval like signing must be done with consent. Not only that, limits on authorisation should be clearly specified too.

Personnel control:

These are procedures put in place to ensure that staffs have capabilities commensurate with their responsibilities. Kan (2013, p.162) highlights that the hiring of well-motivated competent employees, who have the required integrity for their tasks, will ensure that the control system operates properly. Most importantly, the consideration here should stress on the qualification, selection, training and the worker’s innate personal characteristics. Besides, big companies usually have their own dress code systems which require personnel to wear specific attire or uniform in order to indicate a personnel’s rank or department.

Arithmetical and accounting control:

Persons in charge should ensure that all transactions have been authorised before they are sent for recording and processing purposes. After that, the persons in charge must check whether they got left out anything and make sure that all transactions are correctly recorded and accurately processed. Such controls may include checking the arithmetical accuracy of the records like control accounts, cross totals, reconciliations, trial balance and sequential controls over documents.

Management control:

These are the controls exercised by the management outside the daily routine of the system. For example, overall supervisory controls, review of management accounts, budgetary controls, internal audit function and other special review procedures.

Organisational control:

Kan (2013, p.162) states that a well-defined organisational structure shall show clearly how responsibilities and authorities are delegated as well as identify lines of reporting for all aspects of the enterprise’s operations. A tall organisational structure usually has a narrow span of control where managers can manage their subordinates easily but communication might be distorted due to higher level of hierarchy plus employing many managers is costly. Research organisations normally have these characteristics. Conversely, a flat organisational structure has a wider span of control where managers have fewer time to supervise all their subordinates but there will be lesser distortion in communication as the hierarchy level is shorter plus subordinates are cheaper to hire as compared to managers. This is common in manufacturing industries (Jones and George, 2003, pp.311-312). 

Supervision control:

Supervision by responsible officials of the day-to-day transactions and the recording thereof is an integral part of any control system. For instance, management accounts are reviewed for reasonableness by a qualified accountant. Centralisation might facilitate supervision across management.

Segregation of duties:

Ideally, responsibilities and duties must be separated to a number of people, so that no individual can fully record and process a transaction completely. Furthermore, it reduces the risk of intentional manipulation or mistake and increase the element of checking. Functions which should be separated include authorisation, execution, custody, recording and so on. However, if collusion takes place or if people work together to circumvent the system, then segregation of duties may be ineffective as this situation often making fraud difficult to detect (Gray and Manson, 2011, p.282).  


            It is noted that significant deficiencies in internal controls shall be communicated in writing to those charged with governance in a report to management. The written communication should include a description of the deficiencies and their potential effects. ISA 265 requires auditors to find out the number of identified deficiencies and their relative significance. Auditors may also provide suggestions for remedial action.


Gray, I. and Manson, S., 2011. The audit process: principles, practice and cases. 5th ed. Australia: South-Western Cengage.

Jones, G.R. and George, J.M., 2003. Contemporary management. 3rd ed. New York: McGraw-Hill.

Kan, E., 2013. Audit and assurance – principles and practices in Singapore. 3rd ed. Singapore: CCH.

Kwok, B.K.B., 2005. Accounting irregularities in financial statements: a definitive guide for litigators, auditors, and fraud investigators. Aldershot: Gower Publishing Limited.

Friday, 4 October 2013

Just-in-time systems

By Jackie, Researcher
Topic: Education
Area of discussion: Management and Cost Accounting
Chapter: Cost Management – Just-in-time systems

Question: Discuss the benefits and drawbacks of implementing JIT systems


           Just-in-time (JIT) is a popular lean manufacturing tool especially in supply chain management. Unlike conventional manufacturing practice which utilises “push approach” of which finished goods are completed and stored in advance before customer orders are received, JIT uses “pull approach” whereby the manufacturing of products begins right after the customer places an order with the company (Weygandt, Kimmel & Kieso 2009, p.174). Fundamentally, JIT aims to produce the required items, at the required quantities and quality only when they are needed (Drury 2008, p.556). Essentially, JIT system covers three main areas: purchasing, production and distribution (El Dabee, Marian & Amer 2013, p.140). Some industrial examples of companies which have successfully use JIT are Toyota, McDonald's, Harley-Davidson and Dell. Below are the discussion on the pros and cons of implementing JIT system.


               Firstly, JIT keens to eliminate wastes in time, effort and resources as well as get rid of non-value added activities (El Dabee, Marian & Amer 2013, p.140). For examples: inspecting, moving items, reworks, storing, queuing and waiting. Such activities only add cost without creating additional usefulness to the product; customers will not pay extra for these. Under JIT, the removal of all non-value added activities can be attained if raw materials are converted to finished products with lead times equal to process time (Drury 2008, p.557). For that reason, factory is laid out based on flow line principles instead of batch production functional layout to maintain a continuous flow of components with no stoppages and storage. This will minimise transfer time and shorten the lead time (Bower 2010, p.4).

               Secondly, in pursuing “zero inventories” goal, JIT entails keeping a minimum inventory of raw materials, work-in-progress and finished goods (Scarlett 2010, p.44). As a consequence, it may reduce the number of warehouses that a company maintains or even allow them to completely eliminate all warehouses in one-shot. Subsequently, it layoffs storekeepers as stocks related tasks like counting, recording, checking and arranging are no longer required. Likewise, the number of security guards can also be cut down because there will be limited items for them to safeguard. Besides, it can also reduce direct physical stocks loss and damage caused by burglary and pilferage activities or perhaps in other extents like fire and flood. Therefore, inventory insurance seems to be unnecessary as the risk is at minimal level since companies that are practising JIT will not keep the stocks for a long duration. In short, this enables companies to enjoy a greater saving in warehouse rent, warehousing salaries and insurance payments. Money saved can be used for other better usage like investment. Ideally, this is perfect for companies that are dealing with stocks that expired quickly such as daily newspapers, products that spoiled easily like food as well as electronic items that are quickly outdated.

                 Thirdly, JIT aims for zero defects. This can be achieved if total quality control exists. Vincent (2011, p.3192) points out that quality and productivity need to be refine throughout all manufacturing stages. As per Kanbans - visible signalling systems: if problems happen at a later stage, earlier stage will not receive the pull signal; if problems arise at the earlier stage, the later stage will not have their pull signal answered (Drury 2008, p.558). Total quality control requires workers and supervisors to monitor continuously at every work station. Hence, if any defects are found in any work station, operations will shut down immediately (Weygandt, Kimmel & Kieso 2009, p.175). Then, appropriate corrective action could be taken instantly to rectify the problems at that exact work station. For this reason, the products that are being produced at the end are of high-quality and defects free. So, inspection is not needed anymore and there will be no reworks or replacements of products too. At such, it enables saving in inspection cost and cost of replacement for defective items (Singh & Singh 2013, p.1582).

                Fourthly, Vercio and Shoemaker (2007) state that JIT processes stress on reducing batch or lot sizes to one. Undeniably, production in large batches often causes delays, long waiting time and creates a higher level of inventories. So, producing in smaller batch size will eventually shorten the production cycles, reduce finished goods inventories and enables more customer-specific or customised manufacture (Holl, Pardo & Rama 2010, p.525). Drury (2008, p.558) supports by stating that JIT allows works to flow smoothly to the next stage without the need for storage and to schedule the next machine to accept this item. This facilitates a firm to adapt more readily to short-term fluctuations in market demand and react quickly to customer requests. Not only that, JIT helps in reducing and eliminating set-up times too. For instance, purchase a sophisticates manufacturing machine that allows settings to be adjusted automatically instead of manually. When this happens, small batch sizes will be economical and cost-effective.     

                Al-Matarneh (2012, p.63) highlights that one of the biggest obstacle in implementing sound JIT is lack of integrated cooperation, direct communication and mutual understanding between suppliers and management. Meanwhile, variability in demand patterns caused by random purchases will worsen the situation; sharing accurate, timely and relevant information about sales forecasts remains a challenge due to trust and incompatible information systems (Horngren, Datar & Rajan 2012, p.736). Although significant coordination between them could be improved by having a real time management information system by using technologically advanced software, it is very costly to carry out. For this reason, sometimes the cost of implementing JIT system outweighs the expected benefits derive from its application, making it not worthwhile to do so. Normally, this happens in small organisation during initial start ups. As production is heavily reliant and dependent on suppliers and if stock is not delivered on time, the whole production schedule can be delayed.

             Next, worker competencies are imperative as they are the critical success factor of JIT. Apparently, companies usually will face a lot of employees’ issues. For instance: attitudes, commitment, punctuality, participation, cooperativeness, learning ability, resistance to change and et cetera. Horngren, Datar and Rajan (2012, p.737) state that workers need trainings to be multi-skilled and enable them to perform a variety of tasks like minor repairs and routine equipment maintenance. Hence, companies might need to pay high costs for all the trainings and workshops. It is noted that having a higher proportion of temporarily workers as compared to permanent workers as well as having a high labour turnover rate will further jeopardise the implementation of JIT. This is due to low probability of achieving the peak stage in learning curve to be real efficient which need a lot of time.

             Furthermore, JIT does not provide any provision for mistakes, errors and uncertainties as it aims for perfection. Hence, it could be very dangerous and risky as back-up plans like safety stock are usually not prepared whilst complexity creates confusion. Sometimes companies face difficulties in identifying and categorising which activities are value-added and which are not (Al-Matarneh 2012, p.57). Insufficient precise information leads to inaccurate forecast and prediction too especially when sales and demand fluctuates during festival seasons. In addition, JIT does not take into account of external factors such as weather, congestion and unexpected accidents which can cause serious delay in JIT manufacturing (Cheng 2011, p.276).

                Moreover, high costs are required to implement JIT system. Cheng (2011, pp.276-278) claims that the demand for more frequent long-distance transportation, small-size and premium shipments will definitely cause high transport cost. Thus, it is not economical as carriage inwards will be more expensive (Akbalik & Penz 2010, p.2567). Yet, implementing JIT is not eligible for trade discount because bulk purchases are avoided. Besides, initial investment could be very high as companies need to purchase all those software and equipments such as global positioning system (GPS) and provide trainings for workers too.


                All in all, evidences have proven that JIT really helps in improving organisations’ efficiency, productivity, responsiveness, competitiveness and products quality; at the same time, minimising unnecessary costs and wastes. However, it is costly to implement. Hence, it appears to be unfavourable for small business start-ups. Plus, it requires time to inculcate this philosophy to the existing corporate culture. Although some companies have tried to execute backward and forward integrations to eliminate the conflicts with suppliers and distributors, but consideration on further analysis need to be taken like NPV, CBA and risk assessment to evaluate whether it is worthwhile to do so. Fruitful results cannot be obtained overnight; it needs quite a long time to enjoy the success as it is long-term oriented.


Akbalik, A & Penz, B 2011, ‘Comparison of just-in-time and time window delivery policies for a single-item capacitated lot size problem’, International Journal of Production Research, vol.49, no.9, pp.2567-2585, viewed 7 July 2013, <>.

Al-Matarneh, GF 2012, ‘Requirements and obstacles of using just in time (JIT) system: evidence from Jordan’, International Management Review, vol.8, no.1, pp.55-64, viewed 4 July 2013, <>.

Bower, C 2010, Inventory Control, Association of Chartered Certified Accountants (ACCA), viewed 30 June 2013, <>.

Cheng, LC 2011, Logistics strategies to facilitate long-distance just-in-time supply chain system, InTech, viewed 7 July 2013, <>.

Drury, C 2008, Management and cost accounting, 7th edn, Cencage Learning, London.

El Dabee, F, Marian, R & Amer, Y 2013, ‘An optimisation model for a simultaneous cost-risk reduction in just-in-time systems’, Australian Journal of Multi-Disciplinary Engineering, vol.9, no.2, pp.139-148, viewed 27 June 2013, <>.

Holl, A, Pardo, R & Rama, F 2010, ‘Just-in-time manufacturing systems, subcontracting and geographic proximity’, Regional Studies, vol.44, no.5, pp.519-533, viewed 4 July 2013, <>.

Horngren, CT, Datar SM & Rajan MV 2012, Cost accounting: a managerial emphasis, 14th edn, Pearson Education Ltd, Harlow.

Scarlett, B 2010, CIMA Official Learning System – Performance Operations, CIMA Publishing, viewed 30 June 2013, <>.

Singh, DK & Singh, DS 2013, ‘Jit: various aspects of its implementation’, International Journal of Modern Engineering Research (IJMER), vol.3, no.3, pp.1582-1586, viewed 10 July 2013, <>.

Vercio, A & Shoemaker, B 2007, Assign the batch cost to the product that required the batch activity? Maybe not!, Journal of Accountancy, viewed 4 July 2013, <>

Vincent, T 2011, ‘Multicriteria models for just-in-time scheduling’, International Journal of Production Research, vol.49, no.11, pp.3191-3209, viewed 3 July 2013, <>.

Weygandt, JJ, Kimmel, PD & Kieso, DE 2009, Managerial accounting: tools for business decision making, 5th edn, John Wiley & Sons, United States of America.

Thursday, 4 April 2013

Calculation of optimum selling price using differential calculus

By Jackie, Researcher
Topic: Education
Area of discussion: Management and Cost Accounting
Chapter: Pricing decisions and profitability analysis

The primary objective of this posting is to demonstrate the computation of optimal selling prices using differential calculus. Ideally, the theoretical solution to pricing decisions is derived from economic theory, which explains how the optimal selling price is determined. Interestingly, it is possible to derive simultaneously the optimum output level and selling price using differential calculus, if the demand and cost schedules are known. For discussion purpose, I have taken a past year question from ICAEW Management Accounting; this is an advanced question and it focuses a lot on “equation”.

Suggested answers with workings:

Solution for a:

Fundamentally, profit maximization is achieved when dTC/dx = dTR/dx (or when MC = MR). Therefore, it is advisable to calculate the marginal cost (MC) and the fixed costs (FC) first, so that we can use them to form the total cost (TC) function later. On the other hand, total revenue (TR) function can be found by multiplying selling price (SP) per unit with the output quantity. To solve ‘question a’, we need to calculate what is the maximum profit when the new machine is not leased and when the new machine is leased. Decision on whether to lease or not to lease the machine will depend on the option that can give a higher profit.

Note: The cost of materials per unit (i.e. £2/unit) could be found by dividing £400,000 with 200,000 units. However, do not apply this method (i.e. £90,000 ÷ 200,000 units = £0.45/unit) to compute piecework rate because the computed figure is a sunk cost and hence, it is irrelevant for decision making purposes as the price of the piecework rate will increase to £0.50 per unit in the coming quarter.


Note: If the new machine is leased, then the cost of materials will now be £1 (i.e. £2/unit x 50%) as the quality control problems will be eliminated, resulting in a halving of the usage of materials. Besides, the cost of leasing the new machine per quarter (i.e. £115,000) will now be an additional fixed cost element.

Solution for b(i):

Again, this is quite similar with ‘question a’. Profit maximization is achieved when dTC/dx = dTR/dx (or when MR = MC).

Solution of b(ii):

Please bear in mind that, profit maximization sales maximization. Total revenue will be maximized when MR=0.

Additional readings, related links and references:

For more questions on pricing decisions and profitability analysis, you may go to this link; there are a lot of past year questions taken directly from CIMA, ACCA and ICAEW.

Product costing/Pricing strategy: Emphasize more on economics. Computations of profit maximization are included and well-explained. Ample graphs and tables are provided for illustration purposes.

For students who are interested to learn this in a greater level of details, you may download extra notes, print out, and keep a copy for your own references/studies purposes.

Optimization problems & solutions in calculus. This is a very short article. It explains the formula: f'(x) = a(x^(a-1))

Calculus review and minor short exercises.

Tuesday, 19 March 2013

Product-mix decisions when capacity constraints exist

By Jackie, Researcher
Topic: Education
Area of discussion: Management and Cost Accounting
Chapter: Measuring relevant costs and revenues for decision-making

The primary objective of this posting is to critically describe the key concept that should be applied for presenting information for product-mix decisions when capacity constraints apply. In this discussion, I have taken a past year question from CIMA Cost Accounting 2 and prepared sample solutions with detailed workings to aid illustration purposes. Personally, I like this question because it is very tricky as ‘duo ranking system’ applies due to the nature of allotment and the presence of ‘market commitment’ in this question.  

Suggested answers with workings:

Solution for a(i):

Note: Variable costs are quoted per acre, but selling prices are quoted per tonne. Therefore, it is necessary to calculate the planned sales revenue per acre. 

Solution for a(ii):

Ordinarily, the allocation of scarce resources will strictly follow the ascending order of rankings (in term of contribution amount); starting with the product that gives the highest contribution per limiting factor and then, leaving behind the balance of scarce resources to be taken up by other products that give lesser contribution per limiting factor. However, ‘market commitment’ exists in this case. So, the ‘market commitment’ will be the first one to get allocated. For profit maximization purposes, ‘market commitment’ has to be filled up with the product that gives the lowest contribution per limiting factor and the balancing figure to be taken up by other products that give a higher contribution per limiting factor. Also, due to the ‘market commitment’, the nature of allocation of scarce resource (i.e. land space) has been splitted into two.

Solution for b(i):

‘No market commitment and the land could be cultivated in such a way that any of the above crops could be produced’ simply means that the clause (i.e. the land that is being used for the production of carrots and parsnips can be used for either crop, but not for potatoes or turnips. The land being used for potatoes and turnips can be used for either crop, but not for carrots or parsnips. In order to provide an adequate market service, the gardener must produce each year at least 40 tonnes each of potatoes and turnips and 36 tonnes each of parsnips and carrots.) was not in effect anymore.

Solution for b(ii):

Note: To get 100 acres, sum up all the area occupied (i.e. 25 + 20 + 30 +25); while the contribution of £960/acre is taken from solution for a(i).

Solution for b(iii):

There are two ways to calculate this. The first one is to calculate the BEP in acres by dividing the fixed costs with the contribution per acre, and then used the computed figure to further multiply with its sales revenue per acre. (i.e £54,000 ÷ £960/acre = 56.25 acres, then 56.25 acres x £1,620/acre = £91,125). The second one is shown below by dividing the fixed costs with the contribution/sales ratio. Both methods are well explained in Cost-Volume-Profit analysis’ chapter.

Additional readings, related links and references:

Throughput accounting and TOC, one step beyond limiting factor analysis. The time frame is so short until all operating expenses are treated as fixed including direct labour; only direct materials are treated as variable.

Reframing the Product Mix Problem using the Theory of Constraints

Product Mix: Determining My Winners and Losers

Limiting factors analysis

Short-term Decisions Overview and Product Mix Decisions