Month: April 2020

Internal Control comprises of the plan of the organization and all the co-ordinate methods and measures adopted within a business to safeguard its assets, check the accuracy and reliability of its accounting data to promote operational efficiency and to encourage adherence to prescribed managerial policies.

Purpose of Internal Control

Let us now understand the purpose of Internal Control from different points of view.

From Auditor’s Point of View

It is very important from the Auditor’s point of view to study and evaluate the system of internal control. To obtain an adequate understanding of the internal control system, that must be tested. The Auditor has to determine whether audit is possible, if yes, then he should determine the scope of audit.

From Client’s Point of View

• Internal control system provides reliable and accurate data that is necessary for decision making and to run business activity efficiently.
• Adequate internal control system safeguard business assets, in absence of it, assets of the company may be stolen, misused or accidentally destroyed.
• Internal control system within organization is necessary to discourage and stop non performing business activities and to protect business from wastage is all aspects of the business.
• Internal control system insures that rules and procedures are to be followed by business personnel.

Characteristics of Internal Control

Following are the main characteristics of Internal Control usually abbreviated as CROSSASIA:

• Competent and trustworthy personnel
• Records, Financial and other Organization plan
• Organizational plans
• Segregation of duties
• Supervision
• Authorization
• Sound practice
• Internal Audit
• Arithmetic and accounting controls

Limitations of Internal Control

Following are the inherent limitations of Internal Control:

• Management decision to choose cost effective control system may reduce the effectiveness of internal control system.
• There are chances of misuse by a person of authority who is operating on internal control system.
• Objectives of internal control systems may be defeated by manipulation of management.
• Since internal control system is involved in routine transactions, irregular transactions may be overlooked.
• Changes in conditions may affect the effectiveness of internal control system.

Scope of Internal Control

Following are the main areas which are generally covered by a good internal control system:

1. Cash

Here, internal control is applied over payments and receipts of an organization. This is to safeguard from misappropriation of cash.

2. Control over Sale and Purchase

With proper and efficient control system for transactions regarding purchase and sale of material, handling of material and accounting for the same is must.

3. Financial Control

It deals with the efficient system of accounting, recording and supervision.

4. Employee’s Remuneration

Internal control system is applied to preparation and maintenance of records of employees and the payment methods also. It is also necessary to safeguard against misappropriation of cash.

5. Capital Expenditure

Internal control system ensures the proper sanction of capital expenditure and also the use of it for the purpose intended.

6. Inventory Control

It covers the proper handling of inventory, minimization of slow moving items or dead stock, proper valuation of stock, recording of it, etc.

7. Control over Investments

Internal control system is applied to the proper recording of transactions be it purchases, additions, sale or redemption, income on investments, profit or loss on investment.

Internal Control and Auditor

An Auditor should ensure that certain rules and procedures are followed by the business unit he is working on, in spite of the fact that a sound system of internal control is as sole responsibility of the management. The Auditor can simply guide or help the management if he is asked to do so, because he has no authority to prescribe such rules and procedures. The degree of reliance on the system depends upon the effectiveness of internal control system; therefore, the Auditor should review and evaluate the internal control system of an organization to prepare his audit Program.

Review of Internal Control System

Internal control system should be reviewed by the Auditor before star audit as described below:

• Reviewing the system of accounting entries, whether recorded as per accounting standard or not.
• To frame audit program according to present circumstances.
• Frauds, errors and mistakes are likely to be located or not.
• To review existence of internal audit program and to check the efficiency of internal control system.
• To review the reliability of reports, records and certificates as presented by the management.
• To check if there is any possibility of improvement in existing internal control system.

Internal control procedures for the receipt of cash help your small business prevent loss due to employee fraud and accounting errors. These controls are intended to limit access to cash to specified employees and verify that all receipts, refunds or transfers are documented correctly and in a timely manner. Any withdrawals of company cash must be accompanied by the proper authorization from a supervisor or manager. The company should never use cash receipts from customers for petty cash or check cashing.

Job Duties

Separating the key tasks involved in cash processing makes it more difficult for a dishonest employee to conceal fraudulent transactions. The person who receives and deposits the cash should not also perform the reconciliations. This also serves as a double-check to find and correct clerical mistakes and bank deposit errors. In smaller companies, it may not be possible to split the accounting duties between more than one employee. In this case, a supervisor should carefully review the cash receipt logs and reconciliations every month to ensure there are no discrepancies.

Access

All employees who handle cash should complete a training course on the appropriate procedures before having access to the log and safe. These procedures should be documented in writing and handed to the employee at the start of training. Store all cash in a safe or lockbox until it is deposited in the bank. Only the cash handling clerk and one backup employee should have a key to the lockbox or the combination to the safe. If either of these employees leaves the company or is reassigned to another position, change the lock or safe combination.

Documentation

When a payment comes into the office, the cash processing clerk should immediately record the transaction into the cash receipt log and assign it an identification number. If the payer is present in the office, the clerk should issue a signed receipt listing the date and amount received. The transaction numbers must be unique and sequential so an auditor can quickly see if a cash receipt is missing from the log. If an employee transfers possession of a cash receipt to another employee, both parties must sign a receipt stating the date and dollar amount of the transfer.

Reconciliation

Each day, the employee responsible for preparing the reconciliations should compare the day’s total from the cash receipts log with the daily bank deposits and the cash held in the lockbox or safe. At the end of the month, he will print the general ledger reports for the company’s cash account and compare them to the monthly totals on the cash receipt log. Any discrepancies not due to deposits in transit should be investigated and the reasons noted on the reconciliation report. Each reconciliation must be signed and dated by the person who prepared it.

1. Segregation of duties: On the accounts receivable side, ensure that the same person who is receiving cash, is not also depositing it and recording it in the accounting records. For accounts payable, ensure that the same person approving payments is not also writing the checks and reconciling the bank account.
2. Make timely deposits: Cash and checks received at a business should be deposited daily to decrease the chance of the money being stolen.
3. Review check signing authority: Review the records with the bank to ensure that the appropriate team members have check signing authority. Consider requiring more than one signature for checks above a certain threshold.
4. Control access to check stock, accounting systems, and cash: Unused check stock should be locked up. Access to computer systems or banking systems where checks can be generated should require strong passwords. Cash and checks waiting for deposit should be securely stored in a safe.
5. Discourage management override of controls: Management override of existing controls should be strongly discouraged as it sets a poor example for team members about the importance of internal controls, and because external thieves are targeting businesses this way. We have seen thieves pretend to email as the company CEO requesting funds be wired, and the accounting employees follow those instructions without following the normal process and controls for purchases resulting in payments made to cybercriminals.
6. Reconcile the bank accounts: All bank accounts should be reconciled on at least a monthly basis. Ideally, a person uninvolved in the day to day accounting activities for cash receives an unopened bank statement with canceled check copies to reconcile the bank account from so that the statement activity and canceled checks can be reviewed for irregularities. If there are not enough team members for this to happen, it is important that an owner, manager, or board member obtain the bank statement and review for irregularities prior to the regular bookkeeper preparing the reconciliation.
7. Utilize technology to help: New technology exists to help businesses prevent theft. Segregation of duties can be easily accomplished via system-based approval processes for purchases and payments. Controls on customer payments received can be gained by streamlining client payment collection via lockbox services. The risk of stolen check stock can be reduced by utilizing a bill payment service. Positive pay systems can be enabled at the bank to ensure fraudulent checks are not paid.

Steps of Cash Control are

1. Cash transactions of a business are to be accounted for properly to know cash flow and cash balance.
2. Cash sufficiency is to be ensured on due dates of notes payable.
3. Idle cash should be minimal because additional cash investment earns more revenue.
4. Loss caused due to misappropriation and forgery is to be controlled and stopped.

The necessity of cash control is very clear and it has many sides. A business cannot survive without time-related cash flow and proper cash management.

At this stage cash receipts, control and cash disbursement control are discussed.

Controlling of Cash Receipts

A business concern can receive’ cash of sale proceeds immediately after the sale or at an interval of some days or weeks.

A cash counter clerk records cash receipts immediately and posts them into the cash register.

If cash receipts of cash sales are recorded in the cash register in the presence of the customers, it is almost certain that the cashier has recorded be a correct figure of cash in cash register.

At the close of the day, the accountant reconciles the balance of cash register with that of cash register-tape or computer statement (for register concerned).

Later, when a cheque is received for sale, the accountant records it immediately in the books of accounts. A business concern receives cash through cheques from customers after the expiry of a certain period.

Difference between assets and liabilities is assets gives you future financial benefit, and on the other hand, liabilities will give you a future obligation. The proportion of assets to liabilities should always be higher. The difference between assets and liabilities is your equity in the company. We classify these assets and liabilities into different parts.

Classification of Assets and Liabilities:

Classification of Assets:

1. Fixed Assets
2. Current Assets
3. Liquid Assets
4. Wasting Assets
5. Intangible Assets
6. Fictitious Assets

1. Fixed Assets:

Fixed Assets are those assets which are not to be sold by the firm and to be used for a long period of time, such types of assets are also known as Long-term Assets.

For example, land and building, plant and machinery, vehicles, equipment, patents, trademarks etc, are examples of Fixed Assets.

2. Current assets:

Currents assets are those assets which can be converted into cash easily from the market. Generally within a year. For example cash in hand, cash at bank, trade receivables, inventory, etc.

3. Liquid Assets:

Liquid Assets are those which are already in the form of cash or can easily be convertible into cash and has a negligible effect on the price available in the market.

For example marketable securities, government bonds, certificates of deposits etc.

4. Wasting Assets:

Wasting Assets are the assets that have a useful life and as we use it depreciates with the time and after some time or years, it becomes useless.

For example Natural resources such as gas, timber, coal. The value of these assets goes down as we take out the contents. And when we take out these completely, it will become useless.

5. Intangible assets:

Intangible Assets are the assets which cannot be seen or touched. These are not necessarily useless.

For example goodwill, patents, copyrights, etc.

6. Fictitious Assets: 

The assets which are valueless but are shown in the financial statements or the expenses which are treated as assets are known as Fictitious Assets.

For example, preliminary expenses which incur at the time of establishment of the company.

Classification of Liabilities:

We can classify the liabilities into three parts. These are:

1. Long-term liabilities
2. Fixed Liabilities
3. Current Liabilities
4. Contingent Liabilities

1. Long-term liabilities:

Long-term liabilities are those which exists for one or more than one year. For example a long-term loan from the bank.

2. Fixed Liabilities:

Liabilities which are paid at the time of termination of the business are known as Fixed Liabilities.

For example proprietor’s capital.

3. Current liabilities:

Current liabilities or short-term liabilities are those which are to be settled within a year.

For example trade payables, creditors, outstanding expenses, etc.

4. Contingent Liabilities:

Liabilities which are not actual liabilities but these can become the actual liability and it depends on the happening of certain events.

Accounting rate of return (ARR) is also known as average rate of return. ARR is based upon accounting information rather than on cash flow. In other words, Accounting rate of return (ARR) refers to the rate of earning or rate of net profit after tax on investment.
ARR consider profitability rather than liquidity. Under ARR technique, the average annual expected book income is divided by the average book investment in the project.

ARR = (Average net income/Average investment) x 100
Where,
Average net income= Total net income/No. of years
Average investment= Net investment/2

Calculation Of Accounting Rate Of Return (ARR)

illustration:
The initial investment of the project is $30,000. The net profit after tax is as follows:
Year……………………….Net profit after tax($)
1………………………………25000
2………………………………30000
3……………………………….20000
4………………………………..25000
5………………………………..40000

Required: Accounting rate of return.
Solution
Calculation of ARR:
ARR = (Average net income/Average investment) x 100
= (28000/15000) x 100 = 18.67%.
Where,
Average net income = Total net income/No, of years
= 25000+30000+20000+25000+40000/5 = 28000
Average Investment = Net investment/2 = 30000/2 = 15000

Decision Rules Of Accounting Rate Of Return (ARR)

1. If projects are independent
   Accept the project which has higher ARR than standard.
   Reject the project which has lower ARR than standard.
   B. If projects are mutually exclusive
   Accept the project which has highest ARR
   Reject other projects.

Advantages Of Accounting Rate Of Return (ARR)

1. ARR is based on accounting information, therefore, other special reports are not required for determining ARR.
2. ARR method is easy to calculate and simple to understand.

3.ARR method is based on accounting profit hence measures the profitability of investment.

Disadvantages Of Accounting Rate OF Return (ARR)

1. ARR ignores the time value of money.
2. ARR method ignores the cash flow from investment
3. ARR method does not consider terminal value of the project.

Source documents are the original written or printed records that provide evidence of financial transactions in a business. They act as the primary proof that a transaction has actually taken place and support all accounting entries recorded in the books of accounts. Accountants use these documents to verify and authenticate financial data before recording it in journals. Common examples include invoices, receipts, vouchers, bills, debit notes, credit notes, and bank statements. Source documents ensure that only genuine transactions are recorded in accounting systems. They are essential for accuracy, transparency, and reliability in financial reporting overall in business today.

Once the information in a source document has been recorded in the accounting system, the source document is indexed for easy access and archived. Documents generated within the past year are generally stored on-site, with older documents being stored in less expensive off-site storage facilities.

Source documents are critical to auditors, who use them as evidence that recorded transactions actually occurred. A source document is also used by companies as proof when dealing with their business partners, usually in regard to a payments. Examples of source documents are:

• Cancelled check
• Credit memo
• Deposit slip
• Expense report
• Invoice
• Materials requisition form
• Purchase order
• Time card
• Sales receipt

For evidentiary purposes, electronic images of source documents are generally acceptable, though paper-based documentation may still be required in some cases.

It is usually necessary to retain source documents for several years. The Internal Revenue Service mandates retention intervals for some types of documents related to payroll.

Functions of Source Documents

• Evidence of Business Transactions

Source documents serve as primary evidence that a financial transaction has actually taken place in a business. They provide written or printed proof such as invoices, receipts, and vouchers. These documents confirm the authenticity of transactions before they are recorded in accounting books. Without such evidence, transactions cannot be verified or justified. They ensure that only genuine business activities are entered into financial records. This function is essential for maintaining accuracy and reliability in accounting systems. Source documents also help in preventing false entries and fraud, thereby strengthening the trustworthiness of financial reporting in business organizations overall today.

• Basis for Recording Transactions

Source documents act as the foundation for recording financial transactions in the accounting system. Accountants use these documents to prepare journal entries and ledger postings. Every entry in the books of accounts must be supported by a valid source document. This ensures that financial data is accurate and properly verified before being recorded. It also helps in maintaining consistency in accounting records. Without source documents, accounting entries would lack proper justification. This function ensures systematic and organized recording of transactions, forming the first step in the accounting cycle and supporting reliable financial reporting in business operations overall today.

• Prevention of Fraud and Errors

One of the key functions of source documents is to help prevent fraud and errors in financial records. Since every transaction must be supported by documentary evidence, it becomes difficult to record false or unauthorized entries. Source documents ensure that only verified transactions are included in the accounting system. They also help accountants cross check and validate data before recording. This reduces the chances of mistakes and manipulation in financial statements. By providing strong proof, source documents strengthen internal control systems. Therefore, they play an important role in maintaining accuracy, honesty, and reliability in financial accounting practices overall today.

• Support for Auditing Process

Source documents are essential for the auditing process as auditors rely on them to verify financial transactions. During audits, accountants present invoices, receipts, and other documents as evidence of recorded entries. These documents help auditors confirm the accuracy and authenticity of financial statements. They also assist in detecting errors, fraud, or irregularities in accounting records. Without source documents, auditing would be incomplete and unreliable. This function ensures transparency and accountability in financial reporting. Therefore, source documents play a vital role in supporting both internal and external audits and maintaining trust in financial systems and business organizations overall today.

• Legal and Tax Compliance

Source documents are important for ensuring compliance with legal and taxation requirements. They serve as official proof of financial transactions during tax assessments and legal inspections. Government authorities use these documents to verify income, expenses, and tax liabilities of businesses. Proper documentation helps organizations avoid penalties and legal disputes. Source documents also ensure that financial records meet statutory requirements under accounting and tax laws. This function strengthens financial discipline and accountability in business operations. Therefore, they play a key role in maintaining legal transparency and ensuring that businesses comply with regulatory frameworks in financial accounting systems overall today.

• Facilitates Financial Analysis

Source documents help in financial analysis by providing detailed and accurate data about business transactions. Accountants use these documents to study income, expenses, and other financial activities. This information is used to prepare financial reports and analyze business performance. It helps management in understanding cost patterns, profitability, and financial trends. Source documents ensure that analysis is based on real and verified data rather than assumptions. This improves the quality of financial decision making. Therefore, they play an important role in supporting accurate financial analysis and helping businesses plan and control their operations effectively in accounting systems overall today.

• Maintaining Historical Records

Source documents help in maintaining permanent and systematic historical records of all financial transactions. These records are preserved for future reference and can be used whenever required. Businesses may need past transaction details for audits, disputes, or decision making. Source documents ensure that complete financial history is available in an organized form. They help track the financial performance of a business over time. This function improves accountability and continuity in accounting systems. Therefore, source documents play an important role in preserving financial history and ensuring that businesses have reliable records for long term analysis and reference overall today.

• Support for Financial Reporting

Source documents provide essential data required for preparing financial statements such as Profit and Loss Account and Balance Sheet. Accountants use these documents to ensure that all financial information is accurate and complete. They help in summarizing business performance in a structured manner. Without source documents, financial reports would lack authenticity and reliability. This function ensures that financial statements are based on verified transactions. It improves the quality and credibility of financial reporting. Therefore, source documents play a crucial role in supporting accurate financial reporting and helping stakeholders make informed decisions in business accounting systems overall today.

Types of Source Documents

1. Invoices

The field of O.B. has developed from the studies conducted by behavioural scientists such as industrial psychologists, psychologists and sociologists. The focus of these studies lies in the understanding of the human behaviour in the organizations. The levels at which these studies have been carried out relate to individuals, the small group, the inter-group and the total organization as a socio – economic – technical system. Some studies have also examined the interaction of the organization with its environment. The discipline of OB is based on empirical studies of human behaviour at the work settings. On the other hand human relations is the study of behavioural knowledge in working to develop human motivation towards the attainment of organizational goals. Human relations is action oriented and goal directed approach.

According to Keith Davis the difference between the two is that of between a pathologist and the physician. While the pathologist attempts to understand human illness, the physician tends to employ that knowledge to gain results. Thus O.B. and human relations are complimentary to each other.

Behavioural scientists are focusing their attention on organizational theory, especially organizational adaptability, the relationship of organization structure to human behaviour and decision making. The study of managerial behaviour includes not only the tasks of getting things done through others but also why and how an individual behaves as he does. The specific questions which form the subject matter of O.B. are related to individual, interpersonal, small group and intergroup behaviour, interaction of formal organization and the informal groups and organization as a system, etc.

The predecessors of O.B. are:

• Industrial psychology
• Scientific management movement
• Human relations movement

1. Industrial psychology

Psychology is the “science of human (and also animal) behaviour because it collects facts about behaviour by utilizing methods of science”. Industrial psychology is simply the application or extension of psychological facts and principles concerning human beings operating within the context of business and industry. Industrial psychology draws upon the facts, generalizations and principles of psychology. It uses the methods from the parent discipline. Because it applies the techniques of psychology to the industrial scene and the problems confronting it, industrial psychology formulates and modifies procedures to meet the conditions found in the industry rather than in the laboratory.

Among the early names is that of Walter Dill Scot who opened up the beginning of industrial psychology in America by showing how psychology could be applied to advertising and selling. Edward K Strong Jr. branched industrial psychology into guidance on vocational interests. Hugo Munsteberg with this his researches into industrial accidents and his book “psychology and Industrial Efficiency”, published in 1913, put industrial psychology in to the study of the worker.

During World War I psychologists were quite active in the war effort, developing group tests for army recruits and aiding in the development of procedures for the selection of officer personnel. In fact, many of the post-war developmental areas of industrial psychology such as group testing, trade testing, rating scales, and the personality inventory had their roots in the activities of psychologists in the World War I efforts. During the post world war I era industry first began to show an interest in the discipline of industrial psychology. Certain firms such as Proctor & Gamble, the Philadelphia Company and the Hawthorn plant of Western Electric Co. formed their own personnel research programs. In fact, it was at the Hawthorne Western Electric Plant that the famous Hawthorne studies were begun in 1924. These studies provided the foundation and impetus for the expansion of Industrial Psychology beyond the realm of selection, placement and working conditions into the study of motivation and morale and human relations. The depression itself had considerable effect on the development of industrial psychology.

While it may have slowed growth in some directions, it nevertheless opened many additional areas for study. After the depression the importance of employee attitudes began to be recognized; consequently much development since that time has been in this area. World War II was also a major factor in the growth of psychology in industry. Although American Association for Applied Psychology was formed in 1937 as the official organization of industrial psychology, it was the huge psychological contribution to the war effort that proved to industry and others alike that applied psychology had important contributions to offer. Alongside also developed were various training programs of specialized types, and job analysis and performance appraisal techniques.

2. Scientific management movement

Frederick W Taylor with his ideas, he called “scientific management”, created the interest in the worker and the supervisor. It was he who advocated parity of wages the internal as well as external parity. It was he who developed various wage payment plans. It was he who insisted on supervisory training in order to make supervisor a strong link between nonmanagement and the management group. F. W. Taylor also recognized the need for giving financial incentives to the workers and therefore developed incentive payments plans too. The changes he brought to the management thought paved the way for later development of O.B.

3. Human relations movement

According to Fred Luthans three events cumulatively ushered in the era of human relations movement.

They are

• The great depression
• Rise of trade unionism.
• The Hawthorne experiments

(a) The great depression

The economy was operating in the high gear just before the thundering financial crash occurred in 1929. The production and organizational specialists had achieved great results prior to the crash. After the crash the management began to realize that production could no longer be the only major responsibility of management. Marketing, finance and more importantly personnel were also required in order for a business to survive and grow. The depression’s after math of unemployment, discontent and insecurity brought to the surface the human problems that managers were now forced to recognize and cope with. Personnel departments were either created or given more importance and most managers now began to develop a new awakened view of the human aspects of their jobs. Thus human relations took an added significance, as an indirect, and in some cases direct.

(b) The rise of trade unionism

Another important factor contributing to the rise of human relation’s role of management was the organized labour movement. Although labour unions were in existence in America as early as 1792, it was not until the passage of Wagner Act in 1935 that the organized labour movement made an impact on management. In India, though workers’ unions existed since the later half of the 19th century, they operated under terrible legal constraints. It was only in 1926 with the passage of Trade Union Act 1926 that the managers began realizing that the trade unions had come to stay in spite of the wishes of the managers or for that matter management. The only go to avoid any probable friction with the trade union was to understand the human relations role of the management.

(c) Hawthorne experiments (From 1924 to 1933)

 Western Electric Co. conducted at its Hawthorne Works a research program or a series of experiments on the factors in the work situations which affect the morale and productive efficiency of workers. The first of these, the “Illumination Experiments”, was studied in cooperation with the National Research Council of the National Academy of Sciences. In the remainder of the studies, the company was aided and guided by the suggestions of Prof. Elton Mayo and his associates from Harvard University. Because of the large part that Harvard played in the project it is often referred to as the Hawthorne-Harvard Experiments or studies.

As Blum and Naylor in their treatise “Industrial Psychology” observed, “the Hawthorne studies are of utmost significance as they form an honest and concerted attempt to understand the human factor rarely understood in industry, recognizing the employee attitudes, his social situation on the job and his personal history and background”. The Hawthorne studies represent the pioneer attempts to make a systematic and intensive study of the human factor and to demonstrate the utmost complexity in work setting where people interact in small groups under varied organizational conditions. The studies point out that the needs for recognition, security and sense of belonging exert greater impact on workers’ productivity than the physical working conditions; that the attitudes and effectiveness of workers are determined by the social requirements obtained inside and outside the factory environment.

The Hawthorne works of the Western Electric Co., Chicago, manufactured equipment for the Bell Telephone system and employed 30,000 workers at the time of experiments. Although, in all material aspects, this was the most progressive company with pension and sickness schemes and numerous recreational and other facilities, there had been a great deal of employee discontent and dissatisfaction among its employees. After a failure of investigation conducted by efficiency experts of the company, in 1924, the company asked for the assistance of the National Academy of Sciences, which initiated its experiments with a view to examining the relationship between the workers efficiency and illumination in the workshop. Like any experimental design the researchers manipulated the independent variable (illumination) to observe its effects on the dependent variable (productivity) and attempted to hold other factors under control. The following are the broad segments of the study:

Illumination Experiments: 1924 to 1927

To study the effects of changed illuminations on work, two groups of employees were formed. In one group (control group) the illumination remained unchanged throughout the experiments whereas in other group (experimental group) the illumination was enhanced in intensity. As anticipated, the productivity in experimental group showed an improvement. But, strangely enough the output of the control group also went up. The researchers then proceeded to decrease the illumination for the experimental group. The output went up once more. This showed that some factor was operating which increased productivity (dependent variable) regardless of higher or lower intensity of light. Obviously, there was something much more important than wages, hours of work, working conditions, etc. which influenced productivity. Despite their negative results the illumination experiments did not end up in the waste paper basket but provided a momentum to the relay room phase of the studies.

Relay Room Experiments: 1927 to 1932

The relay room experiments that were initiated in 1927 represent the actual beginning of the Hawthorne studies conducted by Elton Mayo and his Harvard colleagues. Taking a cue from the preceding illumination experiments the researchers attempted to set up the test room and selected two girls for the experiments. These girls were asked to choose other four girls, thus making a small group of six. The group was employed in assembling telephone relays. Throughout the series of experiments that lasted over a period of five years, an active observer was sitting with the girls in the workshop. He recorded all that went on in the room, kept the girls informed about the experiments, asked for advice and listened to their complaints. The experiment started by introducing numerous changes each of which continued for a test period ranging from four to twelve weeks. Under normal working conditions with a forty-eight hour week and no rest pauses, each girl produced 2400 relays a week. These girls were then placed on piecework basis for eight weeks and productivity increased.

Next, two five minutes rest pauses were introduced and afterwards increased to ten minutes; productivity increased sharply. After this six five-minute breaks were introduced, there was a slight fall in the productivity as the girls complained that their work rhythm was broken because of these breaks. Therefore, again two five-minute pauses were introduced. The company provided a hot meal free of charge, the productivity increased.

The girls dispersed at four thirty instead of five p.m. and productivity increased. Subsequently, they were allowed to disperse at four p.m. and productivity still remained the same. After that all the amenities were withdrawn and the girls returned to their normal working conditions with a forty eight-week, including Saturdays, no rest breaks, no piecework and no free meals. This remained for a period of twelve weeks and the productivity was the highest ever achieved.

These results imply that productivity increased basically because of a change in the girls’ attitudes towards their work and their work groups. They were made to feel important by soliciting assistance and cooperation. They were no longer cogs in a machine but formed congenial group attempting to assist the company to solve a problem. A feeling of stability and a sense of belonging grew. Therefore, they worked faster and better than before. Medical examination conducted regularly revealed no symptoms of cumulative fatigue. Absenteeism also decreased by eighty percent. It was also observed that girls employed their own techniques of assembling the parts of relays together to avoid monotony. The girls were also given freedom of movement. Under the circumstances the group developed a sense of responsibility and self-discipline. It was concluded that the independent variables i.e. rest etc. were not by themselves causing the variations in the dependent variable i.e. productivity.

Second Relay Room and Mica Splitting test room experiments

These studies were conducted as a follow up measure. The researchers set up the second relay assembly group to assess the effects of wage incentives on productivity. A group of five workers with adequate experience were shifted to similar positions in the regular department, the nature of supervision, general working conditions and the work setting were similar to those of other workers in the regular department. The difference was that the assemblers in the second relay group were engaged on a different, small group piece rate scheme. This arrangement led to a twelve percent rise in productivity of the experimental group.

In the Mica Splitting study, although the isolated test room conditions of the original relay study were reproduced, the workers were engaged under their normal individual piece rate plan rather than small group incentive schemes employed with the lay room experimental subjects. The results revealed an average increase of fifteen percent of productivity during a period of fourteen months. The outcome of these two studies was quite vague. As Rothlisberger & Dickson in their concluding remarks observed, “there was no evidence to support the hypothesis that the constant rise in the productivity in the relay assembly test room could be attributed to the wage incentives variable alone.” It was concluded that the efficacy of a wage incentive scheme was so dependent on other variables as well that it could not be considered as the sole factor to affect the worker.

Mass Interviewing Program: 1928-1930

Another major aspect of the Hawthorne studies consisted of 21,000 interviews carried out during 1928 to 1930. The original objective was to explore information, which could be used to improve supervisory training. Initially, these interviews were conducted by means of direct questioning. However, this method had the disadvantages of either stimulating antagonism or the over simplified yes or no responses, which could not get to the root of the problems. Therefore, the method was changed to “non-directive” interviewing where the interviewer was to listen instead of talk, argue or advice, and take on the role of confidant. On the basis this interviewing program, the following inferences were drawn.

• Only giving a person an opportunity to talk and air his grievances had a positive impact on his morale.
• Complaints were no longer necessarily objective statements job facts. Rather, they were frequently symptoms of more deep-rooted disturbances.
• Workers were governed by the experiences obtained, both inside and outside the company in respect of their demands
• The worker is satisfied or dissatisfied depending upon how he regarded his social status in the company and what he felt he was entitled to rather than in terms of any objective reference.

Bank wiring room study: Nov 1931 to May 1932

The chief objective was to conduct an observational analysis of the work group.

There were fourteen men employed on “bank wiring”. This was the process where two lose wire ends were soldered. This group of fourteen employees included nine wiremen, three soldermen and two inspectors. The job involved attaching wires to switches for certain parts of telephone equipment. Because of some practical difficulties the study was conducted in a separate test room. However, the study involved no experimental changes once it had started, it was carried out by two persons – an observer and an interviewer. The observer sat in the wiring room being friendly but appeared non-committal. Thus, he won the confidence of the group and was accepted as a regular member.

The interviewer, however, remained an outsider and his task was to explore as much as possible by interviewing the individual worker about his thought and feeling, his values and attitudes etc. He carried out his work under strict confidence, privately and in a different part of the factory. Although he never entered the wiring room, he kept in constant touch with observer. Besides these arrangements, other conditions were identical with the Bank wiring department itself in-so-far as that even the department’s regular supervisors were used the Bank wiring room to maintain order and control.

The results of the Bank wiring room which are markedly opposite to those obtained Relay Room, revealed that this small group of workers emerged as a team with informal leaders who had come up spontaneously.

The group was indifferent towards the financial incentives of the factory because despite the incentive scheme, the output was neither more nor less than 6000 units although optimum capacity was 7000 units per day. It may be noted that whenever any worker attempted to produce more than this group determined quota, he was soon compelled to return to his original output. To do this, the group invented a game known as “binging”. The group norms were more important to the group members than any financial incentive. There prevailed an unwritten code of conduct, which determined a fair day’s work and had influence over the group members. Thus, there existed a highly integrated group in the Bank wiring room, which possessed its own social system contradictory to the objectives of the factory. This implied that it would be irrational to break up these groups. Rather, attempts should be made to see that the interests of the management and workers are identical to such an extent that these informal groups facilitate the achievement of the organization’s objectives rather than obstructing them.

Implications of the Hawthorne Studies

Why were such contradictory results obtained in the Relay room and the Bank wiring room?

As pointed out earlier, in the relay room production constantly increased throughout the test periods and relay assemblers were greatly motivated and equipped with positive attitudes whereas, in the Bank wiring room there prevailed a restriction of production among dissatisfied workers who displayed negative attitudes towards the objective of the factory. Why? The answer to this question can be found in the reactions of the girls to the Relay test room. They unanimously showed marked preference for working in the test room rather than in the regular department, because of small group, nature of supervision, earnings, novelty of situation, interest in the experiment and attention received in the test room. It may be noted that the last three reasons are related to the well-known “Hawthorn effect”. Numerous behavioural scientists tend to overlook the significance of the first three reasons and are of the opinion that the phenomenal increase in the productivity in the relay room can be attributed primarily to this effect.

It may be noted that the Relay room and the Bank wiring room studies differed in the supervisory aspects. Although in the Relay room there were no regular supervisors engaged, the girls assigned the second priority to nature of supervision which prompted them to increase production and made them feel happier. They regarded the friendly, attentive and genuinely interested.