Well if you look on the PC in Internet Explorer tools\internet options\browsing history settings\view files. You will see cookies sent from the websites they visit and also the picture from websites. This is called you windows cache it's used to speed up site that a person goes to alot. So instead having to download those pictures for the internet it stores the to this cache area. Its faster to load the pictures from your hard drive then to pull them down for the internet every time you go to a page.
Good in theory... but there are ways around your option for those of us with a little bit of knowledge
IE cache size can be controlled, you can change history settings, A simple program can remove your cookies and clear your IE cache when you close IE, etc... server level logging (something I've not needed so I haven't looked into) is probably the best way to track what's going on, then it doesn't matter if the user wipes every trace of what their doing from their PC.
Dayak, I'm not going to tell you how to run your business, but some studies have suggested that allowing employees to use company internet for personal use can improve overall productivity, as long as they aren't spending hours on personal stuff. Same concept as paid vacations, by getting away from the grind (in this case for a few minutes instead of a few days), you're refreshed & come back with renewed vigor.
Personally, I can think more clearly on important work issues if I stop concentrating on them by checking email, or seeing what's on sale at newegg, etc...