Internal Control

ATG 383, Chapter 8

Spring 2002

Introduction

Define internal controlWho is responsible for

control.Why is control important?

Internal Control is …..

The steps a company takes to prevent employee fraud.

True False

Internal Control is …..

What you do to provide reasonable assurance you will achieve your objectives.

Who is responsible for internal control?

Everyone has a part!

Board of directorsManagementEmployees

Why is internal control important?

Management has a fiduciary responsibility to establish controls.

Go to jail. Foreign Corrupt

Practices ActGet shut down.

Ways to categorize controls

Prevent

Detect

Correct

Problem:Web site is hacked

Ways to categorize controls

Prevent

Detect

Correct

Problem:Employees not qualified

Ways to categorize controls

General

Application

Components of Internal Control

Control EnvironmentRisk Assessment

Control Activities

Monitoring

Info

rmat

ion

&

Com

mun

icat

ion

Control Environment

The following slides provide examples, both good & bad, of the control environment’s components.

Components of Control Environment

Penn Square’s assets doubled every two years. The chief loan officer was known

for wearing his Mickey Mouse hat and drinking beer from cowboy boots.

Components of Control Environment

During orientation, company policies are explained. Each employee

is given a policy manual

Components of Control Environment

This group is composed of business professionals who are not employees

of the company. E.F. Hutton, usedthe owner’s granddaughter,

an actress.

Components of Control Environment

At E.F. Hutton, branch managersreceived 10% of the interestprofits as a year-end bonus.

Managers were encouraged to becreative so as to increase profitability.

Components of Control Environment

At Sumitomo Corp, the chief coppertrader could execute off-the-bookstrades without special approval,

resulting in $1.8 billion loss.

Components of Control Environment

In order to maintain depositinsurance, banks must comply

with the Federal Deposit Insurance Corporation’s standards.

Components of Control Environment

At Lincoln Savings, the president’ssalary was $1 million.Age = mid-twenties.

Prior experience = owner’s son & busboy.

Components of Internal Control

Control EnvironmentRisk Assessment

Control Activities

Monitoring

Info

rmat

ion

&

Com

mun

icat

ion

Risk Assessment (2nd component)

Why have risk assessment?

Risk Assessment

How do you manage potential problems?

Fig 8.3 (p. 270) & Table 8.4 (p. 273) illustrate this process.

Risk Assessment Example

Assume 260 processing runs per year.

Cost to reprocess data: $5,000Frequency of reprocessing: 1%Cost of control: $30,000

3 year expected lifeNew frequency of

reprocessing: .001%

Components of Internal Control

Control EnvironmentRisk Assessment

Control Activities

Monitoring

Info

rmat

ion

&

Com

mun

icat

ion

Control Activities (3rd component)

Policies and rules that provide reasonable assurance that management’s control objectives are achieved.

5 categories - p. 261

Proper Authorization

Specific authorizationGeneral

authorization

Segregation of Duties

Segregation of Duties

Authorize Record Custody

Record Authorize falsepayment. Do notrecord check.Fudge bankreconciliation.

Custody

Segregation of Duties

Authorize Record Custody

Record Writeunauthorizedcheck. Do notrecord. Fudgereconciliation.

Custody

Segregation of Duties

Authorize Record Custody

Record

Custody Steal cash.Authorize falsetransaction that isonly recorded.Never paid.

Remaining control activities

Adequate documents and records

Safeguards over assets and records

Independent checks on performance

Batch Totals

Employee No Name Hours

123 Able 40

125 Baker 40

126 Cain 35

130 Dodge 30

132 Edwards 32

Components of Internal Control

Control EnvironmentRisk Assessment

Control Activities

Monitoring

Info

rmat

ion

&

Com

mun

icat

ion

Monitoring (4th component)

Ongoing evaluations - during the normal course of operations.

Separate evaluations - a “fresh pair of eyes” such as internal auditing.

Information from external parties.

Monitoring

OngoingEvaluation

SeparateEvaluation

Effectivesupervision

ResponsibilityAccounting

InternalAuditing

Review to now

Establish good control environmentAssess riskInstall control activitiesMonitor internal control to be sure

that Risks are addressed. Controls are properly designed and

operating effectively.

Components of Internal Control

Control EnvironmentRisk Assessment

Control Activities

Monitoring

Info

rmat

ion

&

Comm

unic

atio

n

Information and Communication

Characteristics of an effective accounting information system?

Information & Communication (5th comp.)

Good internal control requires that information be identified, captured, and communicated in a form and timeframe that enables people to carry out their jobs.

Today’s Headlines

Information example

Convenient Foods Stores - accounting system could not handle rapid growth

Number of stores increased from 1,050 to 1,400 in two years.

Original report of income: $2.5 M July - revised to $80 K October - revised to ($2.0) M

Summary - Internal Control has 5 components

Control Environment

Risk AssessmentControl

ProceduresMonitoringInformation and

Communication