Internal Control ATG 383, Chapter 8 Spring 2002

Introduction zDefine internal control zWho is responsible for control. zWhy is control important?

Internal Control is ….. The steps a company takes to prevent employee fraud. True False

Internal Control is ….. zWhat you do to provide reasonable assurance you will achieve your objectives.

Who is responsible for internal control? Everyone has a part! zBoard of directors zManagement zEmployees

Why is internal control important? zManagement has a fiduciary responsibility to establish controls. zGo to jail. yForeign Corrupt Practices Act zGet shut down.

Ways to categorize controls zPrevent zDetect zCorrect Problem: Web site is hacked

Ways to categorize controls zPrevent zDetect zCorrect Problem: Employees not qualified

Ways to categorize controls zGeneral zApplication

Components of Internal Control Control Environment Risk Assessment Control Activities Monitoring Information & Communication

Control Environment zThe 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, used the owner’s granddaughter, an actress.

Components of Control Environment At E.F. Hutton, branch managers received 10% of the interest profits as a year-end bonus. Managers were encouraged to be creative so as to increase profitability.

Components of Control Environment At Sumitomo Corp, the chief copper trader could execute off-the-books trades without special approval, resulting in $1.8 billion loss.

Components of Control Environment In order to maintain deposit insurance, banks must comply with the Federal Deposit Insurance Corporation’s standards.

Components of Control Environment At Lincoln Savings, the president’s salary was $1 million. Age = mid-twenties. Prior experience = owner’s son & busboy.

Components of Internal Control Control Environment Risk Assessment Control Activities Monitoring Information & Communication

Risk Assessment (2nd component) Why have risk assessment?

Risk Assessment zHow do you manage potential problems? zFig 8.3 (p. 270) & Table 8.4 (p. 273) illustrate this process.

Risk Assessment Example zAssume 260 processing runs per year. zCost to reprocess data: $5,000 zFrequency of reprocessing: 1% zCost of control: $30,000 y3 year expected life zNew frequency of reprocessing:.001%

Components of Internal Control Control Environment Risk Assessment Control Activities Monitoring Information & Communication

Control Activities (3rd component) zPolicies and rules that provide reasonable assurance that management’s control objectives are achieved. z5 categories - p. 261

Proper Authorization zSpecific authorization zGeneral authorization

Segregation of Duties

Remaining control activities zAdequate documents and records zSafeguards over assets and records zIndependent checks on performance

Batch Totals

Components of Internal Control Control Environment Risk Assessment Control Activities Monitoring Information & Communication

Monitoring (4th component) zOngoing evaluations - during the normal course of operations. zSeparate evaluations - a “fresh pair of eyes” such as internal auditing. zInformation from external parties.

Monitoring

Review to now zEstablish good control environment zAssess risk zInstall control activities zMonitor internal control to be sure that yRisks are addressed. yControls are properly designed and operating effectively.

Components of Internal Control Control Environment Risk Assessment Control Activities Monitoring Information & Communication

Information and Communication zCharacteristics of an effective accounting information system?

Information & Communication (5th comp.) zGood 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 zConvenient Foods Stores - accounting system could not handle rapid growth zNumber of stores increased from 1,050 to 1,400 in two years. zOriginal report of income: $2.5 M yJuly - revised to $80 K yOctober - revised to ($2.0) M

Summary - Internal Control has 5 components zControl Environment zRisk Assessment zControl Procedures zMonitoring zInformation and Communication