1. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart1 of 315 C HAPTER 6 Control and Accounting Information Systems

2. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart2 of 315 INTRODUCTION Why AIS threats are increasing –Control risks have increased in the last few years because: There are computers and servers everywhere, and information is available to an unprecedented number of workers. Distributed computer networks make data available to many users, and these networks are harder to control than centralized mainframe systems. Wide area networks are giving customers and suppliers access to each other’s systems and data, making confidentiality a major concern.

3. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart3 of 315 INTRODUCTION Historically, many organizations have not adequately protected their data due to one or more of the following reasons: –Computer control problems are often underestimated and downplayed. –Control implications of moving from centralized, host-based computer systems to those of a networked system or Internet- based system are not always fully understood. –Companies have not realized that data is a strategic resource and that data security must be a strategic requirement. –Productivity and cost pressures may motivate management to forego time-consuming control measures.

4. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart4 of 315 INTRODUCTION Some vocabulary terms for this chapter: –A threat is any potential adverse occurrence or unwanted event that could injure the AIS or the organization. –The exposure or impact of the threat is the potential dollar loss that would occur if the threat becomes a reality. –The likelihood is the probability that the threat will occur.

5. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart5 of 315 INTRODUCTION Control and security are important –Companies are now recognizing the problems and taking positive steps to achieve better control, including: Devoting full-time staff to security and control concerns. Educating employees about control measures. Establishing and enforcing formal information security policies. Making controls a part of the applications development process. Moving sensitive data to more secure environments.

6. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart6 of 315 INTRODUCTION To use IT in achieving control objectives, accountants must: –Understand how to protect systems from threats. –Have a good understanding of IT and its capabilities and risks. Achieving adequate security and control over the information resources of an organization should be a top management priority.

7. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart7 of 315 INTRODUCTION Control objectives are the same regardless of the data processing method, but a computer- based AIS requires different internal control policies and procedures because: –Computer processing may reduce clerical errors but increase risks of unauthorized access or modification of data files. –Segregation of duties must be achieved differently in an AIS. –Computers provide opportunities for enhancement of some internal controls.

8. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart8 of 315 INTRODUCTION One of the primary objectives of an AIS is to control a business organization. –Accountants must help by designing effective control systems and auditing or reviewing control systems already in place to ensure their effectiveness. Management expects accountants to be control consultants by: –Taking a proactive approach to eliminating system threats; and –Detecting, correcting, and recovering from threats when they do occur.

9. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart9 of 315 INTRODUCTION It is much easier to build controls into a system during the initial stage than to add them after the fact. Consequently, accountants and control experts should be members of the teams that develop or modify information systems.

10. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart10 of 315 OVERVIEW OF CONTROL CONCEPTS In today’s dynamic business environment, companies must react quickly to changing conditions and markets, including steps to: –Hire creative and innovative employees. –Give these employees power and flexibility to: Satisfy changing customer demands; Pursue new opportunities to add value to the organization; and Implement process improvements. At the same time, the company needs control systems so they are not exposed to excessive risks or behaviors that could harm their reputation for honesty and integrity.

11. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart11 of 315 OVERVIEW OF CONTROL CONCEPTS Internal control is the process implemented by the board of directors, management, and those under their direction to provide reasonable assurance that the following control objectives are achieved: –Assets (including data) are safeguarded. This objective includes prevention or timely detection of unauthorized acquisition, use, or disposal of material company assets.

12. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart12 of 315 OVERVIEW OF CONTROL CONCEPTS Internal control is the process implemented by the board of directors, management, and those under their direction to provide reasonable assurance that the following control objectives are achieved: –Assets (including data) are safeguarded. –Records are maintained in sufficient detail to accurately and fairly reflect company assets.

13. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart13 of 315 OVERVIEW OF CONTROL CONCEPTS Internal control is the process implemented by the board of directors, management, and those under their direction to provide reasonable assurance that the following control objectives are achieved: –Assets (including data) are safeguarded. –Records are maintained in sufficient detail to accurately and fairly reflect company assets. –Accurate and reliable information is provided.

14. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart14 of 315 OVERVIEW OF CONTROL CONCEPTS Internal control is the process implemented by the board of directors, management, and those under their direction to provide reasonable assurance that the following control objectives are achieved: –Assets (including data) are safeguarded. –Records are maintained in sufficient detail to accurately and fairly reflect company assets. –Accurate and reliable information is provided. –There is reasonable assurance that financial reports are prepared in accordance with GAAP.

15. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart15 of 315 OVERVIEW OF CONTROL CONCEPTS Internal control is the process implemented by the board of directors, management, and those under their direction to provide reasonable assurance that the following control objectives are achieved: –Assets (including data) are safeguarded. –Records are maintained in sufficient detail to accurately and fairly reflect company assets. –Accurate and reliable information is provided. –There is reasonable assurance that financial reports are prepared in accordance with GAAP. –Operational efficiency is promoted and improved. This objective includes ensuring that company receipts and expenditures are made in accordance with management and directors’ authorizations.

16. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart16 of 315 OVERVIEW OF CONTROL CONCEPTS Internal control is the process implemented by the board of directors, management, and those under their direction to provide reasonable assurance that the following control objectives are achieved: –Assets (including data) are safeguarded. –Records are maintained in sufficient detail to accurately and fairly reflect company assets. –Accurate and reliable information is provided. –There is reasonable assurance that financial reports are prepared in accordance with GAAP. –Operational efficiency is promoted and improved. –Adherence to prescribed managerial policies is encouraged.

17. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart17 of 315 OVERVIEW OF CONTROL CONCEPTS Internal control is the process implemented by the board of directors, management, and those under their direction to provide reasonable assurance that the following control objectives are achieved: –Assets (including data) are safeguarded. –Records are maintained in sufficient detail to accurately and fairly reflect company assets. –Accurate and reliable information is provided. –There is reasonable assurance that financial reports are prepared in accordance with GAAP. –Operational efficiency is promoted and improved. –Adherence to prescribed managerial policies is encouraged. –The organization complies with applicable laws and regulations.

18. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart18 of 315 OVERVIEW OF CONTROL CONCEPTS Internal control is a process because: –It permeates an organization’s operating activities. –It is an integral part of basic management activities. Internal control provides reasonable, rather than absolute, assurance, because complete assurance is difficult or impossible to achieve and prohibitively expensive.

19. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart19 of 315 OVERVIEW OF CONTROL CONCEPTS Internal control systems have inherent limitations, including: –They are susceptible to errors and poor decisions. –They can be overridden by management or by collusion of two or more employees. Internal control objectives are often at odds with each other. –EXAMPLE: Controls to safeguard assets may also reduce operational efficiency.

20. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart20 of 315 OVERVIEW OF CONTROL CONCEPTS Internal controls perform three important functions: –Preventive controls Deter problems before they arise.

21. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart21 of 315 OVERVIEW OF CONTROL CONCEPTS Internal controls perform three important functions: –Preventive controls –Detective controls Discover problems quickly when they do arise.

22. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart22 of 315 OVERVIEW OF CONTROL CONCEPTS Internal controls perform three important functions: –Preventive controls –Detective controls –Corrective controls Remedy problems that have occurred by: –Identifying the cause; –Correcting the resulting errors; and –Modifying the system to prevent future problems of this sort.

23. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart23 of 315 OVERVIEW OF CONTROL CONCEPTS Internal controls are often classified as: –General controls Those designed to make sure an organization’s control environment is stable and well managed. They apply to all sizes and types of systems. Examples: Security management controls.

24. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart24 of 315 OVERVIEW OF CONTROL CONCEPTS Internal controls are often classified as: –General controls –Application controls Prevent, detect, and correct transaction errors and fraud. Concerned with accuracy, completeness, validity, and authorization of the data captured, entered into the system, processed, stored, transmitted to other systems, and reported.

25. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart25 of 315 OVERVIEW OF CONTROL CONCEPTS An effective system of internal controls should exist in all organizations to: –Help them achieve their missions and goals. –Minimize surprises.

26. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart26 of 315 SOX AND THE FOREIGN CORRUPT PRACTICES ACT In 1977, Congress passed the Foreign Corrupt Practices Act, and to the surprise of the profession, this act incorporated language from an AICPA pronouncement. The primary purpose of the act was to prevent the bribery of foreign officials to obtain business. A significant effect was to require that corporations maintain good systems of internal accounting control. –Generated significant interest among management, accountants, and auditors in designing and evaluating internal control systems. –The resulting internal control improvements weren’t sufficient.

27. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart27 of 315 SOX AND THE FOREIGN CORRUPT PRACTICES ACT In the late 1990s and early 2000s, a series of multi-million-dollar accounting frauds made headlines. –The impact on financial markets was substantial, and Congress responded with passage of the Sarbanes-Oxley Act of 2002 (aka, SOX). Applies to publicly held companies and their auditors.

28. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart28 of 315 SOX AND THE FOREIGN CORRUPT PRACTICES ACT The intent of SOX is to: –Prevent financial statement fraud –Make financial reports more transparent –Protect investors –Strengthen internal controls in publicly-held companies –Punish executives who perpetrate fraud SOX has had a material impact on the way boards of directors, management, and accountants operate.

29. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart29 of 315 CONTROL FRAMEWORKS A number of frameworks have been developed to help companies develop good internal control systems. Three of the most important are: –The COBIT framework –The COSO internal control framework –COSO’s Enterprise Risk Management framework (ERM)

30. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart30 of 315 CONTROL FRAMEWORKS A number of frameworks have been developed to help companies develop good internal control systems. Three of the most important are: –The COBIT framework –The COSO internal control framework –COSO’s Enterprise Risk Management framework (ERM)

31. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart31 of 315 CONTROL FRAMEWORKS COBIT framework –Also know as the Control Objectives for Information and Related Technology framework. –Developed by the Information Systems Audit and Control Foundation (ISACF). –A framework of generally applicable information systems security and control practices for IT control.

32. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart32 of 315 CONTROL FRAMEWORKS The COBIT framework allows: –Management to benchmark security and control practices of IT environments. –Users of IT services to be assured that adequate security and control exists. –Auditors to substantiate their opinions on internal control and advise on IT security and control matters.

33. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart33 of 315 CONTROL FRAMEWORKS The framework addresses the issue of control from three vantage points or dimensions: –Business objectives To satisfy business objectives, information must conform to certain criteria referred to as “business requirements for information.” The criteria are divided into seven distinct yet overlapping categories that map into COSO objectives: –Effectiveness (relevant, pertinent, and timely) –Efficiency –Confidentiality –Integrity –Availability –Compliance with legal requirements –Reliability

34. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart34 of 315 CONTROL FRAMEWORKS The framework addresses the issue of control from three vantage points or dimensions: –Business objectives –IT resources Includes: People Application systems Technology Facilities Data

35. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart35 of 315 CONTROL FRAMEWORKS The framework addresses the issue of control from three vantage points or dimensions: –Business objectives –IT resources –IT processes Broken into four domains: –Planning and organization –Acquisition and implementation –Delivery and support –Monitoring

36. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart36 of 315 CONTROL FRAMEWORKS COBIT consolidates standards from 36 different sources into a single framework. It is having a big impact on the IS profession. –Helps managers to learn how to balance risk and control investment in an IS environment. –Provides users with greater assurance that security and IT controls provided by internal and third parties are adequate. –Guides auditors as they substantiate their opinions and provide advice to management on internal controls.

37. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart37 of 315 CONTROL FRAMEWORKS A number of frameworks have been developed to help companies develop good internal control systems. Three of the most important are: –The COBIT framework –The COSO internal control framework –COSO’s Enterprise Risk Management framework (ERM)

38. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart38 of 315 CONTROL FRAMEWORKS COSO’s internal control framework –The Committee of Sponsoring Organizations (COSO) is a private sector group consisting of: The American Accounting Association The AICPA The Institute of Internal Auditors The Institute of Management Accountants The Financial Executives Institute

39. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart39 of 315 CONTROL FRAMEWORKS In 1992, COSO issued the Internal Control Integrated Framework: –Defines internal controls. –Provides guidance for evaluating and enhancing internal control systems. –Widely accepted as the authority on internal controls. –Incorporated into policies, rules, and regulations used to control business activities.

40. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart40 of 315 CONTROL FRAMEWORKS COSO’s internal control model has five crucial components: -Control environment The core of any business is its people. Their integrity, ethical values, and competence make up the foundation on which everything else rests.

41. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart41 of 315 CONTROL FRAMEWORKS COSO’s internal control model has five crucial components: -Control environment -Control activities Policies and procedures must be established and executed to ensure that actions identified by management as necessary to address risks are, in fact, carried out.

42. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart42 of 315 CONTROL FRAMEWORKS COSO’s internal control model has five crucial components: -Control environment -Control activities -Risk assessment The organization must be aware of and deal with the risks it faces. It must set objectives for its diverse activities and establish mechanisms to identify, analyze, and manage the related risks.

43. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart43 of 315 CONTROL FRAMEWORKS COSO’s internal control model has five crucial components: -Control environment -Control activities -Risk assessment -Information and communication Information and communications systems surround the control activities. They enable the organization’s people to capture and exchange information needed to conduct, manage, and control its operations.

44. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart44 of 315 CONTROL FRAMEWORKS COSO’s internal control model has five crucial components: -Control environment -Control activities -Risk assessment -Information and communication -Monitoring The entire process must be monitored and modified as necessary.

45. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart45 of 315 CONTROL FRAMEWORKS A number of frameworks have been developed to help companies develop good internal control systems. Three of the most important are: –The COBIT framework –The COSO internal control framework –COSO’s Enterprise Risk Management framework (ERM)

46. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart46 of 315 CONTROL FRAMEWORKS Nine years after COSO issued the preceding framework, it began investigating how to effectively identify, assess, and manage risk so organizations could improve the risk management process. Result: Enterprise Risk Manage Integrated Framework (ERM) –An enhanced corporate governance document. –Expands on elements of preceding framework. –Provides a focus on the broader subject of enterprise risk management.

47. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart47 of 315 CONTROL FRAMEWORKS Intent of ERM is to achieve all goals of the internal control framework and help the organization: –Provide reasonable assurance that company objectives and goals are achieved and problems and surprises are minimized. –Achieve its financial and performance targets. –Assess risks continuously and identify steps to take and resources to allocate to overcome or mitigate risk. –Avoid adverse publicity and damage to the entity’s reputation.

48. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart48 of 315 CONTROL FRAMEWORKS ERM defines risk management as: –A process effected by an entity’s board of directors, management, and other personnel. –Applied in strategy setting and across the enterprise. –To identify potential events that may affect the entity. –And manage risk to be within its risk appetite. –In order to provide reasonable assurance of the achievement of entity objectives.

49. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart49 of 315 CONTROL FRAMEWORKS Basic principles behind ERM: –Companies are formed to create value for owners. –Management must decide how much uncertainty they will accept. –Uncertainty can result in: Risk The possibility that something will happen to: –Adversely affect the ability to create value; or –Erode existing value.

50. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart50 of 315 CONTROL FRAMEWORKS Basic principles behind ERM: –Companies are formed to create value for owners. –Management must decide how much uncertainty they will accept. –Uncertainty can result in: Risk Opportunity The possibility that something will happen to positively affect the ability to create or preserve value.

51. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart51 of 315 CONTROL FRAMEWORKS –The framework should help management manage uncertainty and its associated risk to build and preserve value. –To maximize value, a company must balance its growth and return objectives and risks with efficient and effective use of company resources.

52. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart52 of 315 CONTROL FRAMEWORKS COSO developed a model to illustrate the elements of ERM.

53. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart53 of 315 CONTROL FRAMEWORKS These issues led to COSO’s development of the ERM framework. –Takes a risk-based, rather than controls-based, approach to the organization. –Oriented toward future and constant change. –Incorporates rather than replaces COSO’s internal control framework and contains three additional elements: Setting objectives. Identifying positive and negative events that may affect the company’s ability to implement strategy and achieve objectives. Developing a response to assessed risk.

54. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart54 of 315 CONTROL FRAMEWORKS –Controls are flexible and relevant because they are linked to current organizational objectives. –ERM also recognizes more options than simply controlling risk, which include accepting it, avoiding it, diversifying it, sharing it, or transferring it.

55. © 2008 Prentice Hall Business Publishing Accounting Information Systems, 11/e Romney/Steinbart55 of 315 CONTROL FRAMEWORKS Over time, ERM will probably become the most widely adopted risk and control model. Consequently, its eight components are the topic of the remainder of the chapter.