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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