Internal Control

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Internal Control

• ATG 383, Chapter 8
• Spring 2002

2
Introduction

• Define internal control
• Who is responsible for control.
• Why is control important?

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Internal Control is ..

• The steps a company takes to prevent employee
  fraud.

True
False
4
Internal Control is ..

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

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Who is responsible for internal control?

• Everyone has a part!
• Board of directors
• Management
• Employees

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Why is internal control important?

• Management has a fiduciary responsibility to
  establish controls.
• Go to jail.
• Foreign Corrupt Practices Act
• Get shut down.

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Ways to categorize controls
Problem Web site is hacked

• Prevent
• Detect
• Correct

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Ways to categorize controls
Problem Employees not qualified

• Prevent
• Detect
• Correct

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Ways to categorize controls

• General
• Application

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

• The following slides provide examples, both good
  bad, of the control environments components.

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Components of Control Environment
Penn Squares assets doubled every two years.
The chief loan officer was known for wearing his
Mickey Mouse hat and drinking beer from cowboy
boots.
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Components of Control Environment
During orientation, company policies are
explained. Each employee is given a policy manual
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Components of Control Environment
This group is composed of business professionals
who are not employees of the company. E.F.
Hutton, used the owners granddaughter, an
actress.
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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.
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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.
17
Components of Control Environment
In order to maintain deposit insurance, banks
must comply with the Federal Deposit Insurance
Corporations standards.
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Components of Control Environment
At Lincoln Savings, the presidents salary was 1
million. Age mid-twenties. Prior experience
owners son busboy.
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Components of Internal Control
Monitoring
Information Communication
Control Activities
Risk Assessment
Control Environment
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Risk Assessment (2nd component)

• Why have risk assessment?

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Risk Assessment

• How do you manage potential problems?
• Fig 8.3 (p. 270) Table 8.4 (p. 273) illustrate
  this process.

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Risk Assessment Example

• Assume 260 processing runs per year.
• Cost to reprocess data 5,000
• Frequency of reprocessing 1
• Cost of control 30,000
• 3 year expected life
• New frequency of reprocessing .001

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Components of Internal Control
Monitoring
Information Communication
Control Activities
Risk Assessment
Control Environment
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Control Activities (3rd component)

• Policies and rules that provide reasonable
  assurance that managements control objectives
  are achieved.
• 5 categories - p. 261

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Proper Authorization

• Specific authorization
• General authorization

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Segregation of Duties
27
Segregation of Duties
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Segregation of Duties
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Segregation of Duties
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Remaining control activities

• Adequate documents and records
• Safeguards over assets and records
• Independent checks on performance

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Batch Totals
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Components of Internal Control
Monitoring
Information Communication
Control Activities
Risk Assessment
Control Environment
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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.

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Monitoring
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Review to now

• Establish good control environment
• Assess risk
• Install control activities
• Monitor internal control to be sure that
• Risks are addressed.
• Controls are properly designed and operating
  effectively.

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

• Characteristics of an effective accounting
  information system?

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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.

Todays Headlines
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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

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Summary - Internal Control has 5 components

• Control Environment
• Risk Assessment
• Control Procedures
• Monitoring
• Information and Communication