Introduction: Internal Control Principles are extremely important in a growing company in order to safeguard assets from misuse, and to enhance the accuracy and reliability of account records. The U.S. Securities and Exchange Commission (SEC) has been monitoring and enforcing disclosure laws and regulations on publicly owned companies in order to protect investors from false information provided by the company about its financial condition, operating results, management compensation, and anything that has a direct effect on the financial success of the company. The whole purpose of internal controls is to avoid a serious bankruptcy such as Enron, WorldCom, and Tyco. Investors lost billions of dollars due to poor internal controls, corruption, fraudulent financial records, and accounting irregularities after which the SEC created the Sarbanes-Oxley Act (SOX) in order to prevent investors from receiving fraudulent information. Private Accounting Firm has reviewed the internal controls used at LJB Company and although some of the internal controls are effective, many are lacking, these controls will be discussed further along with future recommendations. First, we must define the Sarbanes-Oxley Act as it pertains to a public company now that LJB would like to open its shares to investors. Then, we will review the internal control principles that are effective in a public company, after which the internal controls that are being used correctly will be addressed. Finally, the incorrect internal controls and future recommendations will be addressed in order to improve the security of LJB Company.
SEC Regulations and the SOX: The U.S. Securities and Exchange Commission (SEC) is responsible for monitoring disclosure laws for publicly-traded companies. In 2002, the SEC passed the Sarbanes-Oxley Act (SOX) in order to provide security to investors in regards to the information they receive from their invested company. The SOX requires a level of internal controls, the disclosure of compensation and responsibilities of corporate directors and officers, conflict of interest by stock analysts, and effective and timely disclosure of information in regard to the financial state of the company, the falsification of documents, and finally the requirement that chief executives review the financial results submitted to investors and personally approve them as accurate (Sec Disclosure Laws and Regulations.) Publicly owned companies must prepare two annual reports, one for the SEC, and one for investors/shareholders. The annual report to the SEC is called a “10-K,” it contains financial and operating information as well as management statements in regards to the operations of the company. The annual report to the shareholders must be accompanied with a two-year audited balance sheet, and a three-year audited income and cash flow statements. Essentially, both of the annual reports contain financial information in regards to the company’s well-being and current/future plans.
Internal Control Principles: Internal control principles are in place to safeguard company assets and prevent mishandling of accounting records. There are five principles that govern internal controls, the first being establishment of responsibility. This principle states that it is more effective for open person to be responsible for a given task. For example, the handling of cash, only one designated person should be authorized to handle cash receipts. The second principle is segregation of duties. This principle states that responsibility for related activities should be assigned to different individuals, and the responsibility for recording assets should be separate from physical inventory of the asset. If one individual is responsible for all accounting activities, they have a higher potential to make an error or cause an irregularity in record keeping to occur. The third principle is physical, mechanical and electronic controls. This principle states that a physical inventory of the assets is necessary in order to prevent theft, as well as mechanical and electronic controls are important in order to make sure the accounting records are accurate. This particular principle can include the implementing of safes, locked storage units, passkeys, alarms, anti-theft monitors, etc. The fourth principle of control is independent internal verification. This principle states that periodically the company must perform verification of date, essentially an internal audit to make sure that the internal control is effective within the company. The fifth is insuring assets and bonding employees, essentially this states that if an employee was to steal from the company, the insurance policy would pay out the cash that was stolen. Internal controls are in place to protect both the company and the investors from fraud and misrepresented information.