Internal Controls

Ashly Rea

XACC/280

September 22, 2012
Adrienne Cooper

Internal Controls

If you cannot trust your employees to protect your revenue, whom can you trust? In most cases the answer is not whether you can trust your employees but how effectively you are monitoring them. Internal control means doing just that, setting up methods and measures within an organization to establish control. Companies such as Tyco and Enron are examples of company destruction from a lack of internal control. With a strong internal control in place companies are able to protect their assets. This includes employees engaging in theft or robbery and takes care of any unauthorized use of any of the assets. Companies are also able to have reliable accounting financial records. Internal control helps to ensure accuracy in the work. In order for internal control to be functional there are specific control principles in place. Depending on the size and functions of the business, these principles can alter slightly. The majority of companies follow four internal control principles. These four principles are establishing responsibility, segregation of duties, using physical, mechanical, and electronic controls, and independent internal verification, It is impossible for one person to make sure all areas of the business are perfect. In order to be the most efficient, companies need to assign the responsibility to certain employees. It makes it easier and more organized when certain people are in charge of specific things versus multiple people trying to cover it. Companies are able to narrow down any errors or irregularities. When people are held more responsible for the work they do, errors or theft are less likely to occur. Establishing responsibility principle also covers who is authorized to handle certain transactions or create new policies. Segregation of duties, like establishing responsibility, is a principle in internal control that protects the company. With segregation of duties there are two areas. The first is multiple people should be responsible for activities that are related. The second is people who control certain assets should be different then the individuals who are responsible for record keeping of those assets. When thinking of how to protect a company’s asset, the simple things make a difference. This is where physical, mechanical, and electronic controls come into place. From simply things such as having video monitoring of the store and employees or ensuring the use of a proper time clock system are all forms of control the company has. Physical controls are in place to do the safeguarding of the assets. These range from a variety of items such as safes, vaults, and safety deposit boxes. Mechanical and electronic controls do more than just safeguard assets. They also help with reliability of the work in the accounting records. Examples of these controls are alarms and monitoring devices. Another principle of internal control is independent internal verification. This principle basically enforces the review of work that has been prepared by employees. In order for this principle to be the most effective companies should verify records on a surprise basis. It is also important to make sure the verifier is unbiased to the employee who preformed the work. Any discrepancies should be reported. These four principles of internal control are used for the benefit of employees and employers. It is important to limit the traffic over financial reports and to engage in verification checks all the way through the process. The sooner mistakes are found, the easier to find how it happened and why. Too many times have company’s used the excuse “We just did not know this was happening” in order to get out of responsibility for financial mistakes. Companies like Enron allowed their internal control to be absent from everyday procedures and the results were devastating. In order to prevent these types of financial tragedies, Congress passed the Sarbanes-Oxley Act of 2002 (SOX). The SOX forced companies to take action and be more diligent with their internal controls. It has made corporate executives and boards of directors more responsible for how reliable and effective their internal control is. Making sure all areas are being covered, the SOX created the Public Company Accounting Oversight Board (PCAOB). The PCAOB was established to create auditing standards and regulates auditor activity. Although some business view SOX as nothing more than a money headache, the vast have found it to make their company more accountable and thus boost trust from their consumers. Even with a reliable form of internal control, incidents do occur. Companies find errors and make corrections as needed. Although the problem is being fixed, companies that have announced deficiencies in its internal control experiences repercussions. As investors look at potential investing options, a company that is having any problem with their internal control would be seen as a negative. This means at some point the company has lost a form of control and could potentially be harmful to their investment. With less interest in the company, the stock price will fall. After everything is done, does that mean it will be perfect? In most cases no, even with the best internal control system set in place, there is still limitations. Companies still have to factor in the human element. Employees still may have a chance to influence the systems. If a computer system is set in place to determine the amount of each item but may be also imputed manually, could allow for employees to enter false information. The human element may also be what actually is missing in the internal control. With small companies, they are limited with their internal control by the lack of employees or funds available. With a small amount of employees, the company is not able to disburse task that would provide adequate checking. Without the proper funding certain tools, such as video monitoring, are not easily obtained. In order for company’s to protect all of the assets, they need to invest in establishing and maintaining a firm internal control. By following the principles set in place by the SOX, any company can get a handle on their internal control and take responsibility for the financial accounting information they provide. Although internal control is not perfect, it is the best defense companies have to produce reliable records and protect what is theirs.