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FInancial leverage: essentials of corporate finance chapter 2
Internal controls case study
Internal controls case study
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Introduction Senior executives have long sought ways to better control the enterprises they run. Internal controls are put in place to keep the company on course toward profitability goals and achievement of its mission, and to minimize surprises along the way. Corporate governance has become a top priority for boards of directors, management, auditors, and stakeholders. How can Enterprise Risk Management (ERM) be integrated with internal controls and corporate governance to effectively minimize risk for an organization? Internal Controls Internal control is broadly defined as a process, effected by an entity's board of directors, management and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following categories: • Effectiveness and efficiency of operations. • Reliability of financial reporting. • Compliance with applicable laws and regulations Because internal control serves many important purposes, there are increasing calls for better internal control systems and report cards on them. Internal control is looked upon more and more as a solution to a variety of potential problems. Internal control is, to some degree, the responsibility of everyone in an organization and therefore should be an explicit or implicit part of everyone's job description. Virtually all employees produce information used in the internal control system or take other actions needed to effect control. Also, all personnel should be responsible for communicating upward problems in operations, noncompliance with the code of conduct, or other policy violations or illegal actions (http://www.coso.org/publications/executive_summary_integrated_framework.htm.). Balance sheet account reconciliations are one of the oldest and most important accounting processes. Yet, in many companies they're underappreciated as an internal control over financial reporting. Before Sarbanes- Oxley many companies relegated this control to a corrective role; since the control operates after the financial reports are issued, it is effective only in identifying misstatements for correction. Some companies are not capable of completing the necessary reconciliations in time to use them as a preventative control. They should risk-rate all accounts and reconcile high- and medium-risk accounts in time to incorporate general ledger adjustments into the company’s earnings release. Reconciling all accounts that could contain a significant or material misstatement and posting the necessary adjustments to the general ledger will reduce the risk of material misstatement. Because account reconciliations are so important under Sarbanes-Oxley, adopting a continuous improvement process with a goal of reconciling all accounts before the post-closing adjustment review process will enhance the internal controls of the organization. Corporate Governance It was not that long ago that a seat on a corporate board was considered a plum assignment.
Internal controls is defined as a process, effected by an entity’s board of directors, management, and other personnel, designed to provide reasonable assurance
In order for Trinity to improve internal control compliance, Trinity must prepare for potential risks. Companies will also need to evaluate the impact these differences may have on their accounting policies, as well as the underlying information technology systems that support the company’s financial reporting structure, (Arnold, 2009). Trinity must undergo changes to internal control in order to meet IFRS changes. ERP and consolidation systems will need to be assessed to determine if they can handle the requirements of dual ledgers and reporting, (Arnold, 2009). First, Trinity must establish an internal control team that can identify the differences between GAAP and IFRS.
While the external control prescribes the use of new rules, adoption of new legislation or the institution of new regulations to cover up loopholes, the internal control involves personal character that has developed over time. External control is stated to be the code of ethics (Cooper, 2012). For example, in the conduction of the activities of the ABC Foundation, there is a requirement for balance between these internal and external controls. The external control ensures discourages inclinations to self-interest by the members of the organization, while internal control ensures socially constructive, idealistic, and creative impulses. These leads to the timely implementation of their duties to the various countries the ABC Foundation serves all over the world.
The COSO Internal Control—Integrated Framework provides a blueprint for implementing an internal control system to assist in ensuring the reliability of financial statements and compliance with Sarbanes-Oxley legislation. The purpose of internal control is to provide reasonable assurance in achieving internal control objectives: Effectiveness and efficiency of operations Reliability of financial reporting Compliance with laws and regulations
Controlling in management is a function of management that is concerned with making sure that all other functions of the management are put in place and operated effectively. Controlling ensures that it has taken into consideration the monitoring of the output of the employees as well as the establishing standards of performance that will guarantee that the performance of the will always meets the set standards (Spellman,
It is important to develop and maintain internal controls inside nonprofit organizations because they assist in maintaining ethical standards. According to the National Council of Nonprofits (NCN) internal controls are financial management practices which are systematically used to prevent misuse and misappropriation of assets
In this approach, the focus will be on the internal control objectives so that the control design can be well assessed. First, the auditor will define the control measures and objectives and then find out which measures already installed meet the objectives (Tyrer, 1994).
Internal controls are a big factor in a company’s growth and value. Proper accounting practices are a big part of this process. Following the scandal caused by the unethical practices used by companies such as Enron, Tyco, Global Crossing and Worldcom, the Sarbanes-Oxley Act of 2002 was enacted. This act held companies accountable for their actions. Companies could either face fines, imprisonment or both if the act was not followed. Also, if there are deficiencies in a company’s internal control, stock prices can plummet. There are many physical, mechanical and electronic controls involved in internal controls. Some of these are good controls while others, even though helpful, are not as effective as others.
Implementing strategies to create an effective internal control environment is needed to prevent and detect controls of fraud (Murphy, 2015). Control is needed to combat fraud, enforcing employees and volunteers to do the right thing. Management must have control of the organizations operations to tackle risks when they arise (Arshad et al, 2015). According to Arshad et al (2015):
The companies will begin to implement its enterprise risk management system by developing an appropriate internal control and corporate governance system. In the wake of high-profile corporate scandals and subsequent regulatory legislation, reporting internal controls has become a requirement. These requirements have led to organizations viewing risk management as an area of vital importance.
Internal Audit Department To monitor the implementation of internal procedures, policies, internal control system and report any violations. Detection and control of financial risk and fraud.
“The control process gives managers the tools needed to effectively monitor progress towards an objective” (Satterlee 2013. p.74). There are basically two types of controls utilized by management: internal and external controls. “Internal controls generally can be classified into two categories: preventive or detective” (Satterlee, 2013. p75). As the names depict, preventive is used to ensure things do not happen unless desired and detective is described as determining what happened after it already occurred. Preventive is generally the best choice. Merchant states, “The need for controls over any particular behavior or operation within an organization depends very simply on the impact of that area on overall organizational performance” (Merchant, 1982, p. 48). External control is on the outside of the organization which may deal with polices, auditing and procedures to name a few. The organization has little-to-no control over many of external controls; however, managers must remain cognizant of their affect on the organization and plan for any
The role of internal control to restrain the corruption in organisation is to adopt the integrated control framework to institute the internal written policies and procedures in offer to provide reasonable assurance to management and ensure compliance with the applicable rules and regulations (National Internal
According to the online business glossary, ‘Internal control is the plan of an organization and all the methods and measures used by a business to monitor assets, prevent fraud, minimize errors, verify the correctness and reliability of accounting data, promote operational efficiency, and ensure that established managerial policies are followed’. (Retrieved from http://www.allbusiness.com/glossaries/internal-control/4943791-1.html)
Overall, the company is having ineffective controls regarding different departments and in the whole organization. An effective internal audit department should be established within the organization which should test the effectiveness of these controls on regular basis and make it sure that all controls are working effectively and efficiently with the different departments of the organization. Also the Internal auditor should implement the most effective processes and measures to prevent and detect the fraud, corruption and non compliance with the laws and regulations in the organization. Establishment of internal audit committee would be helpful in this regard which comprises of executive and non executive directors.