Internal Control
ATG 383,
Chapter 8
Spring 2002
Introduction
Define internal control
Who 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 directors
Management
Employees
Why is internal control
important?
Management has a
fiduciary responsibility
to establish controls.
Go to jail.
Foreign Corrupt
Practices Act
Get shut down.
Ways to categorize
controls
Problem:
Web site is hacked
Prevent
Detect
Correct
Ways to categorize
controls
Problem:
Employees not qualified
Prevent
Detect
Correct
Ways to categorize
controls
General
Application
Components of Internal
Control
Monitoring
Control Activities
Risk Assessment
Control Environment
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, used
the owner’s granddaughter,
an actress.
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.
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.
Components of Control
Environment
In order to maintain deposit
insurance, banks must comply
with the Federal Deposit Insurance
Corporation’s standards.
Components of Control
Environment
At Lincoln Savings, the president’s
salary was $1 million.
Age = mid-twenties.
Prior experience = owner’s son & busboy.
Components of Internal
Control
Monitoring
Control Activities
Risk Assessment
Control Environment
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: $5,000
Frequency of reprocessing: 1%
Cost of control: $30,000
3 year expected life
New frequency of reprocessing: .001%
Components of Internal
Control
Monitoring
Control Activities
Risk Assessment
Control Environment
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 authorization
General authorization
Segregation of Duties
Segregation of Duties
Authorize
Record
Custody
Authorize false
payment. Do not
record check.
Fudge bank
reconciliation.
Record
Custody
Segregation of Duties
Authorize Record Custody
Record
Custody
Write
unauthorized
check. Do not
record. Fudge
reconciliation.
Segregation of Duties
Authorize
Record
Custody
Steal cash.
Authorize false
transaction that is
only recorded.
Never paid.
Record Custody
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
Monitoring
Control Activities
Risk Assessment
Control Environment
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
Ongoing
Evaluation
Effective
supervision
Responsibility
Accounting
Internal
Auditing
Separate
Evaluation
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.
Components of Internal
Control
Monitoring
Control Activities
Risk Assessment
Control Environment
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 Assessment
Control Procedures
Monitoring
Information and
Communication