CHAPTER
7
INTERNAL CONTROL
AND CASH
Friday, we will meet in room 217
Performance Review
Internal Review:
• In large companies, controal activities
(including internal review) are monitored
by internal auditors.
• Internal Auditors are company
employees who evaluate the internal
control system of the company. (whether
the system is effective)
• They periodically review the activities of
departments and individuals to determine
whether the correct control activities are
being followed.
Performance Review
Internal Review:
• Internal Review have become so important
that CEO and CFO must certify that they
have evaluated the effectiveness of the
company’s internal control over financial
reporting.
• Their conclusions must be included in the
company’s management discussion and
analysis section of the annual report.
(disclosure note)
Performance Review
External Review :
• Internal auditors work for the same
company they review, but external
auditors do not work for the company
they review but typically work for CA
firms.
• External auditors focus on making sure
that financial statements fairly present the
company’s financial position. (also
whether the company is complying with
IFRS rules.)
Performance Review
External Review :
• All public companies (their shares are traded in
stock exchange) are required to have an external
audit.
• Auditors check, verify and audit (tracing and
vouching) the books of the client.
• This is why accounting firms make millions of
dollars.
•
Other Controls
1. Bonding of employees who handle cash:
 Bonding means getting insurance called
fidelity insurance. If one of the employee
steals money (or asset) then the insurance
compay will compensate the employer for
losses due to dishonesty of an employee.
 When employees know that the company has
fidelity insurance, they will think twice
before stealing company’s asset because the
insurance company will prosecute all
criminals.
Other Controls
2. Rotating employees’ duties and requiring
employees to take vacations.
 These measures discourage employees from
attempting any thefts since they will not be
able to permanently hide their improper
actions.
 Many bank embezzlements, for example,
have been discovered when the guilty
employee was on vacation.
LIMITATIONS OF INTERNAL CONTROL
Cost / Benefit
 No matter how well it is designed and operated, a company’s
system of internal control can only give reasonable assurance
that assets are properly safeguarded and that accounting
records are reliable.
 The concept of reasonable assurance is based on the belief that
the cost of control activities should not be more than their
expected benefit.
 Cost < Benefit then they will implement the internal
control system.
 For example, security guard at Wal-Mart
Cost is 40000 a year > benefit of 10000 then we
LIMITATIONS OF INTERNAL CONTROL
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Collusion
Two or more employees may work together to
get around controls.
Such collusion eliminates the protection
which is offered by segregation of duties.
LIMITATIONS OF INTERNAL
CONTROL
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Size of business
Size of the business may also limit internal
control.
For example, in small companies, it is difficult
to segregate duties or have independent
performance reviews.
This is why in small business, the owner does
internal review and many other functions.
LIMITATIONS OF INTERNAL
CONTROL
Human element
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Human factor is an important limit in internal control
system.
A good system can become ineffective as a result of
employee fatigue, carelessness, indifference and lack
of training.
Classwork / Homework
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P378 Ex 7.1
P379 Ex 7.2
P383 P7.1