C
HAPTER 6
Control and Accounting
Information Systems
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INTRODUCTION
• Questions to be addressed in this chapter:
– What are the basic internal control concepts, and why are
computer control and security important?
– What is the difference between the COBIT, COSO, and ERM
control frameworks?
– What are the major elements in the internal environment of a
company?
– What are the four types of control objectives that companies
need to set?
– What events affect uncertainty, and how can they be identified?
– How is the Enterprise Risk Management model used to assess
and respond to risk?
– What control activities are commonly used in companies?
– How do organizations communicate information and monitor
control processes?
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INTRODUCTION
• Why AIS threats are increasing
– Control risks have increased in the last few years
because:
• There are computers and servers everywhere, and
information is available to an unprecedented number of
workers.
• Distributed computer networks make data available to many
users, and these networks are harder to control than
centralized mainframe systems.
• Wide area networks are giving customers and suppliers
access to each other’s systems and data, making
confidentiality a major concern.
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INTRODUCTION
• Historically, many organizations have not adequately
protected their data due to one or more of the following
reasons:
– Computer control problems are often underestimated and
downplayed.
– Control implications of moving from centralized, host-based
computer systems to those of a networked system or Internetbased system are not always fully understood.
– Companies have not realized that data is a strategic resource
and that data security must be a strategic requirement.
– Productivity and cost pressures may motivate management to
forego time-consuming control measures.
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INTRODUCTION
• Some vocabulary terms for this chapter:
– A threat is any potential adverse occurrence
or unwanted event that could injure the AIS or
the organization.
– The exposure or impact of the threat is the
potential dollar loss that would occur if the
threat becomes a reality.
– The likelihood is the probability that the
threat will occur.
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INTRODUCTION
• Control and security are important
– Companies are now recognizing the problems and
taking positive steps to achieve better control,
including:
• Devoting full-time staff to security and control concerns.
• Educating employees about control measures.
• Establishing and enforcing formal information security
policies.
• Making controls a part of the applications development
process.
• Moving sensitive data to more secure environments.
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INTRODUCTION
• To use IT in achieving control objectives,
accountants must:
– Understand how to protect systems from
threats.
– Have a good understanding of IT and its
capabilities and risks.
• Achieving adequate security and control
over the information resources of an
organization should be a top management
priority.
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INTRODUCTION
• Control objectives are the same regardless of
the data processing method, but a computerbased AIS requires different internal control
policies and procedures because:
– Computer processing may reduce clerical errors but
increase risks of unauthorized access or modification
of data files.
– Segregation of duties must be achieved differently in
an AIS.
– Computers provide opportunities for enhancement of
some internal controls.
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INTRODUCTION
• One of the primary objectives of an AIS is to
control a business organization.
– Accountants must help by designing effective control
systems and auditing or reviewing control systems
already in place to ensure their effectiveness.
• Management expects accountants to be control
consultants by:
– Taking a proactive approach to eliminating system
threats; and
– Detecting, correcting, and recovering from threats
when they do occur.
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INTRODUCTION
• It is much easier to build controls into a
system during the initial stage than to add
them after the fact.
• Consequently, accountants and control
experts should be members of the teams
that develop or modify information
systems.
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OVERVIEW OF CONTROL CONCEPTS
• In today’s dynamic business environment,
companies must react quickly to changing
conditions and markets, including steps to:
– Hire creative and innovative employees.
– Give these employees power and flexibility to:
• Satisfy changing customer demands;
• Pursue new opportunities to add value to the organization;
and
• Implement process improvements.
• At the same time, the company needs control
systems so they are not exposed to excessive
risks or behaviors that could harm their
reputation for honesty and integrity.
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OVERVIEW OF CONTROL CONCEPTS
• Internal control is the process implemented by the
board of directors, management, and those under their
direction to provide reasonable assurance that the
following control objectives are achieved:
– Assets (including data) are safeguarded.
• This objective includes prevention or timely
detection of unauthorized acquisition, use, or
disposal of material company assets.
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OVERVIEW OF CONTROL CONCEPTS
• Internal control is the process implemented by the
board of directors, management, and those under their
direction to provide reasonable assurance that the
following control objectives are achieved:
– Assets (including data) are safeguarded.
– Records are maintained in sufficient detail to accurately and
fairly reflect company assets.
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OVERVIEW OF CONTROL CONCEPTS
• Internal control is the process implemented by the
board of directors, management, and those under their
direction to provide reasonable assurance that the
following control objectives are achieved:
– Assets (including data) are safeguarded.
– Records are maintained in sufficient detail to accurately and
fairly reflect company assets.
– Accurate and reliable information is provided.
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OVERVIEW OF CONTROL CONCEPTS
• Internal control is the process implemented by the
board of directors, management, and those under their
direction to provide reasonable assurance that the
following control objectives are achieved:
– Assets (including data) are safeguarded.
– Records are maintained in sufficient detail to accurately and
fairly reflect company assets.
– Accurate and reliable information is provided.
– There is reasonable assurance that financial reports are
prepared in accordance with GAAP.
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OVERVIEW OF CONTROL CONCEPTS
• Internal control is the process implemented by the
board of directors, management, and those under their
direction to provide reasonable assurance that the
following control objectives are achieved:
– Assets (including data) are safeguarded.
– Records are maintained in sufficient detail to accurately and
fairly reflect company assets.
– Accurate and reliable information is provided.
– There is reasonable assurance that financial reports are
prepared in accordance with GAAP.
– Operational efficiency is promoted and improved.
• This objective includes ensuring that company
receipts and expenditures are made in accordance
with management and directors’ authorizations.
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OVERVIEW OF CONTROL CONCEPTS
• Internal control is the process implemented by the
board of directors, management, and those under their
direction to provide reasonable assurance that the
following control objectives are achieved:
– Assets (including data) are safeguarded.
– Records are maintained in sufficient detail to accurately and
fairly reflect company assets.
– Accurate and reliable information is provided.
– There is reasonable assurance that financial reports are
prepared in accordance with GAAP.
– Operational efficiency is promoted and improved.
– Adherence to prescribed managerial policies is encouraged.
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OVERVIEW OF CONTROL CONCEPTS
• Internal control is the process implemented by the
board of directors, management, and those under their
direction to provide reasonable assurance that the
following control objectives are achieved:
– Assets (including data) are safeguarded.
– Records are maintained in sufficient detail to accurately and
fairly reflect company assets.
– Accurate and reliable information is provided.
– There is reasonable assurance that financial reports are
prepared in accordance with GAAP.
– Operational efficiency is promoted and improved.
– Adherence to prescribed managerial policies is encouraged.
– The organization complies with applicable laws and
regulations.
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OVERVIEW OF CONTROL CONCEPTS
• Internal control is a process because:
– It permeates an organization’s operating activities.
– It is an integral part of basic management activities.
• Internal control provides reasonable, rather
than absolute, assurance, because complete
assurance is difficult or impossible to achieve
and prohibitively expensive.
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OVERVIEW OF CONTROL CONCEPTS
• Internal control systems have inherent
limitations, including:
– They are susceptible to errors and poor decisions.
– They can be overridden by management or by
collusion of two or more employees.
• Internal control objectives are often at odds with
each other.
– EXAMPLE: Controls to safeguard assets may also
reduce operational efficiency.
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OVERVIEW OF CONTROL CONCEPTS
• Internal controls perform three important
functions:
– Preventive controls
• Deter problems before they arise.
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OVERVIEW OF CONTROL CONCEPTS
• Internal controls perform three important
functions:
– Preventive controls
– Detective controls
• Discover problems quickly when they do arise.
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OVERVIEW OF CONTROL CONCEPTS
• Internal controls perform three important
functions:
– Preventive controls
– Detective controls
– Corrective controls
• Remedy problems that have occurred by:
– Identifying the cause;
– Correcting the resulting errors; and
– Modifying the system to prevent future
problems of this sort.
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OVERVIEW OF CONTROL CONCEPTS
• Internal controls are often classified as:
– General controls
• Those designed to make sure an
organization’s control environment is stable
and well managed.
• They apply to all sizes and types of systems.
• Examples: Security management controls.
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OVERVIEW OF CONTROL CONCEPTS
• Internal controls are often classified as:
– General controls
– Application controls
• Prevent, detect, and correct transaction errors
and fraud.
• Concerned with accuracy, completeness,
validity, and authorization of the data captured,
entered into the system, processed, stored,
transmitted to other systems, and reported.
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OVERVIEW OF CONTROL CONCEPTS
• An effective system of internal controls
should exist in all organizations to:
– Help them achieve their missions and goals.
– Minimize surprises.
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SOX AND THE FOREIGN CORRUPT
PRACTICES ACT
• In 1977, Congress passed the Foreign Corrupt
Practices Act, and to the surprise of the profession, this
act incorporated language from an AICPA
pronouncement.
• The primary purpose of the act was to prevent the
bribery of foreign officials to obtain business.
• A significant effect was to require that corporations
maintain good systems of internal accounting control.
– Generated significant interest among management, accountants,
and auditors in designing and evaluating internal control
systems.
– The resulting internal control improvements weren’t sufficient.
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SOX AND THE FOREIGN CORRUPT
PRACTICES ACT
• In the late 1990s and early 2000s, a series
of multi-million-dollar accounting frauds
made headlines.
– The impact on financial markets was
substantial, and Congress responded with
passage of the Sarbanes-Oxley Act of 2002
(aka, SOX).
• Applies to publicly held companies and their
auditors.
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SOX AND THE FOREIGN CORRUPT
PRACTICES ACT
• The intent of SOX is to:
– Prevent financial statement fraud
– Make financial reports more transparent
– Protect investors
– Strengthen internal controls in publicly-held
companies
– Punish executives who perpetrate fraud
• SOX has had a material impact on the way
boards of directors, management, and
accountants operate.
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SOX AND THE FOREIGN CORRUPT
PRACTICES ACT
• Important aspects of SOX include:
– Creation of the Public Company Accounting
Oversight Board (PCAOB) to oversee the auditing
profession.
• Has five members, three of whom cannot be
CPAs.
• Charges fees to firms to fund the PCAOB.
• Sets and enforces auditing, quality control,
ethics, independence, and other standards
relating to audit reports.
• Currently recognizes FASB statements as
being generally accepted.
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SOX AND THE FOREIGN CORRUPT
PRACTICES ACT
• Important aspects of SOX include:
– Creation of the Public Company Accounting Oversight
Board (PCAOB) to oversee the auditing profession.
– New rules for auditors
• They must report specific information to the company’s audit
committee, such as:
– Critical accounting policies and practices
– Alternative GAAP treatments
– Auditor-management disagreements
• Audit partners must be rotated periodically.
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SOX AND THE FOREIGN CORRUPT
PRACTICES ACT
• Important aspects of SOX include:
– Creation of the Public Company Accounting Oversight
Board (PCAOB) to oversee the auditing profession.
– New rules for auditors
• Auditors cannot perform certain non-audit services, such as:
– Bookkeeping
– Information systems design and implementation
– Internal audit outsourcing services
– Management functions
– Human resource services
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SOX AND THE FOREIGN CORRUPT
PRACTICES ACT
• Important aspects of SOX include:
– Creation of the Public Company Accounting Oversight
Board (PCAOB) to oversee the auditing profession.
– New rules for auditors
• Permissible non-audit services must be approved by the
board of directors and disclosed to investors.
• Cannot audit a company if a member of top management was
employed by the auditor and worked on the company’s audit
in the past 12 months.
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SOX AND THE FOREIGN CORRUPT
PRACTICES ACT
• Important aspects of SOX include:
– Creation of the Public Company Accounting Oversight
Board (PCAOB) to oversee the auditing profession.
– New rules for auditors
– New rules for audit committees
• Members must be on the company’s board
of directors and must otherwise be
independent of the company.
• One member must be a financial expert.
• The committee hires, compensates, and
oversees the auditors, and the auditors
report directly to the committee.
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SOX AND THE FOREIGN CORRUPT
ACT
• The CEO andPRACTICES
CFO must certify that:
•
– The financial statements and disclosures are fairly
Important
aspects
of SOXbyinclude:
presented,
were reviewed
management, and are not
misleading.
– Creation
of the Public Company Accounting Oversight
– Management
responsible
for internal
Board
(PCAOB)isto
oversee the
auditingcontrols.
profession.
– The auditors were advised of any material internal control
– New
rules for auditors
weaknesses
or fraud.
– New
rules
for audit
committees
– Any
significant
changes
to controls after management’s
evaluation
were
disclosed and corrected.
– New
rules for
management
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SOX AND THE FOREIGN CORRUPT
PRACTICES ACT
•
• If management willfully and knowingly violates the
certification,
they canofbe:
Important
aspects
SOX include:
– Imprisoned up to 20 years
– Creation of the Public Company Accounting Oversight
– Fined up to $5 million
Board (PCAOB) to oversee the auditing profession.
• Management and directors cannot receive loans that would not
– New
rules for
auditors
be available
to people
outside the company.
•– New
They rules
must disclose
a rapid and current basis material
for auditoncommittees
changes to their financial condition.
– New rules for management
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SOX AND THE FOREIGN CORRUPT
• New internal
control requirements:
PRACTICES
ACT
•
– Section 404 of SOX requires companies to issue a
report accompanying the financial statements that:
Important aspects
of SOX include:
• States management is responsible for
– Creation of the
Public Company
Accounting
Oversight
establishing
and maintaining
an adequate
internal
Board (PCAOB)
to oversee
profession.
control
structure the
and auditing
procedures.
• Contains
– New rules for
auditorsmanagement’s assessment of the
company’s internal controls.
– New rules for audit committees
• Attests to the accuracy of the internal controls,
– New rules forincluding
management
disclosures of significant defects or
noncompliance
found during the tests.
– New internalmaterial
control
requirements
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SOX AND THE FOREIGN CORRUPT
PRACTICES ACT
• Important aspects of SOX include:
– Creation of the Public Company Accounting Oversight
Board (PCAOB) to oversee the auditing profession.
– New rules for auditors
• SOX also requires that the auditor attests to and reports
– New rules
for audit committees
on management’s
internal control assessment.
– New• rules
management
Eachfor
audit
report must describe the scope of the
auditor’scontrol
internal requirements
control tests.
– New internal
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SOX AND THE FOREIGN CORRUPT
PRACTICES ACT
• After the passage of SOX, the SEC further
mandated that:
– Management must base its evaluation on a
recognized control framework, developed using a
due-process procedure that allows for public
comment. The most likely framework is the COSO
model discussed later in the chapter.
– The report must contain a statement identifying the
framework used.
– Management must disclose any and all material
internal control weaknesses.
– Management cannot conclude that the company has
effective internal control if there are any material
weaknesses.
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SOX AND THE FOREIGN CORRUPT
PRACTICES ACT
• Levers of control
– Many
people feel there is a basic conflict
• Communicates company core values to employees and
between
creativity
and
controls.
inspires
them to live
by those
values.
• Draws attention to how the organization creates value.
– Robert
Simons has espoused four levers of
• Helps employees understand management’s intended
controls
to help companies reconcile this
direction.
conflict:
• Must be broad enough to appeal to all levels.
• A concise belief system
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SOX AND THE FOREIGN CORRUPT
PRACTICES
• Helps employees
act ethicallyACT
by setting limits beyond
•
which they must not pass.
• Does
create rules and standard operating
Levers
ofnotControl
procedures that can stifle creativity.
– Many
people feel there is a basic conflict
• Encourages employees to think and act creatively to
between
creativity
solve problems
and and
meet controls.
customer needs as long as
they operate within limits such as:
– Robert
Simons
has
espoused
four
levers
of
– Meeting minimum standards of performance
controls
to help
companies
– Shunning
off-limits
activitiesreconcile this
conflict:
– Avoiding actions that could damage the company’s
reputation.
• A concise
belief system
• A boundary system
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SOX AND THE FOREIGN CORRUPT
PRACTICES ACT
• Levers of control
• Ensures
efficient
effective
of important
– Many
people
feeland
there
is a achievement
basic conflict
controls.
between creativity and controls.
• This system measures company progress by comparing
actual
to planned
performance.
– Robert
Simons
has
espoused four levers of
• Helps to
managers
track critical performance
controls
help companies
reconcile outcomes
this
and monitor performance of individuals, departments,
conflict:
and locations.
•• AProvides
concise feedback
belief system
to enable management to adjust and
• Afine-tune.
boundary system
• A diagnostic control system
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SOX AND THE FOREIGN CORRUPT
• Helps top-level
managers with
high-level activities that
PRACTICES
ACT
demand frequent and regular attention. Examples:
– Developing company strategy.
– Setting company objectives.
Many– people
feel there
is a basic
conflict
Understanding
and assessing
threats
and risks.
– Monitoring
changes
competitive conditions and
between
creativity
and incontrols.
emerging technologies.
Robert
Simons has
espoused
fourplans
levers
– Developing
responses
and action
to of
with these reconcile
high-level issues.
controlsproactively
to help deal
companies
this
• Also helps managers focus the attention of subordinates
conflict:
on key strategic issues and to be more involved in their
• A concise
belief system
decisions.
• •A boundary
system
Data from this
system are best interpreted and
discussed in face-to-face meetings.
• Levers of Control
–
–
• A diagnostic control system
• An interactive control system
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CONTROL FRAMEWORKS
• A number of frameworks have been
developed to help companies develop
good internal control systems. Three
of the most important are:
– The COBIT framework
– The COSO internal control framework
– COSO’s Enterprise Risk Management
framework (ERM)
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CONTROL FRAMEWORKS
• A number of frameworks have been
developed to help companies develop
good internal control systems. Three
of the most important are:
– The COBIT framework
– The COSO internal control framework
– COSO’s Enterprise Risk Management
framework (ERM)
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CONTROL FRAMEWORKS
• COBIT framework
– Also know as the Control Objectives for
Information and Related Technology
framework.
– Developed by the Information Systems Audit
and Control Foundation (ISACF).
– A framework of generally applicable
information systems security and control
practices for IT control.
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CONTROL FRAMEWORKS
• The COBIT framework allows:
– Management to benchmark security and
control practices of IT environments.
– Users of IT services to be assured that
adequate security and control exists.
– Auditors to substantiate their opinions on
internal control and advise on IT security and
control matters.
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• To satisfy business objectives,
information must conform to
certain criteria referred to as
“business requirements for
information.”
The framework addresses
the issue of
• The criteria are divided into
control from three vantage
oroverlapping
sevenpoints
distinct yet
categories that map into COSO
dimensions:
objectives:
– Business objectives – Effectiveness (relevant,
pertinent, and timely)
– Efficiency
– Confidentiality
– Integrity
– Availability
– Compliance with legal
requirements
– Reliability
CONTROL FRAMEWORKS
•
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CONTROL FRAMEWORKS
• The framework addresses the issue of
control from three vantage points or
dimensions:
– Business objectives
– IT resources • Includes:
•
•
•
•
•
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People
Application systems
Technology
Facilities
Data
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CONTROL FRAMEWORKS
• The framework addresses the issue of
control from three vantage points or
dimensions:
– Business objectives
– IT resources
– IT processes • Broken into four domains:
–
–
–
–
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Acquisition and implementation
Delivery and support
Monitoring
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CONTROL FRAMEWORKS
• COBIT consolidates standards from 36 different
sources into a single framework.
• It is having a big impact on the IS profession.
– Helps managers to learn how to balance risk and
control investment in an IS environment.
– Provides users with greater assurance that security
and IT controls provided by internal and third parties
are adequate.
– Guides auditors as they substantiate their opinions
and provide advice to management on internal
controls.
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CONTROL FRAMEWORKS
• A number of frameworks have been
developed to help companies develop
good internal control systems. Three of
the most important are:
– The COBIT framework
– The COSO internal control framework
– COSO’s Enterprise Risk Management
framework (ERM)
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CONTROL FRAMEWORKS
• COSO’s internal control framework
– The Committee of Sponsoring Organizations
(COSO) is a private sector group consisting
of:
•
•
•
•
•
The American Accounting Association
The AICPA
The Institute of Internal Auditors
The Institute of Management Accountants
The Financial Executives Institute
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CONTROL FRAMEWORKS
• In 1992, COSO issued the Internal
Control Integrated Framework:
– Defines internal controls.
– Provides guidance for evaluating and
enhancing internal control systems.
– Widely accepted as the authority on internal
controls.
– Incorporated into policies, rules, and
regulations used to control business activities.
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CONTROL FRAMEWORKS
• COSO’s internal control model has five
crucial components:
- Control environment
• The core of any business is its people.
• Their integrity, ethical values, and competence make
up the foundation on which everything else rests.
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CONTROL FRAMEWORKS
• COSO’s internal control model has five
crucial components:
- Control environment
- Control activities
• Policies and procedures must be established and
executed to ensure that actions identified by
management as necessary to address risks are, in
fact, carried out.
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CONTROL FRAMEWORKS
• COSO’s internal control model has five
crucial components:
- Control environment
- Control activities
- Risk assessment
• The organization must be aware of and deal with the
risks it faces.
• It must set objectives for its diverse activities and
establish mechanisms to identify, analyze, and
manage the related risks.
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CONTROL FRAMEWORKS
• COSO’s internal control model has five
crucial components:
-
Control environment
Control activities
Risk assessment
Information and communication
• Information and communications systems surround the
control activities.
• They enable the organization’s people to capture and
exchange information needed to conduct, manage, and
control its operations.
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CONTROL FRAMEWORKS
• COSO’s internal control model has five
crucial components:
-
Control environment
Control activities
Risk assessment
Information and communication
Monitoring
• The entire process must be monitored and modified
as necessary.
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CONTROL FRAMEWORKS
• A number of frameworks have been
developed to help companies develop
good internal control systems. Three
of the most important are:
– The COBIT framework
– The COSO internal control framework
– COSO’s Enterprise Risk Management
framework (ERM)
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CONTROL FRAMEWORKS
• Nine years after COSO issued the preceding
framework, it began investigating how to
effectively identify, assess, and manage risk so
organizations could improve the risk
management process.
• Result: Enterprise Risk Manage Integrated
Framework (ERM)
– An enhanced corporate governance document.
– Expands on elements of preceding framework.
– Provides a focus on the broader subject of enterprise
risk management.
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CONTROL FRAMEWORKS
• Intent of ERM is to achieve all goals of the
internal control framework and help the
organization:
– Provide reasonable assurance that company
objectives and goals are achieved and problems and
surprises are minimized.
– Achieve its financial and performance targets.
– Assess risks continuously and identify steps to take
and resources to allocate to overcome or mitigate
risk.
– Avoid adverse publicity and damage to the entity’s
reputation.
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CONTROL FRAMEWORKS
• ERM defines risk management as:
– A process effected by an entity’s board of
directors, management, and other personnel.
– Applied in strategy setting and across the
enterprise.
– To identify potential events that may affect the
entity.
– And manage risk to be within its risk appetite.
– In order to provide reasonable assurance of
the achievement of entity objectives.
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CONTROL FRAMEWORKS
• Basic principles behind ERM:
– Companies are formed to create value for
owners.
– Management must decide how much
uncertainty they will accept.
– Uncertainty can result in:
• Risk
• The possibility that something will happen to:
– Adversely affect the ability to create value; or
– Erode existing value.
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CONTROL FRAMEWORKS
• Basic principles behind ERM:
– Companies are formed to create value for
owners.
– Management must decide how much
uncertainty they will accept.
– Uncertainty can result in:
• Risk
• Opportunity
• The possibility that something will happen to
positively affect the ability to create or preserve
value.
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CONTROL FRAMEWORKS
– The framework should help management
manage uncertainty and its associated risk to
build and preserve value.
– To maximize value, a company must balance
its growth and return objectives and risks with
efficient and effective use of company
resources.
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CONTROL FRAMEWORKS
• COSO developed a
model to illustrate
the elements of
ERM.
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CONTROL FRAMEWORKS
• Columns at the top
represent the four types of
objectives that
management must meet to
achieve company goals.
– Strategic objectives
• Strategic objectives are
high-level goals that are
aligned with and support
the company’s mission.
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CONTROL FRAMEWORKS
• Columns at the top
represent the four types of
objectives that
management must meet to
achieve company goals.
– Strategic objectives
– Operations objectives
• Operations objectives deal with
effectiveness and efficiency of
company operations, such as:
– Performance and
profitability goals
– Safeguarding assets
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CONTROL FRAMEWORKS
• Reporting objectives help
ensure the accuracy,
completeness,
• Columns
at the and
top reliability of
internal and
company
represent
theexternal
four types
of
reports of both a financial and
objectives
that
non-financial nature.
management must meet to
• Improve decision-making and
achieve
goals. and
monitorcompany
company activities
–performance
Strategic objectives
more efficiently.
– Operations objectives
– Reporting objectives
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CONTROL FRAMEWORKS
Compliance
objectives
help the
• • Columns
at the
top
company the
comply
represent
fourwith
types of
applicable laws and
objectives
that
regulations.
management
must meet to
– External parties often set
achieve
company goals.
the compliance
rules.
– –Strategic
objectives
Companies
in the same
– Operations
objectives
industry often
have similar
concerns
in this area.
– Reporting
objectives
– Compliance objectives
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CONTROL FRAMEWORKS
• ERM can provide reasonable
assurance that reporting and
compliance objectives will be
achieved because companies
have control over them.
• However, strategic and
operations objectives are
sometimes at the mercy of
external events that the
company can’t control.
• Therefore, in these areas, the
only reasonable assurance the
ERM can provide is that
management and directors are
informed on a timely basis of the
progress the company is making
in achieving them.
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CONTROL FRAMEWORKS
• Columns on the
right represent the
company’s units:
– Entire company
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CONTROL FRAMEWORKS
• Columns on the
right represent the
company’s units:
– Entire company
– Division
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CONTROL FRAMEWORKS
• Columns on the
right represent the
company’s units:
– Entire company
– Division
– Business unit
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CONTROL FRAMEWORKS
• Columns on the
right represent the
company’s units:
– Entire company
– Division
– Business unit
– Subsidiary
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CONTROL FRAMEWORKS
• The horizontal rows are
eight related risk and
control components,
including:
– Internal environment
• The tone or culture of the
company.
• Provides discipline and
structure and is the foundation
for all other components.
• Essentially, the same as control
environment in the COSO
internal control framework.
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CONTROL FRAMEWORKS
• The horizontal rows are
eight related risk and
control components,
including:
– Internal environment
– Objective setting
• Ensures that management implements a process to formulate
strategic, operations, reporting, and compliance objectives that
support the company’s mission and are consistent with the company’s
tolerance for risk.
• Strategic objectives are set first as a foundation for the other three.
• The objectives provide guidance to companies as they identify riskcreating events and assess and respond to those risks.
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CONTROL FRAMEWORKS
• The horizontal rows are
eight related risk and
control components,
including:
– Internal environment
– Objective setting
– Event identification
• Requires management to identify events that may affect the company’s
ability to implement its strategy and achieve its objectives.
• Management must then determine whether these events represent:
– Risks (negative-impact events requiring assessment and
response); or
– Opportunities (positive-impact events that influence strategy and
objective-setting processes).
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• Identified risks are assessed to
determine how to manage them
and how they affect the
company’s ability to achieve its
objectives.
• Qualitative
and
quantitative
• The
horizontal
rows
are
methods
arerisk
used
to assess
eight
related
and
risks individually and by
control
components,
category
in terms of:
including:
– Likelihood
– Internal
environment
– Positive
and negative
– Objective
impactsetting
– Event
identification
– Effect
on other
organizational
– Risk
assessment units
• Risks are analyzed on an
inherent and a residual basis.
• Corresponds to the risk
assessment element in COSO’s
internal control framework.
CONTROL FRAMEWORKS
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• Management aligns identified risks
with the company’s tolerance for
risk by choosing to:
– Avoid
– Reduce
• The
horizontal rows are
– Share
eight
related risk and
– Accept
control
components,
• Management takes an entity-wide
including:
or portfolio view of risks in
– Internalthe
environment
assessing
likelihood of the
– Objective
setting impact, and
risks,
their potential
costs-benefits
of alternate
– Event identification
responses.
– Risk assessment
CONTROL FRAMEWORKS
– Risk response
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CONTROL FRAMEWORKS
Tohorizontal
implement rows
management’s
• •The
are
riskrelated
responses,
eight
risk control
and policies
and procedures are established
control
components,
and implemented throughout
including:
the various levels and
–
•–
–
–
–
–
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Internal environment
functions
of the organization.
Objective setting
Corresponds
to the control
activities
element in the COSO
Event identification
internal
control framework.
Risk assessment
Risk response
Control activities
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• Information about the company
and ERM components must be
identified, captured, and
communicated so employees
can fulfill their responsibilities.
Information
beare
able to
• •The
horizontalmust
rows
flowrelated
throughrisk
all levels
eight
and and
functions in the company as
control
components,
well as
flowing to and from
including:
external parties.
Internal environment
• – Employees
should understand
role and
importance in
– their
Objective
setting
how these
– ERM
Eventand
identification
responsibilities relate to those
– Risk assessment
of others.
– Risk response
• Has a corresponding element
– in
Control
activities
the COSO
internal control
– framework.
Information and
communication
CONTROL FRAMEWORKS
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CONTROL FRAMEWORKS
• The horizontal rows are
eight related risk and
•control
ERM processes
must be
components,
monitored on an ongoing basis
including:
–
–
–
•–
–
•–
–
•
–
© 2008 Prentice Hall Business Publishing
and modified as needed.
Internal environment
Accomplished with ongoing
Objective setting
management
activities and
Event identification
separate
evaluations.
Risk assessment
Deficiencies
are reported to
Risk response
management.
Control activitiesmodule in
Corresponding
COSO
internal
Information
andcontrol
framework.
communication
Monitoring
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CONTROL FRAMEWORKS
• The ERM model is
three-dimensional.
• Means that each of
the eight risk and
control elements are
applied to the four
objectives in the
entire company
and/or one of its
subunits.
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CONTROL FRAMEWORKS
• ERM
Framework
Vs. the
• Examining
controls without
first Internal
examining purposes and
risks of
business processes provides little context for
Control
Framework
evaluating the results.
– The
internal
control
framework has been
• Makes
it difficult
to know:
– Which
controlas
systems
are most important.
widely
adopted
the principal
way to
– Whether
they adequately
risk.
evaluate
internal
controlsdeal
as with
required
by SOX.
– Whether important control systems are missing.
However,
there are issues with it.
• It has too narrow of a focus.
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CONTROL FRAMEWORKS
• ERM framework vs. the internal control
framework
– The internal control framework has been
widely adopted as the principal way to
• May contribute to systems with
evaluate internal controls
as
required
by
SOX.
many controls to protect
However, there are issues
withrisks
it. that are no longer
against
important.
• It has too narrow of a focus.
• Focusing on controls first has an inherent bias
toward past problems and concerns.
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CONTROL FRAMEWORKS
• These issues led to COSO’s development of the
ERM framework.
– Takes a risk-based, rather than controls-based,
approach to the organization.
– Oriented toward future and constant change.
– Incorporates rather than replaces COSO’s internal
control framework and contains three additional
elements:
• Setting objectives.
• Identifying positive and negative events that may affect the
company’s ability to implement strategy and achieve
objectives.
• Developing a response to assessed risk.
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CONTROL FRAMEWORKS
– Controls are flexible and relevant because
they are linked to current organizational
objectives.
– ERM also recognizes more options than
simply controlling risk, which include
accepting it, avoiding it, diversifying it, sharing
it, or transferring it.
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CONTROL FRAMEWORKS
• Over time, ERM will probably become the
most widely adopted risk and control
model.
• Consequently, its eight components are
the topic of the remainder of the chapter.
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INTERNAL ENVIRONMENT
• The most critical component
of the ERM and the internal
control framework.
• Is the foundation on which the
other seven components rest.
• Influences how organizations:
– Establish strategies and
objectives
– Structure business activities
– Identify, access, and respond
to risk
• A deficient internal control
environment often results in
risk management and control
breakdowns.
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INTERNAL ENVIRONMENT
• Internal environment consists of the following:
– Management’s philosophy, operating style, and risk
appetite
– The board of directors
– Commitment to integrity, ethical values, and
competence
– Organizational structure
– Methods of assigning authority and responsibility
– Human resource standards
– External influences
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INTERNAL ENVIRONMENT
• Internal environment consists of the following:
– Management’s philosophy, operating style, and
risk appetite
– The board of directors
– Commitment to integrity, ethical values, and
competence
– Organizational structure
– Methods of assigning authority and responsibility
– Human resource standards
– External influences
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INTERNAL ENVIRONMENT
• Management’s philosophy, operating style,
and risk appetite
– An organization’s management has shared beliefs
and attitudes about risk.
– That philosophy affects everything the organization
does, long- and short-term, and affects their
communications.
– Companies also have a risk appetite, which is the
amount of risk a company is willing to accept to
achieve its goals and objectives.
– That appetite needs to be in alignment with company
strategy.
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INTERNAL ENVIRONMENT
– The more responsible management’s
philosophy and operating style, the more
likely employees will behave responsibly.
– This philosophy must be clearly
communicated to all employees; it is not
enough to give lip service.
– Management must back up words with
actions; if they show little concern for internal
controls, then neither will employees.
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INTERNAL ENVIRONMENT
– This component can be assessed by asking
questions such as:
• Does management take undue business risks or
assess potential risks and rewards before acting?
• Does management attempt to manipulate
performance measures such as net income?
• Does management pressure employees to achieve
results regardless of methods or do they demand
ethical behavior?
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INTERNAL ENVIRONMENT
• Internal environment consists of the following:
– Management’s philosophy, operating style, and risk
appetite
– The board of directors
– Commitment to integrity, ethical values, and
competence
– Organizational structure
– Methods of assigning authority and responsibility
– Human resource standards
– External influences
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INTERNAL ENVIRONMENT
• The board of directors
– An active and involved board of directors
plays an important role in internal control.
– They should:
• Oversee management
• Scrutinize management’s plans, performance, and
activities
• Approve company strategy
• Review financial results
• Annually review the company’s security policy
• Interact with internal and external auditors
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INTERNAL ENVIRONMENT
• Directors should possess management,
technical, or other expertise, knowledge,
or experience, as well as a willingness to
advocate for shareholders.
• At least a majority should be independent,
outside directors not affiliated with the
company or any of its subsidiaries.
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INTERNAL ENVIRONMENT
• Public companies must have an audit
committee, composed entirely of independent,
outside directors.
– The audit committee oversees:
• The company’s internal control structure;
• Its financial reporting process; and
• Its compliance with laws, regulations, and standards.
– Works with the corporation’s external and internal
auditors.
• Hires, compensates, and oversees the auditors.
• Auditors report all critical accounting policies and practices to
the audit committee.
– Provides an independent review of management’s
actions.
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INTERNAL ENVIRONMENT
• Internal environment consists of the following:
– Management’s philosophy, operating style, and risk
appetite
– The board of directors
– Commitment to integrity, ethical values, and
competence
– Organizational structure
– Methods of assigning authority and responsibility
– Human resource standards
– External influences
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INTERNAL ENVIRONMENT
• Commitment to integrity, ethical values,
and competence
– Management must create an organizational
culture that stresses integrity and commitment
to both ethical values and competence.
• Ethical standards of behavior make for good
business.
• Tone at the top is everything.
• Employees will watch the actions of the CEO, and
the message of those actions (good or bad) will
tend to permeate the organization.
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INTERNAL ENVIRONMENT
• Companies can endorse integrity as a basic
operating principle by actively teaching and
requiring it.
– Management should:
• Make it clear that honest reports are more important than
favorable ones.
– Management should avoid:
•
•
•
•
•
•
•
Unrealistic expectations, incentives, or temptations.
Attitude of earnings or revenue at any price.
Overly aggressive sales practices.
Unfair or unethical negotiation practices.
Implied kickback offers.
Excessive bonuses.
Bonus plans with upper and lower cutoffs.
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INTERNAL ENVIRONMENT
• Management should not assume that employees
would always act honestly.
– Consistently reward and encourage honesty.
– Give verbal labels to honest and dishonest acts.
– The combination of these two will produce more
consistent moral behavior.
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INTERNAL ENVIRONMENT
• Management should develop clearly stated
policies that explicitly describe honest and
dishonest behaviors, often in the form of a
written code of conduct.
– In particular, such a code would cover issues that are
uncertain or unclear.
– Dishonesty often appears when situations are gray
and employees rationalize the most expedient action
as opposed to making a right vs. wrong choice.
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INTERNAL ENVIRONMENT
• SOX only requires a code of ethics for senior
financial management. However, the ACFE
suggests that companies create a code of
conduct for all employees:
– Should be written at a fifth-grade level.
– Should be reviewed annually with employees and
signed.
– This approach helps employees keep themselves out
of trouble.
– Helps the company if they need to take legal action
against the employee.
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INTERNAL ENVIRONMENT
• Management should require employees to report
dishonest, illegal, or unethical behavior and discipline
employees who knowingly fail to report.
– Reports of dishonest acts should be thoroughly investigated.
– Those found guilty should be dismissed.
– Prosecution should be undertaken when possible, so that other
employees are clear about consequences.
• Companies must make a commitment to competence.
– Begins with having competent employees.
– Varies with each job but is a function of knowledge, experience,
training, and skills.
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INTERNAL ENVIRONMENT
• The levers of control, particularly beliefs
and boundaries systems, can be used to
create the kind of commitment to integrity
an organization wants.
– Requires more than lip service and signing
forms.
– Must be systems in which top management
actively participates in order to:
• Demonstrate the importance of the system.
• Create buy-in and a team spirit.
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INTERNAL ENVIRONMENT
• Management should require employees to
report dishonest, illegal, or unethical
behavior and discipline employees who
knowingly fail to report.
– Reports of dishonest acts should be
thoroughly investigated.
– Those found guilty should be dismissed.
– Prosecution should be undertaken when
possible, so that other employees are clear
about consequences.
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INTERNAL ENVIRONMENT
• Companies must make a commitment to
competence.
– Begins with having competent employees.
– Varies with each job but is a function of
knowledge, experience, training, and skills.
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INTERNAL ENVIRONMENT
• The levers of control, particularly beliefs
and boundary systems, can be used to
create the kind of commitment to integrity
an organization wants.
– Requires more than lip service and signing
forms.
– Must be systems in which top management
actively participates in order to:
• Demonstrate the importance of the system.
• Create buy-in and a team spirit.
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INTERNAL ENVIRONMENT
• Internal environment consists of the following:
– Management’s philosophy, operating style, and risk
appetite
– The board of directors
– Commitment to integrity, ethical values, and
competence
– Organizational structure
– Methods of assigning authority and responsibility
– Human resource standards
– External influences
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INTERNAL ENVIRONMENT
• Organizational structure
– A company’s organizational structure defines
its lines of authority, responsibility, and
reporting.
• Provides the overall framework for planning,
directing, executing, controlling, and monitoring its
operations.
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INTERNAL ENVIRONMENT
• Important aspects or organizational structure:
–
–
–
–
Degree of centralization or decentralization.
Assignment of responsibility for specific tasks.
Direct-reporting relationships or matrix structure.
Organization by industry, product, geographic
location, marketing network.
– How the responsibility allocation affects
management’s information needs.
– Organization of accounting and IS functions.
– Size and nature of company activities.
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INTERNAL ENVIRONMENT
• Statistically, fraud occurs more frequently
in organizations with complex structures.
– The structures may unintentionally impede
communication and clear assignment of
responsibility, making fraud easier to commit
and conceal; or
– The structure may be intentionally complex to
facilitate the fraud.
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INTERNAL ENVIRONMENT
• In today’s business world, the hierarchical
organizations with many layers of management
are giving way to flatter organizations with selfdirected work teams.
– Team members are empowered to make decisions
without multiple layers of approvals.
– Emphasis is on continuous improvement rather than
on regular evaluations.
– These changes have a significant impact on the
nature and type of controls needed.
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INTERNAL ENVIRONMENT
• Internal environment consists of the following:
– Management’s philosophy, operating style, and risk
appetite
– The board of directors
– Commitment to integrity, ethical values, and
competence
– Organizational structure
– Methods of assigning authority and responsibility
– Human resource standards
– External influences
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INTERNAL ENVIRONMENT
• Methods of assigning authority and
responsibility
– Management should make sure:
• Employees understand the entity’s objectives.
• Authority and responsibility for business objectives is
assigned to specific departments and individuals.
– Ownership of responsibility encourages employees to
take initiative in solving problems and holds them
accountable for achieving objectives.
– Management:
• Must be sure to identify who is responsible for the IS security
policy.
• Should monitor results so decisions can be reviewed and, if
necessary, overruled.
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INTERNAL ENVIRONMENT
• Authority and responsibility are assigned through:
–
–
–
–
Formal job descriptions
Employee training
Operating plans, schedules, and budgets
Codes of conduct that define ethical behavior, acceptable
practices, regulatory requirements, and conflicts of interest
– Written policies and procedures manuals (a good job reference
and job training tool) which covers:
• Proper business practices
• Knowledge and experience needed by key personnel
• Resources provided to carry out duties
• Policies and procedures for handling particular transactions
• The organization’s chart of accounts
• Sample copies of forms and documents
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INTERNAL ENVIRONMENT
• Internal environment consists of the following:
– Management’s philosophy, operating style, and risk
appetite
– The board of directors
– Commitment to integrity, ethical values, and
competence
– Organizational structure
– Methods of assigning authority and responsibility
– Human resource standards
– External influences
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INTERNAL ENVIRONMENT
• Human resources standards
– Employees are both the company’s greatest control
strength and the greatest control weakness.
– Organizations can implement human resource
policies and practices with respect to hiring, training,
compensating, evaluating, counseling, promoting, and
discharging employees that send messages about the
level of competence and ethical behavior required.
– Policies on working conditions, incentives, and career
advancement can powerfully encourage efficiency
and loyalty and reduce the organization’s vulnerability.
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INTERNAL ENVIRONMENT
• The following policies and procedures are
important:
–
–
–
–
–
–
–
–
Hiring
Compensating
Training
Evaluating and promoting
Discharging
Managing disgruntled employees
Vacations and rotation of duties
Confidentiality insurance and fidelity bonds
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INTERNAL ENVIRONMENT
• The following policies and procedures are
important:
–
–
–
–
–
–
–
–
Hiring
Compensating
Training
Evaluating and promoting
Discharging
Managing disgruntled employees
Vacations and rotation of duties
Confidentiality insurance and fidelity bonds
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INTERNAL ENVIRONMENT
• Hiring
– Should be based on educational background,
relevant work experience, past achievements,
honesty and integrity, and how well
candidates meet written job requirements.
– Employees should undergo a formal, in-depth
employment interview.
– Resumes, reference letters, and thorough
background checks are critical.
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INTERNAL ENVIRONMENT
• Background checks can involve:
– Verifying education and experience.
– Talking with references.
– Checking for criminal records, credit issues, and other
publicly available data.
– Note that you must have the employee’s or
candidate’s written permission to conduct a
background check, but that permission does not need
to have an expiration date.
– Background checks are important because recent
studies show that about 50% of resumes have been
falsified or embellished.
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INTERNAL ENVIRONMENT
• Sometimes professional firms are hired to do the
background checks because applicants are
becoming more aggressive in their deceptions.
– Some get phony degrees from online “diploma mills.”
• A Pennsylvania district attorney recently filed suit against a
Texas “university” for issuing an MBA to the DA’s 6-year-old
black cat.
– Others actually hack (or hire someone to hack) into
the systems of universities to create or alter
transcripts and other academic data.
• No employee should be exempted from
background checks. Anyone from the custodian
to the company president is capable of
committing fraud, sabotage, etc.
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INTERNAL ENVIRONMENT
• The following policies and procedures are
important:
–
–
–
–
–
–
–
–
Hiring
Compensating
Training
Evaluating and promoting
Discharging
Managing disgruntled employees
Vacations and rotation of duties
Confidentiality insurance and fidelity bonds
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INTERNAL ENVIRONMENT
• Compensating
– Employees should be paid a fair and
competitive wage.
– Poorly compensated employees are more
likely to feel the resentment and financial
pressures that lead to fraud.
– Appropriate incentives can motivate and
reinforce outstanding performance.
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INTERNAL ENVIRONMENT
• The following policies and procedures are
important:
–
–
–
–
–
–
–
–
Hiring
Compensating
Training
Evaluating and promoting
Discharging
Managing disgruntled employees
Vacations and rotation of duties
Confidentiality insurance and fidelity bonds
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INTERNAL ENVIRONMENT
• Policies on training
– Training programs should familiarize new employees
with:
• Their responsibilities.
• Expected performance and behavior.
• Company policies, procedures, history, culture, and operating
style.
– Training needs to be ongoing, not just one time.
– Companies who shortchange training are more likely
to experience security breaches and fraud.
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INTERNAL ENVIRONMENT
– Many believe employee training and
education are the most important elements of
fraud prevention and security programs.
– Fraud is less likely to occur when employees
believe security is everyone’s business.
– An ideal corporate culture exists when:
• Employees are proud of their company and
protective of its assets.
• They believe fraud hurts everyone and that they
therefore have a responsibility to report it.
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INTERNAL ENVIRONMENT
• These cultures do not just happen. They must
be created, taught, and practiced, and the
following training should be provided:
– Fraud awareness
• Employees should be aware of fraud’s prevalence and
dangers, why people do it, and how to deter and detect it.
– Ethical considerations
• The company should promote ethical standards in its practice
and its literature.
• Acceptable and unacceptable behavior should be defined
and labeled, leaving as little gray area as possible.
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INTERNAL ENVIRONMENT
– Punishment for fraud and unethical behavior.
• Employees should know the consequences (e.g.,
reprimand, dismissal, prosecution) of bad behavior.
• Should be disseminated as a consequence rather
than a threat.
• EXAMPLE: “Using a computer to steal or commit
fraud is a federal crime, and anyone doing so
faces immediate dismissal and/or prosecution.”
• The company should display notices of program
and data ownership and advise employees of the
penalties of misuse.
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INTERNAL ENVIRONMENT
• Training can take place through:
– Informal discussions
– Formal meetings
– Periodic memos
– Written guidelines
– Codes of ethics
– Circulating reports of unethical behavior and
its consequences
– Promoting security and fraud training
programs
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INTERNAL ENVIRONMENT
• The following policies and procedures are
important:
–
–
–
–
–
–
–
–
Hiring
Compensating
Training
Evaluating and promoting
Discharging
Managing disgruntled employees
Vacations and rotation of duties
Confidentiality insurance and fidelity bonds
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INTERNAL ENVIRONMENT
• Evaluating and promoting
– Do periodic performance appraisals to help
employees understand their strengths and
weaknesses.
– Base promotions on performance and
qualifications.
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INTERNAL ENVIRONMENT
• The following policies and procedures are
important:
–
–
–
–
–
–
–
–
Hiring
Compensating
Training
Evaluating and promoting
Discharging
Managing disgruntled employees
Vacations and rotation of duties
Confidentiality insurance and fidelity bonds
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INTERNAL ENVIRONMENT
• Discharging
– Fired employees are disgruntled employees.
– Disgruntled employees are more likely to
commit a sabotage or fraud against the
company.
– Employees who are terminated (whether
voluntary or involuntary) should be removed
from sensitive jobs immediately and denied
access to information systems.
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INTERNAL ENVIRONMENT
• The following policies and procedures are
important:
–
–
–
–
–
–
–
–
Hiring
Compensating
Training
Evaluating and promoting
Discharging
Managing disgruntled employees
Vacations and rotation of duties
Confidentiality insurance and fidelity bonds
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INTERNAL ENVIRONMENT
• Managing disgruntled employees
– Disgruntled employees may be isolated and/or
unhappy, but are much likelier fraud candidates than
satisfied employees.
– The organization can try to reduce the employee’s
pressures through grievance channels and
counseling.
• Difficult to do because many employees feel that seeking
counseling will stigmatize them in their jobs.
– Disgruntled employees should not be allowed to
continue in jobs where they could harm the
organization.
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INTERNAL ENVIRONMENT
• The following policies and procedures are
important:
–
–
–
–
–
–
–
–
Hiring
Compensating
Training
Evaluating and promoting
Discharging
Managing disgruntled employees
Vacations and rotation of duties
Confidentiality insurance and fidelity bonds
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INTERNAL ENVIRONMENT
• Vacations and rotation of duties
– Some fraud schemes, such as lapping and
kiting, cannot continue without the constant
attention of the perpetrator.
– Mandatory vacations or rotation of duties can
prevent these frauds or lead to early
detection.
– These measures will only be effective if
someone else is doing the job while the
usual employee is elsewhere.
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INTERNAL ENVIRONMENT
• The following policies and procedures are
important:
–
–
–
–
–
–
–
–
Hiring
Compensating
Training
Evaluating and promoting
Discharging
Managing disgruntled employees
Vacations and rotation of duties
Confidentiality insurance and fidelity bonds
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INTERNAL ENVIRONMENT
• Confidentiality agreements and fidelity
bond insurance
– Employees, suppliers, and contractors should
be required to sign and abide by
nondisclosure or confidentiality agreements.
– Key employees should have fidelity bond
insurance coverage to protect the company
against losses from fraudulent acts by those
employees.
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INTERNAL ENVIRONMENT
• In addition to the preceding policies, the
company should seek prosecution and
incarceration of hackers and fraud perpetrators
• Most fraud cases and hacker attacks go
unreported. They are not prosecuted for several
reasons.
– Companies fear:
• Public relations nightmares
• Copycat attacks
– But unreported fraud and intrusions create a false
sense of security.
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INTERNAL ENVIRONMENT
– Law enforcement officials and courts are busy with
violent crimes and may regard teen hacking as
“childish pranks.”
– Fraud is difficult, costly, and time-consuming to
investigate and prosecute.
– Law enforcement officials, lawyers, and judges often
lack the computer skills needed to investigate,
prosecute, and evaluate computer crimes.
– When cases are prosecuted and a conviction
obtained, penalties are often very light. Judges often
regard the perps as “model citizens.”
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INTERNAL ENVIRONMENT
• Internal environment consists of the following:
– Management’s philosophy, operating style, and risk
appetite
– The board of directors
– Commitment to integrity, ethical values, and
competence
– Organizational structure
– Methods of assigning authority and responsibility
– Human resource standards
– External influences
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INTERNAL ENVIRONMENT
• External influences
– External influences that affect the control
environment include requirements imposed
by:
•
•
•
•
•
FASB
PCAOB
SEC
Insurance commissions
Regulatory agencies for banks, utilities, etc.
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OBJECTIVE SETTING
• Objective setting is the
second ERM
component.
• It must precede many
of the other six
components.
• For example, you must
set objectives before
you can define events
that affect your ability
to achieve objectives
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OBJECTIVE SETTING
• Top management, with board approval, must
articulate why the company exists and what it
hopes to achieve.
– Often referred to as the corporate vision or mission.
• Uses the mission statement as a base from
which to set corporate objectives.
• The objectives:
– Need to be easy to understand and measure.
– Should be prioritized.
– Should be aligned with the company’s risk appetite.
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OBJECTIVE SETTING
• Objectives set at the corporate level are
linked to and integrated with a cascading
series of sub-objectives in the various subunits.
• For each set of objectives:
– Critical success factors (what has to go right)
must be defined.
– Performance measures should be established
to determine whether the objectives are met.
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OBJECTIVE SETTING
• Objective-setting process proceeds as follows:
– First, set strategic objectives, the high-level goals that
support the company’s mission and create value for
shareholders.
– To meet these objectives, identify alternative ways of
accomplishing them.
– For each alternative, identify and assess risks and
implications.
– Formulate a corporate strategy.
– Then set operations, compliance, and reporting
objectives.
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OBJECTIVE SETTING
• As a rule of thumb:
– The mission and strategic objectives are
stable.
– The strategy and other objectives are more
dynamic:
• Must be adapted to changing conditions.
• Must be realigned with strategic objectives.
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OBJECTIVE SETTING
• Operations objectives:
– Are a product of management preferences,
judgments, and style.
– Vary significantly among entities:
• One may adopt technology; another waits until the
bugs are worked out.
– Are influenced by and must be relevant to the
industry, economic conditions, and
competitive pressures.
– Give clear direction for resource allocation—a
key success factor.
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OBJECTIVE SETTING
• Compliance and reporting objectives:
– Many are imposed by external entities, e.g.:
• Reports to IRS or to EPA
• Financial reports that comply with GAAP
– A company’s reputation can be impacted
significantly (for better or worse) by the quality
of its compliance.
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EVENT IDENTIFICATION
• Events are:
– Incidents or occurrences that
emanate from internal or
external sources.
– That affect implementation of
strategy or achievement of
objectives.
– Impact can be positive,
negative, or both.
– Events can range from
obvious to obscure.
– Effects can range from
inconsequential to highly
significant.
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EVENT IDENTIFICATION
• By their nature, events represent
uncertainty:
– Will they occur?
– If so, when?
– And what will the impact be?
– Will they trigger another event?
– Will they happen individually or concurrently?
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EVENT IDENTIFICATION
• Management must do its best to anticipate all
possible events—positive or negative—that
might affect the company:
– Try to determine which are most and least likely.
– Understand the interrelationships of events.
• COSO identified many internal and external
factors that could influence events and affect a
company’s ability to implement strategy and
achieve objectives.
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• Availability
of capital; lower or higher costs of
EVENT
IDENTIFICATION
capital
• Lower barriers to entry, resulting in new
competition
• Price movements up or down
External factors:
• Ability to issue credit and possibility of default
• Economic
• factors
Concentration of competitors, customers, or
vendors
• Presence or absence of liquidity
• Movements in the financial markets or
currency fluctuations
• Rising or lowering unemployment rates
• Mergers or acquisitions
• Potential regulatory, contractual, or criminal
legal liability
• Some of these factors include:
–
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EVENT IDENTIFICATION
• Some of these factors include:
– External factors:
• Economic factors
• Natural environment
• Natural disasters such as fires,
floods, or earthquakes
• Emissions and waste
• Energy restrictions or
shortages
• Restrictions limiting
development
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EVENT IDENTIFICATION
• Some of these factors include:
– External factors:
• Economic factors
• Natural environment
• Political factors • Election of government
officials with new agendas
• New laws and regulations
• Public policy, including higher
or lower taxes
• Regulation affecting the
company’s ability to compete
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EVENT IDENTIFICATION
• Changing demographics, social
mores, family structures, and
work/life priorities
• Consumer behavior that
External factors:
changes demand for products
and services or creates new
• Economic factors
buying opportunities
• Natural environment
• Corporate citizenship
• Political factors
• Privacy
• Social factors
• Terrorism
• Human resource issues
causing production shortages
or stoppages
• Some of these factors include:
–
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EVENT IDENTIFICATION
• New e-business technologies
that lower infrastructure costs
or increase demand for ITExternal factors:
based services
• Economic factors • Emerging technology
• Increased or decreased
• Natural environment
availability of data
• Political factors
• Interruptions or down time
• Social factors
caused by external parties
• Some of these factors include:
–
• Technological factors
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EVENT IDENTIFICATION
• Some of these factors include:
– Internal factors:
• Infrastructure
• Inadequate access or poor allocation of capital
• Availability and capability of company assets
• Complexity of systems
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EVENT IDENTIFICATION
• Some of these factors include:
– Internal factors:
• Infrastructure
• Personnel
• Employee skills and capability
• Employees acting dishonestly or unethically
• Workplace accidents, health or safety
concerns
• Strikes or expiration of labor agreements
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EVENT IDENTIFICATION
• Some of these factors include:
– Internal factors:
• Infrastructure
• Personnel
• Process
• Process modification without proper change
management procedures
• Poorly designed processes
• Process execution errors
• Suppliers cannot deliver quality goods on time
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EVENT IDENTIFICATION
• Some of these factors include:
– Internal factors:
•
•
•
•
•
•
•
•
•
•
Infrastructure
Personnel
Process
Technology
Insufficient capacity to handle peak IT usages
Security breaches
Data or system unavailability from internal factors
Inadequate data integrity
Poor systems selection/development
Inadequately maintained systems
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EVENT IDENTIFICATION
• Lists can help management identify factors,
evaluate their importance, and examine those
that can affect objectives.
• Identifying events at the activity and entity levels
allows companies to focus their risk assessment
on major business units or functions and align
their risk tolerance and risk appetite.
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EVENT IDENTIFICATION
• Companies usually use two or more of the
following techniques together to identify
events:
– Use comprehensive lists of potential
events
• Often produced by special software that can
tailor lists to an industry, activity, or process.
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EVENT IDENTIFICATION
• Companies usually use two or more of the
following techniques together to identify
events:
– Use comprehensive lists of potential events
– Perform an internal analysis
• An internal committee analyzes events, contacting
appropriate insiders and outsiders for input.
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EVENT IDENTIFICATION
• Companies usually use two or more of the
following techniques together to identify
events:
– Use comprehensive lists of potential events
– Perform an internal analysis
– Monitor leading events and trigger points
• Appropriate transactions, activities, and events
are monitored and compared to predefined
criteria to determine when action is needed.
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EVENT IDENTIFICATION
• Companies usually use two or more of the
following techniques together to identify
events:
– Use comprehensive lists of potential events
– Perform an internal analysis
– Monitor leading events and trigger points
– Conduct workshops and interviews
• Employee knowledge and expertise is gathered
in structured discussions or individual
interviews.
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EVENT IDENTIFICATION
• Companies usually use two or more of the
following techniques together to identify
events:
– Use comprehensive lists of potential events
– Perform an internal analysis
– Monitor leading events and trigger points
• Examine data on prior events to identify trends
causes that help
possible events.
– Conductand
workshops
andidentify
interviews
– Perform data mining and analysis
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EVENT IDENTIFICATION
• Companies usually use two or more of the
following techniques together to identify
events:
– Use comprehensive lists of potential events
– Perform an internal analysis
– Monitor leading events and trigger points
• Analyze
internal and
external
factors that affect
– Conduct
workshops
and
interviews
inputs, processes, and outputs to identify events
– Perform
and analysis
thatdata
mightmining
help or hinder
the process.
– Analyze processes
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RISK ASSESSMENT AND RISK
RESPONSE
• The fourth and fifth
components of
COSO’s ERM model
are risk assessment
and risk response.
• COSO indicates
• The risk that exists before
there aretakes
twoany
types
management
steps to
control
the likelihood or impact
of risk:
of a risk.
– Inherent risk
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RISK ASSESSMENT AND RISK
RESPONSE
• The fourth and fifth
components of
COSO’s ERM model
are risk assessment
and risk response.
• COSO indicates
there are two types
• The risk that remains after
ofmanagement
risk: implements
–internal
Inherent
riskor some other
controls
of response
to risk.
–form
Residual
risk
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RISK ASSESSMENT AND RISK
RESPONSE
• Companies should:
– Assess inherent risk
– Develop a response
– Then assess residual risk
• The ERM model indicates four ways to respond
to risk:
– Reduce it
• The most effective way to reduce
the likelihood and impact of risk is
to implement an effective system of
internal controls.
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RISK ASSESSMENT AND RISK
RESPONSE
• Companies should:
– Assess inherent risk
– Develop a response
– Then assess residual risk
• The ERM model indicates four ways to respond
to risk:
– Reduce it
– Accept it
• Don’t act to prevent or mitigate
it.
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RISK ASSESSMENT AND RISK
RESPONSE
• Companies should:
– Assess inherent risk
– Develop a response
– Then assess residual risk
• The ERM model indicates four ways to respond
to risk:
– Reduce it
– Accept it
– Share it
• Transfer some of it to others via
activities such as insurance,
outsourcing, or hedging.
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RISK ASSESSMENT AND RISK
RESPONSE
• Companies should:
– Assess inherent risk
– Develop a response
– Then assess residual risk
• The ERM model indicates four ways to respond
to risk:
–
–
–
–
Reduce it
Accept it
Share it
Avoid it
• Don’t engage in the activity that
produces it.
• May require:
– Sale of a division
– Exiting a product line
– Canceling an expansion plan
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RISK ASSESSMENT AND RISK
RESPONSE
• Accountants:
– Help management design effective controls to
reduce inherent risk.
– Evaluate internal control systems to ensure
they are operating effectively.
– Assess and reduce inherent risk using the risk
assessment and response strategy.
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RISK ASSESSMENT
AND RISK RESPONSE
• Event
identification
Identify the events or threats
that confront the company
Estimate the likelihood or
probability of each event occurring
Estimate the impact of potential
loss from each threat
– The first step in risk
assessment and
response strategy is
event identification,
which we have already
discussed.
Identify set of controls to
guard against threat
Estimate costs and benefits
from instituting controls
Is it
costbeneficial
to protect
system
No
Avoid,
share, or
accept
risk
Yes
Reduce risk by implementing set of
controls to guard against threat
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RISK ASSESSMENT
AND RISK RESPONSE
• Estimate likelihood
and impact
– Some events pose
more risk because they
are more probable than
others.
– Some events pose
more risk because their
dollar impact would be
more significant.
– Likelihood and impact
must be considered
together:
– If either increases, the
materiality of the event
and the need to protect
against it rises.
© 2008 Prentice Hall Business Publishing
Identify the events or threats
that confront the company
Estimate the likelihood or
probability of each event occurring
Estimate the impact of potential
loss from each threat
Identify set of controls to
guard against threat
Estimate costs and benefits
from instituting controls
Is it
costbeneficial
to protect
system
No
Avoid,
share, or
accept
risk
Yes
Reduce risk by implementing set of
controls to guard against threat
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RISK ASSESSMENT
AND RISK RESPONSE
• Identify controls
– Management must
identify one or more
controls that will protect
the company from each
event.
– In evaluating benefits of
each control procedure,
consider effectiveness
and timing.
Identify the events or threats
that confront the company
Estimate the likelihood or
probability of each event occurring
Estimate the impact of potential
loss from each threat
Identify set of controls to
guard against threat
Estimate costs and benefits
from instituting controls
Is it
costbeneficial
to protect
system
No
Avoid,
share, or
accept
risk
Yes
Reduce risk by implementing set of
controls to guard against threat
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RISK ASSESSMENT
AND RISK RESPONSE
• All other factors equal:
– A preventive control is
better than a detective
one.
– However, if preventive
controls fail, detective
controls are needed to
discover the problem,
and corrective controls
are needed to recover.
– Consequently, the three
complement each other,
and a good internal
control system should
have all three.
– Similarly, a company
should use all four
levers of control.
© 2008 Prentice Hall Business Publishing
Identify the events or threats
that confront the company
Estimate the likelihood or
probability of each event occurring
Estimate the impact of potential
loss from each threat
Identify set of controls to
guard against threat
Estimate costs and benefits
from instituting controls
Is it
costbeneficial
to protect
system
No
Avoid,
share, or
accept
risk
Yes
Reduce risk by implementing set of
controls to guard against threat
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RISK ASSESSMENT
AND RISK RESPONSE
• Estimate costs and
benefits
– It would be costprohibitive to create an
internal control system
that provided foolproof
protection against all
events.
– Also, some controls
negatively affect
operational efficiency,
and too many controls
can make it very
inefficient.
Identify the events or threats
that confront the company
Estimate the likelihood or
probability of each event occurring
Estimate the impact of potential
loss from each threat
Identify set of controls to
guard against threat
Estimate costs and benefits
from instituting controls
Is it
costbeneficial
to protect
system
No
Avoid,
share, or
accept
risk
Yes
Reduce risk by implementing set of
controls to guard against threat
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RISK ASSESSMENT
AND RISK RESPONSE
• The benefits of an
internal control
procedure must
exceed its costs.
• Benefits can be hard
to quantify, but include:
– Increased sales and
productivity
– Reduced losses
– Better integration with
customers and suppliers
– Increased customer
loyalty
– Competitive advantages
– Lower insurance
premiums
© 2008 Prentice Hall Business Publishing
Identify the events or threats
that confront the company
Estimate the likelihood or
probability of each event occurring
Estimate the impact of potential
loss from each threat
Identify set of controls to
guard against threat
Estimate costs and benefits
from instituting controls
Is it
costbeneficial
to protect
system
No
Avoid,
share, or
accept
risk
Yes
Reduce risk by implementing set of
controls to guard against threat
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RISK ASSESSMENT
AND RISK RESPONSE
• Costs are usually
easier to measure
than benefits.
• Primary cost is
personnel, including:
– Time to perform control
procedures
– Costs of hiring
additional employees to
effectively segregate
duties
– Costs of programming
controls into a system
Identify the events or threats
that confront the company
Estimate the likelihood or
probability of each event occurring
Estimate the impact of potential
loss from each threat
Identify set of controls to
guard against threat
Estimate costs and benefits
from instituting controls
Is it
costbeneficial
to protect
system
No
Avoid,
share, or
accept
risk
Yes
Reduce risk by implementing set of
controls to guard against threat
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RISK ASSESSMENT
AND RISK RESPONSE
• Other costs of a poor
control system include:
– Lost sales
– Lower productivity
– Drop in stock price if
security problems arise
– Shareholder or
regulator lawsuits
– Fines and penalties
imposed by
governmental agencies
Identify the events or threats
that confront the company
Estimate the likelihood or
probability of each event occurring
Estimate the impact of potential
loss from each threat
Identify set of controls to
guard against threat
Estimate costs and benefits
from instituting controls
Is it
costbeneficial
to protect
system
No
Avoid,
share, or
accept
risk
Yes
Reduce risk by implementing set of
controls to guard against threat
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RISK ASSESSMENT
AND RISK RESPONSE
• The expected loss
related to a risk is
measured as:
– Expected loss =
impact x likelihood
• The value of a
control procedure
is the difference
between:
– Expected loss with
control procedure
– Expected loss without it
Identify the events or threats
that confront the company
Estimate the likelihood or
probability of each event occurring
Estimate the impact of potential
loss from each threat
Identify set of controls to
guard against threat
Estimate costs and benefits
from instituting controls
Is it
costbeneficial
to protect
system
No
Avoid,
share, or
accept
risk
Yes
Reduce risk by implementing set of
controls to guard against threat
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RISK ASSESSMENT
AND RISK RESPONSE
• Determine costbenefit effectiveness
– After estimating
benefits and costs,
management
determines if the control
is cost beneficial, i.e., is
the cost of
implementing a control
procedure less than the
change in expected
loss that would be
attributable to the
change?
Identify the events or threats
that confront the company
Estimate the likelihood or
probability of each event occurring
Estimate the impact of potential
loss from each threat
Identify set of controls to
guard against threat
Estimate costs and benefits
from instituting controls
Is it
costbeneficia
l
No
to protect
system
Avoid,
share, or
accept
risk
Yes
Reduce risk by implementing set of
controls to guard against threat
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RISK ASSESSMENT
AND RISK RESPONSE
• In evaluating costs
and benefits,
management must
consider factors other
than those in the
expected benefit
calculation.
– If an event threatens an
organization’s existence, it
may be worthwhile to
institute controls even if
costs exceed expected
benefits.
– The additional cost can be
viewed as a catastrophic
loss insurance premium.
Identify the events or threats
that confront the company
Estimate the likelihood or
probability of each event occurring
Estimate the impact of potential
loss from each threat
Identify set of controls to
guard against threat
Estimate costs and benefits
from instituting controls
Is it
costbeneficia
l
No
to protect
system
Avoid,
share, or
accept
risk
Yes
Reduce risk by implementing set of
controls to guard against threat
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•
•
•
•
•
•
Expected Loss without control procedure = $800,000 x .12 = $96,000.
Expected RISK
loss withASSESSMENT
control procedure = $800,000
.005 = $4,000.
ANDx RISK
Estimated value of control procedure = $96,000 - $4,000 = $92,000.
RESPONSE
Estimated cost of control procedure = $43,000 (given).
Benefits exceed costs by $92,000 - $43,000 = $49,000.
• Let’s go through an example:
In this case, Hobby Hole should probably install the motion detectors.
– Hobby Hole is trying to decide whether to install a
motion detector system in its warehouse to reduce
the probability of a catastrophic theft.
– A catastrophic theft could result in losses of $800,000.
– Local crime statistics suggest that the probability of a
catastrophic theft at Hobby Hole is 12%.
– Companies with motion detectors only have about a
.5% probability of catastrophic theft.
– The present value of purchasing and installing a
motion detector system and paying future security
costs is estimated to be about $43,000.
– Should Hobby Hole install the motion detectors?
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RISK ASSESSMENT
AND RISK RESPONSE
• Implement the
control or avoid,
share, or accept the
risk
– When controls are cost
effective, they should
be implemented so risk
can be reduced.
Identify the events or threats
that confront the company
Estimate the likelihood or
probability of each event occurring
Estimate the impact of potential
loss from each threat
Identify set of controls to
guard against threat
Estimate costs and benefits
from instituting controls
Is it
costbeneficia
l
No
to protect
system
Avoid,
share, or
accept
risk
Yes
Reduce risk by implementing set of
controls to guard against threat
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RISK ASSESSMENT
AND RISK RESPONSE
• Risks that are not
reduced must be
accepted, shared, or
avoided.
– If the risk is within the
company’s risk tolerance,
they will typically accept
the risk.
– A reduce or share
response is used to bring
residual risk into an
acceptable risk tolerance
range.
– An avoid response is
typically only used when
there is no way to costeffectively bring risk into
an acceptable risk
tolerance range.
© 2008 Prentice Hall Business Publishing
Identify the events or threats
that confront the company
Estimate the likelihood or
probability of each event occurring
Estimate the impact of potential
loss from each threat
Identify set of controls to
guard against threat
Estimate costs and benefits
from instituting controls
Is it
costbeneficia
l
No
to protect
system
Avoid,
share, or
accept
risk
Yes
Reduce risk by implementing set of
controls to guard against threat
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CONTROL ACTIVITIES
• The sixth component of
COSO’s ERM model.
• Control activities are
policies, procedures,
and rules that provide
reasonable assurance
that management’s
control objectives are
met and their risk
responses are carried
out.
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CONTROL ACTIVITIES
• It is management’s responsibility to develop a
secure and adequately controlled system.
– Controls are much more effective when built in on the
front end.
– Consequently, systems analysts, designers, and end
users should be involved in designing adequate
computer-based control systems.
• Management must also establish a set of
procedures to ensure control compliance and
enforcement.
– Usually, the purview of the information security officer
and the operations staff.
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CONTROL ACTIVITIES
• It is critical that controls be in place during
the year-end holiday season. A
disproportionate amount of computer fraud
and security break-ins occur during this
time because:
– More people are on vacation and fewer
around to mind the store.
– Students are not tied up with school.
– Counterculture hackers may be lonely.
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CONTROL ACTIVITIES
• Generally, control procedures fall into one
of the following categories:
– Proper authorization of transactions and
activities
– Segregation of duties
– Project development and acquisition controls
– Change management controls
– Design and use of documents and records
– Safeguard assets, records, and data
– Independent checks on performance
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CONTROL ACTIVITIES
• Generally, control procedures fall into one
of the following categories:
– Proper authorization of transactions and
activities
– Segregation of duties
– Project development and acquisition controls
– Change management controls
– Design and use of documents and records
– Safeguard assets, records, and data
– Independent checks on performance
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CONTROL ACTIVITIES
• Proper authorization of transactions
and activities
– Management lacks the time and resources to
supervise each employee activity and
decision.
– Consequently, they establish policies and
empower employees to perform activities
within policy.
– This empowerment is called authorization
and is an important part of an organization’s
control procedures.
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CONTROL ACTIVITIES
• Authorizations are often documented by signing
initializing, or entering an authorization code.
• Computer systems can record digital
signatures as a means of signing a document.
• Employees who process transactions should
verify the presence of the appropriate
authorizations.
• Auditors review transactions for proper
authorization, as their absence indicates a
possible control problem.
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CONTROL ACTIVITIES
• Typically at least two levels of authorization:
– General authorization
• Management authorizes employees to handle routine
transactions without special approval.
– Special authorization
• For activities or transactions that are of significant
consequences, management review and approval is
required.
• Might apply to sales, capital expenditures, or
write-offs over a particular dollar limit.
• Management should have written policies for
both types of authorization and for all types of
transactions.
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CONTROL ACTIVITIES
• Generally, control procedures fall into one
of the following categories:
– Proper authorization of transactions and
activities
– Segregation of duties
– Project development and acquisition controls
– Change management controls
– Design and use of documents and records
– Safeguard assets, records, and data
– Independent checks on performance
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CONTROL ACTIVITIES
• Segregation of duties
– Good internal control requires that no single
employee be given too much responsibility
over business transactions or processes.
– An employee should not be in a position to
commit and conceal fraud or unintentional
errors.
– Segregation of duties is discussed in two
sections:
• Segregation of accounting duties
• Segregation of duties within the systems function
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CONTROL ACTIVITIES
• Segregation of duties
– Good internal control requires that no single
employee be given too much responsibility
over business transactions or processes.
– An employee should not be in a position to
commit and conceal fraud or unintentional
errors.
– Segregation of duties is discussed in two
sections:
• Segregation of accounting duties
• Segregation of duties within the systems function
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CONTROL ACTIVITIES
• To learn a little about segregation of
duties, let’s first meet Bill.
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CONTROL ACTIVITIES
• Bill is in charge of a pile of the
organization’s money—let’s say $1,000.
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CONTROL ACTIVITIES
Ledger
$1,000
• Bill also keeps the books for that
money.
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CONTROL ACTIVITIES
Ledger
$1,000
• Bill has a date tonight, and he’s a little desperate to
impress that special someone, so he takes $100 of
the cash. (Thinks he’s only borrowing it, you know.)
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CONTROL ACTIVITIES
Ledger
$1,000
• Bill has a date tonight, and he’s a little desperate to
impress that special someone, so he takes $100 of
the cash. (Thinks he’s only borrowing it, you know.)
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CONTROL ACTIVITIES
Ledger
$900
• Bill also records an entry in the books to show that
$100 was spent for some “legitimate” purpose. Now
the balance in the books is $900.
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CONTROL ACTIVITIES
Ledger
$900
• How will Bill ever get caught at his
theft?
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CONTROL ACTIVITIES
• Now let’s change the story. Bill is in
charge of the pile of cash.
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CONTROL ACTIVITIES
Ledger
$1,000
• But Mary keeps the books.
• This arrangement is a form of segregation of duties.
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CONTROL ACTIVITIES
Ledger
$1,000
• Bill gets in a pinch again and takes
$100 of the organization’s cash.
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CONTROL ACTIVITIES
Ledger
$1,000
• How will Bill get caught?
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CONTROL ACTIVITIES
• Segregation of accounting duties
– Effective segregation of accounting duties is achieved
when the following functions are separated:
• Authorization—Approving transactions and decisions.
• Recording—Preparing source documents; maintaining
journals, ledgers, or other files; preparing reconciliations; and
preparing performance reports.
• Custody—Handling cash, maintaining an inventory
storeroom, receiving incoming customer checks, writing
checks on the organization’s bank account.
– If any two of the preceding functions are the
responsibility of one person, then problems can arise.
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CONTROL ACTIVITIES
•
•
•
•
•
•
CUSTODIAL FUNCTIONS
Handling cash
Handling inventories, tools,
or fixed assets
Writing checks
Receiving checks in mail
•
•
•
•
RECORDING FUNCTIONS
Preparing source
documents
Maintaining journals,
ledgers, or other files
Preparing reconciliations
Preparing performance
reports
EXAMPLE OF PROBLEM: A person who has custody of cash receipts and the
AUTHORIZATION
recording for those receipts can
steal some of the cash and falsify accounts to
FUNCTIONS
conceal the theft.
Authorization
of
SOLUTION: The pink fence •(segregation
of custody
and recording) prevents
transactions
employees from falsifying records to conceal theft of assets entrusted to them.
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•
EXAMPLE OF PROBLEM: A
person who has custody of
checks for transactions that
he has authorized can
authorize fictitious
transactions and then steal
RECORDING
the payments.FUNCTIONS
Preparing source
SOLUTION:
The green fence
documents
(segregation of custody and
Maintaining journals,
authorization)
prevents
ledgers, or from
otherauthorizing
files
employees
fictitious
orreconciliations
inaccurate
Preparing
transactions
as a means of
Preparing performance
concealing
a theft.
reports
CONTROL ACTIVITIES
•
•
•
•
CUSTODIAL FUNCTIONS
Handling cash
Handling inventories, tools,
or fixed assets
Writing checks
Receiving checks in mail
••
•
•
•
AUTHORIZATION
FUNCTIONS
• Authorization of
transactions
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•
EXAMPLE OF PROBLEM: A
person who can authorize a
transaction and keep
records related to the
transactions can authorize
and record fictitious
CUSTODIAL
FUNCTIONS
payments
that might,
for
•
example,
be sent
• Handling
cashto the
employee’s
addresstools,
• Handlinghome
inventories,
or the
address
of a shell
•
or fixed
assets
company
creates.
• Writinghe
checks
SOLUTION:
purple
•
• ReceivingThe
checks
in mail
fence (segregation of
•
recording and authorization)
prevents employees from
falsifying records to cover
up inaccurate or false
transactions that were
inappropriately authorized.
AUTHORIZATION
FUNCTIONS
• Authorization of
transactions
CONTROL ACTIVITIES
•
© 2008 Prentice Hall Business Publishing
RECORDING FUNCTIONS
Preparing source
documents
Maintaining journals,
ledgers, or other files
Preparing reconciliations
Preparing performance
reports
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CONTROL ACTIVITIES
• In a system that incorporates an effective
separation of duties, it should be difficult
for any single employee to commit
embezzlement successfully.
• But when two or more people collude,
then segregation of duties becomes
impotent and controls are overridden.
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CONTROL ACTIVITIES
Ledger
$1,000
• If this happens . . .
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CONTROL ACTIVITIES
Ledger
$1,000
• Then segregation of duties is out the window.
Collusion overrides segregation.
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CONTROL ACTIVITIES
• Employees can collude with other employees or
with customers or vendors.
• The most frequent form of employee/vendor
collusions include:
– Billing at inflated prices
– Performing substandard work and receiving full
payment
– Payment for non-performance
– Duplicate billings
– Improperly funneling more work to or purchasing
more goods from a colluding company
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CONTROL ACTIVITIES
• The most frequent form of
employee/customer collusions include:
– Unauthorized loans or insurance payments
– Receipt of assets or services at unauthorized
discount prices
– Forgiveness of amounts owed
– Unauthorized extension of due dates
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CONTROL ACTIVITIES
• Segregation of duties
– Good internal control requires that no single
employee be given too much responsibility over
business transactions or processes.
– An employee should not be in a position to commit
and conceal fraud or unintentional errors.
– Segregation of duties is discussed in two sections:
• Segregation of accounting duties
• Segregation of duties within the systems function
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CONTROL ACTIVITIES
• Segregation of duties within the
systems function
– In a highly integrated information system,
procedures once performed by separate
individuals are combined.
– Therefore, anyone who has unrestricted
access to the computer, its programs, and live
data could have the opportunity to perpetrate
and conceal fraud.
– To combat this threat, organizations must
implement effective segregation of duties
within the IS function.
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CONTROL ACTIVITIES
• Authority and responsibility must be divided clearly
among the following functions:
– Systems administration
• Responsible for ensuring that
the different parts of an
information system operate
smoothly and efficiently.
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CONTROL ACTIVITIES
• Authority and responsibility must be divided clearly
among the following functions:
– Systems administration
– Network management
• Ensures that all applicable devices are
linked to the organization’s internal
and external networks and that the
networks operate continuously and
properly.
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CONTROL ACTIVITIES
• Authority and responsibility must be divided clearly
among the following functions:
– Systems administration
– Network management
– Security management
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• Ensures that all aspects of the
system are secure and protected
from internal and external
threats.
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CONTROL ACTIVITIES
• Authority and responsibility must be divided clearly
among the following functions:
–
–
–
–
Systems administration
Network management
Security management • Manages changes to the
Change management
organization’s information
system to ensure they are made
smoothly and efficiently and to
prevent errors and fraud.
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CONTROL ACTIVITIES
• Authority and responsibility must be divided clearly
among the following functions:
–
–
–
–
–
Systems administration
Network management
Security management
Change management
Users • Record transactions, authorize
data to be processed, and use
system output.
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CONTROL ACTIVITIES
• Authority and responsibility must be divided clearly
among the following functions:
–
–
–
–
–
–
Systems administration
Network management
Security management
Change management
Users
• Help users determine their
information needs and design
Systems analysts
systems to meet those needs.
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CONTROL ACTIVITIES
• Authority and responsibility must be divided clearly
among the following functions:
–
–
–
–
–
–
–
Systems administration
Network management
Security management
Change management
Users
Systems analysts
Programming • Use design provided by the
systems analysts to write the
computer programs for the
information system.
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CONTROL ACTIVITIES
• Authority and responsibility must be divided clearly
among the following functions:
–
–
–
–
–
–
–
–
Systems administration
Network management
Security management
Change management
Users
Systems analysts
• Run the software on the
Programming
company’s computers.
Computer operations
• Ensure that data are input
properly, correctly processed,
and needed output is produced.
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CONTROL ACTIVITIES
• Authority and responsibility must be divided clearly
among the following functions:
–
–
–
–
–
–
–
–
–
Systems administration
Network management
Security management
Change management
Users
Systems analysts
• Maintains custody of corporate
databases, files, and programs in
Programming
a separate storage area.
Computer operations
Information systems library
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CONTROL ACTIVITIES
• Authority and responsibility must be divided clearly
among the following functions:
–
–
–
–
–
–
–
–
–
–
Systems administration
Network management
• Ensures that source data have
Security management
been properly approved.
Change management
• Monitors the flow of work
Users
through the computer.
Systems analysts
• Reconciles input and output.
Programming
• Maintains a record of input
Computer operations
errors to ensure their correction
Information systemsand
library
resubmission.
Data control • Distributes system output.
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CONTROL ACTIVITIES
• It is important that different people perform the
preceding functions.
– Allowing a person to do two or more jobs exposes the
company to the possibility of fraud.
• In addition to adequate segregation of duties,
organizations should ensure that the people who
design, develop, implement, and operate the IS
are qualified and well trained.
• The same holds true for systems security
personnel.
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CONTROL ACTIVITIES
• Generally, control procedures fall into one of the
following categories:
–
–
–
–
–
–
–
Proper authorization of transactions and activities
Segregation of duties
Project development and acquisition controls
Change management controls
Design and use of documents and records
Safeguard assets, records, and data
Independent checks on performance
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CONTROL ACTIVITIES
• Project development and acquisition controls
– It’s important to have a formal, appropriate, and proven
methodology to govern the development, acquisition,
implementation, and maintenance of information systems and
related technologies.
• Should contain appropriate controls for:
– Management review and approval
– User involvement
– Analysis
– Design
– Testing
– Implementation
– Conversion
• Should make it possible for management to trace information
inputs from source to disposition and vice versa (the audit
trail).
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CONTROL ACTIVITIES
• Examples abound of poorly managed
projects that have wasted large sums of
money because certain basic principles of
project management control were ignored.
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• A multi-year strategic plan
should align the
organization’s information
system with its business
strategies and show the
• The following basic principlesprojects
of control
be
thatshould
must be
applied to systems development
in order
reduce
the
completed
to to
achieve
longgoals.
potential for cost overruns andrange
project
failure and to
• Should address
hardware,
improve the efficiency and effectiveness
of the
IS:
software, personnel, and
– Strategic master plan
infrastructure requirements.
• Each year, the board and top
management should prepare
and approve the plan and its
supporting budget.
• Should be evaluated several
times a year to ensure the
organization can acquire
needed components and
maintain existing ones.
CONTROL ACTIVITIES
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• A project development plan shows
how a project will be completed,
including:
• Modules or tasks to be
• The following basic principles of performed
control should be
• Who will perform them
applied to systems development
in order to reduce the
Anticipated completion dates
potential for cost overruns and• project
failure and to
• Project costs
improve the efficiency and effectiveness
of the IS:
• Project milestones should be
– Strategic master plan
specified—points when progress
– Project controls
is reviewed and actual completion
times are compared to estimates.
• Each project should be assigned
to a manager and team who are
responsible for its success or
failure.
• At project completion, a project
evaluation of the team members
should be performed.
CONTROL ACTIVITIES
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CONTROL ACTIVITIES
• The following basic principles of control should be
applied to systems development in order to reduce the
potential for cost overruns and project failure and to
improve the efficiency and effectiveness of the IS:
– Strategic master plan
– Project controls
– Data processing schedule
• Data processing tasks should
be organized according to a
schedule to maximize the use of
scarce computer resources.
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CONTROL ACTIVITIES
• The following basic principles of control should be
applied to systems development in order to reduce the
potential for cost overruns and project failure and to
improve the efficiency and effectiveness of the IS:
–
–
–
–
Strategic master plan
Project controls
Data processing schedule
Steering committee • A steering committee should
guide and oversee systems
development and acquisition.
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CONTROL ACTIVITIES
• To
evaluated
properly,
• The following basic principles
of be
control
should
be a
system should be assessed
applied to systems development
in order to reduce the
with measures such as:
potential for cost overruns and project failure and to
– Throughput (output per
improve the efficiency and effectiveness
of the IS:
unit of time)
–
–
–
–
–
Strategic master plan
– Utilization (percent of time
Project controls
it is used productively)
Data processing schedule
– Response time (how long it
takes to respond)
Steering committee
System performance measurements
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CONTROL ACTIVITIES
• The following basic principles of control should be
applied to systems development in order to reduce the
potential for cost overruns and project failure and to
improve the efficiency and effectiveness of the IS:
–
–
–
–
–
–
Strategic master plan
• A review should be performed
Project controls
after a development project is
Data processing schedule
completed to determine if the
Steering committee
anticipated benefits were
System performance measurementsachieved.
Post-implementation review • Helps control project
development activities and
encourage accurate and
objective initial cost and
benefit estimates.
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CONTROL ACTIVITIES
• To simplify and improve systems development,
some companies hire a systems integrator—a
vendor who uses common standards and
manages the development effort using their own
personnel and those of the client and other
vendors.
– Many companies rely on the integrator’s assurance
that the project will be completed on time.
– Unfortunately, the integrator is often wrong.
– These third-party systems development projects are
subject to the same cost overruns and missed
deadlines as systems developed internally.
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CONTROL ACTIVITIES
•
• Before third parties bid, provide clear
When using
systems
integrators,
specifications,
including:
– Exact
descriptions
andto
definitions
of the system
companies
should
adhere
the same
– Explicit deadlines
basic rules
used for project management
– Precise acceptance criteria
of internal
projects.
In addition,
• Although
it’s expensive
to developthey
these
should: specifications, it will save money in the end.
– Develop clear specifications
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• A sponsors committee should monitor third-party
development projects.
– Established by the CIO and chaired by the
project’s internal champion.
– Should include department managers from all
units that will use the system.
– Should establish formal procedures for
companies should
adhere
to the
same
measuring
and reporting
project
status.
– Best for
approach
is to: management
basic rules used
project
• Divide project into manageable tasks.
• Assign responsibility for each task.
should:
• Meet on a regular basis (at least monthly)
to review progress and assess quality.
CONTROL ACTIVITIES
• When using systems integrators,
of internal projects. In addition, they
– Develop clear specifications
– Monitor the systems integration project
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CONTROL ACTIVITIES
• Generally, control procedures fall into one
of the following categories:
– Proper authorization of transactions and
activities
– Segregation of duties
– Project development and acquisition controls
– Change management controls
– Design and use of documents and records
– Safeguard assets, records, and data
– Independent checks on performance
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CONTROL ACTIVITIES
• Change management controls
– Organizations constantly modify their information
systems to reflect new business practices and take
advantage of information technology advances.
– Change management is the process of making sure
that the changes do not negatively affect:
•
•
•
•
•
Systems reliability
Security
Confidentiality
Integrity
Availability
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CONTROL ACTIVITIES
• Generally, control procedures fall into one
of the following categories:
– Proper authorization of transactions and
activities
– Segregation of duties
– Project development and acquisition controls
– Change management controls
– Design and use of documents and records
– Safeguard assets, records, and data
– Independent checks on performance
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CONTROL ACTIVITIES
• Design and use of adequate documents and
records
– Proper design and use of documents and records
helps ensure accurate and complete recording of all
relevant transaction data.
– Form and content should be kept as simple as
possible to:
• Promote efficient record keeping
• Minimize recording errors
• Facilitate review and verification
– Documents that initiate a transaction should contain a
space for authorization.
– Those used to transfer assets should have a space
for the receiving party’s signature.
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CONTROL ACTIVITIES
• Documents should be sequentially prenumbered:
– To reduce likelihood that they would be used
fraudulently.
– To help ensure that all valid transactions are
recorded.
• A good audit trail facilitates:
– Tracing individual transactions through the system.
– Correcting errors.
– Verifying system output.
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CONTROL ACTIVITIES
• Generally, control procedures fall into one
of the following categories:
– Proper authorization of transactions and
activities
– Segregation of duties
– Project development and acquisition controls
– Change management controls
– Design and use of documents and records
– Safeguard assets, records, and data
– Independent checks on performance
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CONTROL ACTIVITIES
• Safeguard assets, records, and data
– When people consider safeguarding assets, they
most often think of cash and physical assets, such as
inventory and equipment.
– Another company asset that needs to be protected is
information.
– According to the ACFE’s 2004 National Fraud Survey,
theft of information made up only 17.3% of non-cash
misappropriations; however, the median cost of an
information theft was $340,000. This cost was 126%
higher than the next most costly non-asset theft.
(Equipment theft had a median cost of $150,000.)
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CONTROL ACTIVITIES
• Many people mistakenly believe that the
greatest risks companies face are from
outsiders.
• However, employees pose a much greater
risk when it comes to loss of data
because:
– They know the system and its weaknesses
better.
– They are better able to hide their illegal acts.
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CONTROL ACTIVITIES
• Insiders also create less-intentional threats to
systems, including:
– Accidentally deleting company data.
– Turning viruses loose.
– Trying to fix hardware or software without appropriate
expertise (i.e., when in doubt, unplug it).
• These actions can result in crashed networks,
corrupt data, and hardware and software
malfunctions.
• Companies also face significant risks from
customers and vendors that have access to
company data.
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CONTROL ACTIVITIES
• Many steps can be taken to safeguard
both information and physical assets from
theft, unauthorized use, and vandalism.
Chapters 7 and 8 discuss computer-based
controls. In addition, it is important to:
– Maintain accurate records of all assets
• Periodically reconcile recorded amounts to
physical counts.
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CONTROL ACTIVITIES
• Many steps can be taken to safeguard
both information and physical assets from
theft, unauthorized use, and vandalism.
• Use restricted
storage areas
Chapters 7 and 8 discuss
computer-based
for inventories and equipment.
controls. In addition, •it Use
is important
cash registers,to:
safes,
lockboxes,
and safe deposit
– Maintain accurate records
of all assets
boxes to limit access to cash,
• Periodically reconcile recorded
amounts
to assets.
securities,
and paper
physical counts
• Restrict access to assets
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CONTROL ACTIVITIES
• Many steps can be taken to safeguard
both information and physical assets from
theft, unauthorized use, and vandalism.
Chapters 7 and 8 discuss
computer-based
• Use fireproof storage areas,
controls. In addition, it is
important
to: backup
locked
filing cabinets,
of files (including copies at
– Maintain accurate records
of all assets
off-site locations).
• Periodically reconcile recorded
amounts
to checks
• Limit access
to blank
physical counts
and documents to authorized
• Restrict access to assets personnel.
• Protect records and documents
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CONTROL ACTIVITIES
• Generally, control procedures fall into one
of the following categories:
– Proper authorization of transactions and
activities
– Segregation of duties
– Project development and acquisition controls
– Change management controls
– Design and use of documents and records
– Safeguard assets, records, and data
– Independent checks on performance
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CONTROL ACTIVITIES
Ledger
$1,000
• Let’s look at Bill and Mary again. Assume that Bill
stole cash but Mary did NOT alter the books.
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CONTROL ACTIVITIES
Ledger
$1,000
• Can Bill’s theft be discovered if an independent party
doesn’t compare a count of the cash to what’s
recorded on the books?
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CONTROL ACTIVITIES
Ledger
$1,000
• Segregation of duties only has value when
supplemented by independent checks.
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CONTROL ACTIVITIES
• Internal checks to ensure that transactions
are processed accurately are an important
control element.
• These checks should be performed by
someone independent of the party(ies)
responsible for the activities.
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CONTROL ACTIVITIES
• The following independent checks are
typically used:
– Top-level reviews
• Management at all levels should monitor company
results and periodically compare actual performance
to:
– Planned performance as shown in budgets, targets,
and forecasts
– Prior-period performance
– The performance of competitors
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CONTROL ACTIVITIES
• The following independent checks are
typically used:
– Top-level reviews
– Analytical reviews
• Examinations of relationships between different sets of
data.
• EXAMPLE: If credit sales increased significantly during
the period and there were no changes in credit policy,
then bad debt expense should probably have increased
also.
• Management should periodically analyze and review
data relationships to detect fraud and other business
problems.
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CONTROL ACTIVITIES
• Check the accuracy and completeness of records by
reconciling them with other records that should have the
same balance.
typically
used:
• EXAMPLES:
– Bank reconciliations
– Top-level
reviews
– Comparing accounts payable control account to sum
– Analytical
reviewsaccounts.
of subsidiary
• The following independent checks are
– Reconciliation of independently
maintained sets of records
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CONTROL ACTIVITIES
• The following independent checks are
typically used:• Periodically, count significant assets
–
–
–
and reconcile the count to company
Top-level reviews
records.
• EXAMPLE: Annual physical inventory.
Analytical reviews
• High-dollar items and critical
Reconciliation ofcomponents
independently
maintained
should be
counted more
sets of records frequently.
– Comparison of actual quantities with
recorded amounts
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CONTROL ACTIVITIES
• The following independent checks are
typically used:
– Top-level reviews
– Analytical reviews
– Reconciliation of independently maintained
sets of records
– Comparison of actual• quantities
with recorded
Ensure that debits equal
amounts
credits.
– Double-entry accounting
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CONTROL ACTIVITIES
• The following independent checks are
typically used:
– Top-level reviews
– Analytical reviews
– Reconciliation of independently maintained
sets of records
– Comparison of actual quantities with recorded
• After one person processes a
amounts
transaction, another reviews
– Double-entry accounting
their work.
– Independent review
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INFORMATION AND COMMUNICATION
• The seventh component of
COSO’s ERM model.
• The primary purpose of the AIS is
to gather, record, process, store,
summarize, and communicate
information about an organization.
• So accountants must understand
how:
– Transactions are initiated
– Data are captured in or
converted to machine-readable
form
– Computer files are accessed
and updated
– Data are processed
– Information is reported to
internal and external parties
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INFORMATION AND COMMUNICATION
• Accountants must also understand the
accounting records and procedures,
supporting documents, and specific
financial statement accounts involved in
processing and reporting transactions.
• The preceding items facilitate an audit trail
which allows for transactions to be traced
from origin to financial statements and vice
versa.
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INFORMATION AND COMMUNICATION
• According to the AICPA, an AIS has five
primary objectives:
– Identify and record all valid transactions.
– Properly classify transactions.
– Record transactions at their proper monetary
value.
– Record transactions in the proper accounting
period.
– Properly present transactions and related
disclosures in the financial statements.
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INFORMATION AND COMMUNICATION
• How to safeguard information and physical
assets:
– Create and enforce appropriate policies and
procedures.
– Maintain accurate records of all assets.
– Restrict access to assets.
– Protect records and documents.
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INFORMATION AND COMMUNICATION
• Accounting systems generally consist of several
accounting subsystems, each designed to
process transactions of a particular type.
• Though they differ with respect to the type of
transactions processed, all accounting
subsystems follow the same sequence of
procedures, referred to as accounting cycles.
• The five major accounting cycles and their
related control objectives and procedures are
detailed in Chapters 10–14.
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MONITORING
• The eighth
component of
COSO’s ERM
model.
• Monitoring can be
accomplished with a
series of ongoing
events or by
separate
evaluations.
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MONITORING
• Key methods of monitoring performance include:
–
–
–
–
–
–
–
Perform ERM evaluation
Implement effective supervision
Use responsibility accounting
Monitor system activities
Track purchased software
Conduct periodic audits
Employ a computer security officer, a Chief
Compliance Officer, and computer consultants
– Engage forensic specialists
– Install fraud detection software
– Implement a fraud hotline
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MONITORING
• Key methods of monitoring performance include:
–
–
–
–
–
–
–
Perform ERM evaluation
Implement effective supervision
Use responsibility accounting
Monitor system activities
Track purchased software
Conduct periodic audits
Employ a computer security officer, a Chief
Compliance Officer, and computer consultants
– Engage forensic specialists
– Install fraud detection software
– Implement a fraud hotline
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MONITORING
• Perform ERM evaluation
– Can measure ERM effectiveness through a
formal evaluation or through a selfassessment process.
– A special group can be assembled to conduct
the evaluation or it can be done by internal
auditing.
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MONITORING
• Key methods of monitoring performance include:
–
–
–
–
–
–
–
Perform ERM evaluation
Implement effective supervision
Use responsibility accounting
Monitor system activities
Track purchased software
Conduct periodic audits
Employ a computer security officer, a Chief
Compliance Officer, and computer consultants
– Engage forensic specialists
– Install fraud detection software
– Implement a fraud hotline
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MONITORING
• Implement effective supervision
– Involves:
•
•
•
•
Training and assisting employees;
Monitoring their performance;
Correcting errors; and
Safeguarding assets by overseeing employees
with access.
– Especially important in organizations that:
• Can’t afford elaborate responsibility reporting; or
• Are too small for segregation of duties.
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MONITORING
• Key methods of monitoring performance include:
–
–
–
–
–
–
–
Perform ERM evaluation
Implement effective supervision
Use responsibility accounting
Monitor system activities
Track purchased software
Conduct periodic audits
Employ a computer security officer, a Chief
Compliance Officer, and computer consultants
– Engage forensic specialists
– Install fraud detection software
– Implement a fraud hotline
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MONITORING
• Use responsibility accounting
– Includes use of:
• Budgets, quotas, schedules, standard costs, and
quality standards;
• Performance reports that compare actual with
planned performance and highlight variances; and
• Procedures for investigating significant variances
and taking timely actions to correct adverse
conditions.
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MONITORING
• Key methods of monitoring performance include:
–
–
–
–
–
–
–
Perform ERM evaluation
Implement effective supervision
Use responsibility accounting
Monitor system activities
Track purchased software
Conduct periodic audits
Employ a computer security officer, a Chief
Compliance Officer, and computer consultants
– Engage forensic specialists
– Install fraud detection software
– Implement a fraud hotline
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MONITORING
• Monitor system activities
– Risk analysis and management software
packages are available to:
•
•
•
•
•
Review computer and network security measures;
Detect illegal entry into systems;
Test for weaknesses and vulnerabilities;
Report weaknesses found; and
Suggest improvements.
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MONITORING
• Cost parameters can be entered to
balance acceptable levels of risk tolerance
and cost-effectiveness.
• Software is also available to monitor and
combat viruses, spyware, spam, pop-up
ads, and to prevent browsers from being
hijacked.
• Also helps companies recover from frauds
and malicious actions and restore systems
to pre-incident status.
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MONITORING
• System transactions and activities should be
recorded in a log which indicates who accessed
what data, when, and from which terminal.
• Logs should be reviewed frequently to monitor
system activity and trace any problems to their
source.
• Data collected can be used to:
–
–
–
–
Evaluate employee productivity;
Control company costs;
Fight corporate espionage and other attacks; and
Comply with legal requirements.
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MONITORING
• Companies that monitor system activities need to ensure
they do not violate employee privacy rights.
• Employers cannot discreetly observe communications of
employees when those employees have a “reasonable
expectation of privacy.”
• Employers must therefore ensure that employees realize
their business communications are not “private.” One
way to accomplish that objective is to have written
policies that employees agree to in writing which
indicate:
– The technology employees use on the job belongs to the
company.
– Emails received on company computers are not private and can
be read by supervisory personnel.
– Employees should not use technology in any way to contribute to
a hostile work environment.
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MONITORING
• Key methods of monitoring performance include:
–
–
–
–
–
–
–
Perform ERM evaluation
Implement effective supervision
Use responsibility accounting
Monitor system activities
Track purchased software
Conduct periodic audits
Employ a computer security officer, a Chief
Compliance Officer, and computer consultants
– Engage forensic specialists
– Install fraud detection software
– Implement a fraud hotline
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MONITORING
• Track purchased software
– The Business Software Alliance (BSA) aggressively
tracks down and fines companies who violate
software license agreements.
– To comply with copyrights, companies should
periodically conduct software audits to ensure that.
• There are enough licenses for all users; and
• The company is not paying for more licenses than needed.
– Employees should be informed of the consequences
of using unlicensed software.
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MONITORING
• Key methods of monitoring performance include:
–
–
–
–
–
–
–
Perform ERM evaluation
Implement effective supervision
Use responsibility accounting
Monitor system activities
Track purchased software
Conduct periodic audits
Employ a computer security officer, a Chief
Compliance Officer, and computer consultants
– Engage forensic specialists
– Install fraud detection software
– Implement a fraud hotline
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MONITORING
• Conduct periodic audits
– To monitor risk and detect fraud and errors,
the company should have periodic:
• External audits
• Internal audits
• Special network security audits
– Auditors should test system controls and
browse system usage files looking for
suspicious activities (discussed in Chapter 9).
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MONITORING
• Again, care should be exercised that
employees’ privacy rights are not violated.
• Therefore, inform employees that auditors
will conduct random surveillance, which:
– Avoids privacy violations
– Creates a “perception of detection” that can
deter crime and reduce errors
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MONITORING
• Internal auditing involves:
– Reviewing the reliability and integrity of
financial and operating information.
– Providing an appraisal of internal control
effectiveness.
– Assessing employee compliance with
management policies and procedures and
applicable laws and regulations.
– Evaluating the efficiency and effectiveness of
management.
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MONITORING
• Internal audits can detect:
– Excess overtime
– Under-used assets
– Obsolete inventory
– Padded expense reimbursements
– Excessively loose budgets and quotas
– Poorly justified capital expenditures
– Production bottlenecks
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MONITORING
• Internal auditing should be organizationally
independent of the accounting and
operating functions.
• The head should report to the audit
committee of the board of directors rather
than to the controller or CFO.
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MONITORING
• Key methods of monitoring performance include:
–
–
–
–
–
–
–
Perform ERM evaluation
Implement effective supervision
Use responsibility accounting
Monitor system activities
Track purchased software
Conduct periodic audits
Employ a computer security officer, a Chief
Compliance Officer, and computer consultants
– Engage forensic specialists
– Install fraud detection software
– Implement a fraud hotline
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MONITORING
• Employ a computer security officer, a
Chief Compliance Officer, and computer
consultants
– The computer security officer (CSO) is in
charge of AIS security
• Should be independent of the IS function
• Should report to the COO or CEO
– Many companies also use outside computer
consultants or in-house teams to test and
evaluate their security procedures and
computer systems.
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MONITORING
• Key methods of monitoring performance include:
–
–
–
–
–
–
–
Perform ERM evaluation
Implement effective supervision
Use responsibility accounting
Monitor system activities
Track purchased software
Conduct periodic audits
Employ a computer security officer, a Chief
Compliance Officer, and computer consultants
– Engage forensic specialists
– Install fraud detection software
– Implement a fraud hotline
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MONITORING
• Engage forensic specialists
– Forensic accountants specialize in fraud
detection and investigation.
• Now one of the fastest growing areas of
accounting due to:
– SOX
– SAS-99
– Boards of Directors demanding that forensic accounting
be an ongoing part of the financial reporting and
corporate governance process.
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MONITORING
• Most forensic accountants are CPAs and may
have received special training with the FBI, CIA,
or other law enforcement agencies.
– In particular demand are those with the necessary
computer skills to ferret out and combat fraudsters
who use sophisticated technology to perpetrate their
crimes.
– The Association of Certified Fraud Examiners (ACFE)
has created a professional certification program for
fraud examiners.
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MONITORING
• Management may also need to call on
computer forensic specialists for help.
• They assist in discovering, extracting,
safeguarding, and documenting computer
evidence so that its authenticity, accuracy,
and integrity will not succumb to legal
challenges.
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MONITORING
• Common incidents investigated by
computer forensic experts include:
– Improper internet usage
– Fraud
– Sabotage
– Loss, theft, or corruption of data
– Retrieving information from emails and
databases that users thought they had erased
– Determining who performed certain actions on
a computer
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MONITORING
• Key methods of monitoring performance include:
–
–
–
–
–
–
–
Perform ERM evaluation
Implement effective supervision
Use responsibility accounting
Monitor system activities
Track purchased software
Conduct periodic audits
Employ a computer security officer, a Chief
Compliance Officer, and computer consultants
– Engage forensic specialists
– Install fraud detection software
– Implement a fraud hotline
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MONITORING
• Install fraud detection software
– People who commit fraud tend to follow certain patterns and
leave behind clues.
– Software has been developed to seek out these fraud symptoms.
– Some companies employ neural networks (programs that
mimic the brain and have learning capabilities), which are very
accurate in identifying suspected fraud.
– For example, if a husband and wife were each using the same
credit card in two different stores at the same time, a neural
network would probably flag at least one of the transactions
immediately as suspicious.
– These networks and other recent advances in fraud detection
software are significantly reducing the incidences of credit card
fraud.
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MONITORING
• Key methods of monitoring performance include:
–
–
–
–
–
–
–
Perform ERM evaluation
Implement effective supervision
Use responsibility accounting
Monitor system activities
Track purchased software
Conduct periodic audits
Employ a computer security officer, a Chief
Compliance Officer, and computer consultants
– Engage forensic specialists
– Install fraud detection software
– Implement a fraud hotline
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MONITORING
• Implement a fraud hotline
– People who witness fraudulent behavior are
often torn between conflicting feelings.
• They want to protect company assets and report
fraud perpetrators.
• But they are uncomfortable in the whistleblower
role and find it easier to remain silent.
– They are particularly reluctant to report if they
know of others who have suffered
repercussions from doing so.
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MONITORING
• SOX mandates that companies set up
mechanisms for employees to anonymously
report abuses such as fraud.
– An effective way to comply with the law and resolve
employee concerns is to provide access to an
anonymous hotline.
– Anonymous reporting can be accomplished through:
•
•
•
•
Phone lines
Web-based reporting
Anonymous emails
Snail mail
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MONITORING
• Outsourcing is available through a number of third
parties and offers several benefits, including:
– Increased confidence on the part of employee that his/her
report is truly anonymous.
– 24/7 availability.
– Often have multilingual capabilities—an important plus for
multinational organizations.
– The outsourcer may be able to do follow up with the
employee if additional information is needed after the initial
contact.
– The employee can be advised of the outcome of his report.
– Low cost.
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MONITORING
• A downside to anonymous reporting
mechanisms is that they will produce a
significant amount of petty or slanderous reports
that do not require investigation.
• The ACFE’s 2004 Report to the Nation indicates
that companies without fraud hotlines had
median fraud losses that were 140% higher than
companies that had fraud hotlines.
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SUMMARY
• In this chapter, you’ve learned about basic internal control
concepts and why computer control and security are so
important.
• You’ve learned about the similarities and differences between
the COBIT, COSO, and ERM control frameworks.
• You’ve learned about the major elements in the internal
control environment of a company and the four types of
control objectives that companies need to set.
• You’ve also learned about events that affect uncertainty and
how these events can be identified.
• You’ve explored how the Enterprise Risk Management model
is used to assess and respond to risk, as well as the control
activities that are commonly used in companies.
• Finally, you’ve learned how organizations communicate
information and monitor control processes.
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