Internal Controls

Internal Controls Nicole Mills XACC/280 1/14/2012 Lisa Pendleton

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Internal control is designed to govern a companys financial system by ensuring effective and efficient operations, reliable financial reporting, and compliance with applicable state and federal laws and regulations. Internal controls safeguard assets against theft and unauthorized use, acquisition, and disposal. A system of internal control serves to enhance accuracy by minimizing errors in accounting records and to prevent fraud, embezzlement and theft by employees, customers, and vendors. The following paragraphs will describe the Sarbanes-Oxley Act of 2002 and how it has affected internal controls; explain deficiencies and how they affect stock prices, and examples of internal control limitations. Bloch (2003), "The Sarbanes-Oxley Act of 2002 addresses perceived weaknesses in internal controls, the systems a public company employs to collect, process, and disclose financial information to satisfy its statutory reporting requirements. Recent corporate and accounting frauds have demonstrated the inadequacy of internal controls with regard to revenue recognition. The Act also contains requirements aimed at ensuring proper revenue recognition (para. 1). Prior to the passage of the Act, corporations were not required to maintain such a high standard of financial recordkeeping. It requires companies to establish a system of internal controls, preparation of quarterly statements assessing the strengths and weaknesses of these controls, and forces the company to company to hire an outside accounting agency to provide an independent assessment of the in-house auditing controls, and to report flaws or fraudulent practices that occurred. Lawmakers made certain that corporations are required to maintain paper and electronic records for a minimum of five years, which has imposed a heavy strain on IT departments. Internal controls limit the amount of unethical practices and errors that occur in the financial reporting process. Under the Sarbanes-Oxley Act companies are required to assess their

Internal Controls internal controls systems and report any deficiencies. Internal controls protect against theft and manipulation of accounting figures by employees (Waygandt, Kimmel, & Kieso, 2008). In the event that a company has poor internal controls, investors will have less confidence that its financial statements are accurate. Resulting in company stock price falling (Waygandt, Kimmel, & Kieso, 2008).

A proficient internal control system can only offer reasonable assurance that an agencys financial control, operating systems, reporting, and other agency processes are working effectively. No matter how well designed and functioning, internal control systems are, they cannot provide complete guarantee that agency objectives have been, and will continue to be, met. Effective internal control systems decrease the likelihood of mistakes or exclusions in agency operations. However, there can be limitations in the effectiveness of internal controls. Limitations of internal controls may result from human factors, system omissions, lack of system flexibility, or resource constraints. There are many potential limitations of internal controls including staff carelessness, lack of knowledge, or poor judgment. The internal control system may be outdated and no longer reflects the changes that have been made in operating conditions or new risks. Collusions made by staff, eliminates the protection that segregation provides (Waygandt, Kimmel, & Kieso, 2008). Controls become undermined when methods are viewed as a hindrance in the delivery of agency services. To maintain high standards of record keeping, companies follow precise control principles. Establishment of responsibly must be determined. Each employee should be assigned specific responsibilities to preserve an effective internal control system. For example, only designated personnel have the authority to sign company checks (Waygandt, Kimmel, & Kieso, 2008). Assigning duties to one person makes it easier to determine who is responsible for the mistake. Segregation of duties is imperative to have in an internal control system. This

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requires individuals to be responsible for related duties. Record keeping of an asset should be the responsibility of a separate individual than from the person in physical custody of the asset to decrease possible errors. Physical, Mechanical, and electronic controls play a significant role in the internal control system. Physical controls safeguard material assets. Vaults, safety deposit boxes, locked warehouses, computer facilities with fingerprint scans are different methods of physically safeguarding company assets. Mechanical and electronic controls include alarms to prevent break-ins, television monitors, garment sensors, and time clocks. Each form of control protects company assets from internal or external theft. Independent internal verification is another form on internal control that is useful in comparing recorded accountability with existing assets (Waygandt, Kimmel, & Kieso, 2008). Large companies often hire internal auditors to evaluate the effectiveness of its internal control system. This person is responsible for making sure that procedures are being followed and to recommend improvements to the system when necessary. Internal controls are an important part in maintaining a profitable company that reports its financial situation honestly and accurately to investors. After corporate scandals in the early 2000s, the government intervened and began to demand transparency from publically traded corporations. This is when the Sarbanes-Oxley Act of 2002 was passed into legislation. As a consequence, companies were forced to maintain better financial records for a longer period and to report deficiencies when standards are not met. To reduce the amount of theft, unauthorized use, acquisition, and disposal of assets a company can implement a number of internal controls including segregation of duties. Although internal controls have limitations, they offer a significant amount of asset protection.

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Internal Controls References Bloch, G.D. (2003). The CPA Journal. Retrieved from http://www.nysscpa.org/cpajournal/2003/0403/dept/d046803.htm Waygandt, J.J., Kimmel, P.D., & Kieso, D.E. (2008). Financial Accounting (6th ed.). Hoboken, NJ: Wiley.