internal control structure. learning objectives l to understand the components of an...
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Internal Control Structure
Learning Objectives
To understand the components of an organization’s internal control structure
To know the objectives and limitations of internal control
To learn which characteristics of a control environment promote accurate and reliable data
To learn which characteristics of an accounting system promote accurate and reliable data.
To describe good control procedures.
Example Situation 1
The policy of installing a security system in the house is part of the control environment in the house.
The objective» is to safeguard property and life.
Threat» from intruders.
Risk» of loss of assets/life from this threat.
The control reduces the risk
Example Situation 2
The policy of issuing a driver's licence and the procedure to obtain the licence is part of the control environment on the road.
The objective» safety on the road.
Threat» from people driving on the road not understanding the
rules of the traffic.
Risk» of accidents and loss of assets, health and life.
The control reduces the risk
Example Situation 3 When the person writing the check cannot also enter the
corresponding cash journal entry, there is a control environment in the accounting department.
The objective» is to safeguard the assets of the company» to ensure accurate and reliable information.
Threat» from somebody wanting to commit a fraud.
The risk» is loss of assets and inaccurate records.
The control reduces the risk
The Pattern
In each of the above examples, there is an objective (usually safety)
there is a threat to the objective there are risks associated with those
threats, and there is a control which counteracts the
risk from the threat. The controls are usually in the form of
policies and/or procedures.
Why do we have
Police on the road ? State laws ? Federal Laws ? Rules ? Regulations ? Policies ? Procedures ?
For Controls
How Do controls provide freedom?
Internal Controls
An organization's internal control structure consists of the policies and procedures established by management to achieve organizational objectives.
What are the Objectives ?
Objectives of Accounting Controls:» Safeguard Assets» Ensure Accurate and reliable accounting
data Objectives of Administrative Controls
» Promote Operational Efficiency» Encourage adherance to management's policies
What are the Threats ?
Errors» Unintentional» Clerk enters wrong amount on check» Procedures can be designed to check for
unintentional errors. Irregularities
» Intentional» Management Fraud» Defalcation
What are the risks ?
Inaccurate records Unreliable data Loss of assets
» Cash» Inventory
Internal Control Structure
A company's Internal Control structure tries to fight the threats to minimize the risk so as to meet the objectives.
Reasonable Assurance
Note that risks can be minimized but not totally removed.
Total removal of risk will be extremely costly and often not cost justified.
Internal control policies and procedures are intended to provide reasonable but not absolute assurance that management's objectives are attained.
The above bullet point is called the concept of reasonable assurance.
Limitations of Controls
There are always limitations of controls What are the limitations of Accounting Controls ?
» Errors : e.g. a valid journal entry with wrong amounts.
» Collusion: when two or more employees conspire to commit a theft and conceal it.
» Management Override. The cost of overcoming these limitations can be
enormous.
Components of anInternal Control Structure
Control Environment» Those circumstances surrounding an
organization’s accounting system that influence the effectiveness of the accounting system and control procedures
The Accounting System» Methods and records used to identify, assemble,
analyze, classify and report accounting transactions
Control Procedures
The Control Environment
Internal Control Structure
The Control Environment
Accounting Systems
Internal Control Structure
The Control Environment
Accounting Systems
Control Procedures
Internal Control Structure
Control Environment
Management's philosophy and operating style Organizational structure Audit Committees Methods of assigning authority and responsibility Management control methods Personnel policies and practices External Influences Computer Controls and Policies
Personnel Policies and Practices
Training Recognition for work well done Adequate Pay Background check Job Rotation Required Vacation Bonding
The Accounting System Debit and Credit Analysis Chart of Accounts Standard Journal Vouchers Trial balance
» Transpositions» Misfootings» Abnormal Account Balances
Control Accounts» Sum of Subsidiary Ledger Accounts
Contol Procedures
Proper procedures for Transactions» Prompt recording» Visual checking» Balancing» Batch controls» General Authorization» Specific Authorization
Security for Assets and Records» physical security» Fixed responsibility
Contol Procedures Contd.. Segregation of duties
» Authorize Transactions» Record Transactions» Maintain Custody of Asset
Adequate Documentation and Records» Forms control» Prenumbered Documents
Independent Verification of Performance» Independent Auditors» Internal Auditors
Evaluating Internal Controls
Control Risk Assessment» Likelihood that controls do not
prevent/detect material misstatement Technically done for each management
assertion for each transaction stream
Management Assertions and Transaction Streams
Transaction Streams» Sales» Cash Receipts» Inventory/AP» Other Cash
Disbursements» Payroll» Etc.
Management Assertions» Completeness» Existence/Occurrence» Valuation/Gross» Valuation/Net» Rights/Obligations» Presentation/Disclosure
Steps in CRA
» Evaluate Internal Control Environment – Evaluate potential management override– Evaluate computer controls--Computer auditor
» Document Accounting Processes » Document Controls» Make Preliminary CRA» Test Controls» Make CRA based on Control Tests