Case Study 2 – Internal Control
1. Inform the president of any new internal control requirements if the company decides to go public Each of the five components of an internal control system is important. Let us focus on the control activities. These activities are the backbone of the company’s efforts to address the risks it faces, such as fraud. The specific control activities used by a company will vary depending on management’s assessments of the risks faced. The six principles of control activities are as follows: a. Establishment of responsibility
b. Segregation of duties
c. Documentation procedures
d. Physical controls
e. Independent internal verification
f. Human resource controls
All these apply to most companies and are relevant to both manual and computerized accounting systems. Establishment of responsibility:
An essential principle of internal control is to assign responsibility to specific employees. Control is most effective when only one person is responsible for given task. Establishing responsibility often requires limiting access only to authorized personnel and then identifying those personal. Segregation of duties:
Segregation of duties is indispensable in an internal control system. There are two common applications of this principle: a. Different individuals should be responsible for related activities. b. The responsibility for record-keeping for an asset should be separate from the physical custody of that asset. The rationale for segregation of duties is, the work of one employee should, without a duplication of effort, provide a reliable basis for evaluating the work of another employee. Segregation of related activities – Making one individual responsible for related activities increases the potential for errors and irregularities. Segregation of record-keeping from physical custody – The custodian of the asset is not likely to convert the asset to personal use when one employee maintains the record of the asset, and a different employee has physical custody of the asset.
Documents provide evidence that transactions and events have occurred. By requiring signatures on the documents, the company can identify the individual responsible for the transaction or event. Companies should document transactions when the transaction occurs. Companies should establish procedures for documents. First, whenever possible, companies should use pre numbered documents, and all documents should be accounted for. Pre numbering helps to prevent a transaction from being recorded more than once or conversely from not being recorded at all. Second, the control system should require that employees promptly forward source documents for accounting entries to the accounting department. This control measure helps to ensure timely recording of the transaction and contributes directly to the accuracy and reliability of the accounting records. Physical controls:
Use of physical controls is essential. Physical controls relate to the safeguarding of assets and enhance the accuracy and reliability of the accounting records. Independent internal verification:
Most internal control systems provide for independent internal verification. This principle involves the review of data prepared by employees. To obtain maximum benefit from independent internal verification: a. Companies should verify records periodically or on a surprise basis b. An employee who is independent of the personnel responsible for the information should make the verification c. Discrepancies and exceptions should be reported to a management level that can take appropriate corrective action. Independent internal verification is especially useful in comparing recorded transactions with existing assets. Large companies often assign independent internal verification to internal auditors. Internal auditors are company employees who continuously evaluate the effectiveness of...
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