The success of any business enterprise depends on an effective system of internal control a company’s plan to encourage adherence to company policies and procedures, promote operational efficiency, minimize errors and theft, and enhance the reliability and accuracy of accounting data.. Internal control refers to a company's plan to (a) encourage adherence to company policies and procedures, (b) promote operational efficiency, (c) minimize errors and theft, and (d) enhance the reliability and accuracy of accounting data. From a financial accounting perspective, the focus is on controls intended to improve the accuracy and reliability of accounting information and to safeguard the company's assets. Recall from our discussion in Chapter 1 that Section 404 of the Sarbanes-Oxley Act of 2002 requires that companies document their internal controls and assess their adequacy. The Public Company Accounting Oversight Board's Auditing Standard No. 5 further requires the auditor to express its own opinion on whether the company has maintained effective internal control over financial reporting. | |  <![CDATA[<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/820130/blue_dot.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (9.0K)</a>]]> | LO1
| | The Sarbanes-Oxley Act requires a company to document and assess its internal controls. Auditors express an opinion on management’s assessment. |
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p. 339 Many companies have incurred significant costs in an effort to comply with the requirements of Section 404.1 A cottage industry of consulting firms and software products has arisen to help these companies. A framework for designing an internal control system is provided by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission.2 Formed in 1985, the organization is dedicated to improving the quality of financial reporting through, among other things, effective internal controls. COSO defines internal control as a process, undertaken by an entity's board of directors, management and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following categories: • | | Effectiveness and efficiency of operations. | • | | Reliability of financial reporting. | • | | Compliance with applicable laws and regulations.3 |
A critical aspect of an internal control system is the separation of duties. Individuals that have physical responsibility for assets should not also have access to accounting records. For example, if the same individual has control of both the supplies inventory and the accounting records, the theft of supplies could be concealed by a reduction of the supplies account. | | Employees involved in recordkeeping should not also have physical access to the assets. |
Internal Control Procedures—Cash Receipts As cash is the most liquid of all assets, a well-designed and functioning system of internal control must surround all cash transactions. Separation of duties is critical. Ideally, those who handle cash should not be involved in or have access to accounting records nor be involved in the reconciliation of cash book balances to bank balances. Consider the cash receipt process. Most nonretail businesses receive payment for goods by checks received through the mail. An approach to internal control over cash receipts might include the following steps: | | 1. | | Employee A opens the mail each day and prepares a multicopy listing of all checks including the amount and payor's name. | 2. | | Employee B takes the checks, along with one copy of the listing, to the person responsible for depositing the checks in the company's bank account. | 3. | | A second copy of the check listing is sent to the accounting department where the receipts are entered into the records. |
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The amount received should equal the amount deposited as verified by comparison with the bank-generated deposit slip and the amount recorded in the accounting records. This helps ensure accuracy as well as safeguard cash against theft. Internal Control Procedures—Cash Disbursements Proper controls for cash disbursements should be designed to prevent any unauthorized payments and ensure that disbursements are recorded in the proper general ledger and subsidiary ledger accounts. Important elements of a cash disbursement control system include: | | 1. | | All disbursements, other than very small disbursements from petty cash, should be made by check. This provides a permanent record of all disbursements. | 2. | | All expenditures should be authorized before a check is prepared. For example, a vendor invoice for the purchase of inventory should be compared with the purchase order and receiving report to ensure the accuracy of quantity, price, part numbers, and so on. This process should include verification of the proper ledger accounts to be debited. | 3. | | Checks should be signed only by authorized individuals. |
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p. 340 Responsibilities for check signing, check writing, check mailing, cash disbursement documentation, and recordkeeping ideally should be separated whenever possible. An important part of any system of internal control of cash is the periodic reconciliation of book balances and bank balances to the correct balance. In addition, a petty cash system is employed by many business enterprises. We cover these two topics in Appendix 7A beginning on page 369. |
1In response to the high cost of 404 compliance, the PCAOB issued a second standard, Auditing Standard No. 5, to replace its Standard No. 2. The new standard emphasizes audit efficiency with a more focused, risk-based testing approach for material areas. These guidelines should reduce the total costs of 404 compliance.
2The sponsoring organizations include the AICPA, the Financial Executives International, the Institute of Internal Auditors, the American Accounting Association, and the Institute of Management Accountants.
3www.coso.org. |