Internal Control System

Group 6
Importance of This Chapter
The importance of internal control systems for companies
has evolved over time and encompasses several key
aspects:
• Fraud Prevention
• Consistency and Transaction Monitoring
• Competitive Advantage
• Responsibility and Complexity
• Control Points
• Adaptation and Elimination
• Fraud Detection and Prevention
• Foreign Corrupt Practices Act (FCPA)
The main control objectives:

• Authorization
• Reconciliation
• Recording
• Safeguarding
• Valuation
RESPONSIBILITY FOR INTERNAL CONTROLS

Positions within a company that are responsible

for internal controls:

• Board of Directors

• Senior management

• Financial management

• Internal audit staff

• Independent auditor
EXAMPLES OF INTERNAL CONTROLS
“laundry list” of controls that are commonly used.
The controls are grouped by balance sheet and income statement
category.

• Cash • Revenues
• Investments • Cost of goods sold
• Accounts receivable • Travel and entertainment expenses
• Inventory
• Payroll expenses
• Employee advances
• Occupancy expenses
• Fixed assets
• Accounts payable • General
• Notes payable • Other: Contracts
When to eliminate controls
To determine which controls to eliminate, follow these
steps:
1. Understand existing controls by conducting interviews and creating flowcharts.
2. Schedule quarterly control reviews to identify obsolete controls due to changing
business conditions.
3. Evaluate control costs, categorizing them as major or secondary.
4. Assess the risk of not having costly controls, considering potential asset loss.
5. Continuously review the need for control reports and eliminate unnecessary ones.
6. Conduct intensive control reviews during significant business changes.
7. Involve internal audit staff in examining proposed system changes.
8. Consult potential users before eliminating controls to avoid disruptions.
9. Monitor control implementation to ensure compliance.
10.Strive for fewer controls while maintaining major control objectives.
11.Review proposed control eliminations with employees to avoid unintended
consequences.
TYPES OF FRAUD

• Expense account abuse

• Nonpayment of employee advances
• Purchases for personal use
• Supplier kickbacks
• Theft of cash and investments
• Theft of fixed assets
• Theft of inventory or supplies
PREVENTING FRAUD
The prevention of fraud is crucial for companies, as it can severely impact profits
and even lead to the downfall of the entire organization. There are two sets of
fraud indicators: high-level indicators related to management's behavior and
lower-level indicators at the employee level.

The high-level fraud indicators:

• Management creates an overly complex organizational structure.
• Management has an excessive emphasis on meeting profit goals.
• Management is unwilling to pay for good controls.
• Management is dominated by one person.
• Management prefers excessive decentralization.
• Management turnover is high.
• Customers or suppliers are suing the company.
• Management is forcing a rapid pace of growth.
• Management is acquiring a large number of companies.
PREVENTING FRAUD
lower-level indicators at the employee level.
• 401k withdrawals.
• Bad debt write-offs.
• Inventory discrepancies.
• Invoicing discrepancies.
• Lack of supervision.
• Large personal expenditures.
• No competitive bidding.
• No payment from the sale of assets.
• No vacations.
• Supplier addresses match employee addresses.
PREVENTING FRAUD
However, it's essential to consider that some of these indicators may have legitimate
explanations, so a combination of factors should be used to justify an investigation. Moreover,
many fraud cases occur without warning signs, often involving small-scale losses that are not
worth implementing extensive controls to prevent.

To prevent significant fraud, controllers should assess potential high-risk areas in the
company and implement controls accordingly. A strong understanding of the business is
crucial, and auditors can provide valuable insights. Open communication with employees is
vital, as they can provide information about fraud cases.

In summary, preventing fraud requires vigilance at both high and low levels within the
organization, a combination of indicators, and effective communication with employees.
Controllers should regularly review control systems and be prepared to adapt them as needed
to mitigate the risk of fraud.
HOW TO DEAL WITH A FRAUD SITUATION
THE FOLLOWING LIST NOTES THE PRIMARY OPTIONS
AVAILABLETO A COMPANY WHEN RESOLVING A FRAUD
SITUATION:

• Bring criminal charges.

• Demand restitution and fire the employee.
• Dismiss employee for cause.
• Permit employee to resign.
FOREIGN CORRUPT PRACTICES ACT
The Foreign Corrupt Practices Act requires a publicly traded
company (it does not apply to privately held companies) to keep in
reasonable detail “books, records, and accounts” that accurately
and fairly reflect its transactions and disposition of assets, and
maintain an adequate system of internal controls.
The control system must have the following attributes:
• Transactions must occur under the authorization of management.
• Transactions must be properly recorded.
• There must be reasonable controls over access to assets.
• There must be periodic reconciliations of recorded to actual assets, with an
investigation of any differences.
To be in compliance with the Act be particularly mindful of the adequacy of
company control systems, as well as of subtle changes in financial results that
may indicate the presence of control problems.
Thank you!