Internal Control Essay

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. Documentation procedures: 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 the company’s internal control systems. They review the activities of departments and individuals to determine whether prescribed internal controls are being followed. They also recommend improvements when needed. Human resource controls: Human resource control activities include the following: a. Bond employees who handle cash – Bonding involves obtaining insurance protection against theft by employees. It contributes to the safeguarding of cash in two ways: First, the insurance company carefully screens all individuals before adding them to the policy and may reject risky applicants. Second, bonded employees know that the insurance company will vigorously prosecute all offenders. b. Rotate employees’ duties and require employees to take vacations – these measures deter employees from attempting thefts since they will not be able to permanently conceal their improper actions. c. Conduct through background checks – Many believe that the most important and inexpensive measure any business can take to reduce employee theft and fraud is for the human resources department to conduct through background checks. 2. Advice the president of what the company is doing right (they are doing some things well) and also recommends to the President whether or not they should buy the indelible ink machine. When you advise the President, please be sure to reference the applicable internal control principle that applies. Some of the things that the company is doing right are: a. Documentation procedures – The organization uses pre numbered invoices. Documents provide evidence that transactions and events have occurred. This internal control activity says that whenever possible the 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. This control measure helps to ensure timely recording of the transaction and contributes directly to the accuracy and reliability of the accounting records. b. Establishment of responsibility – The organization uses petty cash. Employees are asked to place a note if they use any of the cash. This is according to the internal control activity ‘Establishment of responsibility’. This is an essential principle of internal control is to assign responsibility to specific employees. Control is most effective when only one person is responsible for a given task. This limits access only to authorized personnel. c. While interviewing, the president and the accountant do it together. It is good to have more than one people in an interview. d. The fact that he realizes the issues of any problems The president should not buy the indelible ink machine, because anyone in the company will have the access to print. The president has to voluntaries himself and decides about the indelible ink machine. He need not wait for authorization from anybody on installing this indelible ink machine. 3. Advice the president of what the company is doing wrong (they are definitely doing some things poorly). Please be sure to include the internal control principle that is being violated along with a recommendation for improvement. Some of the things that the company is doing wrong are: a. Meeting in a public place to discuss. This should happen in a private room. b. Physical control – The Company does not follow the physical control activity. The company does not have individual passwords to restrict access. The use of physical controls is essential. Physical controls relate to the safeguarding of assets and enhance the accuracy and reliability of the accounting records. The organization should have individual passwords for all employees. c. Establishment of responsibility – The Company does not follow the internal control activity of establishing responsibility. The indelible ink machine is a wrong option because anyone can use the machine to print. An essential principle of internal control is to assign responsibility to specific employees. Control is most effective when only one person is responsible for a given task. d. Human resource controls – The organization does not follow the human resource controls internal activity. Among the human resource controls internal activity, they do not follow the conduct thorough background checks. The company did not do background check. The employee did pornography and was a convicted felon who served time for molesting children. Conducting thorough background checks is the most important and inexpensive measure any business can take to reduce employee theft and fraud for the human resources department. The two tips are: 1. Check to see whether job applicants actually graduated from the schools they list. 2. Never use the telephone numbers for previous employees given on the reference sheet; always look them up yourself. The company must conduct background checks when recruiting. e. They have faith in their long term employees. The long term employees know well about the organization f. Establishment of responsibility – The organization does not have a responsible person for issuing the pay checks. This is an essential principle of internal control to assign responsibility to specific employees. Control is most effective when only one person is responsible for a given task. The company leaves the payday checks in the office for pick up. The paychecks should be mailed separately or it should be deposited directly into the employees’ account. Else one person should have the responsibility to handle the paycheck on pay day. g. Segregation of duties – It is an indispensable internal control system that the organization is not following. The two common applications of this principle are: Different individuals should be responsible for related activities and the responsibility for record keeping for an asset should be separate from the physical custody of that asset. Making one individual responsible for related activities increases the potential for errors and irregularities. 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. In a company, same person cannot be both the treasurer and controller. The duties of the employees must be segregated clearly. h. Physical control – Use of physical controls is essential. Physical controls relate to the safeguarding of assets and enhance the accuracy and reliability of the accounting records. There is no internet sec urity in the company. They should have proper internet security.