INTERNAL CONTROL

• Internal Control


  Set of procedures established to achieve the specific objectives of an organization
• Types of controls


  • Accounting controls
  • Administrative controls
  • Primary operational controls
• Accounting controls


  The plan of organization and all methods and procedures that are concerned with the safeguarding of assets and the reliability of the financial records
• Administrative controls


  The plan of organization and all methods and procedures that relate to operational efficiency and adherence to managerial policies
• Primary operational controls


  Concerns the establishment of policy and basic guidelines by which an enterprise will be directed as a means of achieving the business objectives
• Parts of internal control structure


  • Control Environment
  • Accounting systems
• Control Environment


  The corporate atmosphere in which the accounting controls exist and in which the financial statements are prepared
• Factors of Control Environment


  • Management philosophy and operating style
  • Organization structure
  • Functioning of board of directors and the board committees
  • Methods of assigning authority and responsibility
  • Management control methods
  • The existence and effectiveness of an internal and audit function
  • Personnel policies and procedures
  • Influence of external factors
• Accounting System


  The proper direction of the accounting system is one of the principal responsibilities of the controller
• Activities of an effective accounting system


  • Identify properly and record all valid transactions
  • Describe the transactions on a timely basis and in sufficient detail
  • Determine the time period in which the transactions occurred
  • Measure the value of the transaction
  • Permit proper presentation of the transactions
• Fraudulent financial statements


  One way to appraise the control system
• Steps in Evaluating Internal Controls


  • Management must identify the principal activities, risks, and exposures in each operating component and define the control objectives
  • Management must describe, and understand the various systems used to process transactions, safeguard asset, and prepare the financial reports
• Examples of control objectives

  • Sales control objectives
  • Production or service control objectives
  • Finance control objectives
  • Administration control objectives
• General control objectives


  • Authorization
  • Recording
  • Safeguarding
  • Reconciliation
  • Valuation
• Controls in Accounting System - CASH


  • Control check stock
  • Control signature plates
  • Separate responsibility for the cash receipt and bank reconciliation functions
  • Perform bank reconciliations
  • Reconcile petty cash
  • Require that bank reconciliations be completed by people independent of the cash receipts and disbursement functions
  • Require that petty cash vouchers be filled out in ink
  • Compare the check register to the actual check number sequence
  • Review un-cashed checks
  • Route incoming cash payments through a lockbox
  • Verify amount of cash discounts taken
• Controls in Accounting System - INVESTMENTS


  • Require board approval of substantial changes in investment account designations for transfer between available-for-sale and trading investments
  • Impose investment limits for transfers of debt securities among portfolios
  • Require authorizations to shift funds among accounts
• Controls in Accounting System - PREPAID EXPENSES


  • Reconcile all prepaid expense accounts as part of the month-end closing process
  • Review all employee advances with the payroll and payables staffs at least once a month
  • Require approval of all advance payments to employees
• Controls in Accounting System - RECEIVABLES


  • Confirm payment terms with customers
  • Require approval of bad debt write-offs
  • Require approval of credits
  • Match invoiced quantities to the shipping log
  • Verify invoice pricing
• Controls in Accounting System - INVENTORY IN TRANSIT


  • Audit shipment terms
  • Audit the receiving dock
  • Reject all purchases that are not preapproved
• Controls in Accounting System - INVENTORY ACCOUNTING


  • Conduct inventory audits
  • Control access to bill of material and inventory records
  • Keep bill of material accuracy levels at a minimum of 98 percent
  • Pick from stock based on bills of material
  • Require approval to sign out inventory beyond amounts on pick list
  • Require transaction forms for scrap and rework transactions
  • Restrict warehouse access to designated personnel
  • Segregate customer-owned inventory
• Controls in Accounting System - INVENTORY VALUATION


  • Audit inventory material costs
  • Audit production setup cost calculations
  • Compare unextended product costs to those for prior periods
  • Review sorted list of extended product costs in declining dollar order
  • Control updates to bill of material and labor routing costs
  • Review inventory for obsolete items
  • Verify the calculation and allocation of overhead cost pools
• Controls in Accounting System - FIXED ASSETS


  • Ensure that fixed asset purchases have appropriate prior authorization
  • Compare capital investment projections to actual results
  • Verify that correct depreciation calculations are being made
  • Verify the fair value assumptions on dissimilar asset exchanges
  • Ensure that capital construction projects are not delayed for accounting reasons
  • Verify that fixed asset disposals are properly authorized
  • Verify that cash receipts from asset sales are properly handled
  • Verify that fixed assets are being utilized
  • Test for asset impairment

  
• Controls in Accounting System - CURRENT LIABILITIES


  • Include an accrual review in the closing procedure for bonuses, commissions, property taxes, royalties, sick time, vacation time, unpaid wages, and warranty claims
  • Review accrual accounts for un-reversed entries
  • Create standard entries for reversing journal entries
  • Include a standard review of customer advances in the closing procedure
  • Include an accrual review in the closing procedure for income taxes payable
  • Maintain historical expense information about warranty claims both for ongoing product sales and new product introductions
  • Match the final monthly payroll pay date to the last day of the month
  • Automate the period-end cutoff
  • Create a standard checklist of recurring supplier invoices to include in the month-end cutoff
  • Automate or sidestep the matching process
• Contingency


  Potential negative event which may occur in the future
• Controls for CONTINGENCIES


  • Include an assessment of contingent debt guarantees in the closing procedure
  • Include an assessment of debt covenant violations in the closing procedure
  • Include an assessment of debt covenant violations in the budgeting process and interim financial planning
  • Include an assessment of all contingency reserves in the monthly closing procedure
• Controls for DEBT: GENERAL


  • Require evidence of intent and ability to re-categorize debt from short term to long term
  • Require approval of the terms of all new borrowing agreements
  • Require supervisory approval of all borrowings and repayments
• Controls for DEBT: EXTINGUISHMENT


  • Include in the debt procedure a line item to charge unamortized discounts or premiums to expense proportionate to the amount of any extinguished debt
  • Report to the board of directors the repayment status of all debt
• When the bond interest rate = the market rate, the bonds are issued at par
• When the bond interest rate < the market rate, the bonds are issued at a discount
• When the bond interest rate > the market rate, the bonds are issued at a premium
• Convertibles


  Securities, usually bonds or preferred shares, that can be converted into common stock
• Controls for CONVERTIBLE EQUITY


  • Verify the market value of equity on conversion dates when the market value method is used
  • Verify the market value of equity on debt retirement dates when offsetting equity entries are being reversed
  • Include a review of accrued interest expense on all recently converted debt
  • Verify expense calculations associated with any sweetened conversion offers
• Sweetener


  A special feature or benefit added to a debt instrument (such as bonds) or a preferred stock offering to increase its value in the markets
• Controls for LEGAL STOCK AND CAPITAL STOCK


  • Independent substantiation must be obtained to verify the valuation of stock issued in exchange for goods and services received
• Treasury stock


  The portion of shares that a company keeps in its own treasury
• Controls for TREASURY STOCK


  • Require the use of a separate additional paid-in capital account for treasury stock transactions
  • Require board approval of all stock repurchases conducted under
• Offsetting


  Equity entries are being reversed
• Treasury stock (treasury shares)


  The portion of shares that a company keeps in its own treasury
• Treasury stock


  May have come from a repurchase or buyback from shareholders, or it may have never been issued to the public in the first place
• Greenmail


  The practice of buying enough shares in a company to threaten a takeover, forcing the owners to buy them back at a higher price in order to retain control