Xacc 280 Internal Control Research Paper

Internal Controls

XACC 280

By

University of Phoenix

Professor

This paper will discuss the internal controls and how they work in business. I will shed some light on the organizations financial and business policies, process and procedures. The purpose of these internal controls is to protect the company’s resources against fraud, misappropriate funds and most important waste. A company can spend quite a bit of money that does not make the company any profit. This paper will examine all aspects if internal controls and their functions.

When we look at the world of internal controls, there are two main goals for internal controls in a company. First is to ensure
the company’s assets/trade secrets are safe. That could mean robbery, theft, fraud and other unauthorized individuals walking away with the corporation 's possessions. The second primary of internal controls is to ensure the accounting/finance accounts are chronicled properly. This means that there are no account errors and receivables and payables are recorded appropriately. Everyone in a company theoretically has internal controls. Their responsibility varies from their day-to-day involvement. President of the company and senior executives laid the foundation for ethics, competence, integrity for a positive control environment. This is important because this sets the environment in the company. If the senior staff and management hold them selves to a high standard, that should trickle down to the entire company. Head of departments have responsibility for internal controls in their divisions that are given to managers. Managers are responsible for implementing procedures and internal controls at the lower level that are then dispersed to the employee. Every person in the organization is aware the of internal control procedures that coincide with their position/responsibility.
An internal audit is designed to scrutinize the competency and efficiency of the company’s internal controls and make suggestions as to how the company can improve. It is important to have an internal audit to ensure your company is adhering to the rules and standards that are put in place. Typically a company will use an outside company to complete an audit because they have no allegiance or stake in the company. Since an internal audit is to remain objective and is independent, the internal audit does not have main responsibility for creating or preserving internal controls within the company. The objective is to test the existing internal controls that are in place. Having said that, the effectiveness of the internal controls is augmented through the reviews achieved and suggestions made by an internal audit.

This brings us to the Sarbanes-Oxley Act also known as the government implemented the SOX.
“An act passed by U.S. Congress in 2002 to protect investors from the possibility of fraudulent accounting activities by corporations. The Sarbanes-Oxley Act (SOX) mandated strict reforms to improve financial disclosures from corporations and prevent accounting fraud. SOX was enacted in response to the accounting scandals in the early 2000s. Scandals such as Enron, Tyco, and WorldCom shook investor confidence in financial statements and required an overhaul of regulatory standards.” http://www.investopedia.com/terms/s/sarbanesoxleyact.asp
“The rules and enforcement policies outlined by the SOX Act amend or supplement existing legislation dealing with security regulations. The two key provisions of the Sarbanes-Oxley Act are:

1. Section 302: A mandate that requires senior management to certify the accuracy of the reported financial statement
2. Section 404: A requirement that management and auditors establish internal controls and reporting methods on the adequacy of those controls. Section 404 had very costly implications for publicly traded companies, as it is expensive to establish and maintain the required internal controls.” http://www.investopedia.com/terms/s/sarbanesoxleyact.asp

When a company announces weakness/problems from within, the faith that stockholders have in the company can become diluted. There are fears of mismanagement and other improprieties that could hinder the income and stock of the company and its shareholders. NYSSCPA.org says
“Glass Lewis & Co. found that 1,118 U.S. companies and 90 foreign companies—one of every 12 companies with U.S. listed securities—filed a total of 1,342 material weakness disclosures in 2006. Furthermore, 97 U.S. companies voluntarily disclosed significant deficiencies in 2006, down from 116 in 2005 (see “The Materially Weak,” Yellow Card Trend Alert, February 27, 2007). This total includes both SEC registrants currently required to have integrated audits, and those not so required. Companies that were required to disclose section 404 material weaknesses in 2006 reported 35% fewer material weaknesses than in 2005, while companies voluntarily disclosing such weaknesses reported 20% more. Exhibit 1, using data from the Glass Lewis & Co. study, shows material-weakness disclosures by stock exchange. Compliance Week added to the analysis, finding that while the number of companies that cannot meet filing deadlines may have risen in the second year of SOX compliance, fewer companies reported problems with internal controls.” http://www.nysscpa.org/cpajournal/2008/208/essentials/p42.htm

The majority of companies have a high level manager that can override the internal controls procedure that are put in place and would allow the manager to benefit from ill-gotten gains.
Alternative weakness to internal controls would be conspiracy. There could be employees that are in synergy (finance and or accounting departments) can alter the financial material that neither would be captured by an internal control. This is something that took place in companies like Enron and MCI WorldCom. With all the internal controls set in place, there can still be errors like human errors.
Controls are set in place so the company is protected. This would include things like from theft, fraud and other things that could damage a company and cause a lost in stock price. Sarbanes Oxley was created to safeguard the company and their records are fortified. Business’ that do not follow internal control procedures will lose money an ultimately not be able to keep their doors open. Companies have to understand that there are restrictions to internal controls. Internal controls are most important and have to be in place for a company to grow and have some type of
stability.
One good illustration is a retail corporation that did not have any inner controls in place. There could be two people or the entire shift using the cash register for the day. If that register came up short, there would be no way to track the lost money because there were multiple people using the cash register. Internal controls would work to prevent this chaos because there would be procedures in place. Responsibility would belong to each employee in that business that uses that particular register. When a shift is over, they would change draws and count out for the evening.

In conclusion, it is imperative for a company that wants to maintain order and responsibility has to install internal controls in order to be in compliance with the federal government as well as have a vote of confidence from shareholders. As a stockholder, I would never invest in a company that did not have internal controls in place because; it shows that leadership/management does not have a solid grasp on their company. It could potential foster an environment that would not make the company profitable.

References

http://www.nysscpa.org/cpajournal/2008/208/essentials/p42.htm http://www.investopedia.com/terms/s/sarbanesoxleyact.asp Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2008). Financial accounting (6th ed.) Hoboken, NJ: Wiley.

http://www.cafm.vt.edu/dbmg/internal_controls.php