1. Explain internal control affecting Liabilities and Equity
and potential misstatements on assets and how weakness in internal control increase risk of misstatement. 2. Explain the relationship between governance, business ethics, risk management and internal control and how the various principles, frameworks and processes interact and enable professional accountants to contribute positively to their organizations, profession and society.
Internal Control for Liabilities & Equity
A. Liabilities
What are potential misstatements on accounts payable
and how weakness in internal control increase these risks? Description of Examples Internal Control Misstatement Weakness Inaccurate recording Fraud of a purchase or ● A bookkeeper ● Inadequate disbursement prepares a check segregation of for himself and duties between records it as having record keeping and been issued to check preparation. major supplier. ● Failure to review and cancel supporting Error documents by ● A disbursement is check signer. made to pay an invoice for goods that have not been ● Ineffective control received. for matching invoices with RR before disbursement are authorized. Fraud ● Goods are ordered ● Ineffective control but delivered to an for matching Misappropriation of inappropriate invoices with RR purchases address and stolen before disbursement are authorized. Duplicate recording of Error purchases ● A purchase is ● Ineffective control recorded when an for review and invoice is received cancellation of from a vendor and supporting recorded again documents by the when a duplicate check signer. invoice is sent by the vendor. Fraud ● Purchase journal ● Ineffective board of “closely early” with director’s audit Late(early) recording this period’s committee. of purchase purchases as ● Undue pressure to having occurred in the subsequent meet earnings period. target.
What internal controls are applicable over Debt?
1. Authorization by the Board of Directors. a. By-laws should clearly state that board of directors are required to approved borrowings. b. Treasurer prepares report on any proposed financing, explaining the need for funds, effect of borrowing upon future earnings and the estimated financial position of the company in comparison with others in the industry both before and after borrowing and alternative methods of raising funds. c. Authorization shall include matters such as choice of bank or trustee, type of security, registration with SEC, agreements with investment banker, listing of bonds on security exchange and compliance with requirements of state of incorporation. d. Board of directors shall be furnished copy of report stating net amount of received and its disposition. 2. Use of Independent Trustee Trustee does not have access to the issuance of company assets or accounting records but are paid by the company as independent part who is charged with the protection of creditor’s interest and with monitoring the company’s compliance with the provision of indenture.
3. Assigned Trustee to Pay Interest on Bonds and Notes
Payable.
B. Equity
Three (3) principal elements of strong internal control
over equity 1. proper authorization of transaction by the board of directors and corporate office. 2. segregation of duties in handling these transactions 3. maintenance of adequate records.
What internal controls are applicable on Equity?
1. Control of Share Capital Transactions by the Board of
Directors 2. Independent Registrar and Stock Transfer Agent 3. Internal Control over Dividend Relationship between Corporate Governance, Business Ethics, Risk Management and Internal Control
CORPORATE
INTERNAL
Figure 24.1
A. Corporate Governance relationship to Business Ethics
A well defined and enforced corporate governance provides a Structure that, at least in theory, works for the benefit of everyone concerned by ensuring that the enterprises adheres to accepted ethical standards and best practices as well as to formal law. Figure 24.2
An effective ethics programme requires continual
reinforcement of strong values. Organizations are challenged with how to make its employees live and imbibe the organization codes and values. To ensure the right ethical climate a right combination of spirit and structure is required.
B. Corporate Governance relationship to Risk
Management
So, risk as defined by ISO as the effect of uncertainty on the
entity’s objectives. When there are no objectives, there are no risks. But that’s not company were made for, therefore should always be assessed in light of the entity’s objectives. Under the principle 12 of Code of Corporate Governance, “To ensure the integrity and proper governance in the conduct of its affairs, the company should have…enterprise risk management framework.” Below is the summary review of OECD for the need of risk management.
● Perhaps one of the greatest shocks from the financial crisis
has been the widespread failure of risk management. In many cases risk was not managed on an enterprise basis and not adjusted to corporate strategy. Risk managers were often separated from management and not regarded as an essential part of implementing the company’s strategy. Most important of all, boards were in a number of cases ignorant of the risk facing the company. ● It should be fully understood by regulators and other standard setters that effective risk management is not about eliminating risk taking, which is a fundamental driving force in business and entrepreneurship. The aim is to ensure that risks are understood, managed and, when appropriate, communicated. ● Effective implementation of risk management requires an enterprise-wide approach rather than treating each business unit individually. It should be considered good practice to involve the board in both establishing and overseeing the risk management structure. ● The board should also review and provide guidance about the alignment of corporate strategy with risk-appetite and the internal risk management structure. ● To assist the board in its work, it should also be considered good practice that risk management and control functions be independent of profit centres and the “chief risk officer” or equivalent should report directly to the board of directors along the lines already advocated in the OECD Principles for internal control functions reporting to the audit committee or equivalent. ● The process of risk management and the results of risk assessments should be appropriately disclosed. Without revealing any trade secrets, the board should make sure that the firm communicates to the market material risk factors in a transparent and understandable fashion. Disclosure of risk factors should be focused on those identified as more relevant and/or should rank material risk factors in order of importance on the basis of a qualitative selection whose criteria should also be disclosed. ● With few exceptions, risk management is typically not covered, or is insufficiently covered, by existing corporate governance standards or codes. Corporate governance standard setters should be encouraged to include or improve references to risk management in order to raise awareness and improve implementation.
C. Corporate Governance relationship to Internal Control
Internal control activities ensure that companies adhere to
corporate governance guidelines. As shown in figure 24.3, internal control is important element of COSO ERM Framework. Corporate governance sets the standards and recommends procedures; internal controls ensure those procedures are being followed. Internal controls also ensure there is an audit trail that can be retraced during internal and external audits. Figure 24.3
Following objectives of Internal Control supports the
objectives of good corporate governance which are summarized as follows: ● Ensure achievement of the organization objectives, including its stated goals and business targets in an effective and efficient manner. ● Ensure economical and effective use of resources and adequately safeguard the organization’s assets against unauthorized use or disposition. ● Ensure compliance with applicable legislation and regulations. ● Ensure maintenance of proper records for providing reliable financial, managerial and operating information for decision-making, evaluation of activities or publication. ● Ensure adequate control for the risks inherent in operations.
To conclude, a good corporate governance can be achieved
when it applies high ethical standards, have established risk management process and implement internal controls.