Internal Controls, Essay Example

Internal controls are heavily utilized in accounting and financial for two overarching purposes. Prevention of a violation of operating procedure and compliance with rules and regulations established to ensure proper business practices are followed. Internal controls in a business environment provide the tools internally to a business to ensure management and leaderships goals and objectives are being met with focus on error prevention, fraud, unethical business behavior and other less than legal means of conducting business. The internal controls act as a governing unit which establishes guidelines and limits for employee, customers and supplier/vendors in regard to business transactions. In accounting and financial management internal controls are based around reliable and accurate financial reporting that provides a clear and concise picture of the business’s financial health.

The first goal of internal controls encompasses the ability to prevent a violation in an established operating procedure set by leadership. An operating procedure includes business ethics, accurate and precise financial reporting, and a set of checks and balances among all entities that involve the financial records or transactions of the company. To uphold the checks and balances multiple areas are addressed. Ensuring someone is held accountable by establishing responsibility will allow a single person or group to own a specific function or action. By allowing ownership leadership, internal auditors or external review will have an entity to hold accountable for the information and actions being reviewed. Controls of information also include multiple aspects of control.

Physical, mechanical and electronic controls are used in combination to negate the deficiencies of one form and allow a control system that’s sum is greater than all of its parts. Through financial reporting the accountant can manually generate the end of year reports and utilized the computer generated reports to cross check the statements to ensure accuracy and generate discrepancies that can be researched and resolved. This leads into another area that ensures compliance with internal controls and that is segregation of duties or SODs. SODs dictates that a person will not and cannot control the inputs and outputs of a process without intervention and input from a separate and distinctive person in the chain. For example, in the reports mentioned before the individual manually generating the year end reports would not be the person who inputted the information into the computer system throughout the year and if so a secondary and tertiary party will need to be involved in the adjudication and validation of the information. In order to ensure compliance a separate entity without a stake in the financial process will be used for internal verification. The goal of the internal auditor is to uphold both internal and external standards and safeguard the company from undue financial harm (Biegelman & Bartow, 2006).

The second primary objective is compliance. Compliance with internal policies and procedures as well as external party’s policies and procedures ensure business practices are followed with integrity and voracity. Internal controls in regard to compliance are meant to provide the baseline for business operations in regard to what is right and what is wrong. Compliance with these policies allows the business to operate within the guidelines without detriment to the business or its shareholders. The internal compliance goals and objectives should, with all intents and purposes, align with the goals and objectives of the external governing agencies and their Acts and standards. Sarbanes-Oxley Act of 2002 impacted internal controls by requiring leadership and management to assess and report the effectiveness of internal control over financial reporting (Office of Economic Analysis 2009). The SOX requirements also require an independent auditor to ensure compliance.

The result to business is increased visibility by external governing bodies and increased cost associated with compliance. The limitations of internal controls are that they are inherently controlled and created internally by the people most familiar with the processes and the owner’s knowledge of the process greatly exceeds the depth and breadth of the internal control (Graham 2008). An example is the reason for the Sarbanes-Oxley act of 2002 was established. SOX requirements are based solely on the fact that large corporations were not following ethical and proper business protocols which lead to the financial decimation on a global area of operation.

In the overall scheme of compliance the cost of maintaining compliance is vastly lower than violating the Sarbanes-Oxley Act or other regulatory guidelines due to the fact that a business could face fines, fees, stricter actions, increased cost to meet more stringent requirements and potentially go out of business altogether. If a company does experience a gap between their financial and accounting standards and actual practices it is important to address the situation, mitigate the impact and resolve the root cause issue before it spreads and has a larger impact.

Although a company may experience a drop in share price after announcing a discrepancy, this mainly caused by the fact that there is an issue with the company, which will hopefully be addressed, and the fact that trust within the business community has been shattered in the recent past by corporation violating standards and policies. Internal controls allow a company to prevent issues from occurring and also ensure compliance with internal and external policies, standards and acts.

Reference

Biegelman, M., & Bartow, J. (2006). Executive roadmap to fraud prevention and internal control. Hoboken: John Wiley & Sons, Inc.

Graham, L. (2008). Internal controls: guidance for private, government and nonprofit entities. Hoboken: John Wiley & Sons, Inc.

Office of Economic Analysis, United States Securities and Exchange Commission (2009). Study of the Sarbanes-Oxley act of 2002 section 404 internal control over financial reporting requirements. Retrieved from http://www.sec.gov/news/studies/2009/sox-404_study.pdf