Internal Control of Accounting System - Essay Example

 Internal Control of Accounting System Fraud is a bigger problem than many people think. Most businesses have to fend off different kinds of threats such as economic changes, rising cost of goods, and competition. However, one of the largest threats to businesses is fraud. Fraud takes a variety of forms, including check and credit card fraud as well as employee theft. Employee fraud may include stealing assets through check tampering or through fraudulent billing schemes. Employee fraud involves employees engaging in fraudulent activities such as skimming cash, paying fictitious vendors, demanding undue overtime, exaggerating an expense account, or stealing inventory. The propensity for loss is great irrespective of the nature of the fraudulent activity. Fraud threatens the stability of a business as it leads to significant financial losses. According to Association of Certified Fraud Examiners, employee theft accounts for 7% of typical businesses losses (Chorafas, 2001). Accounting professionals are the trusted advisors for business clients. It is upon the accountants to educate business clients about the risks associated with fraud, and the significance of good internal controls and how to implement internal controls. This paper discusses suggestions for overcoming the lack of segregation of duties that is often present in small businesses due to inadequate staff. The paper further explains the important role business owners and independent accountants play in creating a good internal control environment. The paper discusses red flags, which may be indications of fraud along with several reports that are helpful in monitoring and reviewing financial records (Vona, 2011). The accounting system offers businesses with a constant way in which to use their data and financial material. A system of control is essential as it controls the three key partitions within the accounting system. These segments include the design, analysis, and implementation. Internal control is a system within a system and it plays a major role in the success of the accounting system. An accounting system controls businesses from fraud and abuse by ensuring that information employees relay timely and accurate information, and that all the accounting processes meet set regulatory requirements. This paper discusses how internal controls are set and how the control system functions (Basingstoke, 2004). Classification of Fraud Financial experts classify fraud into three major categories namely: asset misappropriations, corruption, and financial statements fraud. Asset misappropriations are frauds in which the perpetrator misuses or steals a firm’s resources. Corruption concerns schemes in which swindlers use their power in business transactions in a manner that infringes their duty to employers in order to get an undeserved benefit for himself or herself or someone else. Financial statement fraud entails an intentional omission or misstatement of material information from the firm’s financial reports. Financial statement frauds are normally cases of ‘cooking the books’ and often make front business page headlines (Willborn, 2009). Rationale for Internal Controls Businesses need to care about internal controls in order to reduce the risk of fraud and protect their assets. Furthermore, the increasing awareness of fraud has led to investors and other financial experts to focus on stronger internal controls at all business levels. It is important for businesses to understand internal controls and the need for different procedures to protect the business from risk of fraud. Now days, banks and other financial institutions need assurances of internal controls in the businesses that they lend money to, and from their audit firms. A business needs to implement strong internal controls for the following reasons; a Strong internal control focuses on the credibility of financial statements. Working on internal controls is helpful in addressing and preventing potential and future problems. Most stakeholders such as banks and investors recommend strong internal controls to solve existing business problems. The potential to go public may require a company to implement good internal controls. Strong internal controls initiate a business structure that is sensitive to any fraudulent activities. This is significant in prevention of fraud, detection of any embezzlement detection, and ensuring accurate financial reporting. Nonetheless, implementing controls into the financial accounting software does not necessarily guarantee compliance to strong internal controls. Accountants play a crucial advisory role in helping businesses design and implement strong internal controls (Internal Control). Elements of Internal Control  There are five major elements of internal control: risk assessment, monitoring, environmental control, control procedures, and information and communication.  These segments constitute an essential part of the control system and lack of all the major elements leads to failure of the controls and the control system (Vona, 2011). Environmental control refers to management and employee behavior and attitude.  The goals and aims of management affect employee attitude and behavior throughout a business. If the goal of the management is to realize certain sales levels at all costs, it may discourage employees from adhering to the internal controls of the business, as they would focus on achieving management’s goals without taking caution of consequences. Normally, it is the obligation of the human resources department of a business to provide greatly towards effective environmental control (Vona, 2011). Risk assessment entails a business’s ability to examine business risks, appraise their importance, and act accordingly.   Risk assessment is a managerial function, but can also be incorporated in a daily analysis by staff, if the work environment includes dangers and risks. The control procedures  provides stated approaches for carrying out the risk assessment, environmental controls, information communication, and monitoring, which must take place in the internal control process.  Control procedures are important as they help decrease the potential for fraud, incompetently trained personnel, and abolish process error. Control procedures benefit the company, employees, and the management of a business.  Control procedures significantly affect the information and communication feature of the business, in that so much of the communication of the state of the business depends upon the information provided by each unit.  The balances and checks that the control procedures deliver assures a business that each unit will provide honest, accurate, timely, and useful information (Vona, 2011). On the other hand, monitoring of internal controls for necessity and effectiveness is the pointer element of the process.  Lack of adequate monitoring of implemented procedures makes it difficult for the business to determine the effectiveness of the accounting systems Information is for educational purposes only and does not provide legal or financial advice. Information does not represent recommendation to invest (Vona, 2011). Key Components of Good Internal Controls Three main factors are necessary in the creation of a strong internal control to reduce risk of fraud of a business. These factors include the tone at the top management, the accounting system, and the accuracy of financial statements. Tone at the Top Management The Management’s commitment to implementing internal control sends a strong signal to all staff about the significance of internal controls, financial statement accuracy, and fraud prevention. In some businesses, the management may consist of the business owner and possibly two managers. Typically, the business owner and these managers’ experience and main business focus are in the business and not in accounting (Basingstoke, 2004). Many times, business owners ignore the importance of sound financial information and do not follow strict bookkeeping practices. The attitude of such managers presents itself in most fraud cases on businesses. Accounting professionals need to highlight to business owners that they investing much trust on employees on matters of bookkeeping increases the risk of fraud. Instead, business owners and top-level managers should monitor the business financials on a regular basis. Management involvement and oversight helps reduce the risk of fraud. It is therefore upon the management to take relevant steps to reduce risk of fraud and create a culture that yields timely and accurate financial information. These steps entail taking an interest in the books by enrolling the services of accountants to help in better understanding of the books. Secondly, the management needs to provide oversight and review. This would show employees that the business manager or owner checks on their activities. Lack of oversight provides a window for committing fraud even for the employees a business owner may trust (Chorafas, 2001). Thirdly, the management needs to put down on paper a well-articulated integrity and ethics policy. The management should distribute a copy of the policy to all employees throughout the business. Additionally, the business should review the policies annually to adjust the working environment. Finally, the management of the business should conduct random stop checks. This would involve choosing back up documentation and other reports other than monthly financial reports to spot check. Random spot checks are necessary as they help establish a predictable pattern in the performance of the business in the process sealing any loopholes for employees to engage in fraudulent activities (Chorafas, 2001). Accounting System Procedures and Control Creating accounting procedures and implementing controls is an important step in setting up internal controls. One consideration is to determine persons who can access QuickBooks and the accessible functions and areas. In small business environments, the bookkeeping department often has one or two employees only. Nevertheless, it is still important to consider the areas of the system that is accessible to these employees. QuickBooks allow the limitation of accessing certain areas of the system. The business management needs to familiarize with the capabilities of QuickBooks and place limitations on area that might be inappropriate for employees to access. Accountant professionals need to help management in implementing users and restrict access of QuickBooks (Vona, 2011). Financial Statement Accuracy and Fraud Prevention Business owners should consider having an independent accountant review the financial books on a periodic basis. CPA’s can evaluate reports for management use without having to give an opinion. This practice can help management find inconsistencies and inaccuracies and in their financial reporting. Just as knowing that management is reviewing their work helps to thwart fraud, knowing that an accountant will be reviewing their work further helps prevent potential fraud and ensures accurate financial reporting by employees (Willborn, 2009). Factors to Consider when Creating an Internal Control Policy Without internal controls, business managers can never know if financial information is accurate, complete, or reliable. There is need for the business to set, implement, and review a policy of internal controls. The management should ensure that employees adhere to controls of established policies. The following factors are crucial when creating an internal control policy (Willborn, 2009). Segregation of duties One of the most important ways of detecting and fighting fraud in a business is setting up shared responsibilities for the business’ financial management. The business should restrict and control the access to financial assets and information, including the accounting system. Managers need to make sure that there is a separation of duties where no single employee has too much responsibility within the accounting system. Businesses can outsource to an audit firm and request quarterly evaluations of the financial system by a CPA. It is important to divide financial responsibilities among the management team. This is highly preferable as it alienates the risk of having one person managing all the finances of the business (Chofaras, 2001). Safeguarding Assets In many businesses, the only list of assets that is maintained is the one prepared by the CPA for tax purposes. This relaxed approach to fixed asset management can lead to an opportunity for theft. Assets represent a significant investment of a company’s wealth. If the CPA maintains a fixed asset list, the business owner should get a copy of the list and keep track of all additions and deletions on a regular basis. Other controls to safeguard assets include restriction of access, use of firewalls and passwords on computers, and use of security cameras (Vona, 2011). Red Flags for Fraud Some working conditions create an environment that tolerates fraudulent activities. Business owners need to be aware of such working conditions and counter them to reduce the risk of fraud. These working situations include lack of adequate employee training, poor employee compensation, lack of physical controls inside the company, disorganization of work area, and lack of information system access controls. These working conditions indicate an opportunity to commit fraud. Business managers should move swiftly to avert the fraud risks that may result from these working situations (Basingstoke, 2004). Review and Oversight Businesses should thoroughly review and analyze control policies in line with changes in the business environment. These changes may include changes in accounting employees’ training, adoption of new accounting software, and increase or decrease in number of accounting staff. The business should review its control policies on an annual basis. However, in case of a significant change in the financial environment, the business can review the control policies anytime (Internal Control). References Basingstoke, Hampshire: Palgrave. Green, S. (2004). Manager's guide to the Sarbanes-Oxley Act improving internal controls to prevent fraud. Hoboken, N.J.: Wiley. Chorafas, D. (2001). Implementing and auditing the internal control system. Hound mills, Franks, R. (1994). Implementing an accounting system: A practical guide (Rev. Ed.). London: Kogan Page. Top of Form Bottom of Form Internal Control. (n.d.). Retrieved November 24, 2014, from http://www.aicpa.org/Publications/InternalControl/Pages/InternalControl.aspx Top of Form Bottom of Form Vona, L. (2011). The fraud audit responding to the risk of fraud in core business systems. Hoboken, N.J.: Wiley. Top of Form Bottom of Form Willborn, W. (2009). Quality management system: A planning and auditing guide. New York, N.Y.: Industrial Press. Top of Form Bottom of Form Read More