Significance of Internal Controls to an Organization - Coursework Example

Internal controls Name: Lecturer: Course name: Course code: Date: Introduction Catch me if you can an American crime comedy film which is based on Frank Abegnale. Frank has advance skills of over organized fraud in different entities where he poses in different position to perpetuate frauds such as payroll frauds. Frank majors on confident crimes in different firm’s which shows that most of the organization Frank reveal poor controls that he successfully commit frauds. Internal Control Internal control is a system of pertinent designed policies and procedures aimed at providing reasonable assurance that the organizational goals and objectives are achieved. Internal control system is anticipated to give a sound assurance on the organizational reliability of financial reporting, enhancing management directives on compliance with rules and regulations (Plessis, 2007). Internal controls are evenhanded in safeguarding the organizational assets and promoting effectiveness and efficiency of operation thus promoting profitability measures. Internal controls are designed by the organizational board of director’s management and other responsible personnel. The controls are designed based on their contributions to the organization. Significance of Internal Controls to an organization Internal control ensures that all the organizational transaction adheres to the policies and procedures set by the management. Controls sophisticate the managerial objectives to be carried out in an orderly an efficient manner. Well design controls helps in detecting and preventing errors and fraud at their early stages thus ensures accuracy and completeness of financial statement and also safeguarding misappropriation of the company’s assets. Internal controls also reduces the level of substantive test to be carried by the auditor hence reduces the time and cost of auditing. Responsibility of internal control It is the responsibility management's to ensure that controls are appropriately design and are functional. Management is responsible for delegation of internal controls and they ensure that delegates adhere to the properly documented and maintained internal controls. Employees have some responsibility in enhancing functional effectiveness of the internal control system. Internal controls are economical if a frequent review is carried out to augment the default in their effectiveness in ensuring that organization operates according to the procedures and policies provided by the management. Management should appoint internal audit team that oversees the organizational compliance with the set objectives. Internal audit's function provides assistance to the management in their oversight and operating responsibilities. Auditor’s independently carries out examination and consultations designed to promote and evaluate the mechanism of internal control. The internal audit department activity evaluates the effectiveness and adequacy of controls governing the organization's operations, and information systems (Bathwel.B, 2010). Internal audit appraisals ascertain the extent to which operating systems have been enhanced to achieve the established goals and objectives. Internal audit also assures conformity to the requirement of the standards to those of the organization and the implemented controls as well as their consistency.  External auditor has a responsibility of planning and performing audit to obtain reasonable assurance on whether there is material misstatement and whether the misstatement is caused by errors or frauds.  The An Auditor uses the nature of audit evidence and the characteristics of fraud, to be able to obtain reasonable, but not absolute, assurance that there is occurrence of material misstatements in the book of account. The auditor has no define responsibility over planning and performing the auditing in obtaining reasonable assurance on errors and fraud that are immaterial in financial statements. Internal controls are majorly of two types: a) Detective controls Detective controls refer to controls established to discover the occurrence of errors and frauds. In the movie catch me if you can (2002) Franks succeeded to forge the payroll system and withdrew $2.8 million dollars thus detective controls are used to provide the evidence for the loss resulting from forgery (Accountants, 2002). Detective controls involve physical examination of assets and inventories, carrying out audits, reconciliation of organizational accounts and variance analysis. The auditor's objective in an audit of internal control is to detect and express an independent opinion on assessment of management's effectiveness of the company's internal control over financial reporting.  The auditors basis of forming and expressing an opinion, he must plan and perform the audit to achieve reasonable assurance of whether the company’s effectiveness of internal control is maintained in all material compliments as per the specified. The auditor’s process of auditing the company's financial statements and giving an opinion as of the date specified also give a reasonable conclusion on assessment of the management effectiveness of the internal controls (Schubert Darrel, 2005).  Maintaining effectiveness over internal controls on financial reporting means that there is no existence of material weaknesses therefore, the defined objective of the audit of internal control over financial reporting is obtaining reasonable assurance that no material weaknesses existing as at specified date of management's assessment. The auditor evaluates the assessment performed by management and obtains and critical evaluates evidence whether the internal control over financial reporting was appropriately designed and operated effectively (Plessis, 2007). The auditor uses a variety of sources to obtain the evidence such as performing auditing procedures himself and using work performed by others i.e. working papers and previous reports. b) Preventive controls Preventive controls are proactive controls design to thwart off the occurrence of errors and irregularities within the organization. This control involves separation of duties, adequate documentation of organization transactions, proper controls on access of financial instrument and proper authorization. Effective preventive controls in the movie catch me if you can (2002) could have restricted the access of the forged financial instruments. Internal controls plans that enhance realization of the organizational goals by proper monitoring, evaluation and examination of the controls paradigms involves; Supervising Supervising -Internal control systems need clear supervision process to ensure that controls are implemented and followed to the later. In the movie catch me if you can (2002) controls over the payroll system was not observed hence it lead to fraudulent activities over the payroll (Kille., 2009). Supervision assesses implementation strategy and the quality of the internal system’s performance on the financial years. Management should have clear lines of supervision to ensure that policies stipulated by internal controls are adhered to enhance efficiency of the organizational operations. Controls over the payroll system should ensure that payroll system is free from material misstatement, ghost workers, and ensure that payroll is not subjected to risk of employee manipulation. Regular assessment of payroll employees by management promotes transparency and fair financial reporting disclosures. Lack of defined control measure lowers the reliability and dependency of the financial statement. The $2.8 million dollar is considered material hence failure to of an auditor to reveal the fraud leads to material misstatement of the reports. Poor controls will increase the chances organizational fraud however, reduce the profitability and performances (Godfrey, 2012). The extent and frequency of separate evaluations will primarily depend on risks assessment and the effectiveness of supervising procedures. Internal control deficiencies will lead to less efficient and fraudulent organization activities however; poor internal controls should be reported upstream following the lines of communication. In case of serious controls deficiencies, report should be make top management to ensure that measure are taken to enhance internal control mechanism and ensure that organization goals are achieved. Physical Controls Physical controls refer to security control measures that limit access to the organizational assets, books of accounts and departmental activities. Physical control activities are the policies and procedures that facilitate management directives are carried out effectively and ensure that risk of organizational exposures is reduced (Eilifsen Fallon). Physical controls involve installation of security personnel to ensure physical access restrictions to certain department, use of key and lock security measures to safeguard organizational assets from misappropriation. The use key lock and security guards in the organization limits the access of books of account from unauthorized person thus limiting the level of manipulation. The American biographical crime comedy describes high exposures of cheques to that Frank took an initiative of forgery on the Airways Company. Installation of the physical controls ensures that organizational financial instruments are not subjected for forgery (Schubert Darrel, 2005). However physical ensure that necessary actions are taken to and address risks to achievement of the organizational objectives. These control activities should occur at all functions and levels organization to ensure that fraudulent and errors will be reduces tremendously hence achieving organizational goals Arithmetic controls Arithmetic controls ensure that the organizational financial records and statements are prepared independently and observing due accounting professional care. These facilitate detection of errors and frauds in the financial statements at their initial stages hence corrective measures are installed. Accountants may record understate or overstate a transaction erroneously or willingly to defraud the organization. The incident of catch me if you can reflect poor arithmetic controls the fraud of $2.8 million dollars was revealed at the later stages (Bathwel.B, 2010). Management should enhance the use of internal audit department to examine the books of account on the risk areas to ensure that they are correctly reflected in the financial statements. Counterchecking of arithmetic controls attributively enhance accuracy in financial reporting thus enable organizational goal to be achieved efficiently. Authorization controls The pertinent authorization controls should be recognized, confined and communicated following the organization frame that enables employees to follow the clear lines of endorsement of certain firm activities. Most of managerial employees should aid in enhancing proper controls over the authorization in organization. Top management should be the only responsible employees to authorize certain organizational activities. Poor authorization controls will facilitate authorization of defrauding activities that will reduce the firm’s efficiency and reduce its earning capacity (Arogyaswamy, 2009). Lack of sufficient controls enhanced the Frank fraudulent act to the company of $ 2.8 million dollars in payroll department, Authorization of payroll system and the checks should have been countersigned by two top management employees will reduces the frauds over payroll since checks are checked and sign to facilitate the transaction (Accountants, 2002). Effective and well implemented authorization controls creates a procedural environment that will reduce the changes of fraud and will also reduce the level of substantive testing to an auditor since transparency credibly observe in facilitating transactions. In cases of fraudulent activities to management are held responsible for the act. In conclusion adequate internal controls which are effectively implemented provide a systematical control mechanism that ensures that organization is safeguarded from fraudulent activities that may deem the realization the set objectives. Frauds are costly to organization i.e. Airways company suffered 2.8 million dollars loss resulting from forgery of payroll system however installing controls sufficiently enhances achievement of organizational goals. Reference List Accountants, A.I.o.C.P., 2002. AU Section 110:Responsibilities and Functions of the Mangement.Independent Auditor. [Online] Available at: HYPERLINK "http://pcaobus.org/Standards/Auditing/Pages/AU110.aspx" http://pcaobus.org/Standards/Auditing/Pages/AU110.aspx [Accessed 30 September 2013]. Arogyaswamy, B.&.(.J.o.M..6., 2009. Organizational culture: Internal and external risk. Journal of Risk management, pp.98-105. Bathwel.B, 2010. The impact of strategic-positioning information on auditor judgments about business-process performance. Auditing Journal of Practice, pp.71-78. Eilifsen Fallon, n.d. Application of the business risk audit model. pp.214-31. Godfrey, F., 2012. International Auditing standards: Fraud and errors. Cengage Learning. Kille., M., 2009. International Auditing on business risk. Canada: Gray publishing. pp.123-27. Plessis, J., 2007. Principles of Contemporary management issues in Auditing. Cambridge university press. Schubert Darrel, R., ed., 2005. Assessing and Responding to Risks in a Financial Statement Audit. Read More