Internal Controls

The accounting system gives businesses certain rules to follow when documenting

financial information and other data. The three key branches within the accounting structure,

of analysis, design, and implementation must be partnered with a system of control. The

internal control is a system within a system and has a major role in how good of the accounting

system works. The internal controls protect businesses from fraud; they also ensure that the

information that is received is accurate and that all requirements of the regulatory bodies are

met. (Banks & McConnell,2 003 )

Congress enacted the Sarbanes-Oxley Act of20 02 as a result of high profile business

failures and shady accounting practices. Multi-million dollar companies were doctoring the

books so they could continue to be wealthy .The fall of Enron was the last straw, and the

government decided to step in. Section 404 of the Sarbanes-Oxley Act requires management to

accept the responsibility for implementing and keep sufficient internal controls, including

putting their effectiveness in writing. The financial statement auditor must report on

managements ability to maintain the effectiveness of its internal controls by the end of the

year for the company. This Sarbanes-Oxley Act has a positive, long lasting effect on the way

business is done and hopefully America will not witness another debacle like Enron or

WorldCom. (Banks & McConnell,200 3)

 The sudden fall of Enron made American society look at investing in a whole new light. Investors

now scrutinize a companys financial inside and out before buying stock. According to the article

Reporting on Internal Control over Financial Reporting³the stock prices of

3
Internal Controls

companies that disclosed material weakness experienced declines of 5% to 10%. A study by the

Stanford Law School, sponsored by Financial Executives International (www.fei.org), which

looked at 141 companies that disclosed material weakness between November20 03 and

October2004, found that companies which gave detailed disclosures regarding the material

weakness in their ICOFR experienced less of a decrease in stock price than those that did not.

While admitting weaknesses in internal controls can make a company seem honest and

forthcoming, it can have a negative effect on a companys finances. (Agami,20 06)

Internal controls are based on the policies that management deems to be effective.

With that being said, there are certain limitations that could keep internal control from working

effectively. Environment can limit internal controls. For example, organizational culture can

influence the acceptable behavior of an employee. When employees see unacceptable

behavior being accepted by a senior manager, it becomes acceptable and this behavior can

carry over into other facets of the company. Collusion is the main limitation on internal control.

This was what happened in the Enron scandal; staff working together for gain or other motives.

Finally, lack of knowledge can limit internal controls. If accountants and others who handle
finance are not clear on the provisions of internal controls, then how will it work? Companies

have to make sure that the internal controls are understood by everyone, and to do this

everyone must be properly trained. (Agami,2 006 )

There are four principles of internal controls and they are establishing responsibility,

using physical, mechanical, and electronic controls, segregation of duties, and independent

internal verification. These four principles fall hand in hand, and if they not adhered to properly

4
Internal Controls

the whole internal control system could collapse. First of all, ability should match responsibility

Staff positions should be filled with the most competent persons possible. People who are

under qualified will be less able to perform their duties without errors. Special training may

help here. All companies should have consistent procedures that describe the duties that must

be performed. If the staff has a clear understanding of what is expected of them, they will do a

better, job. Also, errors will be decrease along with the chances of fraud. (Agami,2 006 )

A good division of duties, qualified personnel, and sound, written procedures will not

guarantee good internal control. They system of procedures must be followed through and

through. Results must be monitored to assure the system is working correctly. Internal controls

must be a top priority in any company in order to succeed. When a company has poor internal

controls it can hurt a lot of people. They could lose investors and many people could end up

jobless.
5
Internal Controls

References

Agami, A. (2006). Reporting on Internal Control over Financial Reporting. The CPA Journal.

(Retrieved fromht t p: //w w w . allbus i ne s s . com /prof e s s ional-s cie nt i fic / accou nt ing -t ax /

4103229-
1.html
Banks, G &McConnell, J. (2003, September). How Sarbanes-Oxley Will Change the Audit
Process. Journal of Accountancy. Retrieved at
http://www.journalofaccountancy.com/issues/2003/sep/howsarbanesoxleywillchangetheaudit
process.htm

Internal Controls
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