Limitations of Internal Control PDF

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Limitations of Internal Control 

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Internal control can do so much to protect against both error and fraud and ensure organizations objectives are achieve, still its important to recognize the existence of inherent limitations of internal control Customs, culture, and corporate governance may inhibit fraud but they are not absolute deterrence Mistakes may be made in the performance of controls as a result of the misunderstanding of instructions, mistake of judgement (different judgment), carelessness, distractions (doing something else), or fatigue Errors in judgement may also refer in the designing, maintaining, or monitoring controls Errors may be a limitation in internal control Overdesign, implementation and monitoring of controls Control activities whether manual or automated dependent upon separation of duties may be circumvented by collusion among two or more people Inappropriate management may override internal control – approval of purchase order - someone who has a superior position dapat magoverride with the system, - if may management override, si operations audit ang makakadetect non, this deviation or findings can be presented to the management kung ano ang comment nila Management may enter into side agreement with the customers that altered the terms and conditions of the company’s standard contracts in ways that would preclude revenue recognition or management may improperly modify the accounting records – respect the adopted policy of the company Agency theory – conflict of interest The extent of the controls adopted by a business also is limited by cost consideration, it is not feasible from a cost standpoint to establish controls that provides absolute protection from fraud and risk and reasonable assurance in this regard is generally the best that can be achieved. In the design of control dapat cost effective, the cost should not outweigh the benefit

Elements/Components of Internal Control - should not independently operate of each other - should be working in an interrelated manner to support the overall effectiveness of internal control system.     

Control Environment Risk Assessment Control Activities Monitoring Information and Communication

Control Environment 

- covers the governance, nagseset ng tone

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The control environment sets the tone of an organization, influencing the control consciousness of its people. It is the foundation for all other components of Internal control, providing discipline and structure. - If weak ang control environment, domino effect, because BOD are here. The importance of control to an entity is reflected in the overall attitude, awareness of, and actions of the board of directors, management, and owners regarding control. Serves as an umbrella that covers the entire entity and establishes the framework for implementing the entity’s accounting system and internal controls.

Factors affecting Control Environment (ICHAMPO) 

Integrity and Ethical Values communication and enforcement - The effectiveness of an entity’s internal control is influenced by the integrity and ethical values of the individuals who create, administer, and monitor the controls - - An entity needs to establish ethical the behavioral standards that are communicated to employees and are reinforced by day-to-day practice Ex. Management should remove incentives or opportunities that might lead personnel to engage in dishonest, illegal, and unethical tasks. -

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Some examples of incentives that may lead to unethical behavior are pressures to meet unrealistic performance targets and performance dependent rewards - Examples of opportunities included in ineffective BOD:  a weak internal audit function, and  an insignificant penalty for improper behavior. - Management can best communicate integrity and ethical behavior within an entity by example and through the use of policy statements, code of conducts, and training. - There should be a right balance between what you can give to the people. Dapat may rewards and punishment system ka. - Senior Management and the BOD are expelled to lead by example. - In establishing values and expectations regarding appropriate behavior, when this is done well, the organization is said to have a strong tone at the top. - This commitment to integrity and ethical values is communicated through the organization Standard of conduct – what are the expected behaviors na dapat meron ang isang employee; these are the acceptable behaviors. - Also, this commitment can be also emphasized through directives, action, and behavior. - Examples:  Diligently finish the work  Following the protocols and procedures - An organization should also establish a process to enforce standards of conduct or code of conduct ensuring that the deviations are identified and remedied on a timely and consistent basis. Commitment to Competence - Competence is the knowledge and skills necessary to accomplish the task to define an individual’s job.

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Conceptually, management must specify the competence level for a particular job and translate it into a required level of knowledge and skills. An entity should have a job description for each job, management must hire employees who have the appropriate competence for their jobs. - Good human resource policies helps attract and retain competent and trustworthy employees. - Hire people suitable for the job. Human Resources Policies and Practices - Quality of internal control is directly related to the quality of the personnel operating the system. The entity should have sound human resource or personnel policies for hiring, orienting, training, evaluating, counselling, promoting, compensating, talking remedial action for any corrections of the employee’s behavior, disciplinary action - In hiring employees, standards that emphasize seeking the most qualified individuals should also have an emphasis on educational background, prior working experience, and evidence of integrity and ethical behavior demonstrates an entity’s commitment into employing competent and trustworthy people. - Research into the causes of errors in accounting systems has shown personal related issues to the image or cause of error. Assignment of Authority and Responsibility - This control environment factor involves how authority and responsibility for operating activities are assigned and how reporting relationships and authorization hierarchies are established. It includes policies regarding acceptable business practices, knowledge and experience of key personnel, and resources provided for carrying out device. It also includes policies and communication directed at ensuring that all personnel understand entities key objectives, know how their individual actions interrelate and contribute to those objectives and recognize how and for what they will be held accountable. - An entity can use number of controls to meet the requirements of this control environment factors. For example, the entity can have a well specified organizational chart that indicates line of authority and responsibility. - Management and supervisory personnel should have job description that includes their controls related responsibility - Dapat may key matrix Management's Philosophy and Operating Style - drive the control environment - establishing, maintaining, and monitoring entitys internal control are management responsibility. - Can significantly affect the entitys internal control - decentralized management – reporting mechanism, can be seen transparently let each organization have its own decisions - centralization – decision to few people or authority - CHARACTERISTICS THAT MAY SIGNAL IMPORTANT INFORMATION FOR THE AUDITORS MANAGEMENT PHILOSOPHY AND OPERATING STYLE INCLUDES:  Management approach in taking business risk

Management actions toward financial reporting if they are conservative or aggressive in the selection of the available alternative of accounting principle and their consciousness and conservatism with ach accounting estimate are developed  Management attitude towards information processing, accounting functions and personnel - Conservative – stringent internal control 

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Participation of those charged with governance (Board of Directors/Audit Committee) - - May responsibility over governance – BOD - - BOD and Audit Committee – significantly influences the control consciousness of the entity. The audit committee is the subcommittee of BOD - - Large org – management should be separated from BOD - - Fiduciary responsibility – entrusting assets and capital of the shareholders to agents or management to the best of interest of their principal. They should actively oversee the accounting and reporting policy and procedures - FACTORS THAT CAN IMPACT THE EFFECTIVENESS OF THE BOD AND AUDIT COMMITTEE INCLUDES A. Independence from the Management B. Experience and stature of the members C. Extent of involvement and scrutiny of the entity’s activities D. Appropriateness of its action E. Information it receives – reflective of the performance of the operations, if the BOD wants to ensure the information received, to have assurance - internal or external auditor can go F. The degree to which difficult question are raised and pursued with management G. Interactions with the external and internal auditors – if high interactions, it is effective in terms of discharging responsibilities - IMPORTANT DUTIES OF THE AUDIT COMMITTEE A. Appointment, compensation, and oversight of the external audit firms who will be conducting the auditing firms’ audit B. Resolutions of disagreement between the management and audit team, they provide standpoint over disagreement C. Oversight of the internal audit function D. Approval of non-audit services provided by the public accounting firms performing the audit engagement E. Oversight of anonymous fraud hotlines – whistle blowing Organizational Structure - - defines authority and responsibility are delegated and monitored. It provides the framework which the entity’s achieving the entity wide objectives are planned executed, controlled, and reviewed. - - AN entity develops an entity wide structure suited to its need,

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- Establishing a relevant organization structure includes considering key areas of authority and responsibility, and appropriate lines of reporting - Through org structure, you see the span of control, gaano karaming tao, or functions - The appropriateness of entitys org structure depends on its size and nature of its activities, factors such as level of technology in the entitys industries and external influences such as regulations...