The Importance of Internal Controls for Company Survival

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Internal controls are often overlooked in company planning, and are usually underemployed in businesses. Despite this, internal controls are very important in order for a company to be afloat, and it helps the company to be more efficient and run smoothly. The AICPA defines internal control as the process affected by plan management and other personnel, and those charged with governance and designed to provide reasonable assurance regarding the achievement of objectives in the reliability of financial reporting (AICPA, 2014, pg. 4).

Before taking this class, I had a broad understanding of what internal control was, and how it is important to the survival of the company. Today, however, I can understand the value of internal control and its place in keeping firms profitable and in good standing. A proper internal control reduces the risk of asset loss, and helps ensure that plan information is complete and accurate, financial statements are reliable, and the plan’s operations are conducted in accordance with the provisions of applicable laws and regulations.

When internal controls are effective, the company has reasonable assurance that its plan is achieving its financial reporting objectives. However, when the internal controls are not effective, there is little or no assurance. Therefore, after taking this class, I feel that I can better understand what internal controls are and how to help future companies I will work to use it effectively. Looking back on my previous accounting jobs I realize that some of the companies I worked had internal controls that were not efficient. However, I will choose my first job as an accountant to analyse its internal controls.

In 2009, I started my first accounting job as a junior accountant for a construction company back in my country, Angola. When I started in the company, I was working under a senior accountant who only came once a week to check on how I was doing. However, the owner only asked us to do the financial statements and bookkeeping for a fiscal year, and it was a temporary job. Basically, he only wanted us to update their financial statements because he was trying to get a loan. Now, I realize the company lacked a lot of internal controls, most importantly, it needed an in house accountant because it did not have one since it opened in 2002.

The company was a construction company dedicated to building residential houses, which specialized in helping future homeowners build their dream home to their exact specifications. In addition, it had a community were future homeowners could choose a house to live in or rent. The company had many issues from not having bookkeeping in order, proper inventory and accounts payables procedures to proper cash and customer procedures. For seven years, the company did not have an accountant, in fact, the person that was in charge of the payroll was the same that signed the timesheet, paid vendor and deposited checks. The following is what I would apply based on what I have learned in this class in this company.

In-House Accountant

Accounting is a very important part of the company’s operations, but many organizations have to decide if they will use in-house accounting or outsourced accounting. An in-house accountant is an accountant who works for the company and does the accounting activities of the company. I believe that the in-house accountant would help the company with bank reconciliation, income statement, balance sheet, maintaining a clean general ledger,and keeping track of company’s daily activities. In addition, the accountant would help with completing and filing the required legal and compliance documents for the company, prepare annual statements of accounts, and handle the company’s payroll properly.

In case the owner decides to apply for another loan, it is a good idea to have an in-house accountant because it might improve the company’s chances of getting a loan. This is because it shows that the company is serious about its business, and the accountant would present facts that backs up the application for funding, in addition to answering questions the bank might have regarding revenues and expenses projections.

Segregation of Duties

It is the main concept in a system of internal control. The duties within a department should be segregated so that one person does not perform processing from the beginning to the end. One person should not be in a position to authorize a transaction, execute the transaction, record the transaction and provide the sole review of the transaction. Reconciliations should be performed by a person independent of the basic process. On the accounts receivable side, segregation of duties ensure that the same person who is receiving cash is also not depositing it and recording it in the accounting records. For accounts payable, segregation of duties ensure that the same person approving payments is also not writing the checks and reconciling the bank account. In addition, the owner should be the one paying employees with adequate approval from the supervisor if needed. Furthermore, the employees working on the clients’ house should have a signing sheet which should be signed by the supervisor.

While working there, I noticed that there was no signing sheet, and coworkers would often cover for each other saying that the person was working at the clients’ site when asked, even though most of the time this was not true. In addition, there was only one person doing everything in terms of receivables and payables. This particular employee was in charge of payroll, paying vendors, and receiving money from clients and depositing it afterward. However, according to the owner, there were missing payments.

Therefore, segregation of duties would help reduce the risks of inaccurate financial reporting and improper use of funds. In addition, I would recommend arranging duties so that the employee who authorizes payment of a bill does not sign checks. Otherwise, the checks could be written to friends in payment of fictitious invoices, and those employees who sign checks neither have access to canceled checks nor prepare the bank reconciliation. This policy makes it more difficult for an employee to conceal a theft.

Inventory Management

A strong inventory tracking and management system should be in place and only key personnel should be able to use it. Access to inventory master files and the ability to modify, delete or change data should be restricted to only be used by the owner, and verify that inventory management systems are relevant aids for assessing time to reorder or replenish various products.

Because every time the company would buy inventory a different person would receive it and ask for it to be sent in different places, and there was no log of why they needed the material or who requested it; it would be beneficial to establish a system of access controls that prevents unauthorized access into inventory storage and administrative areas. In addition to conducting a risk assessment for environmental risks due to floods and high winds, and establishing a system for responsible employees to verify delivery, receipt, and storage of inventory.

Creating a paper trail of internal documentation and cross-check to ensure items received and those on the invoice are identical, and confirming that a system of signing items out of inventory and into the client’s site exists, that it requires signature authorization and compliance is enforced as a policy.

One possible solution to this issue would be to establish a basic audit schedule and conduct unannounced audits or check inventory frequently. Additionally, assemble a plan for conducting physical inventory counts when necessary. I recall one event in particular that could have been avoided if these procedures were in place. During this particular project, the company had ordered a lot of bags of cement. When the bags were delivered, the courier left them outside at the client’s site on a Friday afternoon. Since there were no workers at the site, and it rained a lot the whole weekend, by Monday the bags hardened and they had to order a new shipment. However, no one knew who received the shipment, and why it was left outside.

According to Eric Bank, “Before you start the count, improve your odds of success by preparing warehouses and other locations. You can organize work areas, ensuring all items are properly labeled and stored in their correct locations. You can ease the counting process by pre-counting items that are seldom picked and removing excess and obsolete inventory. You also can prepare the inventory takers by reviewing procedures and the instructions for the equipment that they’ll use to make the counts, such as radio frequency tag readers or bar code readers”. Therefore, the physical protection of assets should be one of the primary goals. Cash should be stored in a fire-proof safe, office supplies should be kept at reasonable quantities, and equipment should be stored in a secure locked areas. Keeping accurate lists of equipment helps to reduce the risk of misplacing the equipment or someone converting the equipment to personal use.

Cash and Customers Procedures

In order to accomplish accurate posting of transactions, employees should be properly trained and authorized to perform accounting and cash handling functions. Only authorized personnel should have access to automated accounting systems, cash storage, original accounting documentation, and sensitive information. Proper training should include an understanding of the essential need for timeliness in processing transactions. Errors and omissions should be identified and corrected on a timely basis.

The company would charge fifty percent to start building the client’s house and the rest the clients would pay when the house was completed or in installments. However, there was no actual log of the progress of the houses, and the owners were getting upset because the timeframe given to them had already passed, and the houses were not finished yet.

In order to control cash receipts the company should implement the following procedures: the firm should prepare a record of all cash receipts as soon as cash is received, deposit all cash receipts intact as soon as feasible, preferably on the day they are received or on the next business day. Additionally, duties should be arranged such that the employee who handles cash receipts does not record the receipts in the accounting records, and arrange duties so that the employee who receives the cash does not disburse the cash.

In contrast, in order to control and manage its cash the company should implement the following: account for all cash transactions accurately so that the correct information is available regarding cash flows and balances, make certain that enough cash is available to pay bills as they come due, and prevent loss of cash due to theft or fraud. I believe that by implementing these procedures, it would be easier to track cash easily and efficiently.

Implement Internal Control Over Capital Assets

The company had a lot of equipment that were not being depreciated. Since these equipment are significant to the company’s internal operations, I believe there key internal controls should be implemented over acquisition, storage, and record keeping such as periodic inventory evaluations, purchase authorization, and separated ledgers.

According to Duff and Phelps “The fixed asset accounting records of an organization have farreaching effects. Depending on the type of institution, fixed assets can represent the largest item on the balance sheet. Therefore, deficient fixed asset records can lead to inaccurate financial reporting…and inaccurate financial reporting can lead to a qualified audit opinion, which can damage management’s credibility with shareholders, lenders and suppliers” (Duff and Phelps, 2017, p. 2). The company had a lot of construction equipment such as dump trucks, diggers, lifts and others, but none of them were being depreciated. I believe it is crucial to start implementing internal control over capital assets because the company financial reports are inaccurate.

Utilize Technology to Help

New technology exists to help companies prevent theft, and separation of duties can be easily accomplished via system-based approval processes for purchases and payments. Controls on customer payments received can be gained by streamlining client payment collection via lockbox services, and the risk of stolen check stock can be reduced by utilizing a bill payment service. I believe that this would help the company a lot because everything was on paper, and there was no way to tell for sure if the company was profitable or not.

“If a weak control environment results in weak general IT controls or if there are weaknesses in the application and data-owner controls, management will need to evaluate and understand whether there are alternative or compensating controls at the business-process level relating to segregation of duties and the accuracy and completeness of processing. If application-level controls are weak, management must look for compensating detective and monitoring controls. These detective and monitoring controls would need to be highly detail-oriented and extensive in nature and scope. They must not depend on computer processing to operate effectively and must be documented, evaluated and tested” (Sections 302 and 404 of the Sarbanes-Oxley (SOA) legislation). Information Technology is now included in almost every aspect of a company’s function and has created a need for proper management to provide detailed oversight on this convoluted function. The overall health of a company depend on the operation of its IT department. That is why investing in IT controls is essential for financial operations and to ensure greater operational efficiency. However, it is important to probe the needs of the company and tailor the IT operations to fit those specific needs.

By improving those areas will help the company awareness of the importance of internal control over financial reporting, and will enable the company to assess the costs and benefits of implementing adequate controls, weigh the risks of each significant deficiency or material weakness, and determine if and how to address them. I am aware that it is going to cost the company a lot to implement these measures, however, procedures such as these safeguard companies from going bankrupt. In my country an employee usually gets paid a hundred dollars or less per month, and I realized the company had a lot employed that stayed hours without doing anything.

Internal control procedures such as these can help curtail wasteful spending and would have helped the company tremendously from going bankrupt and closing down. Also, since I started doing this paper, I tried to contact the company without success, so I called one of the employees there and he told me that the company went bankrupt in 2011, and the reasons were financial issues. Now, I know that if a company does not have a proper internal control in place, it will be bankrupt in no time.

References

AICPA. (2014). The importance of internal control in financial reporting and safeguarding plan assets. AICPA. Retrieved July 14, 2019, from https://www.aicpa.org/content/dam/aicpa/interestareas/employeebenefitplanauditquality/resource
Bablani, S. (2016, June 27). Internal Controls Over Information Technology at Your Firm. Retrieved July 14, 2019, from https://www.accountingweb.com/technology/trends/internal-controls-over-information-technology-at-your-firm
Bradford, C. (2016, September 29). Checklist for Internal Inventory Controls. Retrieved July 14, 2019, from https://yourbusiness.azcentral.com/checklist-internal-inventory-controls-10692.html
Cash Management: Internal Controls Checklist. (2017, February 17). Retrieved July 14, 2019, from https://www.cpapracticeadvisor.com/accounting-audit/article/12294853/cash-management-internal-controls-checklist
Duff and Phelps. (2017, Spring). Fixed Asset Controls and Reporting: Who’s Paying Attention To Your Largest Assets? Retrieved June 19, 2019, from https://www.duffandphelps.com/-/media/assets/pdfs/publications/fixed-asset-management-and-insurance-solutions/fixed-asset-controls-and-reporting-whos-paying-attention-to-your-largest-assets.ashx
Walsh, K. (n.d.). Internal Controls: What Are They & Why You Should Care. Reciprocity. Retrieved July 14, 2019, from https://reciprocitylabs.com/what-are-internal-controls-and-why-are-they-so-important/

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