The Importance Scope And Requirement Of Internal Control In An Organization Accounting Essay

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Introduction

This paper will explore the importance, scope and requirement of internal control in an organization for its operation namely production, maintenance and procurement as well as in reporting.

Issues that will be brought forward here are:

The ignorance of why internal control is important that lead to non compliance and higher risk of misdeed.

The ownership and responsibilities of Internal Control - misconception that internal control responsibilities are mainly lies within Finance department only.

The perception - slowing down the process, meticulous, only applicable to Finance

The beliefs that when we act in good faith and in good interest of the organization, internal controls are less important and can be taken lightly.

The enforcement - which party should enforced the control. How to exercise "prevention is better that cure" in the event of non compliance

To create a culture on internal control practices within an organization.

Definition

According to Statement of Auditing Standard (SAS 300): [. . .] an internal control system can perhaps be distilled into the whole set of controls, financial and otherwise, which enable management to run an efficient business, safeguard assets, protect against error and fraud, and prepare accurate, complete and timely accounting records (Auditing Practices Board (APB, 1995a, para. 20).

When it is governed and complied to effectively, it can be used as a tool of fraud prevention and promote better corporate governance as well as financial reporting procedure.

Scope

Internal Control scope covers more than the financial aspect since it is the standard accepted way for each organization to perform their operation. It provides a path for members of the organization to follow in performing their responsibility effectively. Thus the responsibility lies not only in Finance department but the organization as a whole.

Requirement and Governance

From the time business world has been shocked with the fall of ENRON in 2001, Internal Control requirement becomes highly expected. Since this time, it is a requirement for an organization to perform good corporate governance and disclose their practice in their published financial statement reports.

Internal Control governs by many things within the organization as well as generally accepted guidelines, procedures and Act

Internal: Internal Policy, guidelines and Standard Operation Procedure that normally created within an organization based on their current operation and requirement

External: Sarbanes Oxley Act 2002 is an act started in 2002 arising due the infamous Enron scandal in 2001. This act has been used globally as an act to govern internal control. Though it is mostly adopted by a Multinational Company, Malaysian companies also uses it as a guideline. In Malaysia, we have Malaysian Code of Corporate Governance release by Finance Committee of Corporate Governance in 2001.

Compliance

As mentioned above, the compliance of internal control governs mainly by internal policy and guidelines but Sarbanes Oxley Act 2002 can be adopted as a compliance Act for internal control. This is mainly use by a multinational company.

Internal Auditor will act as the point to ensure the activities was performed within the requirement of each organization. Internal Auditor will normally report their findings to the audit committee of an organization. Their major roles and responsibilities were provided in the "Institute of Auditors" guideline which defines an Internal Auditor as an "independent, objective assurance and consulting activity designed to add value and improve an organization's operations.

It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control and governance process".

Critical Issues

Ignorance

In some circumstances, internal control has been totally ignored when performing the operation. This might happen in smaller organizations where it was said that there are not enough personnel to perform internal control requirement. However, sometimes, bigger corporations unintentionally overlooked this issue. Why? There are some related issues to answer this question. One of them is "empowerment". While empowerment is not a bad move at all since it was adopted to enhance the engagement of employee in the company, it still has to be done with much care and observation. Empowerment encourage employee to take part in the decision making. In achieving it, giving extended authority to certain employee will be unavoidable. In this case, when internal control is ignored or taken lightly, there will be higher probability of fraud and white collar crimes.

Most infamous world financial scandal involved persons with higher status and respectable level in the society. Why is this happening? This is the classic example of empowerment gone wrong. Empowerment has given them higher authority business decision making in their organization thus it may lead to the temptation to make decision for their own personal benefit. One might say this is more related to Ethics and Moral rather than internal control but internal control is a mean to "prevent" or reduce these risks. A good internal control combined with higher ethical value will give a better result in preventing business fraud. Hence, why sometimes it has been ignored and overlooked?

From the article entitled "ENRON : Learning the Lessons" by Joanna Sze published in Akauntan Nasional issue March 2002, it was stated by the SC Chairman at that time Datuk Ali Abdul Kadir that Enron-style scandal is unlikely to happen to Malaysia due to our different accounting standard than America's. What about BMF scandal? Though it is an obvious sign of accounting profession failure, are they the only party at fault here? The article still insists on taking adequate measures in performing its operation. What is "adequate measures" in that matter? There is no use to cry over spilt milk but how to prevent the spilt in the first place? Is it only the duties of accounting profession to prevent this financial scandal from happening?

Misconception of ownership and responsibility

Though Internal Control is important for financial reporting, corporate governance and financial statement disclosure, its ownership scope covers activities beyond financial reporting. It mostly covers the operational and management activities in each organization. As such, the responsibility to act according to the compliance lies to all members of the organization. However, this fact has always being misunderstood and ignored in an organization whereby it was deemed that internal controls are only applicable to Finance department since it is under the jurisdiction of "auditor" and financial reporting disclosure requirement.

Many members of the organization will presume that their responsibility does not include the need to comply to the internal control procedures. They will ignore this role when performing their norms in the organization. For them this has nothing to do with them. Members of the organization needs to be educated to be aware that internal control procedure related to each activity in the company, thus the responsibility of compliance lies on them. To educate them, they have to know the importance of internal control as well as its compliance.

Perception

Some feels that these procedures are a setback and hassle for them to perform their duties in a timely manner. Since most internal control procedures focusing on details, sometimes it does take a long way to perform one particular job. When something need to be performed in a short time,

Beliefs

Enforcement

Culture embedded

Actual Scenario

Urgent purchasing requirement - trading off internal control requirement with profit making and abusing of situation

In first example, a plant experienced a failure in one of its equipment. The damage was repaired but it requires urgent replacement as the failure will resulted to product loss thus a reduction in profit. Normal procurement procedure requires 1 month of tendering and approval stage, 2 weeks of awarding and another 2 months of fabrication - totaling to 14 weeks duration. Single sourcing cuts the procurement stage and reduced the fabrication stage to 1.5 months - totaling to only 8 weeks. The plant management decided on option 2 on the justification that profit will be reduced as a result of loss of products. Is internal control being sacrificed for profits? Is this a genuine case of needs to cut corners or was justification made to suit the situation? In this kind of situation, one organization must have a specific guideline to handle "urgent" request so that it is can be objectively justified

Refusal to acknowledge and comply

Literature Review

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