Internal control is a checks and controls system that develop by the several levels of management to make sure effective and efficient to conduct operations business as well as reliably of business reported to make sure management decision-making is well based and that all relevant laws and regulations are complied with. (Trenerry, 1999)
It is important for directors of Rose Co to ensure that the company has an effective system of internal control because it helps to prevent fraud; loss and inappropriate use of resources to make sure the liabilities are identified and manage.
This may facilitate the operation effectively and efficiently towards the achievement of company's performance, profitability and goals. With the effective system of internal control, it can be able to detect fraudulent financial reporting and misappropriation of assets to ensure that the financial report is reliable and make sure compliance with laws and regulations. (Hayes, Dassen, Schilder, & Wallage, 2005).
Performance reviews
It is the third party to check on performance independently instead of involved in the activity directly. It include reviews of actual performance like compare to budgets, surprise checks of procedures, periodic comparisons of accounting records and physical assets and a review of functional or activity performance. (Whittington & Pany, 2010)
For example, the factor that unexpected performance through investigation, Rose Co management may make timely changes in plans, strategies or take other appropriate corrective action.
Information processing
Information processing consists of two types which are application controls which provide a form of determining the information of financial statement and budgets. It only applies to one particular activity such as control the payrolls that help to ensure the transaction are processed completely and accurately. (Whittington & Pany, 2010)
For example, system of accounting software of Rose Co should provide sufficient information to make the accounting functions clearly. While general control activities support application controls that are functioning effectively and help to ensure the continued suitable operation of information system. (Whittington & Pany, 2010). This help to controls the Rose Co data center, system software acquisition, network operations and controls the access of computer software.
Physical controls
It is the procedures to make sure the physical security of assets, important records, documents and blank forms. These should be limited to authorized personnel. If the assets and records that are not protected properly and adequately can be damaged, lost or stold by others. (Whittington & Pany, 2010)
For example, the assets as stocks and securities of Rose Co should not be available to persons who have not need to be handling them. Access to records should be denied to people who do not have a record keeping responsibility for them.
Segregation of Duties
It is important characteristic of effective internal control to separate the functional responsibilities appropriately. It seeks to avoid the persons who can adjust the records and access that record and control those assets. These duties are divided between different people to mitigate the risks of inadequate and inappropriate actions. (Whittington & Pany, 2010)
For example, when Rose Co approve the sales transaction, shipping department obtain the merchandise custody from the inventory stores department implemented the transaction and shipping it to customers. Then sales, credit and shipping department created copies of documentation for accounting department to used to record the transaction and billing the customers. Thus, none of individual or department can execute an unauthorized transaction.
Financial reporting is the process whereby a firm states all its financial records. Financial reporting provide financial information about the report entity that is useful to present and potential equity investors, lenders, and other creditors in making decisions in their capacity as capital providers. (Needles, 2011). Financial reporting are the documents and records to track and review whether the firm earns profit or loss, the performance and position of the firm. Financial reporting including external financial statement which are balance sheet, cash flows' statement, statement of stockholders' equity, income statement and etc.
Financial reporting purposes are as follows:-
Provide the information about the financial state of the firm to investors, creditors and other users whether their money investment worthy, whether they gain profit and dividend, enable the investors to judge whether to continue with their investment, and make rational investment, credit and decisions.
With appropriate financial information through financial reporting may help to enhance decision of scare resources allocation efficiently. Financial reporting also provide information about the economic resources of a firm, effects of event, transactions as well as circumstances that resources claiming and change of resources.
Financial reporting does provide an economic history to use to measure firms' performance and provide financial information to decide the future business whether the business should enlarge or narrow.
Financial reporting help management to formulate the policies and discharge their day to day activities of the business as well. It also helps management to avoid the situation which is unfavorable as management able to know the trends and modify the policies according to study financial statements over a period of time. (Whittington & Pany, 2010)
Internal control can only provide reasonable assurance over financial reporting, it does not intended to provide absolute assurance because of inherent limitation. Therefore financial reporting may not prevent or detect misstatements. Limitation of financial reporting:-
The factors of economic, financial, and social affect the financial position, but only the factors of financial are being recorded in financial statements and left out factors of economic and social. This may cause the incorrect and inaccurate in financial statements when revealed the financial position.
The qualitative factors such as the efficiency and loyalty of employees, reputation and prestige of business with public, integrity of management do not state in the financial statement. These could be equally important to a business. There only state quantitative data which can be measure in terms of value.
Financial statements do not revealed the results of a firm' expenditures on research and development, firms' future prospects, new marketing campaigns, new product introductions, or new pricing strategies. This may mislead individuals in making right decision.
The financial statement influence by personal judgments of the accountant for instance, the provision of bad debts, provision of depreciation and stock valuation. Personal judgments of accountant always misrepresent the true picture of the business.
Base on the case study above, the directors of Rose Co would not appear to be justified in asserting that the company's auditors were negligent in not detecting the fraud. The prevention and detection of fraud and error should be responsible by management not the auditor. Management has to form and maintain the controls and responsible to ensure that the controls are being right in place. Directors and managers have the duty of care to prevent and detect the fraud and error in internal control system, create the policies that make sure provide service effectively and protected assets, also recommend and perform procedures and review carefully and seek to understand policies and procedures presented to them for confirmation.
The auditor is not responsible for internal controls and not to help the directors in preventing and detecting fraud and error. Auditor can remind directors about their responsibilities but not responsible for the internal controls' design and effectiveness. The only responsibility for auditors to get relevant audit evidence sufficiently and reliable to support their idea that the systems are functioning accurately.
Case Study 2: Recruitment Co
The four objectives of the internal controls should be exercised over non-current assets are as following:-
Transaction execution
The assets procedures of using, operating and physically moving should be established follow by the authorization of management because without authorized personnel may not follow the procedures. This may cause in misused or stolen equipment and misplaced. (Ricchiute, 2006)
Recording
To ensure the retired, added or disposed of non-current assets that recorded at the correct amounts, properly classified and recorded in the right period. This can be preventing that the misstated assets and cost of sales that cause by not recorded assets placed in production. (Ricchiute, 2006)
Transaction authorization
The non-current assets such as assets retirements, assets disposals and plant additions should authorized follow by management criteria or otherwise, assets may result in misstated fixed asset records and misapplied cash by sold or purchased assets that without management's knowledge. (Ricchiute, 2006)
Access to assets
To ensure the restriction to personnel authorized of accessing cost accounting, perpetual and production of assets by management. This may avoid the lost, misused and destroyed of asset's records that may result to misused and misstated of asset as well as misapplied of assets. (Ricchiute, 2006)
Non-current assets register is the basis of an asset management information system that contains relevant data required for financial reporting (Motubatse, 2005). It is the asset database that gives the basis for the figures in the financial statements. It includes assets information such as purchase prices, expected life, condition and current replacement cost. Recruitment Co can be registering their non-current assets as Appendix I example to help a decision maker to identify and track the assets.
With the assets register information in the Appendix I, Recruitment Co can be integrating the information of non-current asset, record it properly and correctly to make sure it list the adequate information. Store the information as a data system into computer and maintain the data to make sure the data is keeping up to date.
Non-current assets register is purpose to helps the company to keep tracking the details of each non-current asset in order to make sure control properly and avoid misappropriation of a company's assets. Registrations of non-current assets help to keep tracking the correct value of assets for the purposes of depreciation tax and insurance.
( i ) Disposal of non-current assets where a company may sell off assets that has ended its useful life. There is a profit or loss when assets dispose of because it makes a profit or a loss whenever company sells its assets. (ACCA, 2009). Disposal of cars can be in the way of sale off, trade in, scrap, recycle etc.
Recruitment Co. has 36 employees, most of who are provided with an executive type of company cars. Over 2 years these cars being use, Recruitment Co will purchases and replace them, employees also allow to purchase and replace cars. This may result to sophisticate of the system and transaction of cars disposal.
Recruitment Co should enhance internal controls over disposal of cars because some of employees may or trade it the cars which are less than two years old or some of them may sell off those cars that the scrap sale price not eligible with published price lists and may dispose in unfavorable price subsequently. Hence, Recruitment Co should properly control cars disposals such as establish written procedure, keep record up to date, well control authorization procedure etc.
Internal control that Recruitment Co should employ over the disposal of cars as follow:
Written Procedure
Recruitment Co. should establish written procedures for all disposals of cars and compare scrape sale prices periodically with published price lists to control the unauthorized transactions as to prevent the cars may disposed of at unfavorable price.
Segregation of Duties
It should kept separate the transaction functions such physical protection of disposal of cars, recording transaction as well as authorizing transaction of disposal of cars as to prevents someone that has a protective responsibilities to sell the disposal cars at unfavorable prices then cover it up by making illegal entries to the accounting record.
Authorization Procedures
It should properly take control of authorized transaction over disposal of cars and ensure that someone who is unauthorized not be able to change the transaction of cars disposal of which already recorded. Otherwise, record of those cars disposals may misstated and misapplied cash by sold the cars without management's knowledge.
Reconciliations
It should properly check for the agreement of submitted transactions, processed transactions as well as physical counts with recorded of cars disposal. Reconciliations should be perform by someone who has the authorized to access transaction of cars disposals.
Recording adequately
It should design and use document, records of cars disposals adequately. Disposals of cars should recorded at the correct amounts properly classified and recorded in the right time to prevent the misstated cost of cars disposals that cause by not recorded it in place in production.
( i ) Recruitment Co. cannot be able to reflected the transaction in its accounting records because it had not receive the invoiced by 31 March 2005. Once it have receive the invoiced by 31 March 2005, it should record the the transaction in its accounting records state Debit: Furniture Credit: Bank.
(ii) The procedures should carry out by auditors as follow:-
Auditors should monitor whether whether the condition and quantity of goods that received are accurately and check whether the arrival goods are acceptance and record it.
They should ensure the goods received notes are match with invoices and check whether it match with credit notes of suppliers as well as goods returned notes.
Appendix I
Motor vehicle
Model
Color
Plate number
Usage Period
Price
Warranties
Audi R8
Blue
WWE007
3 Years
300,000
3 Years
BMW X6
White
WWF002
4Years
250,000
2 Years
Toyota Prius
Red
WWS008
6 Years
90,000
3 Years
Office Equipment
Type
Brand
Model
Price
Warranties
Color
Computer
Apple
iMac
3,000
2 Years
White
Printer
Cannon
PiMax
500
1 Years
Black
