Running head: INTERNAL CONTROLS

Internal Controls Kelli Lorenc XACC/280 February 12, 2012 Kerri Gooley

INTERNAL CONTROLS Internal Controls The accounting system gives businesses certain rules to follow when documenting financial information and other data. Internal controls are a system within a system and it has a major role in how successful the accounting system works. (Banks & McConnell, 2003). According to "ehow Money" (1999-2011), Internal controls of accounting are an essential business function for a growth-oriented organization, and include the elements of risk

assessment, information communications and even employees' roles and responsibilities. Internal controls of accounting systems are designed to protect a company from fraud, abuse and inaccurate data recording and help organizations keep track of essential financial activities. (About Internal Controls of Accounting). The Sarbanes-Oxley Act of 2002 was enacted by congress because of the shady accounting practices and the high profile business failures. Several Multi-million dollar companies decided to doctor their books so they could stay wealthy. When Enron was caught doctoring their books it was the last straw for the government and they decided to step in. there are eleven titles within the Sarbanes-Oxley Act. However, there are only six considered the most important as far as compliance which are: 302 which pertains to Corporate Responsibility for Financial Reports, this section explains all the requirements for statutory financial reports. 401 which is disclosures in Periodic Reports, all financial statement must be accurate. 404 which is Management Assessment of Internal Controls this section lets companies know that they must put information regarding internal controls within their annual

INTERNAL CONTROLS reports. 409 which is Real Time Issuer Disclosures this section states that all information pertaining to financial changes must be disclosed to the public with in a timely manner. 802 Crime Penalties for Altering Documents this section shows companies the consequences they will face if they are caught altering documents, also stating that any individual that know of documents that have been altered can also face either fines or imprisonment. The Sarbanes-Oxley Act clearly states the responsibilities a company and it executives have

when it comes to all financial reports. Furthermore it gives them clearly stated consequences if they choose to falsify reports or mislead investors or the public of their financial conditions ("A Guide To The Sarbanes-Oxley Act", 2006). It is necessary for a company to maintain effective internal controls over their financial reporting so that they can produce financial reports that are reliable and prevent financial fraud. Furthermore if a company is unable to maintain effective internal controls than they would see a fall in their stock prices, because internal controls limit the amount of unethical behavior and mistakes that are allowed in financial statement reporting. If they are deficient in those areas it can look as though the company is deceiving investors and the public. Society looks at investing in a whole new light since the sudden fall of Enron. Companys financial reports are looked over very carefully inside and out before an investor will even consider buying stock. Agami (1999-2012), According to this article, the stock prices of companies that disclosed material weakness in ICOFR experienced declines of 5% to 10%. A study by the Stanford Law School, sponsored by Financial Executives International

INTERNAL CONTROLS (www.fei.org), which looked at 141 companies that disclosed material weakness in ICOFR between November 2003 and October 2004, 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. (Impact on Capital Markets). The internal controls are based on management's policies and processes. There are limitations and unforeseen risks that can prevent internal controls from being effective. First environment, a companys culture can influence the behavior of an employee, if an employee sees The CEO, a partner in the company or a senior managers behavior which is unacceptable being accepted, it can than become acceptable behavior throughout the company because employees do naturally go off the behavior of the management team above them. Secondly Collusion is a limitation of internal control. This was what happened in the Enron scandal; basically several employees within the company worked together for their own greed and financial gain. Finally, lack of knowledge can limit internal controls. If employees, accountants

and any other employee that may handle financial records are unclear of their responsibilities and duties within the internal controls created by the company they will not know how to properly do their jobs. It is important that companies outline their internal control policies clearly for all staff members so that they are understood completely, furthermore everyone should be properly trained (Agami, A.M. (1999-2012)). The four principles of internal controls are as follows: (1) Establishing responsibility,(2) Using physical, mechanical, and electronic controls, (3) Segregation of duties, (4) Independent internal verification. each employees abilities should match the responsibilities given to them, for

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example if an individual who is unqualified for a position they are placed in there is a higher risk for errors to occur. however an individual can receive additional training if the company feels that they will be of use in this area. Furthermore all companies should have clear and disrupted procedures that describe each position it duties that must be preformed. Finally it is important that a company gives their employees a clear understanding of what is expected of them, this will prevent the chance of fraud and errors in the future. In conclusion, internal controls are important for a company so that they can prevent the same outcome from happening to them and the individuals that work for them as Enron. Employees and employers should have a complete understanding of how the Sarbanes-Oxley Act of 2002 affects internal controls. They should understand what can happen if there are deficiencies within their internal control system and what the limitations are of internal controls.

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References: A Guide To The Sarbanes-Oxley Act. (2006). Retrieved from http://www.soxlaw.com/ Agami, A.M. (1999-2012). Reporting on Internal Control Over Financial Reporting. Retrieved from http://www.allbusiness.com/professional-scientific/accounting-tax/4103229-1.html Banks, G., & McConnell, J. (2003, September). How Sarbanes-Oxley Will Change the Audit Process. Journal of Accountancy, (),. Retrieved from http://www.journalofaccountancy.com/issues/2003/sep/howsarbanesoxley willchangetheauditprocess.htm ehow Money. (1999-2012). Retrieved from http://www.ehow.com/about_4571081_internalcontrols-accounting.html