Internal control plays a very important role in preventing and detecting fraud, also helps to protect the company’s resources and helps to achieve specific goals or objectives. The company, using internal control in compliance with Sarbanes-Oxley Act and regulations, looks more trustful and stable for investors. Internal control has five elements the company should consider before going public and everyone in the company has responsibility for internal control to some extend.
The top managers of the organization set a “tone at the top” by making “clear that the company values integrity and that unethical activity will not be tolerated”1. The top managers review the way the personnel controls the business and how they establish policies and procedures. The top managers also have responsibility “to identify and analyze the various factors that create risk for the business and must determine how to manage these risks” . The risk management includes external and internal risks, analyzes the environment the company works in and predicts any factors that can influence business activities and profitability. It also includes right attitude, competence and monitoring of the risks to achieve stability and timely decisions.
The main component of internal control is controlling activities. It helps to complete the internal control with a good communication and information system and periodical monitoring. In general control of activities includes: segregation of duties, establishment of responsibility, documentation procedures, independent internal verification, human resources and physical control. The controlling of activities is the backbone of the company’s efforts to prevent fraud and protect resources, and helps to ensure the reliability of financial statements and compliance with laws and regulations. Internal control can be established quite well without an effort, because it is a natural way of keeping a track of the business to be on course toward profitability goal.
LJB Company has started to use pre-numbered invoices and reduced the risk of transactions not to be recorded or to be recorded more than once. To complete a documentation procedures requirement of internal control, company should pre-number all documents used in accounting, and establish procedures, how these documents should be forward to the accountant, to ensure timely recording.
The idea to buy indelible ink machine is also another good step toward improvement of internal control of cash operations, because money are the most susceptible to fraudulent activities. The checks printed by indelible ink machine would prevent the correction of the amount and other information on the check. The physical cash disbursement control of using the indelible ink machine also has to be combined with all other elements of internal control.
LJB Company has a lot of long-term employees and it shows that the human resources control works well. The interviewing new hires by President and an accountant together helps to make a better decision, but if the company does not conduct thorough background checks, it should start to do that, because it is the most important and inexpensive way to reduce the risk related with a new hires and it would prevent the company from liars or the employees with a criminal records.
Unfortunately LJB Company is not ready to go public yet, because there are a lot of violations of controlling activities. The company must segregate duties of the employees and apply the principle that “different individuals should be responsible for related activities” . An accountant being a treasurer and controller violate the segregation of duties. He purchases all of the supplies and pays for these purchases and by doing that he has no restrictions to pay a higher price, to get payback for the ordering from suppliers’ and even to pay to somebody for purchases never maid. The accountant also receives the checks and completes the monthly bank reconciliation and this dual responsibility violates independent internal verification principle and segregation of duties.
The LJB Company also must improve its physical controls and security of resources. The checks on payday are left in the accountant’s office for pick-up and as I mentioned before, any money substitutes should be protected from possible theft or corrections. Some physical control is established in the company’s activities, because an accountant, before he leaves for the weekend, moves the checks into a safe in his office, but this routine should be required at any time during the week and very strictly. The company also needs to provide employees with the individual computer accounts and passwords, because otherwise anybody can access the information and make records without being identified.
A petty cash fund, accessible to all employees, and the note, left after the use of the cash, is not enough to control this fund. It lacks internal verification and supervising. An accountant should require cash receipts and make surprise counts to confirm that amount is correct or to keep a petty cash fund not accessible to employees and make reimbursements for cash receipts by himself.