Internal control systems and organizational governance

Internal Control

The Importance of Internal Control Programs

An effective internal control program in an organization ensures the efficiency of its operations and helps a business to attain its objectives by minimizing the chances of violation of rules and regulations by the employees. It safeguards the organization's assets and promotes the reliability of the accounting and financial information. Failure to implement an effective internal control program results in a corporate culture in which employee theft and fraud and financial misreporting thrives. The importance of having an effective 'internal control program' is reflected in a 2002 Report which estimates a loss of $600 billion in 2001, or about $4,500 per employee, as a result of on-the-job fraud in the United States. (Quoted by Gibson and Thomas, 2003)

Effective Internal Control Techniques

The commitment of the senior management towards an effective Internal Control Program is crucial for its success. The management must look at internal control with a positive attitude, i.e., as a tool that would help the organization in achieving its goals, rather than as an onerous responsibility that has to be fulfilled just to meet the regulatory requirements. (Locatelli, 2002) The attitude of the top management in an organization towards internal control filters down to the employees and helps to create the appropriate company culture in which the internal control policies and procedures are given due importance.

All internal control systems and programs must consist of a written set of policies and procedures. Periodic review of the internal control system by the management is necessary to ensure its effectiveness. An effective internal control system design relies on separating the duties of individuals responsible for decision-making, custody of assets, and accounting. In such a system of checks-and-balances, a decision-maker who authorizes transactions does not have custody of assets or accounts. Similarly a custodian of assets cannot authorize transactions or account for them, while the accountant who maintains a record of transactions and assets cannot authorize transactions or hold custodial responsibilities. (Fishman, 2000)

Relationship between Ethics and Internal Control Techniques

The high profile bankruptcies and management fraud in recent years at Enron and WorldCom and a host of other companies highlight the relationship between ethics and internal controls. For example, the main cause of the Enron collapse was the deliberate disregard of a code of ethics by the company's top management. When the Enron board of directors waived the company's own conflict of interest policy to allow its CFO to invest in the company's special purpose entities (SPE), it sent the wrong signals to many people in the organization. In the resulting corporate culture, adherence to ethical business practices took a back seat resulting in the mayhem that followed. The management's commitment to strict a code of ethics is, therefore, crucial to the effectiveness of the internal control system in any organization. (Locatelli, 2002)