Internal Controls and How Corporations Get Around Them

Internal Controls Provide an example of an item that pertains to either (a) the internal control environment (the umbrella) or (b) a monitoring activity or (c) a risk assessment activity that relates to Microsoft Corporation. In 2002, the SEC settled with Microsoft on allegations of accounting violations that understated revenues. Microsoft did not admit to any wrongdoing. The settlement did call for the corporation to cease and desist from misstating income, without requiring any restatement of earnings reports.

The SEC finding was based on Microsoft's noncompliance with Generally Accepted Accounting Principles (GAAP) in which material amounts of income were misstated in certain periodic filings with the SEC during the period from July 1, 1994 to June 30, 1998. Underscoring the audit finding by the Commission, was both an absence of documentation for the bases used for the accounting and evidence that Microsoft failed to maintain proper internal controls.

A spokesman for SEC, Stephen Cutler, Director of the Commission's Division of Enforcement, stated, "This case emphasizes that the Commission will act against a public company that issues financial statements with material inaccuracies, even in the absence of fraud charges. Public companies must ensure that their accounting is substantiated in the first instance by factual bases and well-reasoned analyses and conclusions.

In order to do so, companies must properly document the bases for their reserves and other accounting entries, so that they and their auditors can verify that the accounting is proper; and they must maintain appropriate internal controls, so that this verification will occur in the normal course of business" (Naraine, 2002, n.p.).

A subsequent decision in 2003 by Microsoft to replace stock options with stock grants as the corporation's method for equity-based employee compensation was followed by an announcement that Microsoft would restate financial for three prior years to reflect this decision (Weil, 2003). Treating stock-options as an expense on the corporation's income statement will depress year-over-year earnings, a situation that could make it easier for Microsoft to justify high stock valuation and demonstrate more impressive stock growth prospects in the years following the restatement (Weil, 2003).

As an aside, current Financial Accounting Standards Board (FASB) regulations have adjusted to the new standard that was a catalyst for Microsoft's decision, as all companies must now treat options-based pay as an expense on their income statements (Weil, 2003). Question 2. Provide a fairly detailed example of a control activity at Microsoft or JP Morgan Chase. You could use the revenue cycle or the expenditure cycle for your example of a control activity.

JP Morgan Chase twice changed the model that measures the level of risk taken by the CIO when trading (Henry & Horowitz, 2012). The bank changed its model for measuring the value-at-risk in the CIO, the department responsible for managing the derivatives portfolio (Henry & Horowitz, 2012). While other divisions of the bank were reported to have kept to more conservation modeling, the new model presented a dramatically different picture of risk than did the old model (Henry & Horowitz, 2012).

Indeed, the disparity is startling: with the old model showing a potential loss of $129 million or more in a single day in the first quarter (a reading higher than any produced during the financial crisis), and the new model showing a potential loss of less than $$67 million -- almost half of the old model risk measure (Henry & Horowitz, 2012). The new model obfuscated risk both inside and outside the bank, and "gave traders leeway to make risky bets" (Henry & Horowitz, 2012).

Early reports on internal controls at the bank did not reveal how the company decided to change the model, but what was evident is that the traders got the upper hand over the risk managers at JP Morgan Chase (Henry & Horowitz, 2012). Chief Executive Jamie Dixon reported in May 2012 that the risk controls on traders were eased in 2011 without his knowledge, and that the bank "had lost at least $2 billion through 'egregious mistakes' in trading" (Henry & Horowitz, 2012).

A common internal control is that "changes in such risk models usually require several layers of approval going up the management ladder" (Henry & Horowitz, 2012, n.p.). As of 2012, the lack of transparency led investors to fear larger and deeper problems at the bank -- disclosure about who made the decisions to change the risk model and when the changes were made are of high interest to institutional money managers, fund analysts and investors (Henry & Horowitz, 2012). Testimony before Congress by Dimon exposed the failed strategy.

Dimon stressed to investors and lawmakers that JP Morgan Chase is financially healthy with "sufficient amounts of capital to weather any economic dislocation" and called the loss of funds a "stupid…isolated incident" (Silver-Greenberg & Craig, 2012). Boston University professor of finance who.