Factors to Consider when Analyzing Internal Control Systems
Question:
Discuss about the Scu Limited Internal Control Systems.
From the case study the business’s financial controller has discovered that the business has not been performing well because of the ineffective and inefficient internal control systems. The management is basically responsible for the business’s performance but it was still adamant on changing the internal control systems of the business. Generally, every business should ensure that its internal controls and its accounting systems are all effective and efficient for the responsibility of achieving the business’s objectives and goals. In that case, the financial controller of SCU Limited worked hard to ensure that the business has implemented the right internal control systems under his supervision. His main aim was basically to assist the business in running its operations easily and effectively. Through this the business was able to perform its operations even better than expected rate and manner simply because most problems were solved by the new internal control systems and especially the accounting systems problems and challenges. For instance, the sales operations, trade receivables operations, transportation and shipment operations and payment operations became way better and effective than before the systems were implemented
Every business should make sure that its internal controls are capable of achieving its objectives and goals besides helping it become successful. Therefore, this means that they have to accessed and analyzed in details by a professional or expert to be sure that they are effective and efficient for their purpose (Gani et al, 2012). In that case, the following are some of the factors that one should consider when analyzing the internal control systems of a business enterprise:
The communication and policing of ethical behavior in the organization.
Effective communication is a key factor for a successful business. However, it means that there should also be effective and efficient policies and ethical practices that are in place. Every business should ensure that its communication channels are effective and in support of the business ethics and moral practices. This will enable effective communication and information sharing among all the employees; including between the management team and the common employee. For instance, in SCU Limited, after the installation of the new internal controls, the business’s communication process has become more effective and efficient than ever before. Apparently, there is a simple and clear channel of passing information and performing the business operations. E.g. every department has specific responsibilities; like the dispatch team deals with all the returned products and then passes the information to the trade receivable clerk who sends a credit note to the customer.
Commitment to competence
Compete basically refers to the ability of performing a certain activity and succeeding simply because the required skills, knowledge and expertise is available. Therefore, when it comes to business operations and internal control systems, the business employees should be able to qualify for their responsibilities and duties for the business to be successful. Every employee should have the required qualifications in terms of experience, knowledge and skills required to tackle a certain business operation. Otherwise, if the employee is short of any character or feature required, then the probability of not succeeding increases which means failure. For instance, in SCU Limited, the financial controller must have had a lot of experience in the business and its internal control systems and that was the reason why he thought that a change would push the business to a better position. Also, when it comes to the trade receivables clerk, he is dealing with all the trade receivables from different department of the business. This means that he has a lot of experience and skills needed for the job. Therefore, this makes them both committed and competent in their jobs.
Communication and Policing of Ethical Behavior in the Organization
Management philosophy and operating style.
A number of businesses are managed by a team of managers mostly referred to as board of directors. Even if the team of managers may have qualified for the responsibility, they all have different opinions and reactions to any decision that may be made when it comes to decision making process. In addition to that, they all have different methods of managing the businesses, different attitudes and reactions towards financial reporting, different attitudes when it comes to information sharing and processing techniques to name just but a few differences (Soto-Acosta et al, 2016). However, for the sake of the whole business’s success, the management team must be able to work together and agree on a one technique that will benefit the business. For instance, SCU’s management team was adamant on installing and installing new internal controls which they had no interest in. However, they later greed on the implementation of the systems which later came to be a very wise decision because of the positive changes that the systems brought to the business operations.
Organizational Structure
The organizational structure of a business refers to the policies, laws, rules and regulations that govern the organization’s employees and management team with the aim of achieving its goals and objectives hence business success. Therefore, to be able to analyze a business’s internal control systems, it should have clear, simple, effective and efficient organizational structure. Additionally, the structure should be able to focus on achieving the set objectives and goals of the whole business. This means that even if the business has several departments or branches operation under its supervision, their specific objectives should be interrelated with the overall business objectives (Ismail et al, 2014). For instance, the organizational structure of SCU Limited is clear and very direct. It enables the business operate effectively and therefore making the assessment and analysis process much easier and effective.
Distribution of responsibility
This refers to the distribution of the authority, power and the responsibilities to the management team and the employees. Every business should ensure that its authorization hierarchy is clear and simple to follow and understand. In addition to that, the business should make sure that the leadership roles are taken by not only the qualified employees but also the experienced and skilled ones (Schäffer et al, 2015). This will ensure effective and efficient management process and operations. Furthermore, the business operations should be performed by the qualified personnel as well. For instance, if it is the trade receivables responsibility, it should be done by the qualified personnel, the sales responsibility, financial control operations to name a few. This is the case for SCU Limited Company.
Recruitment Policy
This basically refers to the principles governing the employee recruitment process and procedures. This policy should sate all the basic requirements of the employees needed by the organization. The policy should as well ensure that only the competent and qualified personnel only pass through the process and only the qualified ones are hired (Eldridge et al, 2013). The process should however, be adequate, simple, precise, efficient and effective for the hiring. A business should ensure all the procedure are included; including procedure before interviews and after interviews for instance. This factor is to be considered because it is one aspect that can affect the internal control operations of the business. This is simply because the employees being hired are the ones that will be directly dealing and operating with the systems and therefore they should be vetted for the purpose of business success.
Commitment to Competence
Internal controls refers to the process of adhering to a business’s policies, principles and laws that govern the auditing and financial statement analysis and assessment with an aim of achieving the goals and objectives of the business. However, most internal control have risks that accompany them if they are not followed to the letter which later may lead to business failure. Therefore, the following are some of the internal controls and the risks associated with them:
Authorization
This relates to the power of authority that is placed in the hands of the management team. Therefore, this means that the leader, manager or the auditor has the authority to approve all the internal control operations; especially those that relate to the financial statements and the accounting activities of the business. Therefore, the person in charge should be qualified, knowledgeable and skilled in that specific area. The authorization factor is likely to mitigate the risk of recording wrong or incorrect transactions of the business operations which means that the risk of inaccuracy and incorrectness will be reduced.
Performance review
It is also known as the performance appraisal. It is basically the evaluation of the performance and progress of a business’s employee or the whole business itself. It accesses the employees’ performance in relation to their productivity levels in their responsibilities and the general objectives and goals of the business (Gholami et al, 2013). This factor focuses on ensuring that the employees are completely committed to the business objectives and goals and that they are committed to that fact. Also, it makes sure that their productivity levels are optimum hence rating the productivity levels of the whole business high as well. With this factor in place, the business will reduce the risk of failure in its market as well as the risk of being unproductive. By conducting a performance evaluation for the employees themselves and the whole business in general, the business will be able to focus its commitment and attitude towards the set objectives and goals hence leading to business success.
Information processing controls
Information processing controls are in relation to effective and efficient information sharing and communication process. Also, it relates to the procedures and processes involved in data analysis and result identification. The information processing controls of a business should be extremely effective because they are the key factors that will determine the end product of any information or data. In addition to that, they should be easy to understand as well as operate to make the process faster and even more effective. For instance, as for SCU Limited company, the information processing controls for processing a customer’s order, their complaints regarding the returned tiles and the process of passing on that information to the trade receivables clerk and lastly to the customer the response. In that case, the business will be able to reduce the risk of time wastage and the risk of ineffective and in efficient communication system and information sharing.
Physical controls
This relates to the physical equipment or measures taken to control the business operations and to ensure security of the business apparatus. This is especially for the case of restricted business information or data. The installation of such control systems reduce the risk of theft of the data, information or anything that is restricted from the unauthorized personnel. In the case of SCU business, after the implementation of the new internal control systems, the business was able to install the new strategies of safeguarding the business information by installing programs that require passwords for one to access the databases.
Management Philosophy and Operating Style
Segregation of duties
This relates to the separation of duties and responsibility in a business enterprise. This is a process that ensure that one employee does not have to complete one process on their own, instead it should take a number of people to complete the whole process. For instance the process of recording and processing the transaction activities are not controlled by just one individual. Therefore, for the case of SCU business enterprise, the recording, processing, responding, and documenting employees are all different. However, they are all involved in one process and therefore able to complete the all the process procedures in time.
Just like any other business factor or aspect with strengths and benefits, the internal control systems also have their weaknesses and strengths. The following are some of the weaknesses:
Inadequate documentation or record
Recording and documentation ensures that every business operation and activity has evidence and is accounted for. However, the documentation may not be as effective and efficient as it should therefore causing challenges to the business operations; e.g. transaction repetition (Siska, 2015). Nevertheless to avoid this problem, the documents should be well labelled and properly stored to increase the ease of following up queries and come up with suitable solutions for customer complaints.
Improper definitions of the key business issues
Every business organization should ensure that every business operations has an identified and effective business process to follow or guide it. For instance the sale operations should have the sale system flow chart to ensure process completion and simple. However, even the trade receivables process of a business should be specified and made simple and easy for the employees and any other personnel to follow.
Lack of control with transaction authorizations
When businesses lack the control of the authorization process, they increase the chances of business failure. The transaction authorizations should be in place to ensure that the business does not overspend its finances on a customer or operations that is not prioritizing business objectives and goals. Therefore, the transaction authorizations should therefore be focused on business success and customer satisfaction.
Lack of frequent review of business operations
Some business managers concentrate so much on the day to day business activities and forget about the overall and general business review especially the financial statements and the accounting systems’ progress, inventory progress, investment levels, financial reports among other reviews required in a business organization. Lack of these may lead to theft, fraud and business misconduct to name few things.
Ineffective information systems
This is a weakness that challenges businesses that do not the time to evaluate and analyze the information used to run its operations. Every business should ensure that its information systems are well maintained, monitored and evaluated frequently to ensure their effectiveness as well as their efficiency.
Lack of physical security
Some internal controls lack physical or even the logical controls that should ensure security and the safe keeping of the business information, data and other equipment. Lack of such controls will encourage theft and easy access to restricted personnel.
Organizational Structure
Lack of formal procedures and policies
Every business has some policies, laws and principles that guide the business operations and the employees themselves. However, the lack of formal policies and procedure encourage disrespect, equipment mismanagement and misuse as well as misappropriation of the business assets and other things (Uyar, 2015). Therefore, every business should ensure clear rules and regulation to govern the business operations especially the sales and trade receivables departments.
Unclear definition of job roles and responsibilities
Some business do not know how to define the roles and duties of some employees which may lead to complexity and confusion of the employees. Therefore, this challenges can mostly be identified in the sale and trade receivables processes. For instance, the person doing the sales is confused on whether they should receive the payment or the goods returned by customers or any other activity involved in such a process.
Lack of duty separation
An effective internal control system must be able to evaluate the required separation of duties for employees. For instance, the process of performing the sale process and the trade receivables operations should be completely separate but intertwined. Therefore, the sales process should be done by one different employee and the trade receivables duty by anther to ensure completion of the whole process.
Inadequate disaster recovery and back up plans
In a sale process, there can occur some challenges and errors which are capable of being rectified. However, if the internal control systems of the business lacks the backup systems then the probability of correcting the error is low and therefore may mess up the whole business process. Also the backups can be used as prove or evidence of an operation performance.
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