Designing an Effective Internal Control System

The purpose of this article is to discuss the three main objectives that an organization should follow in order to design an effective internal control system. These three objectives are reliability of financial reporting, efficiency and effectiveness of operations, and compliance with laws and regulations.

Reliability of Financial Reporting

The reliability of financial reporting "relates to the preparation of reliable published financial statements, including interim and condensed financial statements and selected financial data derived from such statements, such as earnings releases, reported publicly" (Internal Control). According to the Financial Accounting Standards Board (FASB) concepts statement 2, accounting information must be relevant and reliable in order to be useful to investors, creditors, and other users. The statement goes on to define reliability as "the quality of information that assures that information is reasonably free from error or bias and faithfully represents what it purports to represent" (Johnson).

Organizations must establish adequate internal controls in order to ensure the reliability of financial reporting. Adequate internal controls include segregation of duties such as transaction authorization, transaction recording, and physical custody of the assets; information processing controls; and physical control of physical assets such as inventory and petty cash.

Efficiency and Effectiveness of Operations

The efficiency and effectiveness of operations objective "addresses an entity's basic business objectives, including performance and profitability goals and safeguarding of resources" (Internal Control). A mission statement, operational strategy, and formal goals will help organizations in this area. Employee training should include this information, and any updates and changes should be communicated in a timely manner. In addition, performance audits can be conducted periodically, such as biannually or quarterly, to help in this area.

Compliance with Laws and Regulations

Compliance with laws and regulations "deals with complying with those laws and regulations to which the entity is subject" (Internal Control). Laws and regulations that affect many organizations include, but are not limited to, generally accepted accounting principles (GAAP), Sarbanes-Oxley, federal laws, state laws, and local laws. First and foremost the company must be aware of all laws and regulations to which it is subject.

Next, the organization must fully educate all employees of applicable laws. It is important to note the word applicable in the previous sentence. There are a wide variety of laws and regulations that affect different businesses. Some of these laws and regulations are very specific in regard to what departments or employees they may affect. For example, a production worker would not need to be trained in GAAP rules that affect accounting procedures or employment laws that affect new employee hiring procedures; a staff accountant does not need to be trained in OSHA regulations that affect the manufacturing process; and an A/P clerk does not need to be trained in laws regarding the number of consecutive hours a trucker may drive nonstop while making company deliveries. The company must use common sense when implementing its education program.

Finally, a formal company policy regarding compliance with laws and regulations should be created. The formal policy should be in writing and must include specific consequences for noncompliance.

References "Internal Control - Integrated Framework Executive Summary." Committee of Sponsoring Organizations of the Treadway Commission website. URL: http://www.coso.org/publications/executive_summary_integrated_framework.htm Johnson, L. T. "Relevance and Reliability." FASB website. URL: http://www.fasb.org/articles&reports/relevance_and_reliability_tfr_feb_2005.pdf Messier, Jr., W. F., Glover, S. M., & Prawitt, D. F. (2006). "Auditing & Assurance Services: A Systematic Approach." (4^th ed.). New York: McGraw-Hill Irwin.