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Internal Control

It is my understanding that your company, LJB Company, wishes to move forward and become a public entity. I m glad my firm can be of assistance in helping your company make this transaction. First we must review any new rules or regulations that apply to private companies converting public. Good corporate governance within an organization may make a company more attractive to potential buyers, investors, and other capital sources. Under Sarbanes-Oxley, all public traded. U.S. corporations are required to maintain an adequate system of internal controls. Corporate executives and boards of directors must ensure that these controls are reliable and effective. As with any business, the transformation of going from a private to public requires some extensive planning and preparation. It is recommended that LJB being a relatively small sized company in terms of its employees should re-evaluate the costs versus the benefits of being a public traded company. If LJB decides to issue stock it would be wise to answer the following questions 1) How many shares should be authorized for sale? 2) How to issue the stock? 3) What value should be assigned to the stock? The content of this Internal Control report is based on the related methods and measures adopted within an organization to safeguard its assets, enhance the reliability of its accounting records, increase efficiency of operations, and ensure compliance with laws and regulations. The major independent components/variables of the internal control system should include: Control environment Risk assessment Control activities Information and communication Monitoring It has been observed that not all the components of an effective internal control system are present in the control components of a company. If LJB decides to go public in the near future there are some new internal control requirements to be aware of. The most basic component of the internal control system is the company management/leadership in the control environment. In our opinion, it is the responsibility of top management to make it clear that the organization values integrity and that unethical activity will not be tolerated. This should clearly indicate the tone at the top. The second component of the internal control system is the company s effort to address the risks it may face, such as fraud. In

order to reduce the occurrence of fraud, management must design policies and procedures to address the specific risks faced by the company. Since LJB is a relatively small company in items of number of employees, this gives it an advantage over its competitors in the industry. Not only does it show the faith you have in your long term employees, but it also develops loyalty and employee retention. With a smaller organization it will be easier to set new expectations and implement new rules throughout the organization. The accountant s recent decision to switch to pre-numbered invoices was a great idea, and the purchase of an indelible ink machine will be an excellent investment. Pre-numbered invoices will help to prevent a transaction from being recorded more than once, or conversely, from not being recorded at all. Second, the control system requires that employees promptly forward source documents for accounting entries to the accounting department. This control measure will help to ensure timely recording of the transaction and contributes directly to the accuracy and reliability of the accounting records. Indelible ink machine will help organize as well as simplify the accounting duties. Use of physical controls is essential. The accountant s act of keeping the checks in a safe in his office is in accordance with the physical controls principle. This reflects the safeguarding of assets and enhances the accuracy and reliability of the accounting records. It has been observed that the company is violating the principle of control activity of segregation of duties. The accountant is acting as the Treasurer and controller. In this dual role, he purchases all of the supplies and pays for these purchases. He also receivers the checks and completes the monthly bank reconciliation. Various frauds are possible when one person handles related activities. Use of the three principals of internal control segregation of record-keeping from physical custody, documentation and independent internal verification is recommended. This will deliver an effective system of internal controls. Any attempt at fraudulent activity will be detected unless there is collusion among the employees. Internal controls over cash receipts should include: a) Designating only personnel such as cashiers to handle cash b) Assigning the duties of receiving cash, recording cash and having custody of cash to different individuals c) Obtaining remittance advices for mail receipts, cash register tapes for over the counter receipts, and deposit slips for bank deposits d) Using company cash safes and bank values to store cash with access limited to authorized personal and using cash registers in executing over the counter receipts e) Making independent daily counts of register receipts and daily comparisons of total receipts with total deposits

f) Bonding personnel who handle cash and requiring them to take vacations. Internal controls over cash disbursements include: a) Having only specified individuals such as the treasurer authorized to sign checks b) Assigning the duties of approving items for payment, paying the items, and recording the payment to different individuals c) Using pre numbered checks and accounting for all checks, with each check supported by an approved invoice; after payment, stamping each approved invoice paid d) Storing blank checks in a safe or vault with access restricted to authorized personnel, and using a machine with indelible ink to imprint amounts on checks e) Comparing each check with the approved invoice before issuing the check, and making monthly reconciliations of bank and book balances, and f) Bonding personnel who handle cash, requiring employees to take vacations, and conducting background checks. The principle of establishing responsibility does not appear to be strictly applied by company in petty cash handling. All employees have access to the petty cash in desk drawer and are asked to only place a note if they use any of the cash. In the scenario it might be impossible to determine who is responsible for the error. An essential principle of internal control is to assign responsibility to specific employees. Therefore it is recommended to establish responsibility of only one person for a petty cash control. Petty case should be in a safe box and one person should be in charge of keeping a log and a supervisor should reconcile it at least once a week. Also, petty cash has to be entered in the system for replenishing the funds. The hiring process is the most important and inexpensive measure for human resource control activities. The company s human resource department conduct thorough background checks. By conducting thorough background checks they are not risking the company s information/security. After getting hired each employee should have their own computer login, such as identifying pass codes that keep track of employees who log in a particular time. Also, the company should block all websites that are not appropriate to view at work. By having their own log in they can t blame other people for what activity they are involved in. The president or any other employee designated by the company should be the only ones able to access all sites. This will allow the company to have better human resource control and physical internal control.

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