<< Overview
Internal Control Implementation at
Risk
The date
for attestation of the Internal Control System is almost here.
Ñ The attorneys and accountants have done
their work.
Ñ New processes and
procedures are in place.
Ñ
There is
one more critical job: successfully training employees so that there is common
knowledge and skills around these new processes.
Ñ Common interpretation of the processes and a new ethical climate
are essential to making it all work on a day to day basis.
Ñ Is this last step required?
Ñ Absolutely it is, because the SEC
requirement is for tests of the new system to be effective.
Ñ There is no credit for just having them in
place.
Designing
effective controls is only the first step.
Ñ
Everyone who plays a role in implementing internal controls needs to
have a common interpretation of the requirements.
Ñ This is where the difficulties start ¦ interpretations!
Ñ Virtually all employees are asked to certify
that their departments have implemented effective internal controls; they do so
in good faith and based on their interpretation of the control requirements.
Ñ Their boss then assumes that these employees
have the same interpretation of the control requirements that the boss has.
Have these
conversations ever happened in your company?
Production Manager
:
Ñ ?Jane, we really need to get ABC Components
paid this week.
Ñ We need them to ship
more components to us and they say they must be paid for the last shipment.
Ñ I just can?t wait for all of the paperwork
in our system.
Ñ Can you authorize
payment?²
Division
Manager
:
Ñ ?I know how
slow things are.
Ñ Let?s get them paid
now and we?ll work out the back-up documents with Accounting later.²
Branch
Office Manager
:
Ñ ?I just
received a letter from a Big Customer confirming that they plan to buy 2,000
new units.
Ñ Since this is March 31, I
want to be sure we book the sale this quarter.
Ñ
Let?s ship the order today and notify Accounting immediately.²
Shipping
Manager
:
Ñ ?It
probably won?t go out until tomorrow.²
Branch
Office Manager
:
Ñ ?Just put
the paperwork through to ship it today.
Ñ
We can?t always control whether or not the shipping company picks up on
any given day.²
What procedures should be followed in
each of these situations?
Ñ What is the importance
of following the right procedures?
Ñ When
can an exception be made to a procedure?
Ñ
In the first situation, the manager rationalized that this was a special
case and he or she would fix the problem later by submitting appropriate
documentation. The manager, in the second case, rationalized that a letter of intent
was as good as an order and that the exact timing of the shipment was not
important as long as the paperwork was submitted.
These situations illustrate the problem
that companies face when they implement control requirements in accordance with
the requirements of SOX and the SEC.
Ñ When
employees face a situation where they must take action to meet a performance
measure, their interpretation of a procedure or control may be different than
what was intended.
Ñ If employees do not
know the reason for the procedure, the importance of the controls and the
correct interpretation of the process, the company is exposed to significant
risk.
Every month in their SEC filings,
companies disclose material weaknesses or significant deficiencies in internal
controls.
ÑÑÑ The disclosures often use
phrases like: ?irregularities², or ?insufficient supervision of personnel², or
?lack of training related to procedures².
ÑÑ
Although fraud is always a possibility, what typically creates problems
is a misinterpretation of what is acceptable and what is not acceptable, what
is expected and what is prohibited.
What does this mean for the CEO and CFO
of publicly traded companies that will be required to certify their company?s
internal controls starting June 15, 2004?
Ñ
It means they will be relying on everyone in the company to correctly
interpret and implement procedures and internal controls.
Ñ Significant attention has been paid to
enhancing internal controls.
Ñ New checks
and balances, new process, new requirements, new systems will be rolled out in
most companies.
Ñ How these are implemented
will make the difference between an effective system of internal controls and
one with many problems.
Ñ Now it is time
to look at how these controls will be institutionalized and ensure accurate
interpretation.
Ñ
Would all
key employees answer these questions consistently?
-
How do I avoid conflict of interest?
-
What is my role in protecting company assets?
-
What policies and procedures should I follow in my
job?
-
What internal control requirements are parts of my
job?
-
What is my level of authority and the authority
of those around you?
-
What behaviors are expected, or acceptable, and
what is unacceptable?
Most, if not all, employees would be
able to answer at least some of the above questions.
Ñ The key issue is whether or not they would answer them as
expected or would there be a variety of different answers.
Written
policies and procedures are not enough. Two employees can read the same
document and have very different interpretations. They may also have very
different views on how important a procedure is to the company.
ÑÑ Training can provide a cost effective way
to ensure employees have a common interpretation of the control
requirements.
Ñ
An
effective internal controls training program must be targeted to the needs of
specific groups.
Ñ There is little value received
from training the receiving personnel on how to do account reconciliation.
ÑÑ The unique need for information on control
requirements within each group, such as finance, accounting, purchasing,
operations and support staff, must be identified.
ÑÑ In some cases, people may only need limited training to stress
the importance, requirements and boundaries of the process as well as where to
go for clarification.
Ñ This may be the
situation for employees responsible for receiving products and materials.
Ñ In other cases, such as accounts payable,
there may be more control requirements that necessitate detailed training.
Ñ
Adequate
training also reduces risk by providing opportunities for employees to clarify
their roles and responsibilities.
Ñ
Controls are often thought of as an accounting issue.
Ñ The operations personnel may see it as
something outside of their role. Responsibilities are clarified through
effective training.
Training
also provides for discussion so that employees express their interpretations
and get their questions answered, rather than being allowed to make assumptions
about what is expected.
Ñ Misinterpretations
can easily be avoided if employees had an opportunity to get answers.
Ñ In the absence of clear information people
are often very good at filling in the blanks.
Ñ
Reduce the
risk and start the learning process using training conducted in classrooms, interactive
distance learning or synchronous web based trainin.
Ñ These provide critical information, opportunities for questions
and practice using the information.
Ñ The
learning process must be supported by just-in-time training such as on-line job
aids, resources for quick answers to questions and coaching from immediate
supervisors and subject area experts.
Employees
may misinterpret procedures.
Ñ Therefore,
management has a challenge.
Ñ CEOs and
CFOs must be confident when they certify the accuracy of the financials and
effectiveness of internal controls for their company.
ÑÑÑ How can companies minimize the risk of misinterpretation and be
assured that employees are knowledgeable and skilled regarding control
requirements and procedures?
Ñ
The answer
is an integrated training effort that targets skills and knowledge for the job
function, uses a variety of training methods and provides opportunities for all
employees to discuss issues and ask questions.
Œ
?The
Missing Link in Implementing Effective Internal Controls²,
ÑÑ
http://www.bradleylambert.com/html/CW_article.pdf
Œ
?Is Your
Ethics Program Adding Value²,
http://www.bradleylambert.com/html/news0503.htm
Œ
?Who Speaks
Out About Ethics²,
Donaldson,
Carmichael and more:
http://www.bradleylambert.com/html/quotes.pdf
Œ
²Internal
Controls Justification², It's not a cost/benefit analysis. It's risk
aversion:
http://www.bradleylambert.com/html/Internal_Control_Justification.pdf
To learn more about Bradley Lambert
Inc. please visit us at
www.bradleylambert.com
Tell
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Ñ
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Thanks for reading the Bradley Lambert Articles.
Copyright
2004 Bradley Lambert Inc.
6151 W. Century Blvd., Suite 1110, Los Angeles, CA
Ñ 90045
310-670-1400, fax 310-568-0681
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