Presentation on theme: "Control and Accounting Information Systems"— Presentation transcript:
1 Control and Accounting Information Systems Chapter 7
2 Learning Objectives Explain basic control concepts Compare and contrast the COBIT, COSO, and ERM control frameworks.Describe the major elements in the internal environment of a company.Describe the four types of control objectives that companies need to set.Describe the events that affect uncertainty and the techniques used to identify them.Explain how to assess and respond to risk using the Enterprise Risk Management model.Describe control activities commonly used in companies.Describe how to communicate information and monitor control processes in organizations.
3 Internal ControlsProcesses implemented to provide reasonable assurance that the following objectives are achieved:Safeguard assetsMaintain sufficient recordsProvide accurate and reliable informationPrepare financial reports according to established criteriaPromote and improve operational efficiencyEncourage adherence with management policiesComply with laws and regulations
4 Functions of Internal Controls Preventive controlsDeter problems from occurringDetective controlsDiscover problems that are not preventedCorrective controlsIdentify and correct problems; correct and recover from the problems
5 SOX AND THE FOREIGN CORRUPT PRACTICES ACT In 1977, Congress passed the Foreign Corrupt Practices Act, and to the surprise of the profession, this act incorporated language from an AICPA pronouncement.The primary purpose of the act was to prevent the bribery of foreign officials to obtain business.A significant side effect was to require that corporations maintain good systems of internal accounting control.
6 SOX AND THE FOREIGN CORRUPT PRACTICES ACT In the late 1990s and early 2000s, a series of multi-million-dollar accounting frauds made headlines.The impact on financial markets was substantial, and Congress responded with passage of the Sarbanes-Oxley Act of 2002 (aka, SOX).Applies to publicly held companies and their auditors
7 SOX AND THE FOREIGN CORRUPT PRACTICES ACT The intent of SOX is to:Prevent financial statement fraudMake financial reports more transparentProtect investorsStrengthen internal controls in publicly-held companiesPunish executives who perpetrate fraudSOX has had a material impact on the way boards of directors, management, and accountants operate.
8 SOX AND THE FOREIGN CORRUPT PRACTICES ACT Important aspects of SOX include:Creation of the Public Company Accounting Oversight Board (PCAOB) to oversee the auditing profession.New rules for auditorsNew rules for audit committeesNew rules for managementNew internal control requirements
9 SOX AND THE FOREIGN CORRUPT PRACTICES ACT After the passage of SOX, the SEC further mandated that:Management must base its evaluation on a recognized control framework, developed using a due-process procedure that allows for public comment. The most likely framework is the COSO model discussed later in the chapter.The report must contain a statement identifying the framework used.
10 Control Frameworks COBIT COSO COSO-ERM Framework for IT control Framework for enterprise internal controls (control-based approach)COSO-ERMExpands COSO framework taking a risk-based approach
11 COBIT Framework Current framework version is COBIT5 Based on the following principles:Meeting stakeholder needsCovering the enterprise end-to-endApplying a single, integrated frameworkEnabling a holistic approachSeparating governance from management
12 CONTROL FRAMEWORKS COSO’s Internal Control Framework The Committee of Sponsoring Organizations (COSO) is a private sector group consisting of:The American Accounting AssociationThe AICPAThe Institute of Internal AuditorsThe Institute of Management AccountantsThe Financial Executives Institute
13 Components of COSO Frameworks COSO-ERMControl (internal) environmentRisk assessmentControl activitiesInformation and communicationMonitoringInternal environmentObjective settingEvent identificationRisk assessmentRisk responseControl activitiesInformation and communicationMonitoring
14 CONTROL FRAMEWORKS ERM Framework Takes a risk-based, rather than controls-based, approach to the organization.Oriented toward future and constant change.Incorporates rather than replaces COSO’s internal control framework and contains three additional elements:Setting objectives.Identifying positive and negative events that may affect the company’s ability to implement strategy and achieve objectives.Developing a response to assessed risk.
15 CONTROL FRAMEWORKSCOSO developed a model to illustrate the elements of ERM.
16 Objectives Strategic objectives Operations objectives High-level goalsOperations objectivesEffectiveness and efficiency of operationsReporting objectivesImprove decision making and monitor performanceCompliance objectivesCompliance with applicable laws and regulations
17 INTERNAL ENVIRONMENTThe most critical component of the ERM and the internal control framework.Is the foundation on which the other seven components rest.Influences how organizations:Establish strategies and objectivesStructure business activitiesIdentify, access, and respond to riskA deficient internal control environment often results in risk management and control breakdowns.
18 Internal EnvironmentManagement’s philosophy, operating style, and risk appetiteCommitment to integrity, ethical values, and competenceInternal control oversight by Board of DirectorsOrganizing structureMethods of assigning authority and responsibilityHuman resource standards
19 INTERNAL ENVIRONMENTThe following human resource policies and procedures are important:HiringCompensatingTrainingEvaluating and promotingDischargingManaging disgruntled employeesVacations and rotation of dutiesConfidentiality, insurance and fidelity bonds
20 OBJECTIVE SETTING Objective setting is the second ERM component. It must precede many of the other six components.For example, you must set objectives before you can define events that affect your ability to achieve objectives
21 OBJECTIVE SETTINGTop management, with board approval, must articulate why the company exists and what it hopes to achieve.Often referred to as the corporate vision or mission.Uses the mission statement as a base from which to set corporate objectives.The objectives:Need to be easy to understand and measure.Should be prioritized.Should be aligned with the company’s risk appetite.
22 EVENT IDENTIFICATION Events are: Incidents or occurrences that emanate from internal or external sourcesThat affect implementation of strategy or achievement of objectives.Impact can be positive, negative, or both.Events can range from obvious to obscure.Effects can range from inconsequential to highly significant.
23 Event IdentificationIdentifying incidents both external and internal to the organization that could affect the achievement of the organizations objectivesKey Management Questions:What could go wrong?How can it go wrong?What is the potential harm?What can be done about it?
24 RISK ASSESSMENT AND RISK RESPONSE The fourth and fifth components of COSO’s ERM model are risk assessment and risk response.COSO indicates there are two types of risk:Inherent riskResidual risk
25 RISK ASSESSMENT AND RISK RESPONSE Companies should:Assess inherent riskDevelop a responseThen assess residual risk
26 Risk AssessmentAny potential adverse occurrence or unwanted event that could be injurious to either the accounting information system or the organization is referred to as a threat or an event.The potential dollar loss should a particular threat become a reality is referred to as the exposure or impact of the threat.The probability that the threat will happen is the likelihood associated with the threat
27 Risk Response Reduce Accept Share Avoid Implement effective internal controlAcceptDo nothing, accept likelihood and impact of riskShareBuy insurance, outsource, or hedgeAvoidDo not engage in the activity
28 RISK ASSESSMENT AND RISK RESPONSE Identify the events or threatsthat confront the companyEstimate the likelihood orprobability of each event occurringAccountants assess and reduce inherent risk using the risk assessment and response strategyEstimate the impact of potentialloss from each threatIdentify set of controls toguard against threatEstimate costs and benefitsfrom instituting controlsIs itcost-beneficialto protectsystemAvoid, share, or accept riskNoYesReduce risk by implementing set ofcontrols to guard against threat
29 RISK ASSESSMENT AND RISK RESPONSE Identify the events or threatsthat confront the companyEstimate the likelihood orprobability of each event occurringThe expected loss related to a risk is measured as:Expected loss = impact x likelihoodThe value of a control procedure is the difference between:Expected loss with control procedureExpected loss without itEstimate the impact of potentialloss from each threatIdentify set of controls toguard against threatEstimate costs and benefitsfrom instituting controlsIs itcost-beneficialto protectsystemAvoid, share, or accept riskNoYesReduce risk by implementing set ofcontrols to guard against threat
30 RISK ASSESSMENT AND RISK RESPONSE Let’s go through an example:Hobby Hole is trying to decide whether to install a motion detector system in its warehouse to reduce the probability of a catastrophic theft.A catastrophic theft could result in losses of $800,000.Local crime statistics suggest that the probability of a catastrophic theft at Hobby Hole is 12%.Companies with motion detectors only have about a .5% probability of catastrophic theft.The present value of purchasing and installing a motion detector system and paying future security costs is estimated to be about $43,000.Should Hobby Hole install the motion detectors?
31 CONTROL ACTIVITIES The sixth component of COSO’s ERM model. Control activities are policies, procedures, and rules that provide reasonable assurance that management’s control objectives are met and their risk responses are carried out.
32 CONTROL ACTIVITIESIt is critical that controls be in place during the year-end holiday season. A disproportionate amount of computer fraud and security break- ins occur during this time because:More people are on vacation and fewer around to mind the store.Students are not tied up with school.
33 Control Activities Proper authorization of transactions and activities Segregation of dutiesProject development and acquisition controlsChange management controlsDesign and use of documents and recordsSafeguarding assets, records, and dataIndependent checks on performance
34 CONTROL ACTIVITIES Proper Authorization of Transactions and Activities Management lacks the time and resources to supervise each employee activity and decision.Consequently, they establish policies and empower employees to perform activities within policy.This empowerment is called authorization and is an important part of an organization’s control procedures.
35 CONTROL ACTIVITIES Typically at least two levels of authorization: General authorizationManagement authorizes employees to handle routine transactions without special approval.Special authorizationFor activities or transactions that are of significant consequences, management review and approval is required.Might apply to sales, capital expenditures, or write-offs over a particular dollar limit.Management should have written policies for both types of authorization and for all types of transactions.
36 CONTROL ACTIVITIES Segregation of Duties Good internal control requires that no single employee be given too much responsibility over business transactions or processes.An employee should not be in a position to commit and conceal fraud or unintentional errors.Segregation of duties is discussed in two sections:Segregation of accounting dutiesSegregation of duties within the systems function
38 CONTROL ACTIVITIES Segregation of Duties Within the Systems Function In a highly integrated information system, procedures once performed by separate individuals are combined.Therefore, anyone who has unrestricted access to the computer, its programs, and live data could have the opportunity to perpetrate and conceal fraud.To combat this threat, organizations must implement effective segregation of duties within the IS function.
39 CONTROL ACTIVITIESAuthority and responsibility must be divided clearly among the following functions:Systems administrationNetwork managementSecurity managementChange managementUsersSystems analystsProgrammingComputer operationsInformation systems libraryData control
40 CONTROL ACTIVITIES Project Development and Acquisition Controls It’s important to have a formal, appropriate, and proven methodology to govern the development, acquisition, implementation, and maintenance of information systems and related technologies.Should contain appropriate controls for:Management review and approvalUser involvementAnalysisDesignTestingImplementationConversion
41 CONTROL ACTIVITIES Change Management Controls Organizations constantly modify their information systems to reflect new business practices and take advantage of information technology advances.Change management is the process of making sure that the changes do not negatively affect:Systems reliabilitySecurityConfidentialityIntegrityAvailability
42 CONTROL ACTIVITIES Design and Use of Adequate Documents and Records Proper design and use of documents and records helps ensure accurate and complete recording of all relevant transaction data.Form and content should be kept as simple as possible to:Promote efficient record keepingMinimize recording errorsFacilitate review and verificationDocuments that initiate a transaction should contain a space for authorization.Those used to transfer assets should have a space for the receiving party’s signature.
43 CONTROL ACTIVITIES Safeguard Assets, Records, and Data When people consider safeguarding assets, they most often think of cash and physical assets, such as inventory and equipment.Another company asset that needs to be protected is information.
44 CONTROL ACTIVITIES Independent checks Top-level reviews Analytical reviewsReconciliation of independently maintained sets of recordsComparison of actual quantities with recorded amountsDouble-entry accountingIndependent review
45 INFORMATION AND COMMUNICATION The seventh component of COSO’s ERM model.The primary purpose of the AIS is to gather, record, process, store, summarize, and communicate information about an organization.So accountants must understand how:Transactions are initiatedData are captured in or converted to machine-readable formComputer files are accessed and updatedData are processedInformation is reported to internal and external parties
46 MONITORING The eighth component of COSO’s ERM model. Monitoring can be accomplished with a series of ongoing events or by separate evaluations.
47 Monitoring Perform internal control evaluations (e.g., internal audit) Implement effective supervisionUse responsibility accounting systems (e.g., budgets)Monitor system activitiesTrack purchased software and mobile devicesConduct periodic audits (e.g., external, internal, network security)Employ computer security officerEngage forensic specialistsInstall fraud detection softwareImplement fraud hotline