Chapter 5 - Internal Control Systems Flashcards
What is internal control?
- Process designed to provide reasonable assurance regarding the achievement of objectives relating to operations, reporting and compliance
- affected by board of directors, management and other personnel
- Process rather than an end in itself
- Needs people and what they do, rather than just policy and procedures
- Cannot give 100% assurance, only reasonable assurance
- Adaptable to all org’s
Three key focus areas of internal control
- Operational objectives – operational and financial performance goals + safeguarding assets against loss
- Reporting objectives – internal, external, financial and non-financial
- Compliance objectives – laws and regulations
COSO internal control - integrated framework (COSO Cube):
- Objectives:
* Operations
* Reporting
* Compliance - Components of internal control:
* Control environment
* Risk Assessment
* Control activities
* Info + communication
* Monitoring activities - Levels of org:
* Function
* Operational unit
* Division
* Entity level
Factors that support internal control:
- Organisational structure including responsibility centres
- Integrity and ethical values
- Corporate codes of ethics
How does responsibility centres work?
- Managers are given objectives and degree of autonomy to achieve them
- Managed by establishing performance measures to monitor managers performance
- Poorly defined performance measures could be counter-productive
Types of responsibility centres:
- Cost centres:
* Managers control costs only
* Achieved by fixing inputs and requesting output to be maximised or fixing a set level of output and requesting costs to be minimised
* Cost centres could achieve targets by reducing quality, but would not be goal congruent
* Non-financial controls could include introducing efficiencies in way labour is used - Profit centres:
* Managers control revenues and costs
* Grants more discretion over how profit is maximised or targets achieved (either by reducing costs or increasing revenues)
* Managers have little autonomy over available resources - Investment centres:
* Managers control revenues, costs and investment
* Managers accountable for overall performance using whatever funds allocated
* Assessment using specific targets such as return on investment to provide good incentive
* Non-financial controls could include introducing technology and considering trade-off between investment and operational return
Fundamental principles:
Professional behaviour
Integrity – truthful and honest in all situations
Professional competence and due care
Confidentiality
Objectivity – freedom form bias or discrimination
Ethical threats:
Management responsibility – making management decisions but also being responsible for reviewing them Advocacy Self-review Self-interest Intimidation Familiarity
Why are corporate codes of ethics used?
Used to make statement about how org manages risks such as legal and regulatory requirements as well as moral obligations
Responsibility of board according to the COSO Internal Control - Integrated framework:
- Board is responsible for having an effective system of internal control which senior management operates on their behalf
- Board will be supported by internal and external auditors
What is the responsibilities of the risk management group?
- Building on overall strategy and framework prescribed by the board and risk committee
- Prescribe methods of risk management
- Concentrate on risk responses and monitor risk management
- Report to risk committee and will receive reports from line managers and employees
Responsibilities of internal and external auditors:
- External auditors = concerned with risks that have most impact on figures show in financial accounts
- Internal auditors = more flexible, approach will depend on their focus on controls that are being operated or overall risk management process
Responsibilities of line managers:
- Carry out detailed risk management functions
- Communicating risk management policies to staff
- Preparing reports
- Set a good example
Responsibilities of staff:
- Follow risk management procedures
* Report any concerns relating to risk, failures of existing control measures and variances in budgets and forecasts
What is Management accounting?
Process used for decision making, problem-solving, forward planning. Profit measurement, inventory valuation and performance measurement
What is Strategic Management accounting?
- Provides management accounting info on business and competitive environment in which it operates
- Collection of competitor info and external info
- Exploitation of cost reduction opportunities
- Focus on continuous improvements and non-financial performance
- Matching accounting practices to org’s position and expectations
Managerial + operational control info:
Managerial control info:
* Embraces entire business unit
* Quantitative and expressed in financial terms
* Reported regularly from tactical perspective (weekly/ monthly)
Operational control info:
* Daily info
* Detail reported will vary depending on operational requirement
* Usually quantitative non-financial terms (units, hours or kg’s)
Budgeting as internal control:
- Allows individual areas of business to demonstrate accountability
- Encourage goal congruent behaviour
Transfer pricing for internal control:
- Used where divisions each have own performance targets and they require appropriate methods of recording inter-company transfers
- Transaction price economics (costs involved with negotiation, administration and other opportunity costs) is used to calculate transfer prices
- Could lead to dysfunctional behaviour
Advantages and disadvantages of costing systems:
Advantages: * Manages costs in high volume production markets * Identifies fixed costs * Allocated costs to activities (ABC) Disadvantages: * Attempts to manage uncontrollable costs * Ignores value streams * Imprecise overhead valuations * Rewards excess production * No incentive to improve
Advantage and disadvantage of performance management:
Advantage:
* Use of various reward systems aids accountability
Disadvantage:
* Inappropriate measures – e.g. bulk-buying to reduce adverse cost variances ignores sales and profit implications
Advantages and disadvantages of capital investment appraisal:
Advantage:
* Straightforward techniques for matching costs and revenues with timescales
Disadvantages:
* Cost of capital is difficult to estimate
* Assumptions are often too broad
* Ignores non-financial factors
What is JIT and backflush accounting
- System of continuous improvement where demand pulls production
- Reports costs in a simplified way to aid efficiency
What is throughput accounting?
- In the short-term, all costs except for materials are treated as fixed
- Inventory should not be created
- Valuing products using material costs only and profitability is determined by sales, not production
- Requires attention to bottlenecks
What is Lean management accounting?
- Emphasis on continuous improvement and eliminating waste and unnecessary costs
- Eliminating all activities that do not add value
What is Life cycle costing?
- Accumulates all relevant costs and revenues across products whole life cycle
- Manage costs considered primarily during development, not production
What is Target costing?
- Set a target price that customers are willing to pay, deduct a required rate of return to arrive at the target cost the product should not exceed
- Market focused and drives efficiencies
- Difficult to predict realistic sales prices, market behaviour and production volumes
What is Kaizen?
- Continuous improvement in all aspects of an entity’s performance on every level
- Management to identify incremental improvements to reduce costs
What is Economic value added?
- Calculates operating profit less an imputed charge for capital employed
- Focuses on long-term shareholder wealth
- May direct managers to reject projects which require large initial investments and deliver low EVA measures
Non-financial information to use in performance measures:
- Sales budgets = Volumes sold, volumes returned, market segmentation and product mix sold
- Variance analysis = Actual activity vs. budget, no of staff employed vs. budget, quality of output and reject rates
- Investment appraisal = Timescales, assumptions on market behaviour, changes in legislation and forecasting optimism
The balanced scorecard:
- Financial perspective:
* Survive – cash flow
* Succeed – monthly sales growth
* Prosper – increased market share - Customer perspective:
* New products - % sales from new products
* Responsive supply – on-time delivery
* Preferred supplier – share of key accounts purchases - Internal business perspective:
* Technology capability – manufacturing configuration vs. competition
* Manufacturing excellence – cycle time, unit cost, yield
* Design productivity – silicone efficiency - Innovation and learning perspective:
* Technology leadership – time to develop next generation of products
* Manufacturing learning – process time to maturity
* Product focus - % of products that equal 80% of sales
Risks of performance measurements:
- May be too short-term and too focused on financial measures
- Created too long after an event to be of use to an org that may have already lost customers due to poor-quality outputs and changes in market dynamics
Performance measurements in not for profit org’s:
- Economy:
* Obtaining suitable inputs at the lowest cost relative to the quality supplied - Efficiency:
* Process working as expected with minimal waste or downtime
* Maximising the output achieved from inputs available - Effectiveness:
Achieving org’s goals
Performance measurement for service organisations: (FIRE FC)
- Flexibility
- Innovation
- Resource utilisation
- Excellence (quality)
- Financial performance
- Competitive performance
What is Total quality management:
Applies zero defects philosophy to all resources and relationships within org as a means of developing a sustainable culture of continuous improvement that focuses on meeting customers’ expectations
What are the characteristics of TQM?
- Only thing that matters is the customer
- Quality relates to all customer-supplier relationships
- Cause of defects should be prevented in the first place
- Employees must be personally responsible for defect-free production/ service
- Any level of defects must be unacceptable
- Try obsessively to get things right the first time
- Quality certification programmes should be introduced
- Cost of poor quality should be emphasised – good quality generates savings
Costs of quality:
- Conformance costs = prevent problems + appraise quality
- Non-conformance costs = internal failures such as waste + external failures selling faulty goods
- Emphasis should be on minimising or eliminating non-conformance costs
Project controls - project development:
Collecting ideas:
* Gathering environmental info, staff suggestion schemes, innovation committee, innovation targets
Suitability and feasibility of the project:
- Analysis of the project vs. strategic direction (SWOT)
- Analysis of resource requirements (feasibility)
Project controls - Project Analysis:
Acceptability of the project:
- Financial analysis of return (NPV etc.)
- Analysis of risk and uncertainty (sensitivity analysis etc.)
- Analysis of real options
- Analysis of intangible benefits
- Impact on stakeholders (e.g. staff)
Project control
Implementing and monitoring the project:
- Project committee
- Time and cost targets
- Post completion audit – did the project achieve its aims?
Post completion audit:
- Should be independent
- Carried out during the project life
- Used to learn from mistakes
- Should ensure that the original project forecasts were not wildly optimistic
- Danger of creating blame culture
Post completion review:
Focused on results/outcomes of project and establishes whether objectives and target performance criteria have been met
