Internal Control Begins at the Top

Internal controls are needed and/or required in private and public companies alike. The pressure for companies to adopt adequate and effective internal control systems can stem from laws (Sarbanes-Oxley), external accountants, customers, business partners and industry groups. Internal control initiatives must start at the top of the organization to be effective.

A good system of internal control will usually help a company achieve its objectives of profitability and minimize loss of resources. Internal controls cannot, however, change an inherently weak management system or provide absolute assurance as to the reliability of financial reporting.

Corporate governance is the method by which a corporation is directed, administered or controlled. It includes the laws and customs affecting that direction, as well as the goals for which it is governed. The principal participants are the shareholders, management and the board of directors. Other participants include regulators, employees, suppliers, partners, customers and the general community.

The primary goal of corporate governance is to enhance the value of a company through ethical behavior, espousing a policy of openness and fairness and ensuring informed decision making throughout the company. Effective corporate governance policies and practices should be designed to provide for the following:

Transparency and reliability of all financial reporting.
Compliance with applicable laws and regulations.
Protection and increase in shareholder value.
Proper functioning of the entity, including:

Compensation and evaluation of management
Positive impact on the community
Fair and honest dealing/competition
Ongoing successful existence
Effectiveness and efficiency of operations
An appropriate control environment

The control environment sets the tone of an organization, influencing the control consciousness of its people. It is the foundation for all other components of internal control, providing discipline and structure. It provides an atmosphere in which people conduct their activities and carry out their control responsibilities. The control environment includes:

Management's integrity, ethical values and commitment to the competence of the entity's people.
Management's philosophy and operating style.
The way management assigns authority and responsibility, and organizes and develops its people.
The attention and direction provided by the board of directors.

As part of integrity and ethical values, fraud prevention must also be considered. An effective anti-fraud program should consist of the following elements:

Code of conduct/ethics
Hotline/whistleblower program
Hiring and promotion (i.e., background checks)
Investigation and remediation of identified fraud
Oversight by the audit committee and board
Risk assessment

The costs could be high for companies that do not embrace corporate governance principals. Inadequate governance can lead to fraud, restatement, loss of reputation and confidence, loss of competitive position, and loss of key personnel. Internal control policies and practices must be approved by Executive Management and the Board. Only with top level buy-in and oversight, can an organization design and maintain an effective internal control system.

For further information, contact David Blain, Director of Insurance Services, at dblain@macpas.com , or call 717-761-7910.