Tuesday, June 9, 2009

Control Issues and Limitation

Cost of controls

Costs of controls can include the price of physical safeguards, the value of additional hours of employee work incurred, your time, etc. The costs should be less than the benefits. Employee supervision is where most owner-operated businesses get this comparison wrong, particularly by assuming too low a benefit to a control over a long-term and trusted employee. It is not uncommon for the been-there-forever, taken-for-granted, almost-a-member-of-the-family employee to take advantage of the paternal way in which he or she is treated to loot the company blind.


Implementing controls

Proper control design and selection are only the first steps. The most important factors in making them work are communication and organization. Simply putting the controls in place won't guarantee their effectiveness.

Make sure that your people are aware of and understand the controls; and then find ways to influence their behavior so that they agree to respect them. Organization issues involved include the chain of command structure, cost constraints, job descriptions, and the company’s formal and informal feedback loops.

Every control system needs to be flexible and change as the company evolves. No system of internal controls can completely protect against all risks of theft. Keep in mind that risk is a matter of possibilities and probabilities, and therefore must involve the analysis of both positive and negative outcomes. An analysis of internal controls needs to consider the key risks facing the company, the company’s objectives, and the existing controls and procedures.


Employee motivation Perceived equity

Since it isn’t always possible to eliminate the opportunities for theft, attention should also be paid to the rationalization used by wrongdoers. Most cases of employee theft or misbehavior involve issues of perceived equity. Employees who perceive that they are not being treated fairly are much more prone to steal from their employer. It is important to be perceived as being fair, but not weak. Make sure all of your employees know what is expected of them, and treat everybody consistently. Avoid setting unreachable goals or creating other pressures to commit fraud, remove obstacles that block effective performance, and establish clear and consistent procedures with no exceptions.


Limitations:

Internal control can provide reasonable, not absolute, assurance that the objectives of an organization will be met. The concept of reasonable assurance implies a high degree of assurance, constrained by the costs and benefits of establishing incremental control procedures.

Effective internal control implies the organization generates reliable financial reporting and substantially complies with the laws and regulations that apply to it. However, whether an organization achieves operational and strategic objectives may depend on factors outside the enterprise, such as competition or technological innovation. These factors are outside the scope of internal control; therefore, effective internal control provides only timely information or feedback on progress towards the achievement of operational and strategic objectives, but cannot guarantee their achievement.

Internal control involves human action, which introduces the possibility of errors in processing or judgment. Internal control can also be overridden by collusion among employees (see separation of duties) or coercion by top management.

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