Lesson Objectives:

1. Explain internal control affecting Liabilities and Equity

and potential misstatements on assets and how
weakness in internal control increase risk of
misstatement.
2. Explain the relationship between governance, business
ethics, risk management and internal control and how the
various principles, frameworks and processes interact and
enable professional accountants to contribute positively
to their organizations, profession and society.

Internal Control for Liabilities & Equity

A. Liabilities

What are potential misstatements on accounts payable

and how weakness in internal control increase these
risks?
Description of Examples Internal Control
Misstatement Weakness
Inaccurate recording Fraud
of a purchase or
● A bookkeeper ● Inadequate
disbursement
prepares a check segregation of
for himself and duties between
records it as having record keeping and
been issued to check preparation.
major supplier.
● Failure to review
 and cancel
supporting
Error
documents by
● A disbursement is check signer.
made to pay an
invoice for goods
that have not been ● Ineffective control
received. for matching
invoices with RR
before
disbursement are
authorized.
Fraud
● Goods are ordered ● Ineffective control
but delivered to an for matching
Misappropriation of
inappropriate invoices with RR
purchases
address and stolen before
disbursement are
authorized.
Duplicate recording of Error
purchases
● A purchase is ● Ineffective control
recorded when an for review and
invoice is received cancellation of
from a vendor and supporting
recorded again documents by the
when a duplicate check signer.
 invoice is sent by
the vendor.
Fraud
● Purchase journal ● Ineffective board of
“closely early” with director’s audit
Late(early) recording this period’s committee.
of purchase purchases as
● Undue pressure to
having occurred in
the subsequent meet earnings
period. target.

What internal controls are applicable over Debt?

1. Authorization by the Board of Directors.
a. By-laws should clearly state that board of directors
are required to approved borrowings.
b. Treasurer prepares report on any proposed
financing, explaining the need for funds, effect of
borrowing upon future earnings and the estimated
financial position of the company in comparison with
others in the industry both before and after
borrowing and alternative methods of raising funds.
c. Authorization shall include matters such as choice of
bank or trustee, type of security, registration with
SEC, agreements with investment banker, listing of
bonds on security exchange and compliance with
requirements of state of incorporation.
d. Board of directors shall be furnished copy of report
stating net amount of received and its disposition.
2. Use of Independent Trustee
 Trustee does not have access to the issuance of
company assets or accounting records but are paid
by the company as independent part who is charged
with the protection of creditor’s interest and with
monitoring the company’s compliance with the
provision of indenture.

3. Assigned Trustee to Pay Interest on Bonds and Notes

Payable.

B. Equity

Three (3) principal elements of strong internal control

over equity
1. proper authorization of transaction by the board of
directors and corporate office.
2. segregation of duties in handling these transactions
3. maintenance of adequate records.

What internal controls are applicable on Equity?

1. Control of Share Capital Transactions by the Board of

Directors
2. Independent Registrar and Stock Transfer Agent
3. Internal Control over Dividend
Relationship between Corporate Governance, Business
Ethics, Risk Management and Internal Control

CORPORATE

INTERNAL

Figure 24.1

A. Corporate Governance relationship to Business Ethics

A well defined and enforced corporate governance provides a
Structure that, at least in theory, works for the benefit of
everyone concerned by ensuring that the enterprises adheres
to accepted ethical standards and best practices as well as to
formal law.
 Figure 24.2

An effective ethics programme requires continual

reinforcement of strong values. Organizations are challenged
with how to make its employees live and imbibe the
organization codes and values. To ensure the right ethical
climate a right combination of spirit and structure is required.

B. Corporate Governance relationship to Risk

Management

So, risk as defined by ISO as the effect of uncertainty on the

entity’s objectives. When there are no objectives, there are no
risks. But that’s not company were made for, therefore should
always be assessed in light of the entity’s objectives. Under
the principle 12 of Code of Corporate Governance, “To ensure
the integrity and proper governance in the conduct of its
affairs, the company should have…enterprise risk
management framework.” Below is the summary review of
OECD for the need of risk management.

● Perhaps one of the greatest shocks from the financial crisis

has been the widespread failure of risk management. In many
cases risk was not managed on an enterprise basis and not
adjusted to corporate strategy. Risk managers were often
separated from management and not regarded as an
essential part of implementing the company’s strategy. Most
important of all, boards were in a number of cases ignorant of
the risk facing the company.
● It should be fully understood by regulators and other
standard setters that effective risk management is not about
eliminating risk taking, which is a fundamental driving force in
business and entrepreneurship. The aim is to ensure that
risks are understood, managed and, when appropriate,
communicated.
● Effective implementation of risk management requires an
enterprise-wide approach rather than treating each business
unit individually. It should be considered good practice to
involve the board in both establishing and overseeing the risk
management structure.
● The board should also review and provide guidance about
the alignment of corporate strategy with risk-appetite and the
internal risk management structure.
● To assist the board in its work, it should also be considered
good practice that risk management and control functions be
independent of profit centres and the “chief risk officer” or
equivalent should report directly to the board of directors
along the lines already advocated in the OECD Principles for
internal control functions reporting to the audit committee or
equivalent.
● The process of risk management and the results of risk
assessments should be appropriately disclosed. Without
revealing any trade secrets, the board should make sure that
the firm communicates to the market material risk factors in a
transparent and understandable fashion. Disclosure of risk
factors should be focused on those identified as more relevant
and/or should rank material risk factors in order of importance
on the basis of a qualitative selection whose criteria should
also be disclosed.
● With few exceptions, risk management is typically not
covered, or is insufficiently covered, by existing corporate
governance standards or codes. Corporate governance
standard setters should be encouraged to include or improve
references to risk management in order to raise awareness
and improve implementation.

C. Corporate Governance relationship to Internal Control

Internal control activities ensure that companies adhere to

corporate governance guidelines. As shown in figure 24.3,
internal control is important element of COSO ERM
Framework. Corporate governance sets the standards and
recommends procedures; internal controls ensure those
procedures are being followed. Internal controls also ensure
there is an audit trail that can be retraced during internal and
external audits.
 Figure 24.3

Following objectives of Internal Control supports the

objectives of good corporate governance which are
summarized as follows:
● Ensure achievement of the organization objectives,
including its stated goals and business targets in an
effective and efficient manner.
● Ensure economical and effective use of resources and
adequately safeguard the organization’s assets against
unauthorized use or disposition.
● Ensure compliance with applicable legislation and
regulations.
● Ensure maintenance of proper records for providing
reliable financial, managerial and operating information
 for decision-making, evaluation of activities or
publication.
● Ensure adequate control for the risks inherent in
operations.

To conclude, a good corporate governance can be achieved

when it applies high ethical standards, have established risk
management process and implement internal controls.