Internal Controls and Financial Reporting: A Case Study Analysis

This report examines the critical role of internal controls in ensuring operational effectiveness and preventing fraud within an organization. It analyzes a case study involving a company where a section manager engaged in fraudulent activities by paying invoices to a company he and his wife owned, leading to inaccurate financial reporting despite increased turnover. The analysis identifies breaches in internal controls, such as employing individuals within a close circle, including the audit team, and the lack of segregation of duties. The report recommends implementing several internal controls, including restructuring employee hiring practices to avoid conflicts of interest, establishing clear segregation of responsibilities for financial transactions, implementing surprise reviews of departmental operations, enhancing the skills of the accounting department staff, and enforcing a professional code of conduct for the audit team. The report concludes that effective internal controls are essential for organizational well-being and financial prosperity.

Running head: INTERNAL CONTROLS
Internal Controls
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Author Note

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Executive Summary
This particular study aims to provide an overview into the internal control that is
established by the management of a particular organization primarily to ensure operational
effectiveness. Internal controls essentially refer to the controls that are established by a
particular organization in order to mitigate the chances of error or fraud in the execution of
the operations undertaken by the organization.
In order to understand the effectiveness of the implementation of the internal control
inside an organization, the case study that is presented in the question have been analyzed and
the effective internal control that could save the business from the adverse situation have
been discussed in this particular study.

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Table of Contents
Issue............................................................................................................................................3
Analysis and Recommendation..................................................................................................3
Conclusion..................................................................................................................................5
References..................................................................................................................................6

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Issue
The issue presented in the question is that the section manager of ‘How to do it’
company had paid invoices to a company which was owned by him and his wife. This entire
transaction was unaccounted for therefore, in spite of a significant increase in turnover the
yearly profits as shown in the financial statements were not higher.
The breaches of internal control that led to such a situation are the hiring or
appointment of employees among the known circle of people or people who were known to
the other staff. This policy led to rapid increase in the total number of staff as most of them
were in relationship with each other or was married inside the organization. Even the audit
team that had the sole responsibility of auditing the books of accounts of the firm was
regarded a part of the team and attended the all the functions or events held by the
organization. Next the duties delegated to the section manager were that he was solely
responsible for the signing off on work completed and his wife was responsible for issuing
the cheques.
Analysis and Recommendation
The particular recommendation in such a situation is that the management of the
company should as early as possible consider restructuring the entire base of employees. This
means that an internal control should be implemented within the organization regarding the
further employment of employees that they should not be within the known circle of either
the management or the staff. This would definitely mitigate the chances of each and every
employee being either in a relationship or being married to each other. It is very important to
maintain the code of professionalism and ethics while working in any organization. Now
employees being related to each other in this particular company did increase the chances of

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facing conflict of interest by them which is absolutely not desired by any organization. It is
expected by the management of any organization that the employees or other stakeholders
will always prioritize the welfare of the company rather than giving importance to their own
personal interests. Therefore the internal control regarding the further appointment of staff
will ensure that the employees are more focused towards the goals of the company and not
their own personal motives (Badara and Saidin 2013).
Secondly the management of the company should implement an internal control
regarding the monitoring of the work executed by different staff. The segregation of
responsibility of a particular job is an internal control that mitigates the chances of occurrence
of fraud inside an organization. Therefore if the sectional manager and his wife were not
solely responsible for issuing cheques or authorizing payments, if some other staff had been
assigned with the responsibility of monitoring the work done by them then such the company
could have been saved from facing such a situation. A simple internal control like issuing
some other staff as the signatory of the cheque account can be effective in reducing such
fraudulent events. The management may also consider conducting surprise reviews of the
operations carried out by different departments of the organization (Nicolăescu 2013).
Thirdly the accounts or finance department should be sharp enough to point out the
errors on its own. The issue that in spite of increase in turnover, the profit of the did not
increase should have been noticed by the accounts department personnel as they are in charge
of preparing the financial statements that are to be audited. Therefore the management should
consider the implementation of an effective internal control like the proper training sessions
of the accounting department staff in order to increase the level of their skill or restructuring
the entire accounting department (William, Glover and Prawitt 2016).

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Lastly the audit team responsible for carrying out the audit of the company should
maintain a professional code. Any anomaly in the books of accounts should be reported
officially and not informally. Therefore another implementation of internal regarding this
matter is establishing a professional code of conduct by the management and making all the
stakeholders aware of the code so that they behave accordingly (Lobo and Zhao 2013).
These are the internal controls that should be implemented in order to avoid such
situation in the future.
Conclusion
Thus as it can be understood from the above study internal controls are very impotent
for the smooth running of an organization. The company mentioned in this particular case
study is surely to improve its operational efficiency as well as financial position after the
implementation of the above mentioned controls. Therefore each and every organization
should implement internal controls in order to ensure its well being and prosperity.

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References
Badara, M.A.S. and Saidin, S.Z., 2013. Impact of the effective internal control system on the
internal audit effectiveness at local government level. Journal of Social and Development
Sciences, 4(1), pp.16-23.
Lobo, G.J. and Zhao, Y., 2013. Relation between audit effort and financial report
misstatements: Evidence from quarterly and annual restatements. The Accounting Review,
88(4), pp.1385-1412.
Nicolăescu, E., 2013. Understanding Risk Factors for Weaknesses in Internal Controls over
Financial Reporting. Journal of Self-Governance and Management Economics, 1(3), pp.38-
43.
William Jr, M., Glover, S. and Prawitt, D., 2016. Auditing and assurance services: A
systematic approach. McGraw-Hill Education.