Fraud is one of the challenges that businesses face today. Every days, businesses across the planet lose huge amounts as a result of fraudulent activities carried out by their employees and third parties. In an effort to shield themselves from these activities, businesses are adopting internal control systems. Essentially, these are systems that are implemented to ensure that an organization is incorruptible and that employees exhibit accountability and integrity (Leitch, 2012). While they play an important role in securing the finances of an organization, internal control systems are not perfect. These systems are the focus of this essay. Among other things, the essay highlights the limitations of the systems and offers recommendations for plugging the loopholes in the systems.
Limitations of internal control system
In the case provided, it is mentioned that it has been realized that there was a failure to record an entry adjustment. This failure has been blamed on the weak internal control system that company XYZ has adopted. This case serves as evidence that internal control systems are not foolproof as it is still possible for errors to occur. One of the limitations of internal control systems is that they rely heavily on human judgment (“Internal Control”, n.d). The systems require human input to operate and their effectiveness are determined by the quality of the human input. It is possible that the individual required to make the adjusting entry simply forgot or did not know how to. This possibility underscores the fact that internal control systems possess limitations. The second limitation is that these systems are susceptible to breakdowns (“Internal Control”, n.d). Most internal control systems demand the input of several employees. A failure by one employee could introduce errors into the entire system. It can be argued that the failure to make the adjusting entry resulted from other failures. For instance, it could be that a transaction was not properly receipted.
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The limitations mentioned above are not the only ones that plague internal control systems. Management override is another limitation that hinders the effectiveness of the control systems (“Internal Control”, n.d). Essentially, management override refers to the authority that senior management have that allows them to abuse and defy the stipulations that the control system sets out. It is likely that the failure to make the adjusting entry was the result of abuse of power by some manager in the company. The possibility of collusion is another limitation that could impair and internal control system (“Internal Control”, n.d). It is true that the system is intended to ensure that employees behave ethically and with integrity. However, it is also true that employees can collude to circumvent the control system. It would not be surprising if it were to be revealed that the adjusting entry was not made because two employees colluded to defraud the company.
Recommendations
It has already been stated that there was a failure by XYZ to record an adjusting entry. Basically, adjusting entries are made to reflect changes in value or amounts. For example, when the value of an asset depreciates, an adjusting entry should be made. There are a number of measures that the company may implement to ensure that the failure is not repeated. These measures can also be extended to other areas of the internal control system to ensure that it is more effective and reliable. Segregation of duties is one of these measures (Selhorn, 2015). Essentially, this involves mandating different employees with different accounting responsibilities. In the event that the adjusting entry error that occurred in the XYZ Company was the result of employee collusion, this measure would prevent similar incidents.
Restricting access is yet another measure that the company could implement (Selhorn, 2015). The implementation of this measure would involve ensuring that only employees with authorization are able to access the financial system. This measure will ensure that managers do not abuse their authority and that breakdowns in the internal control system do not occur. The third measure that the company could implement concerns oversight. By monitoring their employees, organizations are able to ensure that fraud does not occur and that the integrity of internal control systems is not compromised (Selhorn, 2015). It is possible that the adjusting entry error was the result of poor oversight. If this is true, then the implementation of this measure will address the matter. Inviting outsiders to examine financial statements and the internal control system is another option that the company can explore.
Impact of missing journal entry on financial statements
Journals serve as among the source documents that are used in compiling financial statements. For this reason, it is important to ensure that all entries made are correct and accurate. Any failure to enter an entry could send shockwaves across all financial statements (Bank, n.d). One of the effects of a missing journal entry is that it could lead to inflating or under-reporting amounts. For example, suppose an accountant fails to make a journal entry in the cash account after a sale. This blunder would be reflected in such statements as the income statement where the cash income would be under-reported. (Bank, n.d) Since a journal is a source document, the balance sheet would also be affected. The balance sheet offers an overview of the assets and liabilities of a company. Failure to make a journal entry would mean that the balance sheet will not offer an accurate depiction of the position of the company. Overall, a missing journal entry introduces inaccuracies in financial statements, rendering them unreliable.
In conclusion, there are various principles and codes that govern the operations of accountants. Despite this, the accounting profession has failed to ensure that all its members uphold such values as integrity and transparency. The limitations of internal control systems are also to blame for the tarnished image of the profession. If the profession is to regain its glory, it must work with organizations to improve accounting standards. The profession needs to advise organizations regarding the measures that they can adopt to make their internal control systems more effective and reliable.
References
Bank, E. (n.d). The Impact of Missing Closing Entries on Financial Statements. Retrieved 13 th April 2017 from http://smallbusiness.chron.com/impact-missing-closing-entries-financial-statements-76309.html
Internal Control. (n.d). Retrieved 13 th April 2017 from http://audit.mercer.edu/internal-control/
Leitch, M. (2012). Intelligent Internal Control and Risk Management: Designing High- Performance Risk Control Systems. Gower Publishing.
Selhorn, R. (2015). 5 Ways to Improve Internal Accounting Controls and Oversight in your Business. Retrieved 13 th April 2017 from
http://signatureanalytics.com/5-ways-to-improve-internal-controls-and-oversight-in-your-business/
