Memo
DATE : 1st June 2020
TO: Chief Executive Officer
FROM: Accountant
SUBJECT: Internal Controls
Madoff’s Ponzi Scheme involved luring investors with steady returns of 10% to 15% under a Ponzi Scheme. Investment statements were used to conceal the business dealings from investors throughout a 10-year period where more than $18 billion was lost. The investment had a weak internal control system and this resulted in the Ponzi Scheme running for such a long period. Additionally, the investors that made investments worth billions of dollars may also be blamed for having poor internal control measures. This study considers various internal controls that a company should adopt so as to avoid falling for a similar scheme. The internal control measures that should be adopted include control environment, risk assessment, and control activities.
Control Environment
Control environment is an internal control measure which involves the top management taking responsibility and making it clear that the organization values integrity and ethical conduct. Any unethical activities and practices are thus not to be tolerated. The control environment begins with the top management and trickles down to every employee. It thus sets the tone at the top of the organization and provides a systematic approach for structure and discipline. Control environment would prevent the organization from engaging in any unethical business practices. It would also ensure that in case an employee believes that an investment appears unethical or lacks integrity, the employee can raise the issue to the management who will act on the given scenario. This will prevent any possible engagement in fraudulent behaviors as the employees and management will always seek to conduct themselves in an ethical manner and investment in businesses that promote honesty and integrity.
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Disadvantages
The internal control environment may be disadvantageous because it can cause the auditors to become overly dependent on the internal control. Auditors can believe that the business conducts itself in an ethical manner and this may make them to relax other measures that are used to check for fraudulent behaviors and errors. Additionally, the business may have to undertake additional costs to engage ethical training of its management and staff.
Risk Assessment
Risk assessment involves identifying and analyzing the various factors that can create risk for businesses and then determining the different approaches to manage the risk. Risk assessment will thus involve several steps such as identifying risk, analyzing the risk, evaluating the risk, risk response, and monitoring and controlling the risk. A risk assessment should be conducted for each of the investments. A risk assessment for the investment will determine how to manage and mitigate the possible risks. To prevent any possible engagement in fraudulent investments, a risk assessment will ensure that a business diversifies its risks and thus reduce the negative effects in case of a fraudulent investment. Division of responsibility can also be undertaken in internal controls to ensure that the individual that prepares the risk assessment record is different. This will ensure an objective analysis of the investment and prevent a possible investment fraud.
Disadvantages
The disadvantage of the risk assessment is that it is based on the judgment of the assessors which can be subject to bias and faulty judgments. The risk assessment may also only provide an assessment of the risk without necessarily putting into consideration the specific factors to mitigate the risk and the preparedness of the risk. Risk assessment may also come short of considering the various vulnerabilities and threats that could result in the actual risk. In order to prevent this disadvantages, it is important to provide an objective assessment of the risk and to consider how to mitigate the risk through changes in the vulnerabilities and threats.
Control Activities
Control activities involves the design of policies and procedures by the management so as to address the specific risks which the company faces. There are different policies that can be adopted by the company. Policies that can possibly prevent an investment fraud include independent internal verification and documentation procedures. Independent internal verification involves verification of records periodically or on a surprise basis. This can be used to identify an investment fraud as it would show the discrepancies and exceptions in an investment. Documentation procedures provides evidence for transactions and the events taken place. Proper documentation enables accountability, reliability, and accuracy of accounting records and thus prevents any possible risks to investments. The prevention of an investment fraud should thus begin with the management who should ensure that there are adequate policies and procedures that can identify and prevent any possible investment frauds.
Disadvantage
The disadvantage of control activities is that it will only be successfully implemented when there is a corporation from employees. Employees may also find a way out through the required policies and procedures. Collusion of two or more employees may also result in the internal control policies being overridden. Control activities can also become obsolete after some time. It is thus necessary to have them frequently updated based on the nature and the size of the business.
In conclusion, it was identified that the prevention of an investment fraud can be done through the use of internal controls that include risk assessment, control environment, and control activities. Risk assessment involves identifying, analyzing, and mitigating the possible risks to an organization. Control environment involves promoting integrity and showing that unethical practice would not be tolerated. Control activities involves designing proper policies and procedures. These different factors have their limitations and can be avoided by following the appropriate procedures.
Regards,
Accountant
