Internal Control: A Study of Concept and Themes PDF
Preview Internal Control: A Study of Concept and Themes
Contributions to Management Science For furthervolumes: http://www.springer.com/series/1505 . Olof Arwinge Internal Control A Study of Concept and Themes OlofArwinge DepartmentofFinanceandAccounting UppsalaUniversity Uppsala Sweden ISSN1431-1941 ISBN978-3-7908-2881-8 ISBN978-3-7908-2882-5(eBook) DOI10.1007/978-3-7908-2882-5 SpringerHeidelbergNewYorkDordrechtLondon LibraryofCongressControlNumber:2012951400 #Springer-VerlagBerlinHeidelberg2013 Thisworkissubjecttocopyright.AllrightsarereservedbythePublisher,whetherthewholeorpart of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation,broadcasting,reproductiononmicrofilmsorinanyotherphysicalway,andtransmissionor informationstorageandretrieval,electronicadaptation,computersoftware,orbysimilarordissimilar methodologynowknownorhereafterdeveloped.Exemptedfromthislegalreservationarebriefexcerpts inconnectionwithreviewsorscholarlyanalysisormaterialsuppliedspecificallyforthepurposeofbeing enteredandexecutedonacomputersystem,forexclusiveusebythepurchaserofthework.Duplication ofthispublicationorpartsthereofispermittedonlyundertheprovisionsoftheCopyrightLawofthe Publisher’s location, in its current version, and permission for use must always be obtained from Springer.PermissionsforusemaybeobtainedthroughRightsLinkattheCopyrightClearanceCenter. ViolationsareliabletoprosecutionundertherespectiveCopyrightLaw. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publicationdoesnotimply,evenintheabsenceofaspecificstatement,thatsuchnamesareexempt fromtherelevantprotectivelawsandregulationsandthereforefreeforgeneraluse. While the advice and information in this book are believed to be true and accurate at the date of publication,neithertheauthorsnortheeditorsnorthepublishercanacceptanylegalresponsibilityfor anyerrorsoromissionsthatmaybemade.Thepublishermakesnowarranty,expressorimplied,with respecttothematerialcontainedherein. Printedonacid-freepaper Physica‐VerlagisabrandofSpringer SpringerispartofSpringerScience+BusinessMedia(www.springer.com) Foreword Internalcontrolremainsanimportanttopicinbusinessandorganisationallife.This isalsothereasonforwhythisbookontheconceptandthemesofinternalcontrolis highly relevant for business professionals as well as students and scholars. RepresentingthepartnerteamintheaccountingandauditingfirmGrantThornton inSweden,whichisOlof’sprofessionalhomebase,wetakeprideinthefactthatwe are able to attract and support professionals that want to do exciting and relevant research while remaining in practice. Olof’s book is intriguing as well as current and relevant as it summarises and discusses various perspectives on internal control,asubjectthathasproventobeevenmoreinfocustodaythanever. Whileitseemsattimesthatinternalcontrolisanaccountant’stermonly,thisis ofcoursenottrue.Internalcontrolismostofallimportantforfirmsthemselves,and fortheinvestorsthatinvestinthem.Butalsoimportantforlegislatorsthatneedto understandinternalcontrol-relatedregulation,aswellasthesupervisoryauthorities thatenforcethem. Havingservedasamemberofmanagementteams,ITcompliancemanagerand IT internal audit manager at major financial institutions, I do not have to be convincedabouttheimportanceofhavingadequateandeffectiveinternalcontrols inplace.Thisiswhatdirectorsofboardsaswellasmanagersdependonintheday- to-dayactivityinordertosurviveandremainontrack.Forme,thisiswhatinternal control is all about. Being able to trust data and business-related information and thereforetheprocessesthatareperformedanddecisionsthataremadebasedonthat information.Intheend,Ithinkitisaboutbeingpreparedandgearedupinorderto meet and tackle various market-related challenges head-on. A robust internal control system makes us prepared to go fast while not taking too many chances, much like how a car needs effective brakes in order to be able to go fast, and not slow. Hence, internal control is not primarily or solely an accounting term, as pointed out by Olof, but of vital interest for directors, managers, regulators, investorsandcustomers.Abooklikethismaythusincreaseawarenessandknowl- edgeaboutthedifferentperspectivesandfacetsoftheconceptofinternalcontrol.It canenablethedifferentstakeholderstobetterunderstandwhatinternalcontrolsare, andhowitmaycontributetolong-termbusinesssuccess.Thisbookisaccordingly v vi Foreword anexcellentexamplethatdealswiththewayinwhichinternalcontrolisimportant for customers or the internal control designer, the director and manager, the legislators and supervisory authorities and for those that make investments in firms. As the recent credit and liquidity crisis has shown us, the business system is complex and interrelated. And while business opportunities are perhaps more than ever, ineffective risk management and internal control have proven to have severe negative consequences. I am convinced that a book such as this one may thereforeaddtoourunderstandingaboutthewayinwhichadequateandeffective internal control keep firms safe, while allowing them also to aggressively pursue businessreturn.IcongratulateOlofonthisachievementandrecommendthebook tothevariousprofessionals,studentsandscholarsthatareconcernedwithinternal control. August2011 TomasMunkby, PartnerandHeadofBusinessRiskServices GrantThornton, StockholmSweden. Preface Inrecentyears,therehavebeenincreasingdemandsforimprovedgovernanceand control of all types of organisations. Quite understandably, different stakeholders have differing views both about what should be achieved and how. To some, it seemsasimplematteroftruthfulreporting,sometimesdisregardingtheproblemsof objectivevaluationinanuncertainworld.Toothers,itismoreamatterofavoiding fraud and questionable reward systems. Many link improved control to manage- ment of the risks facing the organisation. Others ask whether organisations, their boards and their management really have incentives to act in the best interests of their owners. Shareholders expect them to develop and exploit the organisation’s assetsinanoptimalway,asprobablydoemployeesandotherstakeholders.Today, such assets include market positions, brand names, available talent and other immaterial assets as well as more traditional ones such as plants, equipment and financial positions. Governance and control should encourage strategically appro- priate actions and risk-taking that is reasonable and well considered. How can all these aims be achieved? And should they all be included in what we call internal control? This book by Olof Arwinge is almost entirelybased on his licentiate thesis for whichweservedasthesisadvisors.AnimportantaimforOlof’sworkwastoclarify theoriginsandalternativeinterpretationsgiventotheconcept‘internalcontrol’.It turnedouttobeolderthanwehadexpected,anditsalternativecontents–moreor lessthosewedescribedinthepreviousparagraph–werealsosuggestedearlyinits history. At least from the mid-1950s, from time to time there has been a debate about what should be achieved for internal control to be considered good or even adequate. Why then is this issue receiving more attention than ever now, a half century later? Webelieveithastodowithincreasingawarenessthatcompetitivenessoreven survivalisbecomingmorecomplex,asmostorganisations, atleastinEuropeand theUSA,dependheavilyonrapidlychangingmarkets,bothfordemandandsupply. Theirdevelopmentsarehardtopredict,yetpreparingforfuturescenariosthrough development efforts, new learning and investments may take longer than before. vii viii Preface Theresultingrisksarehuge,exacerbatedthroughuncertaintiesaboutprotectionof immaterialassetssuchasintellectualpropertyandreputation. As a consequence, we see even organisations with leading positions in their industrieslosetheirgrip,disappointingownersandemployees.Insuchsituations,it is natural to question the actions of boards and management. Did they know enough? Didthey reallyactasstewardsoftheintereststheyshouldrepresent?Or wassomethingwrongwithinternalinformation,processesandincentives? Internal control thus becomes more difficult at the same time as it is more important. Its scope and what reasonably can be expected from it need to be discussed.Forthispurpose,weinstigatedaresearchprogrammewithanadvisory board consisting of representatives of The IIA’s Swedish chapter and Far, the professional institute for public accountants and other accountancy professionals in Sweden. This programme is financed – including funding for the final stage of completingandpublishing Olof’slicentiatethesis–bythe researchfoundation of JanWallanderandTomHedeliusaswellasthatofToreBrowaldh. Thisbookprovidesanup-to-datesummaryoftheemergenceanduseoftheterm internalcontrolintheliterature,andananalysisofsomethemesconcerninghowit canbedesignedandused.LikewithallacademicdissertationsinSweden,thisbook istheworkofitsauthoranddoesnotnecessarilyrepresenttheviewsofhisadvisors orofthepractitionersontheprogramme’sadvisoryboard.Ithas,however,already ledtovaluablediscussionsamongresearchersandpractitionersinSwedenandwill certainlycontinuetodosonowthattheprogrammehascontinuedwithadditional projects. Uppsala8September2011 FredrikNilsson ProfessorofBusinessStudies, especiallyAccounting DepartmentofBusinessStudies UppsalaUniversity Nils-Go¨ranOlve Guestprofessor DepartmentofBusinessStudies UppsalaUniversity Summary This thesis studies the accounting and auditing approach to control where the concept of internal control has developed along with the theory and practice of accounting and auditing and its stated objectives. In this context, internal control hastraditionallybeenregardedasameansofensuringfinancialreportingqualityas wellasawayofpreventinganddetectingfraudulentactivity. We have surveyed scientific research on the subject of internal control and reviewed regulatory texts as well as practical frameworks and standards. Based on this literature study, we have investigated some of the findings from previous research.Componentsandparticularfeaturesofinternalcontrolweredescribedand discussed. We have also identified and summarised themes and issues that fre- quentlyoccurinwritingsonthesubject. During recent years, demands have been made for greater accountability and transparency incorporate governance. Theindependentauditactivityhas become theprimarytoolforsecuringaccountability.Someregardthisastheemergenceof an audit society. An important joint development has been the rise of internal control systems. Internal control, once a private matter for technical assurance specialists, has risen to be an autonomous field of expertise and a mode of organising uncertainty. Traditionally, internal control has had a fairly direct rela- tionship to the accounting records. The wider approaches to internal control have expandeditsboundariessignificantly,farbeyondthefinancialreportsandtheduties oftheaccountant.Internalcontrolhasbecomeanall-encompassingprocess. Enterpriseriskmanagementpracticesaregrowingandevolving.Anassociated development has been that internal control has become more closely tied to these riskmanagementpractices,andthereforealsototheformulationandexecutionof strategies.Newrisk-relatedregulationsandpracticalframeworkshavecontributed to the transformation of internal control into an extension of risk management. Internalcontrolisnowconsideredtobeaformofrisktreatmentthroughwhichrisk maybemanagedindifferentways. Internal control is today a primary regulatory and formal policy object. Lawmakersandsupervisoryauthoritiesareincreasinglyconcernedwiththedesign and operating effectiveness of internal controls. Disclosure requirements imposed ix x Summary onfirmsareforcingthemtoprovidepublicdisclosuresabouttheirinternalcontrol systems,whichwerepreviouslyprivatetofirms. Both scientific research and practical writings suggest that internal control designs are contingent upon certain variables. These variables include company objectivesandstrategies,regulatorycharacteristics,riskandriskappetite,firmsize and managements’ attitudes to risk and control. Building internal control capabilities is important if firms are to be able to design balanced, integrated, dynamicandcost-effectiveinternalcontrols. Internal control is considered to be a key corporate governance mechanism. Someresearchershowever,havepointedoutthatthereisstillmuchtolearnabout internal control quality and how internal control is associated with corporate governancequality.Thefactthatinternalcontrolisaninherentlycomplexconcept poses a significant research barrier, and while all research methods are valid, it is unlikely that archival studies or experiments are able to measure internal control quality. Instead, we recommend case studies of how firms design, apply, and overseetheirsystemsofinternalcontrol. This study was made possible through the research collaboration between my former employer, Skandia, and Linko¨ping University through the Research ProgrammeforAuditorsandConsultants.Duringthefinalstage,generousfunding was provided by the Jan Wallanders and Tom Hedelius foundation as well as the ToreBrowaldhsfoundation.
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