Implementing and Auditing the Internal Control System

The book the reader has on hand addresses the need for a direct confirmation that senior management and the auditors have reviewed the effectiveness of the system of internal financial and operational controls. This text is divided into three parts. Part 1 defines both auditing and internal control, then explains why internal control must be audited and in which way this should be done to improve upon the quality of deliverables. Chapter 1 addresses the role of auditing in an organization. It demonstrates that auditing is an indispensable instrument of management, and documents that rigorous auditing can provide value-added services. This chapter also outlines the functions and responsibilities of the Auditing Committee, at the level of the board of directors. Its existence has been strongly recommended by the Basle Committee on Banking Supervision of the Bank for International Settlements (BIS). Chapter 2 focuses on internal control. After defining the internal control functions and the senior management policies on which these should rest, it presents to the reader the successive steps necessary for implementing a rigorous internal control system, demonstrating why properly studied and applied internal controls can be instrumental in curbing not only fraud but as well credit risk, market risk, operational risk, and other major exposures. Chapter 3 examines the need for internal controls from the viewpoint of globalization of financial markets. It brings home the point that important differences in accounting systems handicap internal control and auditing, and it documents how conflicts of interest work to the detriment of internal control -and therefore of the company's ability to take hold of itself. The theme of Chapter 4 is new standards for auditing internal controls and risk management systems. Practical examples range from the more classical auditing of cash flow to risk-based auditing. A methodology for auditing the internal control system is presented in Chapter 5. Internal control information is compared to military intelligence, and applications examples are taken from trading in derivative financial instruments. Accurate information passed in a timely fashion to decision-makers can enable them to take appropriate steps whether these focus on new business opportunities or on control action. The latter is the role of internal control intelligence. However, numbers and statistics are only a small part of the game. Much of the risk taken by a company because of trading and inventoried positions is inherently unqualified. Yet, we try not only to qualify it but also, whenever possible, to quantify it -because this is the only way to control it. On these premises rests Part II, which addresses top management's accountability for internal control. The line of responsibilities starts at the I am indebted to a long list of knowledgeable people, and of organizations, for their contribution to the research which made this book possible. Also to several senior executives and experts for constructive criticism during the preparation of the manuscript. The complete list of the senior executives and organizations who participated to this research is shown in the Appendix. Let me take this opportunity to thank Stephen Rutt and Zelah Pengilley for suggesting this project and seeing it all the way to publication, and Keith Povey and Barbara Docherty for the editing work. To Eva-Maria Binder goes the credit for compiling the research results, typing the text, and making the camera-ready artwork and index. Cover......Page 1 Contents......Page 6 List of Figures......Page 12 List of Tables......Page 16 Preface......Page 17 Acknowledgements......Page 22 List of Abbreviations and Acronyms......Page 23 PART I: WHY INTERNAL CONTROL SYSTEMS MUST BE AUDITED......Page 26 Introduction......Page 28 Auditing Defined......Page 30 Auditing as an Indispensable Element of a Management System......Page 33 Senior Management Responsibilities in Connection with Auditing and Internal Controls......Page 37 Value-Added Services to be Provided by Auditing......Page 41 The Role of an Independent Auditing Committee and the Contribution of the Treadway Commission......Page 46 Good Practice Guidelines Regarding Auditing Committee Functions and Responsibilities......Page 49 Introduction......Page 53 'Internal Control' Defined......Page 55 What Constitutes a Sound Internal Control Policy?......Page 59 Steps in Implementing an Internal Control System......Page 61 Improving the Status of Internal Control in Business and Industry......Page 65 What Is Meant by a 'Rigorous Internal Control Solution'?......Page 68 A Practical Example with Internal Control Approaches to Operational Risk......Page 72 Appendix: Definitions of Internal Control by AICPA, Basle Committee, EMI, IIA, and COSO......Page 76 Introduction......Page 79 The Impact of Globalization on Internal Control......Page 80 Regulators Look at Internal Control as a Foundation of Sound Management......Page 83 Important Differences Between Accounting Systems Handicap Global Internal Control and Auditing......Page 87 Internal Control Deficiencies, Conflicts of Interest, and the Massaging of Accounting Data......Page 90 A Threat Curve Which Addresses Our Problems and Their Likelihood......Page 103 Introduction......Page 108 Auditing Responsibilities Prescribed by Securities Laws......Page 110 Agency Costs and the Impairment of Assets......Page 112 Using a Company's Cash Flow for Auditing Reasons......Page 116 The Concept Underpinning Risk-Based Auditing......Page 120 Authority and Responsibility for Risk-Based Auditing Solutions......Page 123 Paying Attention to Information Requirements for Risk-Based Auditing......Page 126 Introduction......Page 130 Discovery is the First Major Step of a Valid Auditing Methodology......Page 131 Auditing Strengths and Weaknesses of an Internal Control System: An Example From a Money Centre Bank......Page 135 The Methods of Internal Control Resemble Those of Military Intelligence......Page 139 Internal Control Intelligence and the Calculation of Assumed Exposure......Page 143 Internal Control Intelligence and Dynamic Computing of Capital Requirements......Page 148 Synergy Necessary Between Business Units to Make Internal Control a Reality......Page 152 PART II: MANAGEMENT APPRAISAL OF AND ACCOUNTABILITY FOR THE INTERNAL CONTROL SYSTEM......Page 156 Introduction......Page 158 Legal Reasons Why Internal Control Must be Managed......Page 159 Effective Internal Control Requires Trustworthy People......Page 165 Internal Control, Product Review, and Risk Assumptions......Page 169 Senior Management Cannot Delegate its Accountability for Internal Control......Page 173 Restructuring is a Critical Element of Financial Innovation......Page 177 Beware of Creative Accounting: it is Poison to Internal Control......Page 180 Introduction......Page 184 Which are the Core Functions of a Financial Institution?......Page 185 A Polyvalent Approach to the Implementation of Internal Control: the Commission Bancaire Directives......Page 188 Why Both a priori and a posteriori Studies Improve Internal Control......Page 190 Do We Need a Separate Department to Look After Compliance? The Case of Two Swiss Banks......Page 197 Management Intent: Its Impact on Internal Discipline and Financial Reporting......Page 201 New Rules of Competition and the Need for Market Discipline......Page 207 Introduction......Page 210 Organizational Solutions for Internal Control at Edward Jones......Page 212 The Process of Internal Control and the Prerequisites for Risk Management......Page 215 Commercial Risk, Financial Risk, and the Tuning of Internal Control......Page 218 Should We Analyze the Behavioural Pattern of Our Traders?......Page 221 Developing and Using a System of Internal Margin Calls......Page 227 Internal Controls Should Highlight Information Technology Failures......Page 231 PART III: CASE STUDIES ON THE IMPLEMENTATION OF INTERNAL CONTROL......Page 236 Introduction......Page 238 Limits, Marking-to-Market, and the Contribution of Internal Control......Page 239 Internal Control and the Role of Benchmarks......Page 244 Answers by Leading Institutions to an Internal Controls and Limits Questionnaire......Page 246 Setting Limits is a Business Requiring Know-how and Imagination......Page 250 The Study of Internal Controls by the European Monetary Institute......Page 253 Advance Notice Can Help in Limiting Future Loss Through Repositioning......Page 256 Introduction......Page 260 Internal Controls and Dynamic Limits Management......Page 261 The Role of Auditing in Controlling the Calculation of Prices and Risk Premiums......Page 266 Internal Controls, Leveraging, and the Evaluation of Risk and Return......Page 270 Should Internal Controls Reflect a Portfolio's Diversification?......Page 275 Internal Controls and Limits for Equity Trading......Page 279 Examining and Implementing Limits in Currency Positions......Page 283 Introduction......Page 287 Long-Termism and Short-Termism in R&D......Page 288 A Methodology for Internal Control Applied to Engineering Design......Page 293 Internal Control's Contribution to the Project Manager's Job......Page 296 Internal Control for Prototypes and for Measurements Connected with Different Projects......Page 301 Design Reviews are Essentially a Process of Rigorous Auditing......Page 305 An Infrastructure for Quality Assurance......Page 309 Introduction......Page 314 Positioning Our Institution to Profit From the Fact that Banking is Information in Motion......Page 317 The Use of Advanced Technology is not a Fad but an Obligation......Page 319 Online Banking and the Auditing of Financial Operations......Page 324 The Effective Use of Information Technology for Internal Control......Page 329 The Regulators Emphasize the Need to Use Technology in an Able Manner......Page 333 Why Auditing Increasingly Depends on Computer Systems......Page 335 Introduction......Page 339 Value-Added Duties Beyond Those Classically Performed by External Auditors......Page 340 What Should be Expected from Auditing Internal Controls by External Auditors?......Page 344 Are Central Bank Examiners Better Positioned in Studying the Effectiveness of Internal Controls?......Page 348 The Concept Behind Outsourcing Internal Auditing and Other Duties......Page 352 A Closer Look at Outsourcing Internal Auditing, its 'Pluses' and 'Minuses'......Page 355 Liabilities Which Might Come the Way of External Auditors......Page 359 Bibliography......Page 362 Appendix of Participating Organizations......Page 364 Index......Page 384 With globalisation, deregulation and the advent of derivatives, credit institutions and the treasury operations of manufacturing, merchandising and service companies are finding that their traditional tools for management control no longer suffice. They must develop more efficient processes able to measure and monitor their risks in real-time. Internal control is a dynamic system covering all types of risk, addressing fraud, assuring transparency and making possible reliable financial reporting within such organisations. In Implementing and Auditing the Internal Control System , Dimitris N. Chorafas defines both auditing and internal control, and explains the value of internal control, why it must be audited, and how it can be most effectively achieved. He addresses top management's accountability for internal control, and uses case studies to demonstrate the application of such systems, and the importance of sound and well-informed analysis of the information gathered. Internal control systems are examined within the context of the globalization of financial markets, under the impact of the growth of information technology, and from the viewpoint of new regulations by supervisory authorities in Group of Ten countries as well as by the Basle Committee on Banking Supervision. Based on an extensive research project in the UK, US, Germany, France, Austria, Switzerland and Sweden, this book is an invaluable source of practical advice for implementing internal control systems, and making existing systems more efficient. It provides managers and professionals with guidelines for the interpretation and use of the resulting internal control intelligence.

dimitris N. Chorafas Defines Both Auditing And Internal Control, And Explains The Value Of Internal Control, Why It Must Be Audited, And How It Can Be Most Effectively Achieved. He Addresses Top Management's Accountability For Internal Control And Uses Case Studies To Demonstrate The Application Of Such Systems, As Well As The Importance Of Sound Analysis Of The Information Gathered. Based On An Extensive Research Project In The Uk, Us, And Continental Europe, This Book Is An Invaluable Source Of Practical Advice For Implementing Internal Control Systems And Making Existing Systems More Efficient.

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providing Working Definitions For Both Auditing And Internal Control, This Book Describes The Advantages Of Internal Control, Explains The Need For Auditing, And Recommends Specific Procedures. Case Studies Illustrate The Processes Involved And Emphasize The Need For A Skilled Analysis Of The Information Gathered. The Impact Of Globalization And The Growth Of Information Technology Are Given Particular Attention. Chorafas Is A Financial Consultant. Annotation C. Book News, Inc., Portland, Or (booknews.com)

Annotation Dimitris N. Chorafas defines both auditing and internal control, and explains the value of internal control, why it must be audited, and how it can be most effectively achieved. He addresses top management's accountability for internal control and uses case studies to demonstrate the application of such systems, as well as the importance of sound analysis of the information gathered. Based on an extensive research project in the UK, US, and continental Europe, this book is an invaluable source of practical advice for implementing internal control systems and making existing systems more efficient.