Investors rely on information in financial statements to select stock investments. In order for this information to be reliable, the companies issuing stock must have adequate internal control. Because of large investor losses from fraud, laws mandate stronger evaluation of internal control. Sarbanes-Oxley is one of these laws. Implemented in steps, it aims to increase investor confidence that internal control related to financial reports is effective.
The Committee of Sponsoring Organizations is a voluntary organization that provides internal control guidance. The committee asserts that investors in a company’s stock should be aware that internal control only provides reasonable assurance that financial information provided to investors is accurate. Absolute assurance is nearly impossible to attain and is also cost prohibitive. While documents and forms are crucial components of internal control, the committee emphasizes that internal control is implemented by people at every level of an organization.
The Committee of Sponsoring Organizations states that the control environment is enhanced by strong management support of internal control activities. Management should implement effective communication and sharing of information regarding internal control activities. Control activities should be designed and monitored throughout the organization. Risk assessments should be performed regularly for financial statement reporting and fraud risks.
Top management must set the tone for internal control. In addition to communicating the importance of internal control, management must ensure establishment of internal controls such as a code of ethics, authorization rules for expenditures and safeguarding of physical assets. Separation of duties, or ensuring one person is not in charge of all aspects of a high-risk function, is also vital for effective internal control. For example, a worker who collects cash should not be responsible for recording cash deposits. Stock prices may be negatively affected if management fails to implement effective internal control.
Opponents of stringent internal control regulations express concern that excessive regulations may deter companies from issuing publicly traded stock. These opponents argue that the cost and paperwork involved in complying with regulations is too burdensome. Lackluster support from top management for internal control, ineffective employee education and slow cultural change regarding internal controls might make such companies less effective and therefore not reliable for stock market investors.
- The Institute of Internal Auditors; Tone at the Top; November 2005
- Committee of Sponsoring Organizations of the Treadway Commission: Resources
- Audit Integrity News: Paying the Price for Internal Control Deficiencies; May 2006
- CFO Magazine; Is Going Public Going Out of Style?; Alix Stuart; May 2011
- CFO Magazine: Where There’s Smoke, There’s Fraud; Laton McCartney; March 2011
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