By Chan Hoi Leong,
Researcher
Topic: Education
Area
of discussion: Auditing
Chapter: Internal
Control Systems (PAPAMOSS)
The primary objective
of this posting is to critically discuss and explain each element of PAPAMOSS
in detail, with some practical examples given to facilitate a clearer
understanding. I noticed that there are lack of detailed notes available online
nor in books about this topic, so I decided to do some researches and write
about this PAPAMOSS’s concept. By the way, this topic is examinable in ACCA
examinations (e.g. P1 & P8). Seriously, I hope that this posting can help
you to understand the concept better. Kindly share this information with your
friends, if you find that this is useful. In addition, if you have any comments
which can improve the content of this posting, please do leave a message below.
Internal control systems
As defined in Paragraph 4(c) of ISA
315, internal control is “the process designed, implemented and maintained by
those charged with governance, management and other personnel to provide
reasonable assurance about the achievement of an entity’s objectives with
regard to reliability of financial reporting, effectiveness and efficiency of
operations, and compliance with applicable laws and regulations.”
It includes all the policies and
procedures (internal controls) adopted by the directors and management of an
entity in order to achieve their goals of ensuring, as far as practicable, the
orderly and efficient conduct of its business, including: adherence to
management policies; safeguarding of assets; prevention and detection of fraud
and error; ensuring the accuracy and completeness of the accounting records;
and timely preparation of reliable financial statements (Kan, 2013; Kwok, 2005).
Auditors generally seek to rely on the internal controls within an entity to
reduce the amount of testing on final balances.
Interestingly, the eight features of
an internal control system are popularly known through these two mnemonics
words, namely “PAPAMOSS” or “SOAPSPAM”. The eight features are:
Physical control:
This
is mainly concerned with the custody and protection of assets such as cash and
inventories. It involves tight security measures and procedures to ensure that
only authorised personnel have access to the records and assets. For examples,
the installation of fences, gates, doors as well as the use of locks and keys.
Authorisation and approval control:
No
transactions should be carried out and no documents should be processed,
without the approval or permission from an appropriate and responsible person.
Approval like signing must be done with consent. Not only that, limits on
authorisation should be clearly specified too.
Personnel control:
These
are procedures put in place to ensure that staffs have capabilities
commensurate with their responsibilities. Kan (2013, p.162) highlights that the
hiring of well-motivated competent employees, who have the required integrity
for their tasks, will ensure that the control system operates properly. Most
importantly, the consideration here should stress on the qualification,
selection, training and the worker’s innate personal characteristics. Besides,
big companies usually have their own dress code systems which require personnel
to wear specific attire or uniform in order to indicate a personnel’s rank or
department.
Arithmetical and accounting control:
Persons
in charge should ensure that all transactions have been authorised before they
are sent for recording and processing purposes. After that, the persons in
charge must check whether they got left out anything and make sure that all
transactions are correctly recorded and accurately processed. Such controls may
include checking the arithmetical accuracy of the records like control
accounts, cross totals, reconciliations, trial balance and sequential controls
over documents.
Management control:
These
are the controls exercised by the management outside the daily routine of the
system. For example, overall supervisory controls, review of management
accounts, budgetary controls, internal audit function and other special review
procedures.
Organisational control:
Kan
(2013, p.162) states that a well-defined organisational structure shall show
clearly how responsibilities and authorities are delegated as well as identify
lines of reporting for all aspects of the enterprise’s operations. A tall
organisational structure usually has a narrow span of control where managers
can manage their subordinates easily but communication might be distorted due
to higher level of hierarchy plus employing many managers is costly. Research
organisations normally have these characteristics. Conversely, a flat organisational
structure has a wider span of control where managers have fewer time to
supervise all their subordinates but there will be lesser distortion in
communication as the hierarchy level is shorter plus subordinates are cheaper
to hire as compared to managers. This is common in manufacturing industries
(Jones and George, 2003, pp.311-312).
Supervision control:
Supervision
by responsible officials of the day-to-day transactions and the recording
thereof is an integral part of any control system. For instance, management
accounts are reviewed for reasonableness by a qualified accountant.
Centralisation might facilitate supervision across management.
Segregation of duties:
Ideally,
responsibilities and duties must be separated to a number of people, so that no
individual can fully record and process a transaction completely. Furthermore,
it reduces the risk of intentional manipulation or mistake and increase the
element of checking. Functions which should be separated include authorisation,
execution, custody, recording and so on. However, if collusion takes place or
if people work together to circumvent the system, then segregation of duties
may be ineffective as this situation often making fraud difficult to detect
(Gray and Manson, 2011, p.282).
Conclusion
It
is noted that significant deficiencies in internal controls shall be
communicated in writing to those charged with governance in a report to
management. The written communication should include a description of the
deficiencies and their potential effects. ISA 265 requires auditors to find out
the number of identified deficiencies and their relative significance. Auditors
may also provide suggestions for remedial action.
References
Gray, I. and Manson,
S., 2011. The audit process: principles,
practice and cases. 5th ed. Australia: South-Western Cengage.
Jones, G.R. and George,
J.M., 2003. Contemporary management.
3rd ed. New York: McGraw-Hill.
Kan, E., 2013. Audit and assurance – principles and
practices in Singapore. 3rd ed. Singapore: CCH.
Kwok, B.K.B., 2005. Accounting irregularities in financial
statements: a definitive guide for litigators, auditors, and fraud
investigators. Aldershot: Gower Publishing Limited.
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