chapter 10

1. chapter 10 Section 404 Audits Sarbanes-Oxley Act section 404

2. Societe Generale • junior trader gambled more than the entire net worth of the bank

3. National Commission on Fraudulent Financial Reportingthe “Treadway Commission”1987 Committee of Sponsoring Organizations “COSO”

4. COSO Committee of Sponsoring Organizations organizations that sponsored the Treadway Commission American Institute of Certified Public Accountants American Accounting Association Institute of Internal Auditors Institute of Management Accountants Financial Executives Institute

5. Aarti how does COSO define internal controls ?

6. COSO internal controls Internal control is a process, effected by an entity’s board of directors, management and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following three categories:

7. COSO internal controls • reliability of financial reporting • effectiveness and efficiency of operations • compliance with applicable laws and regulations

8. Foreign Corrupt Practices Act1977 any corporation that has a class of securities registered, or that is required to file reports under the Securities and Exchange Act of 1934

9. U.S. CodeTITLE 15--COMMERCE AND TRADE CHAPTER 2B--SECURITIES EXCHANGES

10. (2) Every issuer pursuant to section 78l or … shall– • make and keep books, records, and accounts, which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer; (B) devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that– (i) transactions are executed in accordance with management's general or specific authorization; (ii) transactions are recorded as necessary • to prepare financial statements in conformity with GAAP, and (II) to maintain accountability for assets; (iii) access to assets is permitted only in accordance with management's general or specific authorization; and (iv) the recorded accountability for assets is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to any differences; and

11. Sarbanes-Oxley Act 2002 § 7262. Management assessment of internal controls (a) Rules required The Commission shall prescribe rules requiring …. an internal control report, which shall— (1) state the responsibility of management for establishing and maintaining an adequate internal control structure and procedures for financial reporting; and (2) contain an assessment, as of the end of the most recent fiscal year of the issuer, of the effectiveness of the internal control structure ... (b) Internal control evaluation and reporting …, each registered public accounting firm that …issues the audit report for the issuer shall attest to, and report on, the assessment made by the management of the issuer.

12. Page 48 We have audited internal control over financial reporting as of Dec. 31, 2011, based criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). MMC’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company's internal control over financial reporting based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audits of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinion. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of managementand directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, MMC maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on COSO criteria.

13. Desiree what is the second standard of field work ?

14. 2nd standard of field work The auditor must obtain a sufficient understanding of the entity and its environment including its internal control structure to assess the risk of material misstatement of the financial statements whether due to error or fraud, and design the nature, timing and extent of further audit procedures

15. Molly what is the definition of control risk?

16. Control Risk Control risk is the probability that the company’s internal controls will fail to prevent or detect material misstatements

17. Michael Discuss reasonable assurance.

18. Reasonable Assurance the concept of reasonable assurance allows for only a remote likelihood that material misstatements will not be prevented or detected on a timely basis

19. Lorena Under Sarbanes-Oxley management must report on the effectiveness of the company’s internal controls. With Regard to Internal Controls, what STATEMENTS must MANAGEMENT include in their annual report ?

20. Section 404 of Sarbanes-Oxley managements’ statements page 253 1 management is responsible for effective internal controls over financial reporting 2 management’s assessment of the effectiveness of the internal controls 3 the framework used to evaluate the effectiveness of the internal controls

21. Evaluate the Effectiveness • management must evaluate the design of internal controls • management must test the operating effectiveness of those controls

22. Macey what framework will management use to evaluate the effectiveness of internal controls ?

23. Controls over Significant Classes of Transactions

24. Page 254 (design of internal control) Risks related to all relevant assertions For all significant accounts and disclosures Evaluating Significant classes of transactions Identify points in the transactions where material misstatements could occur How each significant class of transactions • Initiated • Authorized • Recorded • Processed through the accounting system • Reported in the financial statements and disclosures

25. Page 263 (demonstrate understanding of the accounting system) Document • the Significant Classes of Transactions • Initiated • Recorded - what accounting records exist • How the system captures other events significant to the f/s Procedures to enter transactions into the Gen Ledger • Nature & details of the financial reporting process

26. Thomas COSO – 5 components of internal control what are the five components of the internal control framework ?

27. COSO components of internal controls • Control environment • Risk assessment • Control procedures • Information and communication • Monitoring

28. COSO components of internal controls • Control environment • Risk assessment • Control procedures • Info & Comm --- Accounting System is part of • Monitoring

29. 1. Control environment • management’sintegrity and ethical values • commitment to competence • board of directors and audit committee • management’s philosophy and operating style • organizational structure • human resource policies and practices page 256-57

30. 1. Control environment – Audit Committee Board of Directors - Audit Committee – Outside Directors • Appointment of auditors • Resolve differences between management and auditors • Oversight of internal audit • Approval of non-audit services by auditor page 257

31. COSO components of internal controls • Control environment • Risk Assessment • Control procedures • Information and communication • Monitoring

32. 2. Risk assessment How does the audit client manage risk? Internal control is a process, effected by an entity’s board of directors, management and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following three categories: Focus on risk oversight Page 183

33. Doug how does a business raise money ? what does it do with the money it raises? why do businesses invest in assets instead of government insured savings accounts ?

34. Amanda what can you assume when the Expected Rate of Return for an investment exceeds the interest rate on gov’t insured savings accounts ?

35. business is about managing risk otherwise companies should invest their money in gov’t insured savings accounts companies invest in risky assets and the auditors must understand how the company manages risks to convert those assets into cash receipts

36. How does the audit client manage risk? the little highlight boxes COSO Enterprise Risk Management p. 260 Broader focus on Risk Management p 183

37. COSO components of internal controls • Control environment • Risk assessment • Control procedures • Information and communication • Monitoring

38. 3. Control Procedures Adequate segregation of duties Proper authorization of transactions & activities Adequate documents & records Physical controls over assets & records Independent checks on performance

39. 3. Control Procedures Must separate p. 259 Custody of Assets from (Record-Keeping) Accounting Authorization of Transactions from Custody of related Assets Operational Responsibility from Record-Keeping Responsibility IT Duties from User Departments

40. 3. Control Procedures Must separate p. 259 Custody of Assets Authorization of Transactions Record-Keeping

41. 3. Control Procedures Adequate documents and records Pre-numbered documents • Checks • Purchase orders • Shipping documents

44. Kristin B if you discover a check that was not recorded to which financial statement assertion does an unrecorded check relate ?

45. COSO components of internal controls • Control environment • Risk assessment • Control procedures • Information and communication • Monitoring

46. 4. Information & Communication / Monitoring • Account balances are used to prepare external financial statements • Internal reports are part of management’s feedback for Monitoring operations

47. COSO components of internal controls • Control environment • Risk assessment • Control procedures • Information and communication • Monitoring

48. 5. Monitoring • Internal audit • Compare reports with your knowledge of the business • Customer complaints • Vendor complaints • Regulators’ reports • Periodic reconciliations

49. Understanding Internal Controls Obtain an understanding of internal controls The design of internal controls Document understanding Assess Control Risk (preliminary) Test Operating Effectiveness of controls Assess Control Risk (after ToC’s)

50. Page 263 (demonstrate understanding of the accounting system) Document • the Significant Classes of Transactions • Initiated • Recorded - what accounting records exist • How the system captures other events significant to the f/s Procedures to enter transactions into the Gen Ledger • Nature & details of the financial reporting process