ntroduction

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hello and welcome to this session in
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which we will discuss the control
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environment which is one of the five
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components of the internal control
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according to Koso
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in the prior session we looked at the
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internal control overall if you don't
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understand what internal control is or
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what's the purpose of it please look at
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the prior recording when you think of
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the internal control think of the people
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who manages the company who owns the
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company the owners the board of
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directors top management what we're
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looking at here is their attitude their
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behavior toward internal control why
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that is important here's what research
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shows we have this rule called 10
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80
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10. what is that rule there are 10
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percent of the people that are always
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ethical they're always do the right
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thing no matter what there are 10
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percent of the people who are unethical
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does not matter how much you monitor in
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them train them guide them so on and so
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forth that's fine how about the
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remaining the majority 80 percent the
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majority 80 percent of the people follow
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the people on the top therefore
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what determines whether a company is
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ethical or not is the people on the top
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if the people on the top are part of
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this 10 percent then they're going to
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influence the majority of the company
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the remaining 80 and that's why
1:20
controlled environment and a company is
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very important so control the
Control Environment
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environment are actions policies and
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procedures that reflect the overall
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attitude of stop management directors
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and owners of the company
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what is the attitude toward internal
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control and its importance if they value
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internal control the people at the
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bottom the employees will value internal
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control as well now how can we learn
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about the attitude of the the people at
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the top we could look at their
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management philosophy and operating
1:51
style we could look at their integrity
1:54
and ethical values we can look at their
1:56
commitment to competence we can take a
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look at the board of directors and audit
2:00
committee participation we could look at
2:02
the internal audit function itself we
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can take a look at the organizational
2:06
structure and accountability
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and by examining those six it's going to
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give us an idea about the company's
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control environment which is a critical
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component of the internal control let's
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go ahead and get started in discussing
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each of these components separate before
Example Wells Fargo
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we start our discussion I would like to
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show you a sample example from The Real
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World and that's Wells Fargo Wells Fargo
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Bank is a bank is a major Bank in the
2:32
United States so I'm going to show you
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what happened to that bank what happened
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at that bank and we're going to come
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back and look at the various components
2:40
of the controlled environment Wells
2:43
Fargo has been accused by federal
2:44
regulator of illegal activity on a
2:46
stunning level Authority says employee
2:48
at the bank secretly created millions of
2:51
unauthorized bank and credit card
2:53
accounts between 2011
2:55
and July 2015. allowing Bank to make
2:58
more money in fees and meet internal
3:01
sales Target obviously the bank was
3:03
penalized and 5 300 employees were fired
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former employees tell CNN FN CNN money
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that they felt incredible demand from
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managers to meal sales quota
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the same managers turned a blind eye
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when ethical and even legal lines were
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across so keep that statement in mind I
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had a manager in my face yelling Sabrina
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said who worked as a licensed personal
3:26
banker they wanted you to put open a
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dual checking account for people who
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could not even manage their original
3:33
bank account
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currently she's a middle school teacher
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Sabrina says the sale pressure from
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management was unbearable again keep
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those statements in mind as we go back
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to look at the controlled environment
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the pressure cooker environment is also
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described in a lawsuit filed by the Los
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Angeles against the Wells Fargo Bank in
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May 2015. the lawsuit says that Wells
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Fargo district manager discussed daily
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sales for each branch and employee four
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times a day that's a lot of pressure 11
4:00
am 1pm 3 P.M
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and 5 PM so we're putting a lot of
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pressure on their employees it all stems
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from Wells Fargo internal goals of
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selling at least eight Financial
4:12
products it was called the Great the
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great initiative the great eight
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initiative okay and pursuing of the
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school Wells Fargo employee engage in
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all kind of sordid practices one of them
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was internally called pinning where the
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bank issued ATM cards and assigned PIN
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numbers without customer authorization
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also the bankers would impersonate their
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customers and input false generic email
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addresses such as one two three four at
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wellsfargo.com no name at wellsfargo.com
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to ensure the transaction is completed
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now bear in mind employees were doing so
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because why because they were pressured
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by upper management so this is what we
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need to go back and when we look at the
4:52
controlled environment I want you to
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keep Wells Fargo in mind let's start by
Management Philosophy
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discussing management philosophy and
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operating Style
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serves as the most apparent indicator of
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the workforce about significance of
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internal control so how does the
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management run the company gives the
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most strong signal to employees people
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at the bottom to do what to run the
5:15
company
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it's essentially reflect the attitude
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behavior and action of the organization
5:20
leadership again the leadership will
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whatever they do whatever they believe
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it's going to go down to lower
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management and lower management will
5:27
influence employees and this is how the
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company is run so the key questions to
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consider here might include is the
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management setting unrealistic sales and
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profit Target what do you think in case
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of Wells Fargo yes are employees being
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urged to adopt aggressive strategies to
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achieve goals yes remember management
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we're looking the other way when it
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comes to employees
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so the other ways when it comes to
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employees committing fraud also gaining
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insight into management Philosophy by
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the auditor can help auditor with a
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better understanding of the
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organizational stand toward internal
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control
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what's going to happen is this when I
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see when I see as an auditor the
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company's attitude toward internal
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control I am going to learn a lot about
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the company about their behavior about
6:16
internal control and as a result I will
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do what I will adjust my
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I will adjust my strategy in auditing
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this company
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now integrity and ethical value that's
Integrity and Ethics
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another component that can greatly
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influence how internal control are
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perceived and practiced within the
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company does the company has integrity
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and ethical values well that's important
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what are some indicator about that
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well you could look at factors such as
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is there a well understood and enforced
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stance against fraudulent financial
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reporting irrespective at which level it
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occurs
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in other words
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how do we know whether it's the company
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has Integrity analytical values how are
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they treating a financial reporting
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fraudulent financial reporting is
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occurring how does it how do they look
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at it do they tolerate it or not
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tolerated what do you think in in terms
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of Wells Fargo are individual health
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accountable either through dismissal or
7:18
disciplinary action if they participate
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in such Behavior now eventually Wells
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Fargo fired the employees but that's
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after they were discovered so that's
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different to the board
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and Senior Executives constantly
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demonstrate a high standard of integrity
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and ethical Behavior why because their
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action can significantly impact the
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overall ethical climate within the
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organization remember the 10 80 10 rules
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if the 10 percent on the top are ethical
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they're going to influence the Remain
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the remainder 80 percent and the other
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way is the is is true as well is there
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a rooting code of Ethics available to
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employees now although it's written it
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exists as it actively reinforced through
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training communication from leadership
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and requirements for regular written
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statement of compliance from Key
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employees it's not only that you've got
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to tell taking employees to write down
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they believe in it and they are going to
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follow it in other words is the code a
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living document or something that was
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created filed and forgotten because it's
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very important you can have the best
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code
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if it's not being enforced and followed
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how good is it it's not a living
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document it's just a piece of paper
8:27
commitment to competence
Commitment to Competence
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this relates to the knowledge and skills
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needed to effectively perform tasks that
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Define a person's role within the
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organization how does the company look
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at commitment and competence what are
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some indicators of that does management
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prioritize competence when hiring or is
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favoritism toward friends and relative
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prevalent so when they hire people are
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they hired them based on their
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qualification experience skills or are
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they hire them because they know them
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they're doing them a favor now nothing
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wrong with hiring someone that you know
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as long as they are skilled competent
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actually that's easier for you because
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you know them and you know that they are
9:05
skilled and competent but if you are
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doing favoritism overriding competency
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that's a problem this could potentially
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compromise the quality and integrity of
9:16
the workforce as well as the overall
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effectiveness of internal control
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remember part of the internal control is
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to achieve companies objective well if
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you don't have competent employees
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you're not gonna achieve that
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effectiveness
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that's also important to remember the
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presence of incompetent or dishonest
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individual can drastically undermine the
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effectiveness of any internal control
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system if you're hiring people because
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they are your friends and they're not
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competent that's could also negatively
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affect the internal control on the other
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hand honest and efficient employees can
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maintain high performance level even in
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the absence of substantial support from
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other control mechanisms simply put once
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you hire a person that's not competent
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and ethical whether you have a good
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internal control or not that's not the
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issue on the other hand if you hire
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someone who is ethical well whether you
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have a good internal control or not
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they're gonna behave ethically okay
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however you gotta keep in mind elements
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like boredom dissatisfaction or personal
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issues can still disrupt their
10:12
performance so you always have to
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monitor the employees
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What policies are in place regarding the
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hiring evaluation and promotion and
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compensation of competent trustworthy
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individuals so how do they compensate
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those people do they reward them
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or not reward them if they don't reward
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good people good people would leave and
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only the bad people will stay a
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well-defined and robust policy in these
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areas can contribute significantly to
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maintaining a competent Workforce and a
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strong controlled environment and this
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is the commitment to competence how
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about the participation of board of
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directors or the audit committee how
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involved are they
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again those are the people on the top
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it's going to play a pivotal role in
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shaping the controlled environment when
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you see them they are involved what
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should you consider when you are looking
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at this participation of both of
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directors and all that committee
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does the organization have an audit
11:03
committee that's the first thing because
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the audit committee within the board of
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directors is important because that's
11:08
gonna oversees the audit process which
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is an independent mechanism
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is the audit committee genuinely
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functioning independently now you could
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have an audit committee but are they
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truly independent from management
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because they have to because when the
11:22
auditor is auditing the company they're
11:24
going to have to go back to the audit
11:25
committee if they had any issue and the
11:27
auditor will have to rely that the audit
11:29
committee is independent from management
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because your auditing management is a
11:32
truly independent is there an ongoing
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and open communication between the audit
11:36
committee and internal and external
11:39
auditor that's the audit committee have
11:40
the responsibility for hiring the
11:42
external auditor that's important and we
11:44
learn about this that who hires the
11:46
external auditor the audit committee not
11:49
management because of the independence
11:51
issue does the audit committee authorize
11:53
non-audit services for example if we
11:55
want to if the company wants to have
11:58
Consulting Services stock services does
12:00
It Go by the audit committee to evaluate
12:02
whether there is a conflict of interest
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or no conflict of interest that could
12:05
impair Independence also does the
12:08
members of the audit committee have a
12:10
diverse range of expertise range of
12:11
expertise CPAs Business Leaders cfas
12:15
financer Bankers so on and so forth
12:18
including both operational and financial
12:20
control knowledge
12:22
also is the audit committee responsible
12:23
for overseeing the creation of and the
12:25
compliance with ethical standard within
12:27
the organization okay under oversight
12:30
can be crucial in promo in promoting an
12:32
ethical corporate culture so this is how
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we determine
12:37
whether the participation of the board
12:40
of directors and the audit committee
12:41
contributing positively to the control
12:44
environment
Internal Audit
12:45
obviously if we're talking about
12:46
internal control we cannot ignore the
12:48
internal audit function does the company
12:50
have an internal audit Department
12:52
internal audit function
12:54
and its Effectiveness how effective this
12:56
internal control would help external
12:59
auditor tremendously its Effectiveness
13:02
often relies on the support of that
13:04
management the audit committee and the
13:05
board of directors as well as the
13:07
external auditor because if you have a
13:09
good
13:09
internal audit good internal audit then
13:13
you have a better external audit because
13:15
the external auditor would rely on their
13:17
work it's going to save time and
13:19
complete the audit in an efficient
13:21
manner key aspect to to evaluate when
13:23
you're looking at the internal audit
13:24
function first first the first thing is
13:27
a stop management backing the internal
13:30
audit function
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in other words are they backing it in
13:34
terms of budget are they given the
13:36
internal audit Authority okay is there
13:39
substantial back in front of management
13:41
as well as the audit committee and the
13:43
board of directors okay this support is
13:45
essential for the effectiveness of the
13:47
operating of the internal audit and the
13:49
main one you could look at is their
13:50
budget are they given the money to hire
13:52
people to enforce rules within the
13:54
company
13:55
has the written scope of the internal
13:57
audit responsibility has been evaluated
13:59
by the audit committee for adequacy well
14:01
they have this evaluation ensured that
14:03
the internal auditor cover all necessary
14:05
areas has has that been evaluated
14:08
is the organizational relationship
14:09
between the audit committee
14:12
and Senior executive appropriate and as
14:15
appropriate means is is there an
14:17
independence between them internal
14:18
auditor should be independent from
14:20
senior executives
14:22
also we have to look at the turnover is
14:25
there a high turnover rate that might
14:27
indicate instability or misalignment in
14:29
this relationship if you see that people
14:31
are constantly leaving the internal
14:33
audit Department that's bad news why
14:37
reasons one is they may not be happy
14:39
with what's going on
14:40
that's one
14:42
two
14:43
they are not giving enough resources to
14:45
do their job and both are no good
14:48
are audit reports addressing relevant
14:50
subject distributed to the appropriate
14:52
individuals and acted upon promptly so
14:54
when the internal audit Department issue
14:57
a report is it being followed we can
14:59
look at this we can see what's going on
15:00
the timeliness and relevance of the
15:02
audit report are crucial for maintaining
15:05
an effective control environment so to
15:07
determine whether we have a good
15:08
internal audit function we would look at
15:10
all these factors also part of the
Organizational Structure
15:13
controlled environment is the overall
15:15
organizational structure accountability
15:17
what is an organizational structure
15:19
organization organizational structure we
15:21
have a CEO at the at the top CEO at the
15:24
top and from the CEO you have various VP
15:27
vp1 VP of operation VP of Finance VP of
15:31
HR VP of whatever division you want and
15:35
under those VPS you're gonna have maybe
15:37
a manager and so on and so forth this is
15:39
the organizational structure the
15:41
organizational structure comprising The
15:43
Entity level division operating unit
15:45
indoor function all have their own
15:47
control for example
15:48
the VP controls this man this level the
15:52
CEO controls all of them so what
15:54
relationship do they have in between are
15:56
they well defined okay by grasping the
15:59
structure Auditors can comprehend the
16:00
businesses managerial and functional
16:02
aspect and see how controlled are
16:04
enacted so once once they have a clear
16:06
organizational structure we can see that
16:09
there are controls within each
16:10
department controls people above you
16:13
they're monitoring you people below you
16:14
or monitoring the people below you so
16:16
there's clear line of authority
16:17
management and the board are tasks with
16:20
setting expectation and ensuring
16:21
accountability for internal control
16:23
that's their job now this process if
16:25
they want to do that relies on creating
16:27
suitable structure and Reporting lines
16:30
so if you want to enforce the rules if
16:32
you want to enforce controls you want to
16:34
make sure you have a structure that
16:37
allows you to communicate this
16:38
information and enforce it in a way that
16:41
is in align with the organizational
16:43
structure because you're holding people
16:45
accountable
16:46
and this is the sixth component of the
16:49
control environment so what we did in
Summary
16:51
this session we looked at the controlled
16:53
environment as one a five components of
16:55
the internal control and within the
16:57
control environment we looked at six
16:58
different indicators that determine
17:00
whether the company
17:03
value their control environment and
17:05
what's the control environment it's the
17:07
tone at the top the tone of management
17:09
at the top and why that's important
17:11
because the tone on the top it's going
17:13
to follow all the way down in the next
17:15
session we would look at the second
17:16
component of internal control which is
17:19
called risk assessment what should you
17:21
do now you should go to Farhat lectures
17:23
look at additional mcqs true false
17:26
resources that's going to help you
17:27
understand this topic better good luck
17:29
study hard invest in yourself whether
17:32
you are a CPA exam candidate or an
17:34
accounting student and stay safe.