Summary of Ethics, Fraud, and Internal Control.

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Summary

This chapter began by examining ethical issues that societies have pondered for centuries. It is increasingly apparent that good ethics is a necessary condition for the long-term profit- ability of a business. This requires that ethical issues be under- stood at all levels of the firm, from top management to line workers. In this section, we identified several ethical issues of direct concern to accountants and managers. SOX legislation has directly addressed these issues.

The next section examined fraud and its relationship to auditing. Fraud falls into two general categories: employee fraud and management fraud. Employee fraud is generally designed to convert cash or other assets directly to the employee’s personal benefit. Typically, the employee circumvents the company’s internal control structure for personal gain. However, if a company has an effective system of internal control, defalcations or embezzlements can usually be pre- vented or detected. Management fraud typically involves the material misstatement of financial data and reports to attain additional compensation or promotion or to escape the penalty for poor performance. Managers that perpetrate fraud

often do so by overriding the internal control structure. The underlying problems that permit and aid these frauds are frequently associated with inadequate corporate governance. In this section we examined some prominent corporate governance failures and outlined the key elements of SOX, which was legislated to remedy them. Finally, several well-documented fraud techniques were reviewed.

The third section examined the subject of internal control. The adequacy of the internal control structure is an issue of great importance to both management and accountants. Internal control was examined first using the PDC control model that classifies controls as preventive, detective, and corrective. Next, the SAS 78/COSO framework recommended for compliance with SOX was examined. This consists of five levels: control environment, risk assessment, information and communication, monitoring, and control activities. In this sec- tion, we focused on physical control activities including trans- action authorization, segregation of duties, supervision, adequate accounting records, access control, and independent verification.

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