Internal Controls Can Strengthen Your Business By Jeffrey Burr, CPA Because of the fallout from recent accounting scandals surrounding publicly-held companies as well as real or perceived fraud and abuse in government spending, changes were made to the FAR to address the issue of honesty and integrity for federal contractors. For contracts over $5 million and a period of performance over 120 days, these new FAR rules mandate written codes of business ethics and an internal control structure that: 1) is suitable to the size of the contractor; 2) facilitates timely discovery and disclosure of improper conduct; and 3) ensures corrective measures are promptly instituted. For primes and subcontractors not qualified as small businesses, there are additional requirements for business ethics awareness training and a more rigorous internal control system. Although most set-aside contractors will not fall under these more detailed requirements, forward-thinking business owners should consider the positive impact a strong internal control system can have on the smooth running of the company, its profitability and ultimately its value. This article outlines some key concepts in internal controls. Internal controls can be defined as the methods and procedures adopted by management to achieve its corporate objectives. Internal control systems are set up to achieve control objectives which help mitigate risks, threats and vulnerabilities to the company’s financial information system. Control objectives can be thought of as the purpose for having internal controls. Control objectives are met by means of one or more control techniques, the ways that management controls the operations of the company. Generally, internal controls are divided into two levels: Level 1: General Standards These standards establish the overall corporate culture and set the tone for new and existing employees: Reasonable assurance. Internal control systems provide reasonable, not absolute, assurance that objectives of the system will be achieved. Supportive attitude. Management and employees demonstrate a positive and supportive attitude toward internal controls. Competent personnel. Management and employees demonstrate personnel and professional integrity and maintain a level of competence that allows them to perform their functions. Control objectives. Internal control objectives are identified or developed for each activity that are logical, cost effective and reasonably complete. Control techniques. Internal control techniques are effective and efficient in accomplishing their internal control objectives. Level 2: Specific Controls These controls will help deter fraudulent transgressions and well as ensure proper recordation of accounting transactions: Documentation. All transactions and other significant events in the company are clearly documented and this documentation is kept safe. Recording of Events and Transactions. Transactions and other events are promptly recorded in the period in which they occur and are properly classified. Execution of transaction and events. Transactions are authorized and executed only by persons acting within the scope of their authority. Segregation of Duties. Key duties and responsibilities in authorizing, processing, recording and reviewing transactions are separated among individuals. Supervision. Qualified and on-going supervision is provided to employees to ensure that internal control objectives can be achieved. Access to and accountability for resources. Access to resources and records is limited to authorized individuals only. Accountability for the custody and use of resources is assigned to appropriate individuals and is maintained. Strong internal controls don’t happen by accident. They need to be carefully thought out and strike a balance between the control objective achieved and the cost of implementing the control. The benefits of creating a culture of strong internal control in a company are many and include: Good communication. Written documentation of internal controls builds a culture of compliance and can help the company meet its goals. Education. The existence of strong internal controls helps new employees learn the correct procedures for performing their functions. Reduction in Errors. Strong internal controls minimizes errors and helps ensure business and financial information is correct. Perception of Detection. The existence of strong internal controls acts as a deterrent to those considering fraud. It increases the perception that they will be caught. Business owners who spend the time to create first-class internal control systems for their companies build for the future and put in place the infrastructure to take their companies to the next level, as opposed to “flying by the seat of their pants.” This can result in a more attractive company when it comes time to sell the business. Strengthening the system of internal controls in your company need not be an expensive proposition. Your outside accountant can help you with ways to improve your internal controls and thereby your bottom line. Jeffrey Burr, CPA, MBA, CFE, is a director in the forensics practice of Federal Strategies Group LLC. He provides government contract and management consulting, M&A advisory, forensic accounting and expert testimony to the government contracting and technology industries. He can be reached via email at JeffB@FedStrat.com.