What Are Accounting Controls?
Accounting controls consists of the methods and procedures that are implemented by a firm to help ensure the validity and accuracy of its financial statements. The accounting controls do not ensure compliance with laws and regulations, but rather are designed to help a company operate in the best possible manner for all stakeholders.
Key Takeaways
- Accounting controls are put in place to ensure a firm operates efficiently, aboveboard, and provides accurate financial statements.
- The compliance with laws and regulations are not the purpose of accounting controls, but rather to help a company be the best version of itself for all stakeholders.
- The three main areas of accounting controls are detective controls, preventive controls, and corrective controls.
- The Sarbanes-Oxley Act is a piece of regulation drafted to ensure financial reporting avoids any fraudulent activity.
Understanding Accounting Controls
The purpose of implementing accounting controls in a firm is to ensure that all areas in an organization avoid fraud and other issues, improve efficiency, accuracy, and compliance. Every firm will have different accounting controls in place, depending on their type of business, however, there are three traditional areas that are the most common when it comes to accounting controls: detective controls, preventive controls, and corrective controls.
Types of Accounting Controls
Detective Controls
The controls in this category are meant to seek out any current practices that don’t align with the policies and procedures in place. The goal here is to find any areas that are not functioning as they ought to, if employees are accidentally or purposefully practicing incorrect or illegal actions, or detecting any errors in systems or accounting practices. Examples of detective controls would include inventory checks and internal audits.
Preventive Controls
Preventive controls are simply the controls that have been put in place by an organization to avoid any inaccuracies or incorrect practices. These are the policies and procedures that all employees must follow.
An example of a preventive control would be limiting management’s involvement in the preparation of financial statements. Sometimes it’s helpful for management to be involved since they generally know the company better than anyone. But final say on numbers should be in the hands of an accountantbecause management may have the incentive to distort numbers to inflate the company’s performance.
This idea is implemented throughout an organization as the separation of duties, where employees have different tasks that don’t overlap in areas of reporting or auditing, for example.
Corrective Controls
As the name suggests, corrective controls are put in place to fix any issues found through detective controls. These can also include remedying any issues made on accounting books after the audit process has been completed by an accountant.
The Sarbanes-Oxley Act’s Impact on Accounting Controls
Following several high profile corporate accounting scandals at EnronTyco, and WorldCom, from 2000 to 2002, regulators wanted to usher in a new era of heightened financial and operational protocols. To restore investor trust, it was widely accepted that a new culture was required. A host of accounting and financial reporting breakdowns were already in place, but the most pressing issues involved auditor conflicts of interest, weak boardrooms, conflicts among security analysts, limited resources at regulatory agencies, and executive compensation, to name but a few.
To help address these issues, the U.S. Congress passed the Sarbanes-Oxley Act in 2002. The federal law established new or expanded requirements for all U.S. public company boards, management, and public accounting firms. The bill set forth expected responsibilities of a public corporation’s board of directors, added criminal penalties for certain misconduct, and required the Securities and Exchange Commission (SEC) to create regulations that defined how public corporations must comply with the law.
Accounting control systems do not work under one size fits all scenarios. Research on the relationship between business strategies and accounting-based control systems finds organizational design and corporate culture to play a significant role in a business’s success. Consensus agrees that to maximize firm performance, accounting control systems should be designed specifically to suit the unique business strategies of different entities.