Working as the controller for this company I am accountable for all of the accounting operations, which includes the creating of financial reports, maintenance of the accounting system that house the accounting data, and set internal controls to mitigate risk and enhance the accuracy of the reports. The company’s leadership has approached me with questions about the need for an internal control system. So I will justify the need for the system when controls are in place with insurance and portfolio approaches. Also I will explain why current approaches are valid but why an internal system will be much more beneficial.
Controls in place with insurance approach As we take a look at the internal controls with the insurance approach we will see some of the benefits of this approach. The insurance approach falls under the category of transfer. “By transferring a risk, a company solicits the involvement of a third party to take on some of the impact should a risk event occur”(McCarthy, Flynn, & Brownstein, 2004, P. 94). Insurance is a type of risk management “primarily used to hedge against the risk of a contingent, uncertain loss” (Wikipedia, 2012).
So if a company can find some affordable insurance with deductibles that the company feels comfortable with then this approach can be very beneficial in the event of a catastrophic disaster because then the company would only be responsible for paying the deductible and the insurance company would pay the rest. Controls in place with portfolio approach Now we will look at the internal controls with a portfolio approach, and we will see the benefits from this approach. The portfolio approach is used to minimize risk while maximizing the investment.
Portfolio risk is “the possibility that an investment portfolio may not achieve its objectives. There are a number of factors that contribute to portfolio risk, and while you are able to minimize them, you will never be able to fully eliminate them” (Spowart, 2012). Value at risk “is a widely used risk measure of the risk of loss on a specific portfolio of financial assets. For a given portfolio, probability and time horizon, VaR is defined as a threshold value such that the probability that the mark-to-market loss on the portfolio over the given time horizon exceeds this value is given probability level” (Wikipedia, 2012).
Some of the advantages to this approach are that it quantifies potential losses in simple terms and is very versatile. Current approaches vs. Internal systems The current approaches are for example the two approaches that I used above, insurance approach and portfolio approach. These two approaches are valid in the sense that the insurance approach basically knows where a certain degree of risk exists in the company and that in order to protect the company’s investment they acquire the help from a third party.
So now the third party consumes some of that risk that the company has identified. The company using the insurance company has turned into a tool to protect the investment, thus making it a risk financing tool but not a risk management tool. With the portfolio approach it is used to try an reduce risk while at the same time maximizing the company’s investment. But, with this approach it does not provide protection over the investment but instead it organizes the decision-making process.
Internal control is “defined as a process affected by an organization’s structure, work and authority flows, people and management information systems, designed to help the organization accomplish specific goals or objectives” (Wikipedia, 2012). The reason that internal systems are more beneficial is because it has policies and procedures that will make sure the company’s investments are protected. Internal controls inspire reliability in the company’s financial reporting, and also improve the company’s internal as well as external communication by being proactive and evaluating potential risks and problems.
Another advantage is that it serves as a safeguard to the company’s investment. So I have just gone through how insurance approaches can help a company shift some of their risk to a third party which will help protect the company’s investments. Also, I talked about the portfolio approach and how it can minimize risk while maximizing investments at the same time. The definition of what an internal controls system is and how it can be beneficial to a company versus it current approaches were also mentioned above.
McCarthy, P. , Flynn, T. , & Brownstein, R. (2004). Risk from the CEO and board perspective: What all managers need to know about growth in a turbulent world. New York, NY: McGraw-Hill. Spowart, M. (2012). The Definition of a Portfolio Risk. Retrieved from http://www. ehow. com/about_6193136_definition-portfolio-risk. html Wikipedia. (2012, April 2). Insurance. Retrieved from http://en. wikipedia. org/wiki/Insurance Wikipedia. (2012, March 24). Value at Risk. Retrieved from http://en. wikipedia. org/wiki/Value_at_risk Wikipedia. (2012, March 29). Internal Control. Retrieved from http://en. wikipedia. org/wiki/Internal_control