THE CONTROL ENVIRONMENTSAS 319: The control environment sets the tone of an organization, influencing the control consciousness of its people. It is the foundation for all other components of internal control, providing discipline and structure. ESSENTIAL ELEMENTS OF THE CONTROL ENVIRONMENT ARE:1. BOARD OF DIRECTORSMain power center of the corporationPrimary function to represent shareholdersLegal power to govern the corporation2. ORGANIZATIONAL STRUCTUREDefines areas of responsibility, limits of managerial authority, and lines of reporting. Defines who is expected to do what. Defines what decisions the managers can make, what responsibility people have, who they report to, who reports to them. Provides the framework within which all the organization’s activities are planned, executed, monitored and controlled.Organizational chart and job descriptionsSpan of controlWays to organize a company: by geographic location, by functional activity, by industry or product line, by project, by distribution or marketing network3. MANAGEMENT ATTITUDES, PHILOSOPHY, AND OPERATING STYLEDetermine to large extent the internal control systemFocus on business and personal ethicsApproach to business risk (risk averse, risk loving, risk neutral)Behavior toward other managers or subordinatesExpectations of work quality or performanceAttitude toward accounting functions—accounting principle choicesConcern for internal control4. MANAGEMENT CONTROL MECHANISMSUse of budgets and standardsFormal written statement of management’s goals and objectives expressed in dollars and cents.Provides set of targets for the entire organization, prepared for 12 month periods.Responsibility accounting: balance between management authority and responsibility.Controllable revenues, expenses, assetsWeakness of short term financial control targets vs long term5. PERSONNEL POLICIES AND PRACTICESBuilding a reliable work forcePolicies should address and document: hiring practices, training, evaluation (fair, periodic, copies of written evaluations to employees), promotion policy (hire from outside or from within)Compensation and recognition practicesNecessary resources provided to employeesCorporate code of conduct: behavior toward customers, vendors, other employees, nepotism (marriage to another employee), political contributions, outside activities of employees, confidentiality, personal appearance, conduct in the workplace, controlled substance abuse, safety regulations6. AUDIT COMMITTEEThe audit function is made up of three components: the audit committee, the internal auditor, the external auditor.The audit committee is responsible for:Making recommendations to the board regarding selection of external auditor.Reviewing significant financial informationSeeing that effective internal control structure is maintained (Foreign Corrupt Practices Act 1977, SOX 2002)Conducting investigations concerning potential fraud or irregularities of management.Communications link between internal, external auditors, and the board.7. INTERNAL