Critical requirements of a system of internal accounting control;

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Critical Requirements of a System of Internal Accounting Control
Robert J. Sack
Touche Ross & Co.
This paper will review those requirements of a system of internal control which can be considered to be "critical." First, it will be important to define and clarify some terms, and establish a context for the discussion in the paper. The body of the paper will review a series of critical requirements, considering first the required-elements of a system and then considering the required characteristics of a system. And finally, the paper will explore the possibility that leadership is the most critical element of any internal control system.
Definitions and Context
Before beginning an analysis of the critical requirements of a system, it is im­portant
to ask, "critical for what purpose?" In fact, that question can be asked in a number of ways: We can ask what requirements are critical for the preparation of accurate financial statements, intended for public reliance. Or we can ask what requirements are critical for the preservation and protection of the entity's assets. Or we can ask what requirements are critical to the development of operating and analytical data, necessary for the running of the business. A system that is de­signed
to assure reliable operating data will function at a level of detail, and with such breadth as to assure the protection of assets, and the development of ac­curate,
public financial statements. Because that is the broadest objective, that will be the context of this paper.
By establishing that broad objective, we will also be saying that we expect the system to control errors at a fairly low level of materiality. Because the system must provide accurate information for operating decisions, materiality will be measured against the cost of a wrong decision. Because decisions are ongoing, a wrong decision can have a multiplying effect, and the measure of materiality—the tolerance of the system—must be quite low. Conversely, if we had said that the objective of the system was to preserve the entity's assets, the standards of the system—the materiality of the losses it is designed to control—could be relatively easier. The assets of the entity may be quite valuable, but it is usually more effec­tive
to insure against the loss of an asset, rather than to design a system which will provide comprehensive protection against its loss. Or, if we had said that the ob­jective
of the system was to produce accurate financial statements for public con­sumption,
the standards applied to the system—the measure of materiality required—might have been even less stringent. Published financial statements
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