9611 San Luis Obispo - California State University

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FISMA
CALIFORNIA POLYTECHNIC STATE UNIVERSITY,
SAN LUIS OBISPO
Report Number 96-11
June 19, 1996
Members, Committee on Audit
Ted J. Saenger, Chair
Bernard Goldstein, Vice Chair
Roland E. Arnall Ronald L. Cedillos
James H. Gray William Hauck Joan Otomo-Corgel
Ali C. Razi Frank Y. Wada Stanley T. Wang
Staff
Acting University Auditor: Larry Mandel
Management Auditor: Douglas Kennedy
BOARD OF TRUSTEES
THE CALIFORNIA STATE UNIVERSITY
CONTENTS
ii INTRODUCTION
Purpose .................................................................................................... 1
Scope and Methodology ................................................................................ 1
Background............................................................................................... 2
Opinion .................................................................................................... 3
Executive Summary..................................................................................... 3
OBSERVATIONS, RECOMMENDATIONS,
AND CAMPUS RESPONSES
Cash Receipts .............................................................................................. 6
Purchasing .................................................................................................. 6
Revolving Fund ............................................................................................ 7
Cash Disbursements/Accounts Payable ............................................................... 8
Payroll/Personnel.......................................................................................... 9
Fixed Assets................................................................................................10
Addition of Property to Inventory.............................................................10
Reconciliation of Expenditures with Property Records ...................................11
Investments ................................................................................................12
Trust Funds................................................................................................12
Documentation.....................................................................................12
CONTENTS
iii
APPENDICES
APPENDIX A: PERSONNEL CONTACTED
APPENDIX B: STATEMENT OF INTERNAL CONTROLS
APPENDIX C: CAMPUS RESPONSE
APPENDIX D: CHANCELLOR'S ACCEPTANCE
ABBREVIATIONS
CSU California State University
EO Executive Order
FISMA Financial Integrity and State Manager's Accountability Act
SAM State Administrative Manual
SUAM State University Administrative Manual
PURPOSE
The principal audit objective was to assess the adequacy of controls and systems which assure that:
Ø cash receipts are processed in accordance with laws, regulations and management's policy;
Ø receivables are promptly recognized and balances are periodically evaluated;
Ø purchases are made in accordance with laws regulations and management policy;
Ø revolving fund disbursements are authorized and processed in accordance with laws, regulations
and management's policy;
Ø cash disbursements are properly authorized and are made in accordance with established
procedures and adequate segregation of duties exists;
Ø payroll/personnel criteria for hiring employees, establishing compensation rates and authorizing
disbursements are controlled and personnel and payroll are processing records and processing
areas are restricted;
Ø purchase and disposition of fixed assets are controlled and recording of assets are made promptly
in the subsidiary records;
Ø physical computer controls are in place and functioning;
OBSERVATIONS, RECOMMENDATIONS, AND CAMPUS RESPONSES
4
Ø investments are adequately controlled and securities are safeguarded; and
Ø trust funds are established in accordance with SUAM guidelines.
SCOPE AND METHODOLOGY
The management review emphasized, but was not limited to, compliance with state and federal laws,
Board of Trustee policies, and Office of the Chancellor policies, letters, and directives. For those audit
tests which required annualized data, the 1994-95 fiscal year was the primary period reviewed. In
certain instances, we were concerned with representations of the most current data—in such cases, the
test period was July 1995 to February 1996. Our primary focus was on internal controls. Specifically,
we reviewed and tested:
Ø posting of the original budget and major budget revisions;
Ø procedures for receipting and storing cash, segregation of duties involving cash receipting and
recording of cash receipts;
Ø establishment of receivables and adequate segregation of duties over the establishing of billing for
and payment of receivables;
Ø approval of purchases, receiving procedures and reconciliation of expenditures to State
Controller's balances;
Ø limitations on the size and types of revolving fund disbursements;
Ø use of petty cash funds, periodic cash counts, and reconciliation of bank accounts;
Ø authorization of personnel/payroll transactions, accumulation of leave credits in compliance with
state policies and maintenance of minimum leave balances for participants in the direct deposit
program;
Ø posting of the property ledger, monthly reconciliation of the property to the general ledger, and
physical inventories;
Ø access restrictions to automated accounting systems and proper documentation of the systems;
Ø procedures for initiating, evaluating, and accounting for investments; and
Ø establishing of trust funds, separate accounting, adequate agreements, and annual budget.
OBSERVATIONS, RECOMMENDATIONS, AND CAMPUS RESPONSES
5
We have not performed any auditing procedures beyond the date of our report. Accordingly, our
comments are based on our knowledge as of that date and should be read with that understanding.
Since the purpose of our comments is to suggest areas for improvement, comments on favorable matters
are not discussed.
BACKGROUND
In 1983, the California Legislature passed the Financial Integrity and State Manager's Accountability
Act of 1983 (FISMA). This act required that state agencies establish and maintain a system of internal
accounting and administrative control. To ensure that the requirements are fully complied with, the
head of each agency is required to prepare and submit a report on the adequacy of the system of
internal accounting and administrative control following the end of each odd-numbered fiscal year.
Prior to 1992, the California Department of Finance had conducted these reviews. However, due to
staffing reductions they are no longer conducting such audits. The Office of the University Auditor of
the CSU is now responsible for conducting the audits of internal accounting and administrative control
within the CSU. This report represents our biennial review.
OPINION
We visited the California Polytechnic State University, San Luis Obispo from January 29,1996 through
March 8, 1996 and audited the internal control structure in effect at that time.
In accordance with the Government Code Section 13402, et seq., state agency heads are responsible for
establishing and maintaining systems of internal accounting control. The broad objectives of control
systems for state agencies are to provide management with reasonable, but not absolute, assurance that:
Ø assets are safeguarded from unauthorized use or disposition; and
Ø transactions are executed in accordance with management's authorization and recorded properly
to permit the preparation of financial reports in accordance with the State Administrative Manual.
Because of inherent limitations in control systems, errors or irregularities may occur and not be
detected. In addition, projection of any evaluation of systems to future periods is subject to risk since
procedures may become inadequate as a result of changes in conditions, or the degree of compliance
with the procedures may deteriorate. (See Appendix B, Statement of internal Controls.)
We found that, except for the items noted in the Executive Summary and in the detail of the report,
controls were in place and functioning adequately and compliance with related CSU and campus policies
and procedures were satisfactory.
EXECUTIVE SUMMARY
OBSERVATIONS, RECOMMENDATIONS, AND CAMPUS RESPONSES
6
The purpose of this section is to provide management with an overview of conditions requiring their
attention. Areas of review not mentioned in this section were found to be satisfactory. Numbers in
brackets [ ] refer to page numbers in the report.
CASH RECEIPTS [6]
Checks received in the admissions office were not restrictively endorsed until they were taken to
the cashier (which could be up to four days after receipt). Controls over cash receipting at the
admissions office were not adequate. Endorsing checks by the end of the day received and storing
the checks in a secure location will reduce the risk of misappropriation or theft.
PURCHASING [6]
The purchasing sub-delegation of authority from the director of support services to staff buyers
had not been updated since September 1992. In addition, purchase orders were authorized by
buyers in excess of their individual delegations. Updating the purchasing delegation will allow
the campus to properly communicate control requirements to the individual buyers. Development
of new procedures will restrict buyers from obligating the campus for unauthorized purchases.
REVOLVING FUND [7]
Counts were not occurring as frequently as required for ten of the campus's sixty-five petty
cash/change funds. Internal control over cash funds is strengthened when the required
accountability is enforced.
CASH DISBURSEMENTS/ACCOUNTS PAYABLE [8]
Checks written by the campus, for over $15,000, did not have the required two signatures in six
percent (4/65) of the instances in our sample (August, September, October, and November 1995).
The use of two signatures increases internal control over cash assets and reduces the risk of
misuse of funds.
PAYROLL/PERSONNEL [9]
Personnel separation forms were not completed on a regular basis. Strengthening controls to
assure that all employees complete a clearance form before delivery of their final paycheck will
ensure the return of state property, advances, ID cards and the deletion of computer access codes.
FIXED ASSETS
ADDITION OF PROPERTY TO INVENTORY [10]
OBSERVATIONS, RECOMMENDATIONS, AND CAMPUS RESPONSES
7
Three of twelve of equipment acquisitions sampled were neither added to the equipment inventory
nor tagged. Entering new acquisitions to the inventory timely ensures that property records
reflect true cost. Tagging new acquisitions reduces the potential for the property to be lost or
stolen.
RECONCILIATION OF EXPENDITURES WITH PROPERTY RECORDS [11]
The campus did not prepare monthly property reconciliations with changes to the expenditure subledger accounts. Completing the monthly property reconciliations with changes to the expenditure
sub-ledger accounts reduces the risk of errors and irregularities going undetected for extended
periods of time.
INVESTMENTS [12]
A written agreement between the campus and the Associated Students, Inc., to provide for the
investment of their funds by campus staff, has not been completed. This is a repeat of a FISMA
audit finding in our previous report. The development of a formal written agreement between
the campus and the auxiliary organizations, which delineates promises and considerations from
both sides, reduces the potential for misunderstandings.
TRUST FUNDS
DOCUMENTATION [12]
Trust fund accounts were not fully documented. Obtaining required data reduces speculation as
to the desires of the entity who established the account.
CASH RECEIPTS
Restrictive Endorsements
Checks received in the admissions office were not restrictively endorsed until they were taken to
the cashier which could be up to four days after receipt. The admissions office was not
restrictively endorsing the checks because it had not been issued a restrictive endorsement stamp.
Storage of Checks
Controls over cash receipting at the admissions office were not adequate. Checks were being
stored in an open cabinet close to the rear door of the admissions office. The cabinet doors had
been removed by order of the city fire marshal but the checks had not been moved to a more
secure location.
SAM Section 8023 requires that:
OBSERVATIONS, RECOMMENDATIONS, AND CAMPUS RESPONSES
8
All checks, money orders, and warrants received for deposit will be restrictively
endorsed for deposit as soon as practicable after receipt, but no later than the end
of the working day.
SAM section 8030.1 notes that when accumulated collections are not in use, they will be locked in
a desk, file cabinet, or other device providing comparable safekeeping.
By not endorsing checks by the end of the day received and not storing the checks in a secure
location, the risk of misappropriation or theft is increased.
Recommendation 1
We recommend that all checks received in the admissions office be restrictively endorsed by the
end of the day they are received and checks be stored in a secure location after they are received.
Campus Response
We concur. The Admissions Office is now endorsing checks by the end of the day on which they
are received. At the end of each day any undeposited checks are placed in a locked cabinet. This
practice was initiated while the audit was still in progress.
PURCHASING
The purchasing sub-delegation of authority from the director of support services to staff buyers
had not been updated since September 1992. In addition, purchase orders were authorized by
buyers in excess of their individual delegations.
Two employees have left the staff and one has been added since the 1992 sub-delegation. None of
the procurement staff has been delegated authority to approve purchase orders over $25,000 in
the absence of the support services director. Two of the twenty-five purchase orders sampled, and
authorized by buyers, were for amounts that exceeded $25,000.
Executive Order 615 delegated the procurement authority granted to the CSU to the campus
president. This authority may be further delegated by the president to campus designees subject
to the same conditions.
The director of Support Services indicated that he had inadvertently failed to update the
purchasing sub-delegation. He also noted that the buyers may have exceeded their authority in
an attempt to expedite the purchases while he was away from the office.
By not updating the purchasing delegation, the campus has not properly communicated control
requirements to the individual buyers. Lack of enforceable restrictions has allowed buyers to
obligate the campus for unauthorized purchases.
OBSERVATIONS, RECOMMENDATIONS, AND CAMPUS RESPONSES
9
Recommendation 2
We recommend that the:
a. delegation of authority to the purchasing staff be updated to reflect current conditions; and
b. campus develop procedures which will restrict buyers from exceeding their individual
delegations.
Campus Response
We concur. Delegation letters, reflecting the current authority of each Purchasing Office staff
member, have been issued. Included in the letters are specific instructions regarding proper
procedures for purchases which exceed delegated levels.
REVOLVING FUND
Counts were not occurring as frequently as required for ten of the campus's sixty-five petty
cash/change funds.
Three change funds in the custody of public safety services had never been counted. Five petty
cash funds in the cashier's office had not been counted for a ten month period, one fund in the
health center had not been counted for six months, and one fund in facility services had not been
counted for ten months—although a monthly count was required for eight funds and quarterly
counts were required for two funds.
SAM Section 8111.2 requires that:
An employee other than the custodian of the change or petty cash fund will count
it in accordance with the following schedule and report the count to the accounting
officer.
OBSERVATIONS, RECOMMENDATIONS, AND CAMPUS RESPONSES
10
Size of Fund Frequency of Count
$200.00 or less Annually
$200.01 to $500.00 Quarterly
$500.01 to $2500.00 Monthly
Over $2500.00 Monthly, if not prescribed more frequently
by Fiscal Systems and Consulting Unit,
Department of Finance
The assistant director Fiscal Services-Payment Management indicated that it was difficult to count
the three change funds in the control of the public safety department without closing the parking
pass dispensing operation. The five other cash/change funds were not counted as frequently as
required due to confusion in assignment of fund counting responsibilities.
Internal control over cash funds is compromised when the required accountability is not enforced.
Recommendation 3
We recommend that the campus count petty cash and change funds as frequently as required.
Campus Response
We concur. The petty cash in the Cashiers' Office, the Health Center and Facilities Services are
now counted in accordance with SAM requirements. We will begin cash counts at Public Safety
in accordance with the SAM schedules.
Our view is that the counts required by SAM are too frequent and result in use of excessive
resources relative to the amounts of cash at risk. We suggest that the Trustees Audit Staff conduct
a review of the timing of these counts relative to losses experienced and initiate a request that the
cash count frequencies be adjusted, if such a request can be supported by the results of this
review.
CASH DISBURSEMENTS/ACCOUNTS PAYABLE
Revolving fund checks written by the campus, for over $15,000, did not have the required two
signatures in six percent (4/65) of the instances in our sample (August, September, October, and
November 1995).
SAM Section 8041 states that:
Any check drawn in excess of $15,000 will require two authorized signatures unless
it is payable to (1) the State Treasurer, (2) another State agency or account, or (3)
if the Department of Finance, Fiscal Systems and Consulting Unit, has authorized,
OBSERVATIONS, RECOMMENDATIONS, AND CAMPUS RESPONSES
11
in writing, special instructions permitting an agency to deviate from the
requirement.
The assistant director Fiscal Services-Financial Reporting informed us that the situations noted
above were an oversight as campus procedures do require two signatures on checks over $15,000.
The lack of two signatures compromises internal control over cash assets and leaves the campus
open to possible misuse of funds.
Recommendation 4
We recommend that the campus strengthen controls to assure that all checks over $15,000 have
two authorizing signatures.
Campus Response
We concur. Procedures have been revised to eliminate the releasing checks for amounts of $15,000
or more without the required second signature. Vendors will be advised that scheduled
disbursement dates are tentative and subject to all requirements for release including second
signatures for checks in excess of $15,000.
PAYROLL/PERSONNEL
Personnel separation forms were not completed on a regular basis. Three of eight employees in
our sample review had not completed a personnel separation form before leaving the campus.
Both the campus faculty handbook and the campus staff handbook contain a requirement that all
employees who separate from employment must complete a separation form.
The assistant director of Fiscal Services-Payroll noted that, while the campus has a procedure for
terminating employees to submit separation forms, it is difficult to enforce. She stated that the
campus cannot refuse to disburse the final payroll warrant—it can only withhold the amount of
any advances owed the university. As a result, the campus can only encourage employees to
submit the separation forms.
Completion of the clearance form prior to delivery of the final paycheck helps to ensure internal
control over such areas as: departments (return of keys, state property, phone cards, cancellation
of signature authority); the Computer Center (access codes and account numbers deleted);
University Services (return of ID cards, Department of General Services card, rental car card);
Payroll (salary advances); and Cashiering (advances cleared, accounts receivable cleared,
American Express card returned).
Recommendation 5
OBSERVATIONS, RECOMMENDATIONS, AND CAMPUS RESPONSES
12
We recommend that the campus increase its effort in obtaining separation forms from terminating
employees.
Campus Response
A study has been initiated by the Payroll Office to review the purpose of the personnel separation
form, the form currently in use, and the processes currently in place, and to determine the best
methods for accomplishing the intended purposes of the form. New and existing processes (as
revised, if applicable) will be documented in the Payroll Office Procedure Manual and/or as part
of another permanent reference, as appropriate.
FIXED ASSETS
ADDITION OF PROPERTY TO INVENTORY
Our review of equipment acquisitions indicated that three of twelve items in our sample were
neither added to the equipment inventory nor tagged.
SAM Section 8650 requires that:
Departments will keep records of all capitalized property. Departments will record
the following information when property is acquired:
1. Date acquired;
2. Property description;
3. Property identification number;
4. Cost or other basis of valuation;
5. Owner fund; and
6. Rate of depreciation, if applicable
SAM Section 8651 states that:
When practical, all State property will be tagged after acquisition.
The accounting office prepares a weekly computerized report of equipment purchases which is
transmitted to the property clerk for use in tagging and entering items in the equipment inventory.
The property clerk indicated that the three items noted above were never included in the weekly
reports. The accounting staff is reviewing the current process to determine if the software used
to generate the reports is flawed or if the information was never entered.
When property is not entered on the property inventory, the property records are understated.
When property is not tagged, the potential for the property to be lost or stolen is increased.
Recommendation 6
OBSERVATIONS, RECOMMENDATIONS, AND CAMPUS RESPONSES
13
We recommend that the campus develop procedures to ensure that all equipment acquisitions are
tagged and entered on the equipment inventory.
Campus Response
We concur. Campus procedures for adding equipment acquired by purchase or by other methods
are currently under review. While the review is not yet complete, a number of procedural changes
have been accomplished. A copy of all purchase orders issued is now provided to the Property
Accountant, who reviews them, determines which will need to be added once they have been
received, and places the applicable purchase orders in suspense until the related items are added.
In the past the property accountant received copies of only those purchase orders on which an
equipment subcode was used by the ordering department. The timing of equipment additions
relative to the date of receipt and the date of payment is also under review.
RECONCILIATION OF EXPENDITURES WITH PROPERTY RECORDS
The campus did not prepare monthly property reconciliations with changes to the expenditure subledger accounts.
SAM Section 7969 requires that at the end of each month, or each quarter, if the volume of
property transactions is small, agencies will reconcile the equipment expenditures from the current
year's state operations appropriation with accretions of major property to the property ledger.
The assistant director Fiscal Services-Financial Reporting has been attempting to develop a
procedure to implement this reconciliation for the past year but has been unsuccessful to date.
Failure to complete the monthly property reconciliations with changes to the expenditure subledger accounts increases the risk of errors and irregularities going undetected for extended
periods of time.
Recommendation 7
We recommend that the campus prepare monthly property reconciliations with changes to the
general ledger accounts.
Campus Response
We concur. A reconciliation process has been developed. A reconciliation for the fiscal year
ended 6/30/95 has been completed. A reconciliation for the year ended 6/30/96 is underway.
Monthly or quarterly reconciliations will be completed beginning with the 1996/97 fiscal year.
INVESTMENTS
OBSERVATIONS, RECOMMENDATIONS, AND CAMPUS RESPONSES
14
A written agreement between the campus and the Associated Students, Inc., to provide for the
investment of their funds by campus staff, has not been completed. This is a repeat of a FISMA
audit finding in our previous report.
Title 5, Section 42501 of the California Education Code requires a general written agreement
between the CSU and its auxiliary organizations covering a number of functions performed or a
separate agreement of each function performed.
The Office of the Chancellor also issued general systemwide policy and procedures to the CSU
campuses in coded memorandum BA 83-30, Policy on Chargeable Services to Self-Supporting
Operations, dated December 28, 1983, which states in part:
6. As agreements on charges are reached, they should be documented and
maintained in accordance with stated system policy. Such agreements should be on
file in the campus business office and available for audit.
The director of Fiscal Services stated that a new campus investment policy was being developed;
subsequent to its finalization, an agreement with the Associated Students will be prepared.
The absence of a formal written agreement between the campus and the auxiliary organizations,
which delineates promises and considerations from both sides, increases the potential for
misunderstandings.
Recommendation 8
We recommend that the campus finalize an agreement with the Associated Students Inc. for the
investment of their funds through the campus investment pool.
Campus Response
We concur. A draft agreement with the ASI has been prepared and submitted to the ASI
executive director for review. When this review is completed, the draft will be finalized and a
formal agreement issued.
TRUST FUNDS
DOCUMENTATION
Trust fund accounts were not fully documented. During our review of ten trust funds we noted
the following:
Ø one of the trust accounts did not have a trust agreement on file in the accounting office;
OBSERVATIONS, RECOMMENDATIONS, AND CAMPUS RESPONSES
15
Ø nine trust agreements did not contain information regarding reporting requirements,
instructions closing the account or restrictions on the use of monies for administrative
overhead costs;
Ø one trust agreement did not state the purpose of the trust;
Ø one agreement did not identify the person authorized to expend funds;
Ø two agreements did not contain specimen signatures; and
Ø one agreement did not indicate the disposition of the funds if the account is closed.
SAM Section 19440.1 states:
Each trust account established shall be supported by documentation as to type of
trust, donor or source of trust monies, purpose of the trust, time constraints,
persons authorized to withdraw or expend funds, specimen signatures, reporting
requirements, instructions for closing the account, disposition of any unexpended
balance, and restrictions on the use of monies for administrative or overhead costs.
This documentation will be retained until the trust is dissolved.
The campus had developed a new trust agreement containing all the required supporting
documentation in January 1996. However, copies of the new form had not been sent to all the
trust administrators to fill out.
The lack of required data within the trust agreements allows for speculation on the desires of the
entity who established the account. Such speculation may lead to an inappropriate expenditure
of funds.
Recommendation 9
We recommend that the campus obtain adequate supporting documentation for all trust accounts.
Campus Response
We concur. A review of trust forms had been conducted in response to a previous audit finding
to ensure that all forms were present and that disbursement authority in the purchasing system
was consistent with that authorized by the trust forms. As indicated in this finding, a new form
has also been developed to ensure that all required information is present for each account. The
new forms had been distributed, but not all forms had been returned at the time of the audit. A
complete review of the trust folders will be scheduled to ensure that all folders include a form and
that the forms are the 1/31/96 version or a more current version. The review will also confirm that
all required elements of information are present on each form, the that disbursement authority
for the purchasing system is consistent with that authorized by the trust forms.
OBSERVATIONS, RECOMMENDATIONS, AND CAMPUS RESPONSES
16
17
APPENDIX A:
PERSONNEL CONTACTED
Name Title
Harvey Blatter Staff Accountant
Laurie Borrello Assistant Director Fiscal Services-Data Processing
Ken Burton Director ITS-Computing Services
Carol Clifford Assistant Director Fiscal Services-Payroll
Scott Cooke Assistant Director Fiscal Services-Financial Reporting
Robert Dignan Director of Fiscal Services
Ruth Hale Assistant Director Fiscal Services-Accounting Systems
Vivian Herriman Associate Director of Admissions
Carol Johnston Accounts Payable Manager
Betty Kroeze Head of Health Services Support Services
Frank Lebens Vice President for Administration & Finance
Dario Luis Extended Education Accountant
Ray Macias Director Support Services
Donna Massicotte Payroll Technician
Joan Regulski Accounting Technician
Nancy Reynolds Assistant Director Fiscal Services-Accounts Management
Stan Rosenfield Assistant Director Fiscal Services-Payment Management
Patricia Stoneman Director Extended Education
Fred Strasser Supervising Property Clerk
John Sullivan Accounting Technician
Lee Whitmer Supervising Cashier
STATEMENT OF INTERNAL CONTROLS
A. INTRODUCTION
Internal accounting and related operational controls established by the State of California, the
CSU Board of Trustees, and the Office of the Chancellor are evaluated by the University
Auditor, in compliance with professional standards for the conduct of internal audits, to
determine if an adequate system of internal control exists and is effective for the purposes
intended. Any deficiencies observed are brought to the attention of appropriate management
for corrective action.
B. INTERNAL CONTROL DEFINITION
Internal control, in the broad sense, includes controls which may be characterized as either
accounting or operational as follows:
1. Internal Accounting Controls
Internal accounting controls comprise the plan of organization and all methods and
procedures that are concerned mainly with, and relate directly to, the safeguarding of
assets and the reliability of financial records. They generally include such controls as
the systems of authorization and approval, separation of duties concerned with record
keeping and accounting reports from those concerned with operations or asset custody,
physical controls over assets, and personnel of a quality commensurate with
responsibilities.
2. Operational Controls
Operational controls comprise the plan of organization and all methods and procedures
that are concerned mainly with operational efficiency and adherence to managerial
policies and usually relate only indirectly to the financial records.
C. INTERNAL CONTROL OBJECTIVES
The objective of internal accounting and related operational control is to provide reasonable,
but not absolute, assurance as to the safeguarding of assets against loss from unauthorized use
or disposition, and the reliability of financial records for preparing financial statements and
maintaining accountability for assets. The concept of reasonable assurance recognizes that the
cost of a system of internal accounting and operational control should not exceed the benefits
derived and also recognizes that the evaluation of these factors necessarily requires estimates
and judgment by management.
APPENDIX B
Page 2 of 2
D. INTERNAL CONTROL SYSTEMS LIMITATIONS
There are inherent limitations that should be recognized in considering the potential
effectiveness of any system of internal accounting and related operational control. In the
performance of most control procedures, errors can result from misunderstanding of
instruction, mistakes of judgment, carelessness, or other personal factors. Control procedures
whose effectiveness depends upon segregation of duties can be circumvented by collusion.
Similarly, control procedures can be circumvented intentionally by management with respect
to the executing and recording of transactions. Moreover, projection of any evaluation of
internal accounting and operational control to future periods is subject to the risk that the
procedures may become inadequate because of changes in conditions and that the degree of
compliance with the procedures may deteriorate. It is with these understandings that internal
audit reports are presented to management for review and use.

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