How Does Management Integrity Affect Audits?

We’ve heard it referred to as the “tone at the top.” The character and behavior of an entity’s management sets the standard for other personnel. Despite elaborate codes of conduct, sanctions and whistle-blowing provisions, employees will follow their leaders. Even when leaders use the “do as I say, not do as I do” philosophy of management, subordinates will do as their leaders do.

From the five elements of internal control developed by the Treadway Commission in the late 1970s, we recognize management’s role as the “control environment.” The control environment of an entity is the backbone of its internal control. The smaller the entity, the more directly management’s practices affect control risk. The existence of key, or entity level, controls performed diligently by an owner or manager can reduce control risk, even when there is limited segregation of duties.

Key controls, like inspecting supporting documents when signing checks, or receiving and reviewing bank statements before a bookkeeper reconciles an account, can provide assurance that misstatements due to error or fraud will not go undetected. In other words, control risk can be less than high!

Based on the assumption management’s integrity is high, the following table demonstrates a good system of internal control for a small entity.

BOOKKEEPER	OFFICE MANAGER	OWNER/MANAGER
RECORDS ACCTS. RECEIVABLE	RECEIVES VENDOR INVOICES	SIGNS CHECKS
RECONCILES PETTY CASH	RECEIVES CASH AND MAIL	PREPARES/REVIEWS DEPOSITS
PRINTS CHECKS	MAILS CHECKS	MAKES BANK TRANSFERS
MAKES GENERAL LEDGER ENTRIES	APPROVES INVOICES	RECEIVES BANK STMT. BEFORE REC.
RECONCILES BANK STATEMENTS	APPROVES PURCHASE ORDERS	APPROVES BANK RECONCILIATIONS
	APPROVES PAYROLL	REVIEWS SALES INVOICES./AGINGS
	DISTRIBUTES PAYROLL	MAKES DEPOSITS
	DISBURSES PETTY CASH

Do you think these controls can be audited? Why or why not? If so, what affect can management's integrity have on a small audit? Post your comments below.