IT Archives - MGO CPA | Tax, Audit, and Consulting Services https://www.mgocpa.com/perspectives/topic/it/ Tax, Audit, and Consulting Services Mon, 25 Aug 2025 14:12:47 +0000 en-US hourly 1 https://wordpress.org/?v=6.8.2 https://www.mgocpa.com/wp-content/uploads/2024/11/MGO-and-You.svg IT Archives - MGO CPA | Tax, Audit, and Consulting Services https://www.mgocpa.com/perspectives/topic/it/ 32 32 AI Risks in Manufacturing: How to Protect Your Operations, IP, and Workforce https://www.mgocpa.com/perspective/top-ai-risks-in-manufacturing-and-how-to-manage-them/?utm_source=rss&utm_medium=rss&utm_campaign=top-ai-risks-in-manufacturing-and-how-to-manage-them Mon, 25 Aug 2025 14:12:47 +0000 https://www.mgocpa.com/?post_type=perspective&p=5190 Key Takeaways: — Amid growing cost pressures and dampened sentiment, manufacturers are turning to artificial intelligence (AI) to improve visibility, decision-making, and efficiency across complex operations. According to the Q2 2025 Outlook Survey from the National Association of Manufacturers, 84.7% of manufacturers plan to prioritize digital transformation in the next 12 months — with 21.8% placing […]

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Key Takeaways:

  • AI in manufacturing boosts efficiency, but poor data quality can lead to costly errors and flawed forecasts.
  • Cyber threats grow as AI connects IT and operational technology (OT) systems. Secure your infrastructure to reduce exposure.
  • AI tools risk IP leaks and job disruption. Protect proprietary data and invest in workforce upskills.

Amid growing cost pressures and dampened sentiment, manufacturers are turning to artificial intelligence (AI) to improve visibility, decision-making, and efficiency across complex operations. According to the Q2 2025 Outlook Survey from the National Association of Manufacturers, 84.7% of manufacturers plan to prioritize digital transformation in the next 12 months — with 21.8% placing significant emphasis on these initiatives.

While 72% of manufacturers already report measurable cost savings and performance gains from AI, overall optimism has dropped to 55.4% (the lowest level since Q2 2020). With rising input costs — particularly tariffs and raw material inflation — manufacturers must adopt AI with discipline and oversight.

But with accelerated adoption comes elevated risk. Manufacturing leaders must proactively manage the challenges AI introduces to avoid exposing the business to unnecessary vulnerabilities. This includes building strong governance frameworks with human-in-the-loop oversight, so critical decisions and outputs are always validated by skilled professionals rather than left entirely to automated systems.

Top 5 AI Risks in Manufacturing (and How to Manage Them)

Here are five critical AI risks manufacturing organizations face — and strategies to manage them responsibly:

1. Poor Data Quality Can Lead to Faulty AI Outputs

Manufacturers generate massive amounts of data from internet of things (IoT) sensors, machinery, and supply chain systems. However, if this data is unstructured or inconsistent, AI algorithms may produce inaccurate or misleading insights. This can result in flawed inventory levels, distorted demand forecasts, and even safety risks due to unreliable quality control systems.

How to manage it: Invest in foundational data hygiene and governance, such as continuous metric monitoring. Standardizing, structuring, and validating data across systems before deploying AI models is critical to ensuring reliable outcomes.

2. Cybersecurity Threats Expand with AI-Driven Connectivity

As AI tools integrate with OT and IoT infrastructure, they increase the attack surface across the manufacturing environment as well as regulatory risk exposure. Legacy OT systems, often not built with security in mind, become vulnerable when connected to AI-driven IT networks.

How to manage it: Implement robust cybersecurity protocols across IT and OT systems and adopt zero-trust architecture. Prioritize threat detection, continuous monitoring, and security-by-design when deploying AI platforms.

3. Risk of Intellectual Property (IP) Exposure

AI tools often rely on proprietary data — including process flows, equipment settings, and production methodologies — to generate insights. When shared on open platforms or in unsecure environments, this sensitive information can be at risk of theft or misuse.

How to manage it: Leverage secure AI environments with limited internet exposure and implement enterprise-wide access controls and data classification protocols. Train staff on responsible data handling practices and limit AI exposure to critical IP when possible.

4. Workforce Disruption from Automation and Digital Tools

AI technologies like computer vision and digital twins are redefining job functions on the factory floor. While these tools enhance efficiency, they may also displace certain roles — such as manual inspectors — unless companies invest in reskilling initiatives.

How to manage it: Develop talent strategies that focus on digital upskilling. Align workforce planning with technology adoption and support employees through change management and training programs.

5. Operational Disruptions from AI Model Failures

Without structured oversight, AI systems can produce unexpected outputs, including “hallucinations” — inaccurate or fabricated information. In critical functions like demand forecasting, these errors can lead to overproduction, tied-up capital, or delays.

How to manage it: Establish a cross-functional AI governance model with clear testing, validation, and human-in-the-loop oversight protocols. Embed monitoring systems to continuously evaluate model performance and flag anomalies early.

Graphic showing key AI risks in manufacturing, such as poor data quality, cybersecurity gaps, and IP exposure

How MGO Can Help: Strategic AI Risk Management for Manufacturers

We work closely with manufacturing leaders to develop customized AI governance strategies that align with operational goals and industry regulations. Whether you’re adopting AI for the first time or scaling your digital infrastructure, our solutions — including cybersecurity, risk management, technical accounting, and digital transformation — are designed to help you harness innovation responsibly.

From safeguarding intellectual property to implementing secure, auditable AI platforms, we help you drive performance while reducing exposure to operational, financial, and reputational risk. Let’s build a smarter, safer future for your manufacturing operations together.

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4 Strategies to Keep Your Government Resilient in Uncertain Times https://www.mgocpa.com/perspective/four-strategies-keep-your-government-resilient-uncertain-times/?utm_source=rss&utm_medium=rss&utm_campaign=four-strategies-keep-your-government-resilient-uncertain-times Wed, 26 Mar 2025 18:37:29 +0000 https://www.mgocpa.com/?post_type=perspective&p=3031 Key Takeaways: — In today’s socio-political landscape, priorities are shifting, government transparency is being challenged, and uncertainty within institutions, programs, and services reliant on government guidance and funding is intensifying. Information, policies, funding, etc., are changing rapidly. What may exist today may be rescinded, withheld, or stuck in litigation tomorrow. In all, more confusion and […]

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Key Takeaways:

  • Build government resilience by proactively saving critical documents, questioning information, planning for emergencies, and revisiting your mission.
  • Navigate uncertainty by implementing clear communication plans, verifying data sources, and prioritizing essential functions.
  • Strengthen stability through strategic planning and reaffirming core values to guide decision-making during challenging times.

In today’s socio-political landscape, priorities are shifting, government transparency is being challenged, and uncertainty within institutions, programs, and services reliant on government guidance and funding is intensifying.

Information, policies, funding, etc., are changing rapidly. What may exist today may be rescinded, withheld, or stuck in litigation tomorrow. In all, more confusion and more disruption in governing is an ongoing reality. As such, audit and consulting functions will need to adjust and operate accordingly.

Think, Question, Plan, Revisit (Repeat): A Framework for Stability in a Shifting Landscape

To navigate these uncertainties, proactive documentation, information vetting, and emergency planning are essential. Here are some key considerations to help guide your state or local government entity moving forward:

1. Think Ahead: Save Critical Documentation

If any of your engagements rely on federal regulations and guidance, it is advisable to save relevant documentation before it disappears. PDF and archive these materials, ensuring that file names include the print date. This is especially important for retrospective engagements where criteria may no longer be applicable but remain relevant to the period under review.

For example, if your work involves disadvantaged business enterprises (DBEs), now may be a good time to make sure you have associated federal regulations within your workpaper systems. If documentation has already been removed, consult archival resources like the Wayback Machine or public libraries, which may become increasingly valuable in maintaining access to historical records.

2. Question All Information Before Accepting or Distributing It

Conducting due diligence on data reliability and verifying sources of information is generally par for the course. However, further scrutiny of information will be necessary.

Evaluate the credibility of information by asking:

  • What is the source of the data? Research the organization or individual behind the data, their mission, and their history of reliability. Be mindful of AI-generated data that may be biased or incomplete.
  • What is being omitted? Examine methodologies, assumptions, and potential gaps in the analysis. Data omissions can skew conclusions — as seen during the COVID-19 pandemic when racial and ethnic data was frequently uncollected, impacting public health responses.
  • Is there an agenda behind the message? Be aware of political biases and misinformation. Verify whether videos or stories are current and fact-check social media content before engaging with or sharing it. Seek comparative analyses from subject matter experts to understand the broader implications of policy changes. To that end, consider information from multiple sources — including independent journalists.

As misinformation spreads rapidly, developing internal fact-checking protocols can help prevent costly mistakes.

3. Plan for the Worst Before It Happens

Uncertainty within government can create daily crises. Rapid regulatory changes, disruptions in grant funding, and downsizing can all overwhelm operations. Emergencies will happen. The extent and magnitude of them will vary, and so will the impacts.

Generally, there are teams within organizations that conduct business continuity planning. This may include the IT team that focuses on cybersecurity threats and the emergency operations center (EOC) team that is ready to activate and respond at the onset of an emergency. However, it may be prudent to build emergency planning into daily operations and revisit emergency planning documents to make sure they are updated and relevant.

This includes:

  • Communication plans: With changes in policies, programming, services, funding, etc., occurring daily, it is imperative to understand your entity’s core audience, the audiences’ needs, and potential impacts. Communicate promptly and continuously to minimize misinformation. Revisit and frequently test methods for mass communication (social media, emergency notifications, sign language interpreters, etc.) and internal communication guidelines.
  • Critical and essential functions: Identify “critical and essential functions” to assist with prioritizing limited resources, time-sensitive situations, and/or narrowing the scope of focus as disruptions occur. “Critical functions” are time-sensitive activities that have a direct impact on life, on people, and on property (securing infrastructures, deploying critical personnel, etc.). “Essential functions” are also necessary for addressing and maintaining public health and safety during crisis but have a slightly longer timeframe for restoration (repairing infrastructure, payroll, etc.).
  • Compliance with emergency preparedness standards: Make sure you are compliant with the required emergency plans and/or following best practice for preparedness. For example, the Code of Federal Regulations (Title 42, Section 491.12 Emergency Preparedness) currently requires rural health clinics and federally qualified health centers to establish and maintain an emergency preparedness program. Additionally, the National Incident Management System (NIMS) provides guidance to all levels of government, non-governmental, and private sector on emergency preparedness. Also, the California Emergency Services Act 2021 edition requires the Standardized Emergency Management System (SEMS) for managing multiagency and multijurisdictional responses to emergencies in California.

4. Revisit Your Values and Mission Statement

Many state and local government agencies will face difficult decisions as resources and funding become more constrained. The terms “resourceful,” “innovative,” and “resilient” have long been part of government lexicon, but today they carry more weight.

Now is the time to revisit your agency’s core values and mission statement as a guide for decision-making. When priorities shift and resources become scarce, your mission statement should serve as a touchstone to help you stay focused on what matters most.

  • Are your programs still aligned with your agency’s purpose? In times of financial uncertainty, some initiatives may need to be scaled back or restructured. A clear mission statement can help you determine which services are essential and where adjustments are possible.
  • Does your decision-making process reflect your core values? When facing difficult choices — whether it’s budget reductions, staff realignment, or policy shifts — lean on your agency’s foundational principles to navigate trade-offs while maintaining public trust.
  • Are you communicating your values effectively? In uncertain times, public confidence can waver. Reinforcing your mission through clear, consistent messaging can help stakeholders, employees, and the communities you serve stay informed and engaged.
Graphic summarizing the four basic tenets of the Think, Question, Plan, Revisit (Repeat) framework for resiliency in uncertain times

Preparing for the Winding Road Ahead

Resilience in government isn’t just about reacting to change — it’s about preparing for it. The challenges ahead may be unpredictable, but a proactive approach will help keep your entity stable and responsive in the face of uncertainty.

How MGO Can Help

With a dedicated State and Local Government team, we are here to help you navigate the uncertainty of the current environment. We offer a full suite of audit and consulting services to meet your specific needs, and we are always available to help you address any challenges or concerns that may arise. Reach out to our team today to find out how we can support you.

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FASB ASU: Disaggregating Income Statement Expenses https://www.mgocpa.com/perspective/fasb-asu-disaggregating-income-statement-expenses/?utm_source=rss&utm_medium=rss&utm_campaign=fasb-asu-disaggregating-income-statement-expenses Tue, 25 Mar 2025 19:43:34 +0000 https://www.mgocpa.com/?post_type=perspective&p=3024 Key Takeaways: — In response to persistent calls from investors for enhanced transparency in financial reporting, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2024-03, Income Statement – Reporting Comprehensive Income – Expense Disaggregation Disclosures (Subtopic 220-40): Disaggregation of Income Statement Expenses (DISE). This update introduces a new layer of financial statement […]

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Key Takeaways:

  • A new Accounting Standards Update requires public companies to provide more detailed expense disclosures in their financial statements.
  • Implementing these changes may require modifications to the chart of accounts and adjustments to financial reporting systems.
  • Companies should get a head start assessing whether current accounting systems can support the required disclosures and make necessary upgrades.

In response to persistent calls from investors for enhanced transparency in financial reporting, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2024-03, Income Statement – Reporting Comprehensive Income – Expense Disaggregation Disclosures (Subtopic 220-40): Disaggregation of Income Statement Expenses (DISE). This update introduces a new layer of financial statement disclosures, requiring companies to adjust how they collect and report financial data.

Subtopic 220-40’s New Disclosure Requirements

The finalized ASU requires public companies to provide additional details about specific expense categories in financial statement disclosures.

Currently, companies can consolidate several expense line items into broad categories on income statements. For example, line items like “cost of goods sold,” “cost of sales,” and “selling, general, and administrative expenses” can comprise various direct and indirect costs of producing and selling a company’s goods and services, as well as overhead and administrative costs unrelated to production and sales. This lack of transparency makes it harder for investors, lenders, and other financial statement users to assess the company’s performance.

Subtopic 220-40 requires organizations to disclose (in a tabular format) amounts recognized in each of the following relevant expense captions:

  • Purchases of inventory using the expense or cost-incurred approach
  • Employee compensation
  • Depreciation
  • Intangible asset amortization
  • Depreciation, depletion, and amortization (DD&A) recognized from oil and gas-producing activities

In addition, companies must provide additional details about inventory and manufacturing expenses, including:

  • Inventory purchased
  • Employee compensation related to manufacturing
  • Depreciation and amortization of manufacturing assets
  • Costs capitalized to inventory and manufacturing expenses
  • Changes in inventory balances
  • Other items used to reconcile costs incurred to expenses recognized
  • How the company defines “other manufacturing expenses”

Practical Implications for Public Companies

At first glance, providing more details on expenses might seem simple. However, implementing these changes can become complicated quickly. You may need to reconsider how you categorize expenses, modify your chart of accounts, and evaluate whether your financial systems can extract and present the necessary information.

Some considerations include:

  • Accounting system capabilities: Your current systems may not be configured to capture expense details at the required level of granularity. Evaluate whether your general ledger software and reporting tools can generate the necessary disclosures or if they’ll need modifications.
  • Adjustments to reporting packages: Review whether your existing financial reporting packages can accommodate these new requirements.
  • Audit readiness: The enhanced level of detail required in financial disclosures means auditors will focus on total expense amounts and how those expenses are disaggregated. Make sure you allow enough time to align your internal reporting with the new requirements so your internal and external audits will go smoothly.
  • Training and internal processes: Team members responsible for financial reporting will need training on new data collection and reporting processes.
  • Industry-specific considerations: The requirements apply broadly to all public companies, but the impact varies by industry. Your company should analyze which line items are relevant to your operations and adjust reporting accordingly.

Graphic detailing what's changing and what you need to do as a result of FASB's new DISE Accounting Standards Update

ASU 2024-03’s Scope and Effective Date

The updated requirements apply to all public companies, although some expense categories may not be relevant depending on your industry. ASU 2024-03 is effective for fiscal years beginning after December 15, 2026, and interim periods beginning after December 15, 2027. Early adoption is permitted.

Because the new disclosures are required for annual and interim reporting periods, you cannot simply address these disclosures at year-end. You need to ensure your accounting systems can support the level of detail required for these disclosures throughout the year.

Preparing for Implementation

Adapting to the new reporting standards requires advance planning and preparation. Begin by conducting a gap analysis to determine whether your current financial systems can support the new disclosures. Reach out to your IT team and other advisors as soon as possible if you need modifications to facilitate a seamless transition.

Other steps you may need to take include:

  • Review the detailed FASB guidance to determine the specific disclosures required.
  • Assess internal data collection processes to make sure you’re capturing all necessary expense details.
  • Engage with internal and external auditors to discuss expectations and potential challenges.
  • Test reporting changes in advance to identify and resolve issues before compliance deadlines.
  • Monitor ongoing compliance to ensure you’re prepared to meet interim reporting obligations.

How MGO Can Help

The changes introduced by the FASB’s finalized ASU will improve financial statement transparency, but they also present challenges for companies that are unprepared. Begin your implementation efforts now with planning, system updates, training, and allowing time to make adjustments and avoid last-minute compliance struggles. By proactively addressing these changes, you can minimize disruptions and keep your financial statements clear, accurate, and compliant.

If you have questions about Subtopic 220-40, contact us today to connect with professionals who can help.

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How IT Assessments Strengthen Your Cybersecurity and Business Resilience https://www.mgocpa.com/perspective/how-it-assessments-strengthen-your-cybersecurity-and-business-resilience/?utm_source=rss&utm_medium=rss&utm_campaign=how-it-assessments-strengthen-your-cybersecurity-and-business-resilience Thu, 25 Jul 2024 15:26:00 +0000 https://www.mgocpa.com/?post_type=perspective&p=1445 Key Takeaways: — In today’s rapidly evolving digital landscape, keeping robust and secure information technology (IT) systems is paramount for the success and sustainability of any organization. IT assessments have emerged as a vital part of an effective IT advisory strategy, providing your organization with a comprehensive understanding of its IT infrastructure, finding vulnerabilities, and […]

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Key Takeaways:

  • IT assessments find vulnerabilities and threats, enabling organizations to implement proactive measures and strengthen their security posture.
  • Regular IT assessments help organizations adhere to industry standards and regulatory requirements, avoiding legal penalties and maintaining customer trust.
  • By safeguarding IT systems and confirming their integrity and availability, IT assessments play a crucial role in business continuity and resilience against disruptions.

In today’s rapidly evolving digital landscape, keeping robust and secure information technology (IT) systems is paramount for the success and sustainability of any organization. IT assessments have emerged as a vital part of an effective IT advisory strategy, providing your organization with a comprehensive understanding of its IT infrastructure, finding vulnerabilities, and helping you align with industry standards and regulatory requirements.

IT assessments involve a thorough evaluation of your organization’s IT environment — encompassing systems, networks, applications, and data assets. These assessments aim to show weaknesses, verify compliance, and offer actionable insights to enhance your overall IT performance and security. The scope of IT assessments includes various elements such as risk assessment, IT security management, policy reviews, access controls, network security, data protection, and incident response preparedness.

Key Components of IT Assessments

IT assessments typically encompass the following key components, each critical for a comprehensive evaluation of your organization’s IT infrastructure:

  1. Risk assessment: Conducting a risk assessment is foundational to understanding potential threats and vulnerabilities within your organization’s IT environment. This involves evaluating factors such as cybersecurity threats, data breaches, insider threats, and regulatory non-compliance. Identifying and prioritizing risks based on their potential impact allows your organization to implement proactive measures to mitigate these risks.
  1. Review of policies and procedures: Policies and procedures form the backbone of your organization’s IT framework. Evaluating these policies confirms they are comprehensive, up-to-date, and aligned with industry standards and regulatory requirements. Effective policies facilitate enforcement and adherence, significantly reducing the risk of IT-related incidents.
  1. Access controls: Implementing robust access controls is crucial for protecting sensitive data and systems. Assessing access controls involves evaluating user access rights, privileges, and authentication mechanisms. Effective access controls prevent unauthorized access and mitigate the risk of data breaches.
  1. Network security: Your organization’s network architecture, configuration, and security controls must be assessed to identify vulnerabilities and potential points of compromise. This includes reviewing firewalls, intrusion detection and prevention systems (IDPS), virtual private networks (VPNs), and network segmentation practices.
  1. Data protection: Data protection measures such as encryption, data loss prevention (DLP) controls, and data backup and recovery procedures are vital for safeguarding sensitive information. Confirming these measures helps protect your data against unauthorized access, disclosure, or alteration.
  1. Incident response preparedness: Effectively responding to IT incidents is critical to minimize damage and recovery time. Reviewing incident response plans and procedures — including incident detection, reporting mechanisms, and escalation processes — confirms your organization is prepared to handle IT incidents efficiently.
  1. Vendor and third-party risk management: Many organizations rely on third-party vendors and service providers, introducing additional IT risks. Assessing your organization’s practices for managing these risks, including vendor contracts and due diligence processes, is essential for mitigating supply chain vulnerabilities.

Why IT Assessments Are Essential for Your Organization

IT assessments are not just a regulatory requirement; they are a strategic necessity. IT assessments offer several key benefits for your organization, including:

  • Find potential vulnerabilities and threats before they are exploited, allowing your organization to implement proactive measures to mitigate risks.
  • Verify compliance with industry standards and regulatory requirements to help you avoid legal penalties and keep customer trust.
  • Strengthen your organization’s overall security posture to reduce the likelihood of successful cyberattacks.
  • Offer the insights you need for effective risk management, enabling the allocation of resources to address the most critical threats.
  • Safeguard your business continuity by confirming the integrity and availability of IT systems, protecting your organization against disruptions caused by IT incidents.

The Critical Importance of IT Assessments for Modern Enterprises

In an era where IT systems are the backbone of business operations, the importance of IT assessments cannot be overstated. These assessments provide your organization with a clear understanding of its IT vulnerabilities and offer you a roadmap for mitigating risks.

By investing in regular IT assessments, you will not only help protect your digital assets but also support business continuity and keep stakeholder trust. For enterprises striving to stay ahead in the digital age, IT assessments are an indispensable part of a robust IT advisory strategy.

To learn how MGO’s IT Advisory Solutions can fortify your organization’s defenses, reach out to our team today.

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Internal Controls: Keys to Limiting Fraud and Boosting Your Company Value https://www.mgocpa.com/perspective/internal-controls-keys-to-limiting-fraud-and-boosting-your-company-value/?utm_source=rss&utm_medium=rss&utm_campaign=internal-controls-keys-to-limiting-fraud-and-boosting-your-company-value Tue, 30 Jan 2024 21:35:00 +0000 https://www.mgocpa.com/?post_type=perspective&p=1516 Executive Summary: — As the economy stands on shaky legs, private equity and venture capital firms are necessarily careful and strategic when assessing potential investment opportunities. Whether your long-term plan includes acquiring another company, selling your business, or seeking new capital, strengthening your internal control environment — with a focus on preventing fraud — is […]

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Executive Summary:

  • Internal controls, especially around fraud prevention, are essential for limiting losses, driving efficiency, improving accountability, and boosting company value during investments or M&A deals.
  • The “tone at the top” from leadership in fostering an ethical environment, along with proper segregation of duties, are key elements for fraud prevention and strong internal controls.
  • Well-established policies and procedures, like Delegation of Authority rules and restricted system access protocols, are also vital for maintaining adequate controls to enable company growth.

As the economy stands on shaky legs, private equity and venture capital firms are necessarily careful and strategic when assessing potential investment opportunities. Whether your long-term plan includes acquiring another company, selling your business, or seeking new capital, strengthening your internal control environment — with a focus on preventing fraud — is a powerful way to increase actual and perceived value.

In the following, we will lay out the reasons why fraud prevention is an essential element to proper corporate governance and illustrate key areas to examine whether your internal control environment is built to help your operation succeed.

The Importance of Internal Controls in Fraud Prevention

A robust internal control system is the first step toward managing, mitigating, and uncovering fraud. A strong internal control environment will:

Protect your company’s assets by reducing the risk of theft or misappropriation of cash, inventory, equipment, and intellectual property.

Detect fraudulent activities or irregularities early on and deter employees from attempting fraud in the first place.

Provide cost savings by limiting opportunities for financial losses, costly investigations, and legal expenses associated with fraud.

Drive operational efficiency by providing clear processes and guidelines that reduce the risk of errors or inefficiencies in day-to-day operations.

Improve employee accountability by implementing checks and balances that discourage unethical behavior.

When seeking an investment or undertaking a significant M&A deal, you should have a firm grasp of the strength and quality of your internal control environment. Not only will you reduce the risk of fraud in the near term, but you will also cultivate confidence with potential investors and M&A partners.

Fraud Prevention Starts with the “Tone at the Top”

The first key element to look for in measuring the strength of your internal controls is ensuring a clear and proactive “tone at the top”, meaning an ethical environment fostered by the board of directors, audit committee, and senior management. A good tone at the top encourages positive behavior and helps prevent fraud and other unethical practices.

There are four elements to fraud: pressure, rationalization, opportunity and capability.

Pressure motivates crime. This could be triggered by debt, greed, or illegal deeds. Individuals who have financial problems and commit financial crimes tend to rationalize their actions. Criminals may feel that they are entitled to the money they are stealing, because they believe they are underpaid. In some cases, they simply rationalize to themselves that they are only “borrowing” the money and have every intention of paying it back.

Criminals who can commit fraud and believe they will get away with it may just do it. Capability means the criminal has the expertise as well as the intelligence to coerce others into committing fraud. The board of directors is responsible for selecting and monitoring executive management to ensure best practices are in place to limit the motivations of all four elements of fraud.

Infographic of the four elements of fraud

Proper Segregation of Duties for Internal Controls

The second key element to look for in your internal controls is a well-established segregation of duties. The idea is to establish controls so that no single person has the ability that would allow them the opportunity to commit fraud. Companies must make it extremely difficult for any single employee to have the opportunity to perpetrate a crime and subsequently cover it up.  

Fraud Controls 

There are three types of controls that help manage the risks of fraud: preventative, detective, and corrective.

  • Preventative controls seek to avoid undesirable events, errors, and other occurrences that an enterprise has determined could have a negative material effect on a process or end product. Preventative controls are the best of the three as they are the first line of defense and a backstop to fraud. If designed correctly, preventative controls stop an undesirable event from even happening.  
  • Detective controls exist to detect and report when errors, omission, and unauthorized uses or entries have already occurred. Although it is important to identify these adverse events, you are doing so after the fraud has already been committed.  
  • Corrective (also referred to as compensating) controls are designed to correct errors, omissions, and unauthorized uses and intrusions once they are detected.  
infographic of three types of fraud controls

Preventing Misappropriation of Assets 

An important component of segregation of duties is to prevent the misappropriation of assets and reduce fraud risk. Below are some examples of best practices for various types of assets: 

  • Cash Receipt: segregate the receipt of cash/checks and the recording of the journal entry in the accounting system into two roles.
  • Accounts Receivable: segregate the responsibilities of recording cash received from customers and providing credit memos to customers. (If one person performs both functions, it creates the opportunity to divert payments from the customer to the employee and then cover the theft with a matching credit to the customer’s account).
  • Cash Reconciliation: the individuals who authorize, process, or record cash should not perform the bank reconciliation to the general ledger.
  • Inventory: individuals who order goods from the suppliers should not have the ability to log the goods received in the accounting system.
  • Payroll: segregate the responsibilities of compiling gross and net pay for payroll, with the responsibilities of verifying the calculation. (If a single individual performs both functions, it allows for the opportunity to increase personal compensation and the compensation of others without authorization. It also provides an opportunity to create a fictitious payee and make corresponding payroll checks).

The Importance of Policies and Procedures

The third key element to look for in your investees is well-established policies and procedures. Make sure that any company you consider acquiring has basic policies and procedures in place, such as Delegation of Authority (DOA).

The DOA is a policy where the executive team delegates authority to the management of the company. Individuals should be considered appropriate to fulfill delegated roles and responsibilities. The DOA should be reviewed at least annually. Subsequently, it is important to ensure that the DOA is being followed, and that approvals do not deviate from it. Any such anomalies should be rare and, when they do occur, they need to be reviewed and approved. Constant deviations from the DOA may be a sign that the DOA needs to be restructured.

A second essential policy and procedure is restricted computer and application access. This is to protect sensitive company financials and proprietary data. The company should have a robust control environment and maintain computer logins and password access on a need-to-know basis. Access should only be granted by the owner of the application or system and subsequently logged by the administrator. Now more than ever companies are hiring remote employees. This shift in the dynamic workspace further emphasizes the need for a quality IT controls environment.

How We Can Help

As you prepare your company for future growth, getting an impartial third-party opinion on your internal control environment can be a powerful tool for finding gaps and inefficiencies, and implementing value-added changes.

Our dedicated Public Company teams offer a deep level of industry experience and technical skills. We can help prepare your company for a major capital raise, including going public via an IPO or RTO. Or we can help optimize value for an M&A deal, whether you are buying or selling. Contact us today to access an external, holistic vision focused on helping you grow and succeed.

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