Page 316 - COSO Guidance Book

Additional efficiency opportunities

Companies can enhance their efficiencies over assessing internal control by

 taking a risk-based approach to internal control,
 thinking of internal control as an integrated process,
 right-sizing documentation, and
 considering the “totality” of internal control.

Financial reporting objectives

The overall financial reporting objective is for management to prepare reliable financial statements that
do not contain material misstatements. Management establishes sub-objectives to the financial
reporting objective, which might be influenced by regulatory agencies or other factors. The starting point
is to use the company’s financial statements to identify objectives for business activities, processes, and
events that can materially affect the financial statements.

For example, assume that the company is a manufacturing entity. A sub-objective could be that all sales
are recorded in the proper time period (completeness). Most manufacturing companies recognize
revenue based on the shipping terms free on board destination or shipping point. There is a
manufacturing process that includes preparing a production plan, obtaining materials and labor, and
performing a final inspection of the product. Management then focuses on controls to help ensure that
the completeness assertion is fulfilled by accounting for the numerical sequence of approved customer
orders, production orders, materials requisition reports, labor cost allocations, and work-in-process
forms. All shipping documents issued several days before and after year-end are examined for terms of
sale and traced back to the ledgers to provide assurance that sales were recorded. These critical
procedures help provide assurance that all revenue is recorded in the proper time period (sub-objective of
financial reporting).

There could still be a problem with revenue recognition if the company manufactures a significant
amount of special-ordered goods. Usually, revenue from these goods should be recognized when the
goods are completed. Management should then focus on implementing controls to provide assurance
that special-ordered goods are recorded as revenue in the period when they are completed. These
procedures should also provide assurance that revenue is recognized in the proper time period (sub-
objective of financial reporting). In this case, revenue would be recognized after the finished good is
inspected, not when it is shipped.

Risk assessment

Risk assessment is performed by members of management when they consider the risks to key
business objectives, which include reliable financial reporting. Quantitative and qualitative factors should
be considered. In the preceding manufacturing example, there might be a qualitative risk that the

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