Professional Development Associates

Controls as a MotivatorAGAAudio Session November, 2008 Professional Development Associates Developed and Presented by: Michael L. Piazza

Michael L. Piazza Principal Associate Professional Development Associates piazza@pda-usa.com 601.209.9607 Controls as a Motivator

Session Outline and Topics • Review of Maslow’s Hierarchy of Needs Motivation Concepts • Summary of COSO Concepts • COSO to Maslow • Question and Answer Session Controls as a Motivator 1

Controls as a Motivator 2

Food, clothing, shelter Basic Needs Controls as a Motivator 3

Safety and Security Needs Health and well being Safety against adverse events Less fear of the future Security Needs Controls as a Motivator 5

Need for love Desire for friendship A need for comradeship Group Needs Belongingness Needs Controls as a Motivator 8

Ego/Achievement Desire for self respect A feeling of personal worth Need for autonomy Self Needs Controls as a Motivator 11

SelfActualization The need to create Self in the now No worry of tomorrow, no regret of the past Highest Potential Needs Controls as a Motivator 14

COSO Definition of Internal Control • Internal control is broadly defined as a process, effected by an entity’s board of directors, management and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following categories: • Effectiveness and efficiency of operations • Reliability of financial reporting • Compliance with applicable laws and regulations Controls as a Motivator 17

Key Concepts • A process ‑A means to an end, not an end in itself. Internal control is there for a purpose and the purpose should be the focus of the internal control not the control itself. • Effected by people ‑ not merely policy manuals and forms but people at every level of an organization. How people interpret the control is essential. The way people have been brought up or the beliefs of the individuals have an effect on how they will react in a given situation. Controls as a Motivator 18

Key Concepts • Expected to provide reasonable assurance ‑ Not absolute assurance to an entity's management and board. No system can provide absolute assurance and to think that any system of internal control can is foolish. The cost to develop a system of internal control to ensure compliance will be cost prohibitive so management must settle for a reasonable assurance. • Geared to the achievement of objectives ‑ In one or more separate but overlapping categories. The system of internal control is enacted to provide the organization a better chance of achieving its stated objectives and goals. Controls should signal when the process is starting to go astray and the achievement of objectives or goals is being jeopardized. Controls as a Motivator 19

Components of Internal Control Control Environment Risk Assessment Control Activities Information and Communication Monitoring Controls as a Motivator 20

COSO Internal Control Components • Control Environment - The control environment sets the tone of an organization, influencing the control consciousness of its people. It is the foundation for all other components of internal control, providing discipline and structure. • The core of any business is its people ‑ their individual attributes, including integrity, ethical value and competence ‑ and the environment in which they operate. They are the engine that drives the entity and the foundation on which everything rests. • Integrity and Ethical Values • Commitment to Competence • Board of Directors or Audit Committee • Management's Philosophy and Operating Style • Organizational Structure • Assignment of Authority and Responsibility • Human Resource Policies and Procedures Controls as a Motivator 22

Integrity and Ethical Values Integrity and Ethical Values - An entity's objectives and the way they are achieved are based on preferences, value judgments and management styles. Those preferences and value judgments, which are translated into standards of behavior, reflect management's integrity and its commitment to ethical values. An entity's objectives and the way they are achieved are based on preferences, value judgments and management styles. Those preferences and value judgments, which are translated into standards of behavior, reflect management's integrity and its commitment to ethical values. Because an entity's good reputation is so valuable, the standard of behavior must go beyond mere compliance with law. In awarding reputation to the best companies, society expects more than that. The effectiveness of internal controls cannot rise above the integrity and ethical values of the people who create, administer and monitor them. Integrity and ethical values are essential elements of the control environment, affecting the design, administration and monitoring of other internal control components. Controls as a Motivator 23

Ego/Achievement SelfActualization Integrity is a prerequisite for ethical behavior in all aspects of an enterprise’s activities. Establishing ethical values often is difficult because of the need to consider the concerns of several parties. Top management’s values must balance the concerns of the enterprise, its employees, suppliers, customers, competitors and the public. Balancing these concerns can be a complex and frustrating effort because interests are often at odds. For example, providing and an essential product (petroleum, lumber, food) may cause some environmental concerns. Focusing solely on short-term results can hurt even in the short term. Concentration on the bottom line – sales or profit at any cost – often evokes unsought actions and reactions. High pressure sales tactics, ruthlessness in negotiations or implicit offers or kickbacks, for instance, may evoke reactions that can have immediate (as well as lasting) effects. Controls as a Motivator 24

Ego/Achievement Belongingness Needs Ethical behavior and management integrity are a product of the “corporate culture.” Corporate culture includes ethical and behavioral standards, how they are communicated and how they are reinforced in practice. Official policies specify what management wants to happen. Corporate culture determines what actually happens, and which rules are obeyed, bent or ignored. Top management – starting with the CEO – plays a key role in determining the corporate culture. The CEO usually is the dominant personality in an organization, and individually sets its ethical tone. Controls as a Motivator 25

Ego/Achievement Belongingness Needs Incentives and Temptations. A study several years ago suggested that certain organizational factors can influence the likelihood of fraudulent and questionable financial reporting prac-tices. Those same factors also are likely to influence ethical behavior. Individuals may engage in dishonest, illegal or unethical acts simply because their organiza-tions give them strong incentives or temptations to do so. Emphasis on "results," particularly in the short term, fosters an environment in which the price of failure becomes very high. Incentives cited for engaging in fraudulent or questionable financial reporting practices and, by extension, other forms of unethical behavior are: • Pressure to meet unrealistic performance targets, particularly for short term results, • High performance-dependent rewards, and • Upper and lower cutoffs on bonus plans. Controls as a Motivator 26

Safety and Security Needs Belongingness Needs The study also cites "temptations" for employees to engage in improper acts: • Nonexistent or ineffective controls, such as poor segregation of duties in sensitive areas that offer temptations to steal or to conceal poor performance. • High decentralization that leaves top management unaware of actions taken at lower organizational levels and thereby reduces the chances of getting caught. • A weak internal audit function that does not have the ability to detect and report improper behavior. • An ineffective board of directors that does not provide objective oversight of top management. • Penalties for improper behavior that are insignificant or unpublicized and thus lose their value as deterrents. Controls as a Motivator 27

SelfActualization Safety and Security Needs Providing and Communicating Moral Guidance. In addition to the incentives and temptations just discussed, the aforementioned study found a third cause of fraudulent and questionable financial reporting practices: ignorance. The study found that "in many of the companies that have suffered instances of deceptive financial reporting, the people involved either did not know what they were doing was wrong or erroneously believed they were acting in the organization's best interest." This ignorance is often caused by poor moral background or guidance, rather than by an intent to deceive. Thus, not only must ethical values be communicated, but explicit guidance must be given regarding what is right and wrong. Controls as a Motivator 28

SelfActualization The most effective way of transmitting a message of ethical behavior throughout the organization is by example. People imitate their leaders. Employees are likely to develop the same attitudes about what's right and wrong - and about internal control - as those shown by top management. Knowledge that the CEO has "done the right thing" ethically when faced with a tough business decision sends a strong message to all levels of the organization. Controls as a Motivator 29

Ethics Incentives Integrity Temptations Lack of Moral Guidance Controls as a Motivator 30

Controls as a MotivatorAudio Session November, 2008 Professional Development Associates Michael Piazza piazza@pda-usa.com Controls as a Motivator

Professional Development Associates