Risk Management And Internal Control Guidelines Tennessee Department of Finance and Administration Tennessee Comptroller of the Treasury August 2007

Risk Management And Internal Control Guidelines

Tennessee Department of Finance and AdministrationTennessee Comptroller of the Treasury

August 2007

INTRODUCTION MANAGEMENT’S GUIDE TO RISK

MANAGEMENT AND INTERNAL CONTROL

INTRODUCTION (CONT’D)

Enterprise Risk Management

Changing Political And Regulatory Environment Sarbanes-Oxley Act General Accounting Office AICPA Auditing Standards


Internal Control and Governance Problems Results of Texas State Comptroller’s ERM

Implementation Texas State Auditor Considers Increased

Accountability a Priority


Committee Of Sponsoring Organizations Of The Treadway Commission

Second report Enterprise Risk Management—Integrated Framework

First report Internal Control—Integrated Framework


Guidance--Education and Tools Agency Heads Responsibility

OVERVIEW

Overview

Relationship of COSO I and II COSO Cube (three-dimensional matrix)

Objectives Components Entity Unit

Effectiveness Roles and responsibilities

Relationship of COSO I to COSO II Internal Control—Integrated Framework

(COSO I) Still important for entities looking at internal

control by itself Enterprise Risk Management—Integrated

Framework (COSO II) Broader than internal control Expands and elaborates on internal control Focuses more fully on risk Introduces the concepts of risk appetite, risk

tolerance, and portfolio view

COSO Cube

Direct relationship between objectives and enterprise risk components

Focus on the entirety of an entity’s ERM, or by objectives categories, component, entity unit, or any subset thereof

Objectives Categories

Strategic Effectiveness and efficiency of operations Integrity and reliability of reporting Compliance with applicable laws, regulations,

contracts, and grant agreements Stewardship of assets

Components Internal environment Objective setting Event identification Risk assessment Risk response Control activities Information and communication Monitoring

Effectiveness Are the 8 components present and functioning

effectively? The components are criteria for effective ERM Present and functioning properly = no significant

deficiencies and material weaknesses Test operating effectiveness of controls different

from obtaining evidence of implementation How controls were applied during the period Consistency with which controls were applied By whom and by what means they were applied

Roles and Responsibilities

Audit committee, board of directors, or other oversight body

Commissioner/director/department head Senior management Internal audit Other entity personnel

SECTION IINTERNAL

ENVIRONMENT

SECTION IINTERNAL ENVIRONMENTWhat is it? Risk Management Philosophy

Set of shared beliefs and attitudes Reflects the entity’s values, influencing its culture

and operating style Affects how risks are identified, kinds of risks

accepted, and how they are managed

Internal Environment(cont’d) Risk Appetite

Amount of risk management is willing to accept Influences the entity’s culture and operating style

Oversight by Audit Committee Oversight by another group May significantly influence elements of Internal

Environment

Internal Environment(cont’d) Integrity and Ethical Values

Management’s values Code of conduct

Commitment to Competence Knowledge and skills of staff How well tasks need to be accomplish

Internal Environment(cont’d) Organizational Structure

Framework to plan, execute, control, and monitor activities

Assignment of Authority and Responsibility Extent of authority and responsibility

Human Resource Standards Staff development, training, and evaluation

SECTION II OBJECTIVE SETTING

Objective Setting

EVERY AGENCY FACES A VARIETY OF RISKS FROM EXTERNAL AND INTERNAL SOURCES, AND A PRECONDITION TO EFFECTIVE EVENT IDENTIFICATION, RISK ASSESSMENT, AND RISK RESPONSE IS ESTABLISHMENT OF OBJECTIVES

Objective Setting

OBJECTIVES MUST EXIST BEFORE MANAGEMENT CAN IDENTIFY POTENTIAL EVENTS AFFECTING THEIR ACHEIVEMENT

ENTERPRISE RISK MANAGEMENT (ERM) ENSURES THAT MANAGEMENT HAS IN PLACE A PROCESS TO SET OBJECTIVES AND THAT THE CHOSEN OBJECTIVES SUPPORT AND ALIGN WITH THE AGENCY’S MISSION AND ARE CONSISTENT WITH ITS RISK APPETITE

Objective Setting

WHILE AN AGENCY’S MISSION AND STRATEGIC OBJECTIVES ARE GENERALLY STABLE, ITS STRATEGY AND MANY RELATED OBJECTIVES ARE MORE DYNAMIC AND ADJUSTED FOR CHANGING INTERNAL AND EXTERNAL CONDITIONS

AS CONDITIONS CHANGE, STRATEGY AND RELATED OBJECTIVES ARE REALIGNED WITH STRATEGIC OBJECTIVES

Objective Setting

IN CONSIDERING WAYS TO ACHIEVE ITS STRATEGIC OBJECTIVES, MANAGEMENT IDENTIFIES RISKS ASSOCIATED WITH A RANGE OF STRATEGY CHOICES AND CONSIDERS THEIR IMPLICATIONS

VARIOUS EVENT IDENTIFICATION AND RISK ASSESSMENT TECHNIQUES ARE USED IN THE STRATEGY-SETTING PROCESS

Objective Setting

BY FOCUSING FIRST ON STRATEGIC OBJECTIVES AND STRATEGY, AN AGENCY IS IN A POSITION TO DEVELOP RELATED OBJECTIVES

AGENCY WIDE OBJECTIVES ARE THEN LINKED TO AND INTEGRATED WITH MORE SPECIFIC OBJECTIVES THAT CASCADE THROUGH THE ORGANIZATION TO SUB-OBJECTIVES ESTABLISHED FOR VARIOUS ACTIVITIES

Objective Setting

OBJECTIVES NEED TO BE READILY UNDERSTOOD AND MEASURABLE

ERM REQUIRES THAT PERSONNEL AT ALL LEVELS HAVE AN UNDERSTANDING OF THE AGENCY’S OBJECTIVES AS THEY RELATE TO THAT INDIVIDUAL’S SPHERE OF INFLUENCE

ALL EMPLOYEES MUST HAVE A MUTUAL UNDERSTANDING OF WHAT IS TO BE ACCOMPLISHED AND A MEANS OF MEASURING WHAT IS BEING ACCOMPLISHED

Objective Setting

THREE BROAD CATEGORIES OF OBJECTIVES

OPERATIONS REPORTING COMPLIANCE

SMART OBJECTIVES

Specific Use specific terms rather than vague abstract ones

Measurable Include some method for objectively measuring their achievement

Achievable Are challenging but realistic

Relevant Follow the business strategy of the organization

Timely Specify a time period

Objective Setting

EFFECTIVE ERM PROVIDES REASONABLE ASSURANCE THAT AN AGENCY’S REPORTING AND COMPLIANCE OBJECTIVES ARE BEING ACHIEVED

BECAUSE, HOWEVER, ACHEIVEMENT OF OPERATIONS OBJECTIVES IS NOT SOLEY WITHIN AN AGENCY’S CONTROL (i.e. IT IS SUBJECT TO EXTERNAL EVENTS) ERM PROVIDES REASONABLE ASSURANCE THAT MANAGEMENT IS MADE AWARE OF THE EXTENT TO WHICH AN AGENCY IS MOVING TOWARD THE ACHIEVEMENT OF THESE OBJECTIVES ON A TIMELY BASIS

Objective Setting

• STRATEGIES OF THE BUSINESS

• KEY BUSINESS OBJECTIVES

• RELATED OBJECTIVES THAT CASCADE DOWN THE ORGANIZATION FROM KEY BUSINESS OBJECTIVES

• ASSIGNMENT OF RESPONSIBILITIES TO ORGANIZATIONAL ELEMENTS AND LEADERS (LINKAGE)

Objective Setting

EFFECTIVE ERM DOES NOT DICTATE WHICH OBJECTIVES MANAGEMENT SHOULD CHOOSE, BUT THAT MANAGEMENT HAS A PROCESS THAT ALIGNS STRATEGIC OBJECTIVES WITH AN AGENCY’S MISSION AND ENSURES THAT THE ENTITY’S CHOSEN STRATEGIC AND RELATED OBJECTIVES ARE CONSISTENT WITH THE AGENCY’S RISK APPETITE

Objective Setting – Risk appetite

RISK APPETITE IS A GUIDEPOST IN STRATEGY SETTING

THERE IS A RELATIONSHIP BETWEEN AN AGENCY’S RISK APPETITE AND ITS STRATEGY

DIFFERENT STRATEGIES CAN BE USED TO ACHIEVE DESIRED RETURN, EACH HAVING DIFFERENT RISK

RISK APPETITE IS THE AMOUNT OF RISK, ON A BROAD LEVEL, AN AGENCY IS WILLING TO ACCEPT IN PURSUIT OF ITS MISSION, VISION, BUSINESS OBJECTIVES AND VALUE GOALS

DIRECTLY RELATED TO AN AGENCY’S CULTURE, CAPABILITY, RISK CAPACITY AND STRATEGY

SHOULD CONSIDER RISK APPETITE BOTH QUALITATIVELY AND QUANTITATIVELY - IT IS MANY TIMES EXPRESSED IN ACCEPTABLE/UNACCEPTABLE OUTCOMES OR LEVEL OF RISK



SOME POSSIBLE QUESTIONS WHAT RISKS WILL THE AGENCY NOT ACCEPT?

(For example, environmental or quality compromises) ARE THERE SPECIFIC RISKS THAT THE AGENCY

IS NOT PREPARED TO ACCEPT? (For example, risks that could result in non-compliance with federal regulations)

IS THE AGENCY PREPARED TO ENTER INTO PROGRAMS WITH LOWER LIKELIHOOD OF SUCCESS BUT LARGER POTENTIAL RETURNS?


USE OF A LIKELIHOOD-IMPACT ASSESSMENT (MATRIX) IS A GOOD TOOL IN DOCUMENTING RISK APPETITE

FOR EACH RISK FREQUENCY OF OCCURRENCE (PROBABILITY) AND WORST OUTCOME (IMPACT) ARE ASSESSED AND CAPTURED IN A MATRIX

THE MATRIX IS THEN COMPARED WITH A CHARTED RISK APPETITE MAP THAT OUTLINES THE MAXIMUM ADVERSE RISK AN AGENCY IS WILLING TO ACCEPT

Impact vs. Probability

Exceeds Risk Appetite

Low

High

High

IMPACT

PROBABILITY

Within Risk Appetite

Objective Setting – Risk tolerance

RISK TOLERANCE, THE ACCEPTABLE LEVEL OF VARIATION AROUND OBJECTIVES, MUST BE ALIGNED WITH RISK APPETITE

REQUIRES THE ARTICULATION OF ACCEPTABLE VARIABILITY FROM THE SPECIFIED RISK APPETITE FOR ALL POSSIBLE OUTCOMES

OPERATIONALIZES THE RISK APPETITE GENERALLY EXPRESSED IN TERMS OF RISK

MEASURES OR OUTCOMES

Objective Setting – Risk tolerance

SHOULD BE SET SUCH THAT THE AGGREGATION OF RISK TOLERANCES ENSURES THE ORGANIZATION OPERATES WITHIN THE RISK APPETITE

SECTION IIIEVENT

IDENTIFICATION

EVENT IDENTIFICATION

INTERNAL AND EXTERNAL EVENTS AFFECTING ACHEIVEMENT OF AN AGENCY’S OBJECTIVES MUST BE IDENTIFIED, DISTINGUISHING BETWEEN RISKS AND OPPORTUNITIES

MANAGEMENT IDENTIFIES POTENTIAL EVENTS THAT, IF THEY OCCUR, WILL AFFECT THE AGENCY, AND IN WHAT MANNER

Event identification

EVENTS WITH A POSITIVE IMPACT REPRESENT OPPORTUNITIES THAT SHOULD BE CHANNELED BACK INTO MANAGEMENT’S STRATEGY OR OBJECTIVE-SETTING PROCESSES

EVENTS WITH A NEGATIVE IMPACT REPRESENT RISKS, WHICH REQUIRE MANAGEMENT’S ASSESSMENT AND RESPONSE


AN EVENT IS AN INCIDENT OR OCCURRENCE ARISING FROM INTERNAL OR EXTERNAL SOURCES THAT AFFECTS IMPLEMENTATION OF STRATEGY OR ACHIEVEMENT OF OBJECTIVES

A NUMBER OF EXTERNAL AND INTERNAL FACTORS DRIVE EVENTS


CONTRIBUTING EXTERNAL FACTORS ECONOMIC NATURAL

ENVIRONMENT POLITICAL SOCIAL

CONTRIBUTING INTERNAL FACTORS INFRASTRUCTURE PERSONNEL PROCESS TECHNOLOGY

SOME TYPICAL GOVERNMENT RISKSEconomic changes such as lower

economic growth reduce tax revenue and opportunities to provide a wider

range of services or limit the availability or quality of existing

services

Failure to innovate leading to sub-

standard services

Loss or misappropriation of funds through fraud or

impropriety

Environmental damage caused by

failure of regulations or government

inspection regime

Inconsistent policy objectives resulting

in unwanted outcomes

Project delays cost overruns and

inadequate quality standards

Inadequate skills or resources to deliver services as required

Failure of contractors, partners or other

government agencies to provide services as

required

Failure to properly evaluate pilot projects before a new service is

introduced may result in problems when the

service becomes fully operational

Failure to measure performance adequately

Technical risk – failure to keep pace with technical

developments, or investment in inappropriate or mismatched technology

Inadequate service plans to maintain

continuity of service delivery

Failure to monitor implementation

Achieving Service Delivery


AN AGENCY’S EVENT IDENTIFICATION METHODOLOGY MAY BE COMPRISED OF A COMBINATION OF TECHNIQUES, TOGETHER WITH SUPPORTING TOOLS

TECHNIQUES VARY WIDELY IN LEVEL OF SOPHISTICATION

EXAMPLES OF TECHNIQUES FOR IDENTIFYING EVENTS:• EVENT INVENTORIES (LISTING COMMON

POTENTIAL EVENTS)• INTERNAL ANALYSIS (COMPLETED AS PART OF A

ROUTINE PLANNING CYCLE PROCESS, TYPICALLY THROUGH STAFF MEETINGS)

• ESCALATION OR THRESHOLD TRIGGERS (COMPARE CURRENT TRANSACTIONS OR EVENTS WITH PREDEFINED CRITERIA)

• FACILITATED WORKSHOPS AND INTERVIEWS (DRAW ON ACCUMULATED KNOWLEDGE AND EXPERIENCE OF MANAGEMENT, STAFF AND STAKEHOLDERS THROUGH STRUCTURED DISCUSSIONS)


POTENTIAL EVENTS ARE ALSO IDENTIFIED ON AN ONGOING BASIS IN CONNECTION WITH ROUTINE BUSINESS ACTIVITIES, SUCH AS INDUSTRY/TECHNICAL CONFERENCES PEER WEBSITES BENCHMARKING REPORTS TRADE & PROFESSIONAL JOURNALS MEDIA REPORTS MONTHLY MANAGEMENT REPORTS


ANOTHER USEFUL TOOL IS TO INTRODUCE AN INTERMEDIATE STEP - IDENTIFYING WHAT YOU DEPEND UPON TO ACHIEVE YOUR OBJECTIVES

THIS IS SOMETIMES MUCH EASIER THAN TRYING TO THINK ABOUT ALL THE EVENTS THAT COULD PREVENT SUCCESS


EVENTS DO NOT OCCUR IN ISOLATION – ONE EVENT CAN TRIGGER ANOTHER AND EVENTS CAN OCCUR CONCURRENTLY

MANAGEMENT SHOULD UNDERSTAND HOW EVENTS RELATE TO ONE ANOTHER


IT MAY BE USEFUL TO GROUP EVENTS INTO CATEGORIES (i.e. GROUPS OF SIMILAR POTENTIAL EVENTS)

SIMILAR EVENTS SHOULD BE COMBINED TO DEVELOP AN INITIAL RISK UNIVERSE AND DETERMINE HOW TO TRACK AND UPDATE THE LISTING OF POTENTIAL EVENTS AND RISKS


FINANCIAL FOLKS NEED TO REMEMBER THAT:

EVENT IDENTIFICATION NEEDS TO INVOLVE A COMPLETE CROSS-SECTION OF MANAGEMENT, AS POSSIBLE EVENTS INCLUDE BUSINESS SCENARIOS OF WHICH FINANCIAL MANAGEMENT MAY NOT BE AWARE

INDICATORS THAT THE ERM OBJECTIVE SETTING PRINCIPLES ARE IMPLEMENTED1. THE ORGANIZATION DEFINES GOALS AND

OBJECTIVES FOR THE ENTERPRISE AS A WHOLE

2. AN EFFECTIVE STRATEGIC PLANNING PROCESS IS IN PLACE TO FORMULATE STRATEGIES THAT WILL ENABLE THE ORGANIZATION TO ACHIEVE ITS BUSINESS OBJECTIVE

INDICATORS THAT THE ERM OBJECTIVE SETTING PRINCIPLES ARE IMPLEMENTED (CONT’D)3. BUSINESS STRATEGIES ARE CLEARLY

ARTICULATED WITH OBJECTIVES LINKED TO EACH

4. THE RISK IDENTIFICATION PROCESS IS DESIGNED TO MAKE A CLEAR LINK BETWEEN THE ORGANIZATION’S OBJECTIVES AND THE ASSOCIATED RISKS

INDICATORS THAT THE ERM OBJECTIVE SETTING PRINCIPLES ARE IMPLEMENTED (CONT’D)5. RISK TO THE ACHIEVEMENT OF OBJECTIVES

IS EVALUATED TO ENSURE IT DOES NOT EXCEED THE LEVELS OF RISK DETERMINED BY MANAGEMENT AS ACCEPTABLE

6. ACCEPTABLE TOLERANCE LIMITS ON THE RISK TO THE ACHIEVEMENT OF KEY OBJECTIVES HAVE BEEN DETERMINED.

7. MANAGEMENT USES MEANINGFUL PERFORMANCE MEASURES IN MONITORING RESULTS AGAINST OTHER SET TOLERANCES

INDICATORS THAT THE ERM EVENT IDENTIFICATION PRINCIPLES ARE IMPLEMENTED1. DATA ON THE BUSINESS OPERATING ENVIRONMENT –

POLITICAL, ECONOMIC, ETC., EVENTS IS CAPTURED AND REGULARLY EVALUATED IN TERMS OF THEIR POTENTIAL IMPACT UPON THE ORGANIZATION’S BUSINESS OBJECTIVES

2. A PORTFOLIO OF EVENTS THAT COULD AFFECT THE ACHIEVEMENT OF OBJECTIVES – INTERNAL AND EXTERNAL – HAS BEEN PREPARED

3. EVENTS ARE LINKED TO AND RISK EVALUATED BY INDIVIDUAL OBJECTIVE

INDICATORS THAT THE ERM EVENT IDENTIFICATION PRINCIPLES ARE IMPLEMENTED (CONT’D)

4. GOALS AND OBJECTIVES FOR IDENTIFYING EVENTS AND THE RELATED RISKS EXIST AND ARE COMMUNICATED TO ALL SEGMENTS OF THE ORGANIZATION

5. RESPONSIBILITIES AND ACCOUNTABLES FOR RISK IDENTIFICATION ARE CLEARLY DEFINED AND UNDERSTOOD

6. RISK IS CONSIDERED IN TERMS OF NOT JUST ISOLATED EVENTS BUT ALSO INTER-RELATED EVENTS

7. EVENTS ARE CATEGORIZED INTO USEFUL GROUPS TO FACILITATE THE AGGREGATION OF INFORMATION FOR PURPOSES OF ASSESSING RISKS

8. THE ORGANIZATION EVALUATES EVENTS IN THE CONTEXT OF THE POTENTIAL UPSIDES (OPPORTUNITIES) AS WELL AS THE DOWNSIDE (RISKS)


THE NEXT TOPIC, OR THE RISK ASSESSMENT COMPONENT, ALLOWS AN AGENCY TO CONSIDER THE EXTENT TO WHICH POTENTIAL EVENTS MIGHT HAVE AN IMPACT ON ACHIEVEMENT OF OBJECTIVES

SECTION IVRISK ASSESSMENT

Risk Assessment

Risk is “the possibility that an event will occur and adversely affect the achievement of objectives.”

Thereby decreasing value for the entity’s stakeholders.

Risk Assessment

- Risks are analyzed and assessed as to their likelihood and impact

- Management considers the mix of future events, both expected & unexpected

- Useful first step – often a “brainstorming” session

- What is the “worst that could happen,” or the “worst that happened?”

Consider the “Risk Appetite”

Broadly defined as amount of risk an entity is willing to accept in pursuing its objectives.

For most government entities: risk appetite is fairly low!

Related is risk tolerance: “tolerable level of variation associated w/ a particular objective.”

Consider Both Inherent & Residual Risk

Inherent – Risk without any management activity or before controls are in place.

Example: inherent risk mitigated by payment card’s policies and procedures.

Residual – level of risk that remains after management has a plan in place to deal with the risk.

Example: residual risk remains after payment card policies are in place.

Consider both Likelihood and Impact

Likelihood: possibility an event will occur, measured in “low, medium, high,’ percentage or some frequency of occurrence.

Impact: Effect on an agency on others.

Risk Assessment Uses Qualitative and Quantitative Methods

Quantitative methods more precise Qualitative methods are necessary in

situations where business activity does not lend to quant. evaluation, or is not cost/effective.

Choice should reflect needs of the business unit and its employees.

Consider Risk in Objective Setting

The framework of objectives: strategic, operational, reporting, compliance, (see COSO cube).

Typically considerable overlap. Several examples follow.

Example: Operational

Risk that subrecipients in HIV/AIDS program are being reimbursed for unsupported expenditures.

Assessment – Extent of reimbursement and frequency is analyzed. Note that paying subrecipient invoices for which no documentation exists subjects agency to possible fraud.

Example: Reporting

Risk that management does not notify the Comptroller’s Office of overpayments; and failure to recover funds.

Assess why a breakdown in both state policy and actual recoupment.

Lack of notification negates possibility of a thorough investigation.

SECTION V RISK RESPONSE

V – Risk Response

“Having assessed relevant risks, management determines how it will respond, reviewing likelihood and impact, evaluating costs and benefits, and selecting options that bring residual (remaining risk) within the entity’s risk tolerances.”

The Four Categories of Risk Response:

Avoidance – not participating in events that give rise to risk.

Reduction: Specific actions taken to reduce likelihood or impact or both.

Sharing: Reducing likelihood or impact by sharing portion of the risk (insurance)

Acceptance: No action taken. “learns to live with the risk,” and monitor it...

Additional Factors in Risk Response

- For many risks, responses are obvious & well accepted.

- Response to risk may affect other factors, or affect likelihood/impact differently.

- Cost/Benefit – often cost side easier to analyze; benefit side may be more subjective.

- Risk response may lead to improvements in service areas or additional value.

- Considers both inherent and residual risk.

A Portfolio Perspective

ERM approach requires that risk be considered from a “portfolio” or entity-wide perspective.

Management first determines risk in each division or business unit.

Develops a composite assessment of risk reflecting unit’s residual risk profile relative to its objectives & risk tolerances.

A Portfolio View of Risk:

Can be depicted in several ways – focusing on major risk or event categories across divisions, program units, etc.

While risk in a program unit may be within risk tolerance; taken together they may exceed the risk appetite of entity.

Or have common elements that raise concerns.

Back to our previous examples:

1. Subrecipients in HIV/AIDS programs are routinely reimbursed for unsupported expenditures.

1. After further analysis corrective action plan identified and remedies failures in the reimbursement process, a cost/effective methodology to monitor expenditures.

And our other example…

2. Management did not notify the Comptroller of the Treasury of overpayments and failed to recoup overpaid funds.

2. Corrective action plan requires compliance with Policy 11; reviews recoupment procedures.

SECTION VICONTROL ACTIVITIES

Integration with Risk Responses

Control activities generally are established to ensure risk responses are carried out. However, control activities themselves are risk responses.

Integration with Risk Responses

Risk responses Share risk

Agency participates in state’s collateral pool or risk management fund.

Reduce risk Reduces likelihood and impact, e.g. Disaster recovery plan in place

to reduce the impact of a natural disaster. Risk Avoidance

Policies that forbid certain “risky business” e.g., agency not authorized to invest in certain risky investment instruments.

Risk Acceptance Monitoring of certain activities that are deemed high risk e.g., high

risk investments.

CONTROL ACTIVITIES

A single control activity can address multiple risk responses or

Multiple control activities may be needed for one risk response.

Types of Control Activitieso Preventiveo Detectiveo Manual (People Based)o Automated (System Based)

Types of Control Activities


Preventive Controls are more reliable1. Prevents errors

2. Proactive approach – frees up people resources


LESS RELIABLE

Detective Preventive Detective PreventivePeople Based Automated

MORE RELIABLE

Reconciliations (Detective) Personnel approving or executing transactions

should not perform reconciliations. Reviews (Detective)

Budget to Actual Current to prior period comparisons Performance measurements


Approval/Authorizations (Preventive) Policies and procedures Limits to authority Supporting documentation Question unusual items


Assets Security (Preventive and Detective) Physical safeguards Record retention Periodic counts/Inventories

Types of Controls of Control Activities

Segregation of Duties (Preventive and Detective) The following functions should be segregated

Approval Accounting/Reconciling Asset Custody

Types of Controls of Control Activities

Entity Level Controls Controls management implement to establish the

appropriate tone at the top. (Strategic Objectives) E.g., Employees sign a code of conduct

Process Level Controls Mitigate risks involved in initiating, recording,

processing or reporting transactions. IT and Application Controls

Further mitigates process level risks

Levels of Control Activities

Pervasive Level Adequate training of personnel Access restrictions Authorization Segregation of duties

Specific Level Validation Reconciliation

Levels of Control Activities

The Writing on The Wall Applying too narrow a focus to the identification

of risks can lead to overlooking potential risks and issues.

Think about risks without considering the existing processes and controls in place.

CONTROL ACTIVITIES

Effectiveness and Efficiency

Control activities must be tested to ensure there are no material weaknesses or significant deficiencies.

Management should also ensure that control activities are carried out in a timely manner. Internal auditors may support management by

providing assurance on the effectiveness and efficiency of control activates.

Control Activities Worksheet

Worksheet provided in Section VI can be used as a template for documenting risks and related controls

Divided into 3 parts Part I Strategic, Operations, and Reporting

Objectives Part II Compliance Objectives Part III Fraud

Worksheet is NOT all inclusive. N/A responses need to be addressed. Remember the writing on the wall. Any policy or procedure used as a risk

response in Part I or III should be addressed in Part II, Compliance.

Template may be modified.

Control Activities Worksheet

Categorized by business processes.1. Budget Process2. Cash Disbursement/Expenditures3. Cash Receipts/Revenues4. Cash Management5. Liabilities6. Capital Assets/Inventory/Equipment7. Information Systems/Data Processing8. Personnel/Employee Compensation9. Financial Reporting10. Accounts Receivable11. Investments

Control Activities Worksheet Part I Strategic, Operations, and

Reporting Objectives

Categorized by the Association of Certified Fraud Examiner’s Categories of Fraud. Misappropriation of assets Corruption Fraudulent Reporting

Control Activities Worksheet Part III Fraud


Categories should be applied to each business process.

Fraud control risk management should be integrated into the agency's philosophy, practices and business plans rather than be seen or practiced as a separate program. When it is integrated, risk management becomes the business of everyone in the organization.

Core areas to focus on Information systems; Contracts; Grants and other payments or benefits programs; Purchasing; Services provided to the community; Revenue collection; Use of government credit cards; Travel allowance and other common allowances; Salaries; And Property and other physical assets including physical security.


Other Considerations

Risks with large or moderate impact and probable (high) or reasonably possible (medium) likelihood of occurrence are your significant risks. These are the risks you need to address with control activities. No risk response is needed for insignificant risks but BE

CAUTIOUS AND OBJECTIVE. Insignificant risks still need to be documented on the

worksheet. Explanation of insignificant nature should be documented.


Inherent Risks - Control Activities= Residual Risks Ensure you evaluate all insignificant risks not

addressed with control activities on an aggregate basis to ensure your residual risk is within your risk tolerance.

All risks (regardless of significance) should still be included.


If any of the risks already included in the worksheet are deemed as having a low impact or remote likelihood of occurrence, treat as as a risk that is not applicable to your agency and document explanation on worksheet.

Don’t forget about abuse.

SECTION VIIINFORMATION ANDCOMMUNICATION

Information

Needed at all levels of an organization to identify, assess, and respond to risks to run the entity to achieve its objectives

Internal and external sources Financial and nonfinancial

Strategic and Integrated Systems

Data processing and data management become a shared responsibility

IS architecture needs to be flexible and agile to effectively integrate with affiliated external parties

Has management’s risk management techniques contemplated organizational goals in making technology selection and implementation decisions?

Integration with Operations

Applications facilitate access to information previously trapped in functional or departmental silos Information becomes available for widespread use

Transactions are recorded and tracked in real time Managers have immediate access to financial and

operating information more effectively to control agency activities

Depth and Timeliness of Information

Information infrastructure sources and captures data in a timeframe and at a depth consistent with an entity’s need to identify, assess, and respond to risks, and remain within risk tolerances

Timeliness needs to be consistent with the rate of change in the entity’s internal and external environments

Information Quality Data reliability is a critical attribute of

information systems and data-driven automated decision systems

Inaccurate data results in unidentified risks or poor assessments and bad management decisions

Quality of information includes ascertaining whether informational content is Appropriate Accurate Timely Accessible Current

Communication Inherent in information systems Must provide information to appropriate

personnel to carry out strategic, operating, reporting, compliance, and stewardship responsibilities

Must deal with expectations, responsibilities of individuals and groups Other important matters

Internal Communication Behavioral expectations and responsibilities of

personnel Clear statement of entity’s risk management philosophy

and approach Clear delegation of authority

Should effectively convey The importance and relevance of effective ERM The entity’s objectives, risk appetite, risk tolerances A common risk language Roles and responsibilities of personnel in effecting and

supporting the components of ERM

External Communication Open external communication channels

Constituents provide highly significant input on design and quality of products and services

Enables an entity to address evolving customer demands or preferences

Recognize such implications Investigate Take necessary corrective actions Focus on impact on financial reporting and

compliance as well as operating objectives

Means of Communicating Actions speak louder than words Actions influenced by the entity’s history and

culture Operating with integrity Culture is well understood throughout the

organization Embed communications on ERM into an

entity’s broad-based, ongoing communications programs and into the fabric of the organization

SECTION VIIIMONITORING

Monitoring Assessing the presence and functioning of

components over time Accomplished through

Ongoing monitoring activities Separate evaluations Combination of the two

ERM changes over time Once effective risk responses become irrelevant Control activities become less effective or no longer are

performed Entity objectives might change

Ongoing Monitoring Activities

Occur through regular management activities Variance analysis Comparisons of information with disparate

sources Dealing with unexpected occurrences

Scope and Frequency

Evaluations of ERM depend on significance of risks importance of risk responses and related controls in managing the risks

Address application in strategy setting with respect to significant activities

Scope depends on which objectives categories are addressed

Who Evaluates Self assessments

Person responsible for particular unit or function determines effectiveness of ERM for their activities

Division/function head Line managers Controller Senior management Internal auditors (management cannot delegate its

responsibility) External auditors (caution!)

The Evaluation Process Evaluating ERM is a process in itself Approaches and techniques vary Consistent and disciplined approach should be

brought to the process Understand entity activities and components of ERM

being addressed Determine ERM system actually works Discuss with personnel who actually perform or are

affected by ERM Analyze ERM process design and results of tests

performed Determine if process provides reasonable assurance with

respect to the stated objectives

Methodology

A variety of evaluation methodologies and techniques are available Checklists Questionnaires Flowcharting techniques Comparing or benchmarking to best in class

entity Planning steps Performance steps

Documentation

Varies based on the entity’s size, complexity, and similar factors

Evaluations more effective and efficient with appropriate level of documentation

Document and retain Evaluation process itself Descriptions of tests and analyses Support for statement to external parties

regarding ERM effectiveness Retention policy

Reporting Deficiencies Deficiencies noted from

Ongoing monitoring procedures Separate evaluations External parties

Reported directly to persons directly responsible for achieving business objectives affected by the deficiency

Report specific types of deficiencies to senior management and/or oversight body

Corrective actions taken or to be taken should be reported back to relevant personnel

What Is Reported All identified ERM deficiencies that affect an

entity’s ability to develop and implement its strategy and to set and achieve its objectives

Must report significant deficiencies and material weaknesses Use qualitative and quantitative materiality

Report identified opportunities to increase the likelihood entity objectives will be achieved

To Whom to Report Determining right party is critical Immediate superiors through normal channels They in turn communicate upstream or

laterally so the information ends up with someone who has the authority to act e.g., senior management, department head, audit

committee, other oversight body Consider alternative channels for reporting

sensitive information Fraud and illegal or improper acts

Documents

Risk Management And Internal Control Guidelines Tennessee Department of Finance and Administration Tennessee Comptroller of the Treasury August 2007