Ensuring the Effectiveness of Internal Control

ABSTRACT

With the upcoming application of the Japanese Sarbanes-Oxley Act (J-SOX) scheduled for March 2009, there is no doubt that efforts by Japanese listed companies to evaluate and strengthen internal control will only increase. There is significant anxiety, however, that Japanese companies may be led to overreaction because managers unquestioningly accept excessive advertising slogans of service providers such as the consulting and software industries, and of falling into red tape because of managers’ follow-the-leader mentality. Based on the results of a questionnaire survey, this report shows the actual condition of efforts being made towards internal control within Japanese companies. At the same time, the necessary conditions to achieve goals such as lowering the risk of misconduct and implementing efficient business operations without weakening internal control are analyzed.

As a conclusion to this report, we find that the component among the six with the strongest relationship with the goals of internal control is the establishment of a control environment, such as corporate culture, attitude/behavior of the company and involvement of top management. In reality, however, more companies are giving priority to control activities rather than the control environment. While it is necessary to establish control activities such as developing manuals or visualizing work flows, ignoring the control environment would make achieving the goals of internal control impossible. In order to develop control activities, examples of preceding US and other leading Japanese companies can be used as a reference. However, the control environment such as corporate culture and principles of behavior must be aligned with the history, management environment, and organizational climate of each individual company. For managers, establishing a control environment is critical to develop an effective internal control system tailored to their own company.