The HLB Internal Control Indicator

Today McLeod Governance ventures into the complex (at least to McLeod Governance) world of stock market indicators and their relevance to the world of internal controls.

Lets start with the stock market indicator of choice at the moment – The Coppock Indicator.The Coppock Indicator is a means of tracking market emotion though the extremely unemotional science of technical analysis.The measure was first constructed by Edwin Coppock in 1962.

Coppock, the founder of Trendex Research in Texas, was an economist. He had been asked by the American Episcopal Church to identify buying opportunities for long term investors – that is, the start of a bull market. He thought market downturns were like bereavements and required a period of mourning. He asked the church bishops how long a period of mourning took for people and their answer was 11 to 14 months so he used those periods as the basis for his measure.

Accordingly, the Coppock Indicator is the sum of a 14 month rate of change in an index and 11 month rate of change. This is then smoothed by a 10 period weighted moving average.

When the curve starts to increase from less than zero, it is a ‘buy’ signal. The deeper the indicator below zero, the stronger the rally.

The indicator’s signal does not emerge at the bottom, but comes as a rally is established.

The measure has a strong track record correctly predicting 16 United States rallies from 17 buy signals in the post-war era.

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It is this consistency of success that got McLeod Governance thinking.

Why is that we – as practitioners in the emotional science of independent assurance – do not have an indicator of the strengthening of an internal control environment.

Sure we can compare the same audited area between two reviews and assess whether there has been an improvement or decrease based on audit findings but that fails to take into account that it is unlikely that any one review undertaken a couple of years apart will be identical in terms of scope; management or market conditions or even auditors.

Equally we can suggest that a change in management leads to a strengthened internal control environment but we are all seasoned enough to know that that isn’t always the case.

So … where does that leaves us with what we will call the HLB Controls Indicator.

Here is our attempt at defining what constitutes a real time strengthening of an internal control environment.

Take the weighted 12 monthly average of results actual versus budget; the weighted 12 monthly average of the number of lost days through injury and then add in the weighted 12 monthly average of overdue outstanding internal control rectification recommendations.

So if you are seeing the actual v budget as a positive it shows that there is better than expected performance.

If you are seeing a decrease in the days lost to injury you are seeing either good luck or good processes at work.

Finally if you are seeing a reduction in the number of overdue outstanding internal control rectification recommendations, you are witnessing management diligence at play.

There you have your starting point for assessing the strengthening (or weakening) of an organisation’s internal control environment.

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Will it – like the Coppock Indicator – be a strong indicator?

Who knows.  One thing that McLeod GovernanceThe DOES know is that WITHOUT an indicator like the one proposed NO ONE will know!

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