Introduction to Internal Controls
Internal controls are defined as steps, procedures, and rules which are set by the business to ensure that the financial and accounting information is of the highest integrity, to help promote accountability and help the business to detect grey areas where fraud can happen, eventually preventing it to happen.
Internal controls are the various procedures and steps which are implemented by various business firms to ensure the highest integrity of their financial and accounting information and to promote the degree of accountability. Internal controls also come very handy to detect the concern areas of fraud and hence stop them from happening. Internal controls apart from the above discussed functions also come to use in the areas of operational efficiency where it is used to enhance the accuracy and the timeliness of financial reporting. Accounting controls were established on the basis of the Sarbanes-Oxley Act of 2002 after a lot of fraud was reported in early 2000 at many US companies. The act was mainly introduced to protect the investors from fraud accounting activities and to enhance the reliability of company disclosures.
Objectives of Internal Controls
The objectives of internal controls are as follows:
- To make sure that all the transactions pertaining to the business is conducted according to the guidelines of the authorized management.
- To make sure every transaction gets systematically recorded in a sequential basis.
- To grant enough security to the assets of the company from preventing it to be used in an unauthorized manner.
- To make a comparison between assets that are recorded in the books with the actual ones that are exiting and to this in a fixed interval to find any kind of discrepancy.
- To make a systematic evaluation of the complete accounting process which is used in the authorization of transactions?
- To conduct proper checks and controls to review if the entire organization is in proper shape and to find any loopholes.
- To make sure optimum utilization of resources is taking place within the firm.
- To make sure the financial statements are prepared following the guidelines of the accounting concepts and principles.
Principles of Internal Controls
The various principles of internal control are as follows:
- The first and foremost principle of accounting control is establishing the responsibilities.
- Maintaining records in sequential order is very important.
- The segregation of duties is also an important principle of accounting control
- Rotation of employees on a mandatory basis is needed.
- The usage of technology control is a must.
- Regular independent audit or review must be conducted.
- Insuring of assets must be done by bonding with key employees.
How does it Work?
Internal controls are guided by on the basis of the Sarbanes-Oxley Act of 2002 when there were a lot number of cases of fraud which was reported in early 2000 at many US companies. Corporate governance came under a lot of pressure where managers were made responsible for the financial reporting and an audit trail was created. Mangers that were found guilty of any kind of discrepancy were penalized and had to face criminal penalties. Internal and external audits also came into existence. Generally, external audit is independent auditors who are hired to test the books of accounts and thus they need to give their opinion on the same. Internal audit, on the other hand, evaluates the internal controls of the business and plays a crucial role in the company’s operations and corporate governance.
Components of Internal Control
The components of internal control are as follows:
- Control Environment: It is important to the other four components and sets up the structure at the top of a business firm and decides on the discipline and structure of the organization.
- Risk Assessment: Identification and analysis of risk which could stop a firm from achieving its goals.
- Control Activities: These are the set of steps and procedures to ensure the organization that all the directives given by the management are being followed.
- Information and Communication: This is related to the timely transfer of information that helps other employees perform their responsibilities.
- Monitoring: This is conducted by top management which enables them to see is all controls are well in place and are performed without any gap.
Examples 0f Internal Control
- Bank Reconciliations: One very basic example of internal control can be bank reconciliations where the records of all payments and receipts which are recorded in a business ledger are reconciled to the bank statement to see if there is any discrepancy.
- Audit: Audit is one of the biggest examples of internal control where an external party is hired to give their opinion on the accuracy and integrity of the books of account of the company.
- Procurement Policies: One area where internal control can be applied is the procurement policies of the company where the firms can establish a set mechanism and vendor list to procure the items it requires and establish a thorough check on it.
Responsibilities of Internal Control
The responsibilities of internal controls are as follows:
- The CEO is the prime connect for the application of internal control and makes sure he passed effective directives to his managers to conduct the business.
- Internal controls make sure there is no scope of fraud in the system and prevents it from happening.
- Internal control makes sure the financial and accounting information are of the highest integrity and reliability
- Internal controls assure that all the necessary accounting principles have been followed.
- It also protects the interest of the stakeholders who have invested in the company.
Scope of Internal Control
- The scope of internal control is for the overall governance of the firm and may reach to broader areas like risk management and technology control.
- It ensures that an accounting transaction is reliable and is also recorded by following the accounting principles.
- It is related to the distribution of authority and has a scope in the decision-making process of the organization.
- The Control system may turn out to become redundant with the passage of time.
- It may not prevent the collusion of two or more people.
- It still cannot fully safeguard a firm from the scope of human error.
- Most of the controls will tend to go towards the transactions of usual nature.
- It also bears a cost to implement the same in the business.
Internal control forms the crux of any business if applied properly. Surely the benefits of it are a lot more than the limitations it faces. Internal controls instill the concept of assurance and reliability on the firm and stakeholders also find such firms reliable enough to park their savings.
This is a guide to Internal Controls. Here we also discuss the objectives and principles of internal controls along with scope and responsibilities. You may also have a look at the following articles to learn more –