INTERNAL CONTROLS
CHAPTER OBJECTIVE
I. INTERNAL CONTROL
II. COMPONENTS OF INTERNAL CONTROL
III. CATEGORIES OF INTERNAL CONTROLS
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I. INTERNAL CONTROL
Internal control is the process designed and effected by management and others to provide reasonable assurance about the achievement of the entity’s objectives with regard to reliability of financial reporting, effectiveness and efficiency of operations and compliance with applicable laws and regulations.
Internal control is achieved by management establishing an effective internal control system.
The internal control system comprises the control environment and control procedures. It includes all the polices and procedures adopted by the directors and management of an entity to assist in their objective of achieving , as far as practicable, the orderly and efficient conduct of the business, including adherence to internal policies, the safeguarding of assets, the prevention and detection of fraud and error, the accuracy and completeness of the accounting records, and the timely preparation of reliable financial information.
1. The Controls in the system are sound in principle, and
2. The controls in the system are operating effectively, then
The figures produced by the system are likely to be true and fair.
This chapter deals with item 1 above. The following chapter deals with item 2-how the auditor will assess whether the systems in place are operating satisfactorily.
II. COMPONENTS OF INTERNAL CONTROL
While it is traditional to identify the internal control system as comprising the control environment and control procedures, in fact ISA identifies five separate components of internal control:
1. Control environment
This is a broad concept which refers to the overall attitude, awareness and actions of management regarding internal controls and their importance.
It is reflected, for example, management style, the corporate culture, values, philosophy and operating style, the organizational structure, personnel policies and procedures.
2. The entity’s risk assessment process
This is the entity’s process for identifying business risks relevant to financial reporting objectives and deciding about actions to address those risks.
3. The entity’s information system
This includes the financial reporting system and consists of the procedures established to initiate record, process and report entity transactions and to maintain accountability for the related assets, liability and equity.
4. Control activities
These are more detailed day to day operating procedures established to achieve the entity’s specific objectives. Objectives in an accounting context would include the proper authorisation, timely and accurate recording of transactions in the correct period, the safeguarding of assets and ensuring the existence of assets recorded.
5. Monitoring of controls
An entity should review its overall control system to ensure it still meets its objectives and operates efficiently and effectively. Auditors are required by IASs to identify control deficiencies observed throughout the audit but it remains the company’s responsibility to monitor is own internal controls.
III. CATEGORIES OF INTERNAL CONTROLS
1.Supervision
There should be adequate supervision of work to ensure that controls are being complied with.
Possible application: a supervisor or manager reviews and checks the work of a subordinate.
The existence of a system of supervision is seem to improve the accuracy of records (employees will take more care if their work may be checked and check will reveal errors which can then be corrected.
2.Organisation
Enterprise should have a formal, documented organisation structure with clear lines of responsibility.
Possible application: lines of authority within an organisation make it clear which individuals are responsible for decisions and transactions.
3.Arithmetic and Accounting
The company should ensure that there are adequate controls to ensure the completeness and accuracy of its financial records.
Possible application: standard accounting procedures such as the use of control accounts, reconciliation procedures and the performance of arithmetic checks on accounting records.
4.Physical
There should be adequate physical control to ensure the security and safekeeping of its assets such as plant and machinery, valuable inventory items and cash.
Possible application: banking immediately, controlling; electronic tagging of inventory and portable non-current assets.
5.Management
There should be sufficient controls in existence to ensure management can effectively control the business operations.
Possible application: the use of budgeting and standard costing systems; the establishment of an internal audit department.
6. Authorisation
All transactions should be authorised by the appropriate personnel
Possible application: authorisation of purchases, cash and bank payments, sale of non-current assets, sales to customers on credit, irrecoverable debt write offs.
7.Personnel
Employees should be appropriately qualified and of suitable calibre to perform the required tasks.
Possible application: recruiting the right people for the job; training them effectively, motivating and rewarding employees in an appropriate way.
8.Segregation of duties
There should be an appropriate division of responsibilities to reduce the opportunity for fraud and manipulation.
This is a fundamental control procedure designed to ensure that one person does not have sole charge of a transaction from beginning to end. If this situation were allowed, it would be very easy for that individual to defraud the company if they so desired.
Perfect segregation of duties exists where each of the main stages in a transaction are under the control of a different person.
Possible application: consider an inventory purchasing system in a manufacturing company:
| Stage | Documentation | Responsibility |
| Initiation
Authorisation Custody Recording |
Stores requisition
Purchase order Goods received note invoice |
Stores keeper
Purchasing officer Receiving offer Accounting department |
Source:
1. Kaplan, FAU
2. Phnom Penh HR (www.pp-hr.com)