Find out why internal control is vital for any organization's financial health and sustainability.
Published 12 May 2023
Internal controls are the company's policies and procedures to ensure its operations are efficient, effective, and compliant with laws and regulations. These controls safeguard the company's assets and prevent fraud, errors, and other risks.
Effective internal controls are critical for the success and sustainability of any organization. They help assure stakeholders that the company operates responsibly and ethically and that its financial statements are reliable and accurate in accordance with accounting regulations (e.g., Sarbanes-Oxley Act). Furthermore, it’s essential to regularly review and update internal controls to ensure they remain relevant and valuable.
There are several advantages to having internal control, including:
One of the vital control procedures that can help detect errors and fraud is the segregation of duties. It involves assigning different tasks to different employees, which helps to prevent any single employee from having too much control over a particular process.
For example, one employee may be responsible for recording transactions, while another is responsible for reconciling bank statements. This way, if one employee makes an error or tries to commit fraud, it is more likely to be detected by the other employee.
An auditor may perform testing, checking, or sampling transactions to verify book entries’ accuracy and reliability. As a result, he can finish his auditing tasks and create financial statements within the designated timeframe.
The use of this system promotes accountability, accuracy, and reliability in work performance while reducing inefficiency, fraud, and theft. Additionally, this system allows for the evaluation of employee performance by management. And all of these elements contribute to improving the organization’s overall operational efficiency.
Meanwhile, when implementing internal controls, it’s essential to consider certain limitations that may impact their effectiveness. The following are some examples:
Many businesses implement segregating duties as an internal control measure to prevent fraud by ensuring that no single employee has excessive power. However, employees can collaborate and use a complex process to conceal fraudulent activities.
Human error can impact internal controls, mainly involving manual processes and judgment calls. Manual inventory counts may lead to inaccuracies, and internal audit outcomes may be affected by poor judgment. Implementing automated systems will ensure consistency and minimize human error risk.
A company’s management establishes internal controls to identify and prevent or reduce potential hazards. However, management can’t predict all possible challenges or occurrences. Random variables or circumstances may affect the effectiveness of internal controls.
Moreover, the cost of controlling unusual conditions may outweigh the benefits, leading a management team to accept the risk instead. As a result, it can restrict the effectiveness of internal controls in certain situations.
Listed below are some examples of internal controls that organizations can implement in their operations:
The two fundamental internal controls are preventive and detective. A comprehensive internal control system should include both types, each fulfilling a distinct function. Let’s take a closer look at each:
Preventive controls can reduce the likelihood of errors and fraud by focusing on the separation of duties. They’re an integral component of quality management because they involve a proactive strategy to ensure quality.
The following are examples of preventive controls:
Detective controls identify errors or issues that may have occurred post-transaction. They are essential in proving that preventive controls function correctly and offer the chance to uncover any abnormalities afterward.
The following are examples of detective controls:
There are five components to an internal control system. Let’s examine each and how it contributes to internal control.
In a company, the culture is built and set from the top down by the board of directors and top management, which employees must follow. The control environment plays a critical role in providing support to the other internal control components.
Periodic risk assessments help organizations identify and analyze potential risks that may impact their ability to achieve their goals and objectives. The results are utilized to pinpoint areas that require prioritization and implementation of internal controls.
Eliminate manual tasks and streamline your operations.
Efficient systems and processes should facilitate the identification, capture, and exchange of information on time, allowing individuals to perform their duties effectively. In cases where information is not easily accessible, employees may attempt to bypass internal controls to streamline operations.
They’re the policies and procedures an organization implements to achieve its objectives. These actions prevent or detect errors, fraud, or other irregularities in the organization’s operations. Control activities are an essential component of internal control because they provide the necessary safeguards to protect the organization’s assets and ensure the accuracy and reliability of financial reporting.
Monitoring is essential to internal control as it allows businesses to ensure that their internal control system functions effectively. It involves the ongoing assessment of the internal control system to identify any weaknesses or deficiencies that need to be addressed. It also involves regularly reviewing financial statements and other key performance indicators to ensure accuracy and reliability.
Given the growing complexity of business operations, identifying and assessing internal control deficiencies can pose a challenge for companies and external auditors. The following tips can help you evaluate internal control deficiencies:
The control environment is crucial to evaluating internal control deficiencies. It serves as the basis for internal control and impacts employee behavior. A company that prioritizes a robust control environment operates with integrity and ethical values, attracting and retaining competent employees responsible for their internal control duties.
Thorough risk analysis is vital to effective internal controls. To manage risks, organizations must identify potential obstacles to achieving their objectives. In connection with this, fraud is one of the most common risk areas organizations must consider. Auditing, risk, and compliance professionals can evaluate a company’s risk assessment strategy to ensure that internal controls prevent fraud.
Effective controls are essential for an organization, but policies and procedures must also be in place to manage risks and achieve objectives. Internal control encompasses activities such as performance reviews, segregation of duties, and electronic safeguards like two-factor authentication. Having control activities that minimize the risk of fraud and error indicates a sound control environment.
High-quality internal communications are necessary for supporting internal controls. It’s essential to review the organization’s information and communication systems, particularly the accounting information system, to ensure accurate and efficient reporting.
An organization that regularly evaluates its internal controls can reduce risks to an acceptable level. The frequency and quality of monitoring activities determine the effectiveness of an organization in managing financial risk. Consistent monitoring, assessing, and corrective action for internal control deficiencies lead to tremendous success in risk management.
Top management is responsible for establishing and maintaining the internal control system. They must set the tone at the top by communicating the importance of internal control and establishing policies and procedures to address key risks. They must also monitor the system to ensure its functioning as intended and take corrective action when necessary.
There are instances where internal controls fail. One of the main reasons for this is when employees don’t follow the established procedures. The reason can be a lack of training, an understanding of internal controls, or a choice to bypass them.
External auditors aren’t responsible for internal controls. While they may review and assess the effectiveness of an organization’s internal controls, their primary responsibility is to provide an independent opinion on the accuracy of the financial statements and compliance with laws and regulations.
One of the reasons why internal controls cannot provide absolute assurance is that they aren’t foolproof. Internal controls may not address new risks and threats as they emerge. For example, cyber threats and data breaches are relatively new risks many internal controls fail to address.
Managing internal controls requires attention to detail and organization. It oversees risk assessments, procedures, metrics, audit records, and communication. SafetyCulture (formerly iAuditor) streamlines evidence and audit management for your quality and compliance frameworks.
SafetyCulture is a powerful internal control software that can help businesses do the following:
Rob Paredes is a content contributor for SafetyCulture. He is a content writer who also does copy for websites, sales pages, and landing pages. Rob worked as a financial advisor, a freelance copywriter, and a Network Engineer for more than a decade before joining SafetyCulture. He got interested in writing because of the influence of his friends; aside from writing, he has an interest in personal finance, dogs, and collecting Allen Iverson cards.
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