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Components of Internal Control

Question:

Discuss about the Concept of Internal Control Persisting in an Organization.

This particular study focuses upon the concept of internal control persisting in an organization. Internal control essentially refers to the set of controls that have been established in an organization in order to enable the organization to achieve its objectives in terms of efficiency and effectiveness pertaining to the operations of the business. Internal controls review and recheck the quality of financial reporting and also make sure whether they comply with the laid down policies and regulations. In more simple terms any control that is implemented in the organization in order to mitigate risk falls under the purview of internal controls.

In this particular study the importance of implementing internal controls in an organization and how the implemented controls have helped the organization in achieving the company goals have been discussed.

Internal Control – Concept and Components

Internal control refers to the control that has been established inside an organization in order to strengthen its operational activities and improve the quality of regular day to day proceedings of business. An internal control in general acts as a catalyst that is it improves or influences the already implemented positive policies or regulations of an organization. For instance a successful implementation of internal control lies in segregation of duties. Segregation of duties in an organization is very important. For example a particular employee who is responsible for receiving cash from customers should not also be delegated with the task of recording them in the books. A different employee steps in for handling such a responsibility and therefore it is at this point that the internal control of segregation of duties has been established. Other duties that fall under the principle of internal control are utilization of technological controls, maintenance of records and conducting independent regular reviews. These principles of internal control therefore are the reference points of the management for establishing and implementing procedures for protecting the assets of the company (Hammersley, Myers & Zhou, 2012).


The components of internal control include Control Environment; Information and Communication; Control Activities; Monitoring; and Risk Assessment.

Control Environment refers to that component of internal control which determines the pitch of the organization and instills awareness about such control among the employees. It lays the basic structure for all other components of internal control.

Information and Communication refers to the processes and systems that help in identifying, capturing and exchanging information in a structured and framed way so as to support the employees in carrying out their responsibilities in a proper way.

Importance of Internal Control in Preventing Fraud

Control Activities refer to that component of internal control which establishes a set of regulations and policies for ensuring the execution of the directives set by the management.

Lastly Monitoring refers to the processes that are required for the purpose of assessing the quality of the internal control established in the organization over time.

The above mentioned components of internal control make the entire process easy to understand as well as implement (Hermanson, Smith, & Stephens, 2012).

Benefits of implementing Internal Control

Internal controls not only increase the efficiency of an organization but also simplify the work done by employees by setting clear goals and by continuously monitoring and reviewing the quality of the procedure in which the desired results are obtained. However the major benefits of implementing Internal Control in an organization are that they help in preventing fraud especially in the financial statements of an organization; they also help in preventing errors in preparing the financial statements; spotting the errors in the financial statements is also facilitated by the implementation of internal controls; internal controls also result in reduced lawsuit and insurance claims.

Internal control prevents fraud by segregating the duties of the employees. For instance internal control of a bank may require an employee collecting the cheques for cash withdrawal by customers and another employee authorizing those withdrawals thus mitigating the chances of fraudulent activity.

 Internal controls not only help in preventing fraud but also prevent the occurrence of errors in business. Reviews at periodic intervals and surprise tests of the quality of the finished products help in preventing errors. Implementation of internal control in order to ensure that all the transactions that take place inside an organization are authorized also play an important role in preventing errors.

 Implementation of proper internal control also help in establishing clear, concise and defined guidelines in relation to the ethical conduct and other management implemented policies and regulations of the organization. This help in reducing the risk of lawsuits and costly insurance claims. Essentially the internal controls ensure welfare of the employees.


Internal controls also help to make the financial statements error free. They mitigate the common occurrences of errors in the financial statements like misappropriation of assets and material misstatements (Vijayakumar & Nagaraja, 2012).

An external auditor who has no internal knowledge about the inner operation of an organization obtains great help from the internal controls that are accurately implemented within the organization. An organization that has proper internal control implemented within it will automatically generate certain features that will help an external auditor to assess the organization. One of these features are creation of an ethical code within the organization. The employees of the organization communicate with each other honestly and with integrity. Each of the employees would be competent enough to manage their own task and their dependence on management would be minimized. There would be periodic training sessions and workshops that would keep the employees updated and at par with the technical improvements or implementations within the organization. In addition to all these features the major area where the internal control helps the external auditor is the integrity of the financial statements. A properly implemented internal control would allow an external auditor to spot errors like material misstatements in the books of accounts with much ease. With the introduction of technology in the industries, the companies have become much more exposed to fraud. For instance backing up of data in a computerized system not only increases the risk of losing the data but also the risk of hacking the crucial information from the system by an imposter increases. An accurate internal control like password protected portals and regular backing up of data would help an external auditor to work more easily (Yee et al., 2017).

Errors Prevention and Detection through Internal Controls

The internal auditors within an organization develop a risk assessment plan in order to mitigate the risks related to the preparation of the financial statements. Risk related to the occurrence of material misstatement or fraud in the books of accounts if identified by the internal auditors, they develop internal control in order to reduce the risk. Surprise review of the financial statements and the fixation of the minimum amount of materiality are some of the internal controls adopted by the internal auditors. These implementation of internal controls help an external auditor to execute his job with much ease. According to ISA 315, an internal auditor can be of great help to an external auditor provided that he carries out his work with utmost sincerity and care Feizizadeh, 2012)..


For instance Skoda Minotti an auditing firm was able to find out fraud by performing risk assessment procedures in a scrap industry firm which was its client. The implementation of a proper set of internal control by the audit team helped the company to finally identify the person responsible for the disparity in the books of accounts ("Skoda Minotti Fraud After an Internal Control Assessment", 2017).

Another instance is when a public company required help in order to implement the 2013 COSO Framework hired a consultancy firm named Accounting & Business Consultants. The auditing team after proper scrutiny of the situations prevailing in the company provided proper guidance and leadership in implementing proper internal controls that helped the company in identifying the exact irregularities that hampered business ("Internal Controls Case Study | Audit Services in Northeast", 2017).

There are certain limitations that come along with the implementation of internal control within an organization. These are management override, lack of monitoring due to staff turnover, collusion and limited judgment.

Management override refers to the manipulation of the prescribed policies and procedures by a high level official of the management in order to satisfy his personal needs. Such an action will never let an implemented internal control reach its desired objective.

Another important limitation of internal control is the lack of monitoring. The controls implemented have to be monitored on a regular basis so as to check whether any disparity or irregularity has occurred in its obtained results. But this is not always achieved due to fact that the staff delegated with the responsibility to perform the task does not turn up or lack interest to do the job.

Internal Controls and Ethical Conduct


Collusion refers to a form of fraud that may be done a group of imposters within the organization. A group of people together may manipulate the books of accounting statements in such a way that the internal control will never be able to identify the disparity. The only solution left in that case is external audit.

Lastly quick judgment refers to the fact that internal controls are essentially decisions taken by the management under pressure to find out the loopholes in the company within a given time period. Thus the entire process is based on human judgment that is limited with the information currently available (Li et al., 2012).

Conclusion

Thus from the above study it can be understood that internal controls are very effective and efficient in identifying the irregularities or fraud that otherwise cannot be identified. An internal auditor after proper scrutiny determines the internal controls that are to be implemented within an organization and wait for the controls to come up with the solutions. It is advisable by every financial regulator to implement internal control within an organization. Though there are certain limitations of these controls but most of them are due to carelessness or lack of interest on the part of the management or employees. Therefore an organization that is really interested to make its operations error free should implement internal controls.

References

Feizizadeh, A. (2012). Strengthening internal audit effectiveness. Indian Journal of Science and Technology, 5(5), 2777-2778.

Hammersley, J. S., Myers, L. A., & Zhou, J. (2012). The failure to remediate previously disclosed material weaknesses in internal controls. Auditing: A Journal of Practice & Theory, 31(2), 73-111.

Hermanson, D. R., Smith, J. L., & Stephens, N. M. (2012). How effective are organizations' internal controls? Insights into specific internal control elements. Current Issues in Auditing, 6(1), A31-A50.

Internal Controls Case Study | Audit Services in Northeast. (2017). Abcpas.com. Retrieved 30 October 2017, from https://www.abcpas.com/case-study-sixteen.htm

Li, C., Peters, G. F., Richardson, V. J., & Weidenmier Watson, M. (2012). The consequences of information technology control weaknesses on management information systems: The case of sarbanes-oxley internal control reports. Mis Quarterly, 36(1).

Skoda Minotti Fraud After an Internal Control Assessment. (2017). skodaminotti.com. Retrieved 30 October 2017, from https://cpa.skodaminotti.com/fraud-after-an-internal-control-assessment

Vijayakumar, A. N., & Nagaraja, N. (2012). Internal Control Systems: Effectiveness of Internal Audit in Risk Management at Public Sector Enterprises. BVIMR Management Edge, 5(1).

Yee, C. S., Sujan, A., James, K., & Leung, J. K. (2017). Perceptions of Singaporean internal audit customers regarding the role and effectiveness of internal audit. Asian Journal of Business and Accounting, 1(2), 147-174.

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