Discuss the purpose of internal controls

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26 January 2014 Accounting portfolio

Internal controls

Methods put in place by a business to make sure the reliability of financial and accounting information, meet operational and profitability targets and pass on management strategies right through the association.

Methodical processes (such as reviews, checks and balances, processes and measures) put in place by an association to carry out its trade in an logical and well-organized manner, preserve its assets and capital, discourage and notice errors, fraud, and theft, ensure precision and completeness of its accounting information, produce dependable and timely financial and management information, and ensure faithfulness to its policies and tactics.

Reasons of internal controls

The aim of internal auditor is to assist all management levels with information about the organization and the continuation of satisfactory internal control over all actions and to make certain that these activities can be carried out efficiently and effectively.

Internal Auditors assists the management of a business to meet its responsibilities effectively by evaluating financial, managerial and operating information, making recommendations for the improvements of systems and procedures, and providing other information aimed at promoting effective control by reducing risk at reasonable cost.

Internal auditing does not necessarily confine itself to purely financial control. It can also branch out into operational auditing whereby a businesses' effectiveness is measured against corporate and industry standards so as to identify possible areas where improvements can be implemented. Management and management systems can also be audited

Define internal controls

Internal control is the procedure by which management structures an association to provide reassurance that an business operates efficiently and economically. It has a dependable financial reporting method and complies with valid laws and policies. A thriving system of internal control is not put together immediately, but it is a continuous development of fine modification the inner workings of an association. Most associations sum up internal control methods in operational instruction manuals so that the workforce are able to effortlessly refer to the entity’s guidelines.

What is the purpose of internal controls

A system of internal control is essential to assist workers and other shareholders understand the outlook and purpose of the association as in one piece. Internal controls offer practical assurance to clients and other parties that transactions are recorded correctly and on time. For example, many customers have a preferred shop because the company is known for providing quality service in time. Consumers prefer to support companies that have superior systems of internal control.

The five workings of internal control are check, manage activities, information and communication, risk evaluation and the control environment. Checking entails assess the performance of workers and is achieved by carrying out self-assessments or staff reviews. Control activities assist to decrease and handled risk in an business. For instance, passwords are to be found on computer programs to avoid unauthorized admittance. Information and communication involves providing workers and clients with the facility to communicate and collect information. Successful communication and information ranges from refined computer technology to frequently hold employees meetings. Risk evaluation and the control environment entail the whole organization and assess the overall objectives of the business and how goals are achieved.

Why internal controls are important

An business’s system of internal control is assessed on a regular basis. Before approving financing, creditors often demand a record of management and those persons who are allowed straight access to bank financial records. Auditors are required to attain and document an acceptable understanding of an business’s internal control environment during the development stage of a financial statement audit.

Failure to set up a system of internal control points out a need of direction for the business. Many corporation owners want that their workers sign documents demonstrating that they have read the instruction booklet containing rules and guidelines. This offers a restricted protection to the company owners should an employee go against policies and expose the businesses to the risk of lawful action.

Role of internal auditor does in designing, implementing and monitoring internal controls

An internal auditor is the person who examines and vouches for the correctness and comprehensiveness of accounting records and the financial statements of any company's establishment. These auditors will independently appraise the functions within an organisation.

The internal auditor provides the management of the organisation with analysis, appraisals. recommendations and information about the activities under reviews. The internal auditor will analyse compliance with policies, procedures and practices and also evaluate established controls and appraise the efficiency, effectiveness and economy of operations.

In addition the internal auditor identifies, evaluates and handles risks. They may prepare financial statements for a client such as income statements and balance sheet as well as preparing detailed reports showing items such as operating costs, total assets, liabilities, net sales, net profits and depreciation costs.

An auditor is expected to act as a financial adviser due to their wide knowledge, experience and thorough training. Advise will take form of new bookkeeping systems and will advise companies and individuals on aspects concerning taxation, legal matters and finances.

An internal auditor will examine and evaluate the adequacy and effectiveness of the system of internal control provided by the company. The objective is to provide all levels of management with sufficient, relevant and useful information so as to assure management the following:

· Internal control systems are being implemented correctly and efficiently

· The assets of the enterprise are correctly reflected in the books of the business.

· The liabilities of the enterprise are correctly recorded in the books of the business

· Management processes are adequate and they are able to identify and monitor significant risks

· Confirm the effective operation of the established internal control systems

· Credible processes for feedback on risk management and assurance

· Objective confirmation that the board receives the right quality of information from management and this information is reliable

Instituting procedures

By making internal controls, company owners set up protocols and methods that their employees and specialists must adhere to. Company owners notify their workers of these protocols and anticipate that they will adhere to them as they carry out their day-to-day work functions. These established procedures assist bring instruction and cohesiveness to corporations, as every person knows what is accepted by the business.

Prevention of Fraud and Theft in the business

Setting up internal controls can assist corporations prevent or diminish fraud and theft within their business. Internal controls can comprise of activities such as reconciling bank statements and internal inspection reviews, which can discover whether the business's funds are being taken by management or workers of the business.

Segregation of responsibilities

Internal controls divide the responsibilities amongst the workers, making sure that there is a method of checks and balances. For example, a company's internal controls may make sure that a worker who does the business's financial records receivable does not also do the business's accounts to be paid. This can also help reduce internal fraud and theft.

Organize Information

Internal controls can assist companies keep its financial and management information planned. Planned data can boost output and better arrange the business if the business requires to create documents for lawsuits or if the business requires information for observance reviews or audits. This might comprise of giving each worker his own password to right of entry of files and information on the business's computer, or making a system for filing customers information and financial documents.

Decrease blunders

Internal controls can assist companies reduce errors, which can assist them put aside cash. Worker preparation is an example of an internal control that can reduce faults. By training workers on processes and procedures, workers are not as much of likely to make errors. Training can comprise of how to make use of an internal computer program or learning a new work procedure that exists connecting departments.

What can the business do in order to develop its internal controls?

  • put into practicedivision of dutiesamong different workers to decrease the risk of mistakes or unfortunate actions; make sure no one person has total control over all portions of any financial operation.
  • make sure records are regularly re-examined and reconciled by someone other than the preparer to determine that transactions have been processed precisely and suitably.
  • make sure that money, equipment, stock, and other property are protected physically, counted at regular intervals, and matched up to control records; limit admittance only to authorized people.
  • make available workers with the suitable training, direction, and management to make certain they have the essential information and skills to bring out their duties; inform workers of the appropriate channels for reporting suspected improprieties.
  • document day-to-day functioning procedures and practices to make available to employees with management to ensure management’s directives are carried out and to assist maintain continuity of operations in the event of prolonged worker absences or earnings.

What are the mechanisms of an internal control structure?

The control environment, is the establishment for all other mechanisms of internal control. The control environment is prejudiced by management’s viewpoint, functioning method, reliability, ethical principles, and obligation to proficiency. If this establishment isstrong, if the control environment is optimistic, the overall system of internal control willbe more efficient.

Risk assessment is the identification, examination, and management of risks relevant to the accomplishment of the business’s goals and objectives. Risks include internal and external events or conditions that may happen and unfavourably influence operations. Once risks are recognized, management should think about their impact (or meaning), the probability of their happening, and how to handle them.

Internal control activities are tools - policies, procedures, methods, and mechanisms - that help ensure management’s directives are carried out. Control activities assist to recognize, stop or decrease the risks that can obstruct achievement of the business's objectives. Control activities occur all through the business, at all levels and in all functions; they include activities such as approvals, authorizations, verifications, reconciliations, documentation, separation of duties, and safeguarding of assets.

For a business to run and control its function, it must have applicable, and timely communications describing to the internal and external proceedings. Managers must be able to acquire dependable information to make knowledgeable business decisions, determine their risks, and communicate policies and other significant information to persons who require it.

The business’s internal control method needs to be monitored to consider whether controls are successful and functioning as planned. On-going monitoring occurs through routine managerial activities such as supervision, reconciliations, check-lists, evaluations, performance assessments, and position reports; monitoring may well also take place through split internal evaluations or from use of external sources. Deficiency that originate during monitoring have to be reported to the persons in charge for the purpose, with severe deficiencies being reported to owner.

Why are internal controls vital?

The overall reason of internal control is to assist a business attain its task and complete certain goals and objectives. An successful internal control system assist a business to:

  • encourage orderly, economical, efficient and effective procedures.
  • manufacture quality products and services dependable with the business’s task.
  • protect resources against loss due to waste, abuse, mismanagement, errors and fraud.
  • encourage adherence to statutes, set of laws, procedures.
  • expand and maintain dependable financial and management information, and correctly account that information in time.

Preventative controls and examples

Preventive control activities plan to discourage the occurrence of errors. Preventive activities include methodical documentation and authorization training. Preventive control activities prevent unwanted activities from occurring, thus they entail well thought out procedures and risk recognition. Designed to discourage errors or prevent abnormalities from happening. They are pro-active controls that assist prevent a loss.Examples are Separation of duties, appropriate authorization, sufficient documentation, and substantial management over assets.

Segregation of duties, protecting the cash in the bank

  • whole is responsible for the custody of checks
  • preparing and authorising the supporting documentation on for the payment and signing the cheque
  • management must protect companies cash in the bank and ensure that money is not transferred from the account by the issue of fraudulent cheques or unauthorised electronic transfers

Segregation of duties when issuing stock

  • Store-man is responsible for custody of the inventory only
  • Another employee creates the delivery note
  • Another employee is responsible for keeping of the inventory records ( the store-man will have to collude with the other employees to be in position to steal without detection
  • security guard at the gate checks goods against the delivery note

Detective control and examples

Detective Controlsare designed to discover errors or irregularities following they have happened.Examples: Reviews, analyses, variance analyses, reconciliations, physical inventories, and audits.

The procedures performed by the auditor to reduce risk to an acceptable low level will not detect a misstatement that exists in an assertion that could be material, individually or when aggregated with misstatements.

Corrective control + example

Corrective Controls

Corrective controls are designed to avoid faults and abnormalities from reoccurring previously when they were revealed. Examples of these types of controls are: guidelines and methods for reporting faults and abnormalities so they can be corrected, educating workers on new guidelines and procedures developed as component of the corrective actions, constructive order to avoid workers from making potential faults and permanent development of processes to accept the newest operational methods.

Directive control and examples

internal control measure applied by encouraging or causing a desirable event to take place.

Risk analysis

Risk Assessment Risk assessment is the recognition and examination of the risks related to the accomplishment of the businesses objectives. Assessment may comprise of looking at departmental practices, activities, and employees, identifying any possible trouble. This forms the foundation for determining how the risks must be handled.

Internal controls that are recommended in terms of protecting assets


Control of inventory

Proper control needs to take place of inventory bought, sold and returned. In a perpetual stock taking system, trading stock is constantly recorded when being sold or returned. At the end of the financial year, physical stock count will be done and any stock missing will be brought into account as a trading stock deficit. Management must be informed of all trading stock that is missing.

Segregation of duties when issuing stock

  • Store-man is responsible for custody of the inventory only
  • Another employee creates the delivery note
  • Another employee is responsible for keeping of the inventory records ( the store-man will have to collude with the other employees to be in position to steal without detection
  • security guard at the gate checks goods against the delivery note


A current asset account which includes currency, coins, checking accounts, and any checks hat not been deposited or received from customers. The amounts must be unrestricted. (Restricted cash should be recorded in a different account.

All cash must be properly receipted. It is essential that a receipt book be numbered so that all receipts issued can be accounted for. When a payment is made, cheque counterfoil is filled in so that a proper record is kept of all cash payments.

Segregation of duties, protecting the cash in the bank

  • whole is responsible for the custody of checks
  • preparing and authorising the supporting documentation on for the payment and signing the cheque
  • management must protect companies cash in the bank and ensure that money is not transferred from the account by the issue of fraudulent cheques or unauthorised electronic transfers

A transaction passes through 4 stages

  • Authorising purchase order authorised by chief buyer or checking and approving supporting documentation for payment
  • Executing order placed with supplier by the clerk or preparing the cheque requisition and cheque
  • Custody of asset goods received by the receiving clerk from the supplier and placed in the store or signing the cheque ( the person who signing power has custody of the cash
  • Recording the transaction offered into account records by accounting clerk or recording the payment in the records and posting to the ledger.

Petty Cash

  • The person in charge of the petty cash must sustain successively numbered vouchers and a record book that reflects the total of money at present held by the petty cash keeper. The keeper must then reconcile the amounts on vouchers and the quantity of physical money against the petty cash report.
  • at regular intervals (monthly or weekly), an self-governing designated worker should carry out a re-evaluate of the petty cash on hand by comparing the physical cash and vouchers against the total balance. This process makes certain the figure of both totals is equivalent to thetotal petty cash that was originally paid out.
  • The petty cash, and its supporting documents and vouchers, should be kept back in a protected location under restricted access by designated workers(manager).
  • The worker managing the petty cash procedure should set up a maximum threshold for the individual petty cash spending.

Tangible assets

Tangible assets that have a physical form (e.g. land and buildings, equipment and vehicles). Tangible assets comprise of both fixed assets, such as equipment, land and buildings, and current assets,(e.g. cash and cash equivalents, trade and other receivables and inventory). There are also intangible asset. These are assets, such as patents, trademarks, copyrights, goodwill and brand recognition.

Fixed asset register

Proper record must be kept of the fixed assets that are in the possession of the business.