Internal controls are an organization’s procedures and records for asset protection and financial record dependability.
Internal Control System Fundamentals
An internal control system should suit a company’s information needs.
Thus, the system might range from a simple manual system to a complicated online computerized system with remote terminals nationwide.
Accounting systems, whether manual or digital, must handle data quickly, precisely, and efficiently.
A solid internal control system underpins every good accounting system.
Management must safeguard its assets, verify its accounting records, and enforce its policies.
Management creates internal control, including methods and procedures, to fulfill these duties. Internal control officially means:
“A business’s plan of organization and all of its coordinate methods and measures to protect assets, verify accounting data, improve operational efficiency, and promote policy compliance.”
A good internal control system includes financial and administrative controls.
Administrative controls encompass the organization plan, procedures, and records that govern management’s transaction authorisation decision processes.
Management employs administrative controls to enforce policies and procedures.
Accounting controls are the company’s plan, methods, and records to protect assets and financial records.
These specialized controls ensure:
General or specific management authorization governs transactions.
Transactions are documented to (1) prepare financial accounts in accordance with GAAP or other criteria and (2) maintain asset accountability.
Assets are only accessible with management approval.
Asset accountability is compared to existing assets at acceptable intervals and action is made if there are discrepancies.
A firm needs administrative and financial controls for good internal control.
The accounting controls operate within administrative controls.
If management doesn’t care about administrative controls, accounting controls won’t protect the firm’s assets.
Need for Internal Controls
Accounting systems are built and run by people, who make mistakes.
These are either mistakes or intentional actions. Due to accounting irregularities, huge firms have revised their financial accounts many times.
A major PC manufacturer discovered it had misaccounted for millions of dollars in inventory. Poor record keeping, not fraud, appears to have caused it.
However, some people fake accounting documents to steal or embezzle.
One person stole enormous amounts of money from Wells Fargo Bank in the early 1980s by making basic accounting entries in the bank’s computer system.
Minimizing these incidents and losses requires a solid internal control system.
Paying foreign authorities for business prompted U.S. firms to strengthen internal controls.
Many foreign countries regarded these payments legal, but many Americans thought them unethical.
Many of these problematic payments were made by huge, decentralized international businesses whose top executives were unaware.
These and other instances led the AICPA and Congress to require rigorous internal control.
The AICPA’s auditing guidelines suggest that management should monitor the internal control system to ensure it is working properly and is adjusted as needed.
Concerned about suspicious foreign official payments, Congress created the Foreign Corrupt Practices Act.
This act requires management to create and maintain a strong accounting internal control system to prevent such payments.
Every publicly traded company must have internal control under this act.
The statute also demands that the internal control system confine company assets to management’s stated purpose and compare accounting records to firm assets.
Strong Internal Control System Qualities
An internal control system and its procedures should be customized for the organization.
A well-designed internal control system will incorporate a good accounting system, good personnel practices, and duty separation.
A Good Accounting System
Strong internal control is hard to execute without a good accounting system.
This accounting system should oversee the firm’s assets, liabilities, revenues, and expenses.
Manual or automated accounting systems should have management authorizations and internal checks and balances. Accounting manuals document the system.
Surprise inspections should be done occasionally to verify these procedures are followed and the firm’s assets are protected.
Good Staff and Policies
Any internal control system depends on its operators. People should be in roles that match their skills.
Good personnel rules include rotating critical jobs, requiring all employees to take an annual vacation, and bonding cash handlers.
Bonding checks employees and protects the company from theft.
Separating Duties
Accounting duties should be separated. Thus, those who control an asset should not account for it.
The person in charge of cash receipts should not also handle accounts receivable or bank reconciliation.
This makes it harder for one person to steal business assets.
Limitations of Accounting/ICS
No accounting internal control system is perfect.
This is especially true if upper management wants to override the system. Even if conceivable, foolproofing the system would likely cost more than it would benefit.
However, a well-designed and implemented system can minimize many potential issues and give management confidence that its policies are being followed and the firm’s assets are protected.