Question

Discuss the meaning of “internal control” in the context of accounting. Then share five examples of internal control procedures designed to prevent fraud and accidental accounting errors.

Answer 1

Internal accounting controls govern your financial system. “Management is responsible for developing and maintaining effective internal control,” reports the U.S. Whitehouse Office of Management and Budget, or OMB. Internal controls provide quality assurance and keep an eye on weaknesses in your operation. This allows you to stop problems before they start and keep your business operations running smoothly. The analysis, implementation and design go side by side with a system of control. Accounting controls provide feedback for the system, making sure that everything is working correctly. Without methods of monitoring your procedures, you cannot determine the system’s effectiveness.

Definition

Accounting controls are the methods and procedures a company uses to ensure the accuracy and validity of their financial statements. They do not ensure law and regulatory compliance, but they are designed to help your company comply. The internal controls protect you from abuse and fraud, and make sure all information is received in an accurate and timely manner.

Controls

“The control environment,” according to the OMB, “is the organizational structure and culture created by management and employees to sustain organizational support for effective internal control.” The most effective input for environmental control comes from the human resources department. When management is pushing for a high sales goal at all costs, employees will do the same and internal controls will be ignored, which often leads to financial difficulties.

Risk

“Risk assessment…involves identification and analysis of the risks of material financial misstatement,” states Thomas Ratcliffe in the "Journal of Accountancy". In a small business, risk assessment is often efficient since the management or owner has in-depth knowledge of the company’s workings and therefore knows where the risks are greatest. The main focus is on operations and compliance risks, but risk assessment also considers human error, including improperly entered transactions, lost transactions and transactions on the books that simply didn’t occur.

Systems

According to Ratcliffe, “Information systems identify, capture, process and distribute information supporting the achievement of financial reporting objectives.” Small businesses tend to use small stand-alone information technology--IT--applications to facilitate communication or simply frequent meetings and day-to-day activities where management communicates directly with employees. In larger companies, more formal integrated systems are used because it is impractical for upper level management to speak with all employees.

Monitoring

All internal control systems need to be monitored to assess quality in the system’s performance. This is usually managed through a combination of evaluations and ongoing monitoring activities. In a small business, the executives have first-hand knowledge of expected activities and close involvement with employees and operations allows them to easily identify variances and potential inaccuracies in the reported information or methods.

Procedures

Control procedures are all the methods for implementing environmental controls, risk assessment, monitoring and information communication. Control procedures help to train your personnel so that everyone works the same way. Ratcliffe reports, “Control activities are the policies and procedures that help ensure management directives are carries out.”

Examples like

Perfect segregation of duities among the employees,

Maintenance of books recording and cash with two different employees

Conduct of monthly meeting