Question

Discuss the concept of internal control in detail .( importance , need , principles , process )

Answer 1

Concept of internal control:

As per SA-315, “Identifying and Assessing the Risk of Material Misstatement Through Understanding the Entity and its Environment” the internal control may be defined as “The process designed, implemented and maintained by those charged with governance, management and other personnel to provide reasonable assurance about the achievement of an entity’s objectives with regard to reliability of financial reporting, effectiveness and efficiency of operations, safeguarding of assets, and compliance with applicable laws and regulations. The term “controls” refers to any aspects of one or more of the components of internal control.”

The importance of Internal Control:

The auditor shall obtain an understanding of internal control relevant to the audit. Although most controls relevant to the audit are likely to relate to financial reporting, not all controls that relate to financial reporting are relevant to the audit. It is a matter of the auditor’s professional judgment whether a control, individually or in combination with others, is relevant to the audit. An understanding of internal control assists the auditor in identifying types of potential misstatements and factors that affect the risks of material misstatement, and in designing the nature, timing, and extent of further audit procedures.

1. Minimizing the company’s business risk
2. Ensuring the continuing effective functioning of the company.
3. Ensuring the company complies with relevant laws and regulations.

Most of these reasons funnel back to the ultimate objective that the company continues to operate.

For example, if the company failed to comply with relevant laws and regulations, it might be forced to stop operations.

Need of internal control

1. Internal control helps to protect the assets of the business from misuse, theft, accident, etc.
2. Internal control helps to implement management policies to attain corporate goals.
3. Internal control helps the auditor in his/her work, detecting all the errors and frauds which are committed in the books of accounts.
4. Internal control helps to increase the accuracy and reliability of financial statements and books of accounts.
5. Internal control helps to regulate the work of staff through a division of work among the staff in a scientific manner, which helps to make the daily works of staff effective.
6. Internal control helps the management to prepare and implement effective plans by providing correct and factual information.
7. Internal control helps to put moral pressure on staff

Principles of Internal Control

Internal control is based on the following principles:

1. Principle of Separation

2. Principle of Responsibility

3. Principle of Skepticism

4. Principle of Review

5. Principle of Clarification

6. Principle of Rotation

Process of internal control

Internal control is the process, effected by an entity’s board of directors, management, and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following categories:

• Reliability of financial reporting.
• Compliance with applicable laws and regulations.
• Effectiveness and efficiency of operations.