In: Accounting
Discuss the concept of internal control in detail . ( importance , need , principles , process )
For Companies registered in US, An effective internal control system is a requirement of the Sarbanes- Oxley Act of 2002 which regulates reporting and testing of internal controls over financial reporting for public companies.
Internal controls establish safeguards to an organization’s assets and minimize the opportunities of committing fraud and allowing errors to go undetected in an organization’s daily operations.
Importance and Need of Internal Control
1. Internal Controls help to understand and mitigate risks.
Internal controls are usually established based on a risk-oriented approach to ensure that your organization focuses on high risk areas. Understanding risks will help you to determine if there are adequate controls to mitigate the risks in those areas.A risk assessmenti is a necessary first step, provides a foundation to establish internal controls.
2. Internal Controls help to address financial statement assertions.
One of purposes of internal controls is to safeguard the organization’s assets and thus address financial statement assertions (existence, rights, completeness and accuracy). A familiar example is performing a physical count of inventory used internally by all organizations. Count inventory and track them in the accounting system to ensure the existence. Count cash receipts in retail sales before recording them to verify accuracy
3. Internal Controls help to prevent and detect fraud
Segregation of duties (SOD) is a fundamental element of internal control. Internal controls including proper SOD help to prevent fraud. The principle of SOD is to share responsibilities in a key process such that no one individual should perform two of the three functions: custody, recording and authorization. When the three responsibilities are properly segregated, fraud can be effectively prevented or detected.
4. Internal controls help to prevent misstatement of financial statements.
Internal controls helps to prevent errors and misstatement of financial statements. For example, reconciliation is a critical internal control procedure in accounting and can ensure the account balances on the balance sheet are correct to prevent misstatement of financial statements. Reconciliation also helps management and other users to detect errors and understand the company operations
5. Internal controls help to establish company practices.
If you do not have documental evidence of internal controls, you cannot prove internal controls exist. Most organizations have documentation for their internal controls, i.e. flowcharts and/or narratives, because documentation is critical to communicate internal controls with your external auditors and within your organization, quality documentation can be used to train new employees. By following internal controls documentation, employees get a better understanding of the company processes and practices, which helps to establish the company’s practices.
Principles of Internal Controls
The principles of internal control are the concepts that require management to set procedures in place to ensure company assets are safeguarded.
The main internal control principles include:
The subject of internal controls is always expanding and this list of principles will probably expand in the future as well. This is just a list of the most common and influential ones. That being said, these principles are the basis by which management uses to create and implement the internal controls it establishes. In other words, these are the basic ideas of controls
Internal Control process
The internal control process has five components:
Internal Control Environment
An effective internal control environment:
Risk Assessment
A risk is anything that endangers the achievement of an objective. Always ask: What can go wrong? What assets do we need to protect?
Internal Control Activities.
Information and Communication
Monitoring
After implementing internal controls, organizations must monitor their effectiveness periodically to ensure that controls continue to be adequate and continue to function properly. Management must also revisit previously identified problems to ensure that they are corrected.