Question

In: Accounting

1. A) Explain the meaning of the term internal controls. B) Give an example of an...

1. A) Explain the meaning of the term internal controls. B) Give an example of an internal control.
C) Explain the control objectives that internal controls achieve. D) Describe the types of internal controls.

2. Discuss the internal control regulatory environment – which laws or organizations require that companies maintain a system of internal controls.

Solutions

Expert Solution

1. A) Internal Controls

Internal controls are procedural measures an organization adopts to protect its assets and property. Broadly defined, these measures include physical security barriers, access restriction, locks and surveillance equipment. They are more often regarded as procedures and policies that protect accounting data.

Definition: An internal control is a procedure or policy put in place by management to safeguard assets, promote accountability, increase efficiency, and stop fraudulent behavior. In other words, an internal control is a process put in place to prevent employees from stealing assets or committing fraud.

B) Example

Liquid assets always need to be protected more than illiquid assets because they are more easily stolen. Take cash for example. Cash is the most liquid asset and can be pretty easily stolen by any employee who handles it. Special internal controls are put in place to protect company cash.

The segregation of duties control is often used for cash. This control requires that the person who receives the cash from the customer and the person who records the cash receipt in the accounting system are never the same employee. In fact, some internal control systems take it a step further and require a different employee to collect the cash, deposit it in the bank, and record it in the accounting system.

By segregating the duties of each employee, no single person can collect the cash, deposit it, and record the sale. This prevents fraud because one person can’t pocket some of the cash and just record less cash receipts in the accounting system.

C) Objectives of Internal Control System

  • To ensure that the business transactions take place as per the general and specific authorisation of the management.
  • To make sure that there is a sequential and systematic recording of every transaction, with the accurate amount in their respective account and in the accounting period in which they take place. It confirms that the financial statement fulfils the relevant statutory requirements.
  • To provide security to the company’s assets from unauthorised use. For this purpose, physical security systems are used to provide protection such as security guards, anti-theft devices, surveillance cameras, etc.
  • To compare the assets in the record with that of the existing ones at regular intervals and report to the those charged with governance (TCWG), in case any difference is found.
  • To evaluate the system of accounting for complete authorisation of the transactions.
  • To review the working of the organization and the loopholes in the operations and take necessary steps for its correction.
  • To ensure there is the optimum utilization of the firm’s resources, i.e. men, material, machine and money.
  • To find out whether the financial statements are in alignment with the accounting concepts and principles.

D) Types of Internal Control System

  1. Preventive Controls: These controls are introduced in the firm to stop errors and irregularities from taking place.
  2. Detective Controls: These controls are implemented to reveal errors and irregularities, once they take place.
  3. Corrective Controls: These controls are designed to take corrective action for removing errors and irregularities after they are detected.

2)

Organizations flourish when they establish control environments that foster the efficient execution of operations. When done properly, good internal controls help organizations deliver value to their stakeholders and achieve their strategic objectives while aligning with industry best practices, laws, and regulations to manage risks facing them. This blog will help you understand 1) what a control environment is, 2) the important role internal control plays within the control environment, 3) how to design and implement internal control within your organization, and 4) how to assess the effectiveness of your control environment.

What is the Internal Control Environment of a Company?

The Institute of Internal Auditors control environment definition states that the control environment is the “foundation on which an effective system of internal control is built and operated in an organization that strives to (1) achieve its strategic objectives, (2) provide reliable financial reporting to internal and external stakeholders, (3) operate its business efficiently and effectively, (4) comply with all applicable laws and regulations, and (5) safeguard its assets.”

A control environment is made up of a compilation of an entity’s organizational structure, processes, policies, and standards that are utilized to maintain control across the organization. The board of directors and executive management of a business establish the company culture and attitude regarding the importance of maintaining controls and set the expectations of standards of conduct within the organization—often referred to as “the tone at the top.”

What are the elements of the control environment? They include:

  1. Demonstrating a commitment to Integrity and Ethical Values
  2. Maintaining the independence of the board of directors from management and their oversight of the entity’s internal control
  3. Establishing organizational structure, reporting lines, authority, and responsibilities to pursue business objectives
  4. Demonstrating a commitment to attract, develop, and maintain competent people
  5. Maintaining accountability for the execution of internal control responsibilities

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