INTERNAL CONTROL

Definition of Internal Control

It is the whole system of control,

financial and otherwise,
established by the management
in order to carry on the business of the
company in an orderly manner,
to safeguard its assets and
to secure the reliability and accuracy of its
records.
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Objectives of Internal Control

Companys operations are carried out in

accordance with company policy.
All the income or revenue due to the company is
received and recorded in accounting books.
All expenditure is authorized and recorded.
All assets are properly recorded and
safeguarded, i.e. their acquisition, usage and
disposal is duly authorized and in compliance of
company policies and needs.
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Objectives (2)

All liabilities are properly recorded and

provision is made for all known or
expected losses.
All accounts are kept in conformity of
applicable laws/standards.
Accounting records provide a reliable basis
for preparation of financial statements.

Tools of Internal Control

Basic Controls
Supervisory Controls
Internal Checks
Internal Audit

Basic Controls
These are aimed at ensuring that Companys
transactions:
are valid,
recorded accurately, and
completely, in the
proper books of accounts.

Basic Control Tools

Pre-numbering of primary documents.

Maintaining Control Accounts.
Comparison of documents with related
documents or records.
Regular physical verification of assets.
Regular balancing of ledger and other books.
Physical custody measures.
Drawing up detailed procedure manuals.

Supervisory Controls
These are intended to provide check over
basic controls.

Supervisory Control Tools

Authorization of documents at each stage before

further processing.
Final approval of a document after it has gone
through the basic controls but before the action
authorized by it actually takes place.
Review of basic controls by a supervisor, e.g.
checking reconciliations, control accounts, trial
balance.
Evidence of checking through signature of
responsible officer.
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Internal Check
This essentially involves segregation of
duties of persons working in any
department in such a manner as to ensure
that no worker performs all the steps of
any one transaction. Each persons work is
automatically checked by another person
who carries out the subsequent stage of
the transaction.
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How Internal Check works

No person gets an opportunity to hide his errors

or frauds as his work is checked by some one
else.
Innocent mistakes are detected before they cost
the company any thing.
Actual task and its records are given in separate
hands. For example, the cashier does not
prepare bank reconciliation statement so he
cannot conceal his mistakes by falsifying cash
book or bank reconciliation statement.
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Internal Check Tools

Proper documentation of all work

processes.
Preparation of work flow charts and
standard forms for use in all cases.
Setting formal authority limits for various
officials.
Clear definition of responsibility of each
worker.
Regular rotation of staff.
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Internal Audit

As explained in the first lecture, internal

audit is audit carried out by companys
own employees, on an ongoing basis, to
ensure that all its accounting records are
properly maintained.
Internal Audit Department is generally
independent of Accounts Department and
often reports directly to the chief
executive of the company.
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Duties of Internal Auditor

Regular examination of all accounting records,

checking against source documents.
Verifying that all documents are properly
authorized before being acted upon.
Reviewing the internal control procedures and
suggesting improvement on regular basis.
Keeping management aware of internal control
efficiency or weakness.

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Advantages of Internal Audit

Attainment of internal control objectives.

It helps management performs its basic
function of control.
Effective internal audit can cut down
external auditors work, thereby reducing
audit fee and related costs.
Psychological effect on workers.

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Limitations of Internal Audit

An internal auditor is an employee of the

company.
He reports to management, not to shareholders.
His loyalty with the management.
He aims to ensure that records are free of errors
and helps in uncovering them and rectifying
them.
His reports are generally of no interest to any
outsider, e.g. shareholder, creditor, government.
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Similarities between
Internal and External Auditors

Both have an interest in effectiveness of

internal control systems and test it well
during their audit work.
Both use almost similar techniques to
arrive at their conclusions.
Both are members of the same
respectable profession and try to uphold
professional ethics.
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Cooperation between
Internal & External Auditors
If external auditor is satisfied with the conduct of
internal audit, he may seek internal auditors
help in:
Gathering information on how the internal
controls work.
Assessing general efficiency or weakness of
internal control in specific areas.
Deciding areas requiring more or less than usual
attention by external auditor.
Drafting management letter.
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How to assess Effectiveness

of Internal Controls

Internal Control Questionnaires.

Compliance tests.
Control Check Lists.
Flow charting

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Internal Control Questionnaires

List of questions.
Questions are capable of short answers.
Each question covers only one aspect of
an issue or transaction.
Each questionnaire covers on area of
activity.
Drafted by senior auditor, but completed
by junior audit staff.
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Uses of ICQs
These enable the external auditor know:
The details of procedure being followed
for recording any particular activity.
How effective is the procedure, i.e. what
controls exist to prevent errors and frauds.
How closely is procedure followed in
practice.
What steps would be needed to audit this
procedure.
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Qualities of a good ICQ

It should be comprehensive.
It should use simple language, leaving no
room for confusion or misunderstanding.
Require answers in one or few words only.
Each question to be specific, not general
in nature.

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Reporting to Management
on internal controls

Management Letter, outlining areas of

weakness in internal controls.
However, external auditor must emphasize
that there may other weaknesses that
may not have been noticed.
Does not absolve the auditor of his
responsibility to include them in his formal
report.
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Thank you