Internal control assures the achievement of an organization’s objectives in operational effectiveness and efficiency, reliable financial reporting, and compliance with laws, regulations and policies.
In accounting and auditing, Internal control is a process designed and effected by those charged with governance, management and other personnel to provide reasonable assurance about the achievements of an organization’s objectives with regard to reliability of financial reporting, effectiveness and efficiency of operations and compliance with applicable laws and regulations.
In other words, it is a means by which an organization’s resources are directed, monitored, and measured, which also aids in detecting and preventing fraud and protecting the organization’s resources, both physical (e.g., machinery and property) and intangible (e.g., reputation or intellectual property such as trademarks).
Effective system of internal control should be able to identify, measure and manage those business risks facing an organization and ensure total compliance with internal policies and procedures.
Business Risks and Internal Control
In a broad concept, internal control is designed and implemented to address identified business risks that threaten the achievement of business objectives. It involves everything that controls risks in an organization.
Every organization has its own inherent risk (things that is within the nature of the business capable of hindering achievement of its strategic goals), therefore, a business should first identify what its business risks are and then establish controls to minimize risks to an acceptable level. Once in a while, evaluate the effectiveness of system of internal control existing in the business processes to determine the weakness that can lead to high business risks, and so, determine areas that need special attention.
Internal control plays an important role in the prevention and detection of fraud. Under the Sarbanes-Oxley Act, companies are required to perform a fraud risk assessment and assess related controls. This typically involves identifying scenarios in which theft or loss could occur and determining if existing control procedures effectively manage the risk to an acceptable level.
Controls can be evaluated and improved to make a business operation run more effectively and efficiently. For example, automating controls that are manual in nature can save costs and improve transaction processing. If the internal control system is thought of by executives as only a means of preventing fraud and complying with laws and regulations, an important opportunity may be missed. Internal controls can also be used to systematically improve businesses, particularly with regard to effectiveness and efficiency.
Why is it so important?
The desirability of internal control can be highlighted as follows:
- To ensure the achievement of business objectives. Goals cannot achieve themselves, it is appropriate for businesses to establish control which will ensure that existing business processes and operations are channeled towards achieving of business strategic objectives.
- To ensure complete adherence to management policies and procedures. Management would have to set policies that will guarantee effectiveness of business operations and procedures that it tends apply in order to achieve business objectives. Effective internal controls ensure that these policies are strictly adhered to by all responsible parties.
- To safeguard the assets of the company. There is the tendency for a company without sound system of internal control to keep losing important assets.
- To ensure that financial transactions are recorded completely and accurately. And also reflect the actual transactions that took place. Internal controls must be established to ensure that generated financial reports reflect the true financial performance and position surrounding the company.
- Internal controls drive compliance with outside applicable laws and regulations, including internal procedures and bylaws.
However, the obvious challenge for companies is that even though they implement all of these features in their internal control structure, there still exist some instances of compromise by employees who often circumvent the controls. Employees who are dishonest pose a serious risk to the organization because they easily be involved in some kind of misappropriations and frauds, thus circumventing even the most effective internal control structure. Therefore, companies should insure their assets and cash handling, insurance reimburses the company for loss of a non-monetary asset such as specialized equipment or for losses due to theft of cash and other monetary assets.
In conclusion, internal controls must be directed towards the risk structure of a company to protect its objectives. Internal controls will function properly if they are well directed and demonstrated, managers and staff will be more willing and able to implement controls successfully if they could be demonstrated to them. In addition, a well set out internal control objective will provide a yardstick for monitoring, evaluating and assessing how controls have been operating within the internal processes.
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