Types and components of Internal Control, its procedure and features
Internal Control
may be of following types:
a. Organisation
b. Segregation
of duties
c. Physical
d. Authorisation
and approval
e. Arithmetical
and accounting
f. Personnel
g. Supervision
h. Management
i.
Acknowledgment of performance
j. Budgeting
Organization: An
entity should have a plan of organisation which should define and allocate
responsibilities, and identify the line of reporting.
Segregation of
duties: A single person should not handle recording and processing of a
complete transaction. Several persons should be entrusted with these works.
Functions that should be separated are: initiation, authorisation, execution,
custody, issues of delivery order, and recording.
Physical:
Physical custody and access: Authorisation and approval. All transaction should
require authorisation or approval by a senior auditor and his limits of
authority be specified.
Arithmetical and
Accounting: This can be achieved through arithmetical accuracy of records, and
checking of totals, reconciliations, control accounts, trial balance, accounting
of documents.
Personnel should
be designated to ensure that the task assigned has been properly done.
Supervision: All
actions at all levels of authority should be supervised.
Management:
Certain controls should be enforced like, services by management, comparison
with budgets, internal audit, or any special services procedure.
Acknowledgement
of performance: Persons doing the work must initial, or put rubber stamp to
identify responsibility.
Budgeting is the
common technique used in business.
Components of
Internal Control
Internal control
comprises of the following
a. Control
environment
b. Control
procedures
(a) Control
Environment: Control environment has been defined by (ISA 6.8) as:
Control
environment means the overall attitude, awareness and actions of directors and
management regarding internal control and their importance in the entity. The
control environment encompasses the management style, and corporate culture and
values shared by all employees.
Factors
reflected in the control environment include:
1. Function of
the directors and its committees.
2. Management
philosophy and operating style.
3. Entity’s
organizational structure and methods of assigning authority and responsibility.
4. Management’s
control system including internal audit function, personal policies and
procedures.
Control
Procedures are those policies and procedures in addition to the control
environment which are established to provide a management with procedure so
that specific entity objectives are achieved.
Specific control
procedures include:
1. Reporting,
review and approving reconciliations.
2. Checking
arithmetical accuracy of records.
3. Controls over
computerized application and information technology environment.
4. Maintaining
and reviewing control accounts and trial balances.
5. Approving and
controlling documents.
6. Comparing
internal data with external sources of information.
7. Comparing
results of cash, security and inventory accounts with accounting records.
8. Limiting
direct physical access to assets and records.
9. Comparing and
analyzing financial results with budget.
Essential
Features of Internal Control
A system of
internal control will have the following features or characteristics.
1. Plan of
organization
2.
Authorization, recording and control procedures.
3. Sound
practice in performance of functions.
4. Competency of
personnel
1. Plan of
organization: It should establish clear line of duties, responsibilities,
segregation of operations, and subordination of each member of the staff.
Organization structure must provide for adequate independence for various
functions performed at different levels. The division of duties should be such
that activities of a department are controlled by records maintained outside
it.
2.
Authorization, recording and control procedures: They should ensure that (a)
every item of expenditure has been properly authorized and accounted for, (b)
every item of receipt has in fact been received and accounted for, (c) there is
proper custody of the funds and assets, and (d) there is no misapplication or
misuse of any property of the enterprise.
3. Sound
practice in performance of functions: An effective system of internal check
should lie down that no single person should alone handle any transaction
completely from beginning to end. The system should provide that the work of
one person will be checked by another, the management shall be able to detect
errors and frauds.
4. Competency of
personnel: It means the competency of departmental heads, key personnel and all
persons performing routine tasks at different levels. This will require proper
selection, training, effective direction, supervision and control, quick
corrective action to avoid violation of prescribed procedures.
Auditor’s
Interest in Internal Control
In the case of a
large enterprise and sometimes even in case of a medium sized organization, it
is not possible for the auditor to complete the audit if he indulges himself in
verifying all, or even a major portion of the transactions. In such situation
he should apply sampling technique in carrying out a routine verification of
transaction. In order to determine up to what extent he can reduce his work
would depend upon the effectiveness of the internal control system. So there
should be a proper study and evaluation of the existing internal control as a
basis for reliance thereon and for the determination of the resultant extent of
the tests to which auditing procedures are to be restricted.
An auditor is
only interested in assessing policies and procedures which are relevant to
financial statement assertions. The understanding of relevant aspects of the
accounting and internal control system enables the auditor.
a. to assess the
adequacy of the accounting system as a basis for preparing the financial
statement.
b. to identify
the types of potential misstatement that could occur in the financial
statement.
c. to consider
the factors that effect the risks of misstatements, and
d. to design
appropriate audit procedure.
The auditor
should place reliance on internal controls, only after ascertaining and
evaluating these controls. If the auditor has reasons to believe that a client
has set up a strong system of internal control, the reliance on that system
will help the auditor to reduce the detailed checking which would otherwise be
undertaken.
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