Internal controls are the procedures put in place to safeguard against waste, fraud, and abuse. They are an important part of any organization, and can help to ensure that resources are used effectively and efficiently. There are many different types of internal controls, and the most effective ones will vary depending on the specific needs of the organization. However, some common examples of internal controls include segregation of duties, physical controls, and approval processes.
- Segregation of Duties. When work duties are divided or segregated among different people to reduce the risk of error or inappropriate actions.
- Physical Controls. …
- Reconciliations. …
- Policies and Procedures. …
- Transaction and Activity Reviews. …
- Information Processing Controls.
How internal controls work
Internal controls function in two ways: They require that businesses create audit trails for their financial transactions, and they hold managers personally accountable for physical inventories, accuracy, and regularity of financial reporting. Audit trails are records that detail each step taken to track accounting data back to its origin. To prevent fraudulent bookkeeping practices, audit trails are required for all business endeavors.
What are internal controls?
Internal controls are the tangible measures, rules, and procedures a business implements to safeguard the accuracy of its assets, financial data, and accounting records, foster accountability, and thwart fraud. The steps a business takes to make sure its employees follow all laws and regulations and do not steal from the company are also considered internal controls. Internal controls also include physical measures like door locks, area restrictions, safes, and surveillance apparatus.
A company typically oversees its own internal controls. Organizational outsiders oversee external controls like audits and regulatory examinations
Types of internal controls
There are two types of internal controls:
The foundation of both types of internal controls is the safeguarding of tangible assets, the division of duties, the approval of external business deals, the authorization of money transfers between accounts, and the verification of each step of financial transactions.
Advantages and disadvantages of internal controls
Internal controls have advantages and disadvantages, just like any other business system:
Advantages
Some advantages of internal controls could include:
Disadvantages
Possible disadvantages of internal controls include:
Examples of internal controls
Here are some examples of internal controls:
1. Delegation
To define who is responsible for sensitive tasks like signing legal documents, managing incoming checks and cash, signing company checks, approving employee travel expenses, accessing the safe, accessing petty cash, and having access to accounting records, businesses create a delegated authority document.
2. Authorization
Similar to this, businesses create authorization protocols that specify who can approve which types of transactions. The best practices include, for instance, preventing subordinates from authorizing payments to managers and making sure that no one authorizes any transactions that could financially benefit the author.
3. Assets
Businesses list each asset with an ID number in an assets register. The register serves as a record of where and when each item was purchased, its price, its insurance coverage, its history of repairs, and other information like serial numbers, warranties, or guarantees.
4. Maintenance
Another internal control is to properly maintain the company’s resources, such as its buildings and equipment. In addition to repairs, this also includes typically scheduled inspections and maintenance.
5. Cash
Most companies limit their use of cash, which is in and of itself a form of internal control. Cash on hand leads to opportunities for mismanagement and theft. These internal controls are crucial when it’s necessary to carry cash around:
6. Purchasing
Different individuals are permitted by businesses to request, approve, and pay for goods or services. It is challenging to manipulate the purchasing process in a way that would harm the business because these responsibilities are separated.
7. Inventory
Separate parties place orders and receive deliveries, delegating those inventory-purchasing duties. Physical inventories are routinely counted and recorded on-site by businesses as a form of internal control.
8. Refunds
Making different staff members in charge of authorizing returns and issuing refunds for those returned items is another illustration of how separation can be used as an internal control.
9. Accounts payable
Additionally, companies need separate individuals to approve bill payments and accept incoming bills in their accounts payable (AP) departments.
10. Banking
Companies immediately close any inactive accounts and routinely reconcile all open accounts to eliminate the possibility of bank-related fraud.
11. Checks
Three qualities that businesses look for in check signers are reliability, tolerance, and availability. Many businesses require a minimum of two signatures on checks. Companies can set up a pool of authorized signers so that the absence of one person won’t cause a delay in check issuance.
12. Payroll
Different employees are responsible for recording hours worked, approving payroll amounts, and disbursing payroll funds. Once more, the separation principle aids in preventing improper handling of company funds.
13. Computer use
Businesses frequently employ internal controls such as tracking and analyzing computer usage by staff. This not only sheds light on potential financial fraud by employees, but it also supports the proper management of the company’s one and only irreplaceable resource: employee time.
14. Insurance
Businesses buy insurance to safeguard high-value assets that could be easily stolen as well as assets without which they would struggle to function. A company should insure its property, such as motor vehicles, large sums of money for transportation, specialty equipment, buildings, and their contents.
What are Internal Controls
FAQ
What are the 5 internal controls?
An internal control framework is made up of five related elements: the control environment, risk assessment, control activities, information and communication, and monitoring.
Which is an example of an internal control activity?
Edit checks of entered data, accounting for transactions in numerical sequences, comparing file totals with control accounts, and restricting access to data, files, and programs are examples of internal control activities.
What are three examples of strong internal controls?
The following controls are in place: a firm tone at the top; leadership that emphasizes the value of quality; monthly account reconciliation; leadership reviews of financial results; login credentials; restrictions on check signing; physical access to cash; inventory; invoices marked as paid to prevent double payment; and leadership review of payroll.
