instituted by the organisation to ensure that the business of the company is run in an orderly manner, and establishes safeguards on assets and promotes efficient and economical use of the company’s resources.
The types of controls instituted in a business can generally be divided into:
1. Financial controls: comprising controls over.
a) Cash receipts b) Cash payments
c) Financing operations – rising of finance.
d) Management of receivables and payables.(debtors and creditors)
2. Non – Financial / Administrative controls.
a) Controls over the company’s personnel.
b) Controls over the use of the company’s non-cash assets e.g. Fixed assets c) Controls over company’s policies.
d) Controls over the company’s procedures.
Objectives of the internal control system
1. To ensure that the company runs in an orderly manner.
3. To safeguard the company’s assets.
4. To ensure reliable records which are a source of information necessary for management decision making.
5. To ensure compliance with the laid down company policies.
6. To ensure that the company’s personnel are effectively utilised 7. To ensure compliance with the law e.g. Companies
Areas that fall under the scope of internal control system These are:
1. Internal control 2. Internal check 3. Internal auditing
INTERNAL CONTROL SYSTEM
Internal Control Internal Check Internal Auditing
Whole system of controls:
1. Financial
2. Regulatory within the business
3. Supervisory control
Internal
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Features/ Characteristics of a Sound Internal Control 1. Plan of organisation; organisation chart
This is control over the company’s personnel. This defines:
a) Duties and responsibilities.
b) Relationship between personnel.
It’s Importance
a) Avoids duplication of effort.
b) Avoid conflicting duties.
c) Facilitates delegation of duties.
d) Harmonises operations.
2. Segregation of duties
Segregation of duties strengthens the internal control systems in that:
a) Reduces risk of fraud, error and manipulation.
b) Increase efficiency due to specialisation.
c) Facilitates supervision
Duties that must be segregated a) Authorisation
b) Recording c) Execution
d) Custody of assets
e) System development for computer operations
3. Physical controls
This is concerned with the custody and safety of the company’s assets. Access should be limited to a few individuals at any given time.
Examples of physical controls are:
a) Employment of watchmen/security guards.
b) Alarm systems.
c) Strong electrified gates.
d) Strong rooms and safes.
e) Strong fences.
f) Security lights.
g) Strong locks.
h) Mechanical checks e.g. cash registers i) Use of dogs.
j) Closed circuit TV’s
4. Authorisation and approved
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All transaction should be approved and authorised by a responsible person. The aim is to prevent fraud and streamline the flow of authority and avoid bureaucracy and conflicting authorities.
5. Arithmetic and accounting controls
This aims at assuring the accuracy of transactions. It also ensures proper recording of business transactions according to generally accepted accounting policies / principles.
6. Personnel
The company should employ qualified, experienced, competent and capable people.
Supervisors must be vigilant in their duties to ensure proper implementation of company policies.
7. Supervision (lower level)
Supervisors must vigilant in their duties to ensure proper implementation of company policies. Supervision must be humane to boast subordinates morale.
8. Management supervision and review:
Management must check interim statements, budgetary controls, standard costing statements etc. Management must supervise the whole company.
9. Defined powers
These are powers at lower levels of the organisation e.g. record handling, handling of company assets etc. It must be clearly known and indicated who has these powers. For examples, the cashier should never have access to the company’s ledgers.
10. Responsibilities
Responsibilities should be clearly defined to boast efficiency and hold people accountable for what they do.
11. Routine and automatic checks;
This take the form of surprise checks e.g. for petty cash, stock counts, cash at hand etc.
12. Control of documents;
Involves control of sensitive documents e.g. Receipts, cheques, L.P.Os etc. They must be handled by responsible officers and should be pre-numbered. Must be kept securely.
13. Vacation and rotation of duties;
The company should give leave to especially accountants. This is armed at:
a) Checking the efficiency in their absence.
b) Minimising errors and frauds.
c) Boosting efficiency (having a rest)
14. Cost benefit analysis
The system adopted must justify a cost benefit analysis.
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Advantages of an Internal Control System in a Business
1. Minimise dances of errors and frauds e.g. through segregation of duties, surprise checks, close supervisors etc.
2. Safeguards the company’s assets through:
a) Limiting access by use of physical controls.
b) Use of proper authorisation.
c) Routine checks.
d) Segregation of custody and recording of assets.
e) Arithmetic and accounting controls
3. Boosts efficiency and smooth flow of operations by:
a) Supervisions of duties.
b) Competent and reliable personnel.
c) Defined powers.
d) Managerial review and supervision.
4. Enables the company to achieve its goals through:
a) Budgetary controls.
b) Constant supervision.
c) Managerial reviews.
5. Management has relevant data for decision making through:
a) Qualified and competent staff.
b) Routine and surprise checks.
c) Use of machines.
d) Constant supervision.
6. Boasts control of work and avoids duplication of effort through:
a) Delegation of duties b) Defined powers c) Organisation charts
7. Facilitators efficient statutory audit’s as it acts as the basis on which the auditor will perform his work-reduces tests, amount of time and audit fees.
8. Motivates employees through routine checks, constant supervision etc.
9. Identifies inefficiently and out dated policies e.g. Through:
a) Managerial review.
b) Internal auditing functions.
c) Segregation of duties.
10. Encourages specialisation through segregation of duties.
11. A strong internal control system allows the company to grow due to less frauds, errors and inefficiency.
Disadvantages of a strong internal control system
1. May cause apathy among the staff leading to lower morale due to bad supervision, poor delegation, and all leading to frustration.
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2. It is expansion to install and maintain e.g. an internal auditing function, informal check, physical controls etc.
3. May be very ambitions in approach e.g. setting unrealistic controls e.g. High budgets that cannot be achieved.
4. It may be rigidly designed and inflexible to changes in the environment.
5. Rigid segregation of duties may limit staff development.
6. A strong internal control system may lead to the auditor’s over-dependence on the system and thus relax his tests and leave errors and frauds undetected.
Remedy to the above disadvantages
1. Supervisory staff should be trained in human relations to:
a) Minimize supervision frustrations.
b) Make internal check a job description to employees during their engagement.
c) To employees access to management e.g. through meeting with staff.
d) Everyone should participate in budgeting in order to make realistic estimates.
2. The company can consult an auditor when designing an internal control system.
3. The company should use internal auditors who should bring lax management to the attention of the directors.
b. Use management auditors
4. Specialized personnel should be subject to other controls other than segregation of duties, which may increase their efficiency.
How the internal control system affects the auditor work (internal auditor) 1. If effective reduces the amounts of tests in an audit.
2. Reduces number of entries to be tested in each sample.
3. Minimizes chances of errors and frauds and minimizes the auditor’s liabilities to third parties.
4. Weak control necessitates a qualified report by the auditor and this will lead to negative consequences to the company.
5. An effective internal control system reduces the amount of audit evidence to gather in order to form an opinion.
6. A strong system reduces time needed for an audit and enables the auditor perform an efficient audit.
7. A strong system allows for efficient planning and drawing of programmes by concentrating on only weak areas.
8. Affects the timing of audit tests e.g. If it is weak certain tests will be undertaken early e.g. Debtors and creditors circularization.
9. Its strength or weakness will influence the number of audit staff required.
10. It will affect the audit fees charged.
11. It will affect quantity and quality of advice and forms a basis of the management letter.
Techniques used by auditors to assess strengths or weaknesses in the internal control system.
1. Internal control questionnaires (ICQs)
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A set of questions posed to the client by the auditor. A “yes” indicates strengths and a
“NO” weakness 2. Flow charts
These are diagrammatic representations of accounting functions and procedures. A Gap in flow lines indicates weaknesses.
3. Third party confirmation
e.g. Debtors, creditors, bankers. Discrepancies may indicate a weak internal control
4. Compliance Tests
Tests on records and transactions of the business. Check the adequacy of the company’s recording.
5. Walk through test
Designed to assess in general the effectiveness of the internal control system.
6. Substantive tests:
These are tests on balances to see whether they are genuine. Done on balance sheet and income statement items.
7. Observation.
Done in such areas as stock taking, cash account, wage payment etc.
8. Companions
Using budget estimates that are compared with actual performance. Use of ratios, averages, comparing current statements with previous statement and schedules.
Any deviation may indicate fraud
9. Verification of assets and liabilities
10. Vouching of entries
Vouching is the examination of vouchers to see whether they are:
a) For the business b) Properly authorized c) For the period under audit d) Properly recorded
11. Use of surprise checks e.g. On petty cash, cash at hand etc
Action to be taken in case of weak internal control system a) Alert management immediately.
b) Compile a list of weakness in a management letter and suggest solutions
c) Change approach of the audit (i.e. from system) based to vouching based (audit in depth).
d) Increase sample size to be investigated or tested
e) Uses sufficient audit evidence-various sources of evidence.
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f) Change the timing of the audit-do it earlier so as to have enough time.
g) If weaknesses persists inform shareholders in the audit report
h) Record weaknesses in working papers and concentrate on these in subsequent audits.
i) If the system is extremely weak, the auditor can produce an adverse report.
How the internal control system prevents frauds.
a) Plan and organisation:
Prevents conflicts in duties and duplication of efforts. Provides a clear line of responsibility and prevents frauds through internal checks.
b) Segregation of duties
The work of one person is checked by another person. Boosts accountability.
Boosts specialisation and thus efficiency and reduces chances of fraud. Segregating duties enables management to assess the performance of each employee. The internal auditor should be alert to any frauds or possibilities of fraud.
3. Physical controls
Devices such as locks gates prevent unauthorised access to the company’s assets Mechanised checks e.g. on franking machines, cash registrar, computers etc.
Observation over company’s assets.
4. Authorisation and control
Vested on senior and responsible personnel
Segregation of authority. Approval given to different officers, one supplementing the authority of another person e.g. in signing of cheques.
5. Arithmetic and accounting controls Minimise chances of errors and frauds.
6. Managerial Review:
Subordinate staff knows that their work will be subject to review by senior personnel and this knowledge discourages fraud.
7. Supervision
Both management supervision and lower level supervision will prevent fraud.
Circumstances which indicate weaknesses in the internal control system:
1. Where the informal control system is in the hands of one individual that is no segregation of duties.
2. When staff are reluctant to take up their annual leave.
3. Where officials of the company have conflicting business interest.
4. Where employees are allowed to purchase goods on discount using the company.
5. Employment of relatives.
6. Where business is ran by a small group of people without an oversight committee.
7. Where the integrity and competence of staff is questionable.
8. Where here is with complex corporate structure not justified by the size of the company.
9. Failure to correct highlighted weaknesses.
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10. High turnover in key accounts and finance personnel 11. Prolonged understaffing of accounts department 12. Frequent changes in auditors
13. Frequent changes in accounting policies and practices 14. Excessive payment for such services as audit and legal fees.
Auditor’s duties as regards the internal control system.
The auditor should test it to see whether it is strong enough to prevent fraud and errors- to act as a basis of his audit. The auditor should select a few entries and check these form their original recording to the final posting. The auditor should note that a strong internal control system reduces auditor’s examinations but does not reduce his liabilities and he should use his personal judgement.