Type: Process Essays
Sample donated: Angela Pena
Last updated: May 24, 2019
1. Definitionof Internal ControlsInternalcontrols are key processes and actions introduced by management into anorganization to ensure that objectives and goals are ultimately met. Thesecontrols are designed to (1) conduct business in an effective and efficientmanner, (2) safeguard the company’s assets and resources, (3) prevent anddetect fraud and error, (4) ensure accuracy, completeness and integrity of accountingdata, (5) produce reliable and timely financial and management information, and(6) ensure adherence to regulation, policies and procedures. 2. Purposeof Internal ControlsA system of internal control represents theattitude of an organisation to ensure that sound management practices areimplemented to achieve the objectives of the organization.
Internal controlsprovide reasonable assurance to stakeholders (e.g. customers, investors) thattransactions are recorded completely, timely and in an effective and efficientmanner.3. Roleof the Internal Auditor in Internal Controls InternalAudit is an independent and unbiased activity, and consequently they hold aneutral position within an organization. It is managements’ role to design and implement appropriatesystems of internal control to identify and mitigate risks effectively andefficiently. Internal audit’s role is to evaluate the adequacy andeffectiveness of those systems and processes across the organization (Ultimately,the role of internal audit is to provide independent assurance to the board andexecutives on whether the internal controls are working as intended and whetherthere is adequate and effective governance and risk management processes.
4. Typesand Examples of Internal Controlsa. Preventative controls These aredesigned to prevent errors, inaccuracy or fraud before it occurs. They arebuilt into internal control systems in the initial design and implementationstages. Examples of preventive controls are:· Segregationof Duties: Duties are segregated among different people to reduce the riskof error or inappropriate action (like recording, approval and custodyfunctions).
· Physicalcontrol over assets for protection – like locks on stock warehouses· Securitycameras· Usingpasswords to restrict access to confidential data· Shreddingdocuments with sensitive information b. DetectiveControls These are designedto find irregularities in transactions after they have occurred. Examples ofdetective controls are:· Bank reconciliations (i.e. cash perthe bank account is reconciled to the cash per the company’s books).· A security camera to detectunauthorised activity· Exception reports which list out ofkilter transactions· Physical stock counts (i.e. stock isphysically counted and then compared to the inventory ledger)· Petty cash countsc.
Corrective controls These are designed to fix errors that have occurred. Coupled with detectivecontrols that identify an anomaly, corrective controls are activated to seewhat should be done to fix an error, and hopefully design a new control toprevent recurrence of the error. Examples of Corrective controls are: · Databackups can be used to restore lost data in case of a fire or other disaster· Insuranceis used to help replace damaged or stolen assets· Management accounting reports can highlightvariances from budget to actual for management corrective action· Enhanced training and awareness can be provided toprevent future errors and irregularities d. Directive controls These areactions taken to encourage the right behaviour so that a desirable event can occur.
They are generally of a guidance nature to employees and are broad in nature.Examples of Directive Controls are:· Policiesand procedures – sets compliance standards within the company to adhere to whenundertaking activities. · Laws andregulations enforce a company to adhere to certain standards that governethical behaviour and good corporate governance.· Training manuals(provides ongoing guidance to employees on performing a task)· Jobdescriptions (e.
g. sets roles and responsibilities with performanceexpectations for employees)· Meetings(e.g. a morning meeting in a factory to discuss expectations and output for theday)5. RiskAnalysisBusinessmust conduct and effective risk management process to proactively identify thepotential factors that may stop an organization from achieving its objectivesand to build mitigating controls to manage the associated exposure to risks. Riskmanagement is made up of two parts – one is the likelihood of something goingwrong and the other is dealing with the negative consequence that arises when arisk manifests.
It is managements’ responsibility to identify those riskfactors that may cause exposure to the organisation. Riskanalysis represents the process that helps management identify and manage internaland external problems that could undermine the achievement of key businessinitiatives or projects. To perform a risk analysis, one must first identifythe possible threats (like financial loss, loss of people, operationaldisruption, reputational issues etc.) that the company faces, and then estimate thelikelihood that these threats will materialize and prepare adequate responsesto mitigate the risk. Risk analysis is useful in many situations:· Projectmanagement· Healthand safety management· Disasterrecovery and business continuity planning· Responsesto changes in regulations· Financialmanagement and overall sustainability 6 A.Internal Controls recommended for Inventory· Inventory systems· Twocommon systems for managing the financial transactions of stock are theperiodic and perpetual systems.
Periodic inventory systems update theaccounting ledger once a month or quarterly. A more efficient system is theperpetual inventory system, which updates inventory after each purchase, saleand adjustment. Inventory systems equips management with a better idea ofinventory cost and its effects on the balance sheet, which is an important partof internal controls.· Tracking· Organizingthe inventory is a basic inventory internal control – this can be done by numberingall locations, tag each inventory item, and track these items by location. Mostorganisations use an identification system like barcodes to tag eachitem so that it can be tracked.
· Tag allinventory including scrap which states the part number, description, unit ofmeasure, and quantity. · Goods Ordering and Receiving· Count allincoming inventory to match the quantity stated on the delivery note is correct.Count the inventory before recording it as being received. This keeps errorsfrom being introduced into the inventory records.
· Inspectincoming inventory to verify accuracy of goods received as well as look for anydamages. Damaged goods should bereturned, and the accounts payable staff notified by documents that thereturned items should not be paid for.· Segregateduties like ordering and payment process amongst multiple employees is alsoimportant to avoid theft of stock. · Storage and Security· Stockwarehouses and distribution centres must be under lock and key with onlyauthorised personnel having access. · Alldeliveries from suppliers must be counted and tagged before they go intoinventory so that discrepancies between deliveries and purchase orders areimmediately remedied. · Periodic cyclecounts of sections of inventory must be conducted to pick up any discrepancies and to investigateand correct any errors found.
This gradually improves the inventory recordaccuracy· Safetyfor employees is also key in the warehouse – storage space must be adequate andsafe to accommodate pallets and forklifts and to avoid injury or damage. · Goods issuing· When anitem is removed from the warehouse, companies must have a standard procedurefor recording the picks as soon as they leave the warehouse. · Theperson removing the inventory must sign for the removal, so that there is arecord of who is responsible should the item go amiss. · Review obsolete stock· Conduct aperiodic obsolete inventory review. The warehouse can fill up with obsoleteinventory that cannot be used, which causes high storage costs and can disruptthe production process. Analyse inventory records to determine which itemsshould be sold off or otherwise eliminated.
· Audits· Periodic independentaudits of bills of materials, negative balances in inventory and obsolete stockwill assist in providing assurance that the above controls are working asintended. 6. B.Internal Controls recommended for Cash· Safeguarding assets – Companies must protect thephysical cash and the people handling the casho Physicalaccess shall be restricted to authorized personnel.o Combinationsand passwords should be given to as few people as is necessary.o Combinationsand passwords should be changed periodically, at least annually, or whensomeone leaves the department.
o Conductthe proper background checks on prospective cash handlers.o Lockcash in a secure location like a safe or locked storage facility.o Minimizethe amount of funds held overnight.o Usea buddy system when taking funds from one location to another.
o Countcash discretely, not easily visible to others.· Segregation of duties – The following cash handling dutiesshould be performed by multiple people so that no one person has control overthe entire cash handling process. Separating the cash handling duties amongdifferent people will reduce errors, minimize fraudulent activity and increasethe chance of detecting errors.
o Receivecasho Disbursecash amounts for petty cash floatso Recordcash transactionso Preparebank deposit slip, (preparer and reviewer)o Makethe physical deposit at the banko Reconcilecash receipts to daily sales reportso Investigateand remediate discrepancies noted from reviews and reconciliations.· Accountability – Cash accountability ensures that cashtransactions are authorized, properly accounted for, documented andidentifiable to specific cash handlers This will help determine: Who has access to cash Why they have access to cash Where cash is at all times What has occurred from the transaction’s beginning to end Cash accountability controls are to Record cash receipts when received. Keep funds secure at all time. Document transfers used when cash is moved. Don’t share passwords.
Cash handling staff must have own storage devices Supervisors verify cash deposits and approve all refunds. · Reconciliations – In order to ensure alltransactions have been recorded correctly, (completely and accurately), severalreconciliations should occur on a timely basis.· Comparereceipts to deposit records.· Recordcash receipts when received.
· Countand balance cash receipts daily.· Performperiodic surprise cash counts.· TheFinance Department is responsible for preparing and approving monthly bankreconciliations and reviewing outstanding deposits to ensure timely clearing· Monitoring – regularly review processes to tightencontrols, train staff, and investigate unusual activity. The following reviewsshould be done on a regular basis:· Reviewcash shortages and investigate discrepancies· Analyzesales forecasts and budgets to actual sales and investigate variances (andmargins where applicable)· Reviewcash receipts ledger for unusual items or unapproved changes· Reviewand approve returns, refunds and void transaction logs· Reviewsystem security access· Trainand monitor new staff and provide continual training to existing staff on aregular basis, i.e. at least annually· Providecustomer statements on a regular basis6. C.Internal Controls recommended for Tangible Assets· Policies and Procedures o Policies and procedures for acquisitions, transfersand disposals of fixed assets should be established.
Fixed assets’ usefullives should be clearly defined and be consistent with the company’s fixedassets policies. · FixedAssets Register o An up-to-date Fixed Assets Register must be maintainedshowing the following:– Cost of asset – Asset useful life or depreciation rate– Location – Current and accumulated depreciation rate– Net book valueo As far as possible all tangible fixed assets shouldbe tagged to permit easy identification.o Accuracy of the register should be verified throughperiodic physical fixed assets counts and confirmations with custodians.· Adjustments:o All adjustments to the Fixed Assets Register should beauthorised by the Finance Manager/Accountant after sufficient investigation.
o Land, buildings should be revalued by an independentappraiser periodically.o There should be adequate insurance coverage policyfor fixed assets.· Fixed Assets Movementso All fixed asset movements should be approved inaccordance with the authority limitsand a fixed asset transfer form must be completed and acknowledged bythe receiving department for all permanent transfer of fixed assets.· FixedAssets Acquisitiono Additions to fixed assets should be approved inaccordance with the authority limits. · FixedAssets Disposalo Fixed assets disposals should be authorised inaccordance with the authority limits.· Reconciliationo Fixed Assets Register should be reconciled to theGL on a monthly basis.
· Segregationof dutieso There should be segregation of responsibilitiesbetween the following functions:· Fixedassets custodians· Approvingauthorities for fixed assets movement· Maintenanceof fixed assets account· Fixedassets verification· FixedAssets Counto Physical fixed assets at all locations should becounted and checked against book records at least annually.o Differences between fixed assets counts and bookrecords should be investigated thoroughly before adjustments are approved andmade to the books. · Delegationof Authority (DOA)o Appropriate delegation of authority must exist forfixed assets management and it must cover acquisitions, transfers and disposalsas well as fixed assets write off 6. D.Internal Controls recommended for Debtors· Policyo Thebusiness should have adequate policies and procedures on credit and collection procedures,to ensure that all staff understand the accounts receivable process.· Segregation of Dutieso Different people must deal with invoicing, accountsreceivable, cash collection, and the review and reconciliation of accountingrecords.· Invoice Generation to Customero Check purchase order prices, terms, and conditions.
o Check authorization levels for order approval.o Check the credit rating, limits and address of thecustomer.o Prepare the sales order with details per thepurchase order and stamp the sales order as approved.o Check the accuracy of invoice calculations.o Independently review customer complaints aboutinvoices.o Separate the invoicing function from the cashcollection function.
o Reconcile the goods dispatched to the customer tothe quantities shown on the sales invoice.· Sales Journal and Accounts Receivable ledgero Post the sales journal from a copy invoice as soon as thetransaction occurs, and file the invoices by invoice numbero Use the sales journal totals to post the accounts receivable controlaccount inthe general ledger.o Separate the accounts receivable function and cashcollection function.o Carry out random spot checks on customer tradingactivity and check for signs of unusual activity.o Review credit balances on accounts receivableaccounts.
o Produce an aged accounts receivable report andreview the balances, particularly on large and overdue accounts.o Have a strict credit control procedure forcollecting outstanding accounts receivable.o Review all journal entries made to the accountsreceivable ledger accounts for appropriateness and approvals.o Check cash settlements discounts given tocustomers. Approval limits must be in place.o Reconcile the accounts receivable ledger with theaccounts receivable control account in the general ledger.o Review delinquent accounts and ensure that they areprecluded from receiving additional credit