Components of Internal Control System
Discuss about the Internal Controls in Organizations.
In the era of 21st century, there are many factors contributing towards the success of the business organization and Internal Control is considered as one of them. Internal control can be described as a process that the board of directors, management and other employees design so that reasonable assurance can be provided in some of the major areas such as effectiveness and efficiency of business operations, reliability of financial reporting and compliance with the required laws and regulations (Badara and Saidin 2013. Credulity is considered as a major priority of the businesses and the presence of internal control makes the companies credible for achieving their organizational objectives and goals. At the same time, it needs to be mentioned that the effective implementation of internal control provides the organizations with the necessary protection from financial, strategic and reputations risks (Aziz et al. 2015). In the terms of auditing and accounting, internal control provides the assurance that the business basics of the entities remain operationally efficient and effective. The main aim of this essay is to analyze and evaluate the importance of internal control in the business organizations.
In order to discuss the importance of internal control, it is required to discuss about the major components of an internal control system in the business organizations. It needs to be mentioned that there are five interrelated components of internal control and they are discussed below:
The first component is the Control Environment. Sometimes control environment is regarded as ‘tone at the top’ and it is influenced by different internal factors of organizations like philosophy of the management, operating style, ethical values, integrity and commitment to competence. The overall internal control of the companies will work effectively in case these foundations are strong and the control environment is positive (Chen et al. 2014).
Risk Assessment is considered as the second component of internal control that refers to the identification, analysis and management of the risks related to the achievement of organizational goals and objectives. Different types of risks have adverse effects on the operations of the organizations. After the identification of the risks, management is required to take into consideration the impact of them and the likelihood to their occurrences (Fourie and Ackermann 2013).
The next component is considered as Control Activities. Internal control activities are referred to specific tools like techniques, policies, procedures and different mechanisms helping the management in carrying out their directives. For this reason, control activities helps the management of the companies in the identification, prevention and reduction of the business risks that are considered as the major barriers in the achievement of the organizational objectives. Some of the major examples of control activities are approvals, authorizations, reconciliations, verification, documentation and others (Feng et al. 2014).
Importance of Internal Control in the Organizations
Communication and Information is the fourth component of internal control; and the business organizations must have relevant, valid, reliable and timely communication in order to control the business operations. For this reason, the organizational managers must obtain the necessary information in order to make business decisions, risk determination and the communication of policies and other required information within the organizations (Fourie and Ackermann 2013).
Monitoring is considered as the last and one of the major component of internal control and the management is required to monitor the internal control system in order to ensure that the internal controls are effectively operating. Ongoing monitoring occurs as the forms of different managerial activities like supervision, comparison, checklist, reconciliation and others. All these components play important part in the internal control of the companies (Chen et al. 2014).
The above discussion indicates towards the major components of internal control. Now, it needs to be mentioned that internal control has some of the major benefits for the business organizations and it can be divided into two segments; they are the importance of internal control in the business operations and the importance of internal control in the financial accounting of the business. The following discussion shows all these importance of internal control in the business organizations:
Internal control has significant role to play in the promotion of the daily business operations of the companies and helps the companies in the production of high-quality goods and services at the lowest possible cost. In the presence of effective internal control, the management of the organizations becomes able to limit the excessive inventory, high equipment costs and excessive utilizes in order to ensure that the operation costs are maintained within the budget. In addition, internal control assists the organizational managers to use their machines and equipments effectively and optimally so that the malfunctions in them can be avoided. It implies that the strategies of internal control help in the improvement of the operating environment of the organizations.
Risk assessment is regarded as another major contribution of an effective internal control. It needs to be mentioned that there are certain risk components in every business decision and strong internal control helps in the mitigation or avoidance of these risks (Lam 2014). In the internal control, some of the major procedures for the ministration decision risks are to cap the level of debt used for financing operations and acquisitions, to ensure the reinvestment of cash into the business activities, to provide guidance in order to avoid investment in the risky securities and others. Thus, it can be said that strong internal control has major importance in preventing the management to make potentially hazardous business decisions that would have long-term negative effects on the companies.
Different policies have major role to play for sustaining safe and profitable business environment. These policies can be seen in different aspect of the business organizations like human resources, awareness for the communities, establishment of business to business relations and others and these policies are a major part of the internal control (D’Aquila 2013). The managements of the business organizations inform their employees and organizational staffs about this internal control in order to ensure that the reputation of the companies is not destroyed in the presence of not so educated employee and staffs. It is one of the major requirement of the public business corporations to have their internal control audited in order to find out any kind of loopholes in the internal control system.
In most of the business organizations, the managements link the system of internal control with the process of performance evaluation for the managers and other employees. In the presence of this type of performance evaluation process, the managements of the companies get the opportunity to make the employees aware of the organizational internal control by interacting with them on a regular basis (Estampe et al. 2013). In this process, the employees learn to achieve the organizational goals and objectives by following the policies and procedures of the companies. Most importantly, the importance of internal control cannot be ignored in the effective separation and delegation of duties among all the employees and staffs of the companies. For example, the presence of effective internal control makes the aspect sure that the employees responsible for the management of accounts receivable of the company do not involve in the management of accounts payable. It implies that it helps in the reduction of internal fraud and theft of the companies (Estampe et al. 2013).
Apart from the above areas, strong internal control also ensures the smooth running of the accounting and financial reporting of the organizations. In the organizations, the implementation of internal control is done as per a risk-oriented approach in order to ensure that the managements of the entities put focus on the high risk areas (Skaife, Veenman and Wangerin 2013). For example, in case a staff accuses that the petty cash is locked, the management may immediately sense that there is a risk related to steal the cash. Thus, as a part of internal control it is required to understand the risk as it will help in the determination of adequate internal control for the mitigation of risks in the areas. For this reason, risk assessment is considered as the first step for the establishment of strong internal control (Sharma and Panigrahi 2013).
One of the major purposes of the establishment of internal control is to provide protection to the organizational assets and it leads to address the financial statement assertions of the companies like existence, rights, accuracy and completeness (Feng et al. 2014). In this aspect, performing the physical count of the inventory done in internally by the organization can be presented as an example. Strong internal control helps in the correct counting of inventory and track them in the organizational accounting system in order to ensure their existence. For the verification of accuracy, cash receipts are counted in retail sales before recording them.
In the process of internal control system, segregation of duties is considered as one of the major fundamental elements as the presence of proper segregation of duties assists in the prevention of frauds. The presence of segregation of duties in the internal control is regarded as a key process for making the aspect sure that no employee or staffs should perform two or three business functions; they are custody, recording and authorization (Bentley, Omer and Sharp 2013). Organizational fraud can be effectively detected and prevented when there is effective segregation of these three responsibilities. For example, in case an accountant both receives and records cash, the accountant can easily commit fraud or manipulation. For this reason, committing fraud or manipulation will not easy in case an accountant receives cash and another accountant records them. Thus, companies are required to limit the access to only authorized employees for preventing fraud (Abiola and Oyewole 2013).
Most importantly, the presence of string internal control helps in the prevention of errors and material misstatements in the financial statements. For example, reconciliation is regarded as a major part of internal control that critically ensures that there is not any difference or mismatch in the accounts balances in the balance sheet and it leads to the prevention of material misstatements in the financial statements. Apart from this, reconciliation assists the organizational managers in the detection of errors in the financial statements (Hope, Thomas and Vyas 2013).
Apart from this, implementation of strong internal control helps in the establishment of company practices. In order to make the internal control existent, business organizations must have documental evidence of internal control. Most of the business organizations have necessary documentation of their internal control like flowchart and others as documentation is a critical aspect to the organizations for the communication of internal control to the external auditors. Due to this, the auditors can get better understanding about the organizations (Pizzini, Lin and Ziegenfuss 2014).
Conclusion
From the above discussion, it can be observed that internal control has some major roles to play in the overall betterment of the business organizations. As per the above discussion, five major components of internal control are control environment, risk assessment, control activities, communication and information and monitoring. With the implementation of strong internal control, companies can become beneficial from organizationally as well as financially. Strong internal control helps the companies to promote their daily business activities with the help of cost saving in production, delegation of authorities, implementation of required policies and procedures and others. At the same time, business entities can assess business risk and their impact on the business operations with the help of strong internal control. From the perspective of financial operations, internal control helps in the identification and eradication of finance decisions of the companies. The implementation of internal control prevents the accountants in dealing with several financial activities that helps in the reduction of frauds and errors. At the same time, strong internal control ensures the absence of material misstatements in the financial statements. Thus, based on the above discussion, it can be concluded that internal control has major impotence in the business organizations to increase the overall accuracy and efficiency of financial as well as non-financial operations.
References
Abiola, I. and Oyewole, A.T., 2013. Internal control system on fraud detection: Nigeria experience. Journal of Accounting and Finance, 13(5), p.137.
Aziz, M.A.A., Ab Rahman, H., Alam, M.M. and Said, J., 2015. Enhancement of the accountability of public sectors through integrity system, internal control system and leadership practices: A review study. Procedia Economics and Finance, 28, pp.163-169.
Badara, M.A.S. and Saidin, S.Z., 2013. Impact of the effective internal control system on the internal audit effectiveness at local government level. Journal of Social and Development Sciences, 4(1), pp.16-23.
Bentley, K.A., Omer, T.C. and Sharp, N.Y., 2013. Business strategy, financial reporting irregularities, and audit effort. Contemporary Accounting Research, 30(2), pp.780-817.
Chen, Y., Smith, A.L., Cao, J. and Xia, W., 2014. Information technology capability, internal control effectiveness, and audit fees and delays. Journal of Information Systems, 28(2), pp.149-180.
D’Aquila, J., 2013. COSO’s internal control integrated framework updating the original concepts for today’s environment. The CPA Journal, 83(10), p.22.
Estampe, D., Lamouri, S., Paris, J.L. and Brahim-Djelloul, S., 2013. A framework for analysing supply chain performance evaluation models. International Journal of Production Economics, 142(2), pp.247-258.
Feng, M., Li, C., McVay, S.E. and Skaife, H., 2014. Does ineffective internal control over financial reporting affect a firm’s operations? Evidence from firms’ inventory management. The Accounting Review, 90(2), pp.529-557.
Fourie, H. and Ackermann, C., 2013. The impact of COSO control components on internal control effectiveness: An internal audit perspective. Journal of Economic and Financial Sciences, 6(2), pp.495-518.
Hope, O.K., Thomas, W.B. and Vyas, D., 2013. Financial reporting quality of US private and public firms. The Accounting Review, 88(5), pp.1715-1742.
Lam, J., 2014. Enterprise risk management: from incentives to controls. John Wiley & Sons.
Pizzini, M., Lin, S. and Ziegenfuss, D.E., 2014. The impact of internal audit function quality and contribution on audit delay. Auditing: A Journal of Practice & Theory, 34(1), pp.25-58.
Sharma, A. and Panigrahi, P.K., 2013. A review of financial accounting fraud detection based on data mining techniques. arXiv preprint arXiv:1309.3944.
Skaife, H.A., Veenman, D. and Wangerin, D., 2013. Internal control over financial reporting and managerial rent extraction: Evidence from the profitability of insider trading. Journal of Accounting and Economics, 55(1), pp.91-110.
Order an Essay Now & Get These Features For Free:
Turnitin Report
Formatting
Title Page
Citation
Outline
