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Overview of Internal Control Systems

This document discusses the nature and purpose of internal control systems. It defines internal control as the process put in place by management to reasonably ensure an entity achieves reliable financial reporting, effective and efficient operations, and compliance with laws and regulations. Internal control objectives fall into three categories: reliability of financial reporting, effectiveness and efficiency of operations, and compliance with laws and regulations. The key elements of an internal control system are the control environment, risk assessment, information and communication, control activities, and monitoring.

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Rhea May Balute
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174 views3 pages

Overview of Internal Control Systems

This document discusses the nature and purpose of internal control systems. It defines internal control as the process put in place by management to reasonably ensure an entity achieves reliable financial reporting, effective and efficient operations, and compliance with laws and regulations. Internal control objectives fall into three categories: reliability of financial reporting, effectiveness and efficiency of operations, and compliance with laws and regulations. The key elements of an internal control system are the control environment, risk assessment, information and communication, control activities, and monitoring.

Uploaded by

Rhea May Balute
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOC, PDF, TXT or read online on Scribd

CHAPTER 13

OVERVIEW OF INTERNAL CONTROL

NATURE AND PURPOSE OF INTERNAL CONTROL

Internal control is the process designed and effected by those charged with
governance, management and other personnel to provide reasonable assurance
about the achievement of the entity's objectives with regard to rel iability of
financial reporting, effectiveness and efficiency of operations and com pliance
with applicable laws and regulations. It follows that internal control is designed
and implemented to address identified business risks that threaten the
achievement of any of these objectives.

Those objectives fall into three categories:

Reliability of the entity's financial reporting


Effectiveness and efficiency of operations
Compliance with applicable laws and regulations

Whether an entity achieves its objectives relating to financial reporting and


compliance is determined by activities within the entity's control. However,
achieving its objectives relating to operations will depend not only on
management's decisions but also on competitor's actions and other factors outside
the entity.
INTERNAL CONTROL SYSTEM DEFINED

Internal control system means all the policies and procedures (internal controls)
adopted by the management of an entity to assist in achieving management's
objective of ensuring, as far as practicable, the orderly and efficient conduct of its
business, including adherence to management policies, the safeguarding of
assets, the prevention and detection of fraud and error, the accuracy and
completeness of the accounting records, and the timely preparation of reliable
financial information.
198 Chapter 1 3
ELEMENTS OF INTERNAL CONTROL
Internal control structures vary significantly' from one company to the next.
Factors such as size of the business, nature of operations, the geographical
dispersion of its activities, and objectives of the organization affect the specific
control features of an organization. However, certain elements or features must
be present to have a satisfactory system of control in almost any large scale
organization.

The internal control system extends beyond these matters which relate directly to
the functions of the accounting system and consists of the follow ing components:

a. the control environment;


b. the entity's risk assessment process;
c. the information system, including the related business processes, relevant
to financial reporting, and communication:
d. control activities;
e. monitoring of controls.

A. Control Environment

The control environment wh ich means the overall attitude, awareness and
actions of d i rectors and management regarding the internal control system
and its importance in the entity. The control environment has an effect on the
effectiveness of the specif ic control proced ures. A strong control
environment, for example, one with tight budgetary controls and an effective
internal audit function, can significantly complement specific control
procedures. However, a strong envi ronment does not, by itself, ensure the
effectiveness of the internal control system. Factors reflected i n the control

The function of the board of directors and its committees;

Management's philosophy and operati ng style:

The entity's structure and methods of assigning authority


a. a. a.

Management's control system including the internal audit


personnel policies and procedUres and segregation of duties. a.
. 01VITIOW (11 Internal Control 1 99

The environment in which internal control operates hav an impact on


the effecti of th ilic c procedures. Several factors comprise
the
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(
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standards and the manner in which it com municates and rei nforces them
determine the entity's integrity and ethical behavior. Integrity and ethical
val ues incl ude management's actions to remove or reduce i ncentives and
temptations that might prom pt personnel to engage in d ishonest, illegal,
or u nethical acts. They also include the communication of entity values
and behavioral standards to Personnel through pol icy statements, a code
of cond uct, and management's example of appropriate behavior.

Commitment to Competence

Competence is the knowledge and ski l ls necessary to accompl ish tasks


that define an employee's job. Commitment to competence means that
management considers the competence levels for particular jobs in
determining the ski lls and knowledge requ ired of each employee and that
it hires employees competent to perform the tasks.

Participation by those Charged with Governance


An entity's control consciousness is i nfluenced significantly by those
charged with governance. Attributes of those charged with governance
incl ude i ndependence from management, their experience and stature,
the extent of their i nvolvement and scrutiny of activities, the
appropriateness of theihictions, the i nformation they receive, the degree
to which difficult questions are raised and pursued with management,
and their interaction with internal and external auditors. The importance
of responsibi lities of those charged with governance is recognized in
codes of practice and other regulations or guidance produced for the
benefit of those charged with governance. Other responsibilities of those
charged with governance incl ude oversight of the design and effective
operation of whistle blower procedures and the process for reviewing the
effectiveness of the entity's i nternal control.

Common questions

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The internal audit function complements internal control procedures by providing an independent assessment of the effectiveness of controls, identifying weaknesses or areas for improvement, and ensuring that all control processes are observed as intended. An effective internal audit function helps reinforce the control environment with tight budgetary controls, which support the overall reliability of financial reporting and compliance with applicable laws and regulations .

Policy statements and management's behavior communicate internal control values by setting clear expectations and standards for behavior that align with the organization’s objectives. By establishing a code of conduct and modeling ethical behavior, management fosters an environment of integrity and ethical behavior that guides personnel, promoting adherence to internal controls and supporting the overall internal control system .

Those charged with governance impact internal control systems' effectiveness significantly by providing oversight and ensuring the appropriate design and operation of controls, including whistleblower procedures and effectiveness reviews. Their independence, experience, and involvement ensure that management is held accountable, appropriate questions are raised, and best practices are followed, which reinforces the control environment and increases the reliability of financial reporting and compliance .

The control environment significantly influences the effectiveness of an internal control system as it encompasses the overall attitude, awareness, and actions of directors and management regarding the internal control and its importance. A strong control environment, characterized by tight budgetary controls and an effective internal audit function, can enhance specific control procedures. However, a strong environment alone does not ensure effectiveness; other factors like management’s philosophy, operating style, and policies on authority and segregation of duties must also support the effectiveness of internal controls .

The delegation of duties is critical to the effectiveness of an internal control system because it ensures a separation of responsibilities, reducing the risk of error or fraud. By assigning specific tasks to different individuals, the organization supports accountability and transparency, facilitating the detection of irregularities and verifying the accuracy and completeness of financial records .

Commitment to competence affects the internal control system by ensuring that employees possess the necessary knowledge and skills to perform their tasks effectively, which is crucial for maintaining effective controls. Management must evaluate competence levels for positions and hire individuals who can meet these requirements, contributing to the orderly and efficient functioning of the business and adherence to management policies, thereby supporting the objectives of the internal control system .

The assignment of authority impacts an organization's internal control system by defining the hierarchical structure and establishing clear lines of accountability. Properly assigning authority helps in ensuring that policies and procedures are correctly followed, enhancing the prevention and detection of fraud and errors, safeguarding assets, and ensuring reliable financial reporting .

Management's operating style directly impacts the internal control system, as it sets the tone for how control policies are implemented and observed. A management style that prioritizes risk management and ethical behavior supports a robust control environment, which helps ensure the efficiency and effectiveness of operations, reliability of financial reporting, and compliance with laws and regulations .

A strong control environment supports specific control activities by reinforcing the foundation upon which other control components operate. It ensures that there is a high level of awareness and compliance with control procedures, promoting consistency in adherence to internal policies and enhancing the overall robustness of the control activities in reliability of financial reporting and operational effectiveness .

Ethical values are pivotal in strengthening internal control systems as they shape the standards and manner in which policies are communicated and reinforced, ultimately influencing the entity's integrity and ethical behavior. Management must actively work to remove or reduce incentives for dishonesty or unethical conduct, maintaining a clear code of conduct and setting an example of appropriate behavior, all of which maintain the effectiveness and reliability of internal control structures .

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