Internal Controls (Accounting) - Explained
What are Internal Controls?
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Table of ContentsWhat are Internal Controls?How to Use Internal Controls?Principles of Internal ControlsLimits on Internal ControlsImportance to AuditorsOperational EfficiencyPreventative Versus Detective ControlsDisadvantages of Internal ControlsAcademic Research on Internal Controls
What are Internal Controls?
Internal controls refer to accounting policies and auditing procedures that ensure that the accounting information of a company are accurate and reliable. Companies set up internal controls to achieve a number of objectives. The forms of internal controls in a company determine how complaint, it will be to credible accounting and audit reporting, it also shows the level of resistance to fraud and accounting malpractices. Internal controls are techniques, processes and rules that enhance accountability that financial integrity and also prevent fraud. These controls enable a company provides timely and accurate financial information while complying with the laws of the state.
How to Use Internal Controls?
Not only do internal controls help a company become more reliable and efficient, they improve the accuracy of a company's financial report. These are sets of rules that ensure that a company complies with the accepted accounting principles that will help them identify and control errors when they occur in financial reports. Without internal controls, inaccuracy will occur in the preparation of a company's financial statement. Also, Investors look out for internal controls in companies before they choose to invest in them. As contained in Sarbanes-Oxley Act of 2002, internal controls are part of corporate governance that companies must put in place to safeguard investors from fraudulent activities.
Principles of Internal Controls
Limits on Internal Controls
Importance to Auditors
The internal controls, accounting measures and procedures in an organization will determine the accuracy and reliably of its accounting information. Auditors also look out for the available internal control measures in a company and to what extent the financial statements have complied with the accepted rules. In an audit process, auditors examine the effectiveness of the internal controls of a company and give opinions based on the examination. After the Sarbanes-Oxley Act was passed by Congress in 2002, it made managers responsible for the internal controls. It is the responsibility of company managers to establish internal controls and also effectively manage them. The absence of internal controls in a company can create chaos or accounting crisis.
Primarily, internal controls ensure compliance with accounting laws and regulations by a firm. This helps a company identify its accounting problems and correct them even before internal audits commence. It is vital to note that internal controls are not the same for all companies. There is no rigid internal controls system that all companies are required to establish, this is why there are variances of internal control systems across companies. Internal controls are linked to operational efficiency in a company, in addition to preventing fraudulent activities, they help maintain a healthy level of efficiency in a company. Here are the major points you should note about internal controls;
- Internal controls are techniques and measures put in place by a company to ensure compliance with accounting laws and regulations and also prevent fraudulent activities.
- Internal controls ensure that the accounting or financial information presented by company managers are reliable, accurate and void of fraud.
- The Sarbanes-Oxley Act of 2002 gave managers the capacity to establish and manage internal controls in companies. This act also protects investors from fraudulent accounting activities.
- During audits, internal auditors examine the internal controls of a company to check the level of compliance to laws and regulations and also the accuracy of the financial information provided.
Preventative Versus Detective Controls
There are two major types of internal controls, they are;
- Preventive Controls: These are measures, mechanisms and times set up to prevent accounting errors and fraudulent accounting activities from happening. Some of the mechanisms of preventive controls are documentation and authorization. When the accounting information undergo different levels of documentation and are authorized by various management officials, it is to prevent errors and frauds from occurring.
- Detective Controls: In internal controls, certain procedures are used to identify missing accounting information with the aim of detecting errors and frauds. Through reconciliation, it will be easy to detect missing data and earmark areas where frauds have taken place. Internal and external audits are also means of detective controls used by most firms.
Disadvantages of Internal Controls
There are certain drawbacks of internal controls, despite its importance in accounting accuracy and operational efficiency. It is easy to circumvent internal controls, given that the effectiveness or performance of a company's internal controls are left to the opinions and judgments of humans. In certain cases, auditors give opinions based on how efficient the operations of a company are without paying any thorough attention to the internal control measures and rules.
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