Concept of Internal Control

• Internal control is the whole system of control instituted within the

organization for the purpose of running the business of the company
in an orderly manner, safeguarding the assets and ensuring the
reliability and accuracy of financial records.
• It consist of – a) accounting control b) administrative control.
• Accounting control- internal check, internal auditor
• Administrative control- quality control, budgetary control, statistical
analysis, periodic performance, productivity
Importance of Internal Control

• internal controls can ensure compliance with laws and regulations as well as
accurate and timely financial reporting and data collection. They help to maintain
operational efficiency by identifying problems and correcting lapses before they
are discovered in an external audit.
• With the increasing size and scalability of the company, a large number of people
is employed to carry the business. Therefore, the relevance of internal control
becomes higher to increase productivity and operational efficiency.
• Delegation of power by top management allow them to focus more on strategical
and decision making part. There should be control mechanism to ensure the
efficiency and effectiveness of employee.
• Optimum utilization of scarce resources, for optimum profit , the control system
allow system to drive growth under competitive environment.
Component of Internal control ( COSO Model)

• Control environment
• Risk assessment
• Control activities
• Information and communication
• Reporting and monitoring
Feature of Internal control system

• Proper organization structure

• Scheme of authorization and procedures
• Internal check
• Suitable personnel
• Internal audit system
• Progressive outlook of management
• Audit committee
Objective of internal control system

• To ensure that all transactions are undertaken with management’s

authorization
• To safeguard the asset or resources of business from a) misutilisation
b)fraud c) other casualties like accident theft etc.
• To ensure correct recording of transaction promptly so that financial
statements can be prepared in time within the framework of generally
accepted accounting principles.
• To promote the efficiency of all persons and operations of the organization
• To ensure attainment of sound policy of the company and adherence to
such policies.
Objective of internal control system

• To assist the management to formulate the plans and policies of the

business.
• To improve productivity and profitability of the business.
Limitations of internal control system

• Cost constraint
• Unusual transaction
• Human error
• Possibility of collusion
• Overriding of control
• Outdated procedure
• Manipulation by management
Review of internal control

• An internal control review is an overall assessment of an organization’s internal

control system across each business area to determine if it’s functioning as intended
and if it’s able to manage the risks that the company may face in its day-to-day
operations.
• An internal control review provides company leaders with assurance about the
effectiveness of its internal control environment. Internal controls protect a company
from financial loss as well as help the organization maintain reliable financial
reporting and operate more efficiently and securely.
• The best way for a company to ensure that its internal control system is operating
efficiently is with an internal control review. An internal control review highlights
vulnerabilities in a company’s internal control environment and identifies processes
that can be strengthened.
Study and evaluation of Internal control system

• To assess the efficacy of internal control system, the auditor must study and
evaluate the system. This is done in two stages-a) understanding of internal
control system b)making an assessment of control risk.
• Understanding of internal control system-
i) Narrative record
ii) Check List
iii) Internal control questionnaire
Internal control questionnaire

• Coverage
• Means of disclosing defects
• Transparency
• Rule of framing
• Flexibility
• Enlightening the client
Internal control Questionnaire

• Advantage:
i) There is a least possibility of occurring omission of significant
internal review procedures
ii) It facilitates the preparation of audit Programme.
iii) It provides an orderly means in disclosing the defects of internal
control system
iv) It provides a training facilities to inexperienced auditors
v) Information relating to control system can be obtained in a written
form which could not be otherwise obtained through personal
contacts or oral interview.
Disadvantages

• If the questionnaire happens to be defective, it may lead to erroneous conclusion

about the internal control system
• Mere yes or no answer to questions may not be sufficient to comprehend the
system properly
• This is a very meticulous job which require a large pool of accumulated
experience. So a small or new audit firm may not afford to make a questionnaire
method of evaluation of control system
• There is no guarantee that questionnaire will always portray correct answer.
• There may be a delay in the evaluation as answer to the questionnaire may not be
timely received.
Internal control system_ method of examination

• Inquiry ( Internal control questionnaire)

• Observation
• Examination of documents
• Preparing flow chart
Internal Financial control

• Defined in the explanation to section 134 (5) of the companies act,

2013 to ensure
a) Orderly and efficient conduct of its business
b) Safeguarding of its asset
c) Prevention and detection of error and fraud
d) Accuracy and completeness of accounting records
e) timely preparation of reliable financial information
The primary objective is to improve the performance and productivity
of business and enhance the reliability of its fin. Statements.
Auditor’s duty reg. IFCFR ( Sec. 143(3))
• The components of IFCFR include:
a) Maintenance of financial records
b) Preparation of financial statements in accordance with GAAP
c) Authorization of management of all receipts and expenditure
d) Safeguarding of the assets of the company
Internal check

• Is the system of allocating total work of the organization among various staff
members in such a way that work of one individual is automatically checked by
work of other individual.
• Here accounting system and other works are so laid out that no work is
completely left under the absolute control of one single person, division of work
among the staff members.
• The objective of internal check is prevention of errors and frauds and their early
detection if they are committed. No single person is authorized to undertake all
the operations involved in a transaction.
• De Paula defines internal check “a continuous internal audit carried on by the staff
itself by means of which the work of each individual is independently checked by
other members of the staff.
Feature of internal check system

• Duties are segregated to fix responsibilities.

• The work done by one clerk gets automatically checked by the work
of another clerk
• Duties among the staff are interchanged.
• Each aspects of a transaction is recorded by different clerk
• The person who is the custodian of assets ( custodian of cash) should
not have access to books of accounts and vice versa.
• It operates continuously as a part of routine system.
Objective of internal check system

• To distribute duties and responsibilities among the staff in a

systematic manner for ensuring smooth flow of work.
• To minimize the possibility of errors and fraud likely to be committed
by staff.
• To ensure early detection of error and fraud if ever committed.
• To improve the efficiency in the functioning of the organization.
• To increase reliability of financial data of the business.
• To design accounting system ensuring prompt preparation of financial
statements.
Advantage of internal check

• Rational allocation of work

• Control technique
• Orientation of accounting
• Increase in skill and efficiency
• Improvement in audit work
• Early preparation of financial statement
• Integrity of account
• Economy in operation
• Ethical standard
Disadvantage of Internal check

• Not conducive to creativity

• Developing inefficiency and carelessness
• Collusion
• Expensive
• Chance of chaos and disorder
• Audit risk.
Evaluation of internal check by auditor

• Whether the division of work between the various members of the staff has been
carefully planned and the work of each person has been made complementary to
that of other.
• No single person has complete control over the entire transaction i.e. authorizing,
recording.
• Whether every clerk is compelled to take his annual holiday
• Whether there is a careful supervision by a responsible official.
• Whether a detailed record is maintained of all goods received and sent out.
• Whether a circular is sent to all debtors and creditors to obtain confirmation of
their accounts and whether their replies are received and examined by responsible
official.
General consideration in framing a system of internal check

• No single person should have an independent control over any important

aspect of the business.
• The duties of the staff should be changed from time to time without any prior
notice so that same person does not perform the same function for a period of
time.
• Every member of the staff should be encouraged to go on leave at least once
in a year.
• To prevent misappropriation of cash automatic cash registrar like bank, ATM
should be employed
• The financial and administrative powers should be distributed judiciously
among different officers and it should be periodically reviewed.
General consideration in framing a system of internal check

• Accounting procedures should be reviewed periodically because a well designed

and carefully installed procedures cease to be effective.
• Procedure should be laid down for periodical verification and testing of different
section of accounting record to ensure that they are accurate .

• Internal control vs Internal check

Purchase
• EOQ and ordering level
• Requisition of purchase
• Selection of supplier
• Placement of purchase order
• Monitoring of supply
• Receipt of material
• Inspection
• Storing of material
• Payment of purchase of material
Purchase return
• Receiving of material by inspection department
• Advise supplier to take away good upon non-conformity with order
• Preparation of good return by receiving department
• Adjustment of return in the ledger
• Entry of return by the clerical person.
Credit sales

• Accepting order
• Maintaining sales record
• Arrangement for issue of goods from stores
• Dispatch of goods
• Raising of invoice
• Recording of sales invoice
• Receiving payment
• Sanctions for write offs
payments
• Mode of payment
• Preparation of payment voucher
• Authorisation of payment
• Preparation of cheque
• Signing of cheques
• Dispatch of cheques
• Recording of cash payment
Cash sales of a departmental stores

• Separate sales counter

• Separate cash memo book
• Writing cash memo
• Checking the cash memo
• Handing over the cash memos to the customer
• Payment of cash by customer to cashier
• Separate delivery department or counter
• Daily settlement of sales
• Lodging of cash with cashier