Internal controls are a series of policies and procedures that a business owner puts in place for the following purposes:
- Protecting assets: internal controls protect assets from accidental loss or loss from fraud.
- Maintaining reliability: internal controls make sure that management has accurate, timely, and complete information.
- Ensuring compliance: internal controls keep accounts in compliance with the many federal, state, and local laws and regulations affecting the operations of a company.
- Promoting efficient operations: internal controls create an environment where managers and staff can maximize efficiency and effectiveness.
- Accomplishing objectives: internal controls provide a mechanism for management to monitor the achievement of operational goals and objectives.
The responsibility for maintaining internal controls falls on administrative management. Members of the management team are responsible for communicating to staff their duties and expectations within an internal control environment. They are also accountable for ensuring that other areas of the internal control framework are dealt with consistently.
Framework for Internal Accounting Controls
To be effective, the framework for internal accounting controls should have a system which includes:
- A controlled environment
- Risk assessment
- Monitoring and reviewing
- Information and communication
- Control activities
The Three Main Internal Controls
There are three main types of internal controls, these are:
Detective Internal Controls
This type of control is designed to highlight any problems within a company’s accounting process. Detective internal controls are commonly used for things such as fraud prevention, quality control, and legal compliance. Examples of detective controls include an inventory count, internal audits, and surprise cash counts. Detective internal controls protect a company’s assets by finding errors when they occur so that business owners can minimize their impact on the company.
Preventive Internal Controls
This type of control is a proactive control designed to prevent errors and irregularities from occurring. Preventive internal controls are usually performed on a regular basis. Some examples of preventive controls are:
- Separation of duties: splitting tasks for bookkeeping, deposits, reporting, and auditing, so there’s less chance of employee fraud.
- Controlling access: this feature prevents team members from logging into certain parts of the accounting system unless they have a password.
- Double entry accounting: a system that adds extra reliability so that books are always balanced.
Preventive internal controls are put in place to help with clerical accuracy, backing up data, and preventing employee fraud. These internal controls help to avoid any problems or irregularities so that the business processes can run smoothly.
Corrective Internal Controls
Corrective internal controls are put in place to correct any errors that were found by the detective, internal controls. This type of internal control usually begins by detecting undesirable outcomes and keeping the spotlight on the problem until management can solve it. If an error occurs, then it is essential that an employee follow procedures that have been put into place to correct the mistake. Examples of corrective internal accounting controls include physical audits (such as hand counting money) and physically tracking assets to reveal well-hidden discrepancies. Implementing a quality improvement team can be a great way to address ongoing problems and to correct processes.
Other Forms of Internal Controls
There are other forms of internal accounting controls, these include:
When accounting documents such as inventory receipts, invoices, internal materials requests, and travel expense reports are standardized, this can help to maintain consistency in the company’s records. Standardized document formats also make it easier to review past records when a discrepancy has been found in the system.
This internal control entails using a double-entry accounting system. Doing so increases reliability and keeps the book balanced. Errors may still throw a double-entry system off balance. If employees calculate daily or weekly trial balances, this will help maintain analysis of the state of the system so that discrepancies can be discovered early.
Occasional accounting reconciliations mean that account balances in the company system can be matched up with balances in independent accounts such as credit customers, suppliers, and banks. Any differences between these accounts will highlight errors.
This internal control requires members of the management team to authorize specific transactions. Approval authority adds a further layer of responsibility to accounting procedures because it proves that any transactions have been analyzed and approved by the appropriate managers.
Ways to Improve Internal Accounting Controls
There are things you can do to strengthen your internal accounting controls. Here are a few suggestions:
Allocate Separate Accounting Responsibilities
Instead of relying on one employee or bookkeeper to handle all the accounting duties, segregate the processes to different members of your team. For example, processing receipts and payments can be separated. Other activities that can be separated include signing checks, approving invoices, and reconciling accounts. Allowing a single person to handle all these accounting processes increases the risk of errors or fraud.
Even though you have internal controls, they will not be effective enough without oversight. If you don’t have time to do it yourself, you should allocate a trusted member of your personnel to review statements, account reconciliations, and payment registers periodically. Look out for unapproved expenses or raises, non-existent employees, and unapproved hours. Make it a priority to review your company’s financial data so that you can stay abreast of trends and changes in your financial reports.
Restrict Employee Access to Financial Systems
Typically, business accounting software allows users to edit previous transactions. This unmonitored permission opens up the potential for employees to hide fraud or theft. As a business owner, you should restrict employee access to the company’s financial system to reduce the risk of employees changing and deleting entries. You can also review any transaction changes in the system to reveal any irregular activity.
Have a Third Party Overlook Financial Statements
You can increase the safety of your assets by having a third party review your company’s accounts. Any employees who are involved with internal accounting and aware of your third-party review will be deterred from fraudulent practices. An independent reviewer will also be able to identify errors and inconsistencies.
Perform a Self-evaluation of Your Internal Controls
Performing a self-evaluation can help you to highlight any areas that come up short before problems arise and give you the opportunity to use more effective controls. The easiest process to perform a self-evaluation is by conducting a trace of a particular transaction throughout company records and procedures. The trace will give you a deeper understanding of your internal controls in action, particularly those controls which are in place to detect or prevent fraud. You will also be able to see if your internal controls have been designed effectively and are operating as intended.
Effective internal controls for your accounting and finance should be an integral part of your business plan. Internal controls significantly reduce the risk of loss of assets and increase the reliability and accuracy of all your accounting and finance operations. Additionally, controls ensure that your company’s accounting system is in accordance with applicable laws and regulations.
We Can Help
You can contact us if you need help establishing internal controls for your accounting and finance department to protect your business assets adequately. Signature Analytics is an outsourced accounting firm providing ongoing accounting support and financial analysis to small and mid-size businesses. Our team of highly experienced accountants will act as your entire accounting department (CFO to staff accountant), or complement your internal staff, to provide the ongoing accounting and finance support necessary to effectively run your company, analyze operations, and guide business decisions.