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Internal Controls Explained

April 8, 2014

What are internal controls?  Auditors widely use this term.  It also appears multiple times in engagement letters for audits of businesses and not-for-profits but I do not believe many outside of the accounting profession really know or understand what internal controls are.  I will try to explain it here.

Internal controls refer to an organization’s system of deterrence, oversight, checks and balances.  An illustration is where someone in a business writes and mails the checks to pay a bill.  If this same person then receives the bank statement and performs the reconciliation of that account, there would not be any control or oversight on that person and whether the payment was proper and not misdirected.  They are checking their own work.  This is how many frauds occur.

Another illustration is where merchandise is ordered by a person who also receives it, places it in inventory and authorizes the payment.  There is no oversight of the products received, that they were actually placed in inventory or that the right material was ordered, or even received.  Adding a different person to the process anywhere along the way can provide a control to thwart any theft.

Employee theft can occur at any point if temptation is blatantly put in front of otherwise honest people.  Not always, but occasionally.  Petty thefts of packages of coffee and office supplies, up to scrap metal, to inventory items like parts and finished products and be easily taken without adequate controls.  It is hard to secure coffee and office supplies but parts and inventory can be controlled with a protected location and perhaps a video camera recording activity in and out of the area.

Salespeople can pad their expense accounts and time workers can find ways to punch in earlier than when they show up or later than when they quit for the day.  Simple controls can impede many of these stealth frauds such as with periodic but regular spot checks.

It is incumbent upon every manager of a business or not-for-profit organization to assure that the controls are adequate and appropriate for the organization.  There is also an easy way to approach this.  If you have an independent auditor, ask them to review with you every item on the internal control evaluation checklist they completed for their last review or audit of your system.   If you do not have an independent auditor, email me and I’ll send you a standard internal control evaluation checklist you can start with.

2 Comments leave one →
  1. Robert Nagler permalink
    April 8, 2014 12:10 pm

    HI ED JUST T WLLL I READ ALL YOUR PARTNERS NETWORK ARTICIALS
    I FIND THEM INTERESTING AND INFORMATIVE

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