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What is an Accounting Internal Control?

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Accounting is the art of measuring, reporting, and analyzing financial information in order to keep track of a company’s or individual’s economic health. These days, accounting has become more complex with the growth of globalization and technology that have changed the way we do business. In today’s article, we’re going to answer pertinent questions on what accounting internal controls are and how they work to protect the company from fraud and errors.

What are accounting controls?

Internal controls in accounting refer to the procedure, checks, and balances established by a company’s management to ensure that the transactions are properly recorded from an external point of view. Internal controls help keep track of the activities performed by employees so as to prevent errors, fraud, and other deficiencies during the keeping of records.

What is the purpose of internal controls?

Internal controls in accounting play a vital role in preventing and detecting errors and fraud. Thus, they help ensure that the company’s financial records (Comptroller) are accurate and reliable when it’s time for an audit. This is part of what makes a business sustainable. Internal controls also help prevent or detect theft of property, misappropriation or misuse of assets, and other irregularities related to employees’ activities and transactions.

Internal Controls refers to procedures, checks and balances established by a company’s management to ensure that financial records are accurate and reliable for external users.

What are the 3 types of internal control?

Internal Controls are classified into three types:

  1. Preventive Controls are designed to prevent errors, thefts, or other irregularities from occurring. This kind of control is also called “top-down” control because it works at a high level of management and focuses on what needs to be done to maintain records for external reporting. The preventive controls include a document retention policy to maintain documents such as purchase orders and receipts, segregation of duties so that critical tasks are not performed by a single person, and other policies to ensure accountability.
  2. Detective Controls are designed to detect errors or frauds once they have occurred. This kind of control is also called “bottom-up” control because it works at the lowest level of management and focuses on routine day-to-day activities. The detective controls include Cash Reconciliation to reconcile the totals of cash receipts with deposit slips, price verification for inventory transactions to ensure that the physical count matches both the purchase order and the invoice, and other procedures to detect errors or frauds.
  3. Deterrent Controls are designed to deter theft or other irregularities by making them difficult or unlikely. This kind of control is also called “middle” control because it works at the middle level of management and can be applied in daily activities. The deterrent controls include policies for maximum cash balance, transaction limits on purchases, procedures for approving large outlays, restricted access areas with security cameras, and other policies to deter errors or fraud.

What is the difference between internal controls and accounting systems?

Accounting systems refer to the set of documents that are created for recording, classifying, and summarizing activities that are performed by employees in order to prepare financial reports for external users. A company’s accounting system may be the same as its internal controls system. But, not all of them are always the case.

On the other hand, Internal Controls refer to procedures, and checks, and balances established by a company’s management to ensure that financial records are accurate and reliable for external users. The accounting systems may include some aspect of internal controls such as price verification.

What are the 5 internal controls?

The 5 internal controls are:

1. Control of assets, which includes a system whereby a company can identify its assets and document their acquisition and disposal.

2. Control of the authorization of transactions, which is a procedure by which transactions are properly authorized to ensure that they have been approved by someone who has the authority to sanction them.

3. Separation of duties, which is a requirement that no single employee should be given too much authority since this may result in abuse.

4. Documentation and recordkeeping, which requires all transactions to be documented and recorded to ensure they can be properly traced and reconciled with the accounting records.

5. Protection and custody of assets and documents, which requires that assets and documents are properly protected to prevent loss, damage, or theft.

A control activity is any process, check or review that can serve as a safeguard against error and/or fraud.

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What is the purpose of internal controls?

Internal Controls are established by management for various reasons:

  • To assure that financial records of a company’s activities can be relied upon;
  • To protect assets of a company against theft and fraud;
  • To provide reasonable assurance that a company will continue to operate for an indefinite period of time.

Why do companies commit fraud?

Financial statement fraud is usually perpetrated in order to:

1. Hide an operating loss;

2. Enhance apparent net income; and/or

3. Conceal unrecorded liabilities.

How do accounting internal controls prevent fraud?

Internal controls help prevent fraud by:

1. Providing reasonable assurance that a company’s assets and liabilities reflect the figures reported in its financial statements;

2. Solving or preventing internal control problems before they become major issues; and/or

3. Detecting errors and irregularities in a timely manner so management can take prompt corrective action to improve the financial statements.

What is a control environment?

A control environment is that part of an organization’s internal control system that provides reasonable assurance that:

1. Management will commit to and support adequate, effective, and timely actions to achieve its objectives;

2. Employees understand their responsibility for complying with the company’s policies and procedures;

3. Employees receive adequate training on the company’s policies and procedures;

4. All transactions will be closely monitored and questioned by someone within the company in a timely manner.

5. Procedures and controls are in place to account for all assets, reduce risk exposure, and control losses; and/or

6. The company’s compliance requirements are being enforced.

What is a control activity?

A control activity is any process, check, or review that can serve as a safeguard against error and/or fraud. For example:

1. Periodically comparing transactions to pre-established criteria;

2. Verifying the accuracy of postings to the general ledger;

3. Comparing information in the general ledger with subsidiary records;

4. Auditing or examining transactions to ensure that they are properly recorded, processed, and summarized;

5. Reviewing internal procedures for compliance with standards, policies, and laws;

6. Reviewing reports prepared by others to verify that they correctly reflect transactions;

7. Reviewing reports prepared by others to verify that they are properly identified and support the information contained in them;

8. Monitoring cash collections to ensure that they are properly entered into the accounting records;

9. Arranging for independent annual audits of internal controls; and/or

10. Designating authorized signatories.

What are examples of classes of transactions?

A company may have several different transaction types, including:

1. Cash;

2. Accounts receivable;

3. Sales; and/or

4. Purchases.

The 8 common types of financial statement fraud are:

1. Overstatement of revenue;

2. Understatement of debts or expenses; 3. Reporting fictitious transactions;

4. Misappropriation of assets;

5. Manipulation Of Accounting For Fixed Assets;

6. Manipulation of financial statements by insiders;

7. Misuse of nonpublic information to trade in securities, derivatives, or other instruments.

8. Fraudulent financial reporting by not-for-profits.

What are the 3 internal control weaknesses?

The 3 internal control principles in accounting, which include establishment of responsibility, segregation of duties, and documentation procedures, have weaknesses that can impact the accuracy and integrity of financial statements. These include a lack of sufficient monitoring or follow-up measures, weak authorization or approval processes, and ineffective communication. Furthermore, these control principles are vulnerable to human errors due to the complexity of their instructions if not handled professionally. Additionally, certain transactions may be overlooked due to irregularities in the volume or organization of records. When weaknesses arise from these 3 internal control principles, it could lead to misappropriation, weak accountability mechanisms, and fraudulent activities.

What is the difference between financial reporting fraud and securities fraud?

Financial reporting fraud refers to false or misleading information found in financial reports that are submitted to investors, creditors, or regulatory agencies.

Securities fraud is a crime that involves the deception of buyers and sellers in order to manipulate securities prices for personal gain. Securities law’s primary purpose is to protect investors from losses due to market manipulation by insiders.

What is the impact of accounting fraud on investors and stakeholders?

Criminal penalties, fines, and restitution may not prevent future crimes. According to research by Professor Joseph T. Wells, the consequences for investors are:

1. Loss of confidence in investing in stocks;

2. Decrease in stock prices;

3. Decrease in capital gains earnings;

4. Increase of investment risk for future accounting frauds; and/or

5. Loss of investor confidence, which may lead to decreased foreign direct investments.

How do internal accounting controls contribute to ESG?

Internal accounting controls contribute to ESG by ensuring the proper recording, reporting, and disclosure of financial activities. In other words, internal accounting controls “ensure” management and investors see the same set of financial statements. Internal controls ensure that accountants:

1. Are knowledgeable and trained to perform their work;

2. Understand what is required in various situations;

3. Recognize fraudulent activities; and/or

4. Document all actions taken.

What are the main responsibilities of an auditor?

The main responsibility of an auditor is to provide assurance (i.e., confidence) that the financial statements are free from material misstatements due to error or fraud. Auditors also provide independent confirmation of the information provided by management. Auditors can provide almost all of these services within a single audit, or they may be spread over a series of audits.

What are some specific internal controls that a company can use to prevent accounting fraud?

The following are examples on internal controls that a company can use to prevent accounting fraud include:

1. Risk assessment;

2. Disciplinary procedures for those who violate the rules and procedures;

3. Specialized training for finance staff;

4. Regular internal audits; and/or

5. Separation of duties (avoiding one person performing all the tasks in a transaction).

What are the key internal controls?

The key internal controls are:

1. Control environment;

2. Risk assessment;

3. Control activities; and

4. Information and communication — each of which is described below:

a) Control environment – The control environment includes the policies, structures, planning processes, and people that determine how an entity will implement its objectives with regard to financial reporting.

b) Risk assessment – The risk assessment process identifies potential risks that could affect the entity’s ability to achieve its objectives.

c) Control activities – Control activities are the plans, policies, and procedures used to mitigate identified risks. These control activities are designed to prevent or detect errors, fraud, or irregularities occurring in operations or the preparation of financial statements.

d) Information and communication – The individual who is responsible for a set of activities must communicate with those parties that affect, enable, or control its completion. This includes information about the entity’s goals, objectives, and risks as well as expected outcomes

Accounting is an art of measuring, reporting and analyzing the financial information in order to keep track of a company’s or individual’s economic health.

How can internal controls be used to identify fraud?

Internal controls can be used to identify fraud by:

1. Providing a separation of duties among the entity’s employees so that each employee has limited discretion and review over a specific activity;

2. Verifying transactions through tests, comparisons, and other methods to ensure they have been recorded accurately and on schedule;

3. Ensuring that amounts are in agreement with physical inventory; and

4. Provide a comparison of the calculations and figures included in one record with those in other related records, such as accounts payable to invoices received from suppliers, to ensure consistency. In addition, internal controls must be designed so that they are independent of the entity’s management structure because managers could develop schemes to avoid or override certain controls.

What is the difference between fraud and theft?

Theft involves the unlawful taking of property belonging to another, whereas fraud includes both lawful and unlawful activities. Theft may be considered a lesser crime than an act of fraud if the property was not lawfully obtained.

3 examples of accounting fraud are:

1. Overstating revenues to meet the expected financial results;

2. Underreporting liabilities, especially at year-end, so that net income will appear higher than it truly is; and

3. Falsifying inventory records so that the company appears more profitable or to justify cash disbursements.

Caveats, disclaimers & an internal control system

At ESG | The Report, we believe that we can help make the world a more sustainable place through the power of education. We have covered many topics in this article and want to be clear that any reference to, or mention of the internal control framework of an accounting system, corporate governance vs. external auditors, or other factors affecting the Sarbanes Oxley Act in the context of this article is purely for informational purposes and not to be misconstrued as investment or any other legal advice or an endorsement of any particular company or service. Neither ESG | The Report, its contributors, or their respective companies nor any of its members gives any warranty with respect to the information herein and shall have no responsibility for any decisions made, or actions taken or not taken which relates to matters covered by ESG | The Report. Thank you for reading, and we hope that you found this article useful in your quest to understand ESG and sustainable business practices. We look forward to living in a sustainable world.

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