Finance Business

Internal Control for Better Compliance

Internal control procedures are crucial in any business because they increase the level of system transparency, which boosts operational effectiveness and efficiency. They help create an environment that is conducive to risk reduction and allow a company to identify risk areas and put in place the necessary safeguards to keep an eye on those high-risk regions. In this article, we will address the internal control system, its components and its benefits for better compliance.

What Is an Internal Control?

Internal controls are procedures created to protect a company and reduce risk to its goals. It helps to reduce risks, safeguard assets, maintain record accuracy, enhance operational effectiveness, and promote conformity to laws, rules, and regulations. There are numerous sorts of the internal system of control, including preventive, detective, automatic, and manual ones. 

Although compliance and control are frequently used interchangeably, in the context of an audit, compliance and control are two components of an exemplary process. Control is the portion of the process created to achieve a specific objective. Compliance is the application of the intended procedure. Because of what they perform, internal controls are crucial for any firm.

• Boost the effectiveness and efficacy of business operations.
• Make sure financial disclosures are reliable.
• Helps in preserving the accuracy of accounting records and financial accounts
• Permit the business to achieve its goals for regulatory compliance

A solid internal system of control also improves accountability and transparency across the entire organisation. It encourages moral conduct. It ensures consistency in actions and results, which can raise worker productivity and quality and help the business achieve its objectives.

Components of Internal Control System

All five components must function together for an internal system of control to be effective. It manages and reduces severe risks, and its control actions are created utilising a risk-based approach. Through established channels, stakeholders exchange pertinent information on risks with one another.

Leadership gives guidance and demonstrates its dedication to risk management and internal controls. Leaders also encourage a culture that values openness, truthfulness, and accountability. Such organisations often conduct risk assessments^[1]. The existing control system is routinely and regularly examined. Issues will be identified and fixed right away.

The five components of the internal control system are as follows:

Risk Assessment – Both internal and external risks must be evaluated after the business’s goal has been established. After analysing the risks associated with each goal, management decides on risk control measures.

Controlling the environment – The aspects of the internal system of control are built upon the control environment. The controlling environment also includes more principles, managerial skills, employee integrity, managerial direction, etc.

Controlled Actions – The management sets up a risk-prevention strategy for controlling activities for each target. All policies and procedures employees must adhere to are part of these regulation activities.

Information and communication – Decision-making requires the timely collection and reporting of pertinent information. Events that produce data might come from either internal or external sources. Having effective communication is crucial for managing objectives. The employees must understand what is required of them and how their duties relate to those of others. Communication between the owners and other parties, such as suppliers, is crucial.

Monitoring – When the internal system of control is used, the company monitors its efficacy to make the appropriate adjustments if a severe issue emerges.

A firm can achieve its objectives while avoiding problems if these five components are correctly implemented.

Types of Internal Control

Internal systems of controls can be divided into two primary categories: preventative and detective. Both types are necessary for an efficient internal system of control since each has distinct functions. And the third type is corrective control.

Detective Controls – A problem that has already happened can be found and investigated with the aid of detective controls. These controls, for instance, will assist you in determining the root cause of a recent data breach at the organisation and putting the best possible response plan in place. The proper detective controls demonstrate whether preventive measures act effectively (more on those in a moment) or whether any control gaps led to the unpleasant incident. Detective controls also enhance process quality and avoid mistakes that could harm an organisation’s finances, legal standing, compliance with regulations, or reputation.

Typical detective safeguards include:

• Reconciliations of transactions per month
• performance review
• Physical inventories
• Cash counts
• Audits, both internal and external
• Intrusion Detection Systems (IDS) and surveillance systems.

Preventive controls

As the name suggests, preventive controls work to stop problems or errors before they start. These problems include fraud, substantial misstatements, accounting errors, cyberattacks, financial manipulations, and other things.

Several businesses use the following preventive measures:

Division of labour

• Controls on system access
• Financial permissions
• IT access restrictions
• Controls for physical security
• Intrusion Prevention Systems and Firewalls (IPS)
• Data backups
• Drug testing and employee training

Corrective measures

Corrective measures are implemented when a problem has already arisen and has to be corrected. Because they fix the problem that could lead to fraud, data breaches, financial losses, or reputational harm (or have already done so), they are essential to the internal system of control. These controls also offer some knowledge for the problem to be resolved and won’t happen again.

An example of corrective measures.

• Software patches
• Equipment improvements
• Device quarantine for infected ones
• Updated regulations
• Verification of ledgers
• A disciplinary measure
• Planning for business continuity and incident response.

The combination of investigative, preventative, and corrective controls enables businesses to recognise risks, identify threats, and take the proper action to stop harm to their people, systems, clients, or data.

What Benefits Do Internal Control Systems Offer?

Internal controls give a corporation cohesiveness and consistency to create order and protocol. Owners of businesses create protocols, impose limitations on how the method is carried out, and routinely evaluate controls for effectiveness and correctness. Internal systems of control procedures that have been established specify how financial transactions are handled and how managerial and administrative responsibilities are distributed within the organisation. Employees understand protocol and procedure when they are accurate.

• One benefit of internal controls is that a select group of dependable senior-level employees can only alter them. When fewer people are involved, monitoring irregularities and taking precautions against them is more superficial.
• Internal controls that are effectively planned and implemented boost productivity by making all transactions visible to the public.
• Internal system of controls shields staff from claims of irregularities or financial embezzlement by balancing transparency and fostering efficiency.
• It reduces the risk of over-dependence on a few key personnel by making the company process-driven rather than people-driven.
• It can help you find overlaps in your operational and compliance procedures, allowing you to streamline your business.
• It can serve as an early warning system, allowing for the early detection and remediation of flaws.
• Internal systems of control are set up such that work completed by one person in a process is reviewed by a different employee without the knowledge of the former. Any fraud performed in such a setting is exposed without coordination among fraudsters.
• To confirm the dependability and accuracy of the book entries, the auditor can test-check or sample-check the transactions. As a result, he can finish his audit task and create financial statements in the allotted amount of time.
• Each employee is only given a small amount of work to complete, and the knowledge that his work is being independently reviewed by another puts him on guard at all times. The possibility of making an error or committing fraud is lower in such circumstances.

It makes it easier to establish responsibility, conduct work without making mistakes, ensure the accuracy and dependability of entries, and eliminate inefficiency, fraud, theft, etc. Also, this technology gives management the ability to evaluate staff performance. All of these work together to improve the organisation’s overall operational effectiveness.

Conclusion

Processes and internal controls, as already mentioned, are never perfect. There will always be mistakes and annoyances, with or without intention. That is why any organisation’s annual security policies should include a continuous assessment and analysis process of internal controls. When an incident occurs, it should be thoroughly recorded, looked into, and reviewed by those qualified to implement the above-discussed corrective measures to strengthen the internal system of controls. There will always be restrictions, just like with every human endeavour. It must be considered at all costs while thinking about internal controls.

Also Read:
Internal Controls- A Guide for directors
Internal Control System- Analysis of Benefits & Limitations