CHAPTER 13:
INTERNAL CONTROL
J.L. Boockholdt, Ph.D., C.P.A., C.M.A.
Learning Objectives:
• To understand the components of an
organization’s internal control structure.
• To know the objectives and limitations
of internal control.
• To discover which characteristics of a
Learning Objectives:
• To learn how an accounting system
aids in communicating information
• To describe effective control
Accounting systems provide
information for people both internal and external to an organization. The users of this information rely on the accuracy of the system’s reports and displays.
Organizations adopt internal control
policies and procedures to maintain accurate information and reliable
operations. In this chapter you will learn about the components of an
organization’s internal control, its
Definition
Internal control is a process, effected by an entity’s board of directors, management and other personnel, designed to provide reasonable assurance regarding the achievement of the objectives in the following categories:
• Effectiveness and efficiency of operations • Reliability of financial reporting
• Compliance with applicable laws and
Features
1. Process 2. People
3. Objectives:
1. Accounting controls:
1. Safeguarding assets
2. Ensuring accurate and reliable accounting data
2. Administrative controls:
1. Promoting operational efficiency
2. Encouraging employees to follow management’s policies
4. Reasonable Assurance. A concept applied to
Absolute assurance is
impossible, because:
• Limitations of Internal Control
– Errors
– Collusion: Conspiracy by two or more
people to steal from an organization.
– Management Override: The ability of
managers to overcome control policies or procedures that are effective with
operations-level employees.
Threats to Accounting Data
• Errors
An accidental act, that arise from lack of knowledge (misjudgment) or lack of attention /fatigue
(carelessness)
• Irregularities
An intentional act, such as defalcation or
management fraud, that may misstate accounting data.
– Defalcation: the theft of assets from an
organization.
– Management fraud: management’s deliberate
Internal Control Components
are:
An organization’s control environment, risk assessment procedures, control
activities, information and communication methods, and
CONTROL ENVIRONMENT
Control environment are those
circumstances surrounding an
organization’s accounting system that either improve or limit the effectiveness
Factors Affecting the Control
Environment:
1. Integrity and ethical values. 2. Commitment to competence.
3. Board of directors or audit committee participation.
4. Management philosophy and operating style
5. Organizational structure.
1. Integrity and Ethical Values
As management creates, administers, and monitors the system of internal control, its effectiveness is limited by management attitudes toward integrity
2. Commitment to Competence
Competence means that employees have the knowledge and skills they need to perform theirs tasks. When management
has a commitment to competence, the system of internal control is more likely
to achieve its objectives. Otherwise, both errors and irregularities are more
3. Board of Directors and
Audit Committee Participation
Active and involved board of directors who have an appropriate amount of technical and management knowledge,
4. Management Philosophy
and Operating Style
These include management’s approach to taking business risks, attitudes toward
the accuracy of accounting data, and emphasis on meeting budget and
operating goals. They have a significant influence on the effectiveness of
5. Organizational Structure
It provides an overall framework for planning, executing, controlling, and
monitoring activities performed by
management. Objectives are more easily achieved in an organization whose
structure reflects its management
6. Assignment of Authority and
Responsibility
Management assigns authority and responsibility for operating activities and establishes reporting relationships
and methods of authorization. The
control environment is influenced by the extent to which employees recognize
7. Human Resources Policies
and Practices
They send messages to employees about what the organization expects in the way
of integrity, ethical behavior, and
Good Human Resource
Policies and Practices (1)
1. Training. Employees who
understand their jobs are less likely to make errors.
2. Recognition for work well done. Encourages employees to prevent errors and irregularities.
Good Human Resource
Policies and Practices (2)
4. Investigate employees before hiring. A potential employee may have
history of carelessness or dishonesty.
5. Job rotation. Require employees to change jobs periodically. Then an
Good Human Resource
Policies and Practices (3)
6. Required vacations. An employee filling in for an employee on vacation may
discover an error or irregularity that occurred in the past.
7. Bonding. A bond is a contract whereby a surety company agrees to reimburse the employer for loss if an employee commits theft. The surety company thoroughly
RISK ASSESSMENT
Risk assessment is management’s
CONTROL ACTIVITIES
Control Activities are the policies and procedures that management adopts to
provide reasonable assurance that management directives are carried out. They help ensure that actions are taken
Types of control activities:
1. Procedures for authorizing transactions: 1. General Authorization. Management’s
authorization in advance for a class of transactions.
2. Specific Authorization. Management’s
authorization for a single, specific transaction
2. Security for assets and records.
Types of control activities:
3. Segregation of duties.
Different employees:
1. Authorize transaction in an asset. 2. Record those transactions.
3. Have custody of the asset.
4. Adequate documents and record.
1. Numbered documents.
Good Procedures for
Processing Transactions:
• Prompt recording. Employees record
transactions immediately as they occur. This decreases opportunities for errors and
irregularities regarding the transactions.
• Visual checking. An employee recording
Good Procedures for
Processing Transactions:
• Balancing. An employee determines that
the total debit entries equal the total credit entries for the transaction.
• Batch controls. Employees accumulate
transactions into batches. They total the
amount of the transactions in each batch and attach this total to the batch. In each later
processing step, this total is recalculated and compared to the original batch total. This
INFORMATION AND
COMMUNICATION
Information and communication are required for making operational
decisions, for financial reporting, and for compliance with laws.
Modern accounting systems implement double entry accounting methods with
Double-Entry Accounting
Methods Features:
1. Debit and Credit Analysis 2. Chart of Accounts
3. Standard Journal Vouchers
A document used to record a standard journal entry. It shows the proper accounting entry for a common
transaction and minimizes the likelihood of recording the transaction incorrectly.)
4. Trial Balance
Characteristics of a
Well-Designed Chart of Accounts:
1. Responds to organization needs. Account included in a chart of
Characteristics of a
Well-Designed Chart of Accounts:
2. Facilitates report preparation. Account in the chart of accounts should be listed in their order of appearance in the financial
Characteristics of a
Well-Designed Chart of Accounts:
3. Provides adequate description. A description of each account and its contents should be provided. This guidance to the accounting staff enables consistent use of the
Characteristics of a
Well-Designed Chart of Accounts:
4. Account titles provide clear
distinctions. Account titles should be chosen to minimize ambiguities
concerning the contents of an account.
5. Control accounts. When cost-effective, the chart of accounts
MONITORING
It is a process that assess the quality of internal control performance over time. Monitoring can be done in two ways: 1. Ongoing Monitoring Activities.
Monitoring Activities
Check Example
Clerical checks A shop worker fills out a materials
requisition. The shop supervisor reviews it before signing it.
Reconciliations A shop supervisor examines the sequence of completed materials requisitions to
ensure that non are missing, Comparison of assets
Monitoring Activities
Check Example
Computer-programmed
controls A computer program checks calculations on a materials requisition after the data is entered into the computer.
Management review of
accounts A factory manager investigates the cause of an excessive materials quantity variance.
User review of
QUESTION A
1. Which three categories of objectives do accountants recognize for internal control?
2. Which features of a double-entry
accounting system prevent and detect errors and irregularities?
QUESTION B
1. What is internal control?
2. Identify seven factors that affect an organization’s control environment. 3. What is a standard journal voucher?
QUESTION C
1. What are the two threats to accurate and reliable accounting data?
Describe and distinguish between them.
2. What are the components of internal control?
QUESTION D
1. What is meant by the following statement: “Internal control policies and procedures are intended to provide reasonable but not absolute assurance that management’s
objectives are attained”?
2. Which kinds of errors and irregularities can occur even in an organization having good internal control?
