1. (e.g. customers, investors) that transactions are recorded

1.   
Definition
of Internal Controls

Internal
controls are key processes and actions introduced by management into an
organization to ensure that objectives and goals are ultimately met. These
controls are designed to (1) conduct business in an effective and efficient
manner, (2) safeguard the company’s assets and resources, (3) prevent and
detect fraud and error, (4) ensure accuracy, completeness and integrity of accounting
data, (5) produce reliable and timely financial and management information, and
(6) ensure adherence to regulation, policies and procedures.

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2.   
Purpose
of Internal Controls

A system of internal control represents the
attitude of an organisation to ensure that sound management practices are
implemented to achieve the objectives of the organization. Internal controls
provide reasonable assurance to stakeholders (e.g. customers, investors) that
transactions are recorded completely, timely and in an effective and efficient
manner.

3.   
Role
of the Internal Auditor in Internal Controls

Internal
Audit is an independent and unbiased activity, and consequently they hold a
neutral position within an organization. It is managements’ role to design and implement appropriate
systems of internal control to identify and mitigate risks effectively and
efficiently. Internal audit’s role is to evaluate the adequacy and
effectiveness of those systems and processes across the organization (Ultimately,
the role of internal audit is to provide independent assurance to the board and
executives on whether the internal controls are working as intended and whether
there is adequate and effective governance and risk management processes.

4.   
Types
and Examples of Internal Controls

a.   
Preventative controls

These are
designed to prevent errors, inaccuracy or fraud before it occurs. They are
built into internal control systems in the initial design and implementation
stages. Examples of preventive controls are:

·        
Segregation
of Duties: Duties are segregated among different people to reduce the risk
of error or inappropriate action (like recording, approval and custody
functions).

·        
Physical
control over assets for protection – like locks on stock warehouses

·        
Security
cameras

·        
Using
passwords to restrict access to confidential data

·        
Shredding
documents with sensitive information 

 

b.   
Detective
Controls 

These are designed
to find irregularities in transactions after they have occurred. Examples of
detective controls are:

·        
Bank reconciliations (i.e. cash per
the bank account is reconciled to the cash per the company’s books).

·        
A security camera to detect
unauthorised activity

·        
Exception reports which list out of
kilter transactions

·        
Physical stock counts (i.e. stock is
physically counted and then compared to the inventory ledger)

·        
Petty cash counts

c.    Corrective controls

These are designed to fix errors that have occurred. Coupled with detective
controls that identify an anomaly, corrective controls are activated to see
what should be done to fix an error, and hopefully design a new control to
prevent recurrence of the error. Examples of Corrective controls are:

·        
Data
backups can be used to restore lost data in case of a fire or other disaster

·        
Insurance
is used to help replace damaged or stolen assets

·        
Management accounting reports can highlight
variances from budget to actual for management corrective action

·        
Enhanced training and awareness can be provided to
prevent future errors and irregularities

 

d.   
Directive controls

These are
actions taken to encourage the right behaviour so that a desirable event can occur.
They are generally of a guidance nature to employees and are broad in nature.
Examples of Directive Controls are:

·        
Policies
and procedures – sets compliance standards within the company to adhere to when
undertaking activities.

·        
Laws and
regulations enforce a company to adhere to certain standards that govern
ethical behaviour and good corporate governance.

·        
Training manuals
(provides ongoing guidance to employees on performing a task)

·        
Job
descriptions (e.g. sets roles and responsibilities with performance
expectations for employees)

·        
Meetings
(e.g. a morning meeting in a factory to discuss expectations and output for the
day)

5.   
Risk
Analysis

Business
must conduct and effective risk management process to proactively identify the
potential factors that may stop an organization from achieving its objectives
and to build mitigating controls to manage the associated exposure to risks. Risk
management is made up of two parts – one is the likelihood of something going
wrong and the other is dealing with the negative consequence that arises when a
risk manifests. It is managements’ responsibility to identify those risk
factors that may cause exposure to the organisation.

 

Risk
analysis represents the process that helps management identify and manage internal
and external problems that could undermine the achievement of key business
initiatives or projects. To perform a risk analysis, one must first identify
the possible threats (like financial loss, loss of people, operational
disruption, reputational issues etc.)  that the company faces, and then estimate the
likelihood that these threats will materialize and prepare adequate responses
to mitigate the risk. Risk analysis is useful in many situations:

·        
Project
management

·        
Health
and safety management

·        
Disaster
recovery and business continuity planning

·        
Responses
to changes in regulations

·        
Financial
management and overall sustainability

 

6    
A.
Internal Controls recommended for Inventory

·        
Inventory systems

·        
Two
common systems for managing the financial transactions of stock are the
periodic and perpetual systems. Periodic inventory systems update the
accounting ledger once a month or quarterly. A more efficient system is the
perpetual inventory system, which updates inventory after each purchase, sale
and adjustment. Inventory systems equips management with a better idea of
inventory cost and its effects on the balance sheet, which is an important part
of internal controls.

·        
Tracking

·        
Organizing
the inventory is a basic inventory internal control – this can be done by numbering
all locations, tag each inventory item, and track these items by location. Most
organisations use an identification system like barcodes to tag each
item so that it can be tracked. 

·        
Tag all
inventory including scrap which states the part number, description, unit of
measure, and quantity.

 

·        
Goods Ordering and Receiving

·        
Count all
incoming inventory to match the quantity stated on the delivery note is correct.
Count the inventory before recording it as being received. This keeps errors
from being introduced into the inventory records.

·        
Inspect
incoming inventory to verify accuracy of goods received as well as look for any
damages.  Damaged goods should be
returned, and the accounts payable staff notified by documents that the
returned items should not be paid for.

·        
Segregate
duties like ordering and payment process amongst multiple employees is also
important to avoid theft of stock.

 

·        
Storage and Security

·        
Stock
warehouses and distribution centres must be under lock and key with only
authorised personnel having access.

·        
All
deliveries from suppliers must be counted and tagged before they go into
inventory so that discrepancies between deliveries and purchase orders are
immediately remedied.

·        
Periodic cycle
counts of sections of inventory must be conducted to pick up any discrepancies and to investigate
and correct any errors found. This gradually improves the inventory record
accuracy

·        
Safety
for employees is also key in the warehouse – storage space must be adequate and
safe to accommodate pallets and forklifts and to avoid injury or damage.

 

·        
Goods issuing

·        
When an
item is removed from the warehouse, companies must have a standard procedure
for recording the picks as soon as they leave the warehouse.

·        
The
person removing the inventory must sign for the removal, so that there is a
record of who is responsible should the item go amiss.

 

 

·        
Review obsolete stock

·        
Conduct a
periodic obsolete inventory review. The warehouse can fill up with obsolete
inventory that cannot be used, which causes high storage costs and can disrupt
the production process. Analyse inventory records to determine which items
should be sold off or otherwise eliminated.

·        
Audits

·        
Periodic independent
audits of bills of materials, negative balances in inventory and obsolete stock
will assist in providing assurance that the above controls are working as
intended.

 

6.   
B.
Internal Controls recommended for Cash

·        
Safeguarding assets – Companies must protect the
physical cash and the people handling the cash

o   
Physical
access shall be restricted to authorized personnel.

o   
Combinations
and passwords should be given to as few people as is necessary.

o   
Combinations
and passwords should be changed periodically, at least annually, or when
someone leaves the department.

o   
Conduct
the proper background checks on prospective cash handlers.

o   
Lock
cash in a secure location like a safe or locked storage facility.

o   
Minimize
the amount of funds held overnight.

o   
Use
a buddy system when taking funds from one location to another.

o   
Count
cash discretely, not easily visible to others.

·        
Segregation of duties – The following cash handling duties
should be performed by multiple people so that no one person has control over
the entire cash handling process. Separating the cash handling duties among
different people will reduce errors, minimize fraudulent activity and increase
the chance of detecting errors.

o   
Receive
cash

o   
Disburse
cash amounts for petty cash floats

o   
Record
cash transactions

o   
Prepare
bank deposit slip, (preparer and reviewer)

o   
Make
the physical deposit at the bank

o   
Reconcile
cash receipts to daily sales reports

o   
Investigate
and remediate discrepancies noted from reviews and reconciliations.

·        
Accountability – Cash accountability ensures that cash
transactions are authorized, properly accounted for, documented and
identifiable to specific cash handlers

This will help determine:

Who has access to cash
Why they have access to cash
Where cash is at all times
What has occurred from the transaction’s
beginning to end

Cash accountability controls are to

Record cash receipts when received.
Keep funds secure at all time.
Document transfers used when cash is moved.
Don’t share passwords.
Cash handling staff must have own storage
devices
Supervisors verify cash deposits and approve
all refunds.

·        
Reconciliations – In order to ensure all
transactions have been recorded correctly, (completely and accurately), several
reconciliations should occur on a timely basis.

·        
Compare
receipts to deposit records.

·        
Record
cash receipts when received.

·        
Count
and balance cash receipts daily.

·        
Perform
periodic surprise cash counts.

·        
The
Finance Department is responsible for preparing and approving monthly bank
reconciliations and reviewing outstanding deposits to ensure timely clearing

·        
Monitoring – regularly review processes to tighten
controls, train staff, and investigate unusual activity. The following reviews
should be done on a regular basis:

·        
Review
cash shortages and investigate discrepancies

·        
Analyze
sales forecasts and budgets to actual sales and investigate variances (and
margins where applicable)

·        
Review
cash receipts ledger for unusual items or unapproved changes

·        
Review
and approve returns, refunds and void transaction logs

·        
Review
system security access

·        
Train
and monitor new staff and provide continual training to existing staff on a
regular basis, i.e. at least annually

·        
Provide
customer statements on a regular basis

6.   
C.
Internal Controls recommended for Tangible Assets

·        
Policies and Procedures

o   Policies and procedures for acquisitions, transfers
and disposals of fixed assets should be established.  Fixed assets’ useful
lives should be clearly defined and be consistent with the company’s fixed
assets policies.

·        
Fixed
Assets Register

o   An up-to-date Fixed Assets Register must be maintained
showing the following:

–     Cost of asset

–     Asset useful life or depreciation rate

–     Location

–     Current and accumulated depreciation rate

–     Net book value

o   As far as possible all tangible fixed assets should
be tagged to permit easy identification.

o   Accuracy of the register should be verified through
periodic physical fixed assets counts and confirmations with custodians.

·        
Adjustments:

o   All adjustments to the Fixed Assets Register should be
authorised by the Finance Manager/Accountant after sufficient investigation.

o   Land, buildings should be revalued by an independent
appraiser periodically.

o   There should be adequate insurance coverage policy
for fixed assets.

·        
Fixed Assets Movements

o   All fixed asset movements should be approved in
accordance with the authority limits
and a fixed asset transfer form must be completed and acknowledged by
the receiving department for all permanent transfer of fixed assets.

·        
Fixed
Assets Acquisition

o   Additions to fixed assets should be approved in
accordance with the authority limits.

·        
Fixed
Assets Disposal

o   Fixed assets disposals should be authorised in
accordance with the authority limits.

·        
Reconciliation

o   Fixed Assets Register should be reconciled to the
GL on a monthly basis.

·        
Segregation
of duties

o   There should be segregation of responsibilities
between the following functions:

·        
Fixed
assets custodians

·        
Approving
authorities for fixed assets movement

·        
Maintenance
of fixed assets account

·        
Fixed
assets verification

·        
Fixed
Assets Count

o   Physical fixed assets at all locations should be
counted and checked against book records at least annually.

o   Differences between fixed assets counts and book
records should be investigated thoroughly before adjustments are approved and
made to the books. 

·        
Delegation
of Authority (DOA)

o   Appropriate delegation of authority must exist for
fixed assets management and it must cover acquisitions, transfers and disposals
as well as fixed assets write off

 

6.   
D.
Internal Controls recommended for Debtors

·        
Policy

o  
The
business should have adequate policies and procedures on credit and collection procedures,
to ensure that all staff understand the accounts receivable process.

·        
Segregation of Duties

o   Different people must deal with invoicing, accounts
receivable, cash collection, and the review and reconciliation of accounting
records.

·        
Invoice Generation to Customer

o   Check purchase order prices, terms, and conditions.

o   Check authorization levels for order approval.

o   Check the credit rating, limits and address of the
customer.

o   Prepare the sales order with details per the
purchase order and stamp the sales order as approved.

o   Check the accuracy of invoice calculations.

o   Independently review customer complaints about
invoices.

o   Separate the invoicing function from the cash
collection function.

o   Reconcile the goods dispatched to the customer to
the quantities shown on the sales invoice.

·        
Sales Journal and Accounts Receivable ledger

o   Post the sales journal from a copy invoice as soon as the
transaction occurs, and file the invoices by invoice number

o   Use the sales journal totals to post the accounts receivable control
account in
the general ledger.

o   Separate the accounts receivable function and cash
collection function.

o   Carry out random spot checks on customer trading
activity and check for signs of unusual activity.

o   Review credit balances on accounts receivable
accounts.

o   Produce an aged accounts receivable report and
review the balances, particularly on large and overdue accounts.

o   Have a strict credit control procedure for
collecting outstanding accounts receivable.

o   Review all journal entries made to the accounts
receivable ledger accounts for appropriateness and approvals.

o   Check cash settlements discounts given to
customers. Approval limits must be in place.

o   Reconcile the accounts receivable ledger with the
accounts receivable control account in the general ledger.

o   Review delinquent accounts and ensure that they are
precluded from receiving additional credit

 

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