Principles Of The Internal Control System

In this tutorial, we will learn about the principles of the internal control system of the concepts that require management to set procedures in place to ensure company assets are safeguarded.

In other words, these are the principles management uses to establish the ways to protect company assets.

The main principles of the internal control system:

Establishment Responsibilities.
Maintain Records.
Ensure Assets by bonding key employees.
Segregate duties.
Mandatory employee rotation.
Split related party responsibility.
Use technological controls.
Perform regular independent reviews.

Specific organizational devices are considered as necessary as fundamental principles of the internal control system. It is to note that:

Practically the physical handling of an asset should separate from the accounting work, which should be done by a separate hand. The conclusion between a person handling an asset and other performing accounting work in relation there should be avoided.
The work should divide between persons that another checks the work done by one.

Thus, the result expected from the work done and check can form a basis for the reliability of records and reports maintained in the business. This practice is sound in the sense that one does can be compared well with the results obtained by another.

It is a list of the most common and influential ones. These principles are the basis by which management uses to create and implement the internal controls it establishes. In other words, these are the basic ideas of authorities. They are not controls in and others themselves. Management must take these ideas and apply them to their specific business. For example:

Segregation of duties is one of the most recognizable and standard controls in most organizations so that we will look at that one. It’s an excellent control to make sure that the recording and record-keeping functions are separate from the actual handling of cash.

It is why the cashier is in charge of collecting cash from customers and the possibility of delivering it to the bank deposit box. The bookkeeper or the accounting department is in the cost of recording the cash receipts and doing bank reconciliations.

This way, one person can’t take the money from the customer, embezzle it, and cover up the thief with fraudulent bookkeeping. If two people perform these jobs, the only way fraud will be able to work if each person is in cooperation with the other. Two colluding employees are far less likely than a single employee stealing.

It is just one example of how the segregation of duties principle can apply to a company’s internal control procedures.

It is the process designed to ensure reliable financial reporting, effective and efficient operations, and compliance with applicable laws and regulations. Safeguarding assets against theft and unauthorized use, acquisition, or disposal is also part of internal control. The management style and the expectations of upper‐level managers, particularly their control policies, determine the control environment.

An active control environment helps ensure that established policies and procedures follow. The control environment includes management’s integrity, ethical values, and philosophy, a defined organizational structure with competent and trustworthy employees, and the assignment of authority and responsibility.

Tools Of Auditing

In this tutorial, we will learn about tools of auditing like audit plan, program, evidence, and working papers, which used to support the audit work done.

Auditors use various tools such as audit plans, audit programs, etc. for carrying out an audit. An audit plan lays down the strategies followed for carrying out an inspection. After preparing an audit plan auditor will make an audit program that contains the instructions to be followed by the audit staff.

It helps auditors in proper supervision of the audit. While doing an inspection, the auditor has to collect evidence in support of his opinion. The audit evidence provides ground for providing support for a fact or a point in question. Audit working papers used to support the audit work done to assure that the relevant auditing standards performed the audit.

‘It is an independent audit of the work and all the contracting issues to determine whether existing procedures complied with and whether there should be any changes in those procedures.’ ‘JOHN MULLEN’

An audit plan lays out the strategies followed in conducting an audit. It includes the nature timing and extent of audit procedures to be performed by the engagement team members. The auditor shall develop an audit plan while considering the following:

In the nature timing and extent of planned risk assessment procedures.
In the nature timing and extent of audit procedures at the assertion level.
Other planned audit procedures are required carried out so that the engagement complies with standards on auditing (SAS).

The collection of accurate and comprehensive data is one of the critical factors for an effective audit. Data for inspection can be collected through surveys, questionnaires, interviews, focus groups, and direct observations. There are differences in the way these methods can be applied depending on the type of audit and the nature and sources of data.

Tools of auditing are as given below:

Surveys:

It helps in collecting information on five variables.

Background data (i.e., Age, Education, Income, etc.)

Behavioral data (i.e., Buying habits, etc.)

Data on attitudes and beliefs.

Data on opinions.

Data knowledge of company programs.

Types of surveys:

Written Survey:

It has the lowest response rate. The data is unreliable.

Telephone survey:

It is a fast means of collecting data.

Limitation of surveys:

A survey imposes on the respondents, the structure and standards of relevant of the researcher.
Surveys assume that all people use the same language and interpret survey questions int the same way.
It usually reveals only superficial information that is complete.
The survey distorts the political reality of the organization, implying that all opinions are carrying equal weight.
The use of random samples in the survey approach assumes that the required information is distributed evenly through the organization and could lead the researcher to develop the distorted picture of the company.
The survey process itself affects the response depending on when and by whom the questions asked.
It assumes that peoples have opinions, but in reality, people may not disclose that they do not know. Or they do not have an idea.
It assumes a relationship between attitudes or opinions and behavior.

Questionnaires:

There are certain advantages to this method.
They serve as a guide for the interviewers.
They easily distributed to the respondents.
They serve as a preparation tool for the audit team.

Focus Groups:

This method serves another approach to data gathering. It allows the collection of more information and the involvement of more people than is possible in one-on-one interviews. A focus group may have five to ten personnel. The session may last for a couple of hours.

Successful and productive focus groups have skilled facilitators who are responsible for guiding the group and managing group dynamics, well-selected participants from a homogeneous group, and a useful moderator guide who targets the information required from the session. The facilitator manages the information flow between group members.

Interviews:

It is another method of collecting data on sensitive subjects. Here the skilled interviewers can establish a relationship of trust with the respondent. The audit team often uses meetings. Interviews are more suitable as most respondents enjoy talking rather than writing.

But interviews are among the most expensive research tools. Sometimes it is challenging to aggregate data gathered from interviews.

Direct Observation:

This method finds many applications to incorporate the environment, especially in the audit process. Various techniques are available under direct observation as follows.

Participant observation.
Field observation.
Trace data.
Archival data.

Important Factors To Be Considered While Obtaining Audit Evidence

In this tutorial, we will learn about important factors to consider while obtaining audit evidence to support observation than is required to support contextual information included in the report.

In the quality of the evidence, its relevance, reliability, and validity.
The level of materiality or the significance of the observation or conclusion in general, the higher level of importance or materiality, the higher standard that evidence will have to meet.
Whether an audit level of assurance or a review level of reliability is required, for example, a higher level of security is necessary for evidence to support observation than is needed to support contextual information included in the report.
The risk involved in making an incorrect observation or reaching an invalid conclusion an example, if any chance of legal action against the auditor results from reporting an inspection, the standard of evidence demanded will be high.
The cost of obtaining additional evidence relative to likely benefits in terms of supporting observation and conclusions as in most things, diminishing returns apply in gathering audit evidence at some point, incurring the cost of obtaining more evidence will not justify by changes in the persuasiveness of total body of evidence.

Techniques for obtaining evidence:

Inspection:

I was inspecting the documentary evidence like deed papers, certificates, etc. relating to the audit, whether in possession of the entity or the third parties.

Observation:

We are observing the process or procedure performed by others, like physical verification and counting of inventory.

Inquiry:

He was enquiring from the client his staff or third parties knowing a particular item or activity.

Confirmation:

Seeking information from a third party knowing a particular transaction. It involves checking the arithmetical accuracy of source documents and accounting records.

Analytical review procedures:

Analysis of significant ratios and trends for investigating unusual fluctuations and items.

Independent execution:

In this, the auditor performs the procedures and controls that initially performed as a part of the entity’s internal control system.

Working Papers:

Audit working papers are the documents prepared or obtained by the auditors and retained by him in connection with the audit. Audit working papers used to support the audit work done to assure that the inspection was the performance by the relevant auditing standards. Working papers include all the evidence gathered by an auditor indicating what he has done work and the procedures followed in verifying a particular asset or a liability and also provide information on whether:

The audit was planned correctly.
The audit was carried out
The audit was adequately supervised
The appropriate review was undertaken
The evidence is sufficient and appropriate to support the opinion.

Working papers are the connecting links between the client’s records and the audited accounts. These provide a permanent historical record. These also serve as an excellent guide to staff to whom the work of the audit has assigned.

Types of working papers:

The auditor’s working papers are divided into two parts:

Permanent file
Current file

PERMANENT AUDIT FILE

CURRENT AUDIT FILE

It consists of data which is of continuous use in current as well as subsequent audits

This file has:

● Articles of incorporation.

● Loan agreements.

● Leases.

● Audit observation of previous years.

● Notes regarding significant accounting policies.

● Documents related to understanding internal control.

● Others.

It consists of data that is relevant for the current period audit.

This file has:

●Working trial balance and worksheets.

● Audit program.

● Financial statements.

● Confirmation responses.

● Record of audit exceptions and their resolutions.

● Letter of attorneys and representation letters.

● Others

Advantages of maintenance of working papers:

The working paper helps in proper planning and performance of the audit.
Seniors can supervise the audit work performed by the juniors by examining their working papers.
It provides evidence of the audit work performed to support the auditor’s opinion.

Internal audit and its objectives

In this tutorial, we will learn about internal audits and its objectives; the management needs assurance of the authenticity of the financial records and the firm’s operations’ efficiency.

An internal audit is an evaluation and analysis of the business operation conducted by the internal audit staff. It is part of the overall system of internal control established in an organization.

Internal audit is the independent appraisal activity within an organization for the review of accounting, financial, and other business practices as protective and constructive arms of management. It is a type of control which functions by measuring and evaluating the effectiveness of a different kind of restrictions.

In big organizations, an internal audit is carried out by the team of professionals in the organization. Internal audits are not mandatory, but the organization gets the internal audit done to evaluate the effectiveness of internal control, soundness of the financial system, efficiency of business processes, etc. It provides management with assurance about the organization’s control process and aids in the early detection of inefficiencies or fraud.

OBJECTIVES OF INTERNAL AUDIT:

PROPER CONTROL:

An internal audit is to keep appropriate control over business activities. When there is adequate control, there is maximum efficiency. The internal monitor can determine the degree of control overwork.

ACCOUNTING SYSTEM:

The purpose of an internal audit is to evaluate the accounting system. It is concerned with checking proper authority for transactions like purchases, retirement, and fixed assets disposal. The voucher can be compared with the entries to determine those figures and facts.

HELP MANAGEMENT:

The purpose of internal audit is to help the management. Internal auditors can point out the weakness—the internal audit used as a tool for correcting the situation. The management functions can perform correctly.

WORKING REVIEW:

The purpose of an internal audit is to review the working of a business. The operation of the current year can be examined in detail. There is a need to locate the weak points. The corrective measures can be taken for proper working.

Fair Statements:

The purpose of an internal audit is to detect the error in the accounting records. The work of internal audit can help the management to see that the accounting record is in order.

Check Error:

The purpose of an internal audit is to detect the errors in the accounting records. If the internal auditor’s work goes side by side, there are minimum chances of mistakes.

Detect Fraud:

The purpose of internal audit is to detect fraud in the books of accounting. When the work of the accounting staff is over, the internal audit is started. Accounting staff remains alert because there is no time gap between recording and checking. Thus detection of fraud is possible with it.

Asset Protection:

An internal audit is to protect the assets. The proper records of assets must be there. The internal auditor can examine valuation, verification, and possession.

Internal Check:

The purpose of an internal audit is to evaluate the personal check. There is a division of duties among the employees. When all staff members are working correctly, it means there is an adequate internal check system.

Special Investigation:

The internal audit may be to conduct a special investigation about any business matter—internal audit used as a tool to note the effectiveness of management function.

Use Of Resources:

The purpose of an internal audit is to determine the proper use of resources. The misuse of funds can increase the cost of doing business. The appropriate use of resources means there is efficiency on the part of management.

Determine Liability:

The purpose of internal audit is to determine the liabilities of employees. The duties are divided among the staff; it is easy to note the negligence of the employees. The internal audit can pinpoint the personal responsibilities for carelessness.

Accounting Policies:

The purpose of an internal audit is to examine accounting policies. The understanding of the accounting system and procedure is helpful to device effective audit plans and procedures. The internal auditor may find any weakness in internal control.

Provide Suggestions:

The purpose of an internal audit is to provide suggestions for the improvement of business activities. The internal audit staff can suggest ways and means to remove the difficulties. Anyhow the internal auditor cannot compel the management to implement suggestions.

Help In Independent Audit:

The purpose of an internal audit is to help an independent review. The external auditor can rely on the internal auditor, and there is no need for cent percent checking. There is a saving of time and money due to internal audit.

New Ideas:

Internal audits aim to seek new ideas relating to procedures, marketing, financing, and other business matters. The internal audit staff can provide fresh insights into various business matters. The viable plans can put in practice for the benefit of the business.

Principal Aspects To Be Covered In Auditing

In this tutorial, we will learn about principal aspects to be covered in auditing. The auditor must check the arithmetical accuracy of the books of accounts by checking the proper posting.

The following aspects are required to be covered by an auditor while doing audits of any organization. The principle issues can also call as the function of auditing, and they are as follows:

Review Of System And Procedures:

A review of system and procedures is the primary function of auditing exercise. First, an auditor needs to understand the policy and processes adopted by the entity to further audit it.

Review Of Internal Control System:

A review of the internal control system is very important for the auditor. The internal control system’s effectiveness will determine the extent of checking to be done by the auditor. The compliance test and the substantive procedures performed by the auditor will evaluate the effectiveness of the internal control system. If the internal control system is effective, less checking is required, and vice versa.

An auditor needs to comment on the effectiveness of the internal control system in the organization, so the internal control review is necessary for carrying out the auditing exercise.

Routine Checking Or Arithmetical Accuracy:

The auditor must check the arithmetical accuracy of the books of accounts by reviewing the books’ proper post and balances accounts.

Accounting Principles:

Auditor has to ascertain whether proper distinction has been made between the item of capital and revenue nature and also whether the issue of income and expenditure of a particular period has adjusted in the books of accounts of that accounting period.

Books And Statements:

Auditor has to compare the balance sheet and the profit and loss accounts or other statements with the books of accounts and supporting vouchers to ascertain that the underlying records have made the final reports.

Verification Of Assets:

The auditor must physically inspect the assets and their recording in the books of accounts and verify the legal and official documents to ascertain the existence, obligation, completeness, valuation, and disclosures of an entity’s liabilities.

Accurate And Fair View:

The auditor has to decide whether the financial statement depicts the organization’s accurate and fair view of the state of affairs.

Statutory Compliance:

Auditor has to ensure that all the regulatory requirements have been compiled by the entity like provisions of the income tax act and other acts if the organization has compiled applicable.

Vouching:

Auditor has to inspect documentary evidence that supports and substantiates a transaction.

Reporting:

The auditor has to say to the authority appointing him for conducting audit whether financial statements of accounts examined reveal an accurate and fair view of the state of affairs and the profit and loss earned during the organization’s period.