Internal control techniques
In the management of firms, internal controls suffice for purposes of ensuring efficiencies and effectiveness in the execution of managerial duties. Internal controls could be employed to ensure that the accounting policies and financial reporting standards are complied with. Internal control refers to the framework that the management employs for the smooth running of the company. It should be noted that such controls emanate internally within the firm. The paper briefly discusses some internal control techniques employed by management regarding financial reporting. The objective is to ensure financial reporting is precise, accurate and provides a true and fair representation of the company state of affairs.
Internal Control Techniques
The internal control techniques employed vary and range depending on the circumstances and the business environment. However, two popularly used techniques are the preventive controls and the detective controls. Preventive controls essentially deter the occurrence of fraud, errors and anomalies by limiting the chances of fraud and error. Preventive controls incorporate the rationale in the fraud triangle that attributes occurrence of fraud to three main factors; financial pressure or motivation, opportunity and the employee rationale. It should be appreciated that preventive controls intend to prevent fraud or error in financial reporting to occur. Prevention is achieved through a number of ways. In the ideal business environment, prevention can best be achieved through proper supervision of the execution process. However, absolute supervision is practically impossible to do. The related costs, required resources and time needed in the supervision of work makes it economically unattainable.
Consequently, managerial and auditing practices have come up with practical and applicable prevention control mechanisms. This includes segregation of duties and authorization mechanisms. In segregation of duties, the company duties are spread in the way that a chain of activities involved in the reporting process is not fully performed by one individual. This ensures the process involves a number of people ensuring at step who are segregated from the others performing the prior or following step. This preventive practice is informed by the fact that inherent frauds and mistakes would likely be identified and noticed when more people are involved in the process. Fraud and error is less likely to occur as compared to approaches where an entire process is left at the charge of one individual or a few members in a group. Segregation of duties also involves rotation of staff and personnel regularly from one department to another. Rotation dispenses with the employee chances of performing fraud. The rationale is that the employee should not spend excess time in one department in a way that would expose him to too much information about that department.
In addition, the objective could be in the intention to bring to the attention of the new personnel and possibly the management any anomalies previously performed by the old personnel. Rotation as a preventive control would be applicable only in areas where the division of labour is not highly specialized. In such set ups, the pool personnel is general and any person can be placed anywhere. In areas where the specialization and technicalities involved are limited to specific personnel, the concept of rotation cannot be used. Segregation could also be perceived in light of the requirement of collective action by personnel in the execution of some activities. Some instances exist where execution of an activity require the presence of personnel from different departments. In such instances, the rationale usually lies in the desire to prevent possible abuse of the process by the employees derived from one department.
In addition to segregation, another common preventive mechanism is authorization. The concept of authorization lies in the need to control the scope and powers of personnel. Consequently, management lay framework that delegate powers and duties to personnel based on their abilities and qualifications. The framework outlines the scope of personnel. To prevent abuse of company processes, employees would be required to seek authorization before execution of policies and making decisions. Authority would be vested on their immediate superiors. Superiors would also be answerable to another set of personnel. The chain of authorization is hierarchical in nature. The concept of authorization vests an amount of authority on specific office holders. The office holders would be liable and answerable to the management for any anomalies that occur within their jurisdictions. In that token, they are required to authorize all transactions within their department.
A suitable example of how the concept of authorization works as a preventive mechanism could be in the signing of the company cheques. Ordinarily, company cheques usually require three signatories. The management could appoint the managing director, the financial manager and the chief accountant as the three signatories. The impact of such an election is that the authority of signing of cheques vests on the three office holders. It would, therefore, be only the three who can discharge the function. This would preventive the occurrence of fraud by say a rogue cashier accessing the company cheque book and writing a cheque to himself. The acquisition of the three signatories’ signatures would be a tall order.
Preventive controls can also be supported by detective controls. The difference between the two lie in the fact the former identifies possible fraud or error and prevents it while the latter detect an error or fraud after it has been committed. Detective controls are appreciated for their accuracy and precise nature. An example of a detective mechanism is the need for reconciliations. Reconciliations in financial reporting play an important role in ensuring that transactions are free of any errors and fraud. The inability to reconcile transactions with the eventual outcome serves as a pointer of possible fraud. In financial reporting any failure to reconcile raises the need for suspense accounts. In auditing, a suspense account is usually treated with professional scepticism.
Advantages and disadvantages of the internal control techniques
Preventive controls provide a framework for elimination of possible fraud and eras. These controls tighten and strengthen implementation and application of accounting standards making the misuse of company resources almost impossible. The detective controls help in the identification of fraud and eras. Detection essentially helps bring to the attention of the employer and the management possible areas of frauds and accounting anomalies.
On the other hand, it should be appreciated that implementation of controls increases the overall company expenses. For example, the need to segregate duties in the workplace comes with the additional costs of paying to parties instead of an initially planned one person. In addition, practices such as rotation do not allow employee enough time to specialize and work innovatively. No wonder rotation as a control mechanism is limited to general departments where specialization is unnecessary.
References
Hightower, R. (2008). Internal Controls Policies and Procedures. New York: John Wiley & Sons.
Moeller, R. (2008). Sarbanes-Oxley Internal Controls: Effective Auditing with AS5, CobiT, and ITIL. New York: John Wiley & Sons.
Schaeffer, M. S. (2007). Accounts Payable and Sarbanes-Oxley: Strengthening Your Internal Controls. New York: John Wiley & Sons.
Tarantino, A. (2010). Financial Internal Controls Best Practices. New York: John Wiley and Sons.
