Internal Control

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Internal Control Definition

A process, effected by the entity’s board

of directors, management and other

personnel, designed to provide reasonable

assurance regarding the achievement of

objectives.

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3. Compliance with laws and regulations

2. Efficiency and effectiveness of operations

1. Reliability of financial reporting

Internal Control Objectives

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Five Components of Internal Control

Riskassessment

Controlactivities

Information andcommunication

Monitoring

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The Control Environment

Integrity and ethical values

Commitment to competence

Board of directors or auditcommittee participation

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The Control Environment

Management’s philosophy and operating style

Organizational structure

Human resource policies and practices

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Risk Assessment

Identify factors that may increase risk

Assess the likelihood of the risk occurring

Determine actions necessary to manage the risk

Estimate the significance of the risk

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Control Activities

1. Adequate separation of duties

2. Proper authorization of transactions and activities

3. Adequate documents and records

4. Physical control over assets and records

5. Independent checks on performance

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Adequate Separation of Duties

Custody of assets Accounting

Authorizationof transactions

The custody ofrelated assets

Operationalresponsibility

Record-keepingresponsibility

IT duties User departments

from

from

from

from

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Proper Authorization of Transactions and Activities General authorization

Specific authorization

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Adequate Documents and Records

Prenumbered consecutively

Prepared at the time of transaction

Designed for multiple use

Constructed to encourage correct preparation

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Physical Control Over Assetsand Records

The most important type of protectivemeasure for safeguarding assets andrecords is the use of physical precautions.

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Independent Checks on Performance

The need for independent checks arisesbecause internal control tends to changeover time unless there is a mechanismfor frequent review.

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Information and Communication

The purpose of an accounting informationand communication system is to…

initiate, record, process, and reportthe entity’s transactions and to maintainaccountability for the related assets.

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Monitoring

Monitoring activities deal with management’songoing and periodic assessment of thequality of internal control performance…

to determine whether controls are operatingas intended and modified when needed.

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Methods Used to Document Understanding

Narrative

FlowchartInternalcontrol

questionnaire

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Evaluating Internal Control Operation

Update and evaluate auditor’s previousexperience with the entity

Make inquiries of client personnel

Examine documents and records

Observe entity activities and operations

Perform walk-throughs of the accounting system

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Evaluating Significant Control Deficiencies

MaterialWeakness

LIKELIHOOD

SIGNIFICANCE

Material

Immaterial

ProbableRemote

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Identify Deficiencies and Weakness

Identify existing controls

Identify the absence of key controls

Consider the possibility of compensating controls

Decide whether there is a significant deficiencyor material weakness

Determine potential misstatements that could result

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Communications

Internal audit reports

Communications to thosecharged with governance

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Tests of Controls

The procedures to test effectiveness of controlsin support of a reduced assessed controlrisk are called tests of controls.

End of Chapter