Auditing Essentials: Internal Control, Internal Check, and Internal Audit Demystified

Internal Control meaning and objectives 

Internal Control is broad term with wide coverage. It means a number of checks and controls exercised in a business to ensure its efficient and economic working. This internal control involves a sort of vigilance and direction over important matter like Budget, Finance, Purchase and Sales & Internal administration by the management.

Internal control is best regarded as indicating the whole system of controls, financial and otherwise, established by management in the conduct of a business including internal check, internal audit and other form of control.

Meaning of Internal control

A system created, implemented, and maintained by the company's management and top executives is known as internal control. Its purpose is to provide a high level of assurance in the achievement of business objectives while adhering to policies and laws, protecting assets, maintaining efficiency and effectiveness in daily operations, and ensuring the accuracy of financial statements.

As per W.W. Bigg, “Internal control is best regarded as indicating the whole system of controls, financial and otherwise, established by the management in the conduct of a business, including internal check, internal audit and other forms of control.”

1. Internal Control system is one of the basic and essential factors for efficient and effective management. It covers the whole management system of an organization, both financial and non-financial.
2. Internal Control comprises of the plan of the organization and all the coordinate methods and measures adopted within a business to safeguard its assets.
3. It is the overall control adopted by the management.
4. It comprises of internal check, internal audit, accounting system and administrative control.
5. Internal control system is helpful for the management and also the Auditor in achieving goals and targets effectively.

Objectives of Internal Control System

1. To make sure that commercial transactions follow the management's broad and detailed authorizations.
2. To assess the accounting system for full transaction authorisation.
3. To examine how the company operates, identify any operational gaps, and take the required action to close them. 
4. To make sure that the company's resources namely, its people, materials, machines, and money are used as effectively as possible. 
5. To determine whether the financial statements are consistent with the principles and concepts of accounting.

Internal control elements

Both internal audit and internal are two important elements of a system of internal control and as such, both are complementary and go together.

Every business organisation is expected to have a properly developed system of internal control which may include accounts control, standard of cost control, budgetary control, periodic operating reports, statistical analysis, personnel training program and an internal audit staff. It may also include other activities such as time & motion study and quality controls though inspection. Various other forms of administrative check & control are also included in the internal control system.

Division of internal control

This each division must be considered by management when planning the allocation and distribution of work among its employee.

1. Financial Control – Financial control includes a proper efficient system of accounting, adequate supervision, recording and duplicating system, good efficient staff and maintenance of staff relationship.
2. Cash Control – Cash control includes certain important aspect of control for receipts payment and balance held. A proper system of internal check must operate at all stages.
3. Employee’s Remuneration – Employee’s remuneration this system covers all sections of employee’s remuneration and maintenance of records for remuneration. There preparation and their method of payments should be brought under tight control. There preparation and their method of payments should be brought under tight control.
4. Stock Maintenance – In this system stock of raw material, work in progress, finished good should be properly maintained and accounted for. The flow of goods from outside to the store and then from store to processing unit, should be made under an efficient control and supervision. The task and responsibility connected therewith should be clearly defined and fully allocated.
5. Trading Transactions - Trading transaction includes purchase, sales etc. in purchasing effective procedure should be laid down for acquisition, handling of goods and for accounting technique adopted for such goods.

Internal Control Principles

The physical handing of an asset should be separated from accounting work which should be done by a separate hand. Work should be so divided between persons that the work done by one is checked by another.

Scope or Area of internal control

1. Accounting Controls: These comprise primarily the plan of organization and the records that are concerned with and directly related to the safeguarding of assets and reliability of financial records. These include budgeting control, standard costing, control accounts, bank reconciliation, self-balancing ledgers and internal auditing etc. 
2. Administrative Controls: These comprise the plan of organization that are concerned mainly with operational efficiency. They may include controls, such as time and motion studies, quality controls through inspection, performance reports and statistical analysis. It is concerned with distribution of authority and decision-making process of management.

Essentials of Good internal Control

1. It should be clear and well-developed plan of organization.
2. There should be competent and trust worthy personnel for the success of the business.
3. There should be segregation of duties: - Operational duties are separated from recording duties. Physical handling of asset must be separated from accounting records.
4. There should be administrative traditions and practices for the performance of the duties.
5. There should be well developed and adequate accounting system.
6. There should be a sound system of maintenance and recording of accounts.
7. There should be effective internal check system.

Internal Control Questionnaire

Is a series of questions which are prepared by the auditor to test the adequacy or otherwise of the system of internal control adopted in an organization? Such a questionnaire can be used by auditor for all clients, but it varies according to the requirement of each client. If the answer is positive then the system of control would be satisfactory, if the answer being negative, the system would be presumed to be inadequate.

Internal Check

Internal check means practically a continuous internal audit carried on by the staff itself by means of which the work of each individual is independently checked by other member of the staff.

The work connected with the preparation and maintenance of account is distributed among the various member of the staff in accordance with their qualification, experience.

Example – one person enters transactions in the books, while other person perform task relating to posting, handling cash and entering cash transaction into cash book.

Reason – if only one person is made responsible to finish up a particular work from beginning to the end, there is scope for errors and frauds.

1. Internal Check is a valuable part of Internal Control. It is the built-in check in accounting process itself. 
2. It is an arrangement of duties of staff members in such a way that the work performed by one person is automatically checked by the other. 
3. It is an essential feature that no one employee or a group of employees has exclusive control over any transactions or group of transactions. 
4. It helps in minimizing the possibility of fraud, error or irregularity.

Definition of internal check

1. As per Dicksee, “Internal check may be defined as such an arrangement of the accounting routine that errors and fraud are automatically prevented or discovered by the very operation of the book-keeping.”
2. As per De Paula, “An Internal check means practically a continuous internal audit carried on by the staff itself, by means of which the work of each individual is independently checked by other members of the staff.”
3. According to ICAI “It is a system of allocation of responsibility, division of work and, method of recording transactions whereby the work of an employee or group of employees is continuously by correlating it with the work of others.”

Internal check is based on the principle of division of labour. If the system of internal check is good and efficient, the possibility of error and fraud will be minimum. For example – Big business, number of worker large, 6 clerks are needed to maintain records of their attendance, their wage sheet & to make payment of wages. (2 Options)

1. 1/3rd of work connected with all the three portions of work performed by 2 clerks.
2. 2 clerks maintain attendance, 2 clerk – Wage sheet, 2 Clerk – Payment.

Characteristics of Internal Check

1. To eliminate the frauds and errors which may be committed by the staffs. 
2. To prevent misappropriation of cash or stock. 
3. To ensure the reliability of information produced by the accounting system.
4. To detect errors and frauds promptly which helps to minimize their effects in long term. 
5. To exercise moral pressure over the staffs.
6. To allocate duties and responsibilities of every person in such a way that he can be taken to task for any lapse on his part.
7. To increase overall efficiency of the members of the staff by assigning duties based on the principle of division of labour.

Objective of Internal Check

1. To minimise the possibility of error or fraud or irregularities.
2. To allocate duties and responsibility of every clerk in such a way that he may be held responsible for particular error and fraud.
3. To detect error or fraud easily, if it is committed as in an efficient system of internal check there is a provision for independence checking.

Advantages & Disadvantages of Internal Check

Advantage of internal check

1. It helps in fixing the responsibility as there will be proper segregation of duties among the staff. 
2. A good system of internal clerk increases the efficiency of work in a business as the clerk do their job carefully and consciously
3. It helps in the detection and discovery of error and fraud
4. It helps in preventing errors and frauds. 
5. There is a reliability of the information due to efficient system of Internal Check. 
6. It reduces the workload of auditor. If there is good & efficient system of internal check, the auditor may rely upon it and may not feel the necessity of making detailed checking of the accounts.

Disadvantage of internal check

1. It is a costly process for a small-scale business.
2. It requires proper planning, if the whole system is not properly planned and organised it make create chaos and disorder in the working of a business.
3. There may be situation of compromise while giving importance to faster results. 
4. There are chances of conflicts in business due to detection of error or frauds.

Internal Audit

Internal audit is an independent, consulting activity designed to add value and improve an organization’s operations. Internal audit, a batch of employees known as internal auditors is engaged to check the records of day-to-day transaction. 

1. It is the review of operations and records undertaken by a specially assigned staff on a continuous basis. 
2. It is an important element of the internal control system. 
3. It not only focussed purely on finance but also reviews and undertakes a critical appraisal of companies’ policies and procedures.
4. It is focussed in maximizing organisational effectiveness. 
5. It evaluates companies’ internal controls along with its corporate governance and accounting processes.

Basic principle of Internal Check

The work should be allocated among various clerk such that their duty, responsibility and rights maybe clearly and judicially divided. No single person is allowed to do a job only by himself from beginning to the end. The work of each individual is independently checked by other member of the staff.

Definition of Internal Audit

1. According to W.B. Meegs, “Internal Auditing consists of a continuous, critical review of financial and operating activities by a staff of auditor functioning as full-time salaries employees.” 
2. According to H.F. Stetter, “Internal audit is the audit of company affairs and activities from within.”

Objectives of Internal Audit

1. To verify the correctness, accuracy and authenticity of the financial accounting and statistical records presented to the management. 
2. To comment on the effectiveness of the internal control system and the internal check system in force and to suggest means to improve them.
3. To facilitate the early detection and prevention of frauds.
4. To ensure that the standard accounting practices to be followed by the organization are strictly followed.
5. To confirm that the liabilities have been incurred by the organization in respect of its legitimate activities.
6. To examine the protection provided to assets and the uses to which they are put

Internal Check & Internal Audit

Internal audit and internal check are two important elements of system of internal control and both go together and complement each other.

Difference Between Internal Check, Internal audit and Internal control

INTERNAL CHECK	INTERNAL AUDIT	INTERNAL CONTROL
It is the management of accounting work under which the work of one person comes under another.	Continuous review of records by staff appointed for the purpose	It is the whole system of control established by management
Scope of internal check is less	Scope of internal audit is less that of internal control wider than internal check.	Scope of internal control is very wide. It includes internal checks and internal audit
Objective is to be locate errors and frauds	The object of internal audit is to assure the management that the system of internal control and internal check in operation are in effective in design and operation	The objective is to safeguard the asset of enterprise
There is no separate staff	It is conducted by the staff specially appointed for the purpose called as internal auditor.	There is no separate staff.
Internal check is exercised when the work of employee is in progress	It is undertaken by the auditor after the work has been completed	Internal control is exercised when the work of employees in progress
Any organization can adopt internal check	Internal audit is adopted only those concerns which really need it	Any organization can adopt internal control

FAQ's

What is Internal Audit?

Internal Audit is an independent and objective evaluation of an organization’s internal controls, risk management, and governance processes. It is performed by internal auditors within the organization.

What is Internal Check?

Internal Check is a part of internal control, where the work of one person is automatically verified by another as part of routine operations. It's designed to prevent and detect errors and fraud at the point of occurrence.

 

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