INTERNAL CONTROL AND INTERNAL CHECK

1.0 INTRODUCTION

In this unit, you shall learn the relevance of internal control and internal control system in an organisation. The objectives, essential features and components of internal control will be considered.
You shall also be able to distinguish between internal control and internal check, and explain the relationship, differences and areas of cooperation between the internal and external auditors.
Before the end of the unit, you shall also be able to highlight internal control in specific areas of a business and its limitations.

MUST READ: B

1. Classification of audit
2. Fraud and errors
3. Internal control and internal check
4. Introducing cooperative auditing
5. Overview of auditing
6. Procedures for auditing transactions ii – current assets (cash, debtors and stock)
7. Procedures for auditing transactions iii – liability verification

2.0 OBJECTIVES

At the end of this unit, you should be able to:

1. define internal control and internal control system
2. list the objectives and describe the essential features of internalcontrol
3. identify the components of internal control
4. distinguish between internal control and internal check
5. describe internal control in specific areas of business
6. state the limitations of internal control.

3.0 MAIN CONTENT

3.1 Internal Control

Internal control system means the whole system of controls, financial and otherwise, established by the management in order to carry on the business of the enterprise in an orderly and efficient manner, ensure adherence to management policies, safeguard the assets and secure, as far as possible, the completeness and accuracy of the records.
Also, the American Institute of Certified Public Accountants defines internal control thus.
Internal control comprises the plan of an organisation and all of the coordinated methods and measures adopted within a business to safeguard assets, check accuracy and reliability of its accounting data, promote operational efficiency and encourage adherence to the prescribed managerial policies.
The individual components of an internal control system are known as “controls” or “internal control”

.1.1 Objectives of Internal Control

The objectives of internal control are as follows.

1.  To ensure adherence to management policies.
2.  To safeguard the company’s assets.
3. To ensure accurate and reliable records.

At an early stage of his work, the external auditor will have to decide the extent to which he wishes to rely on the internal controls of the enterprise.
As the audit proceeds, that decision will be subject to review, and depending on the result of his examination, he may decide whether or not to place reliance (less or much) on these controls.

3.1.2 Essential Features of Internal Control

There are three features, namely:
(a) authorisation (the initiation of a contractual obligations).
(b) custody (the handling of assets involved in the transactions). (c) recording (the creation of documentary evidence of the
transactions and its entry in the accounting records).
The essence of internal control lies in the separation of the three functions mentioned above, which represent the objectives of control in any departmental context.

SELF-ASSESSMENT EXERCISE 1

Define internal control.

3.1.3 Components of Internal Control

The basic components of internal controls are:

1.  internal check (segregation).
2. b) internal audit.
3.  physical control.

3.2 Internal Check

This aspect of internal control is exclusively concerned with the prevention and early detection of omissions, errors and fraud. Itinvolves the arrangement of bookkeeping and other clerical duties in such a way to ensure that:

1.  no single task is executed from the beginning to the end by oneperson only.
2.  the work of each clerk engaged upon a task is subjected to an independent check in the course of another’s duties. For example, in a construction firm that employs staff members who are paid by cash (based on the number of hours worked for), the wages section may use a system which involves the following segregation of duties:

(i) Collection and sorting of time cards;
(ii) Calculation and listing of standard hours and overtime hours
worked for by reference to the time cards;
(iii) Calculation of gross pay by reference to records supplied by the
personnel department;
(iv) Production of payroll on accounting machine, that is, entry of
gross pay, deductions, calculation of net pay, cumulative cast and
cross-cast of payroll;
(v) Double check of cast and cross-cast of payroll;
(vi) Submission of payroll to a signatory in order to obtain wages
cheque;
(vii) Visit to bank to obtain cash for wages;
(viii) Insertion of cash into envelopes by reference to duplicate pay list; (ix) Payment of wages against signed receipt from each employee; (x) Returning signed payroll and unclaimed wages to the cash
department for special action.

SELF-ASSESSMENT EXERCISE 2

Distinguish between internal control and internal check.

3.3 Internal Audit

In the previous unit (Unit 2 of Module 1), you learnt the definition of internal audit as an independent appraisal activity within an organisation for the review of accounting, financial and other controls as a basis of service to management. And that it is the managerial control which functions by measuring the effectiveness of other controls. It was also pointed out that the internal auditor is an employee of the organisation and is responsible to its management. You are also aware that the internal auditor requires a degree of independence to function, but because he is an employee of the organisation and, invariably, takes directions from the management, his independence may be impaired.
duties and responsibilities imposed upon the internal audit deserve special attention. The effective operation of a business depends on the effectiveness of the internal audit. Internal audit is one of the features of management control, and therefore, aids management to achieve efficient and effective operation of the business.
Internal audit unit is responsible for designing internal controls and procedures, and providing accurate information to the management for the day-to-day operations of the business.

3.3.1 Relationship between the Internal and External Auditors 

The relationship subsisting between the internal and external auditors is based on the fact that on accounting matters, they operate largely in the same field and have a common interest in satisfying themselves that: (a) there is an effective system of internal check to prevent or detect
errors and frauds, and that the system is operating correctly; (b) there is an adequate accounting system to provide the information
necessary to prepare a true and fair financial statement.

SELF-ASSESSMENT EXERCISE 3

What are the basic differences between the internal and external auditors?

3.3.3 Cooperation between the Internal and External Auditors Without cooperation, 

the work of both the internal and external auditors could be duplicated largely because their procedures are the same. Because of the wider experience gained in the public practice, the external auditor may be of assistance in an advisory capacity in connection with the installation and subsequent operation of internal audit in the company.
He (external auditor) may also derive some benefits from the internal auditor’s intimate knowledge of the business, particularly, in connection with stock-in-trade, the physical existence of fixed assets, depreciation charges, the ascertainment of liabilities and the risk of fraud or misappropriation.
Specific areas of cooperation may be as follows.

1.  The independent auditor may be able to rely, to a larger extent,on the internal auditor in determining whether the system of theinternal check is operating satisfactorily and in assessing the general reliability of the accounting records.
2.  The audit programmes of the internal auditor may include, by agreement, the work which has the effect of giving direct assistance to the external auditor by participating during the accounting period in matters such as cash counts and visits to branches made either by the internal auditor alone or jointly with the external auditor.
3.  The internal auditor may arrange his audit programmes at the end of the accounting period so that assistance is given to the independent auditor in connection with matters such as the confirmation of customer’s account, verification of assets such as stock-in-trade and the preparation of audit working schedules required by the independent auditor for his records.

3.4 Internal Control in Specific areas of a Business

This section is divided up into the areas of activity usually found in a business. At the beginning of each area are the stated the objectives of internal control in the area and then some measures through which the objectives will be achieved.

3.4.1 Internal Control Generally

Objective

To carry on the business in an orderly and efficient manner, to ensure adherence to management policies, safeguard its assets, and secure the accuracy and reliability of records.

Measures

(i) An appropriate and integrated system of accounts and records;

 (ii) Internal controls over those accounts and records;
(iii) Financial supervision and control by management, including
budgetary control, management accounting reports, and interim accounts;
(iv) Safeguarding and if necessary, duplicating records;
(v) Engaging, training, allocating to specific duty staff members who are capable of fulfilling their responsibilities. Rotation of duties and cover for absences.

3.4.2 Cash and Cheques Received by Post

Objectives

To ensure that all cash and cheques received by post are accounted for and accurately recorded in the books; To ensure such receipts are promptly and intactly deposited in the bank.

Measures

(i) Prevent interception of mail between receipt and opening;
(ii) Appointment of an official to be responsible for the opening of the post;
(iii) Two persons to be present at the opening of the post;
(iv) All cheques and other negotiable instruments to be immediately given a restrictive crossing e.g. account payee only, not negotiable;
(v) Immediate entry of the details of the receipts (date, payer, amount, cash, cheque, or other) in a ‘rough cash book’ or post-list of money received. The list should be signed by both parties
present;
(vi) Regular independent comparison of the post list with banking records. The tests should be of total, detail and dating to detect teeming and lading at a later stage in the processing.

3.4.3 Cash Sales and Collections

Objectives

To ensure that all cash, to which the enterprise is entitled, isreceived;
To ensure that all such cash is properly accounted for and entered in the records;
To ensure that all such cash is promptly and intactly deposited.

 Measures

(i) Prescribing and limiting the number of persons who areauthorised to receive cash e.g. sales assistants, cashiers, etc; 

(ii) Establishing a means of evidencing cash receipts e.g. pre-numbered duplicate receipt forms, cash registers with sealed tillrolls. The duplicate receipt form books should be securely held and issue controlled;
(iii) Ensuring that customers are aware that they must receive a receipt form or ensuring that the amount stated in the cash register is clearly visible to the customer;
(iv) Appointment of officers with responsibility for emptying cash registers at prescribed intervals, and agreeing the amount present with till roll totals or internal registers. Such collections should
be evidenced in writing and be initialed by the assistant and the supervisor;
(v) Immediate and intact banking. Payments out should be from funds drawn from the bank on an imprest system;
(vi) Investigation of shorts and overs;
vii) Independent comparison of agreed till roll totals with subsequent banking records;
(viii) Persons handling cash should not have access to other cash funds or to bought or sales ledger records;
(ix) Rotation of duties and cover for holidays (which should be compulsory) and sickness;

3.4.5 Cash Balances

Objectives

To prevent misappropriation of cash balances;
To prevent unauthorised cash payments.

Measures

(i) Establishment of cash floats of specified amounts and locations; 

(ii) Appointment of officials responsible for each cash balance; 

(iii) Arrangement of security measures including use of safes and
restriction of access;
(iv) Use of imprest system with rules on reimbursement only against
authorised vouchers;
(v) Strict rules on the authorisation of cash payments;
(vi) Independent cash counts on a regular and a surprise basis; (vii) Insurance arrangements e.g. for cash balances;
(viii) Special rules for I.O.Us. Preferably these should not be
permitted.

3.4.6 Bank Balances

Objectives

To prevent misappropriation of bank balances;
To prevent teeming and lading.

Measures

(i) Reconciliation should be prepared at prescribed frequency; 

(ii) They should be performed by independent personnel;
(iii) Arrangements should be made for bank statements to be sent direct to the person responsible for the reconciliation;
(iv) Work on reconciliations should include the following: A comparison of each debit and credit in the cash book with the corresponding entries in the bank statements;
A comparison of returned cheques with the cash book entries noting dates, payees and amounts;
A test of the detailed paying-in slips with the cash book;The dates of credits in the bank statements should be traced through to the next period and their validity verified; Any unusual items, for example, dishonoured cheques should be investigated.
(v) The balances at the bank should be independently verified with
the bank at intervals.

.4.7 Cheque Payments

Objective

To prevent unauthorised payments being made from bank accounts. Measures
(i) Control over custody and issue of unused cheque books. A register should be kept if necessary;
(ii) Appointment of an official to be responsible for the preparation of cheques;
(iii) Rules should be established for the presentation of supporting documents before cheques can be made out. Such supporting documents may include orders, invoices, etc;
(iv) All such documents should be stamped ‘paid by cheque no. …’
with date;
(v) Establishment of who can sign cheques. All cheques should be
signed by at least two persons, with no person being permitted to sign if he is a payee;
(vi) No cheques should be made out to bearer except for the
collection of wages or reimbursement of cash funds;
(vii) All cheques should be restrictively crossed;
(viii) The signing of blank cheque must be prohibited;
(ix) Special safeguards where cheques are signed mechanically or
have pre-printed signatures. Such signings are often made for
dividend payments, salary cheques and other reasons;
(x) Rules to ensure prompt despatch and to prevent interception or
misappropriation;
(xi) Measures to ensure cash discounts are obtained;
(xii) Special rules for authorising and checking direct debits and
standing orders;
(xiii) Separation of duties: custody, recording and initiation of cheque
payments: cash records and other areas e.g. debtors and creditors. 

3.4.8 Wages and Salaries

Objectives

To ensure that wages and salaries are paid only to actual
employees at authorised rates of pay;
To ensure that all wages and salaries are computed in accordance
with records of work performed whether in respect of time,
output, sales made or other criteria;
To ensure that payrolls are correctly calculated;
To ensure that payments are made only to the correct employees;

To ensure that payroll deductions are correctly accounted for and
paid over to the appropriate third parties;
To ensure that all transactions are correctly recorded in the books
of account.

ANSWER TO SELF-ASSESSMENT EXERCISE 3 

Basic differences between the internal and external auditors can be seen from the following perspectives:

1.  scope 
2.  approach 
3.  responsibility

ANSWER TO SELF-ASSESSMENT EXERCISE 4 

1.  The objectives of internal control relative to fixed assets are to ensure that fixed assets are: 

(i) only acquired with proper authority;
(ii) properly maintained and used only in the business;
(iii) properly accounted for and recorded;
(iv) to ensure that disposals are properly authorised and that proceeds of disposals are accounted for and recorded.