Internal Control System: Definition, Components (Explained)

Internal Control System

The internal control structure of a company consists of the policies and procedures established to provide reasonable assurance that specific entity objectives will be achieved.

In small business organizations, generally, the owner-manager controls the total activities of his business by his personal supervision and direct participation.

For example;

The owner generally purchases required business materials and other properties.

He himself gives appointment of employees, completes the contract with them through discussion and also keeps, constant watch over their activities.

He himself signs cheques for payments in different heads.

Since the signs all the cheques, he can easily have an idea what commodities, assets, and services he is signing for.

But with the expansion of business, the appointment of additional employees and officers is needed and the scope of business also widens.

Under such condition, it becomes almost impossible on the part of the manager to perform all the activities of the business alone for which he is to delegate authority and so his overall control tends to decrease.

In such circumstances introduction of internal control becomes essential.

Internal control system differs from one business organization to another depending on the nature and size of the business.

Read: Why Accounting is called the Language of Business

To achieve the objective of a business proper execution of business activities in the light of prevailing laws and socio-economic condition of the country is called internal control system or structure.

The internal control system is introduced to avoid errors and frauds and for systematic control of business activities.

American Institute of Certified Public Accountants (AlCPA) says;

The plan of organization and all of the coordinate methods and measures adopted within a business safeguard its assets, check the accuracy and reliability of its accounting data, promote operational efficiency and encourage adherence to preserved managerial policies.

Three elements of the internal control system are:

  1. Environment control: The attitude, alertness, and work-zeal of directors, managers and shareholders are reflected through environment control.
  2. Accounting system: Accounting system means some procedures and recordings with which identification of business transactions, classification, summarization, statement preparation and analysis for timely presentation of correct information are performed.
  3. Control procedure: The additional policies and procedures adopted by the business authority for ensuring achievement of the specific goal of a business organization are the controlling procedures.

These control procedures are:

  • Proper delegation of power,
  • Segregation of responsibility,
  • Preparation and use of documents,
  • Adoption of adequate security measures to protect the properties, and
  • Independent control over the execution of activities.

An internal control system, not only prevent fraud forgery but also fulfills other objects:

  1. The business organization implements its policies complying with the prevailing laws of the country.
  2. Employees and officers discharge their assigned responsibilities to increase efficiency in execution of work.
  3. Financial statements provide correct and reliable information maintaining proper accounts.

In the light of above discussion, it can be briefly stated that the overall policies and plans adopted by the management for proper execution of business activities are called internal control system.

Components of Internal Control System

According to Committee of Sponsoring Organizations of the Treadway Commission, there are five components of an internal control system.

When these components are linked to the organization some prompt changes are marked. These components are:

  1. Controlling environment: Control environment is the basis of other elements of all other components of the internal control system. Moral values, managerial skill, the honesty of employees and managerial direction etc. are included in controlling environment.
  2. Risk assessment: After setting up the objective of business, external and internal risks are to be assessed. The management determines risk controlling means after examining the risks related to every objective.
  3. Control activities: The management establishes controlling activities system to prevent risk associated with every objective. These controlling activities include all those measures that are to be followed by the employees.
  4. Information and communication: Relevant information for taking decision are to be collected and reported in proper time. The events that yield data may originate from internal or external sources.Communication is very important for achieving management goals.

    The employees are to realize what is expected of them and how their responsibilities are related to the activities of others.

    Communication of the owners with outside parties’ like’s suppliers is also very important.

  5. Monitoring: When the internal control system is in practice, the organization to monitor its effectiveness so that necessary charges can be brought if any serious problem arises.

Responsibility for Internal Control System

It is the general responsibility of all employees, officers, management of a company to follow the internal control system. The under-mentioned three parties have definite roles to make internal control system effective:

  1. Management: Establishment and maintenance of effective internal control structure mainly depends on the management.Through leadership and example or meeting, the management demonstrates ethical behavior and integrity of character within the business.
  2. Board of directors: The board of directors possessing a sound working knowledge gives directives to the management so that dishonest managers cannot ignore some control procedures.Board of directors stops this sort of unfair activities. Sometimes the efficient board of directors having access to the internal audit system can discover such fraud and forgery.
  3. Auditors: The auditors evaluate the effectiveness of the internal control structure of a business organization and determine whether the business policies and activities are followed properly.Communication network helps effective internal control structure in execution. And all officers and employees are part of this communication network.
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