Internal Audit » Internal Controls

Internal Controls

Internal Controls

 

Per The Committee of Sponsoring Organizations of the Treadway Commission (COSO), internal control is a process, effected by an entity's board of directors, management and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following categories:

  • Effectiveness and efficiency of operations.
  • Reliability of financial reporting.
  • Compliance with applicable laws and regulations.

The first category addresses an entity's basic business objectives, including performance and profitability goals and safeguarding of resources.  The second relates to the preparation of reliable published financial statements, including interim and condensed financial statements and selected financial data derived from such statements, such as earnings releases, reported publicly.  The third deals with complying with those laws and regulations to which the entity is subject.  These distinct but overlapping categories address different needs and allow a directed focus to meet the separate needs.

 

Key Concepts

  • Internal control is a process.  It is a means to an end, not an end in itself.
  • Internal control is effected by people.  It is not merely policy manuals and forms, but people at every level of the organization.
  • Internal control can be expected to provide only reasonable assurance, not absolute assurance, to an entity's management and board.
  • Internal control is geared to the achievement of objectives in one or more separate but overlapping categories.

 

 

 

 

Components

Internal control consists of five interrelated components.  These are derived from the way management runs a business and are integrated with the management process.  The components are:

 

Control Environment

The control environment sets the tone of an organization, influencing the control consciousness of its people.  It is a foundation for all other components of internal control, providing discipline and structure.  Control environment factors include the integrity, ethical values and competence of the entity's people; management's philosophy and operating style; the way management assigns authority and responsibility and organizes and develops its people; and the attention and direction provided by the board of directors.

 

Risk Assessment

Every entity faces a variety of risks from external and internal sources that must be assessed.  A precondition to risk assessment is establishment of objectives, linked at different levels and internally consistent.  Risk assessment is the identification and analysis of relevant risks to achievement of the objectives, forming a basis for determining how the risks should be managed.  Because economic, industry, regulatory and operating conditions will continue to change, mechanisms are needed to identify and deal with the special risks associated with change. 

 

Control Activities

Control activities are the policies and procedures that help ensure management directives are carried out.  They help ensure that necessary actions are taken to address risks to achievement of the entity's objectives.  Control activities occur throughout the organization, at all levels and in all functions.  They include a range of activities as diverse as approvals, authorizations, verifications, reconciliations, reviews of operating performance, security of assets and segregation of duties.

 

Information and Communication

Pertinent information must be identified, captured and communicated in a form and timeframe that enable people to carry out their responsibilities.  Information systems produce reports, containing operational, financial and compliance related information, that make it possible to run and control the business.  They deal not only with internally generated data, but also information about external events, activities and conditions necessary to allow informed business decision-making and external reporting.  Effective communication also must occur in a broader sense, flowing down, across and up the organization.  All personnel must receive a clear message from top management that control responsibilities must be taken seriously.  They must understand their own role in the internal control system, as well as how individual activities relate to the work of others.  They must have a means of communicating significant information upstream.  There also needs to be effective communication with external parties, such as customers, suppliers, regulators and shareholders.

 

Monitoring

Internal control systems need to be monitored - a process that assesses the quality of the system's performance over time.  This is accomplished through ongoing monitoring activities, separate evaluations or a combination of the two.  Ongoing monitoring occurs in the course of operations.  It includes regular management and supervisory activities, and other actions personnel take in performing their duties.  The scope and frequency of separate evaluations will depend primarily on an assessment of risks and the effectiveness of ongoing monitoring procedures.  Internal control deficiencies should be reported upstream, with serious matters reported to top management and the board. 

  

 * COSO photos used courtesy of the Treadway Commission.