Internal Control

Internal control is an important tool of management. It assists the management in

the performance of its various functions. It means the built in cross-checks in the
systems supplemented with proper supervision and internal audit carried out by
the staff appointed by the organization. These days business has become more
complex both in ' nature and size, the management finds it difficult to get correct
information about the various aspects of the business. Internal control assures
the, management that the information supplied to it is reliable and accurate. The
Internal controls are exercised to ensure accuracy and reliability of accounting
data and other records, to identify weaker areas of operation and to improve
them, to increase operational efficiency of the business, to safeguard its assets
and to ensure orderly conduct of business.

The American Institute of Public Accountants has defined Internal Control as

"The plan of organization and all the coordinate methods, and measures
adopted within a business to safeguard its assets, check the accuracy and the
reliability of its accounting data promote operational efficiency and encourage
adherence to prescribed managerial policies. A system of Internal Control
extends beyond those matters which relate directly to the functions of the
accounting and financial departments".

The Institute of Chartered Accountants of England and Wales defines internal

control as "Internal Control means not only internal check or internal audit, but
the whole system of control, financial and otherwise, established by management
in order to carry on the business of the company in an orderly manner, safeguard
its assets and secure as far as possible accuracy and reliability of its records".

If we analyze the above definitions it would be evident that internal control is a

broad term with a wide coverage. It consists of a number of checks and controls
which are exercised in a business to ensure its efficient and economic working.
Thus, internal control involves a sort of vigilance and direction over important
matters, like budget and finance, purchases and sales and internal administration
by the management.
Every business is expected to devise a suitable system of internal control in order
to carry on the business in an efficient and orderly manner. These controls are
accounting control, standard cost control, budgetary control, statistical analysis
and internal checks and internal audit. In simple words, it means number of
checks and controls over the various activities of a business. Generally, a system
of internal control will include all those measures which assist a business
enterprise to fulfill the following objectives.

Objectives of Internal Control

1 To minimise, if not completely eliminate, wastages and inefficiencies in business

operations and to safeguard the assets of the business.

2 To ensure high degree of accuracy and reliability of accounting data and

promote operational efficiency.

3 To measure how far the policies of the management are being implemented.

4 To evaluate the efficiency of performance in all aspects of business activities

and to highlight the weaknesses.

2.22 Forms of Internal Control

Forms of Internal Control helps in ensuring correct and reliable records of

transactions and operational efficiencies

1 Accounting Controls: It ensures correct and reliable records of transactions in

conformity with normally accepted accounting principles. Such controls comprise
primarily the plan of organization and the procedures and records that are
concerned with and directly related to the safeguarding of assets and liabilities of
financial records. Accounting the financial controls include budgetary controls,
standard cost control, self-balancing ledgers, bank reconciliation, and internal
checks and internal auditing, Accounting controls have a direct and significant
bearing on the work of an accountant. These controls deal with the process of
recording of transactions, safeguarding the assets and adherence to prescribed
managerial policies.
 2 Administrative Controls: The scope of this control is very wide. They also
include accounting controls. Such controls comprise of the plan of organization
that are concerned mainly with 'operational efficiencies. In short, they may
include anything from plan of organization to procedures, record keeping, and the
process of decision-making. They include controls viz. time and, motion studies,
quality control, through inspection, statistical analysis and performance
evaluation, etc. An auditor should make a careful review of accounting controls as
they have a direct bearing on the reliability of the financial statements. He may,
also, evaluate those administrative controls which have direct bearing on the
financial statements. He is primarily concerned with the accounting controls.

2.2.3 Internal Control and Auditor

The position of the auditor regarding internal control has been stated in the
statements on Auditing practices issued by the Institute of Chartered Accountants
of India which says "the duty of safeguarding the assets of a Company is primarily
that of management, and the auditor is entitled to rely upon the safeguards and
internal controls instituted by the management, although he will take into
account the deficiencies, he may note therein while drafting his audit
programme". It clearly means that an auditor is concerned only with the
evaluation of the internal control to know its strength, and weaknesses. In case he
finds that the internal control system is inadequate, he should then plan to carry
out detailed examination of those areas where the system is weak. It is therefore
necessary for the auditor to acquaint himself fully with the internal control a , in
force and their actual operation. It will help him in the formulation of his audit
programme. He may also bring the shortcomings of the internal control system to
the notice of the management.

2.2.4 Requisites of a Good Internal Control System.

The following, are the essential requisites of a good Internal Control System:

1. A well-developed plan of organization with proper delegation of functional

responsibilities should be devised. No internal control system can be effective
without such plan of organization.
2. A scientific system of authorization and record procedures should be
developed with a view to provide proper control over assets, liabilities,
revenues and expenses of the organization. It should be developed in such a
fashion as to ensure that (a) assets are kept under proper custody and they
are not improperly applied, (b) expenditures are incurred on getting proper
authorization and revenues received are duly accounted for.
3. A system of healthy practices and traditions should be developed with a view
to discharge the duties and functions of the various departments of the
organization smoothly.
4. Since internal control system is to be exercised by the personnel employed in
the organization, there should be a team of people with sound character and
integrity who are properly trained and capable of discharging their
responsibilities.
5. Constant managerial supervision and periodical review of the system should
be introduced with a view to make the system more efficient and effective.

INTERNAL AUDIT
Internal audit is described as the verification of the operations and
transactions within the business by a specially assigned staff. It is an important
tool of management to evaluate the correctness of records on a continuous
basis in an organization.

The term internal audit has been defined as "an independent appraisal of
activity within an organization for review of accounting, financial and other
operations as a basis of service to management.
According to Howard F Stettler, "Internal auditing is an independent appraisal
activity within an organization for the review of operations as a service to
management".
The overall objective of internal auditing, therefore, is to assist the
management in the effective discharge of their responsibilities by furnishing
them with objective analysis, appraisals, recommendations and pertinent
comments concerning the activities reviewed. In short, internal audit assures
the management that the system of internal check and other types of controls
are effective in design and operation.
Thus, internal audit is a thorough examination of the accounting transactions
to ensure that –
 the transactions are properly recorded.
 the accounts are maintained systematically, and
 there is no possibility for manipulation of accounts or misappropriation
of property of the business,

In modern times, an internal auditor carries a new task. The traditional

function of checking the arithmetical correctness of the accounts with the help
of vouchers, documents and verification of few items such as stock, cash and
fixed assets is not sufficient. The duty of internal auditor now is to chart the
procedures, examine their efficiency and work on programmes of
improvement of assessing the effectiveness of controls. He is expected to plan
and arrange his task for effective functioning, set clear objectives of his own
section, phase his objectives, gain the confidence of the management and
demonstrate the value of his functions in areas of performance.

The internal audit is carried out generally in the same manner as is followed
for a professional audit. However, it varies in form from enterprise to
enterprise according to its size and specific needs. It is installed in large
organization and is carried out by the salaried stages that are qualified to
conduct professional audit. Being the employee of the organization, he has to
ensure that there is no waste in the organization.

Internal auditor has to follow the provisions of law, standard auditing

practices and procedures prescribed for professional auditors and by the
professional bodies controlling the audit system in the country. At the same
time, internal auditor must be aware of the policies and programmes of the
enterprise. He should be professionally competent to carry out detailed
examination of working of the business. Equipped with professional expertise
and knowledge of the business, he will be in better position to make the
internal audit system more effective.
2.3.1 Objectives of internal Audit

The main objectives of internal audit can thus be stated as under :

1 To verify the correctness and authenticity of the financial records and

statistical records presented to the management.

2 To ensure that the standard accounting practices are strictly followed in the
organization.

3 To facilitate early detection of errors and frauds.

4 To ensure that all transactions have been carried out under a proper
authority and by persons authorized for the same in the business.

5 To review the system of internal check from time to time, to advise the
management on improvement of the system and to undertake special
investigation for the management.

6 To confirm that the liabilities have been incurred by the organization for
legitimate activities.

Thus, efficiency of internal audit depends on the efficiency of the staff

employed for the purpose. Internal audit can be effective only if the internal
auditor is given wider authority to investigate the transactions not only from
financial angles but also from other organizational activities. Internal auditor
should report directly to the top management. He must operate
independently of the accounting and other staff. He must be given an
independent status as an important functionary and a part of the
management.

2.3.2 Internal Audit vs. Statutory Audit (External audit)

Internal audit helps the statutory audit to a large extent. Both the internal
auditor and the statutory auditor have a common interest as far as
authenticity of the accounts is concerned. However, the soundness of internal
audit relieves the statutory auditor from detailed checking.

The internal auditor reviews the operations and performs such functions as
evaluation, compliance, verification and ensures that policies, procedures,
rules and other types of controls of the business are carried out efficiently.

He is helpful to statutory auditor in the matter of examination of the books of

accounts. Generally, the statutory auditor accepts some of the detailed
checking made by internal auditor. However, the area of cooperation
between internal auditor and statutory auditor is somewhat limited as the
statutory auditor has a responsibility under law to various authorities, while
the internal auditor is responsible only to the management. The statutory
auditor cannot get any protection against liability for negligence. The
statutory auditor has to carry out his duties in accordance with standard
accounting and auditing practice and provisions of law which govern the
organizations. Before accepting the checking of accounts and other
documents carried to by internal auditor, the statutory auditor must
undertake such test checks necessary to find out the effectiveness of internal
audit.

But internal auditor and statutory auditor carry out examination of records
and documents-and make physical and other verifications.

Difference between Internal Audit and Statutory Audit

1 Internal audit is the arrangement within the organization to verify on

continuous basis the correctness and truthness and truthfulness of the
transactions by the salaried off.

2 Internal audits is not compulsory

3 Internal audit is carried out by the staff appointed by the business

enterprise. It is not necessary that the internal audit staff should possess the
qualification prescribed for professional auditor.
4 Being an employee of the organization internal auditor is answerable to the
management. His duties, responsibilities etc. regarding audit work are
determined by the management. The management can increase the powers
and authority of the internal auditor. Similarly, it can also curtail its powers.

5 The internal auditor points out irregularities in the procedural aspects and
suggests the ways and means to rectify the same. He assures that the financial
operations and other types of control in-force are carried out in conformity
with the accounting systems.

Statutory Audit

1. Statutory audit is the examination of the books of accounts of the business

by an external auditor and to report that the Profit, and Loss Account and
Balance Sheet are drawn according to provisions of law and the financial
statements reveal the true and fair view of the results of operations and
financial state of affairs of the business.
2. Statutory audit is compulsory in case of business houses incorporated
under the Companies Act and other Acts.
3. Statutory audit can be carried out only by those who are qualified for
appointment as per the provisions of the Companies Act and other Acts.
4. The rights, duties, responsibilities and liabilities of auditors are governed
by the provisions of law. An auditor is independent of management.
5. The statutory auditor is concerned with the legality and validity of the
transactions of business. His audit work is based on the financial statement
prepared by the business.