UNIT : 1

Internal Check, Internal Audit and Internal

Control
INTERNAL CONTROL
Meaning
Internal control is a broad term with a wide coverage. It covers the control of the whole
management system. The control may be financial and non- financial.it involves a number
of clerks and controls exercised in a business to ensure its efficient and economic working.

Definition
According to W.W.Bigg internal control is best regarded as indicating the whole system of
control, financial and otherwise, established by the management in the conduct of a
business, including internal check, internal audit and other forms of control.
According to the American Institute of Certified Public Accountants, internal control
comprises of the plan of organization and all the co-ordinate methods and measures adopted
within a business to safeguard its assets, check the accuracy and reliability of its accounting
data to promote operational efficiency and to encourage adherence to prescribed managerial
policies.
NEED / PURPOSE OF INTERNAL CONTROL

■ From client’s point of view

i. Providing reliable data
ii. Safeguarding assets and records
iii. To promote operational efficiency
iv. To encourage adherence to prescribed policies
■ From the auditor’s point of view
i. Evaluate the clients system of internal control
ii. Review the accounting system
iii. To determine the scope of audit
ELEMENTS OR CHARACTERISTICS OR PRINCIPLES OF
INTERNAL CONTROL
1. Competent and trustworthy personnel
2. Records financial and other organisational plans
3. Segregation of duties
i) separation of operational responsibility from record-keeping responsibility
ii) separation of the custody of assets from accounting
4. Supervision
5. Authorisation
6. Sound practices
7. Internal audit
8. Arithmetic and accounting controls
OBJECTIVES OF INTERNAL CONTROL

i. To protect the assets of the organisation

ii. To follow the policies of the management
iii.To prevent errors and frauds
iv. To make best use of resources
v. To maintain all records accurately
vi.To record all the truncations and expenditure of the orgainsation
vii.To ensure the preparation of statements , balance sheet , reports etc
AREAS/SCOPE OF INTERNAL CONTROL
1. General financial control
2. Cash control
3. Control over trading transactions
4. Control over employees remuneration
5. Capital expenditure control
6. Others:
a) Maintenance of staff relationships
b) Stock maintenance
c) Control over investments
LIMITATION OF INTERNAL CONTROL

i. Involves expenditure on money and time.

ii. Lengthy process
iii.More concerned with routine transaction
iv. Human errors may weaken the system of internal control
v. Manipulation by the management may defeat the objectives of internal control
vi.The possibility that a person responsible for exercising control could abuse the
management
INTERNAL CHECK
Meaning:

It is an arrangement of the duties of members of staff in such a manner that the work performed
by one person is automatically and independently checked by the others. Each employee
operates independently but it does not involve duplicating the work of other.

Definition:
F.R.M De Paula “ 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 staff ”.

Spicer and Peglar, “Internal check is an arrangement of staff duties whereby no one person is
allowed to carry through and record every aspect of transaction so that without collusion between
two or more persons, fraud is prevented and at the same time the possibilities of error are reduced to
the minimum”.
OBJECTIVES OF INTERNAL CHECK

i. To exercise moral pressure over staff.

ii. To ensure the accounting procedure system
iii.To provide protection of the resources of business.
iv. To allocate duties and responsibilities of each clerk.
v. To minimise the chances of errors, frauds or irregularities in the bushiness.
vi.To increase the efficiency of clerks.
vii.To distribute the work in such a manner that no business transaction is left unrecored.
ESSENTIALS CHARATERISTCS / PRINCIPLES OF A
GOOD SYSTEM OF INTERNAL CHECK

i. Responsibility
ii. Completion
iii.Rotation of employees
iv. Automatic check
v. Reliance
vi. Safeguards
vii.Supervision
viii.Formal sanction
ix. Periodical review
ADVANTAGES OF INTERNAL CHECK
■ For the business :
a. Proper division of work
b. Detection of errors and frauds
c. Increased efficiency coupled with economy
■ For auditor :
a. Quick preparation of final accounts
b. Convenience to auditor
■ For the owner :
a. Accuracy of the accounts can be relied upon
b. Increase in profits
DISADVANTAGES OF INTERNAL CHECK
i. Costly for small business
ii. Quality is sacrificed for promptness
iii.Carelessness among high officials
iv. Disorder in the working of a business
v. Risky for an auditor
POSITION OF AN AUDITOR

■ System of internal check in a business concern largely determines the nature and extent of the
scope of an auditor.
■ It determines the reliance which an auditor can place on test checking.
■ The auditor must do detail check when the internal check is not followed properly in the
business because if the system is defective or anything goes wrong the auditor will be
responsible.
■ In case of good internal check system, his work, but not responsibilities is reduced.
■ Statutory auditor cannot be relieved of his liability on the ground of good internal check
system.
■ Auditor should rely upon the system of internal check based on his skills, experience and
training.
 INTERNAL CHECK WITH REGARD TO CASH TRANSACTIONS
CASH RECEIPTS
i. All cheques, drafts postal orders should be cancelled on the receipts by the means of stamp with a
crossing of “ Not Negotiable- Account payee only.
ii. All the receipts should be acknowledge by means of printed receipts.
iii. Unused receipts books must be kept under lock and key with some responsible officer.
iv. Spoiled receipts should be cancelled and not torn off.
v. Copies of the receipts previously issued must be marked duplicate.
vi. Responsible officer should verify the balances of cash by carrying out a surprise check and must
handle inward mail.
vii. All the receipts should be banked daily.
viii. Bank pay in slip should not be prepared by the same person who is in charge of making deposit.
ix. Cashier to be appointed to deal with cash transactions.
– Cashier will be not allowed keep cash with him.
– He should deposit the cash on daily basis.
– He should not be allowed to make any expenditure out of it.
INTERNAL CHECK WITH REGARD TO CASH SALES

Cash sales may be of three types:

1. Sales at the counter
2. Sales by travelling salesmen and
3. Postal sales.
Sales at the counter:
i. Salesmen's authorisation
ii. Cash memos should be printed in a numerical sequences
iii.Four copies of cash memos, three given to customer one maintained by salesmen.
iv. Three copies verified by cashier, amount is collected and two memos are duly stamp-marked and
given to cutomers.
v. Gate keeper handovers the goods and collects one memo.
vi.At the end of the day salesmen , cashier and gatekeeper tally the memos.
vii.Receipts of the cash must be deposited in the bank on same day.
■ Sales by travelling salesmen:
i. Pre-numbered rough receipt books.
ii. Customers should correspond to head office for final receipt.
iii. Salesmen to remit the entire cash to head office.
iv. Special attention should be given for defaulters.
v. Salesmen to be transferred from one area to another.

■ Postal sales :
i. Separate register to record postal sales or V.P.P
ii. Separate register for receiving the cash against postal sales.
iii. Separate bank-in-slip for postal sales.
iv. Special attention for goods returned.
 INTERNAL CHECK WITH REGARD TO CASH TRANSACTIONS
CASH PAYMENTS
i. The person in charge of cash payment should have no connection with cash receipts.
ii. All payment should be preferably through cheque, except petty cash payments.
iii. The cheques drawn for payments should be in order and crossed. The authorised persons should sign on
the cheque.
iv. Person who prepares the cheques should not have the authority to sing the cheque.
v. One voucher should not be supporting two transactions.
vi. An official should check up the statement received form creditors and verify with the invoices and ledger
accounts. Based on this the cheque should be drawn in favour of the creditor.
vii. Confirmation of accounts with the creditors should be made through direct correspondence.
viii. For sanctioning the payment of special nature, only directors or senior officers should be empowered.
ix. Bank reconciliation statement should be prepared on time to time basis, cash balanced must be checked by
some authorities other than cashier.
x. Receipts duly signed and stamped should be obtained for cash payments.
xi. To ensure the availability of cash discounts, monthly or annual payments should be made on fixed dates.
xii. Bank cheques must be held under lock and key with a responsible officer.
INTERNAL CHECK WITH REGARD TO WAGES
The system of internal check for wages should be devised in a careful and planned way,
specially in manufacturing concern. This is because in large manufacturing concern,
employing large number of workers, possibilities of frauds are always are there. Thus to
prevent these frauds internal check must be implemented.

Objectives of internal check with regard to wages :

a) To avoid inclusion of dummy workers in the list of workers.
b) To avoid incorrect time or piece work records
c) To avoid misappropriation of money or manipulation of wage sheets etc.
Maintenance of wage records :

1.Time records
i. The time recording clock
ii. Brass token
iii.Attendance cards

2. Piece work records

3. Over time records
4. Pass-out time records
5. Preparation of wage sheet.
ESSENTIAL PARTICULARS OF WAGE SLIP
The whole work is divided in various parts to be done by separate clerks in the wage department.
1. Two clerks to examine time and piece wage records, overtime and other statements.
2. The third clerk to prepare individual workers statement like name ,code number of worker, his address
etc.
3. The fourth clerk is to check the calculations and deductions of income tax, provident fund etc.
4. The fifth clerk is to check the whole work thoroughly.
All these clerks should initial the wage slip before these are signed by some responsible officer.

Payment of wages :
1) The clerks associated with wage preparation must not be associated with wage payments.
2) The cashier should be entrusted with the job of disbursement.
3) Each worker, who is to receive the wages , should be present.
4) Concerned officer of each department should be present to identify the worker of his section.
5) The signature of the worker, should be obtained when they receive the wages.
6) Proper arrangement should be made with regard to unclaimed wages.
7) Advance payment must not done to the workers.
INTERNAL CHECK WITH REGARD TO PURCHASES

1. Requisition
2. Enquiry
3. Purchase order
4. Receipt of goods
5. Making payments

A good system of internal check with purchase will prevent the following :
6. Fictitious purchase
7. Double payment
8. Artificial inflation of profits
9. Artificial reduction in profits
INTERNAL CHECK WITH REGARD TO STORES
(STOCKS)
The following general rules to be followed to ensure effective check over the stores:
1. Location of the store
2. Receipts of the stores
3. Preservation of the stores
4. Issue of the stores
5. Recording
INTERNAL AUDIT
Definition :
According to Watter B M Meigs, “ internal auditing consists of continuous, critical review
of financial and operating activities by the staff of auditors functioning as full time salaried
employees”.

NEED OF INTERNAL AUDIT :

i. Proper accounting system
ii. Helps in progressive review
iii. Efficiency and effectiveness
iv. Smooth external audit
v. Detection of error and frauds
OBJECTIVES OF INTERNAL AUDIT

1) To improve the system

2) To verify accuracy correctness and authenticity
3) Detect errors and frauds
4) To ensure international accounting standards are followed
5) To take up investigation in the organisation
6) To safeguard and account the assets of the organisation
7) To ensure that the acquisition and disposal of assets are under proper authority
8) To ensure that the organisation follows all the policies laid by top management
DUTIES OF INTERNAL AUDITOR

1. To know the objectives of the company

2. Follow the companies law and status
3. Investigate errors and frauds
4. Communicate the finding and suggestion
5. Evaluate internal control and internal check to make recommendation
6. To promote ethics and assure safeguard
7. To assess companies risk and management efforts
DIFFERENCE BETWEEN INTERNAL AUDIT AND EXTERNAL AUDIT
 Basis Internal Check Internal Audit

Meaning It is an arrangement of the duties of staff Internal Audit is a review of various operations

Internal
members in such a manner that work and records of the company by staff specially
performed by one person is appointed for this purpose.
automatically and independently
checked by the other

Check Object To prevent and minimize the To detect errors and frauds which have already

V/s
possibilities of errors, frauds or been committed.
irregularities.

Timing Internal Check works during the course Internal Audit begins after the completion of

Internal Scope
of transactions.

Scope of Internal Check is very limited.

accounting process of different transactions.

Scope of Internal Audit is very broad.

Audit Staff The arrangement of the duties is done

with the existing staff, no new member
Separate staff is required to do internal audit.

of staff is required for Internal Check.

Nature Internal Check checks the progress of Internal Auditor reports to the management and
work automatically. suggest improvement about various
inefficiencies.

Involvement A large number of employees are For implementation of Internal Audit, a small
involved in the Internal Check system. team with limited members can also perform the
audit.

Device Internal Check acts like a device and Internal Audit is a device for checking the work.
keeps check on the work.