CHAPTER 13 - Internal Control.pptx
CHAPTER 13:
INTERNAL CONTROL
J.L. Boockholdt, Ph.D., C.P.A.,
C.M.A.
By: Dyah Nirmala A.J., M.Si.
Learning Objectives:
• To understand the components of an
organization’s internal control
structure.
• To know the objectives and limitations
of internal control.
• To discover which characteristics of a
control environment promote an
effective accounting system.
Learning Objectives:
• To learn how an accounting system
aids in communicating information
• To describe effective control
activities.
INTRODUCTION
Accounting systems provide
information for people both internal and
external to an organization. The users of
this information rely on the accuracy of
the system’s reports and displays.
Organizations adopt internal control
policies and procedures to maintain
accurate information and reliable
operations. In this chapter you will learn
about the components of an
organization’s internal control, its
limitations, and some basic policies and
procedures.
FEATURES OF INTERNAL
CONTROL
Definition
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 the objectives in the following
categories:
• Effectiveness and efficiency of operations
• Reliability of financial reporting
• Compliance with applicable laws and
regulations.
Features
1. Process
2. People
3. Objectives:
1. Accounting controls:
1.
2.
Safeguarding assets
Ensuring accurate and reliable accounting data
2. Administrative controls:
1.
2.
Promoting operational efficiency
Encouraging employees to follow management’s policies
4. Reasonable Assurance. A concept applied to
internal controls stating that the costs of a control
policy or procedure should not exceed its benefits.
Absolute assurance is
impossible, because:
• Limitations of Internal Control
– Errors
– Collusion: Conspiracy by two or more
people to steal from an organization.
– Management Override: The ability of
managers to overcome control policies or
procedures that are effective with
operations-level employees.
• Costs and Benefits
Threats to Accounting Data
• Errors
An accidental act, that arise from lack of knowledge
(misjudgment) or lack of attention /fatigue
(carelessness)
• Irregularities
An intentional act, such as defalcation or
management fraud, that may misstate accounting
data.
– Defalcation: the theft of assets from an
organization.
– Management fraud: management’s deliberate
distortion of financial information.
COMPONENTS OF INTERNAL
CONTROL
Internal Control Components
are:
An organization’s control environment,
risk assessment procedures, control
activities, information and
communication methods, and
monitoring activities.
CONTROL ENVIRONMENT
Control environment are those
circumstances surrounding an
organization’s accounting system that
either improve or limit the effectiveness
of control procedures.
Factors Affecting the Control
Environment:
1. Integrity and ethical values.
2. Commitment to competence.
3. Board of directors or audit committee
participation.
4. Management philosophy and operating
style
5. Organizational structure.
6. Assignment of authority and responsibility.
7. Human resources policies and practices.
1. Integrity and Ethical Values
As management creates, administers,
and monitors the system of internal
control, its effectiveness is limited by
management attitudes toward integrity
and ethical values.
2. Commitment to Competence
Competence means that employees have
the knowledge and skills they need to
perform theirs tasks. When management
has a commitment to competence, the
system of internal control is more likely
to achieve its objectives. Otherwise,
both errors and irregularities are more
likely to occur.
3. Board of Directors and
Audit Committee Participation
Active and involved board of directors
who have an appropriate amount of
technical and management knowledge,
and audit committee are critical to
effective internal control.
4. Management Philosophy
and Operating Style
These include management’s approach
to taking business risks, attitudes toward
the accuracy of accounting data, and
emphasis on meeting budget and
operating goals. They have a significant
influence on the effectiveness of
organization’s control activities.
5. Organizational Structure
It provides an overall framework for
planning, executing, controlling, and
monitoring activities performed by
management. Objectives are more easily
achieved in an organization whose
structure reflects its management
functions and that assigns authority and
responsibility appropriately.
6. Assignment of Authority and
Responsibility
Management assigns authority and
responsibility for operating activities
and establishes reporting relationships
and methods of authorization. The
control environment is influenced by the
extent to which employees recognize
that they will be held accountable.
7. Human Resources Policies
and Practices
They send messages to employees about
what the organization expects in the way
of integrity, ethical behavior, and
competence. They also describe how the
organization hires, trains, evaluates,
promotes, and compensates employees.
Good Human Resource
Policies and Practices (1)
1. Training. Employees who
understand their jobs are less likely
to make errors.
2. Recognition for work well done.
Encourages employees to prevent
errors and irregularities.
3. Adequate pay. Fairly compensated
employees are less likely to steal.
Good Human Resource
Policies and Practices (2)
4. Investigate employees before hiring.
A potential employee may have
history of carelessness or dishonesty.
5. Job rotation. Require employees to
change jobs periodically. Then an
employee cannot continue to conceal
an error or irregularity that occurred
in the past.
Good Human Resource
Policies and Practices (3)
6. Required vacations. An employee filling
in for an employee on vacation may
discover an error or irregularity that
occurred in the past.
7. Bonding. A bond is a contract whereby a
surety company agrees to reimburse the
employer for loss if an employee commits
theft. The surety company thoroughly
investigates the background of the bonded
employee before issuing the bond.
RISK ASSESSMENT
Risk assessment is management’s
process of identifying and analyzing the
risks that might prevent the organization
from achieving its objective. Risks arise
from both external and internal factors.
CONTROL ACTIVITIES
Control Activities are the policies and
procedures that management adopts to
provide reasonable assurance that
management directives are carried out.
They help ensure that actions are taken
to address risks to the achievement of
the organization’s objectives.
Types of control activities:
1. Procedures for authorizing transactions:
1. General Authorization. Management’s
authorization in advance for a class of
transactions.
2. Specific Authorization. Management’s
authorization for a single, specific transaction
2. Security for assets and records.
1. Physical Security
2. Fixed Responsibility
Types of control activities:
3. Segregation of duties.
Different employees:
1. Authorize transaction in an asset.
2. Record those transactions.
3. Have custody of the asset.
4. Adequate documents and record.
1. Numbered documents.
2. Control of blank forms and completed
documents.
Good Procedures for
Processing Transactions:
• Prompt recording. Employees record
transactions immediately as they occur. This
decreases opportunities for errors and
irregularities regarding the transactions.
• Visual checking. An employee recording
the transaction confirms visually that all
data are complete and correct.
Good Procedures for
Processing Transactions:
• Balancing. An employee determines that
the total debit entries equal the total credit
entries for the transaction.
• Batch controls. Employees accumulate
transactions into batches. They total the
amount of the transactions in each batch and
attach this total to the batch. In each later
processing step, this total is recalculated and
compared to the original batch total. This
verifies that no transactions are lost from
the batch.
INFORMATION AND
COMMUNICATION
Information and communication are
required for making operational
decisions, for financial reporting, and
for compliance with laws.
Modern accounting systems implement
double entry accounting methods with
features that prevent and detect errors
and irregularities, such as:
Double-Entry Accounting
Methods Features:
1. Debit and Credit Analysis
2. Chart of Accounts
3. Standard Journal Vouchers
A document used to record a standard journal entry. It
shows the proper accounting entry for a common
transaction and minimizes the likelihood of recording the
transaction incorrectly.)
4. Trial Balance
5. Control Accounts
Characteristics of a WellDesigned Chart of Accounts:
1. Responds to organization needs.
Account included in a chart of
accounts should meet management’s
needs for control of operations and
financial accounting requirements for
external reporting.
Characteristics of a WellDesigned Chart of Accounts:
2. Facilitates report preparation.
Account in the chart of accounts
should be listed in their order of
appearance in the financial
statements and should be compatible
with the organizational structure.
Characteristics of a WellDesigned Chart of Accounts:
3. Provides adequate description. A
description of each account and its
contents should be provided. This
guidance to the accounting staff
enables consistent use of the
accounts
Characteristics of a WellDesigned Chart of Accounts:
4. Account titles provide clear
distinctions. Account titles should be
chosen to minimize ambiguities
concerning the contents of an
account.
5. Control accounts. When costeffective, the chart of accounts
should incorporate control accounts.
MONITORING
It is a process that assess the quality of
internal control performance over time.
Monitoring can be done in two ways:
1. Ongoing Monitoring Activities.
2. Separate Evaluations:
1. Independent Auditors
2. Internal Auditors
Monitoring Activities
Check
Clerical checks
Reconciliations
Comparison of assets
with records
Example
A shop worker fills out a materials
requisition. The shop supervisor reviews
it before signing it.
A shop supervisor examines the sequence
of completed materials requisitions to
ensure that non are missing,
An internal auditor and an inventory clerk
count the physical inventory. The auditor
compares the count totals with quantities
shown in accounting records.
Monitoring Activities
Check
Example
Computer-programmed A computer program checks calculations
controls
on a materials requisition after the data is
entered into the computer.
Management review of A factory manager investigates the cause
accounts
of an excessive materials quantity
variance.
User review of
An inventory clerk reviews a list of
computer reports
material requisitions to look for duplicate
processing of the same requisition.
QUESTION A
1. Which three categories of objectives
do accountants recognize for internal
control?
2. Which features of a double-entry
accounting system prevent and detect
errors and irregularities?
3. How does debit and credit analysis
aid in preventing and detecting errors
and irregularities?
QUESTION B
1. What is internal control?
2. Identify seven factors that affect an
organization’s control environment.
3. What is a standard journal voucher?
Why is it a good control practice?
QUESTION C
1. What are the two threats to accurate
and reliable accounting data?
Describe and distinguish between
them.
2. What are the components of internal
control?
3. What are four categories of control
activities?
QUESTION D
1. What is meant by the following statement:
“Internal control policies and procedures
are intended to provide reasonable but not
absolute assurance that management’s
objectives are attained”?
2. Which kinds of errors and irregularities
can occur even in an organization having
good internal control?
3. Describe the difference between general
and specific authorization.
INTERNAL CONTROL
J.L. Boockholdt, Ph.D., C.P.A.,
C.M.A.
By: Dyah Nirmala A.J., M.Si.
Learning Objectives:
• To understand the components of an
organization’s internal control
structure.
• To know the objectives and limitations
of internal control.
• To discover which characteristics of a
control environment promote an
effective accounting system.
Learning Objectives:
• To learn how an accounting system
aids in communicating information
• To describe effective control
activities.
INTRODUCTION
Accounting systems provide
information for people both internal and
external to an organization. The users of
this information rely on the accuracy of
the system’s reports and displays.
Organizations adopt internal control
policies and procedures to maintain
accurate information and reliable
operations. In this chapter you will learn
about the components of an
organization’s internal control, its
limitations, and some basic policies and
procedures.
FEATURES OF INTERNAL
CONTROL
Definition
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 the objectives in the following
categories:
• Effectiveness and efficiency of operations
• Reliability of financial reporting
• Compliance with applicable laws and
regulations.
Features
1. Process
2. People
3. Objectives:
1. Accounting controls:
1.
2.
Safeguarding assets
Ensuring accurate and reliable accounting data
2. Administrative controls:
1.
2.
Promoting operational efficiency
Encouraging employees to follow management’s policies
4. Reasonable Assurance. A concept applied to
internal controls stating that the costs of a control
policy or procedure should not exceed its benefits.
Absolute assurance is
impossible, because:
• Limitations of Internal Control
– Errors
– Collusion: Conspiracy by two or more
people to steal from an organization.
– Management Override: The ability of
managers to overcome control policies or
procedures that are effective with
operations-level employees.
• Costs and Benefits
Threats to Accounting Data
• Errors
An accidental act, that arise from lack of knowledge
(misjudgment) or lack of attention /fatigue
(carelessness)
• Irregularities
An intentional act, such as defalcation or
management fraud, that may misstate accounting
data.
– Defalcation: the theft of assets from an
organization.
– Management fraud: management’s deliberate
distortion of financial information.
COMPONENTS OF INTERNAL
CONTROL
Internal Control Components
are:
An organization’s control environment,
risk assessment procedures, control
activities, information and
communication methods, and
monitoring activities.
CONTROL ENVIRONMENT
Control environment are those
circumstances surrounding an
organization’s accounting system that
either improve or limit the effectiveness
of control procedures.
Factors Affecting the Control
Environment:
1. Integrity and ethical values.
2. Commitment to competence.
3. Board of directors or audit committee
participation.
4. Management philosophy and operating
style
5. Organizational structure.
6. Assignment of authority and responsibility.
7. Human resources policies and practices.
1. Integrity and Ethical Values
As management creates, administers,
and monitors the system of internal
control, its effectiveness is limited by
management attitudes toward integrity
and ethical values.
2. Commitment to Competence
Competence means that employees have
the knowledge and skills they need to
perform theirs tasks. When management
has a commitment to competence, the
system of internal control is more likely
to achieve its objectives. Otherwise,
both errors and irregularities are more
likely to occur.
3. Board of Directors and
Audit Committee Participation
Active and involved board of directors
who have an appropriate amount of
technical and management knowledge,
and audit committee are critical to
effective internal control.
4. Management Philosophy
and Operating Style
These include management’s approach
to taking business risks, attitudes toward
the accuracy of accounting data, and
emphasis on meeting budget and
operating goals. They have a significant
influence on the effectiveness of
organization’s control activities.
5. Organizational Structure
It provides an overall framework for
planning, executing, controlling, and
monitoring activities performed by
management. Objectives are more easily
achieved in an organization whose
structure reflects its management
functions and that assigns authority and
responsibility appropriately.
6. Assignment of Authority and
Responsibility
Management assigns authority and
responsibility for operating activities
and establishes reporting relationships
and methods of authorization. The
control environment is influenced by the
extent to which employees recognize
that they will be held accountable.
7. Human Resources Policies
and Practices
They send messages to employees about
what the organization expects in the way
of integrity, ethical behavior, and
competence. They also describe how the
organization hires, trains, evaluates,
promotes, and compensates employees.
Good Human Resource
Policies and Practices (1)
1. Training. Employees who
understand their jobs are less likely
to make errors.
2. Recognition for work well done.
Encourages employees to prevent
errors and irregularities.
3. Adequate pay. Fairly compensated
employees are less likely to steal.
Good Human Resource
Policies and Practices (2)
4. Investigate employees before hiring.
A potential employee may have
history of carelessness or dishonesty.
5. Job rotation. Require employees to
change jobs periodically. Then an
employee cannot continue to conceal
an error or irregularity that occurred
in the past.
Good Human Resource
Policies and Practices (3)
6. Required vacations. An employee filling
in for an employee on vacation may
discover an error or irregularity that
occurred in the past.
7. Bonding. A bond is a contract whereby a
surety company agrees to reimburse the
employer for loss if an employee commits
theft. The surety company thoroughly
investigates the background of the bonded
employee before issuing the bond.
RISK ASSESSMENT
Risk assessment is management’s
process of identifying and analyzing the
risks that might prevent the organization
from achieving its objective. Risks arise
from both external and internal factors.
CONTROL ACTIVITIES
Control Activities are the policies and
procedures that management adopts to
provide reasonable assurance that
management directives are carried out.
They help ensure that actions are taken
to address risks to the achievement of
the organization’s objectives.
Types of control activities:
1. Procedures for authorizing transactions:
1. General Authorization. Management’s
authorization in advance for a class of
transactions.
2. Specific Authorization. Management’s
authorization for a single, specific transaction
2. Security for assets and records.
1. Physical Security
2. Fixed Responsibility
Types of control activities:
3. Segregation of duties.
Different employees:
1. Authorize transaction in an asset.
2. Record those transactions.
3. Have custody of the asset.
4. Adequate documents and record.
1. Numbered documents.
2. Control of blank forms and completed
documents.
Good Procedures for
Processing Transactions:
• Prompt recording. Employees record
transactions immediately as they occur. This
decreases opportunities for errors and
irregularities regarding the transactions.
• Visual checking. An employee recording
the transaction confirms visually that all
data are complete and correct.
Good Procedures for
Processing Transactions:
• Balancing. An employee determines that
the total debit entries equal the total credit
entries for the transaction.
• Batch controls. Employees accumulate
transactions into batches. They total the
amount of the transactions in each batch and
attach this total to the batch. In each later
processing step, this total is recalculated and
compared to the original batch total. This
verifies that no transactions are lost from
the batch.
INFORMATION AND
COMMUNICATION
Information and communication are
required for making operational
decisions, for financial reporting, and
for compliance with laws.
Modern accounting systems implement
double entry accounting methods with
features that prevent and detect errors
and irregularities, such as:
Double-Entry Accounting
Methods Features:
1. Debit and Credit Analysis
2. Chart of Accounts
3. Standard Journal Vouchers
A document used to record a standard journal entry. It
shows the proper accounting entry for a common
transaction and minimizes the likelihood of recording the
transaction incorrectly.)
4. Trial Balance
5. Control Accounts
Characteristics of a WellDesigned Chart of Accounts:
1. Responds to organization needs.
Account included in a chart of
accounts should meet management’s
needs for control of operations and
financial accounting requirements for
external reporting.
Characteristics of a WellDesigned Chart of Accounts:
2. Facilitates report preparation.
Account in the chart of accounts
should be listed in their order of
appearance in the financial
statements and should be compatible
with the organizational structure.
Characteristics of a WellDesigned Chart of Accounts:
3. Provides adequate description. A
description of each account and its
contents should be provided. This
guidance to the accounting staff
enables consistent use of the
accounts
Characteristics of a WellDesigned Chart of Accounts:
4. Account titles provide clear
distinctions. Account titles should be
chosen to minimize ambiguities
concerning the contents of an
account.
5. Control accounts. When costeffective, the chart of accounts
should incorporate control accounts.
MONITORING
It is a process that assess the quality of
internal control performance over time.
Monitoring can be done in two ways:
1. Ongoing Monitoring Activities.
2. Separate Evaluations:
1. Independent Auditors
2. Internal Auditors
Monitoring Activities
Check
Clerical checks
Reconciliations
Comparison of assets
with records
Example
A shop worker fills out a materials
requisition. The shop supervisor reviews
it before signing it.
A shop supervisor examines the sequence
of completed materials requisitions to
ensure that non are missing,
An internal auditor and an inventory clerk
count the physical inventory. The auditor
compares the count totals with quantities
shown in accounting records.
Monitoring Activities
Check
Example
Computer-programmed A computer program checks calculations
controls
on a materials requisition after the data is
entered into the computer.
Management review of A factory manager investigates the cause
accounts
of an excessive materials quantity
variance.
User review of
An inventory clerk reviews a list of
computer reports
material requisitions to look for duplicate
processing of the same requisition.
QUESTION A
1. Which three categories of objectives
do accountants recognize for internal
control?
2. Which features of a double-entry
accounting system prevent and detect
errors and irregularities?
3. How does debit and credit analysis
aid in preventing and detecting errors
and irregularities?
QUESTION B
1. What is internal control?
2. Identify seven factors that affect an
organization’s control environment.
3. What is a standard journal voucher?
Why is it a good control practice?
QUESTION C
1. What are the two threats to accurate
and reliable accounting data?
Describe and distinguish between
them.
2. What are the components of internal
control?
3. What are four categories of control
activities?
QUESTION D
1. What is meant by the following statement:
“Internal control policies and procedures
are intended to provide reasonable but not
absolute assurance that management’s
objectives are attained”?
2. Which kinds of errors and irregularities
can occur even in an organization having
good internal control?
3. Describe the difference between general
and specific authorization.