What Are the Seven Internal Control

Procedures in Accounting?


Internal controls are policies and procedures put in place to ensure the continued reliability of
accounting systems. Accuracy and reliability are paramount in the accounting world. Without
accurate accounting records, managers cannot make fully informed financial decisions, and
financial reports can contain errors. Internal control procedures in accounting can be broken into
seven categories, each designed to prevent fraud and identify errors before they become
problems.

Separation of Duties

Separation of duties involves splitting responsibility for bookkeeping, deposits, reporting and
auditing. The further duties are separated, the less chance any single employee has of committing
fraudulent acts. For small businesses with only a few accounting employees, sharing
responsibilities between two or more people or requiring critical tasks to be reviewed by co-
workers can serve the same purpose.

Access Controls

Controlling access to different parts of an accounting system via passwords, lockouts and
electronic access logs can keep unauthorized users out of the system while providing a way to
audit the usage of the system to identify the source of errors or discrepancies. Robust access
tracking can also serve to deter attempts at fraudulent access in the first place.

Physical Audits

Physical audits include hand-counting cash and any physical assets tracked in the accounting
system, such as inventory, materials and tools. Physical counting can reveal well-hidden
discrepancies in account balances by bypassing electronic records altogether. Counting cash in
sales outlets can be done daily or even several times per day. Larger projects, such as hand
counting inventory, should be performed less frequently, perhaps on an annual or quarterly basis.

Standardized Documentation

Standardizing documents used for financial transactions, such as invoices, internal materials
requests, inventory receipts and travel expense reports, can help to maintain consistency in
record keeping over time. Using standard document formats can make it easier to review past
records when searching for the source of a discrepancy in the system. A lack of standardization
can cause items to be overlooked or misinterpreted in such a review.

Trial Balances
Using a double-entry accounting system adds reliability by ensuring that the books are always
balanced. Even so, it is still possible for errors to bring a double-entry system out of balance at
any given time. Calculating daily or weekly trial balances can provide regular insight into the
state of the system, allowing you to discover and investigate discrepancies as early as possible.

Periodic Reconciliations

Occasional accounting reconciliations can ensure that balances in your accounting system match
up with balances in accounts held by other entities, including banks, suppliers and credit
customers. For example, a bank reconciliation involves comparing cash balances and records of
deposits and receipts between your accounting system and bank statements. Differences between
these types of complementary accounts can reveal errors or discrepancies in your own accounts,
or the errors may originate with the other entities.

Approval Authority

Requiring specific managers to authorize certain types of transactions can add a layer of
responsibility to accounting records by proving that transactions have been seen, analyzed and
approved by appropriate authorities. Requiring approval for large payments and expenses can
prevent unscrupulous employees from making large fraudulent transactions with company funds,
for example.
Five Common Features of an Internal
A system of internal control refers to how businesses maintain environments that deter
fraudulent activities by management and employees. An organization’s components of internal
control are evaluated during the planning phase of an independent financial statement audit. The
results of the evaluation influence the level of detail the auditor will examine. To reduce detailed
testing, and perhaps the audit fee, implement the common features of a proper internal control
system at your business.

Management Integrity

The moral character of managers at your business sets the overall tone for the workplace.
Management integrity is communicated to workers through employee handbooks and procedural
manuals. These same publications also provide employees with necessary training on company
policies and expected behaviors. However, management’s enforcement of policies is the major
indicator of an organization’s commitment to a successful internal control system.

Competent Personnel

Recruiting and retaining competent personnel helps a business properly record accounting
transactions from year to year by providing consistency. The retention of employees increases
the comparability of financial records from year to year. Furthermore, an auditor’s confidence in
the underlying accounting records increases as he observes the reliability of the organization’s
personnel. This in turn reduces an auditor’s assessment of the risk of a material misstatement in
the entity’s financial statements.

Segregation of Duties

Proper segregation of duties is a critical component of internal control because it reduces the risk
of mistakes and inappropriate actions. An effective system separates authoritative, accounting
and custodial functions. For instance, one employee opens incoming mail, a second prepares
deposit slips for daily receipts, while a third deposits receipts in the bank. The previous example
prevents the opportunity of one employee to misappropriate incoming funds.

Records Maintenance

Keeping appropriate records ensures that documentation exists for each business transaction.
Records management involves storing, safeguarding and eventually destroying tangible or
electronic records. Also, appropriate back-up deters an employee or managers from creating
phantom transactions in the underlying accounting records. A good records management
program reduces operating costs, improves efficiency and minimizes the risk of litigation.

Physical and Intangible Safeguards

Safeguards keep unauthorized personnel from accessing valuable company assets. Safeguards
are physical, such as locks on doors, or intangible, such as computer software passwords, and are
a necessary feature of an organization’s internal control system. Many business owners
instinctively protect inventory, cash and supplies. However, blank checks, company letterhead
and signature stamps are items that require safeguarding but are commonly overlooked.
Every company like to believe that its employees and management are above reproach and
would never do something to harm the organization. However, it is also a wise business move to
have systems in place to ensure things are running smoothly and there aren't any issues. Internal
controls are procedural measures an organization adopts to protect its assets and property.
Broadly defined, these measures include physical security barriers, access restriction, locks and
surveillance equipment. They are more often regarded as procedures and policies that protect
accounting data. company records, cash and other assets. Think of these controls as a type of
insurance; no one wants to ever use them, but they are good to have in the event there's an issue.

Internal Control Examples

Internal control procedures document transactions by creating an audit trail. They limit the
actions of employees by requiring authorization, approval and verification of selected
transactions. They segregate duties because certain job responsibilities are mutually incompatible
and, if left unchecked, allow one person too much unsupervised access to company assets. No
individual should be able to initiate a transaction and then approve it, record the information in
accounting records and control the proceeds that result. Internal controls are either preventive or
detective. Preventive controls are designed to prevent errors, inaccuracy or fraud before it occurs.
Detective controls are intended to uncover the existence of errors, inaccuracies or fraud that has
already occurred.

Controls in General

Good insurance is the best "last-resort" internal control a business owner can have. Coverage of
loss due to employee theft may mean the difference between recovering from fraud or closing a
business. Insurers often require certain specified internal controls as a prerequisite for coverage.
An example is requiring pre-employment screening of applicants for key positions. A system of
business forms to track all company transactions is an example of internal controls. Business
forms create an audit trail to track sales, credits, refunds or returns of merchandise; the
movement of inventory; purchasing and ordering from vendors; and receipt of cash and
payments.

Preventive Controls

Detective Controls Explained

Detective controls are internal controls designed to identify problems that already exist. Audits
are an example of a detective control. Monthly reconciliation of bank accounts, review and
verification of refunds, reconciliation of petty cash accounts, audits of payroll disbursements or
conducting physical inventory are all examples of detective controls. Preventive and detective
controls are often required in combination to provide sufficient protection. Computer systems
require preventive controls through acceptable use and access control. Computer usage logs must
be kept. Logs are a form of detective control to be reviewed and audited at regular intervals.
Many prevent controls are based on the concept of separating duties. Examples include
prohibiting the same person from conducting related transactions such as initiating and recording
transactions; making purchases and approving payments; ordering and accepting inventory;
approving vendors and making payments; receiving bills and approving payments; and
authorizing returns and issuing refunds. Payroll preparation and distribution duties and
approving, writing and signing checks should also be done by different people. Examples of
internal controls built around the concept of authorization, approval and verification include
requiring supervisory review and approval of payroll information before disbursement, requiring
interdepartmental dual authorization of payroll data by accounting and human resources
departments and requiring prior approval of credit customers, vendors and purchases.