UNDERSTANDING

INTERNAL CONTROL

Composed by Taufikur Rahman@2002

 Introduction to Internal Control

j Definition of 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 following
categories:
Reliability of financial reporting
Compliance with applicable laws and regulations
Effectiveness and efficiency of operations
 Introduction to Internal Control
j Component of Internal Control
± Control environment
± Risk assessment
± Control activities
± Information and communication
± Monitoring
j Limitation of Internal Control
± Mistakes in judgment
± Breakdowns
± Collusion
± Management override
± Costs versus benefits
 Components of Internal Control

j Control Environment
Integrity and ethical values
Commitment to competence
Board of directors and audit committee
Organizational structure
Assignment of authority and responsibility
Human resources policies and practices
 Components of Internal Control
j Risk Assessment
Changes in operating environment
New personnel
New or revamped information systems
Rapid growth
New technology
New line, products, or activities
Corporate restructurings
Foreign operations
Accounting pronouncements
 Components of Internal Control

j Information and Communication

Refer to Accounting system, consist of
- Methods and records
- Maintain accountability for related assets and liabilities
Providing a clear understanding of individual roles
and responsibilities pertaining internal control
over financial reporting
Focus on control policies and procedures that
transactions be handled in a way that prevents
misstatements in management¶s F/S assertions
 Components of Internal Control
j Control Activities
Segregation of duties
Information processing controls:
- General controls
- Application controls
Physical controls
Performance reviews

j Monitoring
Ongoing activities
Separate periodic evaluations
 Obtaining an Understanding of
Internal Control

j Involve performing some activities such as:

Understand the design of policies and procedures
related to each component of internal control
Determine whether the policies and procedures
have been placed in operation
Identify types of potential misstatements
Consider factors that affect the risk of material
misstatement
Design substantive tests to provide reasonable
assurance of detecting the misstatements related to
specific assertions
 Obtaining an Understanding of
Internal Control

j Procedures to obtain an understanding, consist of:

Reviewing previous experience with the client
Inquiring of appropriate management, supervisory,
and staff personnel
Inspecting documents and records
Observing entity activities and operations
 Documenting the Understanding
of Internal Control

j Required in all audits (included in audit

documentation)
j Form of documentation:
Questionnaires (example F. 9-5 and 9-6)
Flowcharts
Decision table (matrix of the of a computer program) F. 9-7
Narrative Memoranda (auditor¶s consideration of I C)
the end