CHAPTER 13:
INTERNAL CONTROL
J.L. Boockholdt, Ph.D., C.P.A.,
C.M.A.
By: Dr. 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:
1. An organization’s control
environment,
2. risk assessment procedures,
3. control activities,
4. information and communication
methods, and
5. 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.