As discussed previously, the accounting system provides businesses with a uniform way in which to use their data and financial information. The three key divisions within the accounting system, of analysis, design, and implementation must be complemented with a system of control. This internal control is a system within a system, but plays a key role in the success of the accounting system. The internal controls protect our businesses from abuse and fraud; they ensure that the information we're receiving is accurate and timely, and that all regulatory requirements are being met. So how are internal controls set, and how does the control system function? Let's take a closer look.
There are five key elements of internal control: environmental control, risk assessment, control procedures, monitoring and information and communication. Each area contributes an essential part of the control system as a whole, and without all of the key elements present, the controls and control system doesn't work.
The environmental control refers to management and employee attitude and behavior. The goals and objectives of management will affect employee behavior and attitude throughout a business and if the goal and objective of the management is to achieve certain sales levels at all costs, this discourages employees to adhere to the internal controls in place and encourages achievement of what management wants, never mind the consequence. The human resources department of a business will provide much of the input for effective environmental control.
Risk assessment incorporates a businesses ability to analyze business risks, estimate their importance and react or act accordingly. Risk assessment is generally a managerial function, but can be included in a day to day analysis by employees, if the work environment includes risks and dangers.
The first two internal controls elements do not seem to have very much to do with an accounting system, but if you will stop and really think, each of these areas can have a tremendous affect upon the profitability and successful operation of a business. Therefore, they are an essential part of the accounting systems internal controls.
The next element, the control procedures simply provides the stated methods for carrying out the environmental controls, the risk assessment, the monitoring, and the information communication that must take place in the internal control process. In order to decrease the potential for fraud, inadequately trained personnel, and eliminate process error, control procedures benefit the company, the management, and the employee of a business. Control procedures greatly affect the information and communication aspect of the business, in that so much of the communication of the state of the business is dependent upon the information furnished by each department. The checks and balances that the control procedures provide assures a business that each department will provide timely and honest as well as accurate and useful information.
The monitoring of internal controls for effectiveness and necessity is the feedback element of the process. Without adequate monitoring of implemented procedures, how does a business determine the systems effectiveness? They can't.
Information is for educational and informational purposes only and is not be interpreted as financial or legal advice. This does not represent a recommendation to buy, sell, or hold any security. Please consult your financial advisor.