Internal Control

1. Internal Control

2. Internal Control Definition • A process, effected by the entity’s board • of directors, management and other • personnel, designed to provide reasonable • assurance regarding the achievement of • objectives.

3. Internal Control Objectives 1. Reliability of financial reporting 2. Efficiency and effectiveness of operations 3. Compliance with laws and regulations

4. Five Components of Internal Control Control Environment Risk assessment Information and communication Control activities Monitoring

5. The Control Environment • Integrity and ethical values • Commitment to competence • Board of directors or audit committee participation

6. The Control Environment • Management’s philosophy and operating style • Organizational structure • Human resource policies and practices

7. Risk Assessment • Identify factors that may increase risk • Estimate the significance of the risk • Assess the likelihood of the risk occurring • Determine actions necessary to manage the risk

8. Control Activities 1. Adequate separation of duties 2. Proper authorization of transactions and activities 3. Adequate documents and records 4. Physical control over assets and records 5. Independent checks on performance

9. Adequate Separation of Duties Custody of assets from Accounting Authorization of transactions from The custody of related assets Operational responsibility from Record-keeping responsibility IT duties from User departments

10. Proper Authorization of Transactions and Activities • General authorization • Specific authorization

11. Adequate Documents and Records • Prenumbered consecutively • Prepared at the time of transaction • Designed for multiple use • Constructed to encourage correct preparation

12. Physical Control Over Assetsand Records The most important type of protective measure for safeguarding assets and records is the use of physical precautions.

13. Independent Checks on Performance The need for independent checks arises because internal control tends to change over time unless there is a mechanism for frequent review.

14. Information and Communication The purpose of an accounting information and communication system is to… initiate, record, process, and report the entity’s transactions and to maintain accountability for the related assets.

15. Monitoring Monitoring activities deal with management’s ongoing and periodic assessment of the quality of internal control performance… to determine whether controls are operating as intended and modified when needed.

16. Methods Used to Document Understanding Narrative Flowchart Internal control questionnaire

17. Evaluating Internal Control Operation • Update and evaluate auditor’s previous • experience with the entity • Make inquiries of client personnel • Examine documents and records • Observe entity activities and operations • Perform walk-throughs of the accounting system

18. Evaluating Significant Control Deficiencies SIGNIFICANCE Material Material Weakness LIKELIHOOD Remote Probable Immaterial

19. Identify Deficiencies and Weakness • Identify existing controls • Identify the absence of key controls • Consider the possibility of compensating controls • Decide whether there is a significant deficiency • or material weakness • Determine potential misstatements that could result

20. Communications • Communications to those charged with governance • Internal audit reports

21. Tests of Controls The procedures to test effectiveness of controls in support of a reduced assessed control risk are called tests of controls.

22. End of Chapter