UNIT II

INTERNAL CONTROL

1. 1. Meaning, Objectives and Limitations:

Meaning:

"The whole system of controls, financial or otherwise, established by the

management in order to carry on the business of the company in an orderly
manner safeguard its assets & secure as far as possible the accuracy &
reliability of its record".

Definition:

Internal Control has been defined as, “ a plan of organization & all the
methods & procedures adapted by the management of an entity to assist in
achieving management objective of ensuring as far as practicable orderly &
efficient conduct of the business''.

Objectives of Internal Control:

a. To evaluate the efficiency of performance in the various activities of the
business.
b. To ensure orderly, efficient & economic conduct of the business.
c. To see that access to & use of assets are made only with proper authorization.
d. To safe guard the assets of the organization by preventing frauds, waste
& inefficiency.
e. To ensure that there is periodical verification & comparison of assets in
existence with those of accounting records & appropriate action is taken,
when there is any difference between the two.
f. To ensure that transactions are recorded in the proper books of accounts
regularly, correctly & systematically according to policies &
procedures & the accounts are accurate & reliable.

Limitations of internal control

a. Judgement:- the effectiveness of control will be limited by decisions

made with human judgement under pressures to conduct business based on
the information at hand.
b. Breakdowns:- even well designed internal controls can breakdown.
Employees sometimes misunderstand instructions or simply make
mistakes. Errors may also result from new technology & the complexity
of com
c. puterized information system.
d. Management Override:- High level personnel may be able to override
prescribed policies & procedures for personal gain or advantage. This
should not be confused with management intervention, which represents
management actions to depart from prescribed policies & procedures for
legitimate purposes.
e. Collusion:- control systems can be circumvented by employee collusion.
Individuals acting collectively can alter financial data or other management
information in a manner that cannot be identified by control systems.

2. Internal check, Meaning, Objectives and Limitations:

Meaning: It is the arrangement of the accounting duties under which the

work of one person comes under the scrutiny(analysis) of another person,
so that it is not possible to commit fraud without collusion between two or
more persons.

Definitions:

According to Joseph Lancaster" Internal check is a method of organizing the

entity operation of office, factory, warehouse & the duties of the respective
staff so that frauds & irregularities are impossible without collusion".

According to LR Dicksee'' Internal check is an arrangement of the

accounting routine that errors & frauds are automatically prevented or
discovered by the very operation of the book keeping itself.

Objectives of Internal Check

a. To prevent the commission of any error or fraud by a clerk
b. To prevent the misappropriation of cash or goods by any clerk.
c. To throw responsibility on a particular clerk, when the fraud or mistake is
detected
d. To detect a fraud or an error quickly & easily.
e. To have an accurate record of all business transactions.

Limitations of Internal Check:

Depending on each other proves fatal in the quick disposal of the work. if
one person is absent, the day-to-day work will be seriously disrupted. Following
are some of the disadvantages of a system of internal check.

1. COSTLY FOR SMALL BUSINESS A system of Internal check system

quite expensive especially for small business houses.
 2. QUALITY IS SACRIFICED FOR PROMPTNESS In an internal check
system quality of work declines because the clerks of the business attach greater
importance to become quick and do not care if in the process their work gets sub-
standardized.

3. CARELESSNESS AMONG HIGH OFFICIALS The possibility of some of

the responsible and high officials being complacent, increases as they believe,
though not always rightly, that under a sound system of internal check nothing
can go wrong.

4. DISORDER IN THE WORKING OF A BUSINESS In the absence of a

proper organized system of internal check there will be chaos and disorder in the
working of business.

5. RISKY FOR AN AUDITOR If the auditor does not apply tests and
procedure his own and if he relies on the output of the system his work cannot be
free from irregularities if the system itself proves to be defective.

3. ESSENTIAL CHARTERISTICS / PRINCIPLES OF A GOOD SYSTEM

OF INTERNAL CHECK

1. RESPONSIBILITY

Responsibility of each individual must be properly defined and fixed. The work
of the business should be allocated amongst various clerks in such a manner that their
duties and responsibilities are clearly and judiciously divided.

2. COMPLETION

The work should be divided in such a way that no single person is allowed to

complete the work solely by himself from the beginning to the end. However,
there should be no duplication of work.

3. ROTATION OF EMPLOYEES

A good system of internal check should not allow person having custody of assets
to have access to the books of account. A system of transfer or rotation of employees from
one seat of work to another must be followed by the business.

4. AUTOMATIC CHECK

A good system of internal check must provide for an automatic checking of the
work of one clerk by the other.

5. RELIANCE

No clerk of the business should be relied upon too much.

 6. SAFEGUARDS

Safeguards should be prescribed to keep un-used cheque books, files and

securities etc.

7. SUPERVISION

A strict supervision should be exercised to ensure that the prescribed internal checks

and procedures are fully operative.

8. FORMAL SANCTION

No deviation should be allowed from the established procedures till it is formally

sanctioned by the top official.

9. PERIODICAL REVIEW

The system of internal check be reviewed from time to time to introduce improvements.

Principles of Internal Control:

INTERNAL CHECK AS REGARDS TO CASH SALES

Internal Control Component Principles

1. Demonstrates commitment to integrity and values

2. Demonstrates independence and exercises oversight
responsibility
3. Establishes structure, authority and responsibility
4. Demonstrates commitment to attracting, developing and
retaining competent staff
1. Control
5. Enforces accountability
environment
6. Specifies suitable, specific objectives
7. Identifies and analyzes risks
8. Assesses fraud risk
2. Risk assessment 9. Identifies and analyzes significant changes
10. Selects and develops control activities that help mitigate
risks
11. Selects and develops general controls over technology
3. Control activities 12. Bases controls on thorough policies and procedures
13. Uses relevant, high-quality information
4. Information and 14. Communicates internally to support controls
communication 15. Communicates externally
16. Conducts on going and/or separate evaluations
17. Evaluates and communicates deficiencies
5. Monitoring
For efficient workin g of sales departm ent, its activities can be arranged in the followin g
manner.

Sales over the counter

1. For each counter, a separat e salesman should be appointed to look after counter.

Each salesm an should be given a separat e sales memo book. Such books should be of
different colours for different counters.
2. The salesm an when he sells the goods to the customers, he should prepare three copies
of cash memo. One copy should be retained for preparin g sales summary & the remain in g
two copies should be handed over to the customer & instruct the customers to m ake
payment at the cash counter.
3. The cashier, after having received the price of the goods from the customer, shou ld
give one copy duly stamped as cash paid to the customer & other copy must be retain ed
by him.
4. At the end of the day, the cashier should prepare statement showing total cash receiv e d
& salesm an should prepare sales summary to know the total sales. Then both these
statements should be sent to the officer in charge for verificat ion.

Posta Sales:
1. A separate register should be maintained for recording sales made by value payable
by post.
2. The goods returned should also be recorded in the value payable by post register.
3. The total receipts on this account should be entered in the value payable by post
register.
4. Any advance received should be entered in the value payable by post register.

Sales by Travelling Agents:

1. The travellin g agents should be allowed to issue rough receipt s to the customers for
cash received on the sale of the articles. final receipt s should be issued only by the
head office.

2. Agents should remit the entire proceeds to the head office or they should deposit the
cash daily in a bank.

3. Agents should not be allowed to deduct their commission out of sale proceeds
collect ed by them.

4. The agent should be asked to submit statements of sales & such statements should
 be check in detail.

5. Head office should maintain a list of debtors & other customers. Reminders should
be sent to those customers who have not cleared their debts.

INTERNAL CHECK WITH REGARD TO CASH PURCHASES

1) REQUISITION The procedure for issuing purchase requisitions should be specified. The
head of the department, who is in the need of goods, should fill in a requisition slip duly
signed and then should send it to the purchases department. The details about the quantity, is
quality and the time by which the goods must be supplied be clearly mentioned in the
requisition slip.

2) ENQUIRY Purchase department makes an enquiry about the terms and conditions of
purchases from different suppliers. For this purpose tender are generally invited. But, who
shall open and accept the tenders, should be clearly specified. At a rule, the lowest tender
should be accepted and accordingly a decision be taken.

3) PURCHASE ORDER The Purchase Department places orders which should be recorded in
the Purchase Order book. Four copies of purchase order should be prepared. One copy will be
sent to the vendor, second to the store department, third copy to the Accounts department and
fourth one will be retained by the purchase department itself. A responsible officer should
review the purchase order, before signing by the authorized person or director.

4) RECEIPT OF GOODS On receipt of goods, the purchase department should be properly

inspecting them, and there after an entry in the goods inward (Receipt) book, the same should
be sent to the stores. Concerned department should be informed about the receipt of the
goods.

5) MAKING THE PAYMENTS The Purchase Department should thoroughly check the
invoices and send the same to accounting department for payment. The accounting
department should compare the invoice with the purchase order and Incoming Inspection
Report and should also verify the calculation. The Accounts Department should enter the
invoice in the Purchase Book. Only responsible official should draw a cheque for the payment
of invoice. At the time of signing, a signing authority must verify that correct payment is
made. If some portion of the goods is returned to the supplier, a proper entry must be made in
the Purchase Return Book. A Credit Note to that effect must be obtained from the supplier
and accounts section must adjust the payment accordingly.

A good system of internal check with regard to purchase will prevent the following types of
 irregularities, errors and frauds.

a. FICTITIOUS PAYMENT Fictitious Purchase may be recorded in the purchase book

and the payments withdrawn may be misappropriated.

b. DOUBLE PAYMENT

c. S Some invoices may be recorded twice and double payment made may be
misappropriated.

d. ARTIFICIAL INFLATION IN PROFITS Goods purchased may not be entered in the

period so as to inflate profits.

e. ARTIFICIAL REDUCTION IN PROFITS Goods not received in one period may be

entered as purchases so as to show profits less than the actual.

INTERNAL CHECK AS REGARDS TO CREDIT SALES AND CREDIT PURCHASES

As regards to credit sales:

a. All orders received are to be serially numbered and entered in the order received book.

b. The original order copy should be sent to the dispatch department.

c. Dispatch department should take necessary steps to collect and pack the goods as per order.

d. Invoice will be prepared in triplicate.

e. Two copies of invoice should be sent to the customers.

f. Accounts department should collect other documents like railway receipt, bill of lading etc.

g. All goods dispatched should be entered with goods outward book.

h. On the basis of invoice sent the sales book should be recorded.

Possible frauds in regard with credit sales:

1. Omission to record in sales book.

2. Recording fictitious sales.

3. Treating sale of fixed asset as sale of goods.

As regards to credit purchases:

A separate department for credit purchases is maintained in big business houses. The success
of the organization depends upon the purchase manager who looks after this department. The total
works connected to credit purchases of goods are divided into five heads.
 1. Assessment of requirements.

2. Making enquiries.

3. Placing of orders.

4. Receipt of goods.

5. Recording in purchases book.

6. Making payments.

INTERNAL CHECK AS REGARDS TO PAYMENT OF WAGES

To minimize the fraudulent manipulations of wage records, cash & the other risks, the
following internal check system can be adopted.

Maintenance of wage records:

1. Time recordin g clock should be maintained for recordin g the time of workers
entering & leaving the place of work.

2. If the workers are paid on the basis of piece wages system, proper books for
recording the actual work done by workers should be maintained.

3. If workers are allowed to work overtime, overtime slip must be issued to such
workers by the properly authorized official.

4. If any worker wants to go out of the factory, he should take written permission from
the authorized person.

5. If casual workers are also employed in the organization, a list of such workers
must be prepared by the foreman of each department. The list so prepared must
be certified by the officer, who is authorized to appoint casual workers.

Preparation of Wage Sheets

The work of preparation of wage sheets should be done by a separat e departm ent.
This work should be done at least by four clerks, so that irregularit ies may be
minimized. For example two clerks should examine the time records, piece wage
records, overtim e records etc. the third clerk should prepare individu al employee
statements i.e. address of the worker work done & rate of wages. The fourth clerk
should check the calculation s & deduct the rent, PF, income tax & installment of
loans etc., from the gross wages to arrive at the net amount to be paid to the
workers. All these clerks should initial the wage sheets before they arc signed by
 the works manager.

Payment of Wages:

1. The cashier should withdraw the net amount as shown in the wage sheets.

2. The payment of wages must be made by a person, who is in no way concern ed

with the preparation of wages sheets.

3. Each worker, who is to receive the wages, should be present at the time of
disbursem ent.

4. The foreman of each departm ent should be present at the time of payment to
identify the workers of his action.

5. The signatures of the workers must be obtained, when they receive the amount of
wages.
6. Special arrangement should be made to pay to the absentee workers.

7. A list of unpaid workers should be prepared by the cashier & foreman of each
department.
8. The officer employin g casual workers should be connected
with the payment of wages.

9. As far as possible casual workers should be paid wages on a day different from the
payment day of regular workers.

10. A surprise visit of a senior official, while the wages arc disbursed will be an
effective measurement of control.
 INTERNAL CHECK AS REGARDS TO CASH SALES

For efficient workin g of sales departm ent, its activities can be arranged in the followin g
manner.

Sales over the counter

2. 1. For each counter, a separat e salesman should be appointed to look after counter.

3. Each salesm an should be given a separat e sales memo book. Such books should
be of different colours for different counters.
4. 3. The salesm an when he sells the goods to the customers, he should prepare three
copies of cash memo. One copy should be retained for preparin g sales summary & the
remainin g two copies should be handed over to the customer & instruct the customers
to make payment at the cash counter.
5. 4. The cashier, after having received the price of the goods from the customer, should
give one copy duly stamped as cash paid to the customer & other copy must be retained
by him.
6. 5. At the end of the day, the cashier should prepare statement showing total cash
received & salesm an should prepare sales summary to know the total sales. Then both
these statements should be sent to the officer in charge for verification.

Postal Sales:
1.A separate register should be maintained for recording sales made by value payable by
post.
1. 2. The goods returned should also be recorded in the value payable by post register.

4. The total receipt s on this account should be entered in the value payable by post
register.
5. 4. Any advance received should be entered in the value payable by post register.

Sales by Travelling Agents:

6. The travellin g agents should be allowed to issue rough receipt s to the customers for
cash received on the sale fthe articles. final receipts should be issued only by the
head office.

7. Agents should remit the entire proceeds to the head office or they should deposit the
cash daily in a bank.

8. Agents should not be allowed to deduct their commission out of sale proceeds
 collect ed by them.

9. The agent should be asked to submit statements of sales & such statements should
be check in detail.

10. Head office should maintain a list of debtors & other customers. Reminders should
be sent to those customers who have not cleared their debts.

INTERNAL CHECK WITH REGARD TO CASH PURCHASES

6) REQUISITION The procedure for issuing purchase requisitions should be specified. The
head of the department, who is in the need of goods, should fill in a requisition slip duly
signed and then should send it to the purchases department. The details about the quantity, is
quality and the time by which the goods must be supplied be clearly mentioned in the
requisition slip.

7) ENQUIRY Purchase department makes an enquiry about the terms and conditions of
purchases from different suppliers. For this purpose tender are generally invited. But, who
shall open and accept the tenders, should be clearly specified. At a rule, the lowest tender
should be accepted and accordingly a decision be taken.

8) PURCHASE ORDER The Purchase Department places orders which should be recorded in
the Purchase Order book. Four copies of purchase order should be prepared. One copy will be
sent to the vendor, second to the store department, third copy to the Accounts department and
fourth one will be retained by the purchase department itself. A responsible officer should
review the purchase order, before signing by the authorized person or director.

9) RECEIPT OF GOODS On receipt of goods, the purchase department should be properly

inspecting them, and there after an entry in the goods inward (Receipt) book, the same should
be sent to the stores. Concerned department should be informed about the receipt of the
goods.

10) MAKING THE PAYMENTS The Purchase Department should thoroughly check the
invoices and send the same to accounting department for payment. The accounting
department should compare the invoice with the purchase order and Incoming Inspection
Report and should also verify the calculation. The Accounts Department should enter the
invoice in the Purchase Book. Only responsible official should draw a cheque for the payment
of invoice. At the time of signing, a signing authority must verify that correct payment is
made. If some portion of the goods is returned to the supplier, a proper entry must be made in
the Purchase Return Book. A Credit Note to that effect must be obtained from the supplier
and accounts section must adjust the payment accordingly.
 A good system of internal check with regard to purchase will prevent the following types of
irregularities, errors and frauds.

f. FICTITIOUS PAYMENT Fictitious Purchase may be recorded in the purchase book and
the payments withdrawn may be misappropriated.

g. DOUBLE PAYMENTS Some invoices may be recorded twice and double payment made
may be misappropriated.

h. ARTIFICIAL INFLATION IN PROFITS Goods purchased may not be entered in the

period so as to inflate profits.

i. ARTIFICIAL REDUCTION IN PROFITS Goods not received in one period may be

entered as purchases so as to show profits less than the actual.

INTERNAL CHECK AS REGARDS TO CREDIT SALES AND CREDIT PURCHASES

As regards to credit sales:

i. All orders received are to be serially numbered and entered in the order received book.

j. The original order copy should be sent to the dispatch department.

k. Dispatch department should take necessary steps to collect and pack the goods as per order.

l. Invoice will be prepared in triplicate.

m. Two copies of invoice should be sent to the customers.

n. Accounts department should collect other documents like railway receipt, bill of lading etc.

o. All goods dispatched should be entered with goods outward book.

p. On the basis of invoice sent the sales book should be recorded.

Possible frauds in regard with credit sales:

4. Omission to record in sales book.

5. Recording fictitious sales.

6. Treating sale of fixed asset as sale of goods.

As regards to credit purchases:

A separate department for credit purchases is maintained in big business houses. The success
of the organization depends upon the purchase manager who looks after this department. The total
works connected to credit purchases of goods are divided into five heads.

7. Assessment of requirements.

8. Making enquiries.

9. Placing of orders.

10. Receipt of goods.

11. Recording in purchases book.

12. Making payments.

INTERNAL CHECK AS REGARDS TO PAYMENT OF WAGES

To minimize the fraudulent manipulations of wage records, cash & the other risks, the
following internal check system can be adopted.

Maintenance of wage records:

6. Time recordin g clock should be maintained for recordin g the time of workers
entering & leaving the place of work.

7. If the workers are paid on the basis of piece wages system, proper books for
recording the actual work done by workers should be maintained.

8. If workers are allowed to work overtime, overtime slip must be issued to such
workers by the properly authorized official.

9. If any worker wants to go out of the factory, he should take written permission from
the authorized person.

10. If casual workers are also employed in the organization, a list of such workers
must be prepared by the foreman of each department. The list so prepared must
be certified by the officer, who is authorized to appoint casual workers.

Preparation of Wage Sheets

The work of preparation of wage sheets should be done by a separat e departm ent.
This work should be done at least by four clerks, so that irregularit ies may be
minimized. For example two clerks should examine the time records, piece wage
records, overtim e records etc. the third clerk should prepare individu al employee
statements i.e. address of the worker work done & rate of wages. The fourth clerk
should check the calculation s & deduct the rent, PF, income tax & installment of
 loans etc., from the gross wages to arrive at the net amount to be paid to the
workers. All these clerks should initial the wage sheets before they arc signed by
the works manager.

Payment of Wages:

11. The cashier should withdraw the net amount as shown in the wage sheets.

12. The payment of wages must be made by a person, who is in no way concern ed
with the preparation of wages sheets.

13. Each worker, who is to receive the wages, should be present at the time of
disbursem ent.

14. The foreman of each departm ent should be present at the time of payment to
identify the workers of his action.

15. The signatures of the workers must be obtained, when they receive the amount of
wages.
16. Special arrangement should be made to pay to the absentee workers.

17. A list of unpaid workers should be prepared by the cashier & foreman of each
department.
18. The officer employin g casual workers should be connected
with the payment of wages.

19. As far as possible casual workers should be paid wages on a day different from the
payment day of regular workers.

20. A surprise visit of a senior official, while the wages arc disbursed will be an
effective measurement of control.

7.
ADVANTAGES OF INTERNAL CHECK

Some of the widely accepted advantages of an efficient system of internal check are as follows.

I. FOR THE BUSINESS

a) PROPER DIVISION OF WORK: Internal check entails a proper and rational distribution of
work among the members of staff of the enterprises keeping in view their individual qualifications,
experience and area of specialization.

b) DETECTION OF ERRORS AND FRAUDS: since no individual worker is allowed to handle a

job completely from the beginning to the end, and the work of each clerk is automatically checked by
the other, this heaps in the early detection and discovery of errors and frauds and the possibilities of
the commission of errors and frauds can be minimized.

c) INCREASED EFFICIENCY COUPLED WITH ECONOMY: A good system of internal

check increase the efficiency of work among the staff and leads to overall economy.

d) MORAL CHECK: knowledge of subsequent checking of each employees work by others, acts as
a great check to commission of errors and frauds.

II. FOR THE AUDITOR

a) QUICK PREPARATION OF FINAL ACCOUNTS : The Profit & Loss Account and the Balance
Sheet are prepared without any loss of time.

b) CONVENIENCE TO AUDITOR : Where an organization is operating system internal check, the

statutory auditor may conveniently avoid detailed checking of the transactions. He may apply a few
tests here and there and can relieve himself from detailed checking.

III. FOR THE OWNER

a) ACCURACY OF THE ACCOUNTS CAN BE RELIED UPON: If there is a system of internal

check the owner of the concern may rely upon genuineness and accuracy of the accounts.

b) INCREASE IN PROFITS: Overall efficiency and economy in operations result in more profits—
thus ensuring larger dividends for the owners or shareholders.

DISADVANTAGES OF INTERNAL CHECK

Depending on each other proves fatal in the quick disposal of the work. if one person is absent, the
day-to-day work will be seriously disrupted. Following are some of the disadvantages of a system of
internal check.

1. COSTLY FOR SMALL BUSINESS : A system of Internal check system quite expensive
especially for small business houses.

2. QUALITY IS SACRIFICED FOR PROMPTNESS: In an internal check system quality of work

declines because the clerks of the business attach greater importance to become quick and do not care
if in the process their work gets sub-standardized.

3. CARELESSNESS AMONG HIGH OFFICIALS: The possibility of some of the responsible and
high officials being complacent increases as they believe, though not always rightly, that under a
sound system of internal check nothing can go wrong.

4. DISORDER IN THE WORKING OF A BUSINESS: In the absence of a proper organized

system of internal check there will be chaos and disorder in the working of business.

5. RISKY FOR AN AUDITOR: If the auditor does not apply tests and procedure his own and if he
relies on the output of the system his work cannot be free from irregularities if the system itself proves
to be defective.

7) INTERNAL AUDIT, MEANING, ADVANTAGES AND DISADVANTAGES:

INTERNAL AUDIT
Meaning:- Internal audit is a continuous & systematic review of accounting, financial & other
operation s of a concern by the staff specially appoint ed for the purpose.

Internal audit is an indepen dent, objective assurance & consulting activity design ed to add
value & improve an organization s. The role of internal audit is to provide indepen dent
assurance that an organizat ion s risk managem ent govern an ce & internal control process are
operatin g effectively.

Features of Internal Audit

1. Management integrity:- Management integrity is communicated to workers through

employee handbooks & procedural manuals. These same publications also provide
employee with necessary training on company policies & expected behaviours
2. Competent Personnel:- Recruiting & 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.
3. Segregation of Duties:- Proper segregation of duties is a critical compon ent of
internal control because it reduces the risk of mistakes & inappropriate actions. An
effective system separat es authorities, accordin g & custodial functions.
4. Records Maintenance:- a good records management program reduces operatin g
costs, improves efficien cy & minimizes the risk of litigation. Keepin g appropriat e
records ensures that document ation exists for each business transaction.

Objectives of Internal Audit

1. To verify the correctness, accuracy & authenticity of the financial accountin g &
statistical records presented to the managem ent.

2. To facilitate the early detection & prevention of frauds.

3. To comment on the effectiven ess of the internal control system & the internal check
system in force & to suggest ways & means to improve these systems.

4. To examin e the protection afforded to compan y's assets & use of them for business
purpose.

5. To identify the authorities respon sible for purchasin g assets & other items as well as
disposal of assets.

6. To ensure that the standard accounting practices which have to be followed by the
 organization are strictly followed.

7. To understand special investigation for the management.

8. To assist managem ent in achievin g the most efficient administration of the operation
by establishin g procedu res by complyin g with compan y's operatin g policies.

Merits of Internal Audit

1. To ascertain whether the internal check & accounting system arc adequate & effective.
2. To ascertain whether the predetermined policies, plans & procedures have been
complied with.
3. To evaluate the perform an ce of the personn el, who are entrusted with certain
responsibilities?
4. To ascertain whether the properties of the concern are safeguarded.
5. To suggest to the management the improvements desired in the internal check system
accounting system.

Demerits of Internal Audit

1. Introduction of an internal audit system is quite expensive, as it involves additional costs,.

Therefore, it is suitable only for big concern but not for big concerns but not for small
concerns.
2. If the internal audit system is not properly organized, it may create chaos
(misunderstanding) disorder in the working of the business.
3. It is purely? Optional or voluntary. It is conducted in addition to external audit by the
employees of the concern, who may or may not be the CA, to ascertain whether the work
of the concern is going on smoothly, efficiently & economically.

8) DIFFERENCES BETWEEN INTERNAL CHECK AND INTERNAL AUDIT:

Basis Internal check Internal Audit

1.Meaning It is the arrangem ent of the Internal audit is a continuous &
accounting duties under which the systematic review of
work of one person comes under the accounting, financial & other
scrutiny (analysis) of another person, operations of a concern by the
so that it is not possible to commit staff specially appointed for the
fraud without collusion between two purpose.
or more person s.

2.Scope The scope of internal check is quite The scope of internal audit is
limited. quite broad.
3.commcncem ent It starts operatin g from the moment a It starts only after the
of work transaction is entered. transaction have been recorded
in the books.

4.suitability Any organization can adopt the It is adopted only by those

system of internal check business undertakings, who
really need it.
5.Nature of work The work of one employee is The work of an employee is
automatically & indepen dently checked by the internal auditor,
checked by another person after the former has finished the
simultaneously. work.
6.Appointment of There is no separate staff anointed There is a separate salaried staff
staff specially for the purpose of internal auditors specially
appointed for the purpose of
internal audit

7.Objectives Aims at the prevention or Aims at discoverin g the errors

minimization of errors & frauds. & frauds already committed.

DIFFERENCES BETWEEN INTERNAL AUDIT AND EXTERNAL AUDIT

Basis Internal Audit External Audit

I .conduct of audit It is conducted by the staff of the It is conducted by an
organization. independent & qualified
chartered accountants.
2.Periodicity It is carried out continuously It is carried out generally,
throughout the year. once m a year.
3.scope of audit The scope of internal audit is The scope of external audit is
determined by the management determin ed either by statue or
by agreem ent.
4.Object of audit It is to ascertain whether the internal It is to find out whether the
check & accounting systems in the financial statements exhibits a
business are adequate & effective true & fair state of affairs of
. the business unit or not.
5.Naturc of work Auditor examin es both accountin g & Auditor examines only the
non-accountin g transaction s accounting transaction s
6.Audit Report It is not required to submit any audit It is required to submit his
report. audit report to the
shareholders or owners of the
business unit.
7.Respon sibility It is responsible only to the It is responsible to all the
management. stake holders of the business
unit.
8.Duties The duties of an internal auditor can The duties of an external
be modified or reduced by the auditor cannot be modified or
management. reduced.
9.Appointm ent It is appointed by the management. It is either appointed by the
shareholders or by the
government.
I 0.REmuneration The remuneration of an internal The remuneration of an
auditor is fixed by the management. external auditor is fixed by the
shareholders or owners.
11.status Internal auditor does not enjoy External auditor enjoys
indepen dent status indepen dent status.
12.Detection of Detection of errors & frauds are the Detection of errors & frauds
errors & frauds
main objective of internal audit. arc the secondary objective of
external audit.
 DEPRECIATION AND OTHER TERMS

INTROCUTION:
The concept of depreciation is linked with the concept of business income. In the revenue
generating process the use of fixed assets consume their economic potential. At some
point of time these assets become useless and are disposed of and replaced.

DEFINITION:
According to pickles, “Depreciation is the permanent and continuing diminution in the
quality, quantity or value of the asset.

MEANING:
Depreciation is a continuous, permanent and gradual decrease in the value of an asset
due to one or the other cause.
CAUSES OF DEPRECIATION:
1. Wear and tear.
2. Exhaustion.
3. Obsolescence.
4. Efflux of time.
5. Accidents.

DISTINCTIONS BETWEEN DEPRECIATION AND OTHER TERMS

1. Depreciation and Depletion: The term depreciation necessarily means fall in the book value
of a fixed asset, whereas the term depletion implies removal of an available but irreplaceable
resource. Such as extracting coal from coal mine.
2. Depreciation and Amortization: Depreciation is different from amortization. Amortization
is a process writing off intangible assets such as patents, copy rights etc.
3. Depreciation and Fluctuation:

DEPREC IAT ION FLUCTU AT ION

It reduces productive capacity or It does not reduce productive capacity

1. utility of asset. 1. or utility of asset.

2. It must occur 2. It may not occur

 It reduces value of asset The value of asset may arise or fall on
3. gradually. 3. account of fluctuation.

Generally it is not taken into account.

Loss by way of depreciation must However, in case of current assets
4. be considered. 4. permanent fall in price is considered.

It is a regular loss – it must be

charged throughout the working
5. life of asset. 5. It is generally irregular.

It may indicate either profit or loss.

Increase in market value means profit,
6. It always indicates loss 6. while decrease means loss.

OBJECTIVES OF PROVIDING DEPRECIATION:

a. To Replace Fixed Assets

The main objective of charging depreciation is to accumulate adequate fund to replace old asset with
the new one after the useful life.

b. To Reveal True Financial Position

Depreciation is charged to fixed assets which help to show the current value of the asset. Therefore it
helps to show true financial position (assets and liabilities position) of the business.
c. To Reduce Tax Liability

Amount of depreciation is deducted from the operational profit of the business which reduces taxable
liability of the firm.

d. To Determine True Profit

Depreciation (the decline in the book value of fixed assets) is charged to revenue like other operating
expenses. So, it helps to determine true profit of the firm.

e. To Determine Cost Of Production

Depreciation should be charged to fixed assets like machinery and plants in order to determine true or
actual cost of production.