2.

1 Internal control
Every businessman wishes to control its internal accounting work in
such way, that maximum profit can be earned and fraud or error can be
eliminated. So, a planned control is internal control to manage activities.
It controls economic and administrative all types of activities. In other
words, control of expenses on various resources like labor, machine,
currency, management and market is called internal control.
Internal control means not only internal check or internal audit, but the whole
system of control, financial and otherwise, established by the management in
order to carry on the business of the company in an orderly manner, safeguard
its assets and secure as far as possible accuracy and reliability of its records.
-Institute of Chartered Accountants of England and Wales (ICAEW)
Internal control comprises the plan of organisation and all the coordinated
methods and measures adopted within a business to safeguard its assets, check
the accuracy and reliability of its accounting data, promote operations efficiency
and encourage employees to prescribed managerial policies.
-American Institute of the Certified Public Accountants

Internal control is best regarded as indicating the whole system of controls,

financial or otherwise, established by the management in the conduct of a
business including internal check, internal audit and other forms of control.
-W. W. Bigg
Section 134(5)(e) of Companies Act,2013 states the applicability of IFC
for the following persons:

• Directors, to state in their director’s responsibility statement & Board’s Report,

whether they had laid down adequate and efficient internal financial controls
(IFC) to be followed by the company
• Auditors, to additionally present an opinion on whether or not an organization
has an adequate IFC system in place and also the operation effectiveness of such
controls. This should be in addition to the prevailing audit opinion on financial
statements.
So, on the basis of above definitions, it may be stated that a system of
internal control provides a measure for the management to obtain
information, protection and control which are quite important for the
successful working of a business organization

Basic Elements of Internal Control

An effective system of internal control should have the following basic elements:
(a) Financial and other organizational plans: This may take the form of a manual suitably
classified by flow charts. It should specify the various duties and responsibilities of both
management and staff, stating what powers of authorization reside in various members. This is
important as in the event of staff absence or otherwise the correct flow of work and the internal
control system could be vitiated by the wrong implementation of procedures by staff either
innocently or wilfully.
(b) Competent personnel: Personnel are the most important element of any internal control
system. If the employees are competent and efficient in their assigned work, internal control
system can be operated effectively even if some of the other elements of internal control
system are absent.
(c) Division of work: It means the procedure of division of work properly among the
employees of the organization. Each and every work of the organization should be divided in
different stages and should be allocated to the employees in accordance with quality and skill.
(d) Separation of operational responsibility from record-keeping: If each department of
an organization is being assigned to prepare its own records and reports, there may be a
tendency to manipulate results for showing better performance. So, in order to ensure reliable
records and information, record-keeping function is separated from the operational
responsibility of the concerned department.
(e) Separation of the custody of assets from accounting: To protect against misuse of
assets and their misappropriation, it is required that the custody of assets and their accounting
should be done by separate persons. When a particular person performs both the functions,
there is a chance of utilizing the organization’s assets for his personal interest and adjusting
the records to relieve himself from the responsibility of the asset.
(f) Authorization: Under the internal control system, all the activities must be authorized by
a proper
authority. The individual or a group which can grant either specific or general authority for
transactions should hold a position commensurate with the nature and significance of the
transactions and the policy for such authority should be established by the top management.

(g) Managerial supervision and review: The internal control system should be implemented
and maintained in conformity with the environmental changes of the concern. For adapting
any specific control system permanently, how far the procedures of flexible controls have
been followed in real practice should be observed and re-examined.
Objectives of Internal Control
Internal control is of fundamental importance to the auditor, because before he can plan the
tests he intends to carry out in his audit programme, he must decide the extent to which he
intends to rely on the system of internal control. But before depending upon the internal control
system of the organization, the auditor should ensure himself that the following objectives of
internal control being achieved by the organization:
(a) Proper authorization: Transactions are executed with management’s general and specific
authorization.
(b) Prompt recording of transactions: All the transactions are promptly recorded in the
correct amount in the appropriate accounts and in the accounting period in which executed so
as to permit preparation of financial information within a framework of recognized accounting
policies and to maintain accountability of assets.
(c) Restricted access to assets: Access to assets is permitted only in accordance with
management’s authorization.
(d) Actions against deviations: The recorded accountability for assets is compared with the
existing assets at reasonable intervals and appropriate action is taken with regard to any
differences.

Types of Internal Control

The types of internal control can be categorized as follows:
(a) Organization: An enterprise should have a plan of organization which should—
(i) Define and allocatee responsibilities—every function should be in the charge of a specified
person who might be called the responsible official.
(ii) Identify lines of reporting.
In all cases, the delegation of authority and responsibility should be clearly specified. An
employee should always know the precise powers delegated to him, the extent of his authority
and to whom he should report.
(b) Segregation of duties
(i) No one person should be responsible for the recording and processing of a complete
transaction.
(ii) The involvement of several people reduces the risk of intentional manipulation or accidental
error and increases the element of checking of work.
(iii) Functions which for a given transaction should be separated include initiation,
authorization, execution, custody and recording.
(c) Physical
(i) This concerns physical custody of assets and involves procedures designed to limit
access to authorized personnel only.
(ii) Access can be direct or indirect.
(iii) These controls are especially important in that case of valuable, portable,
exchangeable or desirable assets.
(d) Authorization and approval: All transactions should require authorization or approval by
an appropriate person. The limits to these authorizations should be specified. For example, all
credit sales must be approved by the credit control department or all overtime must be
authorized by the works manager.
(e) Arithmetical and accounting
(i) These are the controls in the recording function which check that the transactions have been
authorized, that they are all included and that they are correctly recorded and accurately
processed.
(ii) Procedures include checking the arithmetical accuracy of the records, the maintenance and
checking of totals, reconciliation, control accounts, trial balances, accounting for documents
and preview. Preview means that before an important action involving the company’s property
is taken, the person concerned should review the documents available to see that all that should
have been done has been done.
(f) Personnel
(i) Procedures should be designed to ensure that personnel operating a system are competent
and motivated to carry out the tasks assigned to them, as the proper functioning of a system
depends upon the competence and integrity of the operating personnel.
(ii) Measures include appropriate remuneration, promotion and career development prospects
and selection of people with appropriate personal characteristics and training and assignment
to tasks of the right level.
(g) Supervision: All actions by all levels of staff should be supervised. The responsibility for
supervision should be clearly laid down and communicated to the person being supervised.
(h) Management
(i) These are controls, exercised by the management, which are outside and over and above
the dayto- day routine of the system.
(ii) They include overall supervisory controls, review of management accounts, comparison
with budgets, internal audit and any other special review procedures.
Advantages
The various advantages that may be derived from internal control system are summarized as
follows:
(1) Identification of defects: Under internal control system, the total activities are segregated
in such a way that the work performed by one employee is automatically checked by another
employee. So, if there is any defect in the system, it is easily detected.
(2) Flexibility: In this system, year-wise comparative analysis is done. So, if there is any
change in the mode of operation, the changes in the system could easily be accommodated.
So, the opportunity for flexibility is available.
(3) Savings in time: If the internal control system is in operation in an organization, there is
no needfor the preparation of separate audit programmes for each and every audit
engagement. Thus, it saves time to a great extent.
(4) Lesser risk of omission: Under this system, the total work is subdivided into a number of
activities and each employee is assigned with each type of activity. So, there is least chance
of oversight or omission of any matter.
(5) Provision for training facility: Due to lack of adequate experience, the auditor may face
difficulty in establishing a close relationship between an audit programme and the internal
control system. This system itself provides training facilities to auditors to overcome this
difficulty.
Disadvantages
It is also important to appreciate the following inherent limitations of internal control system:
(1) Chances of human error: The possibility of human error due to carelessness, mistakes of
judgement
or the misunderstanding of instructions may make the system ineffective.
(2) Costly: Management’s usual requirement is that a control procedure should be cost-
effective. But
in many cases, the cost of internal control procedure is not proportionate to the potential loss
due to
fraud and error.
(3) Ignorance of unusual activity: It is the fact that most of the internal control techniques are
directed
towards anticipated types of transactions and not on unusual transactions.
(4) Collusion: There may be the possibility of circumvention of controls through collusion
with parties outside the entity or with employees of the entity.
(5) Abuses of responsibility: It may happen that a person responsible for exercising control
abuses that responsibility.
(6) Rigidity: There is the possibility that the system may become inadequate due to changes in
the conditions and compliance with procedures may deteriorate.
Internal Control Checklist
Checklists are ‘aides-memoire’ to the auditor to ensure all important aspects of the accounts
have been considered. Checklists can also be used in assessing the internal control systems,
when they would list the crucial questions the auditor must ask. Checklists should be
completed, signed and placed on the current working papers files to evidence the fact that the
matters included have been covered.
In fact, checklist is a series of instructions and/or questions which the auditor must follow and
answer. When he completes the instructions, he initials the space against the instruction.
Answers to the checklist instructions are usually ‘Yes’, ‘No’ or ‘Not Applicable’.

A few examples of checklist instructions relating to sales are given as follows:

Checklist for Sales
1. Are books of serially numbered cash sales slips used by sales assistants?
2. Is there a proper system controlling the issue and return of the books of cash sales slips?
3. Are sales assistants forbidden to receive cash?
4. Is a copy of the cash sale slip given to:
(a) the cashier?
(b) the customer?
5. Are the details of prices and calculations shown on the cash sale slips subject to independent
checking?
6. Does the customer, before receiving the goods, take the cash sale slip to the cashier and pay
for the goods?
7. Do sales assistants only deliver goods to the customer against the receipted cash sale slip?
8. Are there regular collections of cash from the cashiers during business hours?
9. Is all cash received banked intact on day of receipt? If not, give details of the system.
10. Is the total of the cash banked reconciled by a responsible official, other than the chief
cashier with:
(a) cashier’s records?
(b) the sales records?

2.2 Internal Check

Internal check includes all methods for true entries in accounts. In its
accounts are checked at various levels by different accounting officers.
In its sequential check eliminates possibilities of frauds.
1. Issue of goods on basis of received purchase order and its entry into
sales book.
2. Cash receiving and issuing receipt
3. Entry in cash ledger
4. Checking of cash ledger.
So, it is very much clear that by dividing a task into units and
checking of each unit separately eliminates possibilities of error and
even can stop the frauds also.
Internal Check is an arrangement of staff duties whereas no one person is
allowed to carry through and to record every aspect of a transaction so that
without collection between two or more persons, fraud is prevented and at the
same time possibilities of error are reduced.
- Spicer and Pegler
Internal check is system under which the accounting methods and details of an
establishment are so laid out that the accounts and procedures are not under the
absolute and independent control of any one person and that on the contrary
the work of employee so complimentary to that of another and that a continuous
audit of the business is made by employees themselves.
- AICPA

All these information cannot define internal control completely but it can be
stated that, it is a management to distribute work among employees in such way that
no transaction can have sole control of any one, any work can be checked by other
employees with the approach to stop fraud.
 Objectives of Internal Check
The objectives of internal check system can be set forth as under—
(a) Assigning responsibility: To allocate the duties and responsibilities of every employee in
such a manner that they may be identified and held responsible for a particular error or fraud.
(b) Minimizing error or fraud: To minimize the possibility of any error or fraud done by any
staff member.
(c) Detecting errors or frauds: To detect errors or frauds easily due to independent checking
of work done by one employee by another employee.
(d) Reducing clerical mistakes: To minimize the possibility of omission of any transaction
from being recorded in the books of accounts.
(e) Enhancing work efficiency: To enhance the efficiency of the staff, as the management of
duties is based on the principle of division of labour.
(f) Obtaining confirmation: To obtain confirmation of facts and entries, physical and
financial, by the presentation and necessary maintenance of records.
(g) Reducing burden of work: To reduce the burden of the work of independent auditor by
introducing the internal check system in a scientific way.
(h) Exercising moral pressure: To exercise moral pressure on the employees by introducing
continuous review process of the total system.
(i) Ensuring reliability: To facilitate business control by ensuring the reliability of accounting
records and books.
(j) Obtaining supervision advantages: To obtain the advantages of supervising the various
assets, inflow and outflow of cash and goods of the business.

Advantages of Internal Check

The advantages that can be derived from internal check can be discussed from
different points of view—

From business point of view

(i) Proper allocation of work: Rational allocation of work among the different staff
members of the organization brings precision in work.
(ii) Control device: The distribution of work under this system is such that it acts as a
control device against unscrupulous employees. The chances of fraudulent
manipulation are thus minimized due to the existence of this check.
(iii) Speedy work: As the individual staff members are engaged in the same type of
jobs for a considerable period of time, it results in efficient performance of the
activities and high speed of work.
(iv) Increase in efficiency and skill: A good system of internal check increases the
efficiency of work among the staff as due to its proper planning for assigning right job
to the right person.
(v) Easy preparation of final accounts: Since no individual worker is allowed to
handle a job completely and the work is divided among the employees in a proper
manner, the books of accounts can be kept up to date and as a result, the final accounts
can be prepared easily.
(vi) Creation of moral check: Knowledge of subsequent checking of each employee,
works by other acts as a great check to commission of errors and frauds.

From the view point of the owners

(i) Reliability on accounts: If there is a good system of internal check, the owner of
the concern may rely upon the genuineness and accuracy of the accounts.
(ii) Orientation of accounting: As the responsibility of each staff is clearly defined
and fixed, it develops a system of accounting, which is known as responsibility
accounting.
(iii) Economical operation: Although it seems that the introduction of well-
integrated system of internal check is costly, but in actual practice it is observed that
the staff patterns are so arranged that the existing staff be properly filled in different
operating area involving no extra cost.

From the viewpoint of the auditor

(i) Facilitation of audit work: Sound and efficient internal check system may
facilitate to a greater extent, the work of the auditor by relying on ‘test check’.
(ii) Attention to other important matters: As the auditor gets confidence on the
internal check system, he can avoid the basic routine checking work to some extent
and can give attention to other important matters.

Shortcoming of Internal Check System

Dependence on each other proves fatal in the quick disposal of the work. If one
person is absent, then day-to-day work will be seriously disrupted. This is the main
shortcoming of the internal check system.

Following are some of the more shortcomings of internal check system:

(a) Monotony: Involvement in the same kind of work may result in monotonous
attitude on the part of the person who is engaged in the same type of job.
(b) Carelessness: The possibility of some of the responsible and high officials being
co-placed, increases as they believe, though not always right that under a sound
system of internal check nothing can go wrong.
(c) Collusion: The real purpose of the internal check is bound to fail if collusion
among the staff exists in disguise.
(d) Limited application: The application of this system is limited only in big
organizations. Its application in small organizations may result in loss of time and
unnecessary expenditure.
(e) Dependence: Statutory auditors in almost all the cases rely on the internal check
system. Accordingly they apply test check and therefore, do not apply thorough
check.
(f) Possibility of disorder: In the absence of a properly organized system of internal
check, there will be chaos and disorder in the working of a business.

2.3 Difference between Internal Check and Internal

audit
Both internal check and audit performs checking but still they have
differences which could understand by following points.
 S. Base of Internal check Internal audit
No. difference
1. Work area It is a method to record It is a method to check
various transactions financial transactions
and accounts
2. Team It is done with accounting It is to be done after
accounting
3. To search out In it fraud is identified In it fraud is identified
fraud during the work after the accounting
work
4. Effectiveness It makes accounting In improves impact of
impactful accounting and internal
checking method
5. Scope Limited upto examining Limited upto internal
checking and
accounting work
6. Time of re In it rechecking is done This work is done after
check with accounting work accounting work
7. Separate staff It do not have separate Separate and qualified
staff for it professional are
recruited.

2.4 Difference between internal audit and statutory

audit
Both internal and statutory audit work for same work area to identify
the errors, but they have some differences as follows –
S.No. Base of Internal Audit Statutory Audit
difference
1. Control of It is freely done by External auditor works
audit business itself by its own auditing
employees
2. Sequence It is done before statutory It is done after internal
audit audit to check its
effectiveness.
3. Duration Work continuously till Starts at end of
year ends accounting year
4. Scope It is wide and includes Scope is limited due to
every business area time limit
5. Statutory No statutory law and Company act 1956,
control control income tax act 1961 and
other laws are
applicable
6. Responsibility Internal auditor Statutory auditor
responsible for managers responsible for
 shareholders and
business owners.
7. Appointment Appointment by Appointment and
managers responsibility
determination by
company
8. Favorable Favorable for company Favorable for managers
managers and all beneficiaries