Internal controls are methods put in place by a company to ensure the integrity of financial and accounting information, meet operational and profitability targets, and transmit management policies throughout the organization. Internal controls are defined as, “Systematic measures (such as reviews, checks and balances, methods and procedures) instituted by an organization to (1) conduct its business in an orderly and efficient manner, (2) safeguard its assets and resources, (3) deter and detect errors, fraud, and theft, (4) ensure accuracy and completeness of its accounting data, (5) produce reliable and timely financial and management information, and (6) ensure adherence to its policies and plans.”
Internal controls are broadly defined into one of two categories: preventative or detective. Preventative internal controls are policies and procedures that do not allow certain events to occur, these controls are proactive in nature and the first line of defense in a financial accounting system. Whilst, Detective internal controls are the backup procedures that ensure the preventative internal controls are operating as intended. Items or events missed by the first line of defense have the potential to be caught by this second set of controls.
Internal controls may also be grouped according to the activity or policy they enact. For preventative controls, the most common internal control, for example, is the implementation of segregation of duties. Tasks are delegated among several people to ensure no single individual is in a position to authorize, record, and be in custody of a financial transaction and the resulting asset. Authorization of invoices and verification of expenses are internal controls. In addition, preventative internal controls include limiting physical access to equipment, inventory, cash and other assets.
Detective internal controls include the use of performance reviews, including the use of budgets, forecasts and other benchmarks. Unexpected conditions or unusual results require follow-up. Reconciliations are used to compare data sets, and corrective action is taken upon material differences.
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