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INTERNAL CONTROL

The whole system of business control is organized by the management to carry on business in an orderly manner. From auditing point of view, internal control is the measures or system or procedure of handling accounting functions which sufficiently ensure the accuracy of data or helps the auditor to form his independent opinion on the preventive measures introduced by a company. It includes:

Internal Check
The term internal check means that check imposed in such a way on day to day transactions that the work of one person is checked by another person automatically. In this way, errors and frauds are either prevented altogether or if committed are detected by another person.

Internal Audit
It is a continuous review of the operations and records of business by a special staff called internal auditor. In other words, we can say that "the audit of a business conducted by the business itself on continuous basis is called internal audit.

Internal Check for Cash


In the absence of an effective internal control system chances of misappropriation of cash are immense. This can be committed either from the receipt side or the payment side.

Cash Receipts 1. Acknowledgement


A fair system should be adopted to instruct the customers to get a receipt on making payment and the cashier be directed to do so in every case. 2. Receipt Book Printed . Serial numbered Carbon copy type. Kept with the Chief Accountant under lock arid key Issuance one by one. 3. Remittance and Deposit Should be deposited into the business bank the same day or the next day.

4. No Access to Ledgers
The cashier is no allowed to record transactions in the customers ledger under any circumstances.

5. Credit Note
Approved by the Chief Accountant first, if any discount or commission is to be made.

6. Physical Check.
A surprise physical inspection carried out by the Chief Accountant off and on.

Cash Payment 1. Mode of Payment


All payments should be made through "cross cheques"

2. Authorization
Every payment must be approved by the Chief Accountant and internal auditors.

3. Petty Cash Fund


A separate petty cash fund should be established on imprest system and all payments above the fixed limits of each petty expenditure should be made the main cashier by the issuance of cheques.

4. Statement of Accounts
At the end of daily business hours a statement should be prepared separately at accounts and cash departments and reconciled by the Chief Accountant.

5. Recording in Cash Book.


As soon as payment is made, it should be recorded in the cashbook. 6. Safety of Cheque Books Blank cheque books must be under safe custody of a responsible officer; so that these may not be misused for payments by any fraud.

7. Documentary Verification
Before signing the cheque one should verify the documentary evidence for the payment like vouchers, invoices or bills etc.

Internal Check for Purchase and Stores 1. Basis for Purchasing


Preferably on credit basis if terms and conditions remain the same.

2. Establishment of Limit
Various limits, like auditing level and auditing quantity are established in the beginning of the year and then followed strictly.

3. Calling of Quotations
A fair quotation system is to be followed and lowest to be accepted.

4. Placing of Orders
(i) Orders prepared by purchase department according to accepted

Quotations (ii) Checked and inspected by the Chief Accountant and sent directly.

5. Receiving of Goods
(i). Inspection by store keeper. (ii). Inspection report to the purchase department and a copy to be sent to accounts department.

6. Purchases Return
Goods not to be returned due to difference of quantity and price but may be returned due to difference of quality.

7. Payment System
(i) Invoice' checked by purchase department according to inspection repot. (ii) Approval by the Chief Accountant. (iii) Payment through cross cheque.

8. Issuance of Material
(i) Always on written requests of the concerned department. (ii) Copy to accounts department.

9. Return of Material
(i) Any material Issued in excess should be returned to the store. (ii) Particulars of material returned should be entered on a stores debit note, a copy of which should be sent to the accounts department.

10. Physical Check


Surprise inspection to be conducted by the Purchase Manager and reconciled with the stock register.

Internal Control for Sales 1. Basis for Sales


Preferably on cash basis.

2. Receiving Orders
Preferably in writing. All the particulars about goods like name, date and mode of transportation should be written in the Order Received Book. Any verbal order should be confirmed before dispatch of goods.

3. Time Limit
A fixed limit of time should be adopted for sales and store department to execute the order.

4. Dispatch of Goods.
(i) Packing by the stores department according to the instructions of sales department. (ii) Dispatch report to be sent to sales and accounts department.

5. Preparation of Invoice
(i) Prepared by sales department according to the given quotations. (ii) Sent to customers along with goods dispatched.

6. Sales Return

(i) Inspection by store keeper. (ii) Reasons for return determining the inferior quality, damage during transit, wrong packing, and delay in dispatch. (iii) Inspection report to be forwarded to sales and accounts department. (iv) Proper steps to be taken to avoid such reputation in future. (v) Adjustment-in accounts department for credit to customer.

7. Remittance Procedure
(i) Fix time for recovery. (ii) Preference to bank draft.

8. Recovery Procedure
(i) Issuance of reminder. (ii) Personal visit by the sales manager. (iii) Moral pressure of trade associations and other business organizations. (iv) Indirect purchasing through another business party. (v) Legal action to be taken at the end:

9. Sales Book
Prompt recording of entries should be made in the sales book and all sales invoices should be numbered consecutively to facilitate their subsequent checking by the auditors.

10. Written Record


For the purpose of fixing responsibilities in the process of sales, all officers' initials must be recorded, so that a written record of part played in connection with selling of goods may be kept.

11. Suggestion but no Guarantee


The above-mentioned procedure, if adopted and properly introduced, will regulate the business sales and avoid the chances of errors and fraud in this connection but should not be treated as a guarantee by the auditor.

PRINCIPLES OF INTERNAL CONTROL 1. Organization


Enterprises should have a plan of organization. It should clearly define the hierarchy of management. The allocation of duties and delegation of power should be very clear. The system should identify the lines of reporting for all its operations i.e., who needs what types of report and who should report whom.

2. Segregation of Duties
This is very important principle of an infernal control system. The system should provide adequate segregation of duties and should ensure that a complete transaction is not recorded or processed by an individual. A transaction should be split up in parts and each part should be processed by a separate individual.

3. Physical Controls
Physical controls are mainly concerned with the safeguarding of assets. Procedures should be implemented to ensure that only authorized persons have physical access to assets.

4. Authorization and Approval


All transactions should occur and should be recorded only with the authorization and approval of a responsible official of the company.

5. Arithmetical and Accounting Controls


These controls should ensure that all the transactions are checked for their arithmetical accuracy. Further, they are recorded in the correct accounts and in proper period and are subject to proper accounting treatment.

6. Supervision
There should be proper supervisory authorities by which the work of lower staff and day to day transactions are supervised.

7. Management Controls
These are controls, which are taken by the higher management and are other than day to day business procedures.

8. Acknowledgement of performance
Every body who performs a work should acknowledge it. For example, every body should place his/her signatures on documents or statements that are prepared, reviewed or approved by him/her. The purpose is to fix responsibility for a certain action on the person who has performed inadequately.

OBJECTIVES OF INTERNAL CONTROL 1. Authorization


The control system should ensure that all financial transaction s are executed with the authorization of the management. There may be general or specific approval for particular transactions. Different types of transaction need to be authorized by different levels of management.

2. Recording of Transaction
All the transactions should be recorded immediately. The system should ensure that correct amount has been recorded and correct account has been selected. It should also be seen that correct period has been used for recording the transactions.

3. Prevention and Detection of Fraud and Error


One of the most important objectives of a system of controls is to eliminate the possibilities of any kind of fraud and to minimize the chances of error. This view is particularly important in certain types of business like banks and insurance companies who deal with

large sums of cash balances. The system should ensure that the frauds are prevented and errors are identified and rectified at an early stage.

4. Preparation of financial Information


Another important objective is the time of preparation of reliable financial information, most significantly balance sheet and income statement. The particular thing is that the information should be reliable and should be conveyed in time. If we prepare financial statements early, we need to use many estimates, which will be confirmed later on. It suggests that there should be a trade off between the two and the financial statements should be reliable in all material respects and should be provided to users on a timely basis.

5. Compliance with Laws


Every organization has to follow some laws. All the companies are required to follow the Companies Ordinance 1984. There may be certain Laws which are operative only for certain types of business. An important objective of the system of internal control is to ensure that all laws and regulations are complied with in all earnest.

6. Re1iability of Information.
As it has been stated above an important object of the system of internal control is to obtain reliable information. All the economic decision by the users of financial statements is taken on the basis of information provided by the accounting and internal control system. The effectiveness of these decisions depends on the reliability of information. It is important to recognize that management uses certain estimates in the preparation of financial statements like provision for doubtful debts and provision for depreciation. .The use of estimates does not undermine the quality of financial statement.

INTERNAL AUDIT
Audit basically is an assurance service. In order to provide assurance regarding a particular issue or subject, the auditors examine the matter in detail and collect related evidence. On the basis of evidential matter they form and express an opinion. During their audit, the auditors come across nearly all the important areas of business. They evaluate controls for each area. In order, to enhance the utility of audit function and to 'have a continuous check on the routine activities, many large firms particularly financial institutions employ the service of internal auditors.

Definition
"An independent appraisal activity within an organization for the review of operations as a service to the management it is a managerial control which functions by measuring evaluating the effectiveness of other control

This definition can be explained in more detail to have an in depth understanding of the subject,

Independence
The definition states that the internal audit is an independent function. The auditor should be independent in appearance and in fact. Internal auditors are the employees of the firm and therefore it is really, difficult to attain the required level of independence. In order to make the internal audit department independent, Following steps may be taken: I. Establishment of an audit committee of non-working directors who control the functions of the internal audit department. II. There is a completely and separate internal audit department. III. Internal audit department-is staffed with qualified and technical personnel who are members of a recognized professional body and follow its code of ethic like Chartered Accountants or Certified Auditors. IV. Internal audit department unrestricted access to information and records that it needs for its profession purposes. V. Interna1udit department has the c6mplete freedom of reporting to the highest level of management or audit committee. VI. Internal audit staff does not perform other functions of which it carries out audit. They should not be responsible for developing new system. VII. The internal audit staff should have ho restrictions placed their work or any conflict of interests

Appraisal Activity
The internal audit should not perform any work himself. His duty is only to appraise the functions being performed by others. He should critically evaluate the system and functions.

With in an Organization
As stated earlier the internal audit is a separate and distinct department with in an organization. They are the employees of the organization and are a very much a part of it.

Service to the Organization


The Management of any organization requires that the policies and procedures developed should be implemented in a correct way. The management and outside parties also require that any information they received is authentic and has been validated because the effectiveness of a decision depends on the accuracy of information. The internal audit helps management by pointing out the areas where the policies and procedures are not implemented or where they are not followed in the required way.

Measurement and Evaluation of Control systems


An important element of the service of the internal audit department is to make a continuous review of the operations, and processes of business: The internal audit department makes an assessment of the control procedures and presents its recommendations to make them more effective. Therefore, we can say that the internal audit function plays a vital role in strengthening the internal control system of an enterprise. It ensures by continuous reporting that the internal control system is well designed and 'has been implemented throughout the period.

FEATURES OF INTERNAL AUDITING


Internal auditing possess following features: 1. It is established by the management. 2. It is service-to the organization. 3. It is an appraisal function. 4. Main purpose is to review, evaluate and report on the system of internal control. 5. Internal auditor should be independent and objective. 6. The internal auditor should gather and evaluate proper audit service. 7. Internal audit should report his findings. 8. Internal auditor should observe that the use of economic resource is proper, efficient and effective.

ELEMENTS OF INTERNAL AUDIT


We have discussed that internal audit is an important management control. It is critical in nature. The essential elements of an internal audit function can be summarized as under:

1. Independence
The internal auditor should be independent in fact and in appearance. He should not be biased towards a particular view point and should be able to analyze the things from all angles. The internal audit department should not have any interest in other areas of business activity.

2. Professional Qualifications
The internal audit staff should be professionally qualified. Although like external auditors who should be chartered accountants no qualification has been prescribed for internal auditor's position. Still a qualified and professional internal auditor should always be preferred too an unqualified person.

3. Documentation
The work of internal audit should always be properly documented. They should observe the same standards as are observed by external auditors, rather their extent of documentation should be greater. All the work of planning, performance and reporting should be adequately recorded. It is better if standardized documentation is used for common procedures.

4. Proper Planning
The work of internal audit should be properly planned and well structured. It should not be haphazard. Proper planning ensures that attention is devoted to all-important areas and work is allocated within a proper time frame work among staff according to their abilities. It also helps completion of work.

5. Review
It should be ensured that the progress of internal audit work is monitored adequately. The work of junior staff and field workers should be reviewed by senior and competent staff. This review should be evidenced by signatures of concerned staff or by preparing an efficiency memo for field workers who should clear all the deficiencies found in review.

6. Internal Control System


The internal audit function is an important element of overall internal control system. The internal audit staff should assess the adequacy of specific control procedures. It is the primary job of internal audit department to make recommendations to improve the effectiveness of internal control system.

7. Audit Evidence
The internal auditor should gather sufficient appropriate audit evidence to support his findings. Sufficiency is a measure of the quantity of audit evidence and appropriateness is a measure of its relevance and reliability for a particular assertion.

8. Reporting
The infernal audit department should present their findings in proper reports. These reports should be addressed to the audit committee where it exists or to the 'supreme body of an organization which is not engaged in day to day business.