Internal Control System

A system of internal control refers to the process by which organizations maintain environments that encourage incorruptibility and deter fraudulent activities by management and employees. An organization’s components of internal control are evaluated during the planning phase of an independent financial statement audit. The results of the evaluation directly influence the auditor’s level of detailed testing. To reduce detailed testing, and perhaps the audit fee, organizations implement common features of a proper internal control system.
Management Integrity
Management integrity, or the moral character of persons of authority, sets the overall tone for the organization. Management integrity is communicated to employees through employee handbooks and procedural manuals. The Management Library indicates that in addition to communicating management integrity, policy manuals facilitate training to employees. However, management’s enforcement of policies is the major indicator of an organization’s commitment to a successful internal control system.
Competent Personnel
An organization’s ability to recruit and retain competent personnel indicates management’s intent to properly record accounting transactions. In addition, the retention of employees increases the comparability of financial records from year to year. Furthermore, an auditor’s confidence in the underlying accounting records increases as he observes the reliability of the organization’s personnel. This in turn reduces an auditor’s assessment of the risk of a material misstatement in the entity’s financial statements.
Segregation of Duties
The University of California at Los Angeles notes that a segregation of duties is critical to effective internal control because it reduces the risk of mistakes and inappropriate actions. An effective system of internal control separates authoritative, accounting and custodial functions. For instance, one employee opens incoming mail, a second employee prepares