Limitations of the internal control systems
Internal controls are the procedures that the management institutes in the company in order to ensure the operations are running smoothly. The objective of implementing an internal control system is to ensure effectiveness and efficiency in the business, enable management detect, prevent and correct irregularities and ensure the organizational assets are safeguarded from misuse or theft. The internal control system however has some limitations. They are events that occur that will prevent the system from accomplishing the mentioned objectives (Pfister, 2009). The three inherent limitations of the internal control system are:
One of the crucial internal controls is segregation of duties and setting of authorization limits. In an organization, there is segregation of duties especially in the finance department. The person who prepares the invoice is not the one preparing and signing the cheque for payment to the suppliers. This is to avoid staff collaborating with the suppliers to defraud the company. However where the staff collude or collaborate together to defraud the company, the internal control system is not able to safeguard the company assets.
2) Overriding of Controls by Management
The involvement of management in the processes of the company acts as an internal control itself that they will ensure the company operations are run smoothly. However where the management chooses to override the controls, the internal control system is not able to meet all its objectives (Hall, 2006). In a credit department, there are different credit limits attached to different suppliers according to the policies of the company. However, the manager may choose to override the control and give excess credit limits to a particular customer. When the customer defaults on payment, the company’s assets are not safeguarded.
3) Human Errors:
There is the operational risk that someone will key in the wrong information in the system. At the source, once the keyed in data is wrong, the data processed at the end will be incorrect. Even with staff checking other staff work, there is the potential for misunderstanding the instructions, judgmental mistakes, carelessness and distraction of the staff as they perform their work.
Internal Control Procedures: There are different kinds of internal control procedures that a company can implement to ensure its operations run smoothly. .
The Internal Audit Function: This is a department that is set up within the organization to check on the effectiveness and efficiency of the other internal controls. A company will have its financial statements audited at the end of the year by external auditors which is mandatory by the laws of the country. However, the management may set up an internal audit function to assist them check on the effectiveness of the internal controls. The audit department carries out an appraisal of all the departments control processes and reports to management any deviations in following the procedures. The auditors recommend to management the corrective actions that should be taken. They can recommend redesigning the other internal controls, training of staff or recruitment of more staff. To carry out its functions properly, the audit department should be independent of other departments and report to senior management.
Reconciliations of company accounts
In an organization there should be continuous reconciliations of the bank and cash accounts, petty cash accounts and inventory accounts (Needles & Powers, 2010, p 264). The staff concerned should document the causes of the differences in the accounts. Differences should not be left un-reconciled for a long time. Reconciliations assist the company detect irregular transactions such as instances of fraud, human error and theft in good time.
The reconciliations could be conducted by an independent person, different from the person who is the custodian of the cash or stock. The independent staff can also carry out stock counts to ensure all is running well.
Signs of lack of an Internal Control System
Occurrences of fraud in an organization are an indication of lack of internal controls. The staff is able to steal the company’s stock, cash and other valuables easily. There is no mechanism in place to ensure that attempts to defraud the company are detected, prevented or addressed. One would observe that the accounting and custodial duties in the organization are not segregated. The person keeping the stock is the same person maintaining the accounting records. He can easily steal the stock and manipulate the accounts to cover the theft.
Unexplained Differences in Bank Accounts
Another sign of a weak internal control system are unexplained differences in the cash or bank accounts. These differences have been in the accounts for long and the staff in charge of the accounts cannot fully explain the differences. There are no reconciliations carried out. Neither is a stock count carried out. There is no independent person supervising the accounts to see that reconciliations are being conducted. Prepaid expenses are an asset for the company since they have paid for a service that they have not yet consumed. If the adjusting entry is not made in the system, then the expenses for that period are overstated leading to understating the profit for that quarter. The management accounts are prepared for senior management to aid in decision making every quarter. Incorrect financial statements may lead to poor decision making.
Hall, J.(2006). Accounting Information Systems. Mason: South Western College Publishers.
Needles, B. & Powers, M.(2010) Financial Accounting. Belmont: Cengage Learning.
Pfister, J.(2009) Managing Organisational Culture for Effective Internal Control: From
Practice to Theory. Berlin: Physica-Verlag Publishers