The Importance of Internal Controls in Accounting: A Comprehensive Guide

Every organization needs an effective internal control system to correct discrepancies and support accuracy in financial records. Businesses use internal controls in accounting to set up procedures for quickly detecting mistakes and preventing fraud. 

Using internal control procedures, businesses can prevent accountants from creating fraudulent financial documents, inflating earnings, manipulating the payroll, misreporting liabilities, or hiding expenses and bad debts.

But what types of internal control procedures should businesses set up? What are the benefits of internal control in accounting? This article discusses everything you should know about the need for accounting controls and procedures. Keep reading for more information.

What Are Internal Controls?

Internal controls in accounting are the policies and procedures that organizations use to ensure stability and integrity in their financial records. Through internal controls, businesses can ensure that their accounting practices are more dependable. Internal controls also help businesses to protect their finances and other assets from fraud. It helps accountants, financial controllers, and auditors to ensure accurate financial reporting within the organization.

What Is the Purpose of Internal Controls?

The purpose of internal control could be to find or detect anomalies, prevent accounting errors, or correct errors and stop them from causing further problems. The following are more detailed explanations of the reasons for conducting internal controls in the first place.

1. Detecting Mistakes and Anomalies

One of the reasons for conducting internal controls in accounting is to detect the anomalies and mistakes already inside the business’s accounting processes. After finding the mistakes, the accounting team can take measures to fix them. The forms of internal control include inventory checks and counts, surprise cash counts, internal and external audits, and reconciliations.

2. Prevent Errors and Irregularities

Internal controls in accounting also serve the purpose of preventing errors and irregularities that may occur. This is by improving clerical accuracy, preventing employee fraud, and preventing serious accounting issues. The types of internal control involved in this include double-entry accounting, expense verification, and segregation of duties.

3. Correcting Mistakes

After detecting errors and mistakes in accounting records, businesses must take corrective measures, which are infused into the internal control system. It involves the use of procedures such as physical asset and inventory audits, ledger verification, employee disciplinary action, and accounting system adjustments.

Why Are Internal Controls Important in Accounting?

No business can afford not to have an effective internal control system. That is because without proper internal controls in accounting systems, it could be impossible to support accuracy in the organization’s financial records. Here are the reasons why accounting controls are important:

1. Reliable and Accurate Financial Information

With a strong internal control system, there is a guarantee that a business will have accurate and reliable financial statements. It helps build trust with investors, creditors, and government regulators. Additionally, accurate financial statements help improve accuracy in decision-making.

2. Identification and Rectification of Errors and Discrepancies

Through stringent internal control procedures businesses can detect and rectify errors before they become serious financial issues. A proper internal control system should segregate the duties of those involved in the accounting process to reduce the risk of fraud, manipulation, or embezzlement.

3. Promotion of Transparency and Accountability

Every business should strive to maintain high levels of transparency and accountability in its operations through stringent procedures in accounting. Internal controls in accounting make it possible for employees to understand and stick to their roles and obligations. 

4. Prevention of Fraud

The main reason for the several types of internal control is the protection of business assets from misuse, theft, and fraud. That is because it is possible to detect mistakes before they occur. Even where mistakes have already occurred, the business can take corrective action before it loses any of its properties.

5. Improving Operational Efficiency

A stringent internal control system can streamline workflow and other processes, enabling improved operational efficiency. This is because one of the control activities in accounting is the clear definition of processes and worker responsibilities. Organizations are able to minimize errors, eliminate redundancy, and improve productivity.

6. Meeting Compliance Requirements

One of the roles of internal controls in accounting is to help companies to meet regulatory requirements. Most accounting and organizational internal control procedures align policies and processes with relevant laws and prevailing accounting standards. This is particularly significant for heavily regulated businesses such as those in finance, energy, and health.

Types of Internal Control in Accounting

How many internal controls are there in accounting? There are many types of internal control in accounting but not all of them apply all the time. The following are the most used in all types of businesses:

1. Accounting System Access Controls

One of the main preventive controls in accounting is the restriction of access to accounting systems by employees and managers. This reduces the risk of the manipulation of financial information and the perpetration of fraud.

It is one of the preventive controls in accounting that ensure only authorized persons can review transactions and changes in the system. Later, accountants review the system to uncover irregular activities pointing to inadvertent errors or outright fraud.

2. Separation of Duties

Separation or segregation of duties is also one of the preventive controls in accounting. It prevents any single person in accounting from having enough authority or information to perpetrate fraud or introduce errors into financial transactions. Thus, in segregating duties, an organization should ensure that only one person writes and signs checks, manages cash receipts and deposits, prepares financial statements, approves invoices, reconciles bank accounts, or approves financial statements transactions.

Where complete segregation is not possible, the organization’s internal control system may involve the rotation of various duties and functions among various employees. This ensures that no single employee can work autonomously for too long.

3. Periodic Reconciliation of Business Activities, Accounts, and Transactions

The purpose of this type of internal control is to confirm that independent account balances match those in the accounting system. It involves reviewing payment registers, bank statements, and logs into the system. An authorized and trusted person should conduct the perioding reconciliation of wired funds, cleared checks, and cash deposits. They should highlight any errors and mark them as potential fraud.

4. Double Entry Accounting

Detective controls in accounting, such as the double-entry system, are effective in protecting organizations against costly errors. Making it part of an organization’s internal control system helps in the efficient tracking of assets, liabilities, and equity. It also makes it easier to detect errors by keeping company accounts balanced. Using daily or weekly trial balances, accountants can correct discrepancies and prevent fraud.

Common Internal Control Procedures in Accounting

To conduct the several types of internal control, accountants implement various procedures, which might not be standard for all types of businesses. The following are the internal control procedures that organizations could employ to prevent fraud and promote accountability:

1. Procedural Updates

Effective internal control in accounting involves assessing and reviewing the internal control procedures. The management communicates with the staff about the implementation and functioning of internal controls. Thus, everyone knows what is happening in the organization.

2. Reviewing Processes

Another common procedure involves an organization analyzing or reviewing the effectiveness of its internal control system. They use information from various reports, such as, audits, reconciliation of assets, and trial balances to assess the effectiveness of quality control within the business organization.

3. Assessing Risks

All types of internal control in accounting aim at managing and controlling risks. Thus, as part of its internal control procedures, every organization should evaluate the areas that are most prone to errors and fraud to reduce the likelihood of losses. There should be greater control in areas with the highest risk levels.

4. Creating a Positive Atmosphere

Regardless of the types of internal control involved, businesses should strive to create an environment of trust and integrity among all levels of employees. As such, the leaders should set a tone of honesty and transparency to encourage employees to follow established internal controls and protect the company assets without added scrutiny.

The Place of Technology in Internal Controls in Accounting

You do not have to meet physically with all employees to implement accounting controls in your organization. As part of your internal control system, you could implement collaboration software like the Basil Practice management to easily communicate with all the employees in your accounting function. 

It is refreshingly simple software for accountants looking to use collaboration within or outside the organization. So, if you are looking for an affordable, efficient, all-in-one, and simple collaboration software for accountants and CPAs, get Basil today.