Importance of Internal Control in an Organization

Internal control requires the cooperation of employees on every level within an organization.

Internal controls are rules, procedures and policies put into place to ensure the integrity of financial reporting, operations and compliance within an organization. Internal controls pay an important role in all organizations, no matter the size. Internal controls help prevent errors and detect fraudulent activity. An internal control environment is not absolute but provides reasonable assurance that a company is in compliance with internal and external policies and regulations.

Helps Prevent Errors

Internal controls are very important in the prevention and detection of human errors. A properly implemented internal control system has checks and balances in place to catch errors. For example, after cash entries are entered into the accounting system, a reconciliation process should take place. To further enhance the prevention of errors, a person other than the one entering the cash into the system should reconcile the accounts. In the event an error is detected, a process is in place to rectify the problem before any financial information is presented to anyone. Another example of how internal controls detect errors is by having management sign off on accounting transactions above a certain dollar amount. The manager looks for any data that doesn't seem correct and investigates further. If an error was made, the manager informs the employee so that the error is corrected.

Financial Reporting

Internal controls play an important role in the accuracy of financial reporting. Internal and external users depend on financial reports to make informed decisions in reference to an organization. If financial reporting is skewed, it is harmful to users and the company. Internal controls are not just important in public companies that are required to make financial statements available to the public but also small companies. Federal law governs the use of financial statements within a public company. Internal controls help companies stay in compliance with federal laws and regulations.

Fraudulent Activity

Internal controls help prevent and detect fraudulent activity within an organization. An internal control process should implement a separation of duties. One person should not have the responsibility of overseeing an entire process within an organization. For example, in the accounting department of an organization, one group should have the responsibility of receiving payments from customers. The group should make copies of the payments and send them to another group that is responsible for entering the revenue into the accounting system. This process alone would prevent employees from manipulating numbers. All financial information should go in files for a certain period of time. If there is ever suspicion of fraudulent activity, a manager can pull records to reference data.

Increases Credibility

Depressed economic conditions have caused many lenders to become more selective when lending companies money. Vendors have also increased their selectivity in terms of offering lines of credit to companies. Having an effective internal control environment increases your credibility amongst lenders and vendors. Lenders and vendors are more willing to do business with you because they know your company has measures in place to prevent fraud, theft and careless errors.

References

• University of California Office of the President: Understanding Internal Controls
• Woodbridge Risk Management Articles; The Importance of Corporate Internal Controls; Wolfgang Jaegel
• BKD Insights; Benefits of an Effective Internal Control Environment; Jason Myers; June 2010

Resources

• AICPA: The Importance of Internal Controls in Financial Reporting and Safeguarding Assets