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You can’t run an effective business without proper accounting. But sadly, certain names earn accounting a bad rap. Think Bernie Madoff, Worldcom, Enron, and some more recent ones we can’t mention because they need to have their day in court first. It’s too easy to manipulate the numbers, skim, and duplicate the books. That is… if robust internal accounting controls aren’t in place to ensure those numbers are accurate and without omissions.

What Are Internal Controls?

Internal controls include your internally established and followed accounting practices to maintain the integrity of your financial reporting.

Why Are Internal Accounting Controls Important?

Accounting controls help companies comply with government regulations, identify and prevent fraud, and strengthen stakeholder trust. Moreover, they give you confidence you can make financially sound decisions with accurate financial data.

Types of Internal Controls

We’ll group types of internal controls by their purpose within your organization.

Prevention

  1. Segregation of Duties. You don’t have the same person receiving payments in currency or checks, also approving a credit memo or billing adjustment, and also reconciling cash receipts records to bank deposit records. The idea is to assign the access to a process, recording and monitoring of certain transactions to different people so they don’t gain excessive control over a process. 
  2. Authorization Procedures. Clear authorization procedures are fraud protection procedures. Every time the bad actor has to get a signature, they risk getting caught. It’s not worth it.
  3. Physical Controls. These can be locks on drawers or doors to limit access to assets ie. blank check copies or inventory.
  4. Employee Training and Awareness. Training builds employees’ job skills and they know what is expected of them. They’re more vigilant as your team collectively protects your financial integrity.

Detection

  1. Regular Reconciliation of Accounts. Your team compares internal documentation with third parties like banks or vendor records, and other business records to ensure everything has been recorded properly.
  2. Internal Audits and Reviews. Someone separate from the bookkeeper and accounting staff perform risk-based objective procedures to test internal controls of a company.
  3. Monitoring and Surveillance Systems. You use technology and trained professionals to spot potential errors, omissions, and fraud.
  4. Exception Reports. Identifies errors, omissions and abnormalities in accounting information that should be explored further.
accountants discussing accounting controls

Corrective

  1. Investigative Procedures for Discrepancies. You build an investigative team to look into discrepancies quickly and thoroughly before reporting their findings.
  2. Implementation of Remedial Actions. You develop action plans to correct financial records and prevent future issues.
  3. Continuous Process Improvement. You look for ways to streamline your processes further to optimize the accuracy, timeliness, and usefulness of financial reports.

Examples of Internal Accounting Controls

Let’s look at ways to put these types of internal controls in place in your organization.

Cash Handling Controls

  1. Bank Reconciliations. Make it perform monthly bank reconciliations. Don’t just correct errors or omissions and move on. Document the errors or omissions as they could be a sign of fraud or carelessness you need to address. You’ll only spot the pattern if you track it.
  2. Review and Approval Processes. You could have a CFO sign off on transactions of a certain amount. If you don’t have a CFO, interim CFO services can serve this function. You could have a designated CPA or department manager handle the approval for other purchase orders of lesser amounts.

Inventory Controls

  1. Regular Physical Counts. Despite enhanced business accounting technology and procedures, physical inventory counting is critical to understanding and documenting shrinkage due to theft, damage, or obsoletism. This allows for accurate COG tax reporting and gives you a more accurate picture of inventory value.
  2. Inventory Tracking Systems. Human-completed physical counts should be supplemented with effective inventory tracking technology and procedures. As with most internal accounting controls, mistakes can happen in both physical counts and technology-driven ones. Controls are like double-entry accounting. They give you two chances to catch that error.

Payroll Controls

  1. Time and Attendance Tracking. You could limit access to payroll records to reduce the risk of tampering and establish a double approval procedure for payroll, primarily if overtime was worked.
  2. Payroll Audits. Review payroll records for plausibility. Do overtime approvals make sense during your slow season? They may. Document it. A payroll audit is a more in-depth look at payroll. Review compensation packages. Ensure taxes and benefits are calculated correctly.

What are the Limitations of Internal Controls?

Internal accounting controls are essential. But they do have their limits.

Meeting in a conference room of professionals to discuss the limitations of internal controls
  • Human Error. Even when people are checking each other, unintentional errors can happen. Internal controls don’t stop all fraud, mistakes, or omissions. They significantly reduce the chances of it.
  • Procedural Breakdown. It’s one thing to have internal controls and another to ensure those procedures are followed 100% of the time. Training and consistency are critical to establishing controls as the “norm”. Outsourced accounting services can help you establish, train, and educate controls that work.
  • Purchase Order Delays. Tasks take longer when you have controls. People like to complain about “red tape”. But in this case, that “red tape” is there to slow down expenditures just enough to ensure they add value. It’s essential to find balance.
  • Conflict. Too many controls can increase animosity among team members when siloed team members don’t collaborate or the costs outweigh the benefits of specific measures. It’s vital to seek team input and maintain open communications.

Despite the struggles, internal accounting controls are essential to compliance and intelligent financial decisions. Establishing them can give you peace of mind that your accounting is accurate and trustworthy. To learn more about establishing internal controls, reach out to your CPA partner at DHJJ.

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