What are internal controls in accounting?

Can you trust your accounting information? As a leader, you rely on accurate financial reports and bookkeeping records to make well-informed decisions related to hiring, new services, and other critical functions. But, without internal controls, accounting functions like bookkeeping are vulnerable to fraud and misrepresentation of your actual financial health.

What are internal controls?

Internal controls are measures that you put in place to ensure that your accounting operations and workflows are effective, efficient, reliable, and compliant with applicable regulations.

The goals of internal control measures are to prevent, detect, and correct issues that impact the accuracy, integrity, and reliability of a company’s financial information.

Some common examples of internal controls include:

• Segregation of duties: Dividing duties between people reduces the risk of mistakes or fraud
• Physical controls: This category includes steps like locking your cash box in a safe or restricting access to inventory storage areas.
• Reconciliations: This involves employing different staff members to verify the accuracy of transactions and related items, like bank statements and check register entries.
• Policies: Documentation and training are critical aspects of sound internal controls and should clearly describe which actions should and shouldn’t be taken while performing accounting functions.
• Reviews: Executive leaders and a board of directors perform activity reviews, compare financial statements to corporate objectives and identify trends that impact overall financial performance.
• Information controls: This category includes any measures taken to ensure that an entity’s financial data is secure, accurate, complete, and appropriately authorized. Examples include restricting access to those who need it or standardizing sign-off procedures.

Why internal controls are vital for public and private companies

There are several myths about internal controls that are worth clearing up. One of the most prevailing myths is that internal controls are only necessary for public companies that must present financial reports to investors. While this is true, internal controls also help private companies by ensuring their financial statements are accurate and reliable.

Often, private companies hesitate to design and implement internal controls because it is assumed that each manager’s time will be spent on reviews and approvals rather than their core responsibilities.

However, many accounting software options can automate many of the monotonous, mind-numbing aspects of internal control measures so managers and directors can focus on the areas that drive the company forward.

For example, our firm recommends using Bill.com to streamline accounts payable processes, set up roles and permissions, and ensure vendors are paid on time.

Related Reading: MBS Accountancy and Bill.com Bring Transparency to Clients

Best practices for creating and maintaining internal controls

It’s best to assume the best about people but prepare for the worst. If an employee finds themselves in a tough financial situation, you should have safeguards in place that make it difficult, if not impossible, for them to embezzle money from your company or engage in other fraudulent activities.

Perform a risk assessment to identify threats and align with goals

A risk assessment is the first step in creating internal controls and involves determining the threats facing your company and the extent to which they impact your operations and revenue. Throughout a risk assessment, you’ll identify stakeholders, assess current vulnerabilities and outline mitigation strategies to counteract the key business threats.

It’s unfortunately common for companies to jump into designing internal controls without first understanding the operational risks and key threats facing them. While many internal control measures are standard, it’s best to adopt a risk management perspective when designing internal controls. This way, you avoid gaps or insufficiency within your organization’s system of internal controls.

Factors to consider when conducting a risk assessment include:

• Your industry
• General economic landscape
• Your company’s size and structural complexity
• Applicable regulations and standards
• Operational needs and objectives
• Potential exit strategy, if you eventually plan to go public as an initial public offering (IPO), merger and acquisition, or special-purpose acquisition company (SPAC)

Segregate duties among staff to reduce opportunities for internal fraud

In 2020, a year-long audit by the State of Alabama concluded with the conviction of two middle school employees who had used school funds to make personal purchases. Because internal control measures like segregation of duties weren’t in place, the two employees were able to avoid submitting receipts from student activities or documenting gift cards allegedly purchased to reward student academic achievements.

One of the primary goals behind internal control measures is to make sure that no single person controls a process from start to finish. For example, someone who records bill payments shouldn’t also write checks since they could easily create fake vendors and siphon money out of your company.

Here are some steps to take when segregating duties among staff::

• List the steps of each critical accounting function and ensure that no single person controls a process from start to finish.
• Use role-based provisioning in cloud-based software like Bill.com to ensure that staff only see information that’s pertinent to their role.
• Review financial reports and activity logs to ensure procedures are being properly followed.

Create policies and procedures that describe accounting workflows

In a 2022 Riveron survey across 40 companies, 70% of companies described a lack of confidence and uncertainty in their internal controls. Along with segregating duties, it’s vital that you empower everyone in your company to follow consistent processes when performing accounting processes. With clear procedures in place, your staff will need to make fewer guesses and unnecessary searches for answers, which results in improved productivity. Proper internal control policies, usually developed by your CFO, should describe the process, related control, designated role, expected outcome, and outline measures for measuring results.

Internal controls enable you to navigate change successfully

It’s a mistake to assume that internal controls are only for huge corporations or multi-national companies. As CPA Melissa Houston writes in Forbes, “Taking simple steps to prevent any wrongdoing in your business will pay off many times and help you keep peace of mind.” With proper internal controls in place, you’ll be able to rely on your financial statements and reports to make reasonable, profitable decisions for your business.

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Note: Blog feature photo credit to RODNAE Productions