How To Identify Internal Control Weaknesses

A company’s employees, shareholders, senior management, and board of directors expect that company to conduct its business reliably, efficiently, and securely – especially its financial transactions.

Internal controls are the mechanisms a company uses to assure that its business processes meet those expectations. And to keep that system of internal controls running smoothly year after year, you must identify the internal control weaknesses in those systems.

An internal control weakness is a failure in your internal activities that bad actors can exploit. Identifying and mitigating weak internal controls helps to strengthen your company’s operations before malicious actors cna take undue advantage.

What Are Internal Controls?

Internal controls are the rules, mechanisms, and procedures you use to safeguard your financial information, promote accountability, and prevent and detect fraud. Internal controls help you comply with laws and regulations, and are crucial to fraud prevention and asset security.

Internal controls can also help your company operate more efficiently by assuring that your financial statements and reporting are accurate and timely.

The ideal is to implement data security controls to protect your data from all types of cyberattacks. These controls help you detect threats early, then neutralize them to protect your IT assets from attacks.

Moreover, publicly traded companies must implement data security controls to protect their financial data, per the audit requirements of the Section 404 of the Sarbanes-Oxley Act. Section 404 holds executives liable for inaccurate or false financial reporting, and requires them to maintain strong internal controls and the documentation needed to prove compliance.

Internal controls have become an essential business function for every U.S. company since the accounting scandals of the early 2000s. An effective data governance model, rigorous risk management, and compliance software controls can do the heavy lifting of monitoring, measuring and filling control gaps.

Internal Control Categories: Preventive, Detective, Corrective

Internal controls include authorization, documentation, reconciliation, security, and the segregation of duties. And they are generally divided into three categories: preventive, detective, and corrective controls.

• Preventive controls aim to prevent errors or fraud. They include thorough documentation and authorization practices. For example, segregation of duties assures that no one person is in a position to authorize, record, and maintain a financial transaction and its corresponding asset. Verifying expenses and authorizing invoices are other preventive internal controls; so are limits on physical access to equipment, inventory, cash, and other assets.
• Detective controls are procedures that aim to uncover anomalous events after those incidents have occurred. Detective controls provide evidence that a material misstatement or loss has occurred, but they don’t prevent such occurrences from happening. Reviews, analyses, and inventory are all detective controls.
• Corrective controls are usually implemented after detective controls uncover an issue. Examples of these controls include disciplinary action, software patches or modifications, and new policies that prohibit certain practices.

Five Major Internal Control Weaknesses

Five significant internal control deficiencies put your company assets at risk.

Technical control weaknesses

Technical security control focuses on hardware and software changes that might not have been configured or maintained with all necessary controls to secure access and usage.

Architectural control weaknesses

Architectural control helps you build a resilient IT architecture that allows your company to operate effectively. Any weaknesses in setting up and maintaining this architecture can result in a loss of business and reputation.

Operational control weaknesses

Operational control weaknesses often result from a lapse in executing company-mandated operations and standards, which might result in unplanned incidents that disrupt the operating model. (For example, someone might not perform required scans of third-party software before installing that code, and the code introduces a vulnerability or virus into your operating system.) The impact of such unexpected incidents is directly related to your response time and protocol for such incidents.

Administrative control weaknesses

Administrative controls protect your company’s IP and assets and help your workforce handle sensitive information. In addition, running highly available systems is vital to helping your organization recover from IT incidents, so any weaknesses inflicting downtime on your IT systems can be fatal to your business.

Financial control weaknesses

Financial controls protect your company’s cash flow and financial operations. Any weakness in your financial controls leaves the door open for outside attackers or malicious internal actors to exploit. For example, inadequate approval processes might leave your company to fall victim to a business email compromise or to issue payments to bogus vendors.

Internal control weaknesses are also typically grouped into one of two categories for severity: material weaknesses and significant deficiencies.

• A material weakness is a control weakness so severe that the company’s financial statements cannot be relied upon, or the company could be in violation of regulatory compliance obligations. A material weakness is a major problem that needs prompt attention from the board and senior management.
• A significant deficiency is less severe than a material weakness. It is not likely to lead to a material misstatement of financial results or a compliance violation, but it still warrants attention from senior management so that the weakness can be resolved.

A significant deficiency is typically reported to the company’s board, either by its outside audit firm or by internal management. Several significant deficiencies could, taken together, also constitute a material weakness.

How To Identify Internal Control Weaknesses

Here are the steps to help you identify internal control weaknesses: z

• Conduct a thorough risk assessment
• Document and analyze internal control procedures
• Train staff as necessary on control hygiene
• Conduct regular audits
• Listen to stakeholder feedback

Conduct a thorough risk assessment

You should conduct thorough, regular (say, once a year) risk assessments for all your internal control procedures. Identify the most probable incident-prone parts in your company.

When you examine each risk, add columns to indicate which new risks could arise from material weaknesses or significant IT deficiencies, who is in charge of that particular process, who inspected it, solutions, and when the responsible person took action.

Document and analyze internal control procedures

Catalog all the necessary operating procedures in your company that might affect your business model. These procedures include cash reconciliation, accounts payable, and stock and asset inventories. For example, your accounts payable analysis will ensure that your organization’s payments to your suppliers are accurate when reconciled externally with bank statements and receipts.

Train staff as necessary on control hygiene

Educating your employees about modern internal control processes and methods is essential. Ensure that you regularly and repeatedly conduct training on the evolution of IT and financial controls in your organization to keep them updated and educate them on the potential impacts on the business.

Conduct regular audits

Risk assessments are often created by the individuals executing the internal controls, and you can never guarantee that those people act objectively or competently. Hence it’s essential to have an independent third party audit your controls from time to time, to assess whether your controls are properly designed and working effectively.

Listen to stakeholder feedback

Examine customer and stakeholder feedback to determine whether they have any common complaints, such as internal control breaches. For example, if customers identify the exact product failure, such as a button that’s not working correctly, you can work backward through your organization’s processes to uncover the issue.

How to Rectify and Remediate Internal Control Weaknesses

Bad actors can always seem several steps ahead in exploiting internal control weaknesses. Fortunately, you can implement continuous control monitoring, blended with machine learning techniques, to provide real-time insights into new vulnerabilities and threats.

To monitor your internal controls effectively, you must integrate internal audit procedures into your ongoing activities. Integrating these detective, preventive, and corrective measures helps your internal analysts to review the effectiveness of your internal controls on a timely basis.

Manage your Internal Controls Effectively with RiskOptics

Identifying and rectifying internal control weaknesses can seem overwhelming. RiskOptics, with its comprehensive ROAR platform for risk management, can make it easy to stay on top of your internal controls.

The RiskOptics ROAR Platform allows for a single source of truth for all your internal controls, risk assessments, remediation of weak internal controls, tests of controls, and so forth. That evidence then becomes invaluable as you seek to improve your system of internal control or simply want to pass an external audit as efficiently (read: cheaply) as possible.

To understand how to put a rigorous risk management solution for your internal controls in place for your organization, schedule a demo with RiskOptics today.