Internal controls are policies, procedures, and technical safeguards that protect an organization’s assets by preventing errors and inappropriate actions. Internal controls fall into three broad categories: detective, preventative, and corrective.
Several internal control frameworks exist to facilitate the implementation of regulatory compliance obligations and enterprise risk management (ERM) best practices. Perhaps the best-known framework is the Committee of Sponsoring Organizations (COSO) internal control framework.
A system of internal controls weaves together various types of processes and rules to assure an effective internal control process. Some examples of internal controls are internal audits, firewall deployment, training, and employee disciplinary procedures.
All organizations are subject to threats that might harm the organization and could result in asset loss. From inadvertent mistakes to fraudulent manipulation, risks are present in every business.
The importance of internal controls lies in their ability to protect your organization from risks and the consequences thereof. For example, IT security controls reduce the risk of data breaches or malware infection. They help you to find weak spots in your information systems and then shore up those weak spots.
Internal controls do have limits on what they can accomplish; hence it’s essential to have ongoing reviews and monitoring of your system.
What Are Preventive Internal Controls?
Preventive internal controls are put in place to, as the name implies, prevent an adverse event from occurring. For example, many applications have built-in checks and balances to avoid entering incorrect information.
Preventive controls are the best kind of controls because they lessen the need to detect mistakes after the fact. Automated preventative controls are even better because they remove the need for human intervention and streamline auditing.
Examples of Preventive Internal Controls
Training programs, drug testing, firewalls, computer and server backups are all preventive internal controls that block undesirable events from occurring.
Segregation of Duties
Separation of duties is a critical internal control designed to reduce the incidence of mistakes or fraud by assuring that no single employee has the potential to both perpetrate and hide errors or fraud in the course of his or her activities. Assigning one person to write checks and another staff member to authorize the payments is one example of segregation of duties.
In general, the primary incompatible responsibilities that must be separated are:
- Performing transactions
- Authorization or acceptance
- Reconciliations
- Asset custodianship
Access Controls
Access controls govern who or what has access to corporate assets, including IT systems. These controls are a crucial security concept that reduces risk to the company or organization.
Physical access control limits access to campuses, buildings, rooms, and physical IT assets. Security guards verifying ID credentials or access key cards may be employed to enforce physical access control.
Logical access control restricts connections to computer networks, system files, and data. The principle of the least privilege (PoLP) is an information security standard that says users should only access system functions and data that are necessary for the user to do his or her job.
Pre-Employment Screening
Pre-employment screening is a procedure where employers check candidates’ backgrounds, screen them for drugs, check references, and assess their conduct. It is used in the recruiting process to screen out many undesirable candidates before investing in the onboarding process.
What Are Detective Internal Controls?
Detective internal controls detect an error problem after it has occurred. Ideally, detective internal controls will discover an issue before it becomes a significant problem.
Examples of Detective Internal Controls
Some examples of detective controls are internal audits, reconciliations, financial reporting, financial statements, and physical inventories.
Internal Audits
The objective of an internal audit is to evaluate compliance with company procedures, applicable laws, and international standards. Data and reports are reviewed to assure consistency and compliance.
This internal control provides a value-added service to management and the board of directors by detecting and correcting weaknesses in a process before external audits discover them. This can protect the organization from loss of certification and regulatory fines.
Reconciliations and Financial Reporting
Reconciliations are performed to verify financial reporting among various sources. For example, comparing (or reconciling) a bank statement to a company’s internal records is one form of reconciliation.
Financial reporting documents the company’s revenues, spending, cash flow, and financial health. It allows executives and investors to make more informed judgments on performance and opportunities for improvement. Unusual or unexpected figures in financial reporting and financial statements help detect inadvertent errors and inappropriate actions.
Physical Inventory Counts
Physical inventory counts are performed periodically to assure actual inventories match what is recorded in business systems and financial statements. Physical inventory values directly affect the balance sheet, so it’s imperative they are reflected accurately. Inventory discrepancy investigations can reveal system issues, inadvertent errors, and theft.
What Are Corrective Internal Controls?
Corrective internal controls are implemented after the internal detective controls discover a problem. These controls could include disciplinary action, report filing, software patches or modifications, and new policies. They are usually put into place after a root cause investigation.
Examples of Corrective Internal Controls
Corrective internal controls, by nature, are specific to the typical flaws and risks of your company, previously evaluated through comprehensive risk assessments or detective controls, such as audits.
Patch Management
Patch management is the process of delivering and installing software updates. These patches are frequently required to remedy flaws (also known as “vulnerabilities” or “bugs”) in software.
Patches are commonly required for operating systems, applications, and embedded devices (such as network equipment). When a vulnerability is discovered after a piece of software has been released, a patch can remedy it. Proper patch management protects information security by preventing data breaches and leaks.
New or Updated Policies and Procedures
Policies and procedures may be updated when an audit or other detective control identifies a gap in processes. For example, root cause analysis on a physical inventory discrepancy may reveal that employees are inadequately trained on how to decrement parts that fail quality checks. Corrective controls would include updated work instructions and training.
Disciplinary Actions
Disciplinary actions are corrective actions taken in response to employee misbehavior, rule violations, or poor performance. Discipline can take several forms depending on the seriousness of the situation, including a verbal warning, formal warning, an unfavorable performance evaluation, or even termination.
Benefits and Limitations of Internal Controls
Processes and control activities are imperfect, and mistakes and problems will inevitably be found. Therefore, an ongoing review and analysis of internal controls should be a part of any organization’s regular processes.
Benefits of Internal Controls
Management is ultimately responsible for the control environment and the success of internal controls. The benefits of internal controls depend upon correct implementation and ongoing monitoring.
Early Warning System
Internal controls serve as an early warning system to identify issues before they become big problems. Quality checks prevent faulty products from being shipped to customers. The investigation into a slip in on-time delivery metrics may reveal a more significant problem on the horizon. Problems are easier to fix when you catch them early.
Prevent Fraud
Robust internal controls deter employees from engaging in misconduct. When employees can see process gaps, they may be tempted to perform minor inappropriate actions that eventually lead to major ones. With multiple checks and balances, however, fraud is much more difficult. Solid policies assure that employees understand the consequences.
Avoid External Audit Findings and Regulatory Fines
Performing investigations and corrective actions on external audit findings can be an arduous process. If an external audit identifies a significant gap in processes or material misstatements, you could be exposed to losing industry certifications or substantial fines. It is always best to find and fix a problem before an external entity discovers it.
If you still experience a data breach, robust internal controls can also protect you from hefty fines. If an investigation reveals that your organization acted with due diligence and had adequate controls in place, a regulatory agency may reduce penalties.
Limitations of Internal Controls
Despite the benefits, internal controls have some limitations. It’s crucial to be aware of the gaps left by internal controls to assure that those risks are understood.
Collusion
Segregation of duties is one of the most prevalent internal controls businesses use. It separates tasks so that no one employee has the power to commit fraud. Employees can, however, get past this by collaborating together in an elaborate process to disguise their fraud.
Human Error
Human error can be another disadvantage of internal controls, especially when relying on manual processes and judgment calls. For example, mistakes can be made during manual inventory counts, and poor judgment could impact internal audit results. Wherever possible, automated systems should be employed to drive consistency and reduce human error.
For example, scales can be used in stockrooms to verify inventory counts. Automated systems can help perform reconciliations among accounting and financial records. Solid auditing processes, along with management oversight, will support rigorous internal auditing standards.
Unforeseen Circumstances
Internal controls rely on a company’s management anticipating all potential hazards and implementing mechanisms to prevent or mitigate them. Still, management cannot anticipate all potential challenges or events. Random variables or occurrences are prone to render internal controls ineffective.
Moreover, attempting to control unusual conditions can be costly, and a management team may instead choose to accept the risk. As a result, internal controls may be limited in their use under unexpected or extraordinary scenarios.
Enhance Your Internal Controls with ZenGRC
Aside from risk assessments, procedures, reporting, and communication, the only thing that all internal control schemes have in common is arduous documentation and reporting.
Small companies may begin by managing their controls with spreadsheets, but the number of internal and external stakeholders increases as their business grows. As a result, preparing ahead of time for a more streamlined solution can save time and money in the long run.
Instead of using spreadsheets to manage your compliance requirements, use ZenGRC to streamline evidence and audit management for all of your compliance frameworks. ZenGRC’s compliance, risk, and workflow management software is intuitive and simple to use.
It is a single source of truth that assures your organization is always audit-ready. Policies and procedures are revision-controlled and easy to find in the document repository. Workflow management features offer easy tracking, automated reminders, and audit trails. Insightful reporting and dashboards provide visibility to gaps and high-risk areas.
Its advanced features enable straightforward risk assessment, analysis, and mitigation. Easily map controls across various compliance frameworks and monitor them to see which ones impact risk the most.
Schedule a demo of ZenGRC and get started in the hassle-free internal controls implementation and compliance, the Zen Way!
