Internal Control – Internal control system is best regarded as the whole system of controls financial and otherwise made by the management in the conduct of a business entity which include internal check system, internal audit and other forms of controls.

The management lays down internal control. This system contains plan methods and procedures of work done by various departments of an entity. It is the total system of controls and includes two basic parts:

1. Financial Control System, and
2. Other Control System.

1. Financial Control System – This part of internal control system deals with aspects relating to the financial matters. For example, control over bank accounts: control over cash in hand, bills payables, debtors and creditors.

In this control system payments received by the organization and payments made by the organization are totally controlled. It ensures that cash may not be misappropriated. For maintaining such a control, proper entries in books of accounts have to be maintained regarding the receipt and payments of cash.

2. Other Control Systems – Other Control Systems involve controls relating to the other activities of the organization. For example, production, advertising, marketing, quality etc.

First part of internal control system is a very important to the auditor as it deals with the financial matters. Second part is not so important to him.

Before starting the audit, auditor should study the internal control system of the organization thoroughly. It helps him to decide the extent of checking during the conduct of audit. If the auditor finds out the weaknesses in the system or its operation, he reports it to the management by a letter. Such a letter is called ‘letter of weakness’.

This letter of weakness lists down the areas of weakness in the system and offers suggestions for improvement. It helps management to amend the systems.

If the organization has good internal control system, the auditor can reduce the extent of checking and depend upon test checks. Otherwise, he has to conduct detailed checking during the audit.

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