Archive for the 'Internal Audit' Category

Definition of Internal Control

Internal control is a whole system of controls financial and otherwise, established by the management for the smooth running of business; it includes internal cheek, internal audit and other forms of controls.

According to sap-6 entitled, “Study and evolution of the accounting system and related internal control may be defined as “ the plan of organization and all the methods and procedures adopted by management’s objectives of ensuring as far as practicable the orderly and efficient conduct of its business including adherence to management policies the safe guarding of assets, prevention and detection of fraud and error, the accuracy and completeness of the accounting records and the timely preparation of reliable financial information. The system of internal control extends beyond those matters which relates control directly to the functioning of accounting system.”

Internal control is a combination of the following:

1. Financial controls, and
2. Other controls

According to the institute of chartered accountants of India internal control is the plan of organization and all the methods and procedures adopted by the management of an entity to assist in achieving management objective of ensuring as far as possible the orderly and efficient conduct of its business including adherence to management policies, the safe guarding of assets prevention and detection of frauds and error the accuracy and completeness of the accounting records and timely preparation of reliable financial information, the system of internal control extends beyond those matters which relate to the function of accounting system. In order words internal control system of controls laid down by the management for the smooth running of the business for the accomplishment of its objects. These controls can be divided in two parts i.e. financial control and other controls.

FINANCIAL CONTROLS

• Controls for recording accounting transactions properly.
• Controls for proper safe guarding company’s assets like cash stock bank debtor’s etc
• Early detection and prevention of errors and frauds.
• Properly and timely preparation of financial records I e balance sheet and profit and loss account.
• To maximize profit and minimize cost.

Other control – Other controls include the following:

• Quality controls.
• Control over raw materials.
• Control over finished products.
• Marketing control, etc

Some charecteristics of an internal check system.

Division of work – a work job should be divided into small parts and every part of the job should be allotted to a different worker. No one person should be allowed to handle a complete job.

Work rotation – The job among the clerks should be rotated over a period of time so that no one should occupy one position for a long period of time. Holding the same position over a period of time gives that parson chances of manipulations and his errors may also remain undetected.

Delegation of authority – There should be clear-cut delegation of authority. Every worker should know that they should be allowed to work within the level of their authority.

Fixing the responsibilities – responsibilities of all the workers should also be fixed. They should know that they are responsible for a particular type of errors or frauds.

Separating custodian and record keeper – A person who is responsible of keeping custody of a particular asset should never be the person responsible to record transaction regarding it.

Relying on internal check system – Before starting an audit, auditor should examine the internal check system if it is present in the organization. If the check system is efficient, he can rely on it and depend on test checking for the completion of audit.

He should carefully examine the system and then work with caution, if on the other hand during the checking of the books of accounts some point come to his thoroughly, if he ignores those irregularities and later on errors and frauds remain undetected he may be held liable a good internal check system can reduce the extent of work that an auditor has to put for doing the audit but in no case it can reduce his liability. Ultimate responsibility remains with the auditor.

Therefore, it is up to him to decide that how efficient is the internal check system and to what extent he can rely on it he should make a decision and then he should decide the level of his checking.

Difference between Internal Audit and Statutory Audit

Following are the main points of difference between internal audit and statutory audit:

1. Appointment – The management of the organization makes the appointment of an internal auditor. The statutory auditor is appointed by different authorities. First statutory auditors are appointed by the shareholders in the annual general meeting.

2. Qualification – Qualifications of the statutory auditor are prescribed in the companies act, 1956. Essentially a person should be a practicing chartered accountant to be appointed as a statutory auditor. There are no fixed qualification for the position of an internal auditor.

3. Objects – The main object of the statutory audit is to form an opinion on the financial statement of the organization auditor has to state that whether the financial statements are showing the true and fair view of the affairs of the organization or not. The main object of the internal audit is to detect and prevent the errors and frauds.

4. Scope – The scope of the statutory audit is fixed by the company’s act 1956. it can not be changed by mutual consent between the auditor and the management of the audited business unit. The scope of the internal audit is fixed by the mutual consent of the auditor and the management of the unit under audit.

5. Remuneration – Remuneration of the statutory auditor is fixed by the appinting authority, I e in case of first auditors, the auditors the directors fix the Remuneration in case of the subsequent auditors the company in its general meeting fixes the remunration. In case of internal auditor the management who appoints him fixes his Remuneration.

6. Report – The statutory auditor submits his report to the shareholder of the company in its general meeting. The internal auditor submits his report to the management of the company who is also his appointing authority.

7. Removal – The procedure of removal of the statutory auditor is very complex. Only the company in the general meeting can remove the auditor. It also has to take the permission of the central government. The management of the entity can remove internal auditor.

Internal Check System

Internal check system is such a system in which duties of different assistants are divided and allocated to each other in such a way that their work is supplementary and dependent upon each other. By this system the work is automatically checked as it is done.

Since one particular job is not assigned to any single individual chances of mistakes are very less. Division of work and delegation of authority are two basic principles that help this system work.

For example withdrawal of money from a bank: – In this case on clerk enters the cheque in the books of account or ledger. Second person checks the credit balance available in the account and third person gives the payment. In this way, there is a division of work and authority and chances of mistake are minimized.

According to L.R. Dicksee: – “ internal check is such an arrangement of book keeping routine that errors are likely to be prevented or discovered by the very operation of the book-keeping itself”.

Internal control – what does it mean in India

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.

Relationship between internal auditor and statutory auditor.

The relationship of the internal auditor and statutory auditor can be summed up as follows: -

1. As per manufacturing and other companies order 1988 issued under section 227 of the companies’ act the statutory auditor has to comment upon the effectiveness and suitability of internal audit system laid down be the management.

2. To discharge this responsibility: statutory auditor should evaluate the internal audit system he should evaluate the strength of the internal audit staff, their qualification and experience.

3. Evaluation of the actual work of internal auditor – After studying the internal audit system and structure actual work of the internal auditor should also be evaluated. Statutory auditor has to make use of the work of internal auditor. This he can do only when he himself puts faith in the work of internal auditor.

4. Relying on the work of internal auditor – statutory auditor has to decide that up to what extant he can rely upon the work of the internal auditor. This will decide the extent of his own checking. If he feels that internal auditor has properly done his work he can reduce the extent of his checking.

5. No reduction in responsibility – Relying on work of internal auditor in no way reduces the responsible for the discharge of his duties as statutory auditor.

Relying on the internal auditor can only reduce the burden of the statutory auditor.

For all his works statutory auditor would remain responsible.

Internal Audit system and its objects.

Internal audit is an important part of the internal control system. Guidelines issued by the institute of chartered accountants of India on internal auditing define it as “an independent appraisal involving specialized application of the techniques of auditing in accordance with the specific need of the enterprise.”

The institute of internal auditor USA defines internal auditing as an independent appraisal function established of accountancy financial and other operations as a service to the organization and established by the management of organization.”

Objects of internal audit: The objects of internal audit are as follows:

1. To assist the internal control system – Internal audit is a part of the internal control system, its main object is to assist the working of the internal control system.

2. Review of the organization policies and their operations – Another main object of the internal audit is to review the organizational policies and ensure their smooth operations.

3. Verify the accuracy and authenticity of errors and frauds – internal audit help in detecting and preventing the errors and frauds.

4. Detection and prevention of errors and frauds – internal audit helps in detecting and preventing the errors and frauds.

5. Safeguarding the assets – Internal audit helps in safeguarding the asset of the business.

6. Applicability of accounting policies – Internal audit ensures that the decided accounting policies are followed in maintaining the books of account.

7. Right disposal of assets – Internal audit also checks the procedure of disposal of the fixed assets. It ensures that they should be sold to the highest payers.

8. Expenses properly authorized – Internal audit ensures that all the expense are properly authorized.

9. Helps in smooth functioning of internal check system – internal audit system also helps in the smooth running of internal check system

Internal Audit – System followed in India

Internal audit system is a critical evaluation of the functioning of various departments of enterprise. Internal audit implies an audit of books of account by the employees of the organization itself.

Internal audit is done by separate department known as internal audit department. Its staff may or may not have required professional qualifications. An internal auditor has to see that there is no wastage and the business is carried on efficiently.

For example, when purchasing furniture, whether tenders were invited or not. When waste material was sold, whether that was sold by auction or by inviting tenders, and to the highest bidders.

Difference between internal check and internal audit.

Following are the main differences between internal check system and internal audit system:

1. Way of checking – In internal check system work is automatically checked whereas in internal audit system work is checked specially.

2. Cost involvement – in internal check system checking is done when the work is being done. Mistake can be checked at an early stage in internal check system.

3. Thrust of system – Thrust of internal check system is to prevent the errors and whereas the thrust of internal audit system is to detect the errors and frauds.

4. Time of checking – In internal check system checking is done when the work is being done whereas in internal audit system work is checked after it is done. Mistakes can be checked at an early stage in internal check system.

Thus combining these two systems, the purpose of prevention and detection of errors and frauds can be achieved.