Internal controls are a series of policies and procedures that a business owner puts in place for purposes, like:

• Protecting assets
• Maintaining reliability
• Ensuring compliance
• Promoting efficient operations
• Accomplishing objectives

Protecting assets: internal controls protect assets from accidental loss or loss from fraud.

Maintaining reliability: internal controls ensure that management has accurate, timely, and complete information.

Ensuring compliance: internal controls keep accounts in compliance with the many federal, state, and local laws and regulations affecting a company's operations.

Promoting efficient operations: internal controls create an environment where managers and staff can maximize efficiency and effectiveness.

Accomplishing objectives: internal controls provide a mechanism for management to monitor the achievement of operational goals and objectives.

Administrative management typically oversees internal controls as they communicate their duties and expectations to staff within an internal control environment. They are also accountable for ensuring that other areas of the internal control framework are dealt with consistently.

The three main types of internal controls are:

• Detective internal controls
• Preventative internal controls
• Corrective internal controls

Detective internal controls

Detective internal controls are designed to highlight any problems within a company’s accounting process. Detective internal controls are commonly used for fraud prevention, quality control, and legal compliance.

Examples of detective controls include inventory counts, internal audits, and surprise cash counts. Detective internal controls protect a company’s assets by finding errors when they occur so that business owners can minimize their impact on the company.

Preventive internal controls

Preventive internal controls are proactive controls designed to prevent errors and irregularities from occurring. They are usually performed on a regular basis.

Some examples of preventive controls are:

• Separation of duties: splitting tasks for bookkeeping, deposits, reporting, and auditing, so there’s less chance of employee fraud.
• Controlling access: preventing team members from logging into certain parts of the accounting system unless they have a password.
• Double-entry accounting: implementing a system that adds extra reliability so that books are always balanced.

Preventive internal controls are implemented to help with clerical accuracy, backing up data, and preventing employee fraud. These internal controls help to avoid any problems or irregularities so that the business processes can run smoothly.

Corrective internal controls

Corrective internal controls correct any errors that were found by the detective internal controls. This type of internal control usually begins by detecting undesirable outcomes and keeping the spotlight on the problem until management can solve it. If an error occurs, an employee must follow procedures put into place to correct the mistake.

Examples of corrective internal accounting controls include physical audits (such as counting money by hand) and physically tracking assets to reveal well-hidden discrepancies. Implementing a quality improvement team can be a great way to address ongoing problems and correct processes.

Other internal controls

There are other forms of internal accounting controls, including:

• Standardized documentation
• Trial balances • Periodic reconciliations
• Approval authority

Standardized documentation

When accounting documents such as inventory receipts, invoices, internal materials requests, or travel expense reports are standardized, it can help to maintain consistency in a company’s records. Standardized document formats also make it easier to review past records when a discrepancy has been found in the system.

Trial balances

Trial balances use a double-entry accounting system, increasing reliability and keeping the book balanced. Errors may still throw a double-entry system off balance. If employees calculate daily or weekly trial balances, this will help maintain analysis of the state of the system so that discrepancies can be discovered early.

Periodic reconciliations

Periodic accounting reconciliations mean that account balances in the system can be matched up with balances in independent accounts, such as credit customers, suppliers, and banks. Any differences between these accounts will highlight errors.

Approval authority

Approval authority requires members of the management team to authorize specific transactions. This adds a further layer of responsibility to accounting procedures because it proves that the appropriate managers have analyzed and approved any transactions.

How to improve your internal accounting controls

To improve your internal accounting controls, your business can:

• Allocate separate accounting responsibilities
• Increase oversight
• Restrict employee access to financial systems
• Have a third party overlook your financial statements
• Perform self-evaluations of your internal controls

Allocate separate accounting responsibilities

Instead of relying on one employee or bookkeeper to handle all the accounting duties, reassign the processes to different team members. For example, processing receipts and payments can be separated. Other activities to separate include signing checks, approving invoices, and reconciling accounts. Allowing one person to handle all these accounting processes increases the risk of errors or fraud.

Increase oversight

Even though you have internal controls, they will not be effective enough without oversight. If you don’t have time to do it yourself, you should allocate a trusted employee to periodically review statements, account reconciliations, and payment registers.

Look out for unapproved expenses or raises, non-existent employees, and unapproved hours. Make it a priority to review your company’s financial data so that you can stay abreast of trends and changes in your financial reports.

Restrict employee access to financial systems

Typically, business accounting software allows users to edit previous transactions. This unmonitored permission allows employees the potential to hide fraud or theft.

As a business owner, you must restrict employee access to the company’s financial system to reduce the risk of employees changing and deleting entries. You can also review any transaction changes in the system to reveal any irregular activity.

Have a third party overlook your financial statements

You can increase the safety of your assets by having a third party review your company’s accounts. Any employees involved with internal accounting and aware of your third-party review will be deterred from fraudulent practices. An independent reviewer will also be able to identify errors and inconsistencies.

Perform a self-evaluation of your internal controls

Performing a self-evaluation can help you highlight any problem areas before they arise and allow you to use more effective controls. The easiest way to perform a self-evaluation is by conducting a trace of a particular transaction through company records and procedures. The trace will give you a deeper understanding of your internal controls in action, particularly those controls in place to detect or prevent fraud. You will also be able to see if your internal controls have been designed effectively and are operating as intended.

Effective internal controls for your accounting and finance should be an integral part of your business plan. Internal controls significantly reduce the risk of lost assets and increase the reliability and accuracy of all your accounting and finance operations.

Additionally, controls ensure that your company’s accounting system is in accordance with applicable laws and regulations.

Internal controls support for your business

Do you need help establishing internal controls for your accounting and finance department to protect your business assets adequately? Citrin Cooperman provides ongoing accounting support and financial analysis to mid-market businesses.

Our team of highly experienced advisors will act as your entire accounting department (CFO to staff accountant) or complement your internal staff to provide the ongoing accounting and finance support necessary to effectively run your company, analyze operations, and guide business decisions.

Get started improving your internal controls today!