For companies and businesses, controls are necessary for safeguarding assets and mitigating risks. These are crucial as they dictate the efficiency of the effectiveness of the company’s operations. On top of that, internal controls also help in the financial reporting systems in a company. For companies, having a system of internal controls is highly crucial for various reasons.
Most companies put controls in place, expecting these will prevent, detect, or correct errors, fraud, or misstatements. Sometimes, however, these controls may not be sufficient or effective. Having these controls in place can be detrimental to the company. These may come in the form of control deficiency or control weaknesses. Before understanding these, however, it is crucial to understand what internal controls are.
What are Internal Controls?
Internal controls are a group of mechanisms, procedures, rules, or processes that companies use to prevent, detect, or correct risks. For companies, internal controls come in the form of procedures used to protect against specific risks. Together, these processes and procedures ascertain that the company’s assets are safe against any damages. Similarly, these ensure the company’s financial reporting systems are efficient and don’t include material misstatements.
Internal controls are crucial for companies as they can influence the effectiveness and efficiency of a company’s operations. It also helps companies ascertain that the necessary processes are in place to avoid non-compliance with laws and regulations. In short, internal controls include all the procedures and processes companies use to mitigate risks.
What is a Control Deficiency?
A control deficiency is when a company employs internal control systems for specific areas, but these controls are inefficient. According to ISA 265, a control deficiency is when “a control designed, implemented or operated is unable to prevent or detect and correct misstatements in the financial statements”. Similarly, if these controls fail to prevent or detect and correct these errors in a timely manner, it is a control deficiency.
In some cases, companies may also not have sufficient controls to prevent or detect and current misstatements. Therefore, the lack of internal controls where necessary also constitutes control deficiency for companies. Like other audit areas, auditors also need to identify control deficiencies in a timely manner. Based on this analysis, they can contemplate further actions.
Control deficiencies are crucial for several reasons. For auditors, in particular, control deficiencies are useful in establishing a materiality level for audit assignments. Similarly, auditors must use their professional judgment to determine whether a control deficiency is significant. Significant deficiencies include control deficiencies that are of sufficient importance to merit the attention of those charged with governance at the client.
The responsibility to identify control deficiencies lies with auditors, both external and internal. However, external auditors only work passively in this regard. Their primary goal is to establish whether the client’s financial statements are free from material misstatements. However, they must also disclose any control deficiencies to the client’s management and those charged with governance. But these deficiencies need to be significant.
What is a Control Weakness?
A control weakness is when the internal controls put in place at a company fail to prevent or detect and correct risks. Control weaknesses are a part of control deficiencies. However, these weaknesses only occur when there are failures in the implementation or effectiveness of internal controls. These do not include the lack of internal control systems.
For control weaknesses to exist, companies must have internal controls in place. However, when these controls are not sufficient in preventing or detecting and preventing risks, these are control weaknesses. Auditors can identify control weaknesses by continuously monitoring their internal control systems. They must also gauge how capable the controls are in preventing or detecting, and correcting the risks.
Control weaknesses also come in the form of material weaknesses. For auditors, identifying and reporting on material weaknesses is crucial. Material weaknesses are deficiencies or a combination of deficiencies in internal controls that can lead to a material misstatement in the company’s financial statements. However, auditors must be reasonably certain that these misstatements may occur.
Similar to significant deficiencies, auditors need to communicate material weaknesses to the client and its management. It also includes those charged with governance in the client. Usually, this communication is in written form. However, auditors may also choose to give verbal communication to the client and its management. However, they must document such communications.
In general, significant deficiencies are less severe compared to material weaknesses. Since material weaknesses have a material impact on the company’s financial statements, these are crucial enough to merit attention by those charged with governance.
Conclusion
Internal controls are systems that companies put in place to manage risks. In some cases, however, these controls may not be sufficient to meet this purpose. Control deficiencies are when controls do not exist or cannot help prevent or detect and correct risks. Control weaknesses are when the controls in place are not appropriate for the intended purpose.
