For any company or business, having an internal control system is crucial in avoiding and eliminating risks. Internal controls are a set of instructions, rules, procedures, mechanisms, or processes that help in this regard. Internal control systems are also crucial for the financial reporting process that companies follow. There are several benefits of having an efficient and effective internal control system.
Despite its many advantages, however, some companies may allow deficiencies or weaknesses to impact their internal control systems. These deficiencies can have a detrimental effect on the company’s financial reporting systems and operations in general. Before understanding what control deficiencies are, it is critical to understand what internal controls are and how they work.
What are Internal Controls?
As mentioned, internal controls represent the processes, procedures, rules, mechanisms, or instructions that a company uses for risk management. These risks may typically come from both internal or external sources. However, managing these risks can be crucial for a company’s long-term success. Internal controls are also critical in avoiding frauds and errors which can impact a company’s financial reporting.
The primary objective of having an internal controls system is to ensure the integrity of a company’s financial and accounting information. However, it is also critical in safeguarding assets, avoiding losses, preventing fraud, promoting accountability, and much more. Having an efficient and effective internal control system can help companies avoid any unforeseen detrimental threats.
Some companies may consider internal controls as a waste of time and money. However, these systems can also enhance the efficiency of other processes within a business. Therefore, they can help increase a company’s financial performance despite the additional costs. Overall, internal controls are critical for companies, especially when it comes to the integrity of their financial and accounting systems.
How Do Internal Controls Work?
Internal controls are processes that companies put in place to avoid any unforeseen risks. Usually, companies identify areas of high importance before putting controls in place. Once they do so, they estimate how much effort they need to place on those areas. Based on that, they identify the risks related to the selected areas. Lastly, they employ internal controls that can eliminate or reduce those risks to a minimum.
In practice, however, companies cannot cover all areas of significance. However, internal controls can aid them to cover areas of high importance that can cause significant failures. One of the areas within internal controls is having an internal audit function. This function helps in all areas related to internal controls. Internal auditors evaluate a company’s internal controls to identify any deficiencies.
What are Control Deficiencies?
As mentioned, companies place several internal controls over areas of high importance to avoid risks. Sometimes, however, the controls may not be sufficient to prevent those risks. Similarly, some controls may not work in an intended way. These can lead to problems that can result in losses for the company. It is what constitutes control deficiencies.
Control deficiency comes from two sources. When a company designs, implements, or operates internal controls in a way that cannot prevent, detect, or correct risks, it is a control deficiency. In this case, the appropriate controls may exist. However, they may be insufficient or inefficient to prevent, detect or mitigate the risks.
On the other hand, control deficiencies also stem from the non-existence of the appropriate internal controls. These deficiencies arise when companies do not have any systems to prevent, detect, or correct risks that occur in their operations. The lack of an appropriate internal control system or specific measures is also a control deficiency.
What is the Role of Auditors in Control Deficiencies?
Control deficiencies are crucial for auditors. It is because international auditing standards require auditors to communicate these deficiencies to the client’s management and those charged with governance. However, auditors only need to convey those deficiencies that are of sufficient importance that require the management’s attention. In those cases, auditors will need to identify significant control deficiencies and separate those from others.
Significant deficiencies comprise deficiencies that require the attention of those charged with governance in the client. Usually, auditors can use a management letter to convey these control deficiencies to the client. This process occurs once the fieldwork for an audit engagement is over. The management letter must also consist of other parts, such as the consequence of each deficiency and the auditor’s recommendations.
As mentioned, auditors don’t need to communicate every control deficiency. Instead, they will need to identify those which can lead to severe consequences. On top of that, internal auditors will also assess the internal controls for their employers. Once they do so, they will need to disclose them to the management. Usually, they will be responsible for reporting to the audit committee.
Internal controls are systems that companies or businesses employ to avoid risks. There are several other reasons why these are crucial as well. Sometimes, however, some control deficiencies may exist. These control deficiencies come from two sources. If the controls put in place are not sufficient or efficient, they cause control deficiencies. On top of that, the lack of such systems also contributes to it.