Economic sciences/7.
Accounting and audit
Rysbekova J.M.
Karaganda Economic
University of Kazpotrebsoyuz, Kazakhstan
The internal control system
The internal control system is a total combination of organizational
structures, policies, procedures and actions of employees of the organization,
which have a direct to risks minimizing and its objects achieve guarantee. Each
of these risk categories draws the attention to necessity of internal control
system developing. Supervisory departments estimate the internal control system
from the standpoint of each risk category when examine the different fields of
bank activity. The internal control system deficiencies in one of the bank
activities may have unfavorable influence on financial institution generally.
These risk categories should be taken into account in internal control
system considering, despite the fact that the internal control system setting
method may not be in conformity with risk categories. The bank can elaborate
the internal control system of accounting by functional feature, subdivision
and mixed principle. The internal control systems spread all over each of these
risk categories, independently of its approach using.
There are next questions are considered in the article: the internal
control system and “business risk’ conception, the size of risk definition.
1. The internal control system
The internal control is a total combination of organizational
structures, methods and procedures, which were accepted for a business
effective management by the leaders of the economic subject.
The internal control system includes supervision and check, which are
organized in the economic subject:
-
law requirements observing;
-
accuracy and completeness of business
facts on documents;
-
timeliness of the account report
presenting;
-
activities for errors and distortions
prevention;
-
execution of an orders and
instructions;
-
the guarantee of the company property
safety.
The internal control system divides into three parts:
-
intradepartmental financial control;
-
internal control of the organization
(company);
-
activity of the audit commission.
The active measures are accepted for internal control system
strengthening in financial and credit organizations, and commercial banks
especially. The special internal control subdivisions realize a systematic
control of work regulations observance. They elaborate mutual examination plans
of cooperated and interconnected subdivisions. At the same time they discuss
the results of theirs activity. The main problem of the organization directors
in the market economy conditions is creating of the control environment. That
is methods of work, which making the regular mutual control in the basic parts
of work. It realize through the organization and management of the documents flow;
one-man management and collegial management combination; exact definition of
commissions and responsibilities of each employees; collegial discussing of
accepted decisions. The valuation of internal control system is independent
object of auditing.
The organization of effective functioning internal control system is
difficult multistage process, which includes next steps:
Critical analysis and compare of certain purposes for company
functioning; previously received path of actions; strategy and tactic with kind
of activity, size, organizational structure, and its capabilities.
Development and documentation of new (in conformity with changing
economic conditions) business organization concept (what does “organization’
mean, what purposes, what it can do, in what kind of area it has competitive
advantages, what place it is going to hold in the market). The documentation
includes financial, production and technology, innovative, supply, resupply,
investment, accounting and trained policy. These rules must be developed basing
on analysis of each element of the policy and selection most suitable
alternatives for organization. Documentation of company policies in different
areas of its financial and economic activity will allow a preliminary, current
and subsequent control of all aspects of its functioning.
Analysis of the effectiveness of the existing management structure and
its adjustment. It is necessary to develop the document about organizational
structure, which must be described in all organizational units with an
indication of the administrative, functional, methodical subordination,
directions of their activity, the functions they perform, set the rules of
their relations, rights and responsibilities, shown the distribution of types
of products, resources, management functions to these links. The same with
documents of the various structural units (departments, bureaus, groups, etc.),
plans of the work organization of their employees. There is necessary to
develop a plan for documentation and document flow, staff schedule, job
descriptions with indication of rights, duties and responsibilities of each
structural unit. It is impossible to carry out well coordinated functioning of
all parts of the internal control system organization without a disciplined approach.
The development of typical control procedures of the specific financial
and business transactions. That will let improve the relationship between
employees in control of financial and economic activity, manage of resources
effectively, estimate the reliable level (quality) of information for
management decisions.
The purposes of internal control system in the company:
1) carry
out an effective activity of the company;
2) the
guarantee of the observe the company demands by each employee;
3) the
guarantee of the property safety in the company.
The coordination of accounting system and internal control system is
necessary to achieve above-mentioned objects. Because the double entry system,
which form the basis of any accounting system (including automated accounting
systems), determines the procedure of economic operations registration and
ensures a definite control.
The criterion of effective internal control system is observe internal
control principles of the company.
1. The principle of responsibility.
2. The principle of balance (it means subject is forbidden to perform
control functions without certain implements).
3. The principle of under control of each internal control subject
working in the company.
4. The principle of timely reports of deviations.
5. The principle of interest infringement (there is necessity to create
special conditions when any deviations penalize each employee or organizational
unit and induce them to resolve the problem).
6. The principle of integration (there are must be created proper
conditions for close interaction between workers of different functional areas
in solving problems about the control).
7. The principle of administration interest.
8. The principle of competence, conscientiousness and honesty of
internal control subjects. The principle of competence means high level of
knowledge of the controller in the control of financial and economic activity.
Also requires knowledge increasing by professional development courses,
seminars, trainings, be keep up on last law changes, learn experience and new
control methods and increase of professionalism.
9. The correspondence principle (the complexity degree of the internal
control system must correspond to complexity degree of the under control
system).
10. The constancy principle (adequate continuous functioning of the
internal control system allows to notice of deviation possibility timely).
11. The principle of admissibility of internal control methodology
(means expedient distribution of control functions, the expediency of the
internal control programs as well as the methods used).
12. The principle of development and improvement continuity (even the
most progressive management methods become obsolete).
13. The principle of priority (absolute control of the ordinary minor
operations does not make sense and diverts from objectives that are more
important).
14. The principle of complexity (it is impossible to achieve overall
effectiveness, focusing control only on a little number of objects).
15. The principle of coordination capacities of the various parts of the
internal control system.
16. The principle of optimal centralization (dynamicity, stability,
continuity of the system functioning are determined by the unity and optimal
level of centralization of the organizational structure of the organization).
17. The principle of individual responsibility (it is impossible to
fixing one function for two or more centers of responsibility in order to
prevent irresponsibility).
18. The principle of the potential functional simulations (temporary
disposal of individual subjects of internal control should not interrupt the
control process).
19. The standing order principle (the effective functioning of the
internal control system is directly related to how much control activities of
the organization obey the standing order).
20. The principle of the division of responsibilities.
21. The principle of permission and approval.
22. The principle of cooperation and coordination. An important aspect
of the functioning of the internal control system is carrying-out of the
principles of this system. Theirs observance will increase the confidence in it
of external users and auditors as well as internal control data users.
The control must be carried out basing on precise interaction of all
departments and services of the organization.
The totality of these principles is the basis of the effectiveness of
the internal control system.
There are various methods in realizing an internal control. They include
next elements:
1) the financial accounting (inventory and documentation, invoices and
double entry);
2) management accounting (distribution of responsibilities, costs
valuation);
3) audit, control, revision (checking of documents, checking of
authenticity of the arithmetic calculations, checking the observance of the
accounting rules by individual business transactions, inventory, oral
questioning of personnel, confirmation and tracking);
4) management theory.
All of these methods form the unified system and they are used for the
company management purposes.
The general knowledge of internal control system includes receiving
information about the specific features and scale of subject activity, the idea
of its accounting system. The results of the first acquaintance allow making a decision
about the possibility of using internal control system in the checking. If the
Auditor cannot rely on the internal control system, he should plan his check in
this way where his conclusions were not based on confidence in the system. Low
efficiency of the internal control system should be included in conclusion
about subject checking.
The control system must be economically justified, i.e. its functioning
costs should be less than the losses of the company because of its absence. If
the intraeconomic accounting control system will function effectively by
accounting service, it will allow reduce costs for revisions as well as to
external audit.
Intraeconomic control system of accounting department includes three
main elements: control environment, accounting system and control procedures.
Together all the elements of control system provide the risk reduction to
company in the business and financial activities, as well as in accounting.
Control environment is actions, activities and procedures that represent
the general attitude to control of the administration and the owners of the
company, the importance degree of control for the company. There are next
elements when evaluating the control environment: the style and main principles
of management, organizational structure, distribution of authority and
responsibility, management control methods, work with the personnel, the
external factors influence.
The style and main principles of management are relation of the
administration to many elements of the business. For instance, how much the
administration is ready to take a risk in carrying out of business transactions
or avoid all forms of risk, or observance of the ethnic norms of behavior by
directors or violation of financial discipline.
The scheme of accounting organization consist in simple way – accounting
departments under chief accountant’s command. In its turn, accounting
department checks the work of services and structural subdivisions. The less
number of management degrees, the higher checks effectiveness.
Organizational structure determines the existing forms of power and
submission in the company, regulates the area of authority and responsibility
of employees, the procedure for reporting.
The accounting department can be used like a revision department in the
next cases:
1) the interests of business owners, managers and accountants do not
intersect (that is, accounting employees will not to identify errors of the
other employees of company);
2) checking procedures are quite standard, carried out according to plan;
3) a high level of confidence in the control from the accounting
department.
Distribution of authorities and responsibilities between the personnel
of the company guarantees the proper conduct of business operations. For that
purpose, written job descriptions, action plans, recommendations and guidelines
are developed and explained to employees.
The administration uses various management techniques for control over
organization work: identification of employees’ qualification, evaluation of
information processing system and making report, analysis of the achieved
financial results and comparing them with the planned, the study of the
activities of individual departments etc.
The order of implementation of internal management accounting and report
preparing for internal purposes are quiet important for company.
The purpose of personnel work is sufficient number of employees, which
have enough knowledge and experience for carrying-out theirs responsibilities.
The selection system, hire, promotion, education and training have to provide
high qualification and honesty of personnel.
The special feature of that kind of internal control organization –
auditors are employees of a company, not of accounting department. Revision
commissions are gathered by order of director, they carry out the check
procedures and after that do the basic work in the company.
The work of revision commission has informative and consulting meaning
for directors or owners of economic subject. It helps for economic activity
optimization of company, and for responsibilities perform of its leaders.
The control formation usually carry out by revision commissions in the
next cases:
1) when single or unplanned checks of individual departments, employees or
accomplished work are necessary;
2) when accounting department is busy and it doesn’t let divert the other
employees to make a revision. But form individual control service not
necessary;
3) there is possibility of reveal mistakes of the accounting department
during revision, so it should be done by the other employees (not of the
accounting department).
The objects of the revisions may be different. It depends on special
features of economic subject and leaders’ requests.
There is the other way when internal control service is carried out by
internal audit service.
The internal audit service is guided by legislative and standard acts,
ministries and government departments, local self-governments, audit
regulations (standards), also founders’ documents, director’s orders and
instructions, regulations etc. at practice work.
The practice of audit testifies those companies where internal audit
service has created and effectively functions, so there property safety level,
resources employment level, accounting organization level and reporting
authenticity level higher.
2. The “business risk” concept. Determination of the magnitude of risk.
The business risk is risk, which is determined by sectoral features of
business i.e. by the structure of assets, which company decided to invest in.
The manufacturing risk is determined by many factors: the regional features,
market conjuncture, national traditions, infrastructure, etc. There are many
examples that characterize the dependence of the production risk from certain
conditions.
The internal control system is connected with risk. It shows relation of
management to risk. It is hard to describe all advantages of internal control
system without considering the risk. Because it is necessary to understand
types and degree of risk, which credit company makes a deal with, for
development of an effective internal control system. Thereby sustainable
internal control system is necessary for effective risk management. These two
components are so closely connected with each other that ignoring one of them
immediately will have a negative influence on the other.
There are two main category of risk: guaranteed and unguaranteed. Some
risks are unguaranteed. Because of not realizing preventive measures. Risk is
guaranteed when it is understandable, measurable and controlled. Bank should be
opposed to unfavorable finance situation, that caused by that kind of risk.
Guaranteed risks can be managed.
Regulatory authorities determine different kinds of risk. Each of these
authorities may calls kinds of risk differently though, but they think the same
about risks in bank activity. Regulatory authorities determine the next main
types of risk:
1. Credit risk is a risk of losing income part or bank capital. It is
result of inability of loan debtor or contractor to implement contract terms.
Credit risk exist in any economic activity where success depends on contractor,
issuer of financial instruments or borrower. That kind of risk appears every
time credit company gives money, invest them or takes obligations about theirs
giving according to contract or conditions. It is doesn’t depend on including
them as an asset on balance or as an off-balance contingent liabilities.
2. Interest risk is a risk of losing income part and capital in
connection with unfavorable dynamics of interest rates. The interest risk is
included in market risk in some banks. There is special attention to the price
of the bank in interest rates terms and the price sensitivity to changes of
them.
3. Liquid risk is a risk of losing income part and capital in connection
with bank inability to meet its obligations at maturity. Besides liquid risk is
connected with inability to manage the unforeseen reduction or change in the
sources of finance. Liquid risk also appears when bank can’t quickly react to
changes of market situation. It is makes bad influence on its opportunity
convert assets in time with minimum loss.
4. Price risk is a risk of losing income part or capital in connection
with value changes of portfolio financial investments. Activities as a market
maker, dealer, interest rates, currency transactions, operations on the stock
and commodity markets - all of this contributes to the price risk appear. Most
banks use the "market risk" term instead of price risk because price
risk is changes in market factors that have influence on value of traded
instruments. There are interest rates, market liquidity and changeability of
conjuncture (among market factors) that have influence on price risk.
5. Currency risk is a risk of losing income part or capital in connection
with change of currency rate. That kind of risk occurs in external economic
investment and economic activities. Whereas the activity as a market maker on
the currencies and the opening of currency positions connected with price risk.
Currency risk can lead to delayed payments, defaults, partial or complete loss
because of the lack of convertibility.
6. Operational risk is a risk of losing part of income or capital in
connection with the problems with provision of a product or service. That kind
of risk appears when financial companies use electronic means of communication
for customer service. Operational risk depends on internal control system,
information systems, honesty of employees and operational processes. That kind
of risk is in all products and services because it appears every time when
crush occurs in automated systems during processing.
7. The risk of norms discrepancy is a risk of losing part of income or
capital that appears from law infringing, violation of instructions,
regulations, prescriptions or accepted ethical norms. That risk also appears
from ambiguity of laws or rules regulating certain kinds of activity of bank or
its customers. For instance, that risk increases during deal with those kinds
of person like mortgage brokers or auto dealers when crediting its customers.
8. The risk of the wrong strategy is a risk of losing part of income or
capital in connection with incorrect decisions or improper implementation of
these decisions.
9. Risk of reputation is a risk of losing part of income or capital in
connection with negative public opinion. It has influence on finance
institution to attract new customers, provide new services or maintain
relationships with existing customers. Risk of reputation can lead to trial,
financial loss, or a pressure situation about income or has bad influence on
getting license to conduct bank activity.
10. Audit risk means probability accounting reporting of the economic
entity may include not identified significant errors and /or distortion after confirming
its accuracy or it contains a significant misstatement, when there are no such
distortions in the financial statements actually.
Audit risk is the subject of insurance. It consist of three elements:
1. Inherent risk is exposure of the account balance or class of operations
of an economic entity to distortions. If there is absence of appropriate
internal controls, distortions can be essential individually or when aggregated
with distortions of another account balances or classes of transactions.
2. Control risk is a risk that essential distortions were not detected and
corrected by the accounting and internal control systems in the calculation of
balance and class of transactions.
3.
Detection risk is an indicator
of effectiveness and quality of work of the auditor. It depends on the
professionalism of the audit organization in the planning and organization of
the audit, determining selection, the application of audit procedures, and the
qualification of auditors.
The level of detection risk depends on audit
procedures and consist of next elements:
- the risk of analytical procedures –
probability that analytical procedures will not able to detect essential
distortions;
- the risk of detailed tests - probability that test
will not be able to identify essential mistakes;
- the sampling risk - probability of undetected essential distortions in
reporting because of using sampling test instead of a solid test in determining
the size of the sample and its formation, in the establishment of the wrong
size allowable distortion, including unrepresentative elements in the sample.
Director must to determine effectiveness of organizational structure,
role and position of internal control system in the company.
There is important how much the audit plans are composed validly and
planned work is carried out about individual objects correctly; what kinds of
check were used there and how much it was effective; how much information is
reliable according to results of intraeconomic control.
Effective organizational structure of economic subject means justifiable
division of responsibilities and authorities of employees. It has to prevent
violating the control requirements and provide division of incompatible
functions.
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