Internal Control

Definition of Internal Control:

Internal control is the process, effected by an entity's Board of Trustees, management,
and other personnel, designed to provide reasonable assurance regarding the
achievement of objectives in the following categories:
a. Reliability of financial reporting,
b. Effectiveness and efficiency of operations, and
c. Compliance with applicable laws and regulations.

Types of Internal Controls:

1. Detective:
Designed to detect errors or irregularities that may have occurred.
2. Corrective:
Designed to correct errors or irregularities that have been detected.
3. Preventive:
Designed to keep errors or irregularities from occurring in the first place.
Limitations of Internal Controls:
No matter how well internal controls are designed, they can only provide reasonable
assurance that objectives have been achieved. Some limitations are inherent in all
internal control systems. These include:
1. Judgment:
The effectiveness of controls will be limited by decisions made with human judgment
under pressures to conduct business based on the information at hand.
2. Breakdowns:
Even well designed internal controls can break down. Employees sometimes
misunderstand instructions or simply make mistakes. Errors may also result from new
technology and the complexity of computerized information systems.
3. Management Override:
High level personnel may be able to override prescribed policies and procedures for
personal gain or advantage. This should not be confused with management
intervention, which represents management actions to depart from prescribed policies
and procedures for legitimate purposes.
4. Collusion:
Control systems can be circumvented by employee collusion. Individuals acting
collectively can alter financial data or other management information in a manner that
cannot be identified by control systems.
Internal Control Objectives
Internal Control objectives are desired goals or conditions for a specific event cycle
which, if achieved, minimize the potential that waste, loss, unauthorized use or
misappropriation will occur. They are conditions which we want the system of internal
control to satisfy. For a control objective to be effective, compliance with it must be
measurable and observable.

Internal Audit evaluates Mercer's system of internal control by accessing the ability of
individual process controls to achieve seven pre-defined control objectives. The control
objectives include authorization, completeness, accuracy, validity, physical safeguards
and security, error handling and segregation of duties.
Authorization
The objective is to ensure that all transactions are approved by responsible personnel in
accordance with specific or general authority before the transaction is recorded.
Completeness
The objective is to ensure that no valid transactions have been omitted from the
accounting records.
Accuracy
The objective is to ensure that all valid transactions are accurate, consistent with the
originating transaction data and information is recorded in a timely manner.
Validity
The objective is to ensure that all recorded transactions fairly represent the economic
events that actually occurred, are lawful in nature, and have been executed in
accordance with management's general authorization.
Physical Safeguards & Security
The objective is to ensure that access to physical assets and information systems are
controlled and properly restricted to authorized personnel.
Error handling
The objective is to ensure that errors detected at any stage of processing receive
prompt corrective action and are reported to the appropriate level of management.
Segregation of Duties
The objective is to ensure that duties are assigned to individuals in a manner that
ensures that no one individual can control both the recording function and the
procedures relative to processing the transaction.
A well designed process with appropriate internal controls should meet most, if not all of
these control objectives.
Q.1. (a) Define Auditing. Discuss the main objective of an auditing.
Q.1. (b) What are the different kinds of Auditing?
Kinds of Auditing
Continuous Auditor Running Audit
Continuous auditor also known as running audit or detailed audit. In large-scale business it is not possible for the
auditor to get the true and fair view about the business in a short time period. So for the purpose of finding the correct
information the continuous audit is conducted. Continuous audit is the audit that is conducted throughout the year
with the fixed or non-fixed period.
Interim Audit
In normal word Interim means half yearly. It is conducted usually between two annual general meetings and only one
time, not in intervals.
Final Audits or Complete Audit or Balance Sheet Audit
Final audit is also called as the Balance sheet audit or the Periodical Audit. Final audit is started when the books of
accounts closed at the end of the year. It is the most satisfactory form of audit from the point of view of an auditor.
Q. What is internal control. What are the various type of internal control ?
Various Types of Internal Control
JULY 23, 2010 NO COMMENT
Types of Internal Control
1. Organization
Organization is concerned with placement of workers on their jobs. The workers are responsible for their activities.
The head of department is responsible for looking after the worker of his own department.
2. Segregation of Duties
The segregation of duties is necessary. There are many employees. All aspects of a transaction are not completed by
one person. The recording of transaction by many persons can reduce the risk of errors and frauds. The division of
duties can improve the working of workers.
3. Physical
(The physical internal control is desirable to safeguard assets. The access to assets must be limited. The authorized
persons can be allowed to examine the assets). The persons may visit the warehouse or they may release the assets
through requisition slips. The assets require lockers, iron safe possession of keys and use of passes of warehouse.
4. Approval
All transaction in any business requires proper approval of responsible person. The limit for approval may be fixed.
The creditor recovery officer can approve credit sales. The foreman can approve overtime wages. Purchase officer
can approve the purchase of goods.
5. Accounting
The accounting control is concerned with approval of transactions, accurately processing and correctly recording. The
control of total, preparation of trail balance reconciliations and control accounts is necessary. There is examination of
vouchers that every aspect is not over looked so far this type of control is concerned.
6. Management
The top-level management can apply certain controls beyond the routine working of business. The management
control, include internal audit review of management accounts comparing actual result with budgets, supervisory
control and many other review procedure of business functions.
Q.1. (b) What do you mean by clean Audit Report and Qualified Audit Report. Write three points of a qualified audit
report? (10)
Qualified Report
JULY 28, 2010 NO COMMENT
Qualified Report
A qualified opinion is given when the auditor fells the he cannot issue an unqualified opinion. The effect of
disagreement or limitation on scope is not so material as to require an advance opinion or a disclaimer of opinion. A
qualified opinion should be expressed as being except to the effects of the matter to which the qualification relates.
1. No Proper Books
A qualified repeat is issued when proper books of accounts have not kept by the business concern. The law estates
the number of books to be maintained by the companies by the companies. The failure to keep necessary books of
accounts induces the auditor to mention the fact in the reports.
2. Informal Statement
The law states the formal for financial statement. The fourth schedule and fifth are given in the companies ordinance
1984. The companies must prepare their statement according to schedule otherwise the auditor can mention
weakness in the report.
3. Disagreement Between Books and Statements
The financial statement figures must tally with figures recorded in journal and ledgers. The different in figures is not
acceptable as it may lead to receive the shareholders. The auditor can qualified his report that figures of books and
statement are different.
4. Inconsistent Accounting Policies
The accounting policies must remain the same from year to year. The changes in depreciation rate valuation of stock
and provision for bad debts can disturb the financial statements. The auditor can state the inconsistency in
accounting policies toward by the management.
5. Ultra Vires Payments
The management can misuse the power of doing the business. They may not followed articles of association or
companies ordinance 1984. The payment of dividend out of capital is an example. The auditor must report to the
shareholders about the misuse of powers.
6. Expenditure Incurred
The expenditure incurred during the year must be to the purpose of business of company. The expenses incurred
objective may be state by the auditor in the report. The management is responsible to these wrong payments.
7. Business Conducted
The business conducted investment made and the expenditure incurred during the year may not meet the
requirement of memorandum of association, articles of association and the companies ordinance. The auditor can
inform the owners about the violation of law.
8. Scope Limitations
The management may have valued closing stock prior to date of appointment of auditors. There is a scope limitation
as auditor was absence at the time of stock valuatio. The auditor can qualify his report as to the valuation of stack
talking.
9. In Appropriate Accounting Method
The auditor may note that depreciation has not been charged on building. The depreciated on plant and machinery
may be recorded at fewer rates. The difference in actual and recorded expenses may be stated in the report.
10. Inadequate disclosure
The management may have entered in to an agreement for issue of debentures for plant and expansion. The
agreement may restrict the right to pay dividend to shareholders for next years. The auditor can disclose such
agreement to the owners of the company.
11. Departure from Accounting Practice
The qualified report is issued when an auditor is not satisfied with the management policies. The company may not
record the provision for loss on long-term contract. The disagreement with management can be recorded as adverse
opinion in the report for the information.
12. Breakdown of Accounting System
The auditor can issue the qualified report when he is unable to form an opinion about the financial statements. There
may be fire at computer center business office. The figures may be estimated so auditor can disclaim his opinion.
13. Failure To Prove Case Sales
The auditor can check the internal control system. The company may be dealing on cash basis. All sales may be in
terms of cash. The poor internal control system may create hurdle to verify cash sales. The auditor can submit
qualified report with out opinion.
14. Contingency
The auditor may qualify his report where there is contingency (tax dispute court case) which is significant to affect the
financial statement of the company. The auditor has the right to report the matter to the shareholders. The items must
be stated in the footnote as well as audit report.
15. No Zakat Deduction
The Zakat may be deductible at sources under the Zakat and usher ordinance 1980. The auditor may examine the
relevant law. He can not the weakness of the management for deduction of Zakat. This weakness may be present in
the audit report.
16. Incomplete Information
The auditor may not obtain complete and full information and explanation for the purpose of audit. The facts can be
presented to the owners that he is unable to collect necessary information. He can submit qualified report in order to
draw attention. He can submit qualified report in order to draw attention of owners.
17. No Access to Books
The auditor may be refused to have access to the books of accounts and other relevant record. In this case the
auditor is unable to collect true information necessary for the purpose of audit. The qualified report can be presented
to the shareholder due to non-availability of all or any book.
TYPES OF AUDIT TECHNIQUES
Audit techniques can be classified into four types including Operational audit, Financial audit,
compliance audit and Information systems audit. Operational audit is the one which

examines the use of unit resources in the operations to evaluate the
efficiency with which the assets have been used. Financial audit is done to
examine the accounting and reporting standards used to report the financial
transactions,like receipt and disbursement of funds. This audit aims to verify
the internal controls over cash and cash-like assets. Compliance audit checks
the adherence to laws, regulations, policies. The last type of audit,
Information systems audit determines the internal control environment of
automated information processing systems. It also varifies that how people uses
this system to ensure that unethical practices are con conducted.
Audit report :
An audit report is an official evaluation of an entity's financial status, combined with the auditor's opinions
and collected data on the entity's financial transactions and situation.

There are 4 types of auditors report the auditor creates :
Unqualified Opinion Report:

The Unqualified Opinion report is the purest type of auditing report
Unqualified Opinion reports are given when the auditors are able to access all the data they need in the
proper formats.
Qualified Opinion Report :


A Qualified Opinion report is given when the auditors were not able to fully satisfy themselves on all
aspects of the company's financial status.

Adverse Opinion Report:
Adverse Opinions are made when the company's financial situation as a whole is unreliable or
unconfirmed,

Disclaimer Of Opinion:
The Disclaimer report is issued only when the auditors are unable to perform their work. When not
enough time or information is available, a disclaimer of opinion report is issued


Parts of a Report
For the sake of consistency and simplicity, each type of audit report follows a specific style and
organization. An unqualified report is a three-paragraph report. The introduction paragraph outlines
the general purpose of an audit report and gives the legal meanings of the report without being
specific to the company or person being reported on. The scope paragraph then describes the
nature and process of the audit and makes clear that the financial statements are verified and
acceptably reported on. In the final paragraph, the auditor gives his opinion on the findings that lead
to his rating. Each of the other types of audit reports follow this same format; however, they add a
fourth paragraph where the auditor further expounds on why a favorable rating couldn't be given,
citing facts from the audit process.