Nature and Purpose of Internal Control

CHAPTER 13
OVERVIEW OF INTERNAL CONTROL
NATURE AND PURPOSE OF INTERNAL CONTROL
Internal control is the process designed and effected by those charged with
governance, management and other personnel to provide reasonable assurance
about the achievement of the entity's objectives with regard to rel iability of
financial reporting, effectiveness and efficiency of operations and com pliance
with applicable laws and regulations. It follows that internal control is designed
and implemented to address identified business risks that threaten the
achievement of any of these objectives.
Those objectives fall into three categories:
Reliability of the entity's financial reporting

Effectiveness and efficiency of operations
Compliance with applicable laws and regulations
Whether an entity achieves its objectives relating to financial reporting and

compliance is determined by activities within the entity's control. However,
achieving its objectives relating to operations will depend not only on
management's decisions but also on competitor's actions and other factors outside
the entity.
INTERNAL CONTROL SYSTEM DEFINED
Internal control system means all the policies and procedures (internal controls)
adopted by the management of an entity to assist in achieving management's
objective of ensuring, as far as practicable, the orderly and efficient conduct of its
business, including adherence to management policies, the safeguarding of
assets, the prevention and detection of fraud and error, the accuracy and
completeness of the accounting records, and the timely preparation of reliable
financial information.
198 Chapter 1 3
ELEMENTS OF INTERNAL CONTROL
Internal control structures vary significantly' from one company to the next.
Factors such as size of the business, nature of operations, the geographical
dispersion of its activities, and objectives of the organization affect the specific
control features of an organization. However, certain elements or features must
be present to have a satisfactory system of control in almost any large scale
organization.
The internal control system extends beyond these matters which relate directly to
the functions of the accounting system and consists of the follow ing components:
a. the control environment;

b. the entity's risk assessment process;
c. the information system, including the related business processes, relevant
to financial reporting, and communication:
d. control activities;
e. monitoring of controls.
A. Control Environment
The control environment wh ich means the overall attitude, awareness and
actions of d i rectors and management regarding the internal control system
and its importance in the entity. The control environment has an effect on the
effectiveness of the specif ic control proced ures. A strong control
environment, for example, one with tight budgetary controls and an effective
internal audit function, can significantly complement specific control
procedures. However, a strong envi ronment does not, by itself, ensure the
effectiveness of the internal control system. Factors reflected i n the control
The function of the board of directors and its committees;
Management's philosophy and operati ng style:
The entity's structure and methods of assigning authority

a. a. a.
Management's control system including the internal audit

personnel policies and procedUres and segregation of duties. a.
. 01VITIOW (11 Internal Control 1 99
The environment in which internal control operates hav an impact on

the effecti of th ilic c procedures. Several factors comprise
the
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standards and the manner in which it com municates and rei nforces them
determine the entity's integrity and ethical behavior. Integrity and ethical
val ues incl ude management's actions to remove or reduce i ncentives and
temptations that might prom pt personnel to engage in d ishonest, illegal,
or u nethical acts. They also include the communication of entity values
and behavioral standards to Personnel through pol icy statements, a code
of cond uct, and management's example of appropriate behavior.
Commitment to Competence
Competence is the knowledge and ski l ls necessary to accompl ish tasks

that define an employee's job. Commitment to competence means that
management considers the competence levels for particular jobs in
determining the ski lls and knowledge requ ired of each employee and that
it hires employees competent to perform the tasks.
Participation by those Charged with Governance

An entity's control consciousness is i nfluenced significantly by those
charged with governance. Attributes of those charged with governance
incl ude i ndependence from management, their experience and stature,
the extent of their i nvolvement and scrutiny of activities, the
appropriateness of theihictions, the i nformation they receive, the degree
to which difficult questions are raised and pursued with management,
and their interaction with internal and external auditors. The importance
of responsibi lities of those charged with governance is recognized in
codes of practice and other regulations or guidance produced for the
benefit of those charged with governance. Other responsibilities of those
charged with governance incl ude oversight of the design and effective
operation of whistle blower procedures and the process for reviewing the
effectiveness of the entity's i nternal control.

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CHAPTER 13

OVERVIEW OF INTERNAL CONTROL

NATURE AND PURPOSE OF INTERNAL CONTROL

Those objectives fall into three categories:

Reliability of the entity's financial reporting

Whether an entity achieves its objectives relating to financial reporting and

a. the control environment;

The function of the board of directors and its committees;

Management's philosophy and operati ng style:

The entity's structure and methods of assigning authority

Management's control system including the internal audit

The environment in which internal control operates hav an impact on

Competence is the knowledge and ski l ls necessary to accompl ish tasks

Participation by those Charged with Governance

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