H2R CPA Blog

Reduce Risk and Increase Efficiency with Effective Internal Controls

Internal controls have always been an important aspect of an organization’s operations and financial statement audit. More recently, Statement on Auditing Standards No. 145 (effective for year-ends on or after December 15, 2023) placed an added emphasis on the auditing and documentation of these controls.

What are internal controls?

The American Institute of Certified Public Accountants (AICPA) defines internal controls as “the process of assuring achievement of your objectives in operational effectiveness and efficiency, reliable financial reporting, compliance with laws, and regulations and policies; a documented framework for managing risks to value creation and preservation.”  But what does this really mean?

In essence, internal controls are the processes that help protect an organization from fraud, incorrect financial reporting, waste and abuse. Controls can be placed at all levels of an organization including anything from the ordering of office supplies to the receipts of cash. Controls are placed over these processes to ensure that they cannot be abused and, if they are, that the abuse is detected and addressed.

Processes vs. Internal Controls

Your organization may have many processes in its day-to-day and monthly closing procedures. These processes allow your organization to operate efficiently and may be as simple as the office manager orders supplies for the supply room or the accounting manager prepares the bank reconciliation. But how do you know the office manager is not improperly ordering supplies to take or that the accounting manager is not reconciling the statement to help them cover fraud? Internal controls would be the checks over these processes to detect fraud and abuse. For example, a control may be that someone has to review and approve all supply orders over a certain dollar threshold or that the Executive Director and Accounting Manager review the bank reconciliation each month and discuss any irregular transactions.

Important Features of Effective Internal Controls

To optimize the effectiveness of internal controls, remember the following:

  • Your controls can only be relied upon if they are being followed. It is imperative that management and governance stress integrity and the importance of following these controls.
  • Document your processes and controls. Documentation allows controls and processes to be communicated completely to new employees and can allow for the review of processes to determine where controls may be needed.
  • The more formal the control the better. Requiring a formal signature or initialing of a document provides better controls than informal controls. Saying the Executive Director reviews and approves the bank reconciliation does not provide much assurance if they don’t actually do it or if the Accounting Manager can just say they did the review.
  • Having some controls is better than having no controls. If you are a small organization, it may be difficult to separate duties and ensure all processes have control. In these situations, it is important to evaluate what you think are the highest risk areas, such as the same employee handling bank deposits and reconciling the bank statements, and implement controls over the higher risk processes.

You may trust your employees and team 100% and implementing internal controls won’t change that. Rather, these controls will allow your organization to operate more effectively and efficiently.

Reach Out to Learn More

If you would like to learn more about effective internal controls and how to implement them for your organization, reach out to the Accounting & Assurance Group at H2R CPA.

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