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THE TAMIL NADU Dr. AMBEDKAR LAW UNIVERSITY

SCHOOL OF EXCELLENCE IN LAW

PERUNGUDI CAMPUS, PERUNGUDI

CHENNAI – 600113

B.COM LLB (Hons.) – (V Semester)

PRACTICAL AUDITING

Module - III

INTERNAL CONTROL, INTERNAL CHECK & INTERNAL AUDIT

By

Dr. S. THIRUMAL, M.Com., M.Phil., MBA., PGDCA., Ph.D,

Assistant Professor of Commerce

School of Excellence in Law
The Tamil Nadu Dr. Ambedkar Law University
Chennai – 600113
Mobile: 9443978290
Email: drthirumal20@gmail.com
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INTERNAL CONTROL

Meaning: It covers the whole management system of an organization, both financial and
non-financial. Internal control system is helpful for the management and also the Auditor in
achieving goals and targets effectively. Therefore, internal control system covers a number of
checks and control to ensure efficient and economic working.

Definition: Internal Control can be defined as a system designed, introduced and

maintained by the company’s management and top-level executives, to provide a substantial
degree of assurance in achieving business objective, while complying with the policies and laws,
safeguarding the assets, maintaining efficiency and effectiveness in regular operations and
reliability of financial statements.

OBJECTIVES INTERNAL CONTROL

1. Effectiveness and efficiency of operations: Its deals with the entity’s achievement of
basic business objectives.
2. Reliability of Financial Reporting: It refers to the reliability of financial information
(both internal and external) that is used by decision makers.
3. Compliance with applicable laws and objectives: It deals with complying with laws,
regulations, and policies.

TYPES OF INTERNAL CONTROL

Types of Internal Control

Detective
Preventive Corrective
Controls
Controls Controls
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1. Preventive Controls: These controls are introduced in the firm to stop errors and
irregularities from taking place.
2. Detective Controls: These controls are implemented to reveal errors and irregularities, once
they take place.
3. Corrective Controls: These controls are designed to take corrective action for removing
errors and irregularities after they are detected.

EVALUATE INTERNAL CONTROLS

Internal controls represent safeguards that protect a company’s business operations and
financial information. Business owners are typically responsible for developing and
implementing internal controls for a company.

Owners can use internal or external audits to evaluate the effectiveness of internal
controls. This evaluation normally follows a standard process of measuring the company’s
business operations and financial information. Many companies hire public accounting firms or
individual professional accountants to evaluate their internal controls, usually by following a
checklist.

INTERNAL CHECK

Internal check is a part of internal control. Internal check is the process of arrangement of
duties of various staffs of a business in such way that work is automatically checked by the next
staff while performing their duties. Frauds which are committed by a staff are automatically
detected and corrected by the staff. So, it helps a lot in the work of final audit.

OBJECTIVES OF INTERNAL CHECK

a. To encourage adherence to prescribed policies: The system of internal control

is introduced to provide reasonable assurance that the various plans, policies and
procedures laid down by the entity are being followed.

b. To avoid frauds and errors: The main objective of any control system is to
detect and prevent frauds and errors by keeping an inherent check.
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c. To promote operational efficiency: The internal controls within an

organization are meant to prevent unnecessary duplication of efforts, protect
against waste and discourage any inefficient use of resources of the
organization.

d. To safeguard assets and records: The other important objective of internal

control system is to safeguard the assets and records from unauthorized access,
use and disposition.

e. To provide accurate and reliable data: The internal control system ensures
that all the transactions are recorded in the correct amount, in the appropriate
account and in the accounting period to which they relate.

f. To assist in timely preparation of Financial Information: Information is of no

use if it is not provided in time. Internal control system facilitates timely

preparation of financial statements.

ADVANTAGES OF INTERNAL CHECK

a. Moral sway over workers: The system of internal controls keeps staff members'
morale in check and teaches them the value of honesty, diligence, and
straightforwardness.
b. Assessment of Employee Responsibility: The internal check system determines
employee duties. The employee may be held accountable for any irregularity that he
engages in.
c. Detection and Prevention of Errors and Frauds: The main object of internal check is
to minimize the occurrence of errors and frauds, as no individual person does the work
from the beginning to the end and the work of one person is checked by another person.
d. Frauds are less likely to occur: The internal check method reduces the likelihood of
fraud since mistakes and frauds may be caught early.
e. Enhanced Effectiveness: Because the internal check system is based on a division of
labour, it ensures higher efficiency and speed.
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f. Making Auditing Simple: Due to the internal checks system's ability to rely on test
checking, auditors' job is greatly facilitated.
g. It is possible to create final accounts: The "Profit and Loss Account" and Balance
Sheet are quickly created in an internal check system.
h. Proper Distribution of Work: Internal Check helps in proper distribution of work
between employees based on their qualification and experience. It enables the
employees to perform the work efficiently.
i. Complete and accurate records of every transaction: The internal check system may
also provide accurate and comprehensive records of all transactions on each
bookkeeping balance.
j. Identification of Fraud or Unregularity: Before they assume any complications, staff
workers might have any dishonesty or irregularity in the concern caught.
k. Increases Efficiency: A good system of internal check, increases the efficiency of work
of employees as the right work is allocated to the right person taking into account his
skill and experience.
l. Testing Possibility: Let's say the internal cheek system is deemed adequate by the
auditor. Then he may use test checking to aid him by thinking about flaws or weak
places.
m. Determination of Employees Liability: Internal check system clearly determines the
responsibilities of the employees. Hence, the liability of the employees can be easily
fixed due to irregularities or negligence caused by the employee.

DISADVANTAGES OF INTERNAL CHECK

a. Costly for small business: A system of Internal check system quite expensive especially
for small business houses.
b. Lack of Motivation at Work: The auditor can be unfocused at work and rely on the
internal check blindfold system, which might negatively impact the audit work's quality.
This is another significant flaw in the internal check mechanism.
c. Not Appropriate for Small Issues: Small businesses should not use the system of
internal checks since they may find it uneconomical.
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d. Quality is sacrificed for Promptness: In an internal check system quality of work

declines because the clerks of the business attach greater importance to become quick and do
not care if in the process their work gets substandardised.
e. Organization Among Employees: If the worried employees band together, they may
conceal several anomalies from the boss and prevent their detection. It could not be suitable
for the workers to assemble like this.
f. Carelessness among high officials: The possibility of some of the responsible and high
officials being complacent, increases as they believe, though not always rightly, that under a
sound system of internal check nothing can go wrong.
g. High-ranking officials' negligence: There is a chance that some of the responsible and
high-ranking officials may get complacent because they think-perhaps incorrectly-that
nothing can go wrong with a strong internal check mechanism.
h. Risky for an auditor: If the auditor depends on the system's output and does not apply
his checks and procedures, his work cannot be free from errors if the system turns out to be
flawed.
i. Quality is traded for Promptness: In an internal check system, the quality of work
suffers because company clerks prioritize being quick and don't care if doing so results in
subpar work.

ESSENTIALS OF GOOD INTERNAL CHECK SYSTEM

a. All cash receipts are to be deposited in the bank daily. The cashier has no control over
any of the ledger.
b. No single staff shall have absolute control over recording of all the aspects of business
transactions by himself.
c. All payments (other than petty cash payments) are to be made by cheque.
d. The same staff shall not be allowed to have access to all books of accounts as well as
physical custody of the assets.
e. Each member of the staff should be made responsible for a specific work.
f. All officials and employees holding responsibility towards cash, securities or stock
should be encouraged to proceed on annual leave to prevent the concealed fraud.
g. The duties of the members of the staff should be changed from time to time.
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h. Attempt should be made to introduce mechanical devices to prevent mis-appropriation of

cash.
i. Each transaction should pass through a definite route and through several hands.
j. All books, vouchers, documents should be classified and made available for easy
reference.
k. Payment of wages should be under strict supervision and control.
l. Proper record must be maintained of the incoming and outgoing of goods from the
business premises.
m. Self balancing ledger system should be introduced to make the system more efficient and
effective.
n. No undue importance should be given to any staff member and too much reliance on any
staff member should be avoided.
o. Division and allocation of duties among the staff members must provide for an automatic
check by others.

STANDARDS ON INTERNAL AUDITS (SIA)

The Council of the Institute of Chartered Accountants of India at its 240th meeting
held on 5th February 2004 had constituted “the Committee for Internal Audit”, later
renamed as “the Committee on Internal Audit”. The main function of the Committee on
Internal Audit, among other things, was to review the existing internal audit practices in
India and to develop Standards on Internal Audit (SIAs).
Internal Audit is defined as “an independent management function, which involves a
continuous and critical appraisal of the functioning of an entity with a view to suggest
improvements thereto and add value to and strengthen the overall governance mechanism of
the entity, including the entity’s risk management and internal control system”
Internal Audit function has moved a long way, from validating the accounting
records of the organisation to being a strong indispensable control tool in the hands of the
management for effectively and efficiently running the affairs of the company.

Types of Internal Audit carried out in an organisation:

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a. Compliance Audit: Compliance audit is a comprehensive review of an organizations

adherence to rules, regulations and laws applicable to the company.
b. Operational Audit: Operational audit is systematic review of effectiveness, efficiency
and economy of operation in an organisation. Environmental Audit: Environmental
audits intends to evaluate an organizations environmental performance and
environmental management practices against legal and other requirements.
c. Performance Audit: Performance audit refers to an independent examination to ensure
economic, efficient and effective use of entities available resources.
d. Forensic Audit: A forensic audit refers to the application of auditing methods for
detection and gathering evidence of frauds, embezzlement, or any other such white-
collar crime.
e. Special Assignment: A special assignment audit is a limited-scope examination of a
specific has directed and approved by the management of an entity

FRAMEWORK OF SIA
Internal audit is conducted in variant economic, legal, cultural and business
environments. Further, the internal audit activity may be performed by an entity’s
employees or by some external agency. Thus, the Framework for standards on internal audit
applies to all the persons performing internal audit activity, irrespective of whether the
function is performed in-house or by an external agency.
Objective of the Framework for SIA
a. To promote professionalism in the internal audit activity.
b. To provide a yardstick against which the quality of services during an internal audit
can be evaluated
c. To codify the best practices in internal audit services

Framework for Standards on Internal Audit

i. Code of Conduct
ii. Competence Framework
iii. Body of Standards and
iv. Technical Guidance.
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OBJECTIVES OF INTERNAL AUDIT

a. Verification of Accounting Records: To substantiate the authenticity and accuracy of

the accounting records provided to the management.
b. Compliance with Accounting Policies: To ensure compliance with standard accounting
practices and policies.
c. Early Detection of Errors and Frauds: To enable the early detection of errors and
frauds within the organization.
d. Analysis of Internal Check System: To analyze the internal check system at regular
intervals, recommending improvements and conducting special investigations for
management.
e. Verification of Liabilities: To confirm that liabilities have been sustained for legitimate
and valid activities.
f. Authorization and Compliance: To ensure that transactions are performed by
authorized personnel and under the appropriate authority.

DIFFERENCE BETWEEN INTERNAL CONTROL AND INTENAL AUDIT

S.N Basis Internal Control Internal Audit

1. Meaning Internal Control refers to the methods and Internal Audit alludes to the auditing
procedures implemented by the program adopted by the firm, to
management to control the operations, so review its financial and operating
as to assist in achieving the business activities by the professional.
objective.
2. What is it? System Activity
3. Verification One person's work is verified by another. Each and every component of work is
verified.
4. Time of As soon as the transaction is recorded Checking is done after the work is
checking checking is performed. performed.
5. Objective To prevent or minimize the possibilities of To detect the errors and frauds which
errors, frauds or irregularities. have already been committed.
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6. Scope The scope of Internal Check is very The scope of Internal Audit is
limited. comparatively board.
7. Nature Broader concepts Narrower concepts
8. Staff No new appointment is made. A separate staff of employees is
engaged.
9. Internal audit Internal check is a device for doing the It is a device for checking the work
work.
10. Thrust of To prevent errors To detect errors and frauds
System

INTERNAL CONTROL V/S INTERNAL CHECK

S.No Point Internal Check Internal Control

1. Meaning It is a system of allocation of It is the system of control

responsibility, division of work and established by the management in
methods of recording transactions, order to carry on business in an
whereby the work of one employee is orderly and efficient manner, ensure
checked continuously by another. adherence to management policies,
safeguard assets and completeness
of records

2. Relation It is a part of Internal Control. It includes Internal check and

Internal audit.

3. Essence It is arrangement of book-keeping and It includes the essence of Internal

clerical duties. check and internal audit.

4. How are Checks are automatic and continuous It includes the implementation of
they Internal check and Internal audit.
implemented
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5. Nature Checks are objectives It includes Internal check and

Internal audit.