Chapter 1 INTERNAL CHECK

Learning Objectives

• To understand the meaning, objectives, advantages and disadvantages of

Internal Check system.
• To Analyse the Auditor’s duties with regard to Internal Check System.
• To Evaluate the Application of internal check system with respect to Cash
and Trading transactions.

1.1 Introduction among the staff that the work performed by

one individual is independently checked
In business concerns, there are chances
by another in the routine course, such
of misapporopriation and manipulation
that errors and frauds are prevented or
of accounts. In order to overcome such
discovered. Under the system of internal
irregularities and to prevent or minimise
check, care is taken to ensure that no one
the occurrence of errors and frauds, a
person handles a transaction completely
checking system is designed to have a
check on the irregularities. Such a check from beginning to end and the work of
which operates continuously as part of every person is in the ordinary course
the routine system is called as Internal checked by another person.
Check. This chapter highlights the
principles of good internal check system 1.3 Definition
and explains in detail the procedure of
• L.R. Disksee defined Internal Check
internal check with regard to cash and
as, “Internal Check is an arrangement
trading transactions.
of accounting routine that errors and
frauds are automatically prevented or
1.2 Meaning Of discovered by the very operation of
Internal Check book-keeping itself.”
The term Internal Check refers to • According to F.R.M D epaula, “An
allocation of duties to the employees internal check means practically a
in an organisation in such a way that continuous internal audit carried
the work of one person is automatically on by the staff itself, by means of
and independently checked by the other which the work of each individual is
person from the beginning to the end. It independently checked by the other
denotes such an arrangement of duties members of the staff ”.

Internal Check 1
1.4 Principles (or) Features reviewed) and suitable changes should be
of Good Internal Check introduced.
System 8. Usage of Electronic Equipment: The
system of internal check should provide
1. Division of Work: Division of work
for usage of labour saving electronic
refers to dividing the total work among
devices such as calculating machines,
various staffs is such a way that no single
personal computers, time recording
person is allowed to perform the work
clocks, book-keeping machines etc.
from the beginning to the end. The work
The proper training should also be
should be allocated to the employee
given to the employees for using these
based on the capacity of each person.
devices.
2. Authority and Responsibility:
Authority, duties and responsibilities
1.5 Objectives of Internal
of each person should be clearly
Check
defined and there should not be any
overlapping or duplication of duties The objectives of internal check are as
and responsibilities. follows:
3. Automatic Check: Work allocated to the 1. Early Detection of Errors and Frauds:
staff should be in such a way that the work The main objective of internal check is
performed by one person is automatically to detect and prevent the occurrence
checked by another person. of errors and frauds at an early stage.
4. Rotation of Employees: A good system This is possible as the work of each and
of Internal Check should provide every person is independently checked.
transfer or rotation of employees from 2. Minimization of Errors and Frauds:
performing one work to another at It is one of the primary objectives of
frequent intervals. internal check. As the work performed
5. Proper Training to Employees: An by each individual is checked by another
effective system of internal check person, there is a check on errors and
should carefully select the employees frauds. Hence, the possibility of errors
to the organization. The employees and frauds are minimised to a greater
should be properly trained and clear extent.
instructions should be given to them to 3. Division of Work: Internal check
perform their work in an effective and provides for proper division of work
efficient manner. based upon each and every persons
6. Proper system of Documentation: skill, ability, specialisation and
Internal check system should provide effectiveness.
for proper system of filing vouchers, 4. Fixation of Responsibility: The total
correspondences etc. in a systematic work is divided into smaller units and
manner. assigned to different persons. Each and
7. Periodical Review: The system of internal every person knows what is expected
check should at frequent intervals (be from him/her and he/she will be held

2 Internal Check
 responsible for any error or fraud which check is to minimize the occurrence
takes place in it. Internal check provides of errors and frauds, as no individual
clear determination of responsibility. person does the work from the beginning
5. Reliability of Records: The system to the end and the work of one person is
ensures that the books of accounts checked by another person.
and other records maintained provides 3. Increases Efficiency: A good system of
reliable source of information. internal check, increases the efficiency
of work of employees as the right work
1.6 Advantages of is allocated to the right person taking
Internal Check into account his skill and experience.
4. Determination of Employees Liability:
The main advantages of Internal Check
Internal check system clearly determines
are given below.
the responsibilities of the employees.
1. Proper Distribution of Work: Internal Hence, the liability of the employees can
Check helps in proper distribution of be easily fixed due to irregularities or
work among employees based on their negligence caused by the employee.
qualification and experience. It enables 5. Proper Maintenance of Books of
the employees to perform the work Accounts: Internal check system helps
efficiently. to maintain proper records and ensures
2. Detection and Prevention of Errors accuracy of the entries in the books of
and Frauds: The main object of internal accounts.

Internal Check 3
 8. Increases Profitability: Overall
efficiency and economy of operations
lead to increased earnings for the owners
of the enterprise.

1.7 Disadvantages
of Internal Check
The disadvantages of internal check are
given below.
1. Expensive: The system of internal check
is more expensive and time consuming.

2. Not Applicable for Small Organization:

6. Easy and Quick Presentation of Final This system is not applicable for small
Accounts: Internal check enables quick organization where there are only few
presentation of final accounts i.e., employees. Only large organization having
Profit and Loss Account and Balance number of departments and complexity of
Sheet immediately after closing of the jobs can get benefit of this system.
accounting period. 3. Monotonous for the Workers: As
7. Facilitates the Auditor: When there same work is done by the employees
is an effective internal check system continuously the job becomes boring
the statutory auditor can rely on the and the employees lose their creativity.
system. He can avoid detailed checking 4. Risky for the Auditor: When the
of transactions. He can select limited auditor relies on the system of internal
sample of transactions. This enables him check and does not conduct tests he
to finish the audit work within time. will be charged for negligence.
4 Internal Check
5. Disorder in work : If the system is 6. Chances of collusion: Though internal
not fully organized and if there is any check system protects errors and frauds but
failure in the system, it creats disorder in reality there may be chances of collusion
and confusion hence, chances of errors between two or more employee to indulge
and frauds increases. in frauds or malpractices.

1.8 Duties of an auditor with Regards to Internal

Check System

1 To obtain written
statement

2 To examine the system

of check in operation

Auditor’s
Duties with
regard to 3 To identify the
weaknesses of the system
Internal
Check

4 To make suggestions
to improve the system

5 To analyze the extent of

reliance on the system

The system of internal check in an 3. To Identify the Weaknesses: The auditor

organisation determines the scope of should identify the weakness of the system
work of a statutory auditor. The duty of which will result in occurrance of errors and
an auditor is to verify the effectiveness of
frauds taking place.
the system of internal check in operation.
4. To Suggest for Improvements: If the
However, the auditor should perform the
following work in this regard. system of internal check is ineffective,
the auditor should make suggestions to
1. To Obtain Written Statement: An auditor
strengthen the system of internal check.
should obtain a written statement about
the working of the internal check system 5. To Analyse the Extent of Reliance: The auditor
from the business concern. should carefully analyse the extent to which he
2. To Examine the System in Operation: can rely on the effectiveness of Internal Check.
The auditor should carefully examine If the system of internal check is effective, he
the existence and operation of the can check sample transactions thus devoting
internal check system. his attention on other important audit areas.
Internal Check 5
1.9 Internal Check - Cash entrusted with the work of depositing
Transactions cash in the bank.
6. Cash received after the banking
Checking of all cash transactions should hours should be kept in the locker of
be given utmost importance because
the business. The locker should be
employees tend to involve in fraudulent
opened by the cashier in the presence
activities by misappropriating cash and
of a responsible official.
manipulating accounts in an organistion.
7. Printed receipts should be issued for
Hence, the auditor should verify the
all remittances signed by the cashier
system of internal check in operation with
and responsible official.
regard to cash receipts and cash payments,
8. Unused receipt book should be kept
which is explained in detail below –
under lock and key under the custody
of the responsible official.
1.9.1 Internal Check-Cash
9. Cancelled or spoilt receipts should not
Receipts
be detached from the receipt book.
There should be proper system of Internal 10. Cash balance should be physically
Check as regarding cash transactions as verified by a responsible official by
the employees tend to misappropriate surprise check at frequent intervals.
cash in an organisation. Cash receipts
may be misappropriated in the following 1.9.2 Internal Check-Cash
manner: Payments
• Cash receipts may not be entered in the There should be an effective system of internal
cash book. check with regard to all payments made by
• Cash received may be understated by the concern in the form of cash or cheque
preparing duplicate receipts for amount or bank transfers. Cash payments may be
less than what is actually received. misappropriated in the following ways:
• Cash sales may be treated as credit sales.
• Payments may be made against fictitious
The following system of Internal Check vouchers.
may be adopted as regards cash receipts. • Payments may be made against inflated
1. All inward remittances should be vouchers.
opened by the cashier in the presence • Payments may be made without receipt
of a responsible officer. of goods.
2. On receipt of cash or cheque, it should • Revenue expenses maybe treated as capital
be immediately entered in cash book expenditure.
or cheque received notebook. Hence, a proper system of internal
3. All remittances (draft, cheque) must check is necessary. The following system
be crossed as ‘account payee only’. of internal check may be adopted as regards
4. Cash and cheques received should be cash payments.
deposited immediately.
5. Bank pay-in-slips should be prepared 1. The person in charge of making
by a separate person, who is not cash payments should not have
6 Internal Check
 any connection with the person make payment for transactions of
responsible for receiving cash. special nature.
2. The person responsible for making 10. Bank reconciliation statement should
cash payments should not have access be prepared to reconcile cash and
to the books of accounts. bank balances from time to time.
3. All the payments should be paid by
way of crossed cheque. 1.10 Internal checks-
4. After making payment against a Wages
particular bill or invoice, the voucher
Wages are ver y important item of
and the supporting bill or invoices
expenditure. The system of internal
should be stamped as ‘paid’ so that the
check for wages should be devised in a
same voucher is not passed again for
payment. planned and careful manner. There are
5. Unused and cancelled vouchers and great possibilities of frauds in a concern
cheque books should be kept under employing a large number of workers.
the custody of a responsible person. A sound system of internal check for
6. Person who is responsible for payment of wages may avoid errors and
preparing the cheque should be frauds which may be revealed from time
clearly specified. Before passing a bill and piece wages records.
for payment, it should be ensured that The following system of internal check
the goods have been received. may be adopted as regards wages.
7. The bill for which payment is to be
made should be sanctioned by the I. Maintenance of Wages
responsible official.
Records
8. Confirmation of balances from the
creditors should be made through 1. Time Records: It is a record maintained
direct correspondence. by the gate keeper who records the
9. Proper sanction should be obtained entry time and exit time of each
by directors from higher officials to worker. Foremen of each department

Internal Check 7
 also maintain records for time spent by 2. Separate Sheets: Separate wage sheets
an employee. When wages are paid on should be used for time-workers and
the basis of time spent by a worker, the piece-workers.
record maintained by the gate keeper 3. Checking: The wage sheet should be
and record maintained by foremen of inspected and counter signed as correct
each department are summarised for by the works manager and foreman.
payment of wages. 4. Signature: The wage sheet should be
2. Piece-work Records: This record is counter signed by those employees who
maintained by the foremen who records has prepared it.
the actual work done by each employee. 5. Approval: Each and every wage sheet
Each person is provided a job card who should be approved by factory manager
records the work done by him. Finally, the or Managing Director.
record maintained by the foremen and
job card are used in determining wages. III. Payment of Wages:
3. Overtime Records: Overtime should be
sanctioned in advance by a responsible 1. The person who is in-charge for payment
person. Employees should be issued of wages should not have connection
overtime slips bearing the name and with the preparation of wages sheet.
number of worker. Such slips should be 2. Each worker should be asked to receive
issued and initialled by some responsible his wages personally in the presence
official. At the end of the week such slips of his foreman to identify him.
should be sent to the wage office. 3. No payment is made to someone on
behalf of a worker who is absent.
4. Pass-out Records: The workers should
4. Wage payment should be made by cash
not be allowed to leave the factory
department, not by other persons.
without the written permission. For this,
5. The amount of wages for each
a pass-out slip is issued to the worker by
employee should be placed in an
same authority. Such slips are handed
envelope bearing the name and
over to the gate keeper. The wage office
number of person.
should also be given copy of it.
6. Special arrangements should be made
for payment to the absentees.
II. Preparation of Wage Sheet:
7. Exact amount of money should be drawn
The wage sheet should not be prepared from the bank for payment of wages.
by one clerk alone. A set of clerks should 8. Advances to workers should be
compare the records maintained at the discouraged and if it becomes
gate and the wage office and enquire about unavoidable, they should be given
differences, if any. The following points through the petty cashier.
should be taken into account. 9. If casual workers are also employed in
the factory a separate record should
1. Base: The wage sheets should be be maintained for them.
prepared with the help of attendance 10. Undisbursed wages should be
register, overtime slip and pass-out slip. deposited immediately into the bank.
8 Internal Check
1.11 Internal Check goods received note and purchase order
Trading Transactions before making payment.
11. After making payment, the accounts
1.11.1 Internal Check-
department should affix a rubber stamp on
Purchases
the invoices in order to avoid duplication
The following system of internal check
of payments.
may be adopted as regards purchases.
12. At frequent intervals, a responsible person
1. A purchase department should supervise should check the entries in the purchase
and control the entire purchase book with supplier ledger account.
transactions of the organisation.
2. The procedure for purchases should start 1.11.2 Internal Check-Purchase
with issuing purchase requisition, making Returns
enquiry about the terms and conditions of 1. When goods are returned to the supplier it
purchases from different suppliers. should be entered in purchase returns book.
3. Purchase requisition should be in a 2. A credit note should be obtained from the
printed form and serially numbered. They supplier for each return of goods and the
should be given to all the departments in note should be attached to the invoice.
the organisation. 3. The purchase department should check
4. On receipt of requisition from various such advice note with invoice and enter
departments, the purchase department in purchases returns book.
should send enquiry letter to the suppliers. 4. When only part of the goods are
5. The purchase department, after verifying returned to the supplier, the goods
the quotation should place an order with which are accepted alone should be
the supplier. entered in the stores ledger.
6. All the purchase orders should be signed
only by the Purchase Manager or any 1.11.3 Internal Check-Sales
responsible person on his behalf.
Sales are the most important source of
7. Goods should be received by a responsible
revenue in a business and hence the
official and entered in the Goods Received
possibilities of errors and frauds taking
Note and the same should be recorded in
place are greater. Frauds maybe committed
the stock register/stores ledger.
in the following ways:
8. On receipt of invoice from the supplier,
the Purchase department should check • Sales may be omitted from recording in
the invoice with the goods received note the sales book.
and verify the rate, discount, quality and • Fictitious sales may be accounted.
quantity of goods. • Sale of fixed assets may be treated as
9. Goods received should also be entered sale of goods.
in the stores ledger and entries should be In order to overcome the occurrence of such
made in the Bin Card. type of frauds, an effective system of internal
10. The accounts department should check as regards credit sales is necessary
verify the purchase invoice with the which may be in the following manner.
Internal Check 9
1. On receipt of order from the customers, it 7. The persons who are responsible for
should be numbered and the particulars preparing the invoices should not be
entered in the order received book. allowed to post the entries in the customer’s
2. The order copy should be handed over accounts.
to the dispatch department who makes 8. At frequent intervals, the balances in the
necessary arrangements for delivery of customers’ accounts should be verified
goods. with the confirmations received from the
3. When the goods ordered and ready for customers.
delivery the dispatch department should 9. A responsible official should verify that
inspect the goods with the order copy and only sale of goods are accounted in
enter the details of goods delivered in the sales day book and sale of assets are not
dispatch memo. accounted.
4. The invoice should be prepared based 10. A responsible official should deal with
on the dispatch memo in three copies, customers enquiries, overdue accounts
one copy should be sent to the Customer, and writing off bad debts.
second copy to the Accounts department
and third copy will be retained by the 1.11.4 Internal Check-Sales
Sales department. Returns
5. A responsible official should check
1. The goods returned by customer should be
the particulars in the invoices and also
entered in the sales return book and reason
confirm that the terms and conditions
in the order have been duly followed and for the return should also be recorded.
finally he should put his initial on the 2. The gatekeeper should also enter the
invoice. goods received in the goods inward book.
6. The gatekeeper should record particulars 3. A credit note should be prepared, duly
of the goods leaving the premises in the checked and initialled by a responsible
goods Outward book. official.

STUDENTS ACTIVITY

1. Visit an Industry, discuss with Accounts Manager

regarding Internal Check System followed for
cash receipts and cash payments.
2. Visit an Industry, with prior permission to
verify Internal Check System followed with
regard to Purchase and Sale transactions.
3. Set up a model bank in your class room and
discuss the procedure for Deposits, Withdrawals
and Sanctioning of Loans.

10 Internal Check
 SUMMARY

Internal check refers to allocation of duties to the employees in an organisation

in such a way that the work of one person is automatically and independently
checked by the other person. The main object of internal check is to detect errors
and frauds, to provide for division of work, fixation of responsibility, liability of
records. Internal check is based on the principle of division of work, automatic check,
rotation of employees, proper training to employees, periodical review and usage of
electronic equipments. The drawback of the system are expensive, creates confusion
and disorder in work. Internal check is exercised in case of cash transactions i.e., cash
receipts and cash payments and trading transactions i.e., purchases and purchase
returns, sales and sales returns to detect misappropriations of cash and goods.

KEY TERMS

• Internal check: The term Internal Check refers to allocation of duties to the
employee in an organisation in such a way that the work of a person is automatically
and independently checked by the other person.

• Division of work: The total work divided among various staffs based on their
skill and expertise.
• Purchase Returns: When goods are returned to the Suppliers.
• Sales Returns: Goods returned by Customers.
• Invoice: Invoice is a statement prepared by the seller of goods. It contains the
information relating to name and address of the seller and the buyer, the date of
sales, price and quantity of goods sold.
• Debit Note: A Debit Note is a commercial document issued by a buyer to a seller.
Debit Note is the source document to the Purchase Returns Journal.
• Credit Note: A credit Note is a commercial document issued by a seller to a
buyer. It is the source document to the Sales Return Journal.

Internal Check 11
 EVALUATION

I. Multiple Choice Questions

1. A system in which the work of one 6. is a valuable part of

person is automatically checked by Internal Control
another person is called as . a. Internal Audit
a. Internal Check b. Internal Check
b. Internal Control c. Test Check
c. Internal Audit d. Routine Check
d. Interim Audit 7. While making payment for purchases
2. Objects of Internal Check are . are to be checked by a clerk.
a. to minimise errors and frauds a. Account Sales
b. to prevent errors and frauds b. Invoices
c. to allocate duties and c. Cash Receipt
responsibilities d. None of these
d. all of the above 8. When goods are returned to suppliers,
3. A good Internal Check system a should be obtained
. from them.
a. to reduce the liability of an auditor a. Debit Note
b. reduces the work of an auditor b. Credit Note
c. reduce the responsibility of an c. Account Slip
auditor d. None of these
d. All of the above 9. Goods returned by customers will be
4. The system of Internal Check is based entered in
on the principle of . a. Goods Inwards Book
a. Division of labour b. Purchases Returns Book
b. Unity of command c. Goods Outward Book
c. Unity of direction d. Above all the above books
d. Authority 10. Internal check system is useful to
5. Internal check is a kind of . business concerns.
a. Complete audit a. Small scale
b. Division of work b. Large scale
c. Partial audit c. Medium size
d. Final audit d. All the above

Answers 1.(a), 2.(d), 3.(d), 4.(a), 5.(b), 6.(b), 7.(b), 8.(b), 9.(a), 10.(b)

12 Internal Check
 II. Very short answer questions

1. What is meant by Internal Check? 3. What is Piece Wage Records?

2. What is meant by Overtime records?

III. Short answer questions

1. Define “Internal Check”? 3. Briefly explain the duties of an auditor

2. What are the objects of Internal with regard to Internal Check system.
Check?

IV. Essay type questions

1. What are the advantages and

disadvantages of Internal Check? 5. Explain a system of Internal Check as
2. Discuss the features of a good internal regards to Payment of Wages?
Check System. 6. Explain the system of Internal Check
3. Examine a system of Internal Check as regards to Purchase?
as regards to cash receipts? 7. Explain the system of Internal Check
4. Describe a system of Internal Check as as regards to Sales?
regards to cash payments?

References
1. Auditing Practical – B.N. Tandon and Others, S.Chand Publication.
2. Principles and Practice of Auditing – Dinkar Pagare, Sultan Chand & Son’s.
3. Auditing Practical – Dr.G.Anitha & Dr.J.Sankari, Sri Selva Publishers Distributors.
4. Auditing Practical – Dr. L. Natarajan, Margham Publications, Chennai.
5. Auditing – Study Material, The Institute of Cost Accountants of India.

Internal Check 13