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Unit 4: Internal Control

4.2 Types of Internal Control Notes

The Committee of Sponsoring Organizations (COSO) of the National Commission on Fraudulent
Financial Reporting (also known as Tread way Commission) defines internal control as:

“Internal Control is a process, effected by an Entity’s Board of Directors, Management and other
personnel, designed to provide reasonable assurance regarding the achievement of objectives
in the following categories:
1. Effectiveness and efficiency of operations
2. Reliability of financial reporting
3. Compliance with applicable laws and regulations.

From the study of above two definitions, following key concepts of internal control emerge:
1. Internal control is a process. It is a means to an end, not an end in itself.
2. It is designed, implemented and maintained by personnel at every level of organization.

3. Internal control provides reasonable assurance not absolute assurance about the
achievements of stated objectives of an entity.
4. The stated objectives can be regarding reliability of financial reporting, effectiveness and
efficiency of operations, safeguarding of assets and compliance with applicable laws and
regulations.
Based on objectives internal controls can be classified into two ways:

1. Preventive Controls: Designed to discourage errors or prevent irregularities from
occurring. They are proactive controls that help to prevent a loss.

Example: Separation of duties, proper authorization, adequate documentation and
physical control over the assets.
2. Detective Controls: Designed to find errors or irregularities after they have occurred.

Example: Reviews, analysis, variable analysis, reconciliations, physical inventories and
audits.
Based on functions, internal control can again be classified in two ways:

1. Accounting Controls: It comprises “the plan of organization and all methods and procedures
that are concerned mainly with, and relate directly to, safeguarding of assets and the
reliability of financial records.”

Example: Authorization and approval of transactions, separation of duties with regard
to record keeping and accounting reports from those concerned with actual business operations,
custody of assets, physical control over assets and internal audit.

2. Administrative Controls: It comprises “the plan of organization and all methods and
procedures that are concerned mainly with operational efficiency and adherence to
managerial policies, and usually relate only indirectly to the financial records.”

Example: Statistical analysis, time and motion studies, performance reports, employee
training programme, and quality controls.

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