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Unit 4: Internal Control

4.4.1 Control Environment Notes

The control environment is the control consciousness of an organization; it is the atmosphere in
which people conduct their activities and carry out their control responsibilities. An effective
control environment is an environment where competent people understand their
responsibilities, the limits to their authority, and are knowledgeable, mindful, and committed
to doing what is right and doing it the right way. They are committed to following an
organization’s policies and procedures and its ethical and behavioural standards. The control
environment encompasses technical competence and ethical commitment; it is an intangible
factor that is essential to effective internal control. A governing board and management enhance
an organization’s control environment when they establish and effectively communicate written
policies and procedures, a code of ethics, and standards of conduct. Moreover, a governing
board and management enhance the control environment when they behave in an ethical manner-
creating a positive “tone at the top”—and when they require that same standard of conduct from
everyone in the organization. “Risk assessment and internal control” issued by the Institute of
Chartered Accountant of India (ICAI) mentioned some of the factors which influence the control
environment. These are listed below:
Factors Examples
a. Organization Structure a. Segregation of incompatible functions helps in
fixing accountability.
b. Board of Directors and their b. A board which is independent of management
committees or an effective audit committee points out to
strong internal control environment.
c. Management’s philosophy c. Management should not adopt policies that
and operating style encourage company personnel to manipulate
data.
d. Management control system d. A competent internal audit department and
clear cut hiring, training, promoting and
compensating policies for employees are
indicators of strong control environment.

Notes People at every level of an organization affect internal control.

Who is Responsible? Management is responsible for “setting the tone” for their organization.
Management should foster a control environment that encourages:
1. The highest levels of integrity and personal and professional standards.
2. A leadership philosophy and operating style which promote internal control throughout
the organization assignment of authority and responsibility.

4.4.2 Importance of Internal Control

Internal controls help safeguard funds, provide efficient and effective management of assets,
and permit accurate financial accounting. Internal controls cannot eliminate all errors and
irregularities, but they can alert management to potential problems.
Effective controls reduce the risk of asset loss and help ensure that plan information is complete
and accurate, financial statements are reliable, and laws and regulations are complied with.

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