Page 67 - DCOM509_ADVANCED_AUDITING

Advanced Auditing

Notes Internal checking is an accounting procedure or physical control to safeguard assets against loss
due to fraud or other irregularities. Internal check is an element of internal control. Weak
internal check mechanisms mandate a greater degree of auditing procedures. An example of
internal control is segregating the record keeping for an asset and its physical custody, such as
in the case with inventory and cash. No one individual should have complete control over a
transaction from beginning to end. Internal checks make it difficult for an employee to steal cash
or other assets and concurrently cover up by entering corresponding amounts in the accounts.

Example: An example of internal check is the establishment of input and output controls
within a data processing department. A group or person has the responsibility of checking
control totals provided by the user department with those generated during the processing of
the data. Examples of physical controls are guards and gates to restrict access.

4.8 Inherent Limitations of Internal Control

SA 400: “Risks Assessment and Internal Control” issued by the Institute of Chartered Accountants
of India says that, Internal Control can provide only reasonable, but not absolute assurance that
the objectives stated will be achieved. This is because there are some inherent limitations of
internal control, such as:
(a) Management’s consideration that a control be cost effective.
(b) The fact that most controls do not tend to be directed at transactions of unusual nature.
(c) The potential for human error.

(d) The possibility of circumvention of controls through collusion with parties outside the
entity or with employee of the entity.
(e) The possibility that a person responsible for exercising control could abuse that authority
for example, a member of management overriding a control.
(f) The possibility that procedures may become inadequate due to changes in conditions and
compliance with procedures may deteriorate.
(g) Manipulations by management with respect to transactions or estimates and judgments
required in the preparation of financial statements.
Let us try to understand, the inherent limitations of internal control with the help of some
examples:

Example: (for human error): The Finance Manager did not check the ‘Goods Received
Note’ before authorizing the payment to supplier’s bill. The result was excess payments made to
supplier without receiving the materials.

Example: (for possibility of collusion): Mr. X who had custody over incoming cash
receipts colluded with B, who was responsible for processing and recording those receipts, to
misappropriate cash by non recording of cash receipts.

Example: (manipulation by Management): A company has a reliable system of materials
purchase and recording in the books of accounts. The company’s top management wanted to
show increased profit with the help of inflated closing stock in the profit and loss account. They
instruct both the clerks to record fictitious purchase near the end of the accounting period, thus,
undermining the utility of internal control system.

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