Internal control refers to controlling risk within a business and developing standardized procedures for all objectives. This is achieved by optimizing efficiency, accurately reporting finances, and complying with internal and external policies and regulations. All of this is conducted to ensure that a business’s assets are protected from potential fraud. Internal controls are present at both company-wide and individual levels. Individual control refers to how transactions are carried out for optimum efficiency, while company-wide controls concern overarching procedures.
The Committee of Sponsoring Organizations of the Treadway Commission is an organization intended to establish guidelines and conventions for internal control procedures, which many companies today adhere to. The COSO has developed five frameworks with which a business should be run.
The first framework seeks to establish a control environment, which is intended for managers and directors to reinforce the importance of internal control within a business. This importance is noted in internal procedures, company values, and corporate culture.
The second framework assesses risk, internally and externally. In order to assess risks, it is important to first understand what is being risked. Objectives must be established and anything that may interfere with the completion of an objective is a risk.
The third framework establishes control activities within a business. Whenever risks to an objective are encountered, there must be procedures on hand to stop these risks. Risks are often avoided when duties are dispersed within a business. For example, it would not be prudent for one person to handle all financial activities in a company, as human error could occur. So, when multiple employees handle financial activities, there is less risk of error. Control activities also include reconciling account balances and creating systems of authorizations for financial activities.
The fourth framework provides information and communication methods such as monthly, quarterly, or yearly financial reports to ensure accurate and up to date information for business management. Additionally, there must be clear internal and external communication channels to ensure that information is distributed concisely and accurately.
The final framework establishes that internal controls must be monitored on a regular basis, ensuring that business operations are proceeding smoothly and efficiently. If any problems or risks are encountered, these should be detected by the monitoring system and corrected.
Note that these frameworks and operations within a business are designed and sustained by humans. Therefore, while maintaining internal controls, there is the likelihood of error. This could be a result of poorly constructed methodologies or errors in judgment. On the other hand, considering the variety of internal controls created, smaller companies could be overwhelmed by the processes as a whole.