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What is Internal Control in Accounting?

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Internal control is a system of policies and procedures that operate within accounting. These internal controls protect a company from fraud and abuse, ensure that the financial records are timely and accurate, and that all legal and regulatory requirements are being met.

There are five key elements of internal control in accounting. Each element is a vital component of the control system as a whole. Without all of these elements present, the internal control system simply won't work.

Environmental Control: Environmental control refers to the attitude and behavior of management and employees. It is the responsibility of management to enact the policies and procedures that will drive employee behavior and attitude. Management sets the example; if upper managers are lax about adhering to policy, then employees will tend to follow suit. An important piece of environmental control is independent oversight, whether from a board of directors or an audit committee.

Risk Assessment: Risk assessment describes a company's ability to analyze business risks, determine their severity, and act (or react) accordingly. Risk assessment generally falls under the purview of management, but can be integrated with day to day analysis from employees.

Control Procedures: Control procedures are the policies and procedures that are put in place for carrying out the environmental controls, the risk assessment, the monitoring, and the communication necessary to keep the internal control system functioning. When properly enacted, control procedures can reduce the chance for procedural errors and decrease the threat of theft or fraud. By implementing policies that segregate duties and require independent verification, management can create a series of checks and balances that will keep operations running smoothly and efficiently.

Monitoring: Monitoring doesn't refer to the activities of the employees themselves, as this should be adequately covered under control procedures. Instead, monitoring refers to the metrics put in place to ensure that the internal controls themselves are functioning as expected. If a company doesn't properly monitor its internal control system, it has no way of knowing whether or not the system is working. With proper monitoring, problematic control procedures can be readily identified and retooled, replaced, or eliminated to keep the internal control system (and operations as a whole) running smoothly.

Communication: Finally, no internal control system can function without the communication of vital information. Communication should flow downward within each department, laterally between departments, and upward to management. The checks and balances put in place by the internal control procedures ensure that each department will provide information that is timely, accurate, and complete.

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