Accounting controls are the procedures and the methods which are applied by an entity for the assurance, validity and accuracy of the financial statements but these accounting controls are applied for compliance and as a safeguard for the company and not to comply with the laws, rules and the regulations.
What is Accounting Controls?
Accounting Controls are the measures and controls adopted by an organization that leads to increased efficiency and compliance across the organization and ensures that financial statementsFinancial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels. are accurate when presented to auditors, bankers, investors, and other stakeholders.
There are various types of control applied within an organization. Also, there is no straight forward control policy that applies to every organization. The application of controls for each organization is designed and implemented to suit its needs, type of business, aspirations, goals, and other guidelines.
Types of Accounting Controls
There are three major categories of accounting internal controls.
#1 – Detective Controls
As the name suggests, these controls are the controls in place to detect any discrepancy and deviation from the policies in place. It also serves the purpose of the integrity check.
For example – a surprise check of actual cash balance in hand with cashier and cash balance as per accounts will ensure if the cashier is doing his job accurately or not. It might also reflect any accounting postingAccounting PostingIn accounting, posting refers to the transfer of a balance from one ledger to the general ledger in order to make the accounting easier to understand. Depending on the size of the company and the volume of transactions, this posting is done at regular intervals. error. In a computerized environment where the numbers are huge in volume and end to end processing of accounts is done by the system, in those cases, we might want to put a test invoice and track it till accounts finalization to see if it gives the desired result and it is compliant to regulations.
The same way comparing actual physical stock in the warehouse and closing stock as per books will show if there is an issue in the Inventory processing, any pilferage or normal loss. Also, checking that all the assets appearing in the books are physically present ensures the safety of assets.
Now by examples, we have understood that Detective Controls are applied irregularly and are more of audit nature to identify errors or discrepancies.
#2 – Preventive Controls
The controls are applied daily within the organization to stop the errors or discrepancies for happening in the first place. We can say these are the rules which everyone within the organization has to abide by in their day to day job.
For example – in an accounting environment, when a person books an invoice, it goes to another person for peer review and approval. Once the invoice is accounted for, the payment is made by another team. This is called segregation of duties, and it ensures that daily, one person does not have control of booking and paying invoices.
Job rotation is a classic example of preventive control. In a big organization or at a critical place, the personnel is transferred on a regular interval to ensure that any person does not have access to any data or asset for an extended period, which ensures that the person does not get involved in thefts or illegal activities.
In a computerized environment, backing up data daily on the cloud is also a Preventive control to avoid any data loss.
#3 – Corrective Controls
These are the controls that come to rescue when preventive and detective both the controls have failed to avoid an error. In an accounting environment posting an adjustment or rectification entry is an example of corrective controls. Once the books are closed after the financial year and auditorsAuditorsAn auditor is a professional appointed by an enterprise for an independent analysis of their accounting records and financial statements. An auditor issues a report about the accuracy and reliability of financial statements based on the country's local operating laws. find an issue that needs to be addressed. Reopening the financial yearbooks and making the adjustments asked by an auditor is also a part of a corrective control.
For example – While posting a journal entry, the accountant has debited Mr. Tom instead of Mr. Robert for $ 500. In this case, the trial balance still agrees, and later on verification of ledgersLedgersLedger in Accounting, also called the Second Book of Entry, is a book that summarizes all the journal entries in the form of debits & credits to use for future reference & create financial statements. , this error was identified. The rectification entry here is to debit Mr. Robert and credit Mr. Tom, each by $500. This is called corrective control.
Accounting Internal Control Examples
Below given are examples of accounting controls.
- Segregation of duties – processor and approver should be two different people.
- An independent user id and passwords should be provided to all the employees.
- Physical verification of Inventory and Assets should be done.
- Bank reconciliation and other Trial balance reconciliations should be done.
- Standard Operating ProcedureStandard Operating ProcedureThe full form of SOP is Standard Operating Procedure & it is a set of guidelines, policies, & procedures that a Company follows to perform its routine tasks following the industry regulations. documents should be made regarding process flow.
- Surprise check of petty cash and cash bookCash BookThe Cash Book is the book that records all cash receipts and payments, including funds deposited in the bank and funds withdrawn from the bank according to the transaction date. All the transaction which is recorded in the cash book has the two sides i.e., debit and credit. balances.
Advantages of Accounting Internal Controls
Below are some of the advantages of accounting controls.
- The action log identifies the person responsible for any error.
- Accuracy of financial statements and funds application
- Efficient use of the resources for the intended purpose
- Helpful in audit facilitation
- A strong foundation for a more significant growth
- Identification and rectification of any discrepancy identified
- Saving of cost and resources
Disadvantages of Accounting Internal Controls
Below are some of the disadvantages of accounting controls.
- Sometimes irritating and time-consuming for employees
- The high cost of maintaining controls and standards
- Overdependent for financial statements and audit
- Duplication of work
Essential Points to Note about Change in Accounting Control
- Any change in one process impacts the other.
- The change should not be made in the middle of an accounting periodAccounting PeriodAccounting Period refers to the period in which all financial transactions are recorded and financial statements are prepared. This might be quarterly, semi-annually, or annually, depending on the period for which you want to create the financial statements to be presented to investors so that they can track and compare the company's overall performance., as it will affect the transaction flow.
- Any changes should be informed to auditors.
- Any change should also be documented and communicated well with all the stakeholders.
- It should be cost-effective.
Accounting internal controls are not a recent development, these have been in place for a long time. The most significant advantage of accounting controls is that it restores the faith of the general public in the public listed companies. In the wake of high-value scandals in the United States by companies like Tyco and Enron shook the confidence of the general public in the accounting system.
SOX is also known as the Sarbanes-Oxley ActSarbanes-Oxley ActThe Sarbanes-Oxley Act (Sox) of 2002 was enacted by the US Federal Law for increased corporate governance, strengthening the financial and capital markets at its core and boost the confidence of general users of financial reporting information and protect investors from scandals like that of Enron, WorldCom, and Tyco., was enacted by the United States Congress to protect the stakeholders from any corporate accounting scandalsCorporate Accounting ScandalsAccounting Scandals refer to situations which demonstrate intentional falsification or misrepresentation of financial documents. Some of the most famous ones are by Enron, Freddie Mac, HealthSouth, & American Insurance Group etc. . This also makes it a compulsion for organizations to follow corporate disclosure guidelines and other requirements. The point here is that accounting controls are nowadays an integrated part of any organization, without which the accounting system is like a car without brakes, and no one wants to take a ride in such a car. So it is imperative that any organization which aspires to grow big and better must have robust accounting control in place.
This has been a guide to what are Accounting Controls and its definition. Here we discuss the top 3 types of accounting internal controls along with examples, advantages & disadvantages. You may learn more about accounting from the following articles –