Internal control

Background and origin.

In the towns of Egypt, Phenicia, Syria among others, we observe single-entry accounting. In the Middle Ages accounting books appeared to control business operations, it is in Venice where in 1494, the Franciscan Fray Lucas Paccioli or Pacciolo, better known as Lucas di Borgo, wrote a book on double-entry accounting.

It is in the industrial revolution when the need arises to control the operations that due to their magnitude were carried out by machines operated by several people.

It is thought that the origin of internal control arises with the double entry, which was one of the control measures, but it was not until the end of the 19th century that businessmen were concerned with forming and establishing adequate systems for the protection of their interests.

In general, we can affirm that the consequence of the economic growth of business implied greater complexity in the organization and therefore in its administration.

What is the internal control?

Internal Control is the base where the activities and operations of a company rest, that is, that the activities of production, distribution, financing, administration, among others are governed by internal control.

It is an instrument of efficiency and not a plan that provides a police or tyrannical-type regulation, the best internal control system is one that does not harm company-client relationships and maintains relations of high human dignity. employer to employee.

The function of internal control is applicable to all areas of business operation, its effectiveness depends on the administration obtaining the necessary information to select from the alternatives, those that best suit the interests of the company.

Internal control must establish a prior study of the needs and conditions of each company.

Internal control according to the Auditing Standards and Procedures in its technical glossary defines it as:

"It is represented by the set of policies and procedures established to provide reasonable assurance of being able to achieve the specific objectives of the entity."

The structure of internal control

It consists of the following elements:

Control environment.

Accounting system.

Control Procedures.

What is the objective of an internal control system?

It has several objectives such as:

Avoid or reduce fraud. Safeguards against waste. Safeguards against insufficiency. Compliance with operating policies on safer bases. Check the correctness and veracity of accounting reports. Safeguard the assets of the company. Promote efficiency in operation and strengthen adherence to the standards set by the administration.

Internal Control in the Audit of the Financial Statements

1. Study and Evaluation of the Organization.

2. Study and evaluation of systems and procedures.

3. Study and evaluation of flow charts.

4. Study and evaluation of the internal control system.

5. Factor Analysis:

Techniques to be applied in planning the audit.

1. Study and Evaluation of the Organization.

In order for the auditor to be fully aware of the organic structure and gather elements to study and evaluate the organization and the human team that integrates it, it must begin by obtaining a detailed organizational chart of the same, in the event that it does not exist, it will be one more reason for the auditor to elaborate or update it and in the development of this task will find a magnificent opportunity to begin to know the organizational operation of the entity or the function subject to audit and above all, the people involved.

In obtaining the organization chart, it is recommended that it be prepared covering the following points:

Cover the entire entity or function subject to review. Contain the main positions of the entity and the entire structure in the case of revision to a function. The types of authority are perfectly established if they are linear, functional and staff.

2. Study and evaluation of systems and procedures.

It represents one of the most important actions in the planning and development of any audit work.

Every entity must have operating systems and procedures manuals on which the auditor must base himself to make his study and evaluation of these concepts, but we find that very few are the entities that have them, in these cases, the auditor should develop them. for your purposes.

We can observe some problems:

The extension that must be given and that is directly related to the time assigned to the auditor to carry out his / her work. As well as the ability to describe operating procedures.

Let us take into consideration that a system is the conjunction of operating procedures that are framed in administrative policies and / or control provisions, the study and evaluation of said procedures must be carried out independently by each of those who make up that system to, Subsequently, once all those who make up the system have been identified, carry out the study and overall evaluation of it.

The study and evaluation of an operating procedure can be carried out in the following order:

First: Identify the generalities of the procedure:

A name, b) To which system or operational function it belongs.

c) Where does it start.

d) Where it ends.

e) What objectives it pursues.

f) What administrative policies and / or control provisions must be respected.

Second: Describe sequentially the activities involved in the procedure subject to analysis and evaluation.

3. Study and evaluation of flow charts.

The study and evaluation of flow charts is to carry out by means of a graphic representation the operating procedures.

Flowchart technique (flowchart)

Indicates the starting point of the diagram and its location.

It means a document.

Capital letters inside the rectangle indicates the affected document, for example, OC = purchase order and numbers are placed on the edges to mention if it is the original (1) and if they are copies (2).

With the mark in the lower right index

Indicates preparation of a document.

Document with signature or sealed.

It indicates that it will serve as a basis in the preparation of accounting documents or will support those documents.

Shows the physical movement of documents.

Indicates that a document will never reenter the flow. It is also used to show that the document is sent to someone outside the company, or that it is sent to some internal department where the details or uses are not the responsibility of the audit.

Document for some special purpose, book record or basis for the preparation of another document.

Temporary document file.

Destroyed document.

- Documents can end in:

o Permanent archive.

o Go to another flow.

o Pass out of the flow.

o Destroy.

Indicates operation, briefly describing itself.

Reports or listings.

It includes the accounting system, such as books, accounting records, supporting documents.

Accounting record of auxiliaries and records to the last destination.

The descriptions within the diagram should be minimal, simple annotations of letters or numbers, attaching on an additional sheet the meaning of said letters.

4. Study and evaluation of the internal control system.

Internal control includes the organization plan and all the methods and procedures that are coordinated in an entity to safeguard its assets, verify the reasonableness and reliability of its financial information and the complementary administrative and operational information, promote efficiency in operation and provoke adherence to the policies prescribed by the administration.

According to Bulletin 3050 issued by the Auditing Standards and Procedures Commission, within its generalities it explains to us that the study and evaluation of internal control is carried out in order to comply with the work execution standard that requires that “the auditor must carry out an adequate study and evaluation of the existing internal control, which will serve as a basis for determining the nature, extent and opportunity that it will give to the audit procedures ”.

Internal control is divided into:

Administrative Control, where it must be observed and applied in all phases or stages of the administrative process.

Financial - Accounting Control, mainly oriented towards the control of the financial and accounting activities of an entity.

The conjunction of these two elements leads to the Comprehensive Internal Control System.

The Auditing Standards and Procedures Commission of the Mexican Institute of Public Accountants in its bulletin 5030, shows the methodology for the Study and evaluation of Internal control, where it recommends that this process be carried out by transaction cycles, since a study by accounts loses of business dynamics. The basic cycles of transactions to consider are: income, purchases, production, payroll and treasury.

The purpose of studying internal control is to find out what internal control is like, not only in management plans but in the actual execution of day-to-day operations.

The evaluation of internal control is the auditor's estimate, made on the data that he already knows through the study, and based on his professional knowledge, of the degree of effectiveness that this internal control provides.

From this study and evaluation, the Public Accountant may deduce the nature of the different tests on the same item. The extent of the employee audit procedures and the opportunity in which they will be used to obtain the most favorable results possible will depend on this.

Ways of doing the study and evaluation of internal control.

Methods:

a) Descriptive or memorandum method.

b) Graphic Method.

c) Questionnaire Method.

Descriptive method:

It consists of the description of the activities and procedures used by the personnel in the various administrative units that make up the entity, making reference to the accounting systems or records related to those activities and procedures.

The description must be done in such a way that it follows the course of operations in all the administrative units that intervene, it will never be practiced in isolation or subjectively.

Detail in writing the accounting and administrative methods in force, mentioning the accounting records and forms used by the company, the employees who manage them, who are the people who guard assets, how much they receive for wages, etc.

The information is obtained and prepared as deemed appropriate by the Public Accountant, by functions, by departments, by some process that is appropriate to the circumstances.

The form and extent of application of this procedure will depend, of course, on the practice and judgment of the Public Accountant observed in this regard, and which may consist of:

A. Prepare your notes regarding the company study to cover all aspects of your review.

B. That the relative notes contain observations only regarding the deficiencies of the internal control found and should be mentioned in their working papers, also when the existing control in the other sections not covered by their notes is adequate.

The operation in the previous administrative unit and its impact in the next unit should always be taken into account.

Advantage:

The study is detailed of each operation with which a better knowledge of the company is obtained.

The Public Accountant is obliged to make a mental effort, which is customary to the analysis and scrutiny of the established situations.

Disadvantages:

Some abnormal situations may go unnoticed.

There is no efficiency index.

Graphic Method

It consists of the use of questionnaires previously prepared by the auditor, which include questions regarding how operations are managed and who is in charge of the functions.

The questionnaires are formulated in such a way that the affirmative answers indicate the existence of an adequate control measure, while the negative answers indicate a failure or weakness in the established system.

Advantage:

It represents a time saving.

Due to its amplitude, it covers different aspects, which contributes to discovering whether any procedure was altered or discontinued.

It is flexible to know most of the characteristics of internal control.

Disadvantages.

The study of this questionnaire can be laborious due to its length.

Many of the responses, whether positive or negative, are inconsequential if there is no complete idea of why these responses exist.

Its use is the most widespread, due to the speed of application.

Of the methods seen above, none of them deals in relative depth with the key element of the entity, the human.

To cover this gap, a fourth method is presented:

Detection of incompatible functions.

The auditor, through the use of simple questionnaires, will detect incompatible functions of the personnel involved in the operation, administration, control and operation of the entity subject to audit.

It is presented as a questionnaire sheet, in which the key function is mentioned in the upper right, and the names of the performers are noted there, then, on the left side of the sheet, other functions are recorded where the names of the performers, if the name of the person who performs the key function is repeated in the other functions, this constitutes an incompatible function that will be noted below in the observations column and, consequently, we will have discovered a failure in internal control.

Study and evaluation of internal control by transaction cycles.

It consists of identifying, by the auditor, cycles of transactions whose internal control will be subject to review and evaluation. This identification includes determining the functions applicable to each cycle based on its specific characteristics.

To help the auditor, he must rely on the bulletins of the 6000 series of Auditing Standards and Procedures issued by the Auditing Standards and Procedures Commission of the Mexican Institute of Public Accountants.

5. Factor Analysis:

It consists of the distinction and identification of the factors that concur in the operating results of an entity to arrive at the knowledge of each factor, in order to determine its contribution to the result of the operations carried out.

The factor analysis is conceived the operation of an entity as a result of the weighted combination of its generic components, some internal and others external, which are called "operating factors".

The identification, analysis and study of these factors must be done taking into account the activity or business of the entity and its purpose, since it is obvious that they will not be the same factors that affect industrial or commercial entities, the sale of services or products, lucrative, non-profit, governmental or non-governmental.

To illustrate the above, we will mention the internal factors of an industrial entity.

- Environment.

- Administration.

- Products.

- Processes.

- Financial function.

- Production facilities

- Workforce

- Raw Materials.

- Production.

- Marketing.

- Accounting.

- Statistics.

The purpose of the factor analysis applied to an entity is to quantify the contribution of each factor in the result of the operations that it carries out, it is, therefore, a means of control.

The Auditor must rely on the use of questionnaires for this purpose.

This statement must be complemented with the application of simple financial ratios, quantitatively comparing the components of each factor to evaluate its contribution to the result of the entity's operations.

Conclusions.

Internal control is defined as: "It is represented by the set of policies and procedures established to provide reasonable assurance that the entity's specific objectives can be achieved."

The Public Accountant must carry out an adequate study and evaluation of the internal control existing in the company that he examines, with the basic purpose of determining the confidence that he can assign to each phase and activity of the business, to specify the nature, scope and opportunity that he must give your audit evidence.

Techniques to be applied in planning the audit.

1. Study and Evaluation of the Organization.

2. Study and evaluation of systems and procedures.

3. Study and evaluation of flow charts.

4. Study and evaluation of the internal control system.

5. Factor Analysis:

The study of internal control is intended to know what internal control is like, not only in management's plans but in the actual execution of daily operations.

Internal control evaluation is the auditor's estimate, made on the data that you already know through the study, and based on your professional knowledge, of the degree of effectiveness that this internal control provides.

Ways of doing the study and evaluation of internal control.

Descriptive method:

Graphic Method.

Indicates by means of charts and graphs the flow of operations through the posts or places where the control measures for the exercise of operations are established.

Questionnaire Method.

It consists of the use of questionnaires previously prepared by the auditor, which include questions regarding how operations are managed and who is in charge of the functions.

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