The Importance of Internal Controls for Accounting in Business

Fraud affects businesses of all sizes, with potential losses running into the millions. To protect your business against these risks, internal fraud controls within accounting are essential. These controls not only protect a company’s financial assets but also ensure compliance with regulations, appease investors, and maintain the reputation of the organization. Let’s dive into the importance of internal fraud controls, their components, and implementation.

 

What is Internal Fraud

 

Internal fraud, (or “occupational fraud”) refers to when employees or executives use their positions to misappropriate assets, engage in corrupt behaviors, or manipulate financial statements for personal gain. The Association of Certified Fraud Examiners (ACFE) states that businesses lose approximately 5% of their revenues to fraud each year. With statistics like this, it is so important to implement strong internal fraud controls.

  

Imagine this: You have a bookkeeper who manages the weekly check run, and each week they provide your manager with the bills needing to be paid and request the exact number of blank checks for the printer to pay those monthly bills.   Several times recently this bookkeeper requested additional checks because the printer keeps jamming.  We all know how printers like to jam at the worst moments, don’t we?  The bookkeeper later quits and months later it is discovered that those extra checks from the printer jams were printed after all, made out to the bookkeeper with a forged signature!  The total of those checks add up to tens of thousands of dollars.  This company has so much financial activity that this was not noticed, and the only accounting records were kept in the company QuickBooks account that only the bookkeeper had access to.  No one ever double checked their work.

 

The Role of Internal Fraud Controls

 

Internal fraud controls serve multiple functions within a business:

• Prevention: The primary goal of fraud controls is to deter fraudulent activities. By establishing a strong internal control environment, businesses can discourage employees from engaging in fraudulent behavior with high likelihood of detection and consequences. 
• Detection: Despite preventive measures, some fraudulent activities may still occur but effective controls help with early detection of fraud and minimize potential damage.
• Mitigation: When fraud is detected, internal controls help lessen the impact by providing methods for investigation, reporting, and recovery of assets.
• Compliance: Adhering to regulatory requirements is a very important aspect of business operations. Internal fraud controls ensure that companies are complying with laws and regulations around financial reporting and corporate governance.
• Reputation Management: Companies that are known for strong internal controls and ethical practices are more likely to maintain investor and stakeholder trust. This improves the company’s reputation and long-term success.

 

Key Components of Internal Fraud Controls

 

To effectively find and prevent fraud, businesses need to implement internal controls. These controls can be broadly categorized into preventive, detective, and corrective measures.

 

Preventive controls are designed to stop fraud before it starts. Some key preventive measures include:

 

• Segregation of Duties: No single individual should have control over all aspects of a financial transaction. This reduces the risk of fraud by requiring a system of checks and balances.
• Authorization Controls: By creating strict authorization protocols for financial transactions, only authorized personnel should have the ability to approve transactions, access sensitive information, or make financial decisions.
• Background Checks: Conducting thorough background checks on new employees to identify any history of fraudulent behavior. This helps in hiring individuals with integrity and reduces the risk of internal fraud.

• Training and Awareness: Regularly training employees on the importance of internal controls and the consequences of fraud. Awareness programs can help create a culture of integrity and accountability within the organization.

 

Detective controls are designed to identify and uncover fraudulent activities. Detective measures include:

 

• Reconciliations: Regularly reconciling bank statements, accounts payable, and accounts receivable to identify discrepancies. Prompt and consistent reconciliation helps in detecting unauthorized transactions or errors.
• Audits and Reviews: Conducting regular internal and external audits to review financial statements and transactions. Audits can provide an independent assessment of the company’s financial health and internal controls.
• Monitoring Systems: Using Automated systems to monitor financial transactions and flag unusual activities. Data analytics and continuous monitoring tools can identify patterns indicative of fraud.
• Whistleblower Hotlines: Establishing confidential means for employees to report suspicious activities. Encouraging whistleblowing can help uncover fraud that might otherwise go undetected.

 

Corrective controls are measures taken to address and rectify issues once fraud has been detected. Corrective measures include:

 

• Investigations: Conducting thorough investigations to understand the nature and extent of the fraud. This includes identifying the individuals involved and the methods used.
• Disciplinary Actions: Appropriate disciplinary actions against individuals found guilty of fraudulent activities. This can be a deterrent for others and reinforces the company’s commitment to ethical behavior.
• Recovery of Assets: Taking legal action to recover misappropriated assets. This may involve working with law enforcement and legal professionals.
• Review and Improvement: Analyzing the weaknesses in internal controls that allowed the fraud to occur and making necessary improvements. Continuous review and enhancement of controls are essential to prevent future incidents.

 

Best Practices for Implementing Internal Fraud Controls

 

Implementing effective internal fraud controls requires a strategic approach and commitment from all levels of the organization. Some best practices for successful implementation include:

 

• Tone at the Top: Senior management and the board of directors should demonstrate a strong commitment to ethical behavior and internal controls. Their attitude sets the tone for the entire organization.
• Risk Assessment: Conduct regular risk assessments to identify areas susceptible to fraud. Understanding the specific risks faced by the business allows for targeted control measures.
• Clear Policies and Procedures: Develop and communicate clear policies and procedures related to internal controls and fraud prevention. Ensure that employees understand their roles and responsibilities.
• Continuous Training: Provide ongoing training and education on fraud prevention and detection. Keeping employees informed about the latest fraud schemes and control measures is crucial.
• Regular Reviews and Audits: Schedule regular internal and external audits to assess the effectiveness of internal controls. Use audit findings to make necessary improvements.
• Foster a Culture of Integrity: Encourage a culture where ethical behavior is valued and rewarded. Recognize and celebrate employees who demonstrate integrity and commitment to ethical practices.
• Leverage Technology: Utilize technology to enhance fraud detection and prevention. Automated systems, data analytics, and artificial intelligence can significantly improve the effectiveness of internal controls.

 

Conclusion

 

Internal fraud controls are crucial for protecting your company’s financial health and reputation. By implementing preventive, detective, and corrective measures, you can significantly reduce the risk of fraud within your company. Fostering a culture of integrity and continuous improvement ensures that internal controls will remain effective despite evolving fraud trends. 

Need help getting protocols in place?  Schedule a consultation today and we can get you started! After all, you’ve worked hard to get your business where it is today.