Exploring Internal Controls in Auditing Theory and Practice Context

This essay discusses the impact of implementing internal controls within an organization, emphasizing their role in achieving operational effectiveness, ensuring financial reporting quality, and mitigating risks. It explores the concept and components of internal control, including information and communication, control activities, control environment, monitoring, and risk assessment. The essay highlights the advantages of internal controls, such as fraud prevention, error reduction, and the establishment of clear organizational goals. It also examines how internal controls serve as an effective tool for external auditors by providing insights into the organization's internal proceedings and ensuring the reliability of financial statements. Furthermore, the essay addresses the limitations of internal controls, including management override, collusion, and reliance on limited information. The conclusion emphasizes the importance of internal controls and recommends their mandatory implementation for corporate organizations.

Running head: AUDITING THEORY AND PRACTICE
Auditing Theory and Practice
Name of the Student:
Name of the University:
Author Note

1AUDITING THEORY AND PRACTICE
Table of Contents
Introduction................................................................................................................................2
Literature Review.......................................................................................................................2
Internal Control – the concept and its components................................................................2
Advantages of implementation of internal control.................................................................3
Internal controls – an effective tool in the hands of the external auditor...............................5
Limitations of Internal Control..............................................................................................6
Conclusion..................................................................................................................................7
References..................................................................................................................................8

2AUDITING THEORY AND PRACTICE
Introduction
The issue that has been discussed in this particular study is the impact of
implementation of internal controls in an organization. Internal control fundamentally refer to
those set of controls that have been implemented within an organization in order to aid the
organization in the achievement of its objectives in terms of effectiveness and efficiency in
relation to the operations of business. The quality and the genuineness of the financial
reporting done by the organization are checked by the implemented internal controls as to
whether they comply with the laid down policies and regulations. To be precise, the controls
established within an organization for the purpose of mitigating the assumed risks fall under
the purview of internal controls (DeFond & Lennox, 2017).
Literature Review
Internal Control – the concept and its components
The set of controls that the management of an organization or its internal auditor
implements within an organization in order to make its operational activities efficient and to
improve the quality of the internal proceedings of day today business. A set of internal
control essentially act as a catalyst and influence the good practices or policies that are
already implemented within an organization. An example of a potential internal control is
segregation of duties. Segregation of duties refer to the division of tasks among different
employees. For instance, in a bank, a single employee is responsible for the task of collecting
cash from the customers, while another is responsible for, recording these transactions in the
respective books. Thus, here arises the utility of the internal controls as the division of task
mitigates the occurrence of error or fraud. The other principles of internal control are the
maintenance of records, execution of independent reviews that are scheduled to occur in

3AUDITING THEORY AND PRACTICE
regular intervals, usage and implementation of the internal controls. These principles of
internal control act as the points of reference for the purpose of establishment and
implementation of regulations and processes that protect the assets of the organization
(Martin, Sanders, & Scalan, 2014).
The components of internal control can be listed down as Information and
Communication; Control Activities; Control Environment and Monitoring and Risk
Assessment.
Information and Communication cover the systems and processes that lead to the
identification, capture and exchange of information by following a structural framework to
aid the employees in executing their duties properly.
Control Environment is that component of internal control that paves the way for the
implementation of the other components of the internal control. It sets the pitch of the
organization and makes the employees aware about the utilities of the implemented internal
control.
Control Activities refer to that component that very effectively lay down the
directives that by the management of a particular organization for ensuring its compliance by
all the employees.
Lastly, the component of Monitoring and Risk Assessment establishes the processes
that examine the quality of the internal controls established within the organization.
Thus, these components of internal control make the entire process of internal control
easy to understand and implement (Newton et al., 2015).

4AUDITING THEORY AND PRACTICE
Advantages of implementation of internal control
Internal controls not only increase the effectiveness of the operations that are carried
out in an organization but also aim to simplify the job of an employee by setting clear job
goals and by monitoring the quality of the processes undertaken in the achievement of such
goals. However, the major or the most important advantages of internal control revolve
around the fact that the implementation of such controls mitigate the occurrence of frauds,
errors or mistakes in the financial statements of an organization. The implemented internal
controls also aid in the process of spotting the errors in the financial statements. Internal
controls also result in reduced lawsuit and insurance claims.
The prevention of fraud in the financial statements is facilitated by the functions like
segregation of duties. The disintegration of the duties can be particularly helpful in reducing
the occurrence of errors that are either committed deliberately or unintentionally.
Not only fraud but the internal controls also aim to prevent the occurrence of errors
that are common while preparing the financial statements for the accounting period. Regular
reviews at scheduled intervals along with surprise examinations in relation to the quality of
the finished products aid in the prevention of errors. The internal controls also ensure that the
monetary or other transactions of business occurring in and out of the organization are legal
and authorized by a supervising authority (Clinton, Pinello & Skaife, 2014).
Implementation of the internal controls also facilitate the construction of the company
goals that are clear and defined in nature. They also lay down the procedures and guidelines
regarding the ethical conduct that is expected from the employees and other stakeholders of
the organization.

5AUDITING THEORY AND PRACTICE
Thus, as it can be understood from the above discussion, the primary benefit of
internal controls revolve around the function of the preparation of mathematically accurate
and fitting financial statements.
Internal controls – an effective tool in the hands of the external auditor
An external auditor, is essentially a third party to the organization and have no
absolute idea about the internal proceedings of business. Thus, the internal controls are of
great help to the external auditor who obtains knowledge about the organization from the
implemented internal controls. An organization that reaps the benefits of internal controls that
have been properly implemented within it, much naturally generate features that act as aid to
the working process of an external auditor. For instance, a well implemented internal control
that lays down the ethical code of conduct within an organization will automatically result in
an environment that is free of dishonesty or fear. Moreover, a quality organizational
environment results in reduction of the dependence of the workforce over the management of
the company. This is because they communicate with each other freely, honestly and with
integrity. Keeping the work force updated with the required skills is also a part of internal
control that help the external auditor to assess the quality of the company operations (Pizzini,
Lin & Ziegenfuss, 2014).
Another major area where the internal controls aid the external auditor is the
genuineness of the financial statements that have been prepared by the organization whose
books are being audited. The spotting of errors become much more easy with the proper
implementation of the internal controls. The implementation of technology especially in the
process of accounting, have widened the scope of vulnerability of the financial information
that is crucial for an organization. Computerizing the entire process of recording financial
information increases the chances of loss of data or events of security breach by potential
hackers. An internal control that implements regular backing up of data and application of the

6AUDITING THEORY AND PRACTICE
passwords and login ids help the external auditors to obtain related information from the
implemented accounting technology.
Even the errors of misstatements are particularly identified by the implementation of
internal controls. The amount of materiality set by the internal auditor and sudden
assessments of the financial statements are some of the internal controls that help the external
auditor to carry out his assigned task with much ease. According to ISA 315, an internal
auditor can be of great help to an external auditor, provided that he carries out his work with
utmost sincerity and care (Abbott et al., 2016).
For instance, Skoda Minotti is an audit firm that identified fraud in a particular
company that dealt with scrap materials. This firm that dealt in scrap materials had faced
certain losses that they could not account for. Thus, they hired Skoda Minotti for carrying out
for identifying the problem. The audit firm did set certain internal controls inside the
organization that helped the company to identify the exact individual responsible for the
disparity in the financial statements. ("Skoda Minotti Fraud After an Internal
Control Assessment", 2017).
Limitations of Internal Control
There are certain disadvantages in regards to the implementation of the internal
control in the organization. Management override is a major disadvantage of internal control.
This refers to the fact that if the policies of an organization are manipulated by the high end
officials of the organization then it becomes impossible for the successful implementation of
the internal control.
The continuous monitoring of the implemented controls as to whether they have
resulted in the desired outcomes, is always not possible as the staff delegated with such
authority becomes uninterested in the job or do not turn up.

7AUDITING THEORY AND PRACTICE
Collusion refers to the type of fraud that is committed by a group of manipulators
inside the organization who commit fraud in such a way that they are never identified by the
implemented internal controls.
Internal controls lay their foundation upon the limited information that is available for
human judgment (William, Glover & Prawitt, 2016).
Conclusion
Thus, it can be concluded from the discussion that internal controls area n imperative
part of an organization. The purpose and scope of the internal controls are wide and result in
the efficient and effective execution of the organizational operations. It is advisable for every
financial regulator in all parts of the world to make it mandatory for the management of a
corporate organization to implement internal controls in the structure of the organization.

8AUDITING THEORY AND PRACTICE
References
Skoda Minotti Fraud After an Internal Control Assessment. (2017).
skodaminotti.com. Retrieved 30 October 2017, from
http://cpa.skodaminotti.com/fraud-after-an-internal-control-assessment
DeFond, M. L., & Lennox, C. S. (2017). Do PCAOB Inspections Improve the Quality of
Internal Control Audits?. Journal of Accounting Research, 55(3), 591-627.
Martin, K., Sanders, E., & Scalan, G. (2014). The potential impact of COSO internal control
integrated framework revision on internal audit structured SOX work programs. Research in
Accounting Regulation, 26(1), 110-117.
Newton, N. J., Persellin, J. S., Wang, D., & Wilkins, M. S. (2015). Internal control opinion
shopping and audit market competition. The Accounting Review, 91(2), 603-623.
Clinton, S. B., Pinello, A. S., & Skaife, H. A. (2014). The implications of ineffective internal
control and SOX 404 reporting for financial analysts. Journal of Accounting and Public
Policy, 33(4), 303-327.
Pizzini, M., Lin, S., & Ziegenfuss, D. E. (2014). The impact of internal audit function quality
and contribution on audit delay. Auditing: A Journal of Practice & Theory, 34(1), 25-58.
Abbott, L. J., Daugherty, B., Parker, S., & Peters, G. F. (2016). Internal audit quality and
financial reporting quality: The joint importance of independence and competence. Journal of
Accounting Research, 54(1), 3-40.
William Jr, M., Glover, S., & Prawitt, D. (2016). Auditing and assurance services: A
systematic approach. McGraw-Hill Education.