How to implement internal controls for accounting in a business and fraud deterrence?
Internal control refers to the processes and systems that a business puts in place to safeguard its assets. It also ensures accurate financial reporting and promotes operational efficiency. Businesses must implement strong internal controls to mitigate the risk of fraud and errors. It will also help to comply with legal and regulatory requirements.
However, in this article, we will learn about how to implement internal controls in accounting for fraud deterrence.
So, here we go:
Importance of internal controls in a business for fraud deterrence
The importance of internal control cannot be overstated. It provides management with reasonable assurance that the organization’s objectives are being achieved effectively and efficiently.
Let’s have a breakdown of the benefits of implementing internal controls in a business:
- Internal controls help protect a company’s assets from theft, misuse, or misappropriation. Businesses can prevent unauthorized individuals from accessing valuable assets like cash, inventory, or sensitive information by implementing internal controls.
- One of the fundamental principles of internal control is segregating duties. Businesses reduce the risk of fraud and errors by separating responsibilities among different individuals.
- Internal controls help identify and correct errors in financial reporting. Businesses can ensure the accuracy and completeness of financial records by implementing checks and balances.
- Internal controls establish clear policies and procedures that define the responsibilities of employees. This promotes accountability and ensures that individuals are aware of their roles and obligations.
Some common financial fraud scams in accounting
Financial fraud in accounting can take various forms. It comes with the intention of manipulating financial statements or misrepresenting the financial health of a company. Here are some common financial fraud scams in accounting:
Overstating Revenue
Companies may artificially inflate their revenue figures by recording sales before they are made, not making provisions for returns, or improperly recognizing sales made to related parties as revenue.
Understating Expenses
Fraudulent accounting practices may involve understating expenses to make the company’s financial performance appear better than it actually is. It can be done by delaying the recognition of expenses or misclassifying expenses as assets.
Misstating Assets and Liabilities
Manipulating the valuation of assets or liabilities can distort a company’s financial position. It can involve inflating the value of assets or understating liabilities to create a false appearance of financial health.
Ghost Employees
Creating fictitious employees on the payroll is another common fraud scheme. By adding non-existent employees to the payroll, fraudsters can divert funds for personal gain.
Embezzlement
Embezzlement occurs when an employee misappropriates company funds for personal use. It can involve diverting cash, writing fraudulent checks, or manipulating financial records to cover up the theft.
Financial Statement Manipulation
Fraudsters may manipulate financial statements to mislead investors and stakeholders. It can include inflating profits, understating losses, or misrepresenting financial ratios and key performance indicators.
Strategies to implement internal controls for accounting
Implementing effective internal controls is crucial for any business to ensure the accuracy, reliability, and integrity of its financial information. Internal controls not only help prevent fraud and errors but also promote transparency and accountability. In this section, we will explore several strategies that businesses can practice to implement strong internal controls for accounting.
So, here we go:
1. Duties segregation to ensure no individual has access to complete information
One of the fundamental principles of internal controls is segregating duties. You create a system of checks and balances by assigning different responsibilities to multiple individuals. For example, the person responsible for recording transactions should not have access to assets or be involved in approving payments. This segregation of duties minimizes the risk of fraud, as it requires collusion among multiple individuals to manipulate financial information.
2. Restrict individuals’ access to your financial systems
Limiting access to financial systems is another crucial strategy to prevent unauthorized activities. Grant access on a need-to-know basis. It will help in ensuring that employees only have access to the systems and information relevant to their roles.
Regularly review and update access privileges to match changing job responsibilities and employee turnover. This way, you can reduce the risk of unauthorized transactions or data manipulation.
3. Standardize accounting documents
Standardizing accounting documents, like invoices, purchase orders, and receipts, is crucial for maintaining consistency and accuracy in your financial records.
Establish clear guidelines and formats for these documents, ensuring that they include all necessary information. This standardization simplifies the process of reviewing and verifying transactions, reducing the risk of fraudulent or erroneous entries.
4. Reconcile transactions, accounts and business activities.
Regularly reconciling transactions, accounts, and business activities is essential for identifying discrepancies and detecting potential fraud or errors.
Perform bank reconciliations to verify that the recorded transactions match the bank statements. Reconcile accounts receivable and payable to ensure accuracy and completeness. You can promptly identify and address any irregularities by regularly reconciling different aspects of your financial records.
5. Prefer implementing a double-entry account system.
A double-entry accounting system is a widely recognized best practice for maintaining accurate financial records. This system ensures that each transaction must be recorded in two different accounts at least, with one account credited and another debited.
The double-entry system provides a built-in internal control mechanism, as any discrepancies in the records will be immediately apparent. Implementing this system reduces the risk of errors and enhances the reliability of your financial information.
6. Make policies for cash disbursements.
Developing clear policies and procedures for cash disbursements is essential for preventing misappropriation of funds. Establish a robust approval process for all outgoing payments, requiring multiple levels of authorization. Implement controls such as pre-numbered checks, dual signatures, and segregation of duties to ensure accountability and reduce the risk of fraud.
7. Practice invoices approval
Implement a system for approving invoices before payment. This process should involve verifying the accuracy of the invoice details, confirming the receipt of goods or services, and matching the invoices against purchase orders or contracts.
You can prevent unauthorized or fraudulent invoices from being paid by implementing a rigorous approval process.
8. Approval for financial transactions
Require proper authorization for all financial transactions, including expenditures, investments, and transfers.
Implement a hierarchical approval system, ensuring that transactions are reviewed and approved by individuals with appropriate knowledge and authority. This control measure helps prevent unauthorized transactions and ensures that all financial activities align with business goals and objectives.
9. Review payroll periodically
Payroll fraud is a common type of financial misconduct that can significantly impact a business. To prevent such fraud, conduct periodic reviews of your payroll records. Verify the accuracy of salaries, benefits, and deductions, and cross-check employee information with HR records. Regularly compare payroll expenses to the number of employees and investigate any discrepancies promptly.
Final Thoughts
Implementing strong internal controls for accounting is essential to safeguard your business against fraud, errors, and financial mismanagement. Following the strategies outlined here will certainly help you in fraud deterrence.
