The Role and Importance of Internal Control in an Organization

According to Solomon (2007), internal control is the standardized measures such as reviews, checks and balances, and methods and procedures that an organization institutes with an aim of conducting business effectively and efficiently. Internal controls have five primary roles in roles in an organization such as controlling the organizational environment, risk assessment, information dissemination, and communication, controlling organizational activities, and monitoring progress (Solomon, 2007). As such, internal control is imperative in ensuring the company remains socially responsible and corporate code conduct adherence.

Moreover, it is an invaluable tool and accounting control through internal audit and intelligent accountability.

Guided by management theories such as stewardship theory, agency theory, and stakeholder theory, companies are using the internal control to ensure adherence to companies policies as well as the operating environment (Solomon, 2007). As such, the paper discusses the role of internal control in shaping an organization’s ethics and accounting control Precise and efficient control of business is a fundamental purpose of internal control. As Krishnan (2005) asserts, chief executives in organizations oversee the overall activities of the group to ensure everything is in line with the company’s policies and strategies.

In modern organizations, Corporate Social Responsibility (CSR) is an invaluable asset to an enterprise (Roberts, 1992).

Roberts (1992) notes that efficient organizations realize that the company has other relevant stakeholders apart from the shareholders as stakeholder’s theory. According to the theory, converse to the traditional approach where the leading business stakeholders were shareholders hence the need to abide by fiduciary roles, other parties such as employees, customers, suppliers, political groups, and government bodies also matters (Roberts, 1992).

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While developing the model, R. Edward Freeman recommended methods through which management can safeguard the interests of the enterprises’ stakeholders. Through internal control, an organization can give accurate and timely financial information thereby protecting the interests of the stakeholders (Roberts, 1992). Moreover, chief executives use the internal control to ensure the organization’s operations do not affect the surrounding environment hence protecting the interests of the surrounding community. Moreover, internal control techniques such as employees’ reviews ensure efficient addressing of workers needs hence safeguarding the interests of trade unions and the employees as Edward stated in Stakeholders theory. Consequently, the organization can run effectively and efficiently. Secondly, internal controls serve to deter errors, fraud, and thefts in an organization through detection (Roberts, 2009). The role goes further to safeguard the code of conduct within an organization. Messer (2009) suggests that in accounting, the professional code of conduct requires a certified accountant to abstain from any undertaking that manipulates the authenticity of the financial report of a group.

However, the agency theory notes that if an organization leaves the managers to act on their own they are likely to work on their self-interests to the loss to the shareholders (Krishnan, 2005). Managers have the ability to override controls and stifle subordinates thus enabling a dishonest management. Satyam fraud case best exemplifies how to managers stifled checks and had accountants create paper profits to deceive the shareholders that the company was performing (Bhasin, 2013). The agency theory assumes the managers acted on their selfish interests while committing shareholders to significant loss (Messner, 2009). However, effective internal control overcomes such weaknesses through a stronger board of directors. Internal control makes the management accountable to the board of trustees. As such, the board uses effective upward communication and capable legal, financial, and audit functions to deter errors, fraud, and theft within an organization thereby strengthening the employees’ code of conduct (Messner, 2009). Moreover, internal control makes use of auditing committee to conduct internal auditing of an organization’s operations with an aim of adding value and improving them (Solomon, 2007). Assessing the effectiveness of internal control is a fundamental tenet of internal control. In internal control, auditors evaluate a company’s internal control effectiveness depending on the applied effort (Adams & Evans, 2004).

In organizations with effective internal control, internal audit operates separately under the chief executive officer (CEO), and audit reports go to the board of directors. As Adams and Evans (2014) notes, internal audit supports the boards of directors in management and directing operations through inspection and evaluation of the efficiency of business operations, internal control, risks management, and production of the recommendation of ways to enhance the organization’s efficiency (Adams & Evans, 2004). Moreover, internal audit assists board of directors inspect financial reporting of the accounting team to ensure the accuracy of financial reports and timely preparation for the same. Internal audits serve to prove the stewardship theory that states that managers will exercise responsibility for the assets they control if left free to do so (Huse, 2005).

However, human beings are weak when money comes into play. As such, the board of directors knows that managers may not be responsible stewards due to their financial interests. Consequently, it is imperative to conduct internal audits to reduce agency loss due to financial frauds. Moreover, internal audits offer ways to improve organizational performance as stewardship theory does (Adams & Evans, 2004). According to the theory, board of directors, upon recommendations from internal audit committee, may advocate for tie executive compensation, managers incentives, and benefits that match operational, financial interests to motivate them into performing better (Hue, 2005). Lastly, internal control ensures that business operations are within the organizations mission, complies with the law, there is fiscal responsibility, and the company meets annual tax requirements. As Roberts (2009) noted, there is a limit to transparency hence the need to build cumulative capacity and responsibility with internal and external reinforcement. According to him, the aggregate function forms the basic tenet for intelligent accountability. According to Roberts (2009), it will be imprudent for a company to assume that the accounting team will law provide clear errors as they are always prone to inadvertent mistakes.

As such, through internal control, an organization separates the duties of the staffs and introduces a system of checks and balances that allows for detection of misappropriation within the organization and minimizing of unintentional errors. Roberts (2009) notes that the credit crisis was a result of weak internal control that put unnecessary trust on transparency measures implemented in credit institutions thereby lacking a culture of continuous evaluation that would ensure investors are not in a panic. However, internal control overcomes the weaknesses by making use of audit committee, and checks and balances meant to reduce errors in financial data thereby leading to intelligent accountability in organizations (Roberts, 2009). Internal control is playing a significant role majorly in banking institutions in improving the effectiveness of such organizations. Internal control is helping banks decrease the prevalence of loss of assets as well as deterrence and early detection of fraud.

Through measures such as checks and balance, procedures and methods, and periodic reviews, organizations realize better ways to make their organizations profitable. Moreover, internal auditing has proven an invaluable tool for the board of directors averts dishonest management hence saving shareholders untold financial loss perpetuated by managers pursuing their personal interests. Moreover, continuous assessment and evaluation of financial reporting is helping companies build capacity for intelligent accountability by detecting misappropriation and unexpected errors in financial reports. As such, it would be prudent to conclude that though internal control has not been 100 percent free of laws, it has played an invaluable role in assisting organizations build capacity for efficiency and effectiveness in operations.

References

1. Adams, C. A., & Evans, R. (2004). Accountability, completeness, credibility and the audit expectations gap. Journal of corporate citizenship, 2004(14), 97-115.
2. Heald, D. (2012). Why is transparency about public expenditure so elusive? International Review of Administrative Sciences, 78(1), 30-49.
3. Huse, M. (2005). Accountability and creating accountability: A framework for exploring social perspectives of corporate governance. British Journal of Management, 16(s1), $65-S79.