An internal check is a part of an organization’s system of internal control that aims to prevent errors and fraud in the day-to-day transactions and record-keeping activities of the business. This system is designed such that the work of one employee is automatically checked by another, reducing the chance of mistakes or manipulation.
Internal checks involve a division of responsibility in the various transactions processing stages. It’s a method where the work is arranged so that the work done by one person is automatically checked by another in the ordinary course of business.
For example, in a well-designed internal check system, the person who is authorized to sign checks should not be the same person who records the company’s expenses. This arrangement reduces the chance of fraudulent activities or errors, because any manipulation or mistake would require collusion between two or more individuals.
Other examples of internal checks include:
- Segregation of Duties: Responsibilities are divided among different individuals to lessen the possibility of errors or fraud. For instance, the individual who accepts cash from customers should not be the same person who records these transactions.
- Independent Reconciliations: An employee who does not have custody of assets should be assigned to reconcile the company’s assets with the recorded amounts. For example, bank statement reconciliation should be performed by someone other than the individual making deposits or issuing checks.
- Approvals, Authorizations, and Verifications: Transactions should be authorized by appropriate individuals to ensure they are correct and valid.
- Security of Assets and Records: Physical and electronic safeguards should be in place to protect assets and records. This might involve locks, passwords, and alarms.
- Reviews and Analyses: Regular reviews of financial and operational results, including budget variance reports, should be conducted by management.
Remember, a strong system of internal checks can help prevent errors and fraud, but no system is foolproof. Organizations should regularly review and update their internal controls as needed.
Example of Internal Check
Let’s consider a fictional company, “TechEase Inc.” TechEase Inc. is a mid-size tech company that sells software solutions to clients globally. Here’s an example of how internal checks could be applied within their organization:
- Segregation of Duties: When a customer buys a software license from TechEase, the process involves multiple team members. One sales representative interacts with the customer and finalizes the sale. Another employee in the accounting department then issues the invoice, and yet another individual is responsible for receiving payment and recording it in the accounting system. This division of labor ensures no single person has control over the entire sales process, reducing the risk of error or fraud.
- Independent Reconciliations: At the end of each month, a staff member from the finance department (who does not deal directly with cash receipts or disbursements) reconciles the company’s bank statements with its financial records. This process helps identify any discrepancies or irregularities that might have occurred.
- Approvals, Authorizations, and Verifications: For all major expenses (like purchasing new servers or launching an expensive marketing campaign), TechEase requires managerial approval. This ensures that big financial decisions have oversight, which helps prevent unauthorized or wasteful spending.
- Security of Assets and Records: TechEase uses a secure, password-protected database to store sensitive financial information. Only authorized personnel can access this system. Furthermore, physical assets, like company computers and servers, are stored in secure, monitored locations to prevent theft or damage.
- Reviews and Analyses: TechEase’s management conducts regular reviews of their financial and operational results. These reviews include comparing actual performance to budgeted performance, investigating significant variances, and confirming that financial results are consistent with management’s understanding of the company’s operations.
By using these internal checks, TechEase Inc. can significantly reduce its risk of errors and fraud, ensuring a healthier and more efficient operation.