Companies of all sizes, whether private or publicly held, should establish an adequate system of policies and procedures for internal control over financial reporting. A company’s internal control system can prevent fraud and material errors with no material weaknesses in transactions and can present financial transactions fairly. To foster confidence in a company’s financial reporting, ICFR remains an important component and ultimately leads to trust in their capital markets. This blog presents a detailed overview of internal controls over financial reporting.
Management’s Responsibility v/s Auditors’ Responsibility
Over the past two decades, Internal Control Over Financial Reporting has remained an essential element to provide reasonable assurance regarding the reliability of financial reporting and does not contain any material misstatement. The financial records are detailed, accurate, and fair reflecting the transactions of the assets of the company, and are prepared in association with generally accepted accounting principles.
To have an integrated audit performed is required by most large public issuers that includes an external auditors estimation of the persuasiveness of the company’s ICFR. Whether the company has adequate internal financial control systems in place is to be reported by the auditor. The reporting internal controls, reporting of internal financial controls is significantly broader.
The directors’ responsibility statement is required to state that the directors had laid down their internal financial controls and the same were operating effectively. For ensuring the orderly and efficient conduct of its business, internal financial controls are the policies and procedures adopted by the company. It includes compliance with the policy of company, prevention, and detection of corruption, accuracy, and completeness of the accounting records, safeguarding of the company’s assets, and the quick preparation of precise financial information.
On the effectiveness of internal financial control, the auditor is required to conduct the audit of internal financial controls over financial reporting and should express their opinion. If one or more material weaknesses exist, the company’s internal control cannot be considered effective.
Key Concepts of ICFR
Intentionally or unintentionally, effective ICFR provides reasonable assurance that records are not misstated. It provides a commonly used framework to assist companies in structuring and evaluating controls as it is one element of the broader concept of internal control.
Control systems can provide not absolute, but reasonable assurance that financial records are prepared and reliable by GAAP. If the company’s culture reflects the importance of integrity and ethical values and a commitment to reliable financial reporting, controls designed to generate reliable financial reporting are more likely to succeed. The management should consider any relevant controls in addition to internally developed controls at a service organization that may impact a company’s ICFR.
Designed to mitigate financial reporting risk, control activities are the specific actions established through policies and procedures. These activities include segregation of duties, entity-level, and process-level controls, information technology (IT) general controls, and preventative and detective controls but these may vary by company.
Components of Internal Control Over Financial Reporting
Including cash control, accounts payable internal controls, and AP financial controls, the COSO framework is useful for effective ICFR. It comprises five integrated components such as risk assessment, control environment, control activities, information and communication, and monitoring activities.
Within the organization, the control environment refers to the processes, standards, structures, and values. If the company’s culture reflects the importance of integrity, ethical values and a commitment to reliable financial reporting, controls designed to generate reliable financial reporting are more likely to succeed.
The control environment influences the effectiveness of internal controls within it and is the foundation for all other components of internal control. It is an intangible factor encompassing both technical competence and ethical commitment.
The process adopted by the company to identify the Risk of Material Misstatements (RoMM) in financial statements is referred to as risk assessment concerning Internal Control Over Financial Reporting. Financial statement level and account balance and transaction type level are the two levels at which this component calls for a structured analysis of potential risks of misstatements.
The person who is competent to understand the financial reporting process, the disclosure requirements, the temptations of misstatement at employee and or management levels, the vulnerabilities of fraud, etc needs to conduct the risk assessment for ICFR.
Control activities are another key component of ICFR that include policies and procedures, approvals, verifications, security over assets, segregation of duties, and help ensure risk responses are effectively carried out. It includes identifying controls that are no more required and ensuring that IT controls are appropriately mapped.
Across a chapter, at all levels, and in all functions these activities help prevent the risk that chapter objectives will not be achieved.
Information System and Communication
This component refers to multiple types of information flows and communication channels in the context of Internal Control over Financial Reporting. To ensure that the financial statements are complete, accurate, and present a true and fair view, the first is the entire flow of information of all relevant events or transactions ultimately into financial statements.
To ensure transparency and fairness in financial reporting, the second is the flow of relevant information to those charged with governance to make financial estimates. Thirdly, from the company to the owners and other stakeholders, it is the communication of financial statements, including IA. It should be timely and accurate when the information is communicated.
Monitoring of Controls
To ensure that controls, as designed, are operating effectively and that lapses are identified and remedied promptly, this component called monitoring of controls entails the processes established by the management. It evaluates the effectiveness of a chapter’s internal control and is effective when it leads to the identification and correction of control weaknesses before affecting the achievement of the objectives of the chapter.
Business setup consultants in Dubai help entrepreneurs verify the accuracy and completeness of their accounting records. They also help to achieve the timely preparation of reliable financial information and see whether the financial reporting is working efficiently.