Internal
control is defined as follows:
"Internal
control is a process, effected by an entity’s board of directors, management,
and other personnel, designed to provide reasonable assurance regarding the
achievement of objectives relating to operations, reporting, and
compliance."
Objectives of Internal Control
The
Framework provides for three categories of objectives, which allow
organizations to focus on differing aspects of internal control:
- Operations Objectives—These pertain to effectiveness and efficiency of the entity’s operations, including operational and financial performance goals, and safeguarding assets against loss.
- Reporting Objectives—These pertain to internal and external financial and non-financial reporting and may encompass reliability, timeliness, transparency, or other terms as set forth by regulators, recognized standard setters, or the entity’s policies.
- Compliance Objectives—These pertain to adherence to laws and regulations to which the entity is subject.
Components
of Internal Control
The control
environment is the set of standards, processes, and structures that provide the
basis for carrying out internal control across the Software Development Companies. The board of
directors and senior management establish the tone at the top regarding the
importance of internal control including expected standards of conduct.
Management reinforces expectations at the various levels of the organization.
The control environment comprises the integrity and ethical values of the
organization; the parameters enabling the board of directors to carry out its
governance oversight responsibilities; the organizational structure and
assignment of authority and responsibility; the process for attracting,
developing, and retaining competent individuals; and the rigor around
performance measures, incentives, and rewards to drive accountability for
performance. The resulting control environment has a pervasive impact on the
overall system of internal control.
2. Risk
Assessment
Every entity
faces a variety of risks from external and internal sources. Risk is defined as
the possibility that an event will occur and adversely affect the achievement
of objectives. Risk assessment involves a dynamic and iterative process for
identifying and assessing risks to the achievement of objectives. Risks to the
achievement of these objectives from across the entity are considered relative
to established risk tolerances. Thus, risk assessment forms the basis for
determining how risks will be managed.
A
precondition to risk assessment is the establishment of objectives, linked at
different levels of the entity. Management specifies objectives within
categories relating to operations, reporting, and compliance with sufficient
clarity to be able to identify and analyze risks to those objectives.
Management also considers the suitability of the objectives for the entity.
Risk assessment also requires management to consider the impact of possible
changes in the external environment and within its own business model that may
render internal control ineffective.
3. Control
Activities
Control
activities are the actions established through policies and procedures that
help ensure that management’s directives to mitigate risks to the achievement
of objectives are carried out. Control activities are performed at all levels
of the entity, at various stages within business processes, and over the
technology environment. They may be preventive or detective in nature and may
encompass a range of manual and automated activities such as authorizations and
approvals, verifications, reconciliations, and business performance reviews.
Segregation of duties is typically built into the selection and development of
control activities. Where segregation of duties is not practical, management
selects and develops alternative control activities.
4. Information
and Communication
Information
is necessary for the entity to carry out internal control responsibilities to
support the achievement of its objectives. Management obtains or generates and
uses relevant and quality information from both internal and external sources
to support the functioning of other components of internal control.
Communication is the continual, iterative process of providing, sharing, and
obtaining necessary information. Internal communication is the means by which
information is disseminated throughout the organization, flowing up, down, and
across the entity. It enables personnel to receive a clear message from senior
management that control responsibilities must be taken seriously. External
communication is twofold: it enables inbound communication of relevant external
information, and it provides information to external parties in response to
requirements and expectations.
5. Monitoring
Activities
Ongoing
evaluations, separate evaluations, or some combination of the two are used to
ascertain whether each of the five components of internal control, including
controls to effect the principles within each component, is present and
functioning. Ongoing evaluations, built into business processes at different
levels of the entity, provide timely information. Separate evaluations,
conducted periodically, will vary in scope and frequency depending on
assessment of risks, effectiveness of ongoing evaluations, and other management
considerations. Findings are evaluated against criteria established by
regulators, recognized standard-setting bodies or management and the board of
directors, and deficiencies are communicated to management and the board of
directors as appropriate.
Relationship between Objectives and Components
A direct
relationship exists between objectives, which are what an entity strives to
achieve, components, which represent what is required to achieve the
objectives, and the organizational structure of the entity (the operating
units, legal entities, and other). The relationship in IT Companies can be depicted in the form
of a cube.
- The three categories of objectives—operations, reporting, and compliance—are represented by the columns.
- The five components are represented by the rows.
- An entity’s organizational structure is represented by the third dimension.
COSO states
that:
“There is
synergy and linkage among these components, forming an integrated system that
reacts dynamically to changing conditions. The internal control system is
intertwined with the entity’s operating activities and exists for fundamental
business reasons. Internal control is most effective when controls are built
into the entity’s infrastructure and are a part of the essence of the
enterprise. “Built in” controls support quality and empowerment initiatives,
avoid unnecessary costs and enable quick response to changing conditions.”
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