Unlike your professor, Internal Controls are not perfect.
Limitations of Internal Controls
Play a video:
Was this helpful?
So internal controls the system in place to help us prevent fraud or detect fraud in our company. They're not perfect. Let's discuss some of the limitations of our internal controls. So Right. They're not gonna be perfect. What are some reasons that internal control internal controls could fail? And we could have fraud happen first. Is that the human element is going to be involved, Right? Employees aren't perfect, right? They could make mistakes. They could be careless or even indifferent towards the internal control procedures. Right? You might have all these great internal controls in place. But then they're like, yeah, whatever. They were supposed to sign these documents, but you know, it doesn't really matter. Right? So those internal controls could fail because the employees, you know, might not care and you really have to push it on them. Like, hey, it's really important that you sign these documents or whatever, that kind of seemingly meaningless step to the employee could be very important to the company. The next reason internal controls could fail is collusion, collusion is where the employees work together to commit fraud. Right? And this goes with the separation of duty, right? Remember when we talked about separation of duties? Well, when they collude together, right, Maybe we separated these duties to prove to prevent fraud, but then they work together all those employees that were supposed to do different tasks. They work together to steal from the company and there's nothing really you can do about that other than hire employees that aren't going to do that Next is an executive override. So usually what happens is, you know, lower level employees. Well, they need to get verified, they need to ask is this okay, can we get this expense right? But when you think about the executives, the CFO of the company, there's not really anyone that he has to ask to write a check. So top level employee generally does the final verification right there. Usually the one doing the final verification. The CFO. So the CFO can just authorize his own transactions, right? Maybe buy a jet ski on the company's dollar and there's nobody really to uh authorize his transactions. He is the authorize er Okay, and last but not least here we've got the size of the business. So sometimes in a small business it's gonna be tough. Right? They might not have enough employees to separate duties. Right? What if you only have like three or four employees at your company? Well, it might be really tough to do separation of duties in those cases. Right? Um So you have to think about the cost versus the benefit. Right? So the cost in that case would be actually hiring extra employees just for the sake of internal controls for the benefit of having this, you know, fraud prevention. So you know, you gotta weigh that out. Is it worth having this extra cost when maybe we have trustworthy employees? It's it's a tough call in those, in those small businesses. So for these reasons, what we say is that internal controls provide reasonable assurance. Okay, notice this kind of legal terminology, They're using reasonable assurance. They're not saying this, we have internal controls in place. So there's no fraud. We can't say that. We say there's internal controls in place, so we're pretty sure right. We're reasonably assured that there's no fraud happening. Okay. So that's kind of the kind of legal, uh, you know, recourse that you have reasonable assurance. So, over what do we have reasonable assurance over? Well, it's over the safeguarding of assets that what we have is what we say we have is actually there. So, we're doing pretty sure about that. And then the reliability of financial information. Okay. So we feel pretty good that the assets are are there and that our financial information is pretty good, too. Okay, so that's what internal controls do. Alright, let's go ahead and move on to the next video