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Are your assets secure from theft and fraud? Globally, organizations lose 5% of their annual revenue to fraud, with the average incident costing $1,662,000, and 22% of cases costing over $1 million. Over half of fraud incidents happen because of a lack of internal security controls (32%) or an override of existing controls (19%). These numbers illustrate how your internal controls play a decisive role in determining the security of your assets.
In this blog, we'll share what you need to know to implement effective internal controls that keep your assets safe. We'll cover what internal controls are, their components and varieties, their benefits and limitations, and how to put efficient controls in place by combining best practices with asset tracking technology.
Main Takeaways from This Article:
- Internal controls are procedures organizations use to ensure operational efficiency, reporting reliability, and regulatory compliance, mitigating fraud and theft risks.
- Components of internal controls include control environment, risk assessments, control activities, information and communication transparency, and monitoring procedures.
- Internal controls are divided into three groupings: preventive, detective, and corrective.
- Implementing internal controls protects assets, prevents fraud, improves financial reporting, and increases operational efficiency.
- Factors such as human error, fraud, and cost can pose challenges to internal controls.
- Steps for setting up internal control systems include assessing risks, defining control procedures, assigning responsibility, training staff, and adopting asset tracking technology.
What Are Internal Controls?
Internal controls are procedures organizations use to ensure operational efficiency, reporting reliability, and regulatory compliance. They protect assets, organizations, and stockholders by mitigating risks such as fraud, theft, and accounting errors. For example, checking asset ledgers against actual physical inventories helps organizations identify suspicious patterns that might indicate ongoing theft.
Every organization is subject to threats that could harm it. While most businesses don’t frequently face business-ending threats, certain risks could lead to partial or complete asset loss, and those threats need to be mitigated.
Every business faces different threats that impact its assets, from inadvertent mistakes to theft or security breaches.
To limit the risk of threats to company assets — whether financial, technological, or physical threats — companies need to ensure they have the proper internal controls set up.
The question is, what internal controls should be in place?
The three primary controls are:
- Corrective controls
- Detective controls
- Preventive controls
These are critical to keeping your assets secure from external (or internal) threats, including lost assets, theft, and asset failure due to poor maintenance.
Components of Internal Controls
The Committee of Sponsoring Organizations of the Treadway Commission (COSO) has identified five pillars of an effective internal control integrated framework: control environment, risk assessment, control activities, information and communication, and monitoring activities. Additionally, several other important elements that fall into these categories may be highlighted:
Control Environment
The internal control environment consists of the structures and procedures that constitute the framework for executing controls within an organization. These include the company culture and values defined by the board of directors and senior management, authorization for implementing controls, recruitment policies, and performance measurement procedures.
Risk Assessment
Risk assessment identifies events that could impact asset security and assesses their likelihood and impact. Conducting risk assessments helps organizations identify ways to mitigate internal risks such as theft and external risks such as supply chain disruptions.
Control Activities
Control activities consist of policies and procedures that provide reasonable assurance of an organization's asset risk mitigation policies being carried out. They can be designed to prevent, detect, or correct risks and may include both automated and manual safeguards.
Information and Communication
Internal controls depend on a constant, up-to-date flow of accurate information about assets and communication of that information both within organizations and with outside parties. Good internal control procedures must ensure the generation of relevant asset information and transparent sharing of that data with the appropriate parties, such as internal auditors and external auditors.
Monitoring Activities
Proactive monitoring of internal controls helps ensure their effectiveness. Ongoing evaluations and periodic separate evaluations can help assess whether existing controls meet organizational standards and when adjustments are needed.
Physical Safeguards
Certain control activities depend on physical safeguards to secure facility assets, inventory, and IT equipment assets. These can include measures such as locks, access controls, and surveillance systems.
Separation of Duties
Segregation of duties can support control activities by using the distribution of responsibilities between multiple employees to reduce risks to assets. For example, separating purchase requisitioning from purchase approval reduces the risk of improper purchases.
Compliance Activities
Laws and regulations provide external constraints that reduce asset risks. Organizations can support these safeguards with internal policies that promote regulatory compliance.
Understanding the Three Types of Internal Controls
Internal controls fall into three categories:
1. Preventive Controls
Preventive controls implement safeguards in anticipation of likely risks. They form the first line of defense against risks to assets.
Examples of preventive controls include:
- Asset tracking software to monitor resource existence and locations
- Use of asset tags to identify resources
- Segregation of duties
- Authorization procedures for activities such as procurement and invoicing
- Physical safeguards
- Security guards
- Video surveillance
Preventive controls promote operational efficiency by automating control activities and reducing time and cost expended on corrective controls.
2. Detective Controls
Detective controls seek to identify errors, irregularities, or other signs of risks that have become actual threats to assets. They detect problems that preventive controls have failed to avert.
Examples of detective controls include:
- Inventory counts
- Bank reconciliations
- Asset audits
- Log monitoring
- Automated security alerts
- Tying out financial statements
- Performance metric reviews
- Exception reports
Detective controls identify discrepancies and anomalies that signal the existence of active threats. They proactively intercept problems before they can escalate while helping promote consistency and accuracy.
3. Corrective Controls
Corrective controls address issues that have been identified by detective controls. They implement mitigations to resolve threats until updated preventive controls can be installed.
Examples of corrective controls include:
- Backup procedures
- Disciplinary actions
- Policy updates
- Procedural updates
- Modifying your asset check-in and check-out system
- Updating report filing procedures
- Updating auditing procedures
- Improving physical security measures
Corrective controls serve as a secondary line of defense to reinforce preventive and detective controls. If your preventive controls are working effectively, you should be spending minimal time on corrective controls.
Benefits of Implementing an Effective Internal Control System in Your Business
Just how important is it to set up your company's internal controls?
Considering retailers lost $112.1 billion from theft in 2022, there’s a substantial monetary reason.
Internal controls are necessary if you want to keep your assets safe, whether from theft, fraud, or preventable damage.
Here are some reasons you need to implement the right controls:
1. Safeguard Your Assets
The number one reason you should set up the right internal controls in your organization is to keep your assets safe.
Internal controls can help you prevent, identify, and fix issues related to your assets.
Effective controls can be set up to help you track your assets, identify issues ahead of time, and determine how a breach occurred (so you can prevent it in the future).
By taking an active approach to knowing what’s going on with your assets (and putting the right processes in place to mitigate risks), you’ll be able to ensure you reduce asset losses and the subsequent expenses associated with those losses.
2. Prevent Fraud
Unfortunately, fraudulent activity occurs in businesses, resulting in losses in the thousands or even millions — and it’s more common than you might think.
For example, an administrator at Yale University was caught stealing electronics for years amounting to over $40 million.
Internal controls like strict audit procedures and different checks can help prevent fraud so you keep your assets secure in your organization.
3. Accurate Reporting and Cash Flow Forecasting
Establishing internal controls improves the accuracy of your financial reporting. Monitoring discrepancies helps you spot errors and reconcile your asset ledger with verified physical asset counts, aligning your balance statements with your actual assets. You likewise gain insight into the true state of your equipment and inventory and your maintenance and procurement needs, promoting asset optimization.
More accurate financial reports mean more precise expense and cash-flow forecasts. The enhanced accuracy provided by internal controls gives you more realistic expectations of upcoming procurement and maintenance expenses, placing you in a better position to predict and manage your cash flow.
4. Improve Operational Efficiency & Performance
Beyond protecting your assets, there’s one often overlooked benefit of setting up internal controls.
By implementing internal controls effectively, you’ll be able to improve the efficiency of your operations.
For example, by setting up regular maintenance on your assets to prevent a breakdown, you’ll have fewer interruptions and operational standstills, allowing you to work more efficiently.
Plus, with an asset tracking system, you’ll be able to quickly find where different equipment is so you can complete tasks faster.
Limitations of Internal Controls
Internal controls mitigate risks, but they can't eliminate them entirely because they face certain limitations that also call for mitigating measures:
- Human Error: No matter how well your internal control systems are designed, data entry errors, miscommunication, and oversight lapses can still occur. You can offset human error to a degree by leveraging automated tools such as cloud-based asset tracking software, but at the end of the day, even software is written by human beings, and you still must rely on human staff to implement your automation strategy.
- Collusion and Fraud: Human malice also can undermine your internal controls. For example, employees who know your internal controls may collude to bypass them to commit fraud. You can mitigate this risk to an extent by following good hiring screening practices and enacting employee training and monitoring.
- Cost vs. Benefit: There's no way around the fact that internal controls can incur expenses, both in terms of money and in terms of labor and time. You can't avoid the cost of internal controls, but you should conduct a cost-benefit analysis to ensure your organization that internal control expenses are worth your investment. Likewise, you can reduce the risk of high costs by pursuing cost-effective internal control strategies, such as emphasizing preventive controls.
- Management Override: Even if you implement great internal controls, managers with high-level access privileges may have the ability to override them. For example, a manager may have the capability to ignore segregation of duties restrictions on procurement requests, even if this goes against your written policy. Company culture plays a leading role in mitigating this type of risk by instilling the importance of all team members following internal controls.
- Rapidly Changing Risks: Sometimes emerging risks can outpace the effectiveness of your preventive controls. For example, new cybersecurity attack methods that security professionals haven't yet addressed may enable bad actors to get inside your digital assets records. This underscores the importance of constantly updating your internal controls to reflect current risks.
Defining Your Organization’s Internal Control System
How do you go about setting up your internal controls? Here are some actionable steps to get your control systems in place:
- Designate a manager responsible for building your control environment in coordination with upper management and stakeholders, using their input to establish internal control objectives
- Conduct a risk assessment to identify potential risks and assess their likelihood and impact
- Design preventive, detective, and corrective internal control activities, and select appropriate technology to automate your procedures, such as asset tracking software
- Establish mechanisms for capturing asset information, such as asset tag scanning, and communication protocols for sharing information
- Select key performance indicators to monitor internal control effectiveness and set up monitoring systems to track them
After following these steps to define your internal controls, use feedback from your monitoring procedures to continually update and improve your control systems.
Establish Internal Controls & Protect Your Assets with RedBeam
Adopting internal controls increases the efficiency of your asset management, improves the reliability of your reporting, and streamlines regulatory compliance to guard you against fraud, theft, and other risks. Adopting preventive, detective, and corrective control activities can dramatically reduce risks to your assets and protect your company's profitability.
Technology plays a key role in establishing internal controls by allowing you to automate critical control activities. RedBeam's world-class fixed asset tracking platform provides you with a cloud-based interface that lets you leverage barcode and RFID asset tags and mobile scanning technology to automatically capture and update asset information, making it easier to keep your books consistent and identify discrepancies. RedBeam supports SOC 2 Type II compliance, ensuring your data's security and privacy and protecting your asset information from unauthorized access.
Protect your assets with a free trial of RedBeam today.
FAQs
What is An Organization's Control Environment?
Your organization's control environment is composed of the structures and procedures that establish your framework for executing internal controls. It includes the company culture and values adopted by your board of directors and senior management, authorization for control implementation, recruitment policies, and performance tracking procedures.
What's the Difference Between an Internal Audit and Internal Controls?
Internal controls center around procedures to prevent, detect, and correct risks to your assets, while internal audits are a method for detecting risks reflected in discrepancies and reviewing the effectiveness of internal controls.
How Do Internal Controls Help with Safeguarding Assets?
Internal controls protect assets by creating procedures to prevent, detect, and correct risks that threaten assets.
