a$.$ Purpose of Internal Control System

The purpose of an internal control system in a company is to ensure the integrity of financial and accounting information, promote accountability, and prevent fraud. It helps in achieving operational efficiency by improving the accuracy and reliability of financial reporting, safeguarding assets, and ensuring compliance with laws and regulations.

b$.$ Principles of Internal Control System

The principles of an internal control system include:

Establishment of Responsibility: Assigning specific responsibilities to individuals to ensure accountability. For example, only designated personnel should have the authority to approve transactions.

Segregation of Duties: Dividing responsibilities among different individuals to reduce the risk of error or inappropriate actions. For instance, the person who handles cash should not be the same person who records cash transactions.

Documentation Procedures: Using pre$-$numbered documents and requiring that all transactions be properly documented. For example, using sequentially numbered invoices to track sales transactions.

Physical Controls: Implementing physical measures to safeguard assets. For example, using safes for cash storage and locked warehouses for inventory.

Independent Internal Verification: Regularly reviewing and verifying data by an independent person. For instance, having an internal auditor periodically check the accuracy of financial records.

Human Resource Controls: Conducting background checks and providing adequate training to employees. For example, performing background checks before hiring employees who will handle sensitive financial information.

Information and Communication: Ensuring that relevant information is identified, captured, and communicated in a timely manner. For example, using an internal reporting system to communicate financial data to management.

Example: Consider a retail company that implements an internal control system. The company assigns the responsibility of approving purchase orders to the purchasing manager $($Establishment of Responsibility$).$ The tasks of ordering inventory, receiving goods, and making payments are divided among different employees $($Segregation of Duties$).$ All purchase orders and receipts are documented using pre$-$numbered forms $($Documentation Procedures$).$ The inventory is stored in a locked warehouse with restricted access $($Physical Controls$).$ An internal auditor periodically reviews the purchase orders and inventory records $($Independent Internal Verification$).$ The company conducts background checks on new hires and provides training on internal control procedures $($Human Resource Controls$).$ Finally, the company uses an internal reporting system to ensure that all financial data is communicated to the management team $($Information and Communication$).$