Understanding Internal Controls in the Finance Industry

Guest Author by   02.15.2018   Data Security


In this age of digital banking, organizations must implement robust security architectures to keep their customers’ data safe. Cybercrime and internal data oversights can leave financial institutions with huge losses and eroded credibility. This is why security issues should be tackled on all fronts, both internally and externally.

Internal controls are critical to reducing risks in the IT department of any financial organization.

What are Internal Controls?

Protecting your organization from financial and reputational risks is critical at all times. Internal controls are a set of measures implemented by a firm to track credit, capital and investment risks as well as ensure compliance with various industry standards.

For example, the Sarbanes-Oxley Act of 2002 (SOX) is meant to protect investors from losing their money. According to the Act, publicly traded companies are required to provide their financials every year and prove that they have set up internal fraud deterrent systems.

Objectives of Internal Controls

To come up with effective internal controls, you should understand the specific risks that your company faces. Understanding the risks will help you set appropriate objectives to mitigate them.

Here, your objectives will mainly depend on your industry. For example, financial organizations have to think about the risk of customers’ card data getting into the hands of malicious third parties. Therefore, the companies have to explore the internal controls recommended by regulatory authorities and industry standards such as PCI DSS. Firms that want to enter the healthcare industry have to consider the risk of electronic personal health information (ePHI).

Knowing the objectives of your internal control systems will pave the way for defining the risks.

Risk Management and Internal Controls

After defining your goals and objectives, the next step is evaluating the risks to be mitigated.

Understanding the risks your company faces will help you determine the standards and regulations to comply with. Apart from this, you can continuously monitor the risks to ensure the internal controls work.

For example, your firm may be at risk of both intrusions and physical access. Since these risks are different, they have to be tackled in different ways. Intrusion risks will require the use of encryption technology and firewalls while physical access risks will require personnel accreditation.

To implement an effective risk management strategy, it’s important to create structures that support the procedures that will be followed to protect assets and resources.

Creating Effective Internal Controls

There are five types of internal controls you can set for your company. These controls are informed by the COSO Framework and are:

1. Control Environment

The Board of Directors and Senior Management should accord internal control systems the importance they deserve. This can be done by reviewing awareness and actions taken by the firm. Senior Management should implement the recommendations of the internal controls in their organizational structure and operating styles.

2. Risk Assessment

Companies should not only identify risks but also implement strategies to prevent them. Management needs to consider both internal and external risks. Internal risks may be posed by employees while external risks could be brought about by suppliers, vendors, and other parties that do business with the firm.

3. Control Activities

Control activities refer to internal policies, action mechanisms, and procedures that the business follows. Organizations are required to not to only act, but also document the strategies they have implemented to mitigate risks.

4. Information and Communication

Management should not stop at reviewing risks and establishing policies, but continue to monitor internal controls. Proper strategies should be implemented to address multiple policies of the business such as whistleblower policies, segregation of duties, and so on.

It is critical to ensure that the communication passed down to employees is appropriate for their level in the firm.

5. Monitoring

Carrying out internal audits and ongoing activities to ensure that governance, risk management, and compliance policies are implemented is important. Monitoring helps internal analysts to review the effectiveness of internal controls and report to the management with appropriate recommendations.

How to Design Internal Controls

Your business processes that relate to information systems and financial reporting should help you design internal controls. You should design procedures related to the handling of financial transactions. For example, you can create steps for accessing, transferring and reporting cash or electronic transactions of your firm. These procedures should be in sync with the firm’s financial statements.

The control design should also explain how various non-financial events that are pertinent to the operation of the business are recorded. For example, productivity in the firm affects the bottom-line. Poor productivity leads to reduced revenues. Therefore, there should be a way to document the controls set for productivity and how losses resulting from it can be mitigated.

Finally, it is also important to record non-standard transactions of your business. While financial reporting is the main reason for implementing internal controls, your business runs on software and hardware. These assets can be used to track important information that indicates the relationship between internal controls and IT.

Requirements for an Internal Control Audit

The Auditing Standard No. 5 (AS5) defines the standard review for internal controls. You should understand the terms and concepts of AS5 to prepare your firm better for an internal or external audit.

The Section 404 audit will require documentation evidence of internal controls from your firm. In particular, auditors will be looking for proof of the evaluation process. Therefore, it’s important to communicate often with your external auditors frequently to confirm that your organization is following the internal controls as required.

Developing and Monitoring Internal Controls

Implementing internal controls involves a lot of paperwork. During the initial stages of a company, using spreadsheets may be sufficient. However, as a business scales, internal and external shareholders are likely to increase and this will require a better way of tracking controls.

In most companies, internal controls are confined through authorization of shared documents. For example, administrators can set up authorizations for editing and be reviewing documents to ensure the integrity of the information.

There are various SaaS monitoring tools that allow admins to create easy-to-read reports that can provide insight into areas that need to be monitored and controlled. Using a cloud tracking software will make it easy for Management to evaluate the impact of the company’s internal controls and for auditors to do their job.

Control software can provide your organization with accurate internal controls data. The documentation can be presented to internal and external auditors for them to review and evaluate unseen spheres of risk. The auditors can then suggest internal policies for mitigating any uncovered risks.

Using tracking software also helps to keep audit costs down. While the software does not leave a paper trail, the digital trail is there and is even more accurate and readily available.

It is critical for organizations to control both internal and external threats to be in line with their shareholders’ and regulatory requirements. Internal controls should be implemented and evaluated regularly to ensure the firm is adequately prepared for unforeseen risks. In the end, the controls help to protect the financial health of a company.

About the Author

Ken Lynch is an enterprise software startup veteran, who has always been fascinated by what drives workers to work and how to make work more engaging. Ken founded Reciprocity to pursue just that. He has propelled Reciprocity’s success with this mission-based goal of engaging employees with the governance, risk, and compliance goals of their company in order to create more socially minded corporate citizens. Ken earned his BS in Computer Science and Electrical Engineering from MIT.


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