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DPA40123
CHAPTER 3
INTERNAL CONTROL SYSTEM
Learning 01 Explain the fundamental
Outcomes concept
02 Provide the importance of

internal control to auditors
03 Organize the documentation of

internal control
04 Differentiate strengths and

weaknesses
Introduction
Type
1. Preventive controls – to avoid
Definition errors or irregularities. Eg :
The process that is…. segregation of duties;
• designed by the management safeguarding assets
• affected by those charged with
governance, management and 2. Defective controls – to find or
other personnel allocate errors after they have
• to provide reasonable assurance occurred. Eg : management
• about the achievement of the analyses of business losses.
company’s objective
Internal
Control
Importance of internal control Responsibilities
i. Help organization to exert Management Auditor
control over business • To develop, • To obtain
process establish, maintain understanding
ii. Risk management • To provide • To test the
iii. Compliance with applicable reasonable effectivesness
laws and regulations assurance of • To express an
iv. Better communication with operations opinion
employees
Components of Internal Control
Control Environment
01
Risk Assessment 02
05 Information &
Communication
03 04 Monitoring
Control Activities.
• Infographic
ComponentStyle 1 - Control Environment
➢ Set of standards, process,
procedures and structures. 4. Management philosophy and
➢ Overall attitude and actions operating style
of the management.
5. Authority and responsibility

1. Integrity and ethical values
6. Company structure
2. Commitment to competence
3. Participation of Board of 7. Human resource policies and

Directors and Audit Commitee procedures
Component 2 - Risk Assessment
Risk – possibility that an event will occur and adversely affect the
achievement of objectives.
Risk assessment – process of identifying, evaluating, analysing and

responding to the risks
The basis for determining how the risks will be managed - achievement of
objectives
Requires management to consider the impact of possible changes in the

external and internal environment.
Eg : new personnel, rapid growth, new technology, new products or activities,

information systems, corporate restructuring.
Risk assessment for financial reporting – preparation of statements
conform with GAAP.
Component 3 - Control Activities
❑ To ensure management’s directives are

carried out.
❑ To ensure necessary actions are taken
to support the achievement of
objectives.
❑ Performed at all levels of the
Performance
company, various stages within
reviews
business processes and over
technology environment.
Physical
controls
Segregation
of duties
Information
processing
controls
Component 4 - Information & Communication
Identify and record all
valid transactions
✓ To provide clear understanding
of the individual roles and
responsibilities. Financial reporting Record on timely basis
purposes –
✓ Internally : communicates accounting system
objectives and responsibilities Proper recording of
monetary value
✓ Externally : communicates
matters affecting the Record transactions in the
functioning of other proper accounting period
components of internal control.
Present proper financial

statements
Component 5 - Monitoring
Assess the quality of internal Ongoing evaluations to Assess the design and
control performance over ascertain whether the operation of controls
time components of internal control
are present and functioning
Evaluates and communicates Taking necessary corrective 2 important aspects :

internal control deficiencies actions i. Management control
methods
ii. Internal audit function
Importance of Internal Control to Auditors
1. Useful to prepare audit plan

2. To enable auditors to complete their work in less than
the amount needs
Evidence from a system with a good internal control is more

competent than evidence from a system with poor internal
control.
Review & Documentation of Internal Control
System flowchart Written guidelines
Copies of
Internal control
companies
questionnaire
manuals
Requirement by Regulators
Malaysian Code of MCCG 2017:
Bursa Malaysia, Corporate • The role of internal
Chapter 15 – Listing Governance (MCCG) audit function in
Requirements : 2012 – Principle 6 assisting the
• Additional Recognize and company to meet its
statements by BOD Manage Risks : objective
to be included in • BOD should • Improve the
annual report – the establish a sound effectiveness of risk
state of risk framework to management,
management and manage risks and internal control and
internal control internal control governance
system
Massive damage
Data losses
Cyber Threat
to Internal Internet Disruption of operations
Leaked information
Control
Eg :
Computer malware –
spread over 150 countries
- Taking over user files
- NHS (UK), FedEx (US),
gas co (Spain)
Strengths & Weaknesses
Strengths Weaknesses
1. Segregation of functions 1. Human judgement
2. Authorization 2. Failure to understand or take action
3. Input controls 3. Inappropriate management override
of controls
4. Processing controls 4. Collusion by two or more people
5. Management judgement
6. Cost benefit consideration
Communicating with the governance
Deficiency in design Deficiency in operation
✓ Exists when a control necessary to ✓ Exists when a control does not
meet the control objective is operate as designed
missing
✓ Existing control is not properly ✓ The person performing the control
designed does not posses the necessary
authority or competence
❖ Deficiency has to be communicated to those charged with the governance – management,
BOD
❖ Takes place after completion of audit
❖ Management letter – acknowledge the management of their responsibilities for design and
implementation of internal control
❖ Disclosure of any fraud or suspected fraud
❖ Significant effect of fraud on the financial statements

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02 Provide the importance of

03 Organize the documentation of

04 Differentiate strengths and

5. Authority and responsibility

3. Participation of Board of 7. Human resource policies and

Risk assessment – process of identifying, evaluating, analysing and

Requires management to consider the impact of possible changes in the

Eg : new personnel, rapid growth, new technology, new products or activities,

❑ To ensure management’s directives are

Present proper financial

Evaluates and communicates Taking necessary corrective 2 important aspects :

1. Useful to prepare audit plan

Evidence from a system with a good internal control is more

System flowchart Written guidelines

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