Principles and Practice of Auditing Y R Kavyareddy Mcom (PhD) Asst.

professor

Chapter 2 – Internal Control

ROUTINE CHECKING:
Regular checking of all the daily transactions is known as Routine Checking. Routine checking
incorporates the following tasks: Checking of record in primary books, costing, transfer etc.
Checking transfer of transactions from original books of accounts to ledger account. Checking
debit and credit side of various accounts. Checking transfer of balances of various accounts to
other pages or accounts or statements.
Advantages of Routine Checking
1. All the original entries will be checked; so all the errors and frauds can be detected easily.
2. All the entries and posting will be tested.
3. Routine checking helps to conduct final audit because all the balancing and totals have already
been checked.
4. Separate and specific staffs are not needed because it is a regular process.
Disadvantages of Routine Checking
1. Routine checking is a mechanical test, so the staff who performs this work does not have
inspiration. So, there are chances of leaving errors and frauds.
2. Routine checking can only detect small errors and frauds but not the planned frauds.
3. Routine checking is not needed where self-balancing system is applied.
4. Routine checking cannot detect principle and compensating errors.
TEST CHECKING:
Test checking is a substitute for detailed checking. It involves only a partial checking. The auditor
normally does not check completely all the records made into the books of accounts but, through
a process of sampling, selects a few items and if they are found correct, he presumes that the
remaining entries would also be correct likewise. Thus, the whole system of test checking implies
selecting and checking only a few selected transactions so as to enable the auditor to form his final
judgment as to the whole set of transactions. The choice for adoption of testing methods is fully
dependent on the discretion and judgment of the auditor who will depend on the situation of
individual cases.
Advantages of Test Checking:
i. Time Saving ii. Correct Results iii. Utilization of Saved Energy iv. Suitable for large size
enterprise. v. Adds to the significance of Internal Check.
Disadvantages of Test checking
i. Undisclosed errors and frauds. ii. Incredibility and unauthenticity. iii. Enhancement of Auditor’s
Liability iv. Negligent Employees v. Continuance of vicious circle.
Difference between TEST CHECKING VS ROUTING CHECKING
1.Meaning
• Test checking is an accepted auditing procedure wherein only a part of its transactions is
checked to form an opinion instead of checking the transactions.

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• Routine checking is the detailed checking of all transactional aspects such as casts, sub – casts,
carry-forwards, extensions and calculations etc. in subsidiary books, checking of posting into
the ledgers, casting of ledger accounts and extraction of their balances etc.
2.Objectives
• Test checking - To obtain a reasonable level of satisfaction about all transactions but verifying
a few representative transactions called “sample”.
• Routine checking -(a) to verify the arithmetical accuracy of the entries, (b) to verify the
accuracy of posting to ledgers. (c) to check that the ledger accounts have been correctly
balanced, and (d) to ensure that no figures are altered after checking.
3.Advantages
• Test Checking -Saving in time. (b) Proper and careful test checking is helpful & serves the
audit objective. (c) Volume of work is reduced. (d) Time available for other audits.
• Routine checking - (a) Checking of posting and ledgers. (b) Arithmetical accuracy can be
checked. (c) Trial balance tallying is facilitated. (d) Easy detection of errors and frauds. (e)
Delegation of audit work to junior staff.
4. Disadvantages
• Test checking - Client staff may become careless. (b) Some errors and frauds may go
undetected. (c) All items and transactions are not checked. (d) An elements of doubt and risk
is present in the Auditor’s opinion.
• Routine checking - (a) Is a highly mechanical process. (b) Monotonous activity may lead to
boredom. (c) Major items of frauds and high level intricacies and complexities may not be
revealed. (d) Compensating Errors and Errors of Principle will not come to light.
INTERNAL CHECK
Internal check means that check imposed in such a way on a day to day transaction that work of
one person is checked by another person automatically in this way the chances of frauds and errors
minimizes. It is an arrangement of accounting work under which the work of one person comes
under the security of another person. So, that it is not possible to commit fraud without collusion
between two or more persons. The work of one staff is automatically checked by another person
in order to locate errors and frauds.
Spicer and Pegler have defined a system of internal check as "an arrangement of staff duties
whereby no one person is allowed to carry through and record every aspect of a transaction such
that without collusion between two or more persons., fraud is prevented and at the same time
possibilities of errors are reduced to a minimum".
De Paula has defined internal check as "a continuous internal audit carried on by the staff itself
by means of which the work of each individual is independently checked by other member of the
staff."
Internal check is a method of organising the accounts system of a business concern or a factory
where the duties of different clerks are arranged in such a way that the work of one person is
automatically checked by another and thus the possibility of fraud, or error or irregularity is
minimized unless there is collusion between the clerks. It is a kind of division of labour. This

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minimises the possibilities of frauds and errors unless all the three join hands in defrauding their
employer.
According to the special committee on Terminology, American Institute of Accountants, 1949
“Internal check-a system under which the accounting methods and details of an establishment are
so laid out that the accounts procedures are not under the absolute and independent control of any
person - that, on the contrary, the work of one employee is complementary of that of another, and
that a continuous audit of the business is made by the employees.”
The auditor must familiarise himself with the system of internal check in operation. Rotation of
duties relating to cash section should also be enforced.Thus, under internal check system the staff
duties are so arranged that no one person is allowed to record every aspect of the transactions and
the entire work is distributed among the various members of the staff in such a manner that the
work of one person is automatically checked by others.
The essential elements of internal check are as under-
1. Existence of checks on day to day transactions.
2. The check is to be carried out continuously as a part of the routine system.
3. The work is divided among the staff and each staff is assigned a specific task.
4. The work of each staff though independent is complementary to the work of another.
The system of internal check is increasingly recognised by the auditor specially when the size of
the concern is large. The existence of effective internal check system relieves the external auditor
of detailed checking to a larger extent. The extent to which an external auditor can depend upon
the system of internal check is based on the procedural tests applied by him to find out the
effectiveness of the system. However the auditor can not be relieved of his responsibility if he was
found guilty of negligence regardless of the fact that he had tested the internal check in existence
in the organisation before he had accepted it as correct.
Objectives of Internal Check
1. To minimize chances of fraud and errors that may be committed by any member of the staff
2. To detect fraud and errors easily and correct them promptly.
3. To exercise moral pressure among the members of the staff.
4. To allocate duties and responsibilities of every person in such a way that he can be taken to
task for any lapse on his part and ensure proper division of work.
5. To increase overall efficiency of the members of the staff by assigning duties based on the
principle of division of labour.
6. To have an accurate and reliable record of all business transactions.
7. To Ensure the reliability of accounts.
8. To ensure the easy preparation of final account
9. To simplify external auditors work
10. To ensure correct accounting of business transactions
Advantages of Internal Check:
1. Proper division of work, since duties of the staff can be assigned in a precise way.
2. Fixation of responsibility to each staff alerts them and increases efficiency in operation.
3. Early detection of errors and frauds. Mistakes in recording will be minimized.

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4. Truth and accuracy of accounting can be available.

5. Elimination of Errors and minimization of Frauds
6. Easy and fast preparation of final accounts, since all accounting records will be intact.
7. Employees will be cautious and honest which leads to a moral Impact on Work Environment
8. Genuineness and accuracy of the account, as the entire organization works automatically and
there is a moral check on the employees.
9. It is a relief for businessman, since every employee will be honest and cautious.
10. It reduces burden of the external auditor as there is no need for detailed examination of book
of accounts.
11. Internal check helps to improve efficiency in each section of the organization and there is
growth in terms of economy in operations, increased profit and improved work efficiency.
Disadvantages of Internal Check
1) It is mainly suitable only for big concerns.
2) It can lead to sacrifice of quality for quickness.
3) It can create certain type of disorder, confusions etc. in the working of the organization.
4) Useful only when there is no collusion between employees.
5) It is expensive, small companies cannot afford to have internal check .
6) Repetition of work, as the work will be checked again by Internal and External auditor
7) Negligence of Owner as Internal check is already there, he might not personally check matters
related to business
8) Adverse effect on Employees since the same details can be checked many times by different
people
9) If the Internal check system is defective, the auditor cannot depend on it.
Principles and essential of good Internal check system.
1. No single staff shall have absolute control over recording of all the aspects of business
transactions by himself.
2. The same staff shall not be allowed to have access to all books of accounts as well as physical
custody of the assets.
3. Each member of the staff should be made responsible for a specific work.
4. All officials and employees holding responsibility towards cash, securities or stock should be
encouraged to proceed on annual leave to prevent the concealed fraud.
5. The duties of the members of the staff should be changed from time to time.
6. Attempt should be made to introduce mechanical devices to prevent mis-appropriation of cash.
7. Each transaction should pass through a definite route and through several hands.
8. All books, vouchers, documents should be classified and made available for easy reference.
9. Proper record must be maintained of the incoming and outgoing of goods from the business
premises.
10. Self-balancing ledger system should be introduced to make the system more efficient and
effective.
11. No undue importance should be given to any staff member and too much reliance on any staff
member should be avoided.
12. Division and allocation of duties among the staff members must provide for an automatic check
by others.
13. It should be carefully devised and properly regulated.

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14. Staff authority should be clearly defined and there should be proper division of responsibility.
15. No employee of the concern should be relied upon too much
16. Proper reporting to the management
17. Safeguards should be prescribed for the safe custody of unusedcheque book, securities etc
18. There should be a self-balancing ledger system.
19. The receipt of cash and disbursement should be entrusted to different personnel.
20. The cashier should have no access to ledger.
21. All remittance received should be deposited in a bank immediately and all payments should
be made by a cheque.
22. Cash and bank balance should be verified frequently. Petty cash payment should be on Imprest
system.
Internal check system and auditor
The soundness of the system of internal check and the way it is put into operation in the
organisation are matter of great importance for the auditor. In case the system of internal check is
effective the work of the external auditor becomes quite easy. He is relieved of the detailed and
routine checking of the transaction as the internal check system takes care of the same. In case the
internal check system is not effective, then the auditor should have to decide the extent of detailed
checking to be undertaken in order to satisfy himself about the authenticity of the business records.
It is, therefore, necessary for the auditor to study the system in force in the organisation; this he
can do by applying few test checks and if the results are satisfactory he can depend on the internal
check system. In case the internal check system in force is weak or defective then he should carry
out detailed checking of the accounting records. In case he does not do so he may be held liable
for all the undetected errors and frauds.
INTERNAL CONTROL
Meaning
Internal control comprises all the measures whereby every aspect of business is controlled. A
businessman wants to control the internal functions of the business in such a way to maximize
profits and reduce to a minimal level the possibilities of errors, frauds, and embezzlement. For
such a situation, the businessman controls each and every aspect of the business in a planned
manner. Such a measure at the organisational level is called internal control. It helps to control all
sorts of business activities, financial as well as administrative.
Internal control is an important tool of management. It assists the management in the performance
of its various functions. It means the built in cross-checks in the system supplemented with proper
supervision and internal audit carried out by the staff appointed by the organisation These days
business has been become more complex both in nature and size and the management finds it
difficult to get correct information about the various aspects of the business. Internal control
assures the management that the information supplied to it is reliable and accurate. The Internal
controls are exercised to ensure the accuracy and the reliability of accounting data and other
records, to identify weaker areas of operation and to improve them to increase operational
efficiency of the business, to safeguard its assets and to ensure orderly conduct of business.
Internal control involves a sort vigilance and directions over important matters like budget and
finance, purchase and sales and internal administration by the management. Every business
enterprise is expected to devise a suitable system of internal control in order to carry on the
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business in an efficient and orderly manner. These controls are accounting control, budgetary
control, statistical analysis and internal checks and internal audit. In simple words, it means
number of checks and controls over the various activities of a business.
Definition
The American Institute of Public Accountants has defined “Internal control is the plan of
organisation and all the co-ordinate methods, and measures adopted within a business to
safeguards its assets, check the accuracy and the reliability of its accounting data, promote
operational efficiency and encourage adherence to prescribed managerial policies.” A system of
internal control extends beyond those matters which relate directly to the function of the
accounting and financial departments.
The Institute of Chartered Accountants of England and Wales defines internal control as
"internal control means not only internal check or internal audit, but the whole system of control
financial and otherwise, established by management in order to carry on the business of the
company in an orderly manner, safeguard its assets and secure as far as possible accuracy and
Every policy, standard procedure, system, rules, plans, introduced with the sole objective of
establishing the control is known as internal control. Internal control is all pervasive and not
confined to accounting system only.
Internal control system is defined as-
“All the policies and procedures (Internal controls) adopted by the management of an entity to
assist in achieving management’s objective of ensuring, as far as practicable, The orderly and
efficient conduct of its business, including adherence to management policies, The safeguarding
of assets, The prevention and detection of fraud and error, The accuracy and completeness of
the accounting records, and the timely preparation of reliable financial information. “
Features of Internal control:
1) It is the overall control adopted by the management. 2) It comprises of plans, methods and
procedures for the effective control of the operations of the business. 3) It comprises of internal
check, internal audit, accounting system and administrative control. 4) It is established by the
management. 5) It intended to help the management to run the business efficiently. Objectives: 1)
To ensure that transactions are recorded proper books of account. 2) See that all transactions are
carried out only on account of a sanction of authority. 3) See that management policies and
decisions are properly implemented. 4) To ensure efficient conduct of business. 5) To evaluate the
efficiency of performance of the various personnel. 6) To safeguard the assets of the organization.
7) To safeguard the interest of the organization. 8) To ensure reliability of accounting records. 9)
To ensure the periodical verification of assets.
Scope or Area of internal control.
1) Accounting Control. It ensures the reliability of accounting transactions. Accounting
transactions are recorded by using accounting principles. Accounting financial controls include
budgetary control, standard cost control, self-balancing ledger, bank reconciliation and internal
checks and internal auditing. Accounting controls deal with the process of recording of
transactions, safeguarding the assets and adherence to prescribed managerial policies

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2) Administrative Control. It is concerned with distribution of authority and decision-making

process of management. Overall operation efficiency of the organization is ensured. The scope of
this control is very wide. They also include accounting controls. Such controls comprise of the
plan of organisation that are concerned mainly with operational efficiencies. In short they may
include anything from plan of organisation to procedures, record keeping, distribution of authority
and the process of decision making
Objectives of internal control
1 To minimize, if not completely eliminate, wastage and inefficiencies in business operations
and to safeguard the assets of the business.
2 To ensure high degree of accuracy and reliability of accounting data and promote operational
efficiency.
3 To measure how far the policies of the management are being implemented, and
4 To evaluate the efficiency of performance in all aspects of business activities and to highlight
the weaknesses.
5 To control all Internal activities with the objective of minimizing errors and preventing frauds.
6 To manage risk that can otherwise adversely affect the operations of the company
7 To ensure that effective communication system exists along various departments.
8 To supervise the entire organizational operations.
Essentials of Good internal Control:
1 A scientific system of authorisation and record procedure should be developed with a view to
provide proper control over assets, liabilities, revenue and expenses of the organization.
2 It should be developed in such a fashion as to ensure that a) assets are under proper custody
and they are not improperly applied, b) expenditures are incurred on getting proper
authorisation and c) revenues received are duly accounted for.
3 A system of healthy practices and traditions should be developed with a view to discharge the
duties and functions of the various departments of the organisation smoothly.
4 It should be clear and well-developed plan of organization.
5 There should be competent and trust worthy personnel for the success of the business.
6 There should be segregation of duties: - Operational duties are separated from recording duties.
Physical handling of asset must be separated from accounting records.
7 There should be administrative traditions and practices for the performance of the duties. There
should be a team of people with sound character and integrity who are properly trained and
capable of discharging their responsibilities.
8 There should be well developed and adequate accounting system.
9 There should be a sound system of maintenance and recording of accounts.
10 There should be effective internal check system. Constant managerial supervision and
periodical review of the system should be introduced with a view to make the system more
efficient and effective
11 There should be good audit system and a periodic review of internal control.
12 There should be a well-developed plan of organization with delegation of proper
responsibilities at various levels of operational hierarchy.
13 The personnel engaged in the business should be of high quality and character with a deep
understanding of their responsibilities and a proper background of training and ability.

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14 There should be managerial supervision and reviews of the company’s financial operation and
positions at regular and frequent intervals
Advantages of Internal Control
A. Advantages to the business.
1) Provide accurate and reliable data to the management for taking correct decisions. 2) Ensure
that policies and procedures are complied with. 3) Promotes operational efficiency. 4) Help to
attain organizational goal. 5) To safeguard the assets of the organization.6) To ensure the reliability
of17
accounting records.
B. Advantages to the auditors
1) Helps the auditor in framing the audit program. 2) To ascertain extent of test check can apply.
Limitations of Internal control 1) Expensive. 2) Transactions of unusual nature may not be subject
to internal control. 3) Human errors remain in any system of control. 4) Limitation of preventing
frauds committed through collusion between persons. 5) It may not be keep pace with the change
in the condition.
Internal control and the Auditor
An auditor is mainly concerned with the evaluation of the internal control system in force so that
he may be able to know :
(i) whether mistakes, errors and frauds are likely to be located in the ordinary course of business.
(ii) Whether an effective internal auditing department exist or not.
(iii) How far and how adequately the management is discharging its function in so far as correct
recording of transaction is concerned.
(iv) How extensive examination he should carry out in different areas of accounting.
(v) How far administrative control has a bearing on his work.
(vi) What should be the appropriate audit programme in existing circumstances.
(vii) To what extent reliability can be placed on the reports, records and the certificates of the
management.
(viii) Whether some suggestion can be given to improve the existing control system. Therefore
we can conclude by saying that internal control is a broad term which includes internal check,
internal audit, and other forms of control.
In case he finds that the internal control system is inadequate, he should then plan to carry out
detailed examination of those areas where the system is weak. It is therefore necessary for the
auditor to acquaint himself fully with the internal control in force and their actual operation. It will
help him in the formulation of his audit program. He may also bring the shortcomings of the
internal control system to the notice of the management.
Distinguish between Internal check and Internal control

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Internal check Internal control

It is a system of allocation of responsibility,It is the system of control established by the

division of work and methods of recording management in order to carry on business in an
transactions, whereby the work of one orderly and efficient manner, ensure adherence
employee is checked continuously by another to management policies, safeguard assets and
completeness of records
It is a part of Internal Control. It includes Internal check and Internal audit.
It is arrangement of book-keeping and Clerical It includes the implementation of Internal
duties. check and Internal audit.
Checks are automatic and continuous. Checks are objective and subjective

INTERNAL AUDIT
Internal audit is the review of operations and records undertaken within a business by specially
assigned staff on a continuous basis. It is clear that internal audit not only includes the verifications
of accounting matters but also financial and other matters.
Internal auditing is the independent appraisal activity within an organisation for the review of the
accounting, financial and other operations as a basis for productive and constructive service to
management. It is conducted by regular employees of a business concern. Internal audit is
described as the verification of the operations within the business by a specially assigned staff. It
is an important tool of management to evaluate the correctness of records on a continuous basis in
an organisation.
The term Internal Audit has been defined as "an independent appraisal of activity” within an
organisation for review of operations as a basis of service to management. It is a managerial control
which functions by measuring and evaluating the effectiveness of other controls.
According to Howard F. Stettler, "Internal auditing is an independent appraisal activity within
an organisation for the review of operations as a service to management.”
The overall objective of internal auditing, therefore, is to assist the management in the effective
discharge of their responsibilities by furnishing them with objective analysis, appraisals,
recommendations and pertinent comments concerning the activities reviewed. In short internal
audit assures the management that the system of internal check and other types of controls are
effective in design and operation.
Internal audit is a thorough examination of the accounting transactions to ensure that-
• The transactions are properly recorded.
• The accounts are maintained systematically and
•There is no possibility for manipulation of accounts or misappropriation of property of the
business.
The internal audit is carried out generally in the same manner as is followed for a professional
audit. However, it varies in form from enterprise to enterprise according to its size and specific
needs. It is installed in large organisation and is carried out by the salaried staff who are qualified

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to conduct professional audit. Being the employee of the organisation he has to ensure that there
is no waste in the organisation.
Internal auditor has to follow the provisions of law, standard auditing practices and procedure
prescribed for professional auditors and by the professional bodies controlling the audit system in
the country. At the same time internal auditor must be aware of the policies and programs of the
enterprise he should be professionally competent to carry out a detailed examination of the
working of the business. Equipped with professional expertise and knowledge of the business, he
will be in a better position to make the internal audit system more effective.
Objectives of Internal Audit
1. To verify the correctness and authenticity of the financial records and statistical records
presented to the management.
2. To ensure that the standard accounting practices are strictly followed in the organization.
3. To facilitate early detection of errors and prevention of frauds.
4. To ensure that all the transactions have been carried out under a proper authority and by
persons authorised for the same in the business.
5. To review the system of internal check from time to time to advice the management on
improvement of the system and to undertake special investigation for the management.
6. To confirm that the liabilities have been incurred by the organisation for legitimate activities.
7. To assure the effectiveness of internal check.
8. To see that all transactions are authorised
9. To facilitate statutory audit
10. To check the safety and proper accounting of assets. To identify the authorities responsible
for purchasing assets and other item as well as disposal of assets.
11. To facilitate improvement in procedures.
12. To examine the protection provided to assets and the uses to which they are put.
Internal auditor should report directly to the top management. He must operate independently of
the accounting and other staff. He must be given an independent status as an important
functionary and a part of the management.
Distinction Between Internal Check and Internal Audit
Internal check Internal audit
is an arrangement of as duties allocated in such internal audit is an independent review of
a way that the work of one clerk is operations and records undertaken by the staff
automatically checked by another specially appointed for the purpose
Different clerks are assigned with various tasks separate salaried staff of internal auditors is
with which they proceed and carry on checking entrusted with the audit work but in internal
at the same time. check, there is no separate staff appointed
especially for this purpose
the work of one clerk is automatically and the work of a clerk is checked by an internal
independently checked by another auditor after the former has finished the work
simultaneously.
system of internal check is so devised that the errors and frauds which have already been
possibilities of errors and frauds are reduced to committed can be discovered
the minimum.

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Internal check is a device wherein fraud is Internal audit discloses frauds when the work
discovered in the course of the work. ends.

Internal check assures whether the accounting Internal audit assures whether both the
system is reliable and effective or not accounting system and internal check the
reliable and effective or not.
Internal check is an operative function Internal Audit is an advisory function.

Limitations of Internal Audit

1. Limited ability - the internal auditor may or may not be a qualified auditor, because of which
his expertise is limited.
2. Lack of Independence- the internal auditor does have complete flexibility in work and has to
follow the rules prescribed by the management.
3. Use of Employees in Miscellaneous Jobs – the same employees might be given responsibility
of accounting and internal auditing
4. Prejudices - personal preferences and bias of the internal auditor can affect the internal audit
report.
Internal audit v/s Statutory audit(External Audit)
Internal audit helps the statutory audit to a large extent. Both the internal auditor and the statutory
auditor have a common interest as far as authenticity of the accounts are concerned. However
soundness of internal audit relieves the statutory auditor from detailed checking. The internal
auditor reviews the operations and performs such functions as evaluation, compliance, verification
and ensures that policies, procedures, rules and other type of controls of the business are carried
out efficiently.
He is helpful to statutory auditor in the matter of examination of books of accounts. Generally, the
statutory auditor accepts some of the detailed checking made by the internal auditor. However, the
area of cooperation between internal auditor and statutory auditor is somewhat limited as the
statutory auditor has a responsibility under law to various authorities, while the internal auditor is
responsible only to the management. The statutory auditor has to carry out his duties in accordance
with standard accounting and auditing practices and provisions of law which govern the
organisation. Before accepting the checking of accounts and other documents carried out by
internal auditor, the statutory auditor must undertake such test checks necessary to find out the
effectiveness of internal audit.
Both internal auditor and statutory auditor carry out examination of records and documents and
make physical and other verifications. Despite these similarities there are differences in the status,
responsibilities, approach and scope of work of internal auditor and statutory auditor.
Differences between Internal audit and Statutory audit-
Internal audit Statutory audit
arrangement within the organisation to verify examination of the books of accounts of the
on continuous basis the correctness and business by an external auditor and to report

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truthfulness of the transactions by the salaried that the profit and loss account and balance
staff sheet are drawn according to provisions of law
and the financial statements reveal the true and
fair view of the results of operations and
financial state of affairs of the business.
Internal audit is not compulsory. Statutory audit is compulsory in case of
business houses incorporated under the
Companies Act and other acts.
Internal audit is carried out by the staff Statutory audit has to be carried out only by
appointed by the business enterprises. It is not those who are qualified for appointment as per
necessary that the internal audit staff should the provision of the Companies Act and other
possess the qualification prescribed for acts.
professional auditor
Being an employee of the organisation internal The rights, duties, responsibilities and
auditor is answerable to the management. His liabilities of auditors are governed by the
duties, responsibilities are given by them. provisions of law. The auditor is independent
of management. The audit work are
determined by the management.
points out irregularities in the procedural The statutory auditor is concerned with the
aspects and suggests ways and means to rectify legality and validity of the transactions of
the same. He assures that the financial business. His audit work is based on the
operations and other types of control in force financial statement prepared by the business.
are carried out in conformity with the
accounting systems.

INTERNAL CHECK SYSTEM IN DIFFERENT BUSINESS TRANSACTION

Internal check of Cash Transactions
(a) Internal check as regards Cash Receipts
1. Cash receipts must be handled only by the cashier.
2. All the receipts of the day should be deposited in the bank at the end of the day or the next
morning.
3. On receiving cash, it should be acknowledged by issuing a printed receipt. This receipt should
have a counterfoil. These receipts should be consecutively numbered.
4. All cash receipts should be kept under lock and key.
5. Automatic bills or cash registers should be used. Receipts should be issued only when money
is deposited.
6. The cashier should prepare the paying-in-slips to be retained by the bank. However, the
counter-foils of the paying-in-slips should be entered by some other clerk and not by the
Cashier.
7. A proper system for recoding Cash sales should be in operation, as to reduce the chances of
misappropriation to the minimum.
8. Proper arrangements have to be made for dealing with recoding and investigation of any cash
shortage or surplus.
9. Bank reconciliation statement should be made by cashier and someone else frequently.

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10. The cashier should not have access to the ledgers, other funds, securities, negotiable
instruments, credit notes etc.
11. All mail remittances should be opened by the cashier in the presence of a responsible person.
12. All cheques and bank drafts received should be marked - ‘Not negotiable A/c Payee only.’
13. All debtors and customers should be requested to make payments by crossed cheques and
should be informed to collect receipts.
14. Castings of cash book should be independently checked.
(b) Internal check as regards Cash payments
1. As far as possible, all payments should be made by cheques authorised by a responsible person
and signed by responsible persons. Cheques should be marked’ A/c Payee only’ before they
are dispatched. Unused cheque books should be kept under lock and key by a responsible
person.
2. Employees authorised to sign or countersign cheques should not have any other duty connected
with cash. Otherwise, it will provide them with opportunity to influence entries in the ledgers.
3. Petty cash should be maintained by petty cashier.
4. Records of petty cash payment should be made in the petty cash book maintained on the
Imprest system
5. For all payments vouchers and other relevant correspondence should be checked.
6. The names, numbers and the status of the person authorised to sign cheques and their authority
must be decided
7. All cheques and bills should be thoroughly scrutinized and signed by the proper authority.
8. Confirmation of accounts with creditors should be made up to date.
9. All voucher must be serially filed
10. A proper system must be adopted for the control of the supply and issue of cheques.
Cash Receipts –
The internal check system in respect of cash-receipts should be so effective that accounting is
done as soon as cash is received and that the due amount is actually received. Cashreceived can be
of three types: (a) Cash receipts by mail, (b) On window, and (c) Cash Sales.
(a) Cash receipts by mail – A responsible employee must be authorised to open the mail containing
Cash, cheque, Bills of exchange, and Draft etc. This work should never be assigned to the cashier.
All such mails should be duly recorded in Mail-Receipt Register and then handed over to the
cashier. All documents must be crossed and the word ‘Not Negotiable’ put in between the lines.
(b) Cash-receipt on window- The cash-receipt clerk must issue cash-receipt-foil duly singed by
authorised person forthwith to the depositor and keep counterfoil with him. After business hours
the cashier must hand over all the counterfoils and the total amount of cash received to the
employee who has the charge of Cash-book. He shall cash entries and put serial number of receipt
against each entry. Now, a third person shall post the entries in the ledger.
Internal check as regard cash sales
The system of internal check to be followed in each case is discussed below.
1) One salesman should be appointed to look after one counter independently and should be made
responsible for sales effected in his counter.

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2) Each salesman must be issued with a separate cash memo book. The cash memo book must be
printed in different colours to identify different counters of the business.
3) Each salesman must maintain a sales sheet. He should record therein the sales effected by him.
The summary of cash sales effected by him must tally with the cash memos issued by him.
4) Cash memos are to be issued with carbon copies.
5) The salesman must not receive cash on the cash memos issued by him.
6) All payments on the cash memo of the salesman must be made by the customer at the cash
counter.
As chances of committing fraud in connection with cash sales are greater, it calls for devising an
efficient and effective system of internal check. Cash sales may be affected in various ways like
a) sale at counter, b) postal sales, i.e. sales under mail order, and c) sales by representative and
agents.
Sales are to be effected in the following manner
1. Three copies of the cash memo must be issued to customer
2. The customer must present the three copies of cash memo to the cashier at the time of making
payment
3. The cashier must verify the particulars and satisfy himself regarding the total payment with
reference to rates and quantity.
4. The cashier on receiving the payment in cash will place a rubber stamp on all the copies of
memos as "cash paid".
5. He will retain one copy with himself and hand over the other two copies to the customer.
6. The customer must present the cash memos to the delivery department to collect the goods
purchased.
7. The delivery department will put rubber stamp on the memos as "goods delivered". It will retain
one copy as an evidence for delivery and hand over another copy of the memo to the customer.
At the end of the day’s working, the sales man, the cashier and the gate keeper should prepare the
summary and submit to the manager or officer incharge. If these summaries tally, the accounts are
certified as correct.
Postal sales i.e. sales under mail order. This includes following aspects:
1) All sales made by post i.e. V.P.P should be recorded in a separate register to be maintained for
the purpose.
2) The goods returned, if any, should also be recorded in the register.
3) The total amount of cash receipts including advance, if any, against the mail orders should be
entered in the register and the same should be deposited into the bank.
4) All the entries in the V.P.P. register should be checked by some responsible officer and special
inquiries should be made in respect of those goods against which cash has not been received.
5) There should be proper filing of mail orders received and the cash book should be checked
with these mail orders.
Sales by representative and agents

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It is the practice in big business houses to employ representative and agent to promote sales and
to collect the amount due from debtors.
The system of internal check to be introduced in this connection should be as follows:
1. The representatives and agents should be authorised to issue rough receipts to the customers
against cash received from them. However, the final receipt should be issued only by the head
office.
2. The customers should be advised to communicate directly with the head office if they do not
get the final receipt within a reasonable time period.
3. The representatives and agents should be instructed to remit the amount of cash collected by
them to the head office without any delay.
4. The representatives and agents must not be allowed under any circumstances to deduct their
commission or any other expenditure from the amount of cash collected by them. The bill for
commission and other expenses should be submitted to the head office.
5. As a matter of routine the head office should send periodical statements of accounts to the
customer with a view to apprise them of the latest position.
6. The representatives and agents should be advised to submit periodical statements to the head
office showing therein the amount of sales made by them, the amount of cash collected by them
and the names of the defaulters.
7. The head office should issue reminders to those defaulting customers who have failed to clear
their dues.
8 The representatives and agents must not be allowed to operate from a fixed place. On the
contrary, they should be transferred from time to time to other place in order to increase their
efficiency and to avoid the possibility of committing fraud.
II Cash Payments:
Frauds are common regarding payment for purchases of goods, sundry expenses, labour-charge
etc. Therefore, satisfactory evidence of each payment must be obtained.
To make effective check on such payments, the system should be divided into the following
divisions:
(i) Passing the payments for purchases
(ii) Preparing cheques for payment
(iii) Examining the cheques,
(iv) Accounting of the payments.
Internal check as regards purchases
Since chances of committing fraud in connection with the purchases of goods by a big business
house are greater, it calls for devising an efficient and effective control system of internal check.
In this connection one should be familiar with the purchases procedure which should be

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1. The department requiring the material should fill in the purchase requisition indicating the
quantity and quality to the purchase department.
2. The purchase department on the basis of the requisition will send out enquiries to the various
suppliers asking for quotation.
3. On receipt of quotations the order will be placed on the best vendor taking into account the
quality, period of delivery, competitive prices etc.
4. On receiving the order the vendor shall execute the order. The supplies will be received by the
stores department.
5. On receipt of goods it will be verified with reference to the order with the goods received
memo issued by the stores department. If the supplies are made according to the order the
delivery note and invoice sent by the supplier will be forwarded to accounts department with
endorsements for the goods received and taken to stores.
6. The invoice will be passed for payment by a senior officer after verifying the terms and
conditions of the supply with reference to rates and quality and other expenses detailed.
The following system of internal check for purchases is suggested
a. All the orders for purchases should be recorded in the Purchases Order Book. They should be
properly authorised. A carbon-copy of every order placed should be kept.
b. On receipt of the goods, the gate-keeper or store-keeper should make a record in the Goods
Inwards Books.
c. Invoices received from the sellers should be checked with the Orders Books and Goods
Inwards Books as to its quality, quantity, prices and calculations. The clerks checking them
should also initial the invoices. After this, invoice should be entered in the Bought Day Book
and filed.
d. In case, there are a number of departments, each placing its order, the invoice should be sent
to the concerned department for checking.
e. Entry for all goods purchased should be made by an independent person in the stores ledger.
f. The payment of every invoice should be authorised by a responsible official.
g. A proper system of internal check for cash purchases should be in operation.
h. As far as possible, cash purchases should be discouraged.
i. All orders for purchase, should be signed only by the purchase manager or the person
authorised for this purpose.
j. The goods received are to be examined with delivery notes and supply invoices of the seller
regarding quantity, quality and rates.
k. The stores department should acknowledge receipt of goods and send the same to the order
department.
l. The Payment on purchases must be made only after accounts department verifies the invoice,
goods received note and purchase order.
m. A separate purchase register is to be maintained by the purchase department
n. Ledger clerk should have no access to physical stock register or cash to avoid manipulation of
accounts.
o. All Purchases that are made by employee for the personal use must be accounted for separately.
p. A separate return outward book is to be maintained to record the return of goods to suppliers.
q. Credit notes are to be issued for adjusting claims. The purchase department should send a copy
of credit note to accounts department.
r. A purchase ledger control account is to be maintained. Ledger account should be checked
periodically against the suppliers statements.

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Internal Check as regards Sales

The organisation of the sales department depends on the system of selling and distribution of
goods. Unless the department is organised properly there are greater possibilities for suppression
of sales and manipulation of accounts. Goods can also be misappropriated.
A good system of internal check is necessary which may be in the following manner::
1) Sales must be executed against order received from customers.
2) All incoming orders shall be numbered and filled and confirmation of the orders received be
sent to the customers.
3) Proper record is to be maintained for the orders received, order under
execution/executed/refused.
4) The sales shall be authorised by responsible officials after scrutiny of the order and assessing
the portion of supply of goods as well as the terms and conditions of sales accepted by the
customer.
5) All sales orders shall contain invoices prepared in quadruplicate. One copy is to be retained by
the sales department, one to be sent to the customer, one to the accounts department and the last
copy to despatch section for despatch of goods.
6) Separate departments should deal with cash sales and credit sales.
7) In the case of credit sales a separate register should be maintained of the customers with
financial standing. The credit sale is to be allowed only after scrutiny of the customer's order for
supply of goods on credit.
8) Periodical statement of the outstanding balance due towards the customer be sent and
confirmation obtained from them.
9) Regular reminders for payment shall be made to the customers reminding them of their dues.
10) Amount due from the customer shall be written off as bad unless all methods of recovery are
exhausted.
11) The responsible official shall be entitled to treat a debt as bad.
12) The sales invoice clerk shall have no access to physical stock or accounting records.
13) The credit note shall be prepared only after ascertaining the fact from the despatch section and
the sales department for the goods received back from the customers. Credit notes are to be
prepared in quadruplicate. One is to be retained with the invoice department, second copy is to be
sent to despatch department, third copy to the sales department and fourth copy to the customer.
14) In case sales are cancelled, a notice is to be given to the despatch department to stop despatch
of goods.
15) The invoice can be cancelled only by the sales department. All sales invoices must be printed
and numbered in serial order.
16) The sales ledger shall be maintained by a separate clerk.

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17) Periodical statements should be sent to debtors.

18) In the case of credit sales regular confirmation should be obtained from the customers
regarding the outstanding balances. The confirmation of balances must be verified by a senior
person other than the ledger clerk.
19) A sales ledger control account shall be balanced with the control account periodically.
20) A sales ledger control account in the general ledger shall be maintained.
21) Credit to employees can be allowed only after proper authorization from the management.
22) Separate department should be set up to deal with sales on consignment, hire purchase, goods
on sales or return etc.
23) The stock held by the agents should be verified periodically with the statements received from
the agents.
24) The goods sent on sale or return basis but unsold on the date of the balance sheet should not
be treated as sales but unsold stock.
Internal Check as regards Wage Payment
In big organization, the work regarding the maintenance of various type of wage records,
computing the amount of wages and the payment of wages to the right persons are of significant
importance. It is, therefore, necessary to design a proper system of internal check regarding wages
payment to minimize the dangers of fictitious names, errors in wages records and misappropriation
of money. The following system of internal check is suggested:
1) Workers should be employed only after the written order of the Personnel Officer or the
appointing authority. A copy of the appointment order be endorsed to the wage preparing section.
2) Separate staff should record attendance of workers, control of leave, payment of overtime and
disbursement of pay packets. Each staff member shall be responsible to enter relevant information
in the wage sheet. He should also put initials for the work completed by him.
3) The wage sheet shall contain columns for recording relevant information with regard to
payment of wages such as name of the employee, designation, period for which wages are paid,
rate of pay, amount of basic pay, dearness allowance, house rent allowance, compensatory
allowance and other allowance, gross salary drawn, deductions (there should be separate columns
indicating the nature of deductions) and net amount payable and signature of employees, for
acknowledging the payment.
4) Separate records should be maintained for each worker indicating the date of appointment,
scale of pay, rate of pay, etc. Copies of orders relating to increase in pay, promotions and
punishments, deduction in wages on account of Provident Fund, Loan, Medical, Ground Insurance
etc. shall be endorsed to wage preparing section.
5) Separate job cards are to be maintained for recording the work performed by the worker.
6) Each worker is to be given a pay slip indicating the gross wages and net wages.

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7) Separate register is to be maintained for recording the name of workers who may be allowed
to work overtime. No worker shall be allowed to work overtime without the prior sanction of the
proper authority.
8) Time recording clocks shall be installed at the main gate of the factory for recording the arrival
and departure of workers.
9) The rosters of workers for each work should be prepared and copy of the same be sent to the
wage preparing section.
10) Late arrival of workers shall be entered in a separate register and the same be sent to the
personnel section for future reference.
11) Proper watch and ward arrangement is to be maintained to record the arrival of the workers
and the time of leaving the factory.
12) The rate of wages of each worker is to be periodically checked with reference to rate card.
13) All calculations regarding gross wages and net wages payable after deduction are to be
checked by an independent person.
14) In the wage sheet the names of workers, rates of pay, the period for wage to be paid shall be
entered by one person. The calculations regarding gross wages payable shall be made by another
person. The deductions under various heads shall be made by a third person. The net wages payable
and the checking of the wages sheet with reference to leave deductions etc. should be made by a
senior staff member. The wages sheet shall be signed by the authorised official.
15) If the wages are to be paid on the basis of piece wage system, the actual work done by each
worker must be maintained on a job card to be given to each worker. These cards should be counter
signed by the foreman of the department and the store department to which the goods produced
are delivered.
16) The wage sheet shall be prepared in triplicate. One copy shall be endorsed to pay master, the
second copy to the account section and final copy shall be retained by the wage preparing section.
Any system of internal check as regards wages much counteract the following dangers
(i) Inadequate time records. This may result in the workers receiving wages for time not devoted.
(ii) Inadequate piece work records. This will result in workers receiving wages for work not done.
(iii) Errors in preparation of wage-sheets or pay rolls,
(iv) Manipulation of wage sheet by inserting dummies.
The system of internal check to be suggested will vary according to each particular case. However,
to counter-act the above dangers, the following system of internal check is suggested :
1. Time Records : Where the wages are to be paid according to the time basis, the times of
employees entering and leaving the work should be recorded. This may be done either by a
gatekeeper or time recording clock. Further, the foreman of each department should take the time
of entering and leaving the department. This will not only act as a counter-check on the original
records but also as a deterrent to wasting to times by the workers.

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2. Piece work records : Where wages are paid on piece-wages basis, an efficient system of
recording piece work is essential. When the work is given, it should be entered in the concerned
piece worker’s card. On completion, this card should be signed by the worker and foreman. Where
necessary, it should be signed by the store-keeper.
3. Preparation of wage-sheets : Separate wage-sheets should be used for time workers and piece
workers. They should be ruled to record all the essential particulars. Special columns should be
provided for the gross amount payable, deductions for employees, state insurance, provident fund
contribution, loans, fines etc. and the net amount payable. Columns should also be provided
showing the employers’ contribution under the Employees State Insurance Act. For time workers,
the gate-keepers records and departmental time records should be compared by two clerks in the
wage office. Discrepancy, if any, should be enquired into. A third clerks should record on the
wages sheet, the name of the employees, rate of wages and other particulars. These entries should
be checked by another clerk. Net amount payable to each worker should be calculated by another
clerk. Similarly, wage sheets should be prepared for the piece workers following the above
procedure. It should be remembered that each wage clerk should initial for that portion of work
connected with wage sheet undertaken by him. All the wage sheets should be counter signed by
the Works Manager, a Director or a Partner.
4. Payment of wages : Wages should be paid by Cashier. The cashier should not have any hand in
the preparation of wage sheets. A separate cheque should be drawn for the precise amount of the
wages. The workers should attend personally to receive their wages in the presence of their
foreman to avoid impersonation. Wages of the absentees should be paid to a worker only when he
has brought letter of authority. The Works Manager or some responsible officer should be present
at the time of payment.
Purchases Returns and Internal Check
As goods received are sometimes not in agreement with the order for goods or they get broken in
transit, then it becomes imperative to return such goods. In this case, the internal check system
shall take the following form:
1. Intimation by Stores for Purchases Return
2. Action by Purchase Department to Return Goods
3. Action by Accounts Department- The Accounts Department must check the said Advice-Note
with the invoice and Goods-Received-Note received from Store-keeper. After a complete inquiry
the Accounts Department must prepare a Debit Note and record it in the Purchase-Return Book.
4. Return of Goods – As soon as a Debit Note is received by the Purchase Department, action must
be initiated to return the goods accordingly. The purchase Department must issue instructions to
the Stores Clerk to pack the returnable goods and the same must be recorded in Goods Outward
Book kept at the gate.
Internal check and Credit Sales
The object of internal check should be to counteract the above.
1. All orders received should be recorded properly and in writing. Orders received on telephone or
verbally should be confirmed in writing.

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2. All goods supplied should be recorded in the Goods Outward Book.

3. Invoice should be prepared in duplicate - one copy sent to the customer and other carbon copy
should be kept. Details of every invoice should be checked before sent out. Entries in Goods
Outwards Book should be compared with invoices.
4. Entries should be made in the sales Book on the basis of invoices.
5. Goods returned by the customer should be entered in the returns inwards book and a credit note
be prepared.
6. In case of cash sales, cash should be received by a person other than salesman. Goods should be
delivered on the basis of the receipt cash memo.
Internal Check and Auditor
1. Seek a statement from his client in this regard.
2. Examine the system taking into account the size and nature of the business.
3. Examine the system especially from its weakest point to assess the possibilities of errors and
frauds. If the auditor finds that the system of internal check is defective, he should carry on detailed
checking. An efficient system of internal check can reduce to a great extent the work of the auditor
but does not reduce his liability. On the other hand, a defective system makes his work difficult
Difference between Internal Check, Internal Control and Internal Audit
Internal Check Internal Audit Internal Control
Meaning It is an arrangement of It is a review of It is a plan of the
duties in such a operational and organisation to safe
manner that work of records by a special guard its assets, check
one employee is staff accuracy and
checked by the work reliability of its
of another employee accounting data.
Scope Internal check is Scope of internal Scope of internal
exercised when the audit is less than that control is very wide. it
work of employee is of internal control includes internal
in progress. wider than internal check and internal
check. It is audit. The objective
undertaken by the is to safeguard the
internal auditor after asset of enterprise.
the accounting work
has been completed.
Objective To prevent errors and To review the To promote
frauds operations and operational efficiency
records of the
organization,to assure
to management that
the system of internal
control and internal
checkare effective.
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Requirement Any organization can adopted only those Any organization can
adopt internal check. concerns which really adopt internal control
need it
Relationship It is automatic and Checking is done by implementation of
continuous internal auditor internal checks and
internal audit.
Nature of checks It is objective It is subjective Objective and
Subjective Checking
Scope for Suggestions There is no scope for There is a scope for There is a scope for
suggestions suggestions suggestions-internal
check/ internal audit.
System Review of accounting Continuous review of It is the whole system
work under which the records by staff of control established
work of one person appointed for the by management
comes under another. purpose.

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