How To Identify Internal Control WeaknessesPublished October 15, 2020 by Thea Garcia • 6 min read
A company’s employees, shareholders, senior management, and board of directors expect it to conduct business reliably, efficiently, and securely—especially its financial transactions.
An internal control weakness is a failure in the implementation or effectiveness of your internal controls. Bad actors can take advantage of weak internal controls to evade even the strongest security measures.
The wide range of internal controls, numerous new technologies, and the increasing spread of malware make it crucial that you monitor your internal controls. Doing so lets you test the effectiveness of your controls and strengthen internal control deficiencies before malicious actors can exploit them.
What Are Internal Controls?
Internal controls are the rules, mechanisms, and procedures you use to safeguard your financial information, promote accountability, and prevent and detect fraud. Internal controls help you comply with laws and regulations and are key to fraud prevention and asset security.
In addition, internal controls can help your company operate more efficiently by ensuring your financial reporting is accurate and timely.
It’s important that you implement data security controls to protect your data from all types of cyberattacks. These controls help you detect threats early, then neutralize them to protect all your data storage resources from attacks. You must implement data security controls to protect your financial reports, as section 404 of the Sarbanes-Oxley Act of 2002 (SOX) mandates.
Internal controls have become a key business function for every U.S. company since the accounting scandals of the early 2000s. Congress enacted SOX after those scandals to protect investors from fraudulent accounting practices and boost the accuracy and reliability of companies’ corporate information.
SOX holds managers liable for faulty or false financial reporting and requires them to maintain strong internal controls as well as the documentation needed to prove compliance.
Occasionally, your company’s system may fail to implement its internal controls effectively. This is an internal control weakness. At this point, hackers can use this opening to destroy your company. However, you can stop this with the help of regular security check-ups, which help you more rapidly identify malware. A good governance, risk management, and compliance software can do a lot of the work of monitoring, measuring, and filling gaps, often automatically.
There are three types of internal controls: detective, preventative, and corrective.
Preventive, Detective, Corrective
Internal controls include authorization, documentation, reconciliation, security, and the segregation of duties. And they are generally divided into three categories: preventive, detective, and corrective controls.
- Preventive controls aim to prevent errors or fraud and include thorough documentation and authorization practices. For example, segregation of duties ensures that no one person is in a position to authorize, record, and maintain a financial transaction and its corresponding asset. Verifying expenses and authorizing invoices are preventive internal controls, as is limiting physical access to equipment, inventory, cash, and other assets.
- Detective controls are monitoring or backup procedures that aim to uncover events or items that preventive controls might have missed. Detective controls provide evidence that a loss has occurred but they don’t prevent a loss from happening. Reviews, analyses, and inventory are all detective controls.
- Corrective controls are usually implemented after detective controls uncover an issue. Examples of these controls include disciplinary action, software patches or modifications, and new policies that prohibit certain practices.
Four Major Internal Control Weaknesses
There are four major internal control weaknesses that put your data at risk:
- Technical control weaknesses
- Operational control weaknesses
- Administrative control weakness
- Architectural control weaknesses
1. Technical control weaknesses
Technical security control focuses on hardware and software. Weaknesses in your technical control framework typically stem from changes you’ve made in your technology or failures in the way the software and/or hardware have been configured and maintained.
2. Operational control weaknesses
Operational control weaknesses often result from human error. Your company’s operational controls become weakened when the people who conduct operations don’t follow the policies and standards that you’ve put in place.
Incident response is an operational control that needs to be handled as soon as possible. The sooner you respond to an incident the better the chance of lessening its impact on your organization. The longer it takes you to respond, the less effective that response will be.
3. Administrative control weaknesses
Administrative security controls, which are also called procedural controls, are procedures and policies put into place to help your employees deal with your company’s sensitive information. These controls let people know how the business is to be run and how they are to conduct day-to-day operations.
For example, a regularly-scheduled backup routine is an administrative control related to disaster recovery. If you don’t test the integrity and viability of backups, you expose your organization to the risk of media degradation, which can negatively affect your ability to recover your data after a catastrophic event, such as a natural disaster, or human error.
4. Architectural control weaknesses
Security architecture typically entails creating an integrated framework that highlights and addresses risks in your company’s IT environment. These weaknesses can damage your overall security structure.
An unplanned hardware replacement is at high risk for architectural control weakness because employees often try to get around the normal change management process, which may mean the hardware wasn’t configured properly and result in other implementation issues.
How To Identify Internal Control Weaknesses
Here are the steps to help you identify internal control weaknesses:
- Catalog internal control procedures
- Conduct a risk assessment
- Conduct an internal audit
- Train and educate staff
- Conduct regular inspections
- Look at the feedback from customers and stakeholders
- Examine departmental reports
Catalog internal control procedures
This includes documenting financial transactions, product design and testing, purchasing procedures, and internal auditing. You have to know exactly what you’re dealing with before you continue to inspect the procedures.
Try to determine which parts of your company may be at more risk than others. In addition, assess the design of your controls, which includes documentation, the segregation of duties, feedback, and training.
Conduct a risk assessment
You should conduct a risk assessment for all your internal control procedures. Identify the most probable failures in your company. A risk assessment is usually done in the form of a table, with each new risk put into a row.
When you examine each risk, add columns to indicate what could go wrong, why it could go wrong, who is in charge of that particular process, who inspected it, solutions, and when the responsible person took action.
Conduct an internal audit
This includes cash reconciliation, accounts payable and your stock and asset inventories. Cash reconciliation means ensuring that the amount of liquid cash your organization owns is accurate when compared to its income and expenditures.
When you audit accounts payable, you have to check that all payments are going to the correct individuals or companies, cross-referencing those payments against all financial statements both internal, i.e., your accounts department, and external, i.e., banks.
Train and educate staff
It’s important to educate your employees about modern internal control processes and methods as internal controls are constantly evolving. Notify your staff members about any changes and ensure you train them regularly. Employees’ lack of knowledge and training is one of the main reasons for internal control failures.
Conduct regular inspections
You also need to monitor your internal control staff. Risk assessments are usually created by the individuals doing the internal control. That’s why it’s important to monitor these individuals or conduct external inspections. Automated internal audits using software such as ZenGRC are a great way to check your controls objectively in real-time.
During an external inspection, a third party can identify possible weaknesses your internal control staff may have missed. An outside auditing company usually performs such external inspections.
Look at the feedback from customers and stakeholders
Examine feedback from your customers and stakeholders to determine if they have any common complaints, such as breaches of internal control. For example, if customers identify the same product failure, such as a button that’s not working properly, you can work backward through your organization’s procedures to uncover the issue.
Examine departmental reports
Check to see if there are any areas of your company that are becoming worse or aren’t improving as expected. These issues may be caused by other factors but they may also signal some type of internal control failure.
Although each of your departments can control and monitor what it does, you have to ensure that the departmental reports are tied together to reflect your organization in its entirety. Check whether each department has a strong enough method for your employees to report internal control weaknesses
How Risk Management Supports Internal Controls
The core values of governance, risk, and compliance focus on defining risks so that your organization can comply with standards or regulations, while continuously monitoring the processes to make certain that they work. Effective corporate risk management involves creating a structure to support the procedures that protect your resources and assets.
Risk management is an ongoing process. You have to ensure that the internal controls you’ve implemented continue to evolve as the threat landscape evolves because bad actors are continually modifying their methods. For effective internal control, you need to conduct periodic risk assessments throughout the lifecycle of your information systems.
Continuous monitoring includes machine learning tools to provide real-time insights into new vulnerabilities and threats that could wreak havoc with your information systems. Although malicious actors regularly modify malware and ransomware to avoid detection, continuous monitoring will let you more rapidly respond to these threats.
To ensure you’re monitoring your internal controls effectively, you have to integrate internal audit and ongoing activities to ensure that you’ve embedded safeguards within your day-to-day operations. Integrating these detectives, preventive and corrective measures helps your internal analysts review the effectiveness of your internal controls.