- Inherent limitations of an internal control system
The question that always arises in regard to the internal control system is whether such a system could be deemed to be 100% effective.
No internal control system, however elaborate, can by itself guarantee efficient administration and completeness and accuracy of the records nor can it be proof against fraudulent collusion, especially on the part of those holding positions of authority and trust. This implies that there are certain factors that could undermine the effective operation of an internal control system, some of which could be outside the control of management.
This is mainly due to the following inherent limitations of an internal control system:
- Management has to ensure that the benefits expected from an internal control system outweigh the costs. As a result certain important controls might not be put in place due to the costs involved. E.g. a small entity might not have the resources to employ sufficient staff to ensure proper segregation of duties.
- Most internal controls tend to be directed towards routine transactions rather than non-routine transactions. This leaves gaps that can be exploited because the non-routine transactions will not be subjected to appropriate controls.
Human error due to carelessness, distraction, mistakes of judgment and misunderstanding instructions could undermine the effectives of the internal control system.
- A member of management or an employee could circumvent controls through collusion with persons outside or inside the entity. E.g. where duties are segregated the employees could collude to perpetrate and conceal a fraud. Such collusion will render the segregation of duties ineffective.
- Abuse of responsibility e.g. a member of management overriding an internal control
- The possibility that procedures maybe inadequate due to changes in conditions