Accounting controls are methods and procedures that prevent, detect, and correct misstatements that occur within the financial accounting process until the formation of the financial statements. They are one type of a larger set of internal controls that every business should follow. When we talk about accounting controls, we’re referring to controls within the accounting cycle, such as preparing journal entries, posting in the general ledger, and gathering source documents.
In this article, “misstatement” can mean either fraud or error. Fraud is an intentional misstatement with an attempt to conceal its existence, whereas error is unintentional.
We’ll discuss the specific preventive, detective, and corrective controls for the accounting department with a small business setup in mind.
1. Preventive Controls
A preventive accounting control prevents a misstatement from entering the accounting system. It’s the first line of defense, and misstatements spotted here are considered before the fact. An effective preventive control can spot misstated transactions easily at input level. Below are the four common preventive controls:
2. Detective Controls
A detective accounting control uncovers misstatements that have entered the accounting system. These misstatements are considered after the fact, and it’s up to the company’s detective controls to spot where these misstatements lie. Detective controls are your business’ second line of defense because they prevent misstatements that slipped through the preventive controls.
3. Corrective Controls
Corrective accounting controls are directives that aim to resolve weaknesses in preventive and detective controls and correct misstatements. Corrective controls aren’t common in the accounting department since improvements in preventive and detective controls can resolve weaknesses in accounting controls. But for the sake of explaining this concept, here are some examples of corrective controls:
- Updating the accounting manual of the business to modify or correct processes that are susceptible to fraud or error
- Updating the accounting software regularly to solve software errors in the old version; if you’re using QuickBooks Online, you don’t have to worry about this because web-based accounting software is always updated
- Releasing memorandums to instruct accounting employees for minor updates and remedies
- Subjecting poorly performing accounting staff to appropriate disciplinary action in worse cases
Role of Compensating Controls in a Small Business Setup
A compensating control is an alternative control put in place to satisfy the requirements of a good internal control system when traditional controls are impossible. It exists in small businesses because it’s often impractical to follow optimal controls when there are only a few employees (fewer than 10) handling administrative and accounting functions.
This limitation makes it difficult to comply with the segregation of incompatible duties because it’s possible that one or two employees might handle several custody, authorizations, and recording functions. In small business bookkeeping, the owner might only hire one to two accounting staff to record daily transactions, reconcile customer or vendor accounts, or even handle assets.
Due to the limitation, compensating controls must be in place to solve any deficiencies. For small businesses, the best compensating control is the participation of the small business owner in the accounting process. The owner must take an active role by supervising and monitoring accounting activities, and they may delegate minor tasks to managers or supervisors to filter out issues that are material to the small business.
Accounting controls are necessary, even for a small business. They help owners monitor business transactions and ensure that every transaction has been properly recorded in the books. Without controls, you risk your business losing assets or having unreliable financial information that could lead to over or underpaying taxes.