Internal controls implementation results in various benefits such as mitigation of risks, minimization of effects of incidents, and the identification of fraud. However, cost of control must also be considered when planning to design and implement control. This article elaborates on ‘Benefits and Costs of Internal Controls’.
It is necessary because in various risk situations, having controls can cost more than the benefits to be achieved from implementation.
Let’s discuss certain benefits of having internal controls.
Internal control provides many benefits to the organization, and it provides the board and management with greater confidence regarding the achievement of business goals and objectives. It provides feedback on how a business is functioning, and internal controls help reduce surprises.
Increasing revenue and reducing leakages
Among the most significant benefits of effective internal control is the ability of the organization to increase revenue and reduce income leakages. All these benefits contribute to the maximization of the wealth of shareholders. Other benefits of internal controls include timely and reliable financial reporting, better terms with creditors, availability of capital from investors, and achieving compliance with regulatory requirements and other third parties’ agreements.
An effective internal control system improves the overall accounts and financial reporting processes, which in turn enhances shareholders’ confidence.
Other benefits of an effective internal control system
- Reliable financial reports that support the board and management and help them take the right decisions on matters such as business development, assets acquisitions, product pricing, undertaking capital projects, and deployment of human resources;
- Consistency in processing transactions, information communications across the organization, reliability at which transactions are settled, reliable financial records, and ongoing data checks;
- Increased efficiency of operations and business processes;
- Availability of basis to the management for taking appropriate decisions and planning a roadmap; and
- The ability of management to accurately communicate business and operations performance to the relevant stakeholders such as vendors and suppliers of the organization.
Organizations develop limitations on their human and capital resources and constraints on how much they can spend. Therefore, they will often consider the costs relative to the benefits of alternative approaches in managing internal control options.
Usually, it is easier to deal with the cost part in the cost-benefit calculation because in most cases financial costs can be quantified exactly.
Considerations on implementing internal controls
All direct costs associated with implementing the internal controls plus indirect overheads are practically measurable and considered for developing and implementing internal controls. Some organizations also consider the impact of opportunity costs associated with the use of internal controls.
Overall, the board and management consider various cost factors and compare these with expected benefits to be received from the implementation of internal controls. These factors may include:
- Considering the trade-offs between employing and retaining skilled staff and the associated higher compensation costs (for instance, a small organization may not want to, hire an expensive chief financial officer to run the finance department) and
- Understanding how changes in information requirements may call for greater data collection and its storage which could lead to huge data volume
Cost on large organizations
With large organizations, more data and information are available, which causes organizations to face more challenges in terms of management of inherent risks and identification of new risks. Due to such large data and information flow within the organization, management takes measures to identify the flow pattern and devise internal controls to track the key points of stages where risks arise.
For example, an organization’s customer information is commonly a highly sensitive asset that must be appropriately protected. Therefore, organizations often build access rights controls over system data where information is stored. Building such access rights controls incurs costs in terms of software and human resource to manage the software.
However, the benefits for the organization from securing customers’ information is much larger than the costs. In cases where customers’ information is not secured, regulators might impose significant penalties on these organizations, which can lead to critical financial losses.
To avoid financial risks and reputational risks, organizations develop and implement those controls where sensitive customers’ information is to be protected from hackers’ attacks or misused by the employees of the organization.
It is one of the core responsibilities of management to identify those critical processes and information flow points where implementation of strong controls is much needed and the cost of not attending to the risks is much larger than the cost of building and implementing strong controls.
Similarly, management is required to identify those processes and information points where risks are not material but need to be attended to. For such processes, management needs to develop the controls where the desired purpose of management of the risks is achieved.
Not issuing payment reminders to the customers after, for example, 90 days is an important control but to do this, management needs to design a control where the cost of a control should be much less than the benefits of control. Here, depending on the size of the organization, management may hire one or two employees to issue reminders and make calls to those customers who have account balances overdue for more than 90 days.
The implementation of Internal Controls provide benefits such as mitigation of risks, minimization of effects of incidents, and the identification of fraud. It also come with costs and this article elaborates on ‘Benefits and Costs of Internal Controls’.