Page 421 - Introduction to Business

CHAPTER 11 Accounting for Decision Making 395

Internal Control

LEARNING OBJECTIVE 6
Explain the importance of internal controls.
A few generations ago, most businesses were owned and operated by one person.
Under that form of business, the control structure was very simple. The owner-
operator maintained firsthand knowledge of all aspects of the business. In other
words, he or she kept an eye on things so that nothing was stolen or lost. Today
the dominant form of business is the corporation, in which the owners, that is,
the stockholders, rely on professional managers to operate the firm. Professional
managers rely on the accounting information system to supply them with the
financial information they need to make effective decisions. To ensure the accuracy
and reliability of this information, a system of internal controls is established. internal controls A system of rules and
Internal controls prevent dishonest persons from doing wrong, but just as procedures designed to ensure the
accuracy and reliability of financial and
importantly, prevent honest persons from being the subject of suspicion and accounting information
false accusation.

Types of Controls
The internal control structure is designed to prevent errors, or unintentional mis- internal control structure A set of
representations, and irregularities, or intentional misrepresentations, from occur- devices and procedures designed to
prevent unintentional errors and
ring and to identify errors and irregularities after they occur so that corrective
intentional irregularities from occurring
action may be taken. Thus, controls can be categorized as preventive controls or as and to identify errors and irregularities
feedback controls. Both categories of accounting controls are essential in a com- after they occur so that corrective
action may be taken
pany’s control structure.
Preventive controls are a type of internal control whose purpose it is to pre- preventive controls A type of internal
vent mistakes or intentional misrepresentations from occurring in the accounting control whose purpose it is to prevent
mistakes or intentional
data. Segregation of related organizational functions, or separation of duties, is an
misrepresentations from occurring in
example of a preventive control. This control involves assigning the tasks related the accounting data

Bottled milk is inspected by a factory worker of food company Parmalat Calisto Tanzi, located in
Collecchio, Italy. In 2004, Italian prosecutors investigated a multibillion-euro fraud at the company.

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