Internal control over financial reporting: Overview, definition, and example
What is internal control over financial reporting?
Internal control over financial reporting (ICFR) refers to a set of procedures, processes, and policies designed to ensure the accuracy, reliability, and transparency of financial statements and reports. The purpose of ICFR is to prevent errors, fraud, and misstatements in financial reporting by establishing a system of checks and balances within an organization. These controls are particularly important in large companies and publicly traded organizations, where accurate financial reporting is crucial for regulatory compliance, decision-making, and maintaining investor trust.
Internal controls over financial reporting typically involve processes such as verifying the accuracy of financial data, ensuring the proper approval of transactions, safeguarding assets, and monitoring compliance with accounting standards and legal requirements.
Why is internal control over financial reporting important?
ICFR is important because it helps ensure the integrity and reliability of an organization’s financial reporting process. Effective internal controls reduce the risk of material misstatements or fraudulent activity in financial reports, which could lead to significant legal, financial, or reputational harm. For publicly traded companies, internal control over financial reporting is also required by law, particularly under the Sarbanes-Oxley Act in the United States, which mandates that companies disclose their internal control procedures and assess their effectiveness annually.
For organizations, strong ICFR helps build trust with stakeholders, including investors, regulators, and the public, by ensuring that financial reports reflect an accurate and truthful picture of the company's financial health. It also reduces the likelihood of costly errors and legal consequences that can arise from inaccurate financial reporting.
Understanding internal control over financial reporting through an example
Imagine a company that implements internal controls over its financial reporting by requiring two separate approvals for every significant financial transaction. Before any expenditure is recorded in the company’s financial statements, both the department head and the finance team must verify and approve it. Additionally, all financial statements are reviewed by an internal audit team before being published. These processes ensure that the company’s financial records are accurate and comply with accounting standards, minimizing the risk of errors or fraud.
In another example, a publicly traded company hires an external auditor to evaluate its internal controls over financial reporting as part of its annual financial statement audit. The auditor reviews the company’s processes, assesses the effectiveness of its controls, and ensures that the company is adhering to the required accounting principles. This audit helps assure investors that the company’s financial reports are accurate and reliable.
An example of an internal control over financial reporting clause
Here’s how an internal control over financial reporting clause might look in a corporate governance policy:
“The Company shall maintain internal control systems designed to ensure the accuracy and reliability of its financial reporting. These controls will include procedures for the authorization of financial transactions, regular reconciliation of accounts, and periodic reviews of financial statements by internal auditors. The Company’s management is responsible for assessing the effectiveness of these controls on an annual basis and reporting on their adequacy in compliance with applicable regulatory requirements.”
Conclusion
Internal control over financial reporting is a critical framework for ensuring that a company’s financial statements are accurate, reliable, and compliant with accounting standards. Strong ICFR helps protect the organization from fraud, errors, and regulatory non-compliance while building confidence among investors and other stakeholders. Effective internal controls also contribute to sound decision-making, the protection of company assets, and the overall financial health of the organization. For businesses, establishing and maintaining robust internal controls over financial reporting is both a legal obligation and a best practice for maintaining financial integrity.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.