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Internal controls are an important yet challenging part of any organization. In a survey from the Association of Chartered Certified Accountants:
Focusing on the five components of internal controls can help. While internal controls ensure good governance, the internal control components provide a framework for the accounting system. Both accountants and audit teams should incorporate these components when they design and review the accounting system.
The five components of internal controls are:
The control environment refers to the overall culture of compliance. In other words, it’s how both executives and employees buy into internal controls. The more seriously the organization views internal controls, the stronger the system will be.
If executive and management teams disregard existing controls, employees will likely follow suit. Over time, this can create vulnerabilities across the system. Compliance can also happen from the bottom up since audit teams can use their data to make a business case for cyber risk management.
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To effectively manage risk, organizations need to identify their potential risks, then implement internal controls to mitigate them. Accounting teams should have an always-on approach to monitoring since new risks can surface without warning. The teams should then deliver audit reports to the board to surface any new risks.
This is especially important if a business’s products or services frequently evolve since changes in the organization’s infrastructure will also impact its system of internal controls.
'Control activities' means ensuring that the proper controls are in place and using accounting systems and automation to verify that controls are functioning as intended. This can include regular controls testing or inventory audits, all of which should follow an internal audit strategy.
Knowledge is power. Communicating with management about any lapses in internal controls is the best way to mitigate risks quickly. Though audit teams likely have hundreds or even thousands of data points, taking a proactive approach to enterprise risk management is essential.
Audit teams can likely tackle minor breaches independently, but they should inform executives of any major vulnerabilities. Communicate precisely the information the person needs to know, whether that’s a well-versed Chief Audit Executive or a board member who’s more of a layperson in the components of internal controls.
Audit teams should monitor internal controls on an ongoing basis. Doing so ensures that they’ll be able to identify when internal controls are functioning properly and when there are potential lapses in the internal controls system.
That’s what makes this one of the key components of internal controls, since monitoring is how teams identify failures and make improvements. Without monitoring, vulnerabilities may go unchecked, turning minor issues into major breaches.
The five components of internal controls may seem like they’re the business of only the accounting and audit teams. In reality, every member of an organization should understand and support the internal controls system. Without internal controls and the teams supporting them, organizations could face major breaches, compromising their reputation and bottom line.
Understanding the components of internal control opens up an opportunity to future-proof internal audit. Audit teams can prove the internal audit function's value through the internal controls system. They can automate processes, analyze data and deliver insights, all of which can make them an invaluable strategic partner to the board.
Download Diligent’s checklist for optimizing internal audit efficiency and impact for five practical steps to centralize processes, automate workflows, and deliver meaningful insights to leadership.
The control environment is the overall culture of compliance — how seriously leadership and employees take internal controls. Control activities are the specific actions, like approvals and reconciliations, used to carry out those controls day to day. In short: the control environment is the mindset, control activities are the mechanics.
The five components function as one interdependent system: the control environment sets the tone, risk assessment identifies what needs safeguarding, control activities put safeguards into practice, information and communication keeps people informed of issues, and monitoring checks that everything still works. Weakening one component weakens the others' effectiveness too.
No single component is "most important" — they're designed to reinforce each other. The control environment is often considered foundational, since a weak compliance culture undermines how well the other four components are followed, even if they're well designed on paper.
These five components come from the COSO internal control framework, the widely-used standard published by the Committee of Sponsoring Organizations of the Treadway Commission.
Implementation typically starts with assessing your current control environment and risks, then builds out control activities, communication channels, and monitoring routines through a phased approach, like the one in Diligent’s 7-step process to master the implementation of controls.
Yes — AI-powered continuous risk monitoring can evaluate control activities on an ongoing basis and flag anomalies in real time, replacing periodic manual checks with always-on oversight.
Ready to go further? Download Diligent's internal audit infrastructure checklist for five practical steps to centralize processes, automate workflows, and deliver meaningful insights to leadership.
