Controls are required for entities and organizations to protect assets and mitigate risks. These are very important because they determine the efficiency and efficacy of the entity’s operations. Furthermore, internal controls play an important role in an entity’s financial reporting processes.
Therefore, controls are put in place by most entities with the expectation that they will prevent, detect, or correct misstatements, errors, or even fraud.
However, these safeguards may not always be adequate or useful. The presence of these insufficiencies in controls can become harmful to the entity. Such problems may manifest as a control deficiency or a control weakness. For all these reasons, establishing a good internal control system is critical for businesses.
However, before delving into these, it is critical to understand what internal controls are.
What are Internal Controls?
Internal controls are a collection of systems, policies, procedures, and processes used by entities to prevent, detect, and correct risks.
These processes and procedures, when combined, ensure that the company’s assets are safeguarded against certain risks and threats. On the other hand, they also help guarantee that the entity’s financial reporting processes are efficient and free of material errors.
Internal controls are important for entities because they can affect the efficacy and efficiency of an entity’s operations. It also assists entities in ensuring that they have all the essential policies, processes, and procedures to comply with all relevant laws and regulations.
Internal controls, in a nutshell, are all of the procedures and processes that entities employ to manage risks.
Differences between Control Deficiency and Control Weakness
1) They are two different types of problems for the entities.
When an entity uses internal control systems for certain areas, these controls are ineffective, which is referred to as a control deficiency.
Based on ISA 265, a control deficiency occurs when the control that the entity developed, implemented, or managed is incapable of preventing or detecting, and fixing errors in the financial statements. Likewise, a control deficiency occurs when all these measures taken by the entity fail to prevent or detect and fix the misstatements on a timely basis.
Companies may also lack enough procedures to avoid or identify current misstatements in some circumstances. As a result, a lack of internal controls where required also represents a control deficiency for entities.
On the other hand, control weaknesses only appear when internal controls are not properly implemented or effective. The lack of internal control system is not among them.
A control weakness occurs when an entity’s internal controls fail to prevent or detect and correct risks. Control weaknesses are a component of control deficiencies.
Companies must first have internal controls in place for control weaknesses to exist. Control weaknesses occur when the controls put in place are insufficient in preventing or identifying and preventing risks or threats.
2) One is more severe than the other.
Control deficiencies, on the whole, are less serious than control weaknesses. This is because control weaknesses might sometimes result in a material impact on an entity’s financial statements. They will also tend to draw the attention of those charged with governance due to the effect these weaknesses might create on the financial reporting system of the entity.
3) They affect the audit in different ways.
Auditors, both external and internal, play an important role in identifying control deficiencies and control weaknesses. For entities with audits carried out regularly, the auditors are tasked with detecting control deficiencies on a timely basis, just as they do in other audit areas.
Control deficiency is usually identified before any test is performed. It will guide the auditor in determining which controls should be tested.
For control weaknesses, the auditors will perform tests on the internal control systems. This is known as the test of controls. The auditors will assess the controls’ effectiveness in preventing or detecting, and correcting the risks and threats through the tests.
Therefore, for a variety of reasons, control weaknesses are critical. Auditors will use the test results to determine the materiality level that they will use as a threshold for work performed in the audit engagements.
4) Reporting by auditors goes differently.
Auditors also must use their professional judgment to evaluate the severity of a control deficiency. Control deficiencies that are significant enough to warrant the attention of those charged with governance at the client are considered significant.
All control deficiencies must be reported to the client’s management and those charged with governance.
Control weaknesses can sometimes be identified as material weaknesses that will cause material misstatements in the financial statements. Identifying and reporting material weaknesses is critical for auditors.
These material weaknesses in internal controls could either be a control deficiency or a combination of control deficiencies. Auditors must, however, be reasonably assured that these errors will occur because of the weaknesses.
Unlike control deficiencies, auditors must report material weaknesses to the client, its management, those charged with governance, and the audit committee. Also, different from control deficiencies, this communication is usually done in writing and must be included in the financial reports.
5) The entities have to tackle them differently.
For control deficiencies, the entities have to devise new controls to address the issues highlighted by the auditors. That means they have to review suitable measures that can be employed by the entities and request all affected employees to learn and implement these measures.
For control weaknesses, the entities have to revise the controls to see how they can be better modified to address the problems the auditors have highlighted. It will usually require less effort than designing a totally new control and be easier to implement.
Internal controls are risk management measures that entities implement. However, in some situations, these safeguards may not be enough to achieve this goal. Control deficiencies occur when controls are missing or ineffective in preventing, detecting, or correcting risks and threats. When the controls in place are inappropriate, they are called control weaknesses.