Understanding internal controls is important to continued grant funding. A lack of well-developed internal controls can lead to costs being disallowed and even suspension and debarment from future grants. Does it seem overwhelming?
Here is the minimalist guide to internal controls: Just remember 3-5-7…
The simplified 3-5-7 approach to internal controls:
There are 3 main objectives for well-developed internal controls.
Each objective contains 5 key components.
There are 7 primary benefits of effective internal controls.
Let’s break that down step-by-step:
3 Main Objectives for Internal Controls
Well-developed internal controls are a critical defense for reducing risk of fraud, waste, or abuse of grant funding. According to the Standards for Internal Control within the Federal Government, internal controls should be designed with the goal of achieving three main objectives:
Objective #1 : Effectiveness and efficiency of operations
Objective #2: Reliability of financial reporting
Objective #3: Compliance with applicable laws and regulations
Well-developed internal controls meeting these 3 main objectives contain five key components: control environment, risk assessment, control activities, communication, and monitoring.
5 Key Components for Internal Control Objectives
Component #1: Control Environment
An organization’s environment is established by its leadership from the top down. Leaders of each area, activity, and department are responsible to establish and monitor their specific control environment.
Component #2: Risk Assessment
Organizations must assess both external and internal risk. Risk assessment requires identifying and analyzing risks to achieving the goals and objectives of the funded program or project, as well as to maintaining compliance. As conditions constantly change, periodic and systematic risk assessment and analysis is required.
Component #3: Control Activities
Control activities are the actual policies and procedures within internal control. Examples include reviews, supervisory authorizations, separation of duties, as well as written documentation and record keeping. Control activities are designed to reasonably ensure that actions are taken to address risk and ensure compliance throughout the organization. These activities are implemented at all levels and within all functions of the organization.
Component #4: Effective Communication
Every employee (and even volunteers) must clearly understand their individual role and its place in the control functions. Therefore, effective communication mechanisms must be present to collect and distribute information in all directions within the organization. This means people not only understand their role within internal control, but how it relates to what others are doing and the organization as a whole. Effective communication not only includes mechanisms for management to communicate with employees, but a clear channel for employees to communicate with management as well.
Component #5: Monitoring
In order to be effective, internal controls must be consistently and regularly monitored. Monitoring should be built into daily operations in addition to regular and periodic supervisory monitoring. The degree, scope, and regularity of monitoring internal controls is dictated by grant specifications and requirements. This review should include identifying relevant risks to meeting the goals and objectives of the grant.
Well-developed internal controls are consistently assessed and evaluated in order to make continuous improvements. The primary benefits of well-developed internal controls include:
7 Primary Benefits of Well-developed Internal Controls
Benefit #1: Help to ensure grant funding is properly used
Benefit #2: Detect and help prevent errors
Benefit #3: Reduce the risk of direct and indirect fraud
Benefit #4: Contribute to accounting accuracy
Benefit #5: Assist grantee in providing timely financial and management reports to grantor
Benefit #6: Help ensure policies, specifications, and requirements of the grant are met
Benefit #7: Foster taxpayer confidence that public funds are safeguarded and spent as intended
The 3-5-7 approach can help you understand what a well-developed internal control system looks like and avoid the unpleasant reality of poor grant management. How does your organization stack up?
Lucy Morgan CPA, MBA
CEO, Compliance Warrior