## **Learning Outcomes**

After reading this article, you will be able to explain the inherent limitations of internal control systems for ACCA FAU. You will identify common limitations such as human error, collusion, and management override, and understand why these factors mean no system can offer complete protection against all risks. You will also learn how auditors consider these limitations during audit planning and risk assessment.

## **ACCA Foundations in Audit (FAU) Syllabus**

For ACCA Foundations in Audit (FAU), you are required to understand the general principles and limitations of internal controls, and why auditors cannot rely solely on these systems. Specifically, this article addresses:

- The objectives and five components of an internal control system
- The definition and role of control activities
- The inherent limitations of all internal control systems
- Why auditors assess internal controls but do not place complete reliance on them
- The impact of internal control limitations on audit approach and procedures

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. Which of the following is NOT an inherent limitation of internal controls?
   a) Human error
   b) Segregation of duties
   c) Management override
   d) Collusion between employees

2. True or false? An effective internal control system guarantees that all errors and fraud will be prevented or detected.

3. List two ways collusion can undermine internal controls.

4. Briefly explain what is meant by "cost versus benefit" when designing internal control systems.

## **Introduction**

Every business, regardless of size, relies on internal controls to safeguard assets, ensure the accuracy of records, and prevent or detect errors and fraud. However, even the best-designed system cannot remove every risk. Inherent limitations are the factors that prevent internal control systems from being completely effective.

Understanding these limitations is essential for both auditors and management, as it guides proper risk assessment, control design, and audit planning. You must be able to explain these limitations clearly in the exam.

> **Key Term: Internal control system**
> The set of policies and procedures designed, implemented, and maintained by management to provide reasonable assurance about the achievement of objectives relating to reliable reporting, operational effectiveness, and compliance with laws and regulations.

## **Inherent Limitations: Why No System is Foolproof**

Internal controls are only as strong as the people and processes that operate them. No matter how well controls are designed, certain risks always remain:

### 1. Human Error

People can make mistakes. Mistakes in judgment, misunderstanding instructions, tiredness, or distraction can all cause controls to fail. For example, an employee might input the wrong amount on an invoice or forget to check a supporting document.

> **Key Term: Human error**
> Accidental mistakes made by individuals in processing transactions or following procedures, which can lead to the failure of internal controls.

### 2. Collusion

Controls often rely on segregation of duties—the principle that no single person should handle all aspects of a transaction. However, if two or more people collude, they can bypass even well-designed controls. For example, a purchasing officer and a supplier might conspire to process false invoices and share the proceeds.

> **Key Term: Collusion**
> Agreement between two or more people to act together to circumvent controls and commit fraud or conceal errors.

### 3. Management Override

Senior employees or directors may have the authority to bypass controls for specific transactions. If this power is abused, management can instruct staff to ignore procedures, process unauthorized payments, or manipulate records. This overrides intended checks and balances.

> **Key Term: Management override**
> When senior personnel use their authority to bypass or ignore established control procedures for personal or organizational gain.

### 4. Cost-Benefit Constraints

It is not practical or economical to control every risk. Some controls may be too costly relative to the benefit gained. Businesses have to weigh the likelihood and impact of risks against the cost of control measures. Consequently, some risks will always remain unaddressed.

### 5. Controls Over Irregular or Non-Routine Transactions

Controls are usually designed for routine, recurring transactions. Unusual, infrequent, or complex transactions may fall outside standard procedures, with a higher risk of error or intentional misstatement. Year-end adjustments are a common example.

### 6. Outdated or Obsolete Controls

As a business changes, its processes and risks also change. If controls are not updated or reviewed regularly, they may become ineffective. For example, new systems or products may create risks that existing controls do not address.

## **Impact on Auditing Approach**

Auditors cannot—and do not—place complete reliance on internal controls, no matter how robust they appear. Instead, auditors:

- Recognize the unavoidable risks due to inherent limitations
- Supplement control testing with substantive procedures (detailed checking of transactions and balances)
- Exercise professional skepticism—the mindset of questioning evidence and remaining alert to the possibility of misstatement

### **Worked Example 1.1**

**Scenario:** A company uses pre-numbered sales invoices and daily reconciliations. However, a sales manager and a member of the finance team collude to remove invoice numbers from the sequence and steal the proceeds of those sales.

**Question:** Why did the internal controls fail to prevent the fraud?

> **Answer:**
> The controls were bypassed because of collusion. Although invoice reconciliation and pre-numbered documents are effective against most errors or isolated fraud, they cannot prevent two or more employees from conspiring to conceal missing invoices and divert sales income. This demonstrates the inherent limitation of internal controls against collusion.

### **Worked Example 1.2**

**Scenario:** An experienced accounts clerk approves payments based on supporting documents. One month, the clerk, working overtime and feeling tired, mistakenly approves a duplicate invoice, leading to an overpayment.

**Question:** Which inherent limitation is illustrated here?

> **Answer:**
> This is an example of human error. The mistake was unintentional and occurred despite the presence of a control (review of supporting documents). Such errors are always possible, meaning controls cannot offer absolute protection.

### **Exam Warning**

> Be careful not to state that a "strong system of internal control eliminates all possibility of fraud or error." You must explain—using examples—why controls cannot guarantee this.

### **Revision Tip**

> In the exam, give real-world examples of each limitation (human error, collusion, management override) to show clear understanding.

## **Summary**

Internal controls are essential for reducing business risks, but all such systems have inherent limitations. Common causes include human error, collusion, management override, cost limitations, and controls failing to keep up with changes. These factors mean controls provide only reasonable (not absolute) assurance. Auditors always consider these limitations and design audit procedures accordingly.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- Define a system of internal control and its purpose
- Explain why inherent limitations exist in all control systems
- Identify and describe major limitations: human error, collusion, and management override
- Recognize the cost-benefit limitation in designing controls
- Understand the impact of inherent limitations on the auditor's approach and level of assurance

## **Key Terms and Concepts**

- Internal control system
- Human error
- Collusion
- Management override

General principles of internal control - Inherent limitations of internal control