The Difference Between Preventative and Detective Controls

Internal controls are the financial and operational procedures a business establishes to safeguard assets, ensure accurate financial records, and promote regulatory compliance. The effectiveness of these systems depends on the types of controls used, which are categorized by their function and timing within business processes.

Understanding Preventative Controls

Preventative controls are proactive measures designed to stop errors or fraudulent activities before they happen. As the first line of defense in risk management, they build safeguards directly into a process to deter undesirable events from the outset.

A common example is the segregation of duties. This principle ensures that a single individual does not control all phases of a financial transaction. For instance, the employee who approves a purchase order should not be the same person who processes the payment to the vendor, making it more difficult for fraudulent activities to occur without collusion.

Other preventative controls include pre-approval requirements and various security measures. A policy requiring managerial approval for any expense over $500 prevents unauthorized large purchases. Other preventative measures include:

• Physical controls like locked storerooms for valuable inventory
• IT controls such as mandatory strong passwords and two-factor authentication
• Access restrictions to sensitive financial software to block unauthorized actions

Identifying Detective Controls

Detective controls are reactive measures implemented to discover problems after they have occurred. They serve as a second line of defense, operating on the assumption that some irregularities may bypass preventative measures. Their goal is to identify issues so that management can take corrective action.

Bank reconciliations are a classic example of a detective control. This process involves comparing the cash balance on a company’s balance sheet to its bank statement to identify any differences. An accountant might perform this monthly, investigating discrepancies like uncashed checks or unrecorded bank fees to ensure the company’s cash records are accurate.

Additional detective controls include regular physical inventory counts and internal audits. A company might conduct a quarterly physical count of its inventory to compare with its records, which can detect issues like theft or recording errors. Similarly, internal audit teams review financial statements and processes to identify non-compliance with policies or control weaknesses.

The Role of Corrective Controls

Corrective controls are procedures enacted to address problems identified by detective controls. These reactive actions are the final step in the control cycle, ensuring that once an error is found, it is remediated and steps are taken to prevent it from recurring.

When a detective control uncovers an issue, a specific corrective control is triggered. For instance, if a review of system access logs reveals an employee has access to irrelevant financial data, the corrective action is to revoke those rights. If an internal audit discovers a misstatement in financial records, the corrective control is to post adjusting journal entries to fix the error.

How These Controls Work Together

These three types of controls do not operate in isolation; they function as a layered, comprehensive system. This approach ensures that if one control fails, another is in place to either catch the error or fix the resulting problem.

Consider a company’s employee expense reimbursement process. A preventative control would be a corporate policy requiring pre-approval for any travel expense exceeding $1,000. This policy is designed to stop excessive spending before it occurs, as the system can be built to reject any submission that lacks the required electronic approval from a manager.

A detective control in this same process would be the monthly review of all expense reports by the accounting department. An accountant might notice a pattern of an employee consistently submitting expenses just under the $1,000 pre-approval threshold. While no single report violated the preventative control, the pattern suggests an attempt to circumvent the policy, which the detective control identified.

Following this detection, corrective controls are implemented. The immediate action would be to discuss the findings with the employee’s manager and potentially deny reimbursement for the questionable expenses. A broader corrective action might involve updating the expense policy or implementing data analysis software to automatically flag such patterns in the future, thereby strengthening the preventative controls.