component of internal control system

One of the five components of internal control is the ENTITY’s risk assessment process – i.e. the means by which it identifies, assesses and MANAGES risks. To manage risk will require the entity to have controls in place.

You’re probably too young to remember but Nick Leeson became a household name as the “rogue trader” who brought down Barings Bank. Basically, management/the directors had no understanding of the risks involved in the bank’s dealings (in futures and derivatives – you don’t need to know any of this for AA – it’s just the concept I’m trying to illustrate) – transactions that were entered into by Leeson. If the bank had been aware of the risks involved, there would have been controls put in place (e.g. authorisation/approval and segregation of duties) to ensure that the bank could not be exposed to the risk of losses that brought about the bank’s collapse.