Internal/External Audit
Corporate Governance part 5
What is Internal Audit?
The role of internal audit is to provide independent assurance that anorganization's risk management, governance and internal control processesare operating effectively.
What is its value to the organization?
Internal auditors deal with issues that are fundamentally important to the survivaland prosperity of any organization. Unlike external auditors, they look beyondfinancial risks and statements to consider wider issues such as the organization'sreputation, growth, its impact on the environment and the way it treats itsemployees.
In sum, internal auditors help organizations to succeed.
The difference between internal andexternal audit
While sharing some characteristics, internal and external audit have very differentobjectives. These are explained in the table on the following pages:
Reports to
•External Audit
•Internal Audit
The board and senior management whoare within the organizations governancestructure.
shareholders or members whoare outside the organizationsgovernance structure.
Objectives
•External Audit
Add credibility and reliability to financialreports from the organization to itsstakeholders by giving opinion on thereport
•Internal Audit
Evaluate and improve theeffectiveness of governance, riskmanagement and controlprocesses. This provides membersof the boards and seniormanagement with assurance thathelps them fulfil their duties to theorganization and its stakeholders.
Coverage
•External Audit
Financial reports, financial reportingrisks.
•Internal Audit
All categories of risk, their management,including reporting on them.
•External Audit
None, however there is a duty to reportproblems.
•Internal Audit
Improvement is fundamental to thepurpose of internal auditing. But it isdone by advising, coaching andfacilitating in order to not undermine theresponsibility of management.
Responsibility for improvement
Qualification and special skills
To be effective, the internal audit activity must have qualified, skilled andexperienced people who can work in accordance with the Code of ethics andthe International Standards.
Cadbury Report on Internal Audit
The function of the internal auditors is complementary to, but different from, that ofthe outside auditors. It is regarded as good practice for companies to establishinternal audit functions to undertake regular monitoring of key controls andprocedures. Such regular monitoring is an integral part of a company’s system ofinternal control and helps to ensure its effectiveness. An internal audit function iswell placed to undertake investigations on behalf of the audit committee and to followup any suspicion of fraud. It is essential that heads of internal audit should haveunrestricted access to the chairman of the audit committee in order to ensure theindependence of their position.
Importance of Audit
The annual audit is one of the cornerstones of corporate governance. Directors arerequired to report on their stewardship by means of the annual report and financialstatements sent to the shareholders. The audit provides an external andobjective check on the way in which the financial statements have beenprepared and presented, and it is an essential part of the checks and balancesrequired. The question is not whether there should be an audit, but how to ensureits objectivity and effectiveness.
Audits are a reassurance to all who have a financial interest in companies,quite apart from their value to boards of directors. The most direct methodof ensuring that companies are accountable for their actions is throughopen disclosure by boards and through audits carried out against strictaccounting standards.
Internal Control
An effective internal control system is an essential part of the efficient managementof a company.
Directors should report on the effectiveness of their system of internal control, andthe auditors should report on their statement. A great deal of detailed work is nownecessary to develop these proposals, and the accountancy profession, inconjunction with representatives of preparers of accounts, should take the lead in:
a) developing a set of criteria for assessing effectiveness;
(b) developing guidance for companies on the form in which directors shouldreport; and
(c) developing guidance for auditors on relevant audit procedures and the form inwhich auditors should report.
Fraud
The prime responsibility for the prevention and detection of fraud (and otherillegal acts) is that of the board, as part of its fiduciary responsibility for protectingthe assets of the company. The auditor’s responsibility, as defined in auditingguidance, is properly to plan, perform and evaluate his audit work so as tohave a reasonable expectation of detecting material misstatements in the financialstatements.
Problem for the auditors is when they suspect that top management itself isimplicated in the fraud, without having the necessary evidence to back up theirsuspicions. They are not in a strong enough position to confront management,nor have they a case to report to the appropriate authorities.
Audit Committee
These are not easy problems to resolve, but an effective and independent-mindedaudit committee is an essential safeguard. It has an important role to play inconsidering B AUDITING whether any extra work should be undertaken inaddition to the normal audit procedures to investigate defencess against fraud.
The audit committee also provides a forum in which auditors can discuss at boardlevel any concern they may have about the possibility of fraud by seniormanagement. It can then decide whatever investigations are necessary to resolvethe matter.
A group of at least 3 individuals responsible for overseeing all internal and external auditfunctions of a company. In addition, at least one member must be a financial expert orhave significant financial expertise.
•Audit committees are responsible for selecting and appraising independent andexternal CPA firms to provide audit functions.
•They also oversee the financial reporting process including (but not limited to)supervising internal auditors, monitoring internal controls, and ensuring adequatecompliance with SEC and GAPP standards.
Because staff on audit committees report to the board of directors of a company, theycannot have ties to the company`s management team or be in a position where theirindependence can be questioned.
CPA firm – Certified Public Accountant firm
SEC – Security Exchange Commission – Federal government regulatory
GAPP – General Accepted Accounting Principles