Maintain and review financial delegations
Contents
Key to resources
Introduction
Internal audit defined
Employers of internal auditors
Objectives of internal audit
Nature and benefits of internal audit
Internal auditor in the system
Summary
This learning guide is based on the following resource(s):Textbook
Adams K, Grose R & Leeson D, Internal Controls and Corporate Governance(2nd edn) (2004), Pearson/Prentice Hall.
(This textbook is based on the AUS 402 published in 2002. AUS 402 has been updated with the new standard ASA 315 under 2006 legislation).
CD ROM
Adams K, Grose R & Leeson D, Internal Controls and Corporate Governance – Instructor’s Manual(2ndedn) -(2004), Pearson/Prentice Hall
Websites
- The Australian Government Auditing and Assurance Standards Board Select the link Standards and Guidance which brings you to the AUASB Standards and Pronouncements to obtain:
- ASA 610 Considering the Work of Internal Audit
- The Institute of Internal Auditors (IIA)
- ‘History of SEC’ from
- ‘South Sea Bubble’ from
- ‘The Crash of 1987’ from
Key to resources
Resource / Online and text1 / (1) ‘The South Sea Bubble’ from
(2) ‘The Crash of 1987’ from
2 / Textbook: Performance criterion 7.1 Define the term ‘internal auditor’, p191
3 / ‘History of SEC’ from
4 / Textbook: Figure 7.1 p 193
5 / Attempt self-check questions 7.1a to 7.1c, p193—the feedback is at the end of the chapter
6 / Performance criterion 7.2 Describe the objectives of the internal auditor and internal auditing, p 194
7 / Attempt self-check questions 7.2a to 7.2c, p196
8 / Performance criterion 7.3 Describe the position of the internal auditor within the internal control system, p196
9 / Try the self-check questions 7.3a and 7.3b, p198
* The term ‘performance criterion’is the reference used in the textbook. It is not related to the performance criteria for the unit of competency addressed in the learning guide.
Introduction
This learning guide focuses on internal auditors and their role in corporate governance.
Growth in internal auditing and the appointment of internal auditors has increased as high standards of corporate governance are now requiredof boards of directors and management. Stakeholders have demanded that governments and businesses adopt and implement ethics and corporate governance policies. This has occurred because of worldwide corporate failures and the impact on each country’s economy, personal wealth, savings and banking systems.
Corporate failures have been around for hundreds of years but originally they were isolated within the country in which the companies were established.
/ Now go to Resource 1There are several examples of corporate failuresin the literature including two that you should read about; one took place in 1711 and the other in 1987, demonstrating that not a lot has changed today except that the effects are felt around the world. This resource helps you to locate the two readings.
A more recent example is the collapse of One Tel in Australia. You could do your own search on the internet and read about the collapse of this corporation.
The location of this and all other resources for this learning guide is found in the Key to resourcesat the front of this document.
At the core of all these failures is not only greed but fraud and dishonesty by management and boards of directors who produce false financial statements and prospectuses with intent to defraud investors and shareholders.
Internal audit defined
/ Now go to Resource 2While the Institute of Internal Auditors has a definition, it does not depart greatly from the following Auditing Standard:
The external auditor shall consider the activities of internal audit and their effect, if any, on external audit procedures …
Para6: ‘internal audit’ means an appraisal activity established within an entity as a service to the entity. Its functions include, amongst other things, monitoring internal control.
(from ASA610Considering the Work of Internal Audit)
Depending on the size of the organisation, internal audit sections usually operate within theorganisational structure, ideally with reporting linesdirect to an audit committee.
Who may be an internal auditor?
While there is no legislative requirement as to who may be an internal auditor, ASA 610 Considering the Work of Internal Audithas two references:
Para 21:… the auditor needs to evaluate the specific work of internal audit which involves consideration of the adequacy of the scope of work and related programs and whether the assessment of the internal audit remains appropriate. This evaluation may include consideration of whether:
–the work is performed by persons having adequate technical training and proficiency as internal auditors and the work of assistants is properly supervised, reviewed and documented
In the ‘Understanding and preliminary assessment’ questionnaire included in the Standard, the following question addresses the issue of the auditor’s technical competence:
Question 8: Is the head of internal audit a professionally trained auditor? (If not, describe qualifications by training and by experience for the position held.)
9 (a) Do the entity’s hiring and/or internal promotion/transfer policies for internal audit require:
(i) tertiary qualifications?
(ii) formal professional qualifications?
(iii) previous internal audit experience?
Professional recognition is provided by the Institute of Internal Auditors – Australia (IIAA) in itsStandards for the Professional Practice of Internal Auditing through a program of certification of internal auditors.
Certification takes the form of an examination in the areas of:
- internal audit process
- internal audit skills
- management control and information technology
- the audit environment.
Applicants who achieve 75% pass mark gain recognition as a Certified Internal Auditor.
As with all professional accounting bodies, professional development (PD)must be maintained. IIAA providesPD called ‘Member’s Advancement Program’.
Employers of internal auditors
The Institute of Internal Auditors has its origins in the United States, being formed in 1941.
This was theformalisation of what had been operating in the USA since 1936, when the economy startedto slowly come out of the Great Depression as a result ofPresident Franklin D Roosevelt’s New Deal of1932.
Two important issues led to the employment of internal auditors:
- manufacturing for export and domestic consumption started to move again
- greater scrutiny of corporations and their influence on the economy and the financial system emerged in light oftheir actions and complex inter-company arrangements that led up to and continued during the Great Depression.
As a result of US Congress scrutiny, there were enacted several pieces of legislation to cover the establishment ofthe Securities and Exchange Commission 1934, Securities Act 1933 and Securities Exchange Act 1934.Legislative requirements forpublic corporations to produce audited financial statements for shareholders were also introduced.
/ Now go to Resource 3Read about how the stockmarket crash of October 1929 and the ensuing depression in the United States led to Congress hearings which ultimately led to the passing of the Securities Act of 1933 and the Securities Exchange Act of 1934.
It soon became obvious to corporations thatescalating audit fees could only be reduced by having your own in-house auditor, who could save the external auditor a lot of time.
Internal controls also appeared at this time mainly as an evolutionary process but also as a requirement of the external auditor if they were to depend on the internal auditor’s workings.
Internal auditors paid for themselves in the US manufacturing industry particularly in raw material, work-in-process and finished goods inventory control, by highlighting wastage throughrework of faulty products, price and unfavourable consumption variances and non-recovery of scrap costs.
Remember, the giants of the motor industry—Ford, General Motors and Chrysler—became economic powerhouses consuming millions of tons of raw materials that required sophisticated internal controls to rein in material cost overruns. China is experiencing the same problems today as the US experienced in the 1930s and 1940s.
In Australia, demand for increased regulation of corporations and attendant compliancecosts have given birth to audit committees chaired by non-executive directors, followed by increased demand for internal auditors.
You should note that each auditor-general in federal and state jurisdictions is an internal auditor who reports directly to their respective parliaments on all facets of government.
/ Now go to Resource 4This is a diagram showing where the internal auditor fits into the organisational structure.
/ Now go to Resource 5
It’s time to do the self-check questions.
The answers to the questions are at the end of the chapter.
Objectives of internal audit
/ Now go to Resource 6This resource addresses thesequestions:
- What are the types of internal audit proceduresthat can be carried out for management?
- What are the nature and benefits of the internal auditor’s work?
The objectives have broadened from straight policing and monitoring of transactions and processes to providing management with advice on operations, corporate governance implementation and accepting responsibility for quality assurance policies. Operational audits are now commonplace within commerce and industry.
Boards of directors are becoming more dependent on the audit committee and the internal auditor for advice and detailed reports on every segment of the organisation. This has come about as increasing demands are coming from not only shareholders but from all stakeholders including governments for greatly improved corporate governance.
Therefore scope and objectives are only limited by the skill and training of the internal auditor andcommitment byboards of directors through audit committees.
Consider what the Institute of Internal Auditors (IIA) has to say on the objectives of internal audit in the Standards for the Professional Practice of Internal Auditing:
- There should a clear separation between the internal auditor and the functions they audit
- Performance of internal audits should be completed with competence and high standards of professionalism
- Internal auditing should be designed to provide comprehensive assessment of the entity’s internal control policies and procedures in order to establish their economic, efficient and effective outcomes
- Achievement of the auditshould be based on setting goals, reviewing performance and providing those who are ‘charged with governance’ with detailed and comprehensive reporting
- Internal audit sections should be managed in away that is free from criticism
The ASA 610 also considers the scope and objectives of internal audit:
Para8 The scope and objectives of internal audit vary widely and depend on the size and structure of the entity and the requirements of those charged with governance and management. Ordinarily, internal audit activities include one or more of the following:
– Monitoring of internal control:the establishment of adequate internal control is a responsibility of those charged with governance and management which demands proper attention on a continuous basis. Internal audit is ordinarily assigned specific responsibility by those charged with governance for reviewing controls, monitoring their operation and recommending improvements thereto.
– Examination of financial and operating information:this may include review of the means used to identify, measure, classify and report such information and specific enquiry into individual items including detailed testing of transactions, balances and procedures.
– Review of the economy, efficiency and effectiveness of operations including non-financial controls of an entity.
– Review of compliance with laws, regulations and other external requirements and with management policies and directives and other internal requirements.
Types of internal audit procedures
Internal audit procedures can be summarised as follows:
- performing a ‘watchdog’role
- ensuring management policies are being observed
- providing internal control manuals for staff training and compliance (egcredit provision and control of debtors)
- ensuring occupationalhealth and safety and environmental legislation and regulations are being observed to reduce the organisation’s exposure to risk, penalties, high-profile court cases and trial by media. (Witness the case of the young boy who for his first day on the job, fell off the roof and died.)
- conducting performance or operational audits.
The questionnaire in ASA 610 raises the question onthe scope of function for the auditor.
/ Activity 1Go to the Australian Government Auditing and Assurance Standards Board website and download Auditing Standard 610. Study carefully questions 5 and 6 relating to Scope of Functionin Appendix 1.
Read on when you’ve finished the activity.
Nature and benefits of internal audit
Here are some independent (internal audit) questions that could change the way organisations look at themselves, procedures and programs:
- Why do we do it this way?
- Is this really part of our operation?
- Is the likely return worth the effort?
- Can we measure the success of the program?
- Does this answer a customer need?
- Will this benefit our organisation?
Positive answers by management may indicate willingness to question and change direction for the benefit of the firm.
/ Now go to Resource 7It’s time to do the self-check questions in the textbook.
You will find the answers to self-check questions at the end of the chapter in the textbook.
The answers to end of chapter questions and case studies are found in Instructor’s manual for the textbook.
Internal auditor in the system
/ Now go to Resource 8Critical to the success of the internal audit section is the separation of its operations from any control by management. Accordingly, the internal auditor’s line ofaccountability and responsibility should be to an independent authority such as an audit committee chaired by a non-executive director.
Additionally, the external auditor would need to know that the internal auditor and audit section was in no way compromised by management influence and intervention.
Internal auditor selection and appointment again should be by the audit committee with input and advice from the external auditor. If a delegation of powers is from the board of directors this gives the appointmentstatus and authority.
Internal auditors shouldbe put in a position where they can report without fear or favour.The following activity considers the issue of the internal auditor’s organisational status:
/ Activity 2Go to the Australian Government Auditing and Assurance Standards Board website and download Auditing Standard 610. Read questions 1 to 4 in Appendix 1 relating to Organisational Status.
Read on when you’ve finished the activity.
/ Now go to Resource 9It’s time to do the self-check questions in the textbook.
Summary
Central to achieving high levels of corporate governance is the audit committee working together with the internal auditor to ensure the board’s policies are carried out by management.
Internal auditors and their departments play a pivotal role in assisting management by ensuring that, as far as possible:
- the business is conducted in an orderly and efficient manner
- irregularities are prevented or detected and corrected should they occur
- assets are safeguarded from unauthorised use or disposition
- financial records and other relevant databases completely and accurately reflect the entire operational activities of the entity and permit the timely preparation of financial information.
Maintain and review financial delegations1
© NSW DET 2006, 2006/053/12/2006 LRR5094