Chapter 1 - Introduction to Internal Auditing

Internal Auditing AUDB433

Special Semester, 2014-2015 2014-20 15

INTRODUCTION TO INTERNAL AUDITING Overview of Internal Auditing

Introduction Although the internal audit proession is ancient, man! people associate the "#irth$ o modern internal auditing %ith the esta#lishment o &he Institute o Internal Auditors 'IIA( in 1)41*

Changing Roles of Internal Auditing +er the last 0 !ears, the roles pla!ed #! internal auditors hae changed chang ed dramaticall!. Tradi aditio tional Role oles ===

Transit nsitiiona onal Roles les === ===

/nsu /nsuri ring ng accu accura rac! c! o the the /merg /mergence ence o operat operation ional al inancial records. auditing. IA %as merel! an • IA more ocu ocused on • etension o the controls %ithin the Accounts Department organiation IA assumed a • IA perormed • "management acco accoun untting ori orient ented consultant$ role tass ocused on chec checi ing ng accu accura rac! c!  hece heced d compli complianc ancee %ith %ith relia#ilit! o compan! policies  historicalpast procedures. perormance 'e*g*, • /aluated /aluated the eecti eectiee coun counti ting ng ine inent ntor orie ies, s,  eicient use o eri eri! !in ing g pett pett! ! cash cash,, resources auditing pa!roll records, • Ine Inest stig igat ated ed rau raud d  audit #! re-doing tass( othe otherr speci pecial al een eentts such as mergers IA acti acting ng as in-h in-hou ouse se • 6eie%er • o assist assistant antss assis assistin ting g the managem management ent proces processes ses eternal auditors 'pla!ing the role ole o "poli "police cema man$ n$ chec checin ing g on management(

Current Role oles === !!

IA seres the entire orga organi niat atio ion n 'IA 'IA %or %or is ocused on ensuring that the orga organi niat atio ion7 n7ss curr curren entt  uture perormance helps it achiee its o#8ecties 9 see main tet#oo, page 1( Independent rom operating management* :artne :artners rs %ith %ith manage management ment 'IA acting as #usiness cons consul ulttant ants pro proid idiing a serice to the organiation(* :articipates %ith Improement &eams  &as ;orce :rocesses* Uses &echnolog!*

&hese changing roles re
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Special Semester, 2014-2015

"olding #orces ircumstances  eents  orces %hich hae helped to uel increased demand or internal audit serices and helped shape internal auditing into %hat it is toda!. •

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orporate scandals 'or e*g*, /nron, =orldom, and :armalat( %hich hae #rought a#out ne% la%s and regulations 'or e*g*, latest amendments to >ala!sian os Act 1)?5 and amended Bursa >ala!sia7s @isting 6e
&hese orces #ring a#out ne% and dierent t!pes o riss that can preent an organiation rom achieing its #usiness o#8ecties* &o help an organiation7s senior management and B+Ds understand and address these riss, internal auditors are increasingl! #eing called upon to help organiations strengthen their corporate goernance, ris management, and internal control processes*

Definition of Internal Auditing The Institute of Internal Auditors$ 'IIA% current deinition o internal auditing. Internal auditing is an independent, objective, assurance and consulting activity designed to add value and improve an organization’s operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve effectiveness of risk management, c ontrol, and governance processes.

@et7s loo at the e! components o the a#oe deinition in turn.

&el'ing the Organi(ation Acco)'lish its O*+ectives &he oerarching o#8ectie o the internal audit unction is to help an organiation achiee its #usiness o#8ecties*

An organiation eists or a num#er o purposes or #usiness o#8ecties, e*g*, mae proits, increase shareholder %ealth, add gro%th to staeholders7 alue, etc* Its success depends on the accomplishment o these o#8ecties* But eents taing place ma! preent a compan! rom achieing its o#8ecties* Understanding an organiation7s #usiness o#8ecties  helps an internal auditor understand the riss o eents arising that can potentiall! "side-trac$ or hinder o#8ecties #eing met  helps deine the internal auditor7s o%n audit engagement o#8ecties 'i*e* %hat it needs to do( in order to help the organiation accomplish its #usiness o#8ecties. ,-ee E.hi*it /0/1

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Evaluating and I)'roving the Effectiveness of Ris2 "anage)ent3 Control3 and Governance 4rocesses

All 3 processes ocus on the achieement o the organiation7s o#8ecties* Governance process 9 the process conducted #! the B+D to authorie, direct, and oersee management to%ards achieement o the organiation7s o#8ecties* Risk management process 9 the process conducted #! management to understand and deal %ith uncertainties 'i*e* riss( that could aect the organiation7s a#ilit! to achiee its o#8ecties 'e*g* emplo!ee raud(* Control processes 9 the process conducted #! management to reduce riss to accepta#l! lo% leels  to a leel accepta#le to the organiation 'ris appetite(* &he internal audit unction pla!s a prominent role in ealuating and improing these processes* Assurance and Consulting Activit5 Designed to Add 6alue and I)'rove O'erations 2 t!pes o serices internal auditors proide to add alue and improe operations.

ssurance services 9 an o#8ectie eamination o eidence or the purpose o proiding an independent assessment on ris management, control, or goernance processes or the organiation* EauditeeF EauditorF EuserF Consulting services 9 adisor! and related serices, the nature and scope o %hich are agreed to %ith the customer and %hich are intended to improe an organiation7s goernance, ris management, and control processes %ithout the internal auditor assuming management responsi#ilit!* EauditeeF EauditorF &he! dier in three respects. '1( purpose '2( %ho determines nature and scope o engagement, and '3( the parties inoled*

dding !alue 9 a %ell run internal audit unction adds alue in a num#er o %a!s, or eample. •

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It acts as a training ground or uture line managers, #! eposing ast trac mem#ers o the department to a ariet! o situations, actiities and unctions %ithin the organisation* It proides a "one stop shop$ or #est practice adice* It proides an independent, o#8ectie opinion as to the
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It proides specialist proessional independent opinions on a ariet! o situationsG such as due diligence eercises* It reports on raudulent actiit! %ithin the organisation, %ith a ie% to understanding ho% it happened and ho% to preent it occurring again* It ensures that the compan! %ide initiaties, such as a code o conduct, are #eing adhered to*

Inde'endence and O*+ectivit5

Independence reers to the organiational status o the internal audit unction* Independence 9 the reedom rom conditions that threaten o#8ectiit! or the appearance o o#8ectiit!* Such threats to o#8ectiit! must #e managed at the indiidual auditor, engagement, unctional and organiational leels* ;or the internal audit unction to #e independent, the hie Audit /ecutie must report to a leel %ithin the organiation that has suicient authorit! to ena#le it to carr! out its unction properl! %ithout undue inluence rom other parties* &he IIA recommends that the A/ reports unctionall! to the B+D and %here it eists, to the audit committee, and administratiel! to the organiation7s chie eecutie oicer '/+( ':ractice Adisor! 1110-1, +rganiational Independence(* +#8ectiit! reers to the mental attitude o indiidual auditors* Individual objectivity 9 an impartial, un#iased mental attitude and aoidance o conlicts o interest, allo%ing internal auditors to perorm engagements in such a manner that the! hae an honest #elie in their %or product and that no signiicant
A -5ste)atic and Disci'lined A''roach

Speciicall!, this reers to the internal audit engagement process itsel. planning the engagement, perorming the engagement, and communicating engagement outcomes* :lanning the engagement inoles 9 o#taining an understanding o the auditee7s #usiness riss and o#8ecties, auditee7s personnel, resources, operations, etc*

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:erorming the engagement inoles 9 application o speciic audit procedures, or e*g*, maing en
+perational audit :rogramme audit ;raud audit /thical #usiness practices audit ompliance audit Inormation technolog! audit ontrol sel-assessment audit ;inancial audit

';or eplanation o a#oe, see main tet#oo, pages 4-5(

Differences and -i)ilarities *etween Internal Auditing and E.ternal Auditing The Different O*+ectives &he starting place is to clearl! set out the dierent o#8ecties o internal and eternal audit* &he e.ternal auditor sees to test the underl!ing transactions that orm the #asis o the Hnancial statements* &he internal auditor , on the other hand, sees to adise management on %hether its ma8or operations hae sound s!stems o ris management and internal controls*

The "ain -i)ilarities Both the eternal and internal auditor carr! out testing routines and this ma! inole • eamining and anal!sing man! transactions* •

Both the internal auditor and the eternal auditor %ill #e %orried i procedures %ere er! poor andor there %as a #asic ignorance o the importance o adhering to them*

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Both tend to #e deepl! inoled in inormation s!stems since this is a ma8or element o managerial control as %ell as #eing undamental to the Hnancial reporting process*

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Both are #ased in a proessional discipline and operate to proessional standards*

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Both see actie co-operation #et%een the t%o unctions*

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Both are intimatel! tied up %ith the organiation7s s!stems o internal control*

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Both are concerned %ith the occurrence and eect o errors and misstatement that aect the Hnal accounts*

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Both produce ormal audit reports on their actiities*

The "ain Differences &he eternal auditor is an eternal contractor and not an emplo!ee o the organiation • as is the internal auditor* ote, ho%eer, that there is an increasing num#er o contracted-out internal audit unctions %here the internal audit serice is proided #! an eternal #od!* •

&he eternal auditor sees to proide an opinion on %hether the accounts sho% a true and air ie%, %hereas internal audit orms an opinion on the ade
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/ternal audit is a legal re
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Internal audit ma! #e charged %ith inestigating rauds and, although the eternal auditors %ill %ant to see them resoled, the! are mainl! concerned %ith those that materiall! aect the Hnal accounts*

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Internal auditors coer all the organiation7s operations %hereas eternal auditors %or primaril! %ith those Hnancial s!stems that hae a #e aring on the Hnal accounts*

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Internal audit ma! #e charged %ith deeloping alue-or-mone! initiaties that proide saings andor increased eHciencies %ithin the organiation*

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&he internal auditor reie%s s!stems o internal control in contrast to the eternal auditor %ho considers %hether the state o controls %ill allo% a reduced amount o testing*

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Internal audit %ors or and on #ehal o the organiation %hereas the eternal auditor is technicall! emplo!ed #! and %ors or a third part!, the shareholders*

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&he internal audit coer is continuous throughout the !ear #ut the eternal audit tends to #e a !ear-end process een though some testing ma! #e carried out during the !ear*

'See also main tet#oo, pages 5-?(

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Evolution of the Internal Auditing 4rofession

See article. "#he mericas literature revie$ on internal auditing%* &he purpose o this article is to sho% ho% the roles pla!ed #! the internal audit unction hae changed and ho% its scope has epanded in response to shits in glo#al #usiness practices*

Discussion 7uestions for Tutorial Class

1* Deine the ormal deinition o internal auditing* Using this deinition, %hat in !our opinion %ould #e the #eneits that might accrue rom resourcing such a sericeJ 2* Deine goernance, ris management, and control* 3* /plain the dierence #et%een internal assurance serices and internal consulting serices* 4* Deine independence and o#8ectiit! as the! pertain to internal auditors* 5* Ko% should the internal audit unction #e positioned %ithin the organiation so that it maintains its independenceJ ?* =hat roles that !ou carr! out in !our capacit! as the compan!7s internal auditor might compromise !our o#8ectiit!J * @ist the t!pes o procedures an internal auditor might use to test the design and operating eectieness o ris management, control, and goernance process* * =hat are the three undamental phases in the internal audit engagement planJ )* =hat is the association #et%een the client7s #usiness o#8ecties, riss, and controlsJ =hat is the internal auditor7s role in thisJ 10* Ko% does an internal audit unction add alue to the organiationJ 11* Discuss the dierences and similarities #et%een internal and eternal auditing* 12* Identi! some o the signiicant change actors that hae led to increasingl! more signiicant roles #eing carried out #! the internal audit unction oer the past 30 !ears*

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13* &he changing roles re
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Chapter 1 - Introduction to Internal Auditing

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