Internal Audit

Internal AuditInternal Auditing is conceptually similar in many ways to financial auditing by public accounting firms, quality assurance, and banking compliance activities.

The term internal audit has been defined as the independent appraisal of activity within an organization for the review of accounting financial and other business practices as a protective and constructive arm of management.

Professor Walter B. Meigs of America says, “Internal auditing consists of a continuous, critical review of financial and operating activities by a staff of auditors functioning as full-time salaried employees.”

As defined by The Institute of Internal Auditors (IIA), “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 the effectiveness of risk management, control, and governance processes.

The scope of internal auditing within an organization is broad and may involve topics such as;

  • an organization’s governance, risk management, and management control over:
  • efficiency and effectiveness of operations (including the safeguarding of assets),
  • the reliability of financial and management reporting, and
  • compliance with laws and regulations.

Internal auditing may also involve conducting proactive fraud audits to identify potentially fraudulent acts; participating in fraud investigations under the direction of fraud investigation professionals, and conducting post investigation fraud audits to identify control breakdowns and establish financial loss.

The Internal Auditing profession evolved steadily with the progress of management science after World War II.

Objectives of Internal Audit

The objectives of the internal audit can be summarized as follows:

  1. To verify the correctness, accuracy, and authenticity of the financial accounting and statistical records presented to the management.
  2. To confirm that the liabilities have been incurred by the organization concerning its valid and legitimate activities.
  3. To comment on the effectiveness of the internal control system and the internal check system in force and to suggest ways and means improve these systems.
  4. To facilitate the early detection and prevention of frauds.
  5. To examine the protection afforded to the company’s assets and use of them for business purposes.
  6. To identify the authorities responsible for purchasing assets and other items as well as disposal of assets.
  7. To ensure that the standard accounting practices which have to be followed by the organization are strictly followed.
  8. To undertake a special investigation for the management.
  9. To assist management in achieving the most efficient administration of the operation by establishing procedures by complying with the company’s operating policies.

Advantages of Internal Audit

The advantages of internal audit are as follows:

  1. The biggest advantage of internal audit is that it will lead to the discovery of errors and therefore when an external audit is done those errors which were discovered during internal audit would have been rectified by then.
  2. Since the internal audit is done by the employees of the company there is no additional cost involved which again is a big advantage for a company that is doing an internal audit.
  3. As an internal audit is a constant procedure where records are checked regularly it ensures that the accounting staff of a company keep the records up to date.
  4. The auditor can effectively make use of the work performed by the internal auditor by the planned co-ordination of his work.
  5. Internal audit detects the misuse of resources in time which helps to reduce unnecessary expenses.
  6. Internal audit checks the efficiency of staff which helps to increase the efficiency of them.
  7. Internal audit increases the morale of honest staff because the evaluation of the performance of any staff will be made at any time.

Disadvantages of Internal Audit

Side by side with the advantages, there are some disadvantages. They are given as follows:

  1. Internal audits report is not accepted by either the shareholders or tax authorities, it is the external auditor report which is required to be submitted to these parties.
  2. Since the internal audit is done by the employees of the company chances are that it may be biased and therefore a company cannot depend on such reports.
  3. Since an internal audit is not done by the professional auditor chances of the internal auditors not detecting the errors are high.

Charges and Responsibilities of Internal Audit

An internal auditor is assigned with several charges and responsibilities for . effectively conducting the internal audit process.

The charges and responsibilities are as follows:

  1. Develop an audit plan to evaluate the institution’s financial, operational and EDP (Electronic Data Processing) controls.
  2. Assess the economic and efficient use of resources.
  3. Determine the level of compliance with established laws, rules, policies and procedures.
  4. Recommend the adoption of desirable policies or changes to existing policies.
  5. Follow-up on the adequacy of corrective actions.
  6. Conduct special projects at the request of the Board.
  7. Investigate cases of misappropriation, misconduct, fraud.
  8. Establish and maintain a professional rapport with external auditors and management.
  9. Keep Audit Committee and Board fully informed on a timely basis of the activities of the Internal Auditing Department.
  10. Follow the Standards of the Professional Practice of Internal Auditing and Code of Ethics as promulgated by the Institute of Internal Auditors.

Essentials for Effective Internal Auditing

To be effective, internal auditing has to satisfy some essential features. These features are described below:

  1. Independence

The internal auditor should have independence in terms of organizational status and personal objectivity which permits the proper performance of his duties.

  1. Staffing and Training

The internal audit unit should be appropriately staffed in terms of numbers, grades, qualifications, and experience, having regard to its responsibilities and objectives. The internal auditor should be properly trained to fulfill all his responsibilities.

  1. Relationships

The internal auditor should seek to foster a constructive working relationship and mutual understanding with management, with external auditors, with any other review agencies and, where one exists, the audit committee.

  1. Due Care

The internal auditor should exercise due care in fulfilling his responsibilities.

  1. Planning, Controlling, and Recording

The internal auditor should adequately plan, control and record his work.

  1. Evaluation of the Internal Control System

The internal auditor should identify and evaluate the organization’s internal control system as a basis for reporting upon its adequacy and effectiveness.

  1. Evidence

The internal auditor should obtain sufficient, relevant and reliable evidence on which to base reasonable conclusions and recommendations.

  1. Reporting and Follow-up

The internal auditor should ensure that findings, conclusions, and recommendations arising from each internal audit assignment are communicated promptly to the appropriate level of management and he should actively seek a response.

He should ensure that arrangements are made to follow up audit recommendations to monitor what action has been taken on them.

Differences between Internal Audit and Statutory Audit

DifferenceInternal AuditorExternal Auditor
AppointmentAn internal auditor is appointed by the management of the company.An external auditor is appointed by the shareholders of the company.
Legal positionLegally internal audit is not compulsory.The external audit is compulsory by law.
Status of auditorAn internal auditor is an employee of the company.External auditor is an independent person.
Conduct of auditAn internal audit is a kind of continuous audit.The external audit is generally conducted after the preparation of the final accounts.
Scope of workThe scope of work by the internal auditor is determined by management.The scope of work by the external auditor is determined by law.
QualificationFor internal auditors, any specific qualification is not compulsory.For external auditor specific qualification is compulsory.
Submission of reportThe internal auditor has not to submit any report.The external auditor submits a report to the shareholders.
Fixation of remunerationInternal auditor remuneration is fixed by the management of the company.External auditor remuneration is fixed by the shareholders of the company.
Nature of checkingThe internal auditor checks all the transactions.External auditors may apply test checks.
Right of Attending meetingThe internal auditor has no right to attend the meetings of the company’s shareholders.The external auditor has a right to attend the meetings.
DutiesThe internal auditor’s primary duty is to find the frauds and errors.The external auditor does not need to give suggestions unless he is asked.
RemovalThe internal auditor can be removed by the management.External auditors can be removed by the shareholders.
Case of misconductThe internal auditor cannot be prosecuted for professional misconduct except (C.A).External auditors can be prosecuted.
Watch-dogThe internal auditor acts as a watch-dog for the directors.The external auditor acts as a watch-dog for the shareholders.