Internal/External Audit
Corporate Governance part 5
What is Internal Audit?
The role of internal audit is to provide independent assurance that an
organization's risk management, governance and internal control processes
are operating effectively.
What is its value to the organization?
Internal auditors deal with issues that are fundamentally important to the survival
and prosperity of any organization. Unlike external auditors, they look beyond
financial risks and statements to consider wider issues such as the organization's
reputation, growth, its impact on the environment and the way it treats its
employees.
In sum, internal auditors help organizations to succeed.
The difference between internal and
external audit
While sharing some characteristics, internal and external audit have very different
objectives. These are explained in the table on the following pages:
Reports to
• External Audit
shareholders or members who
are outside the organizations
governance structure.
• Internal Audit
The board and senior management who
are within the organizations governance
structure.
Objectives
• External Audit
Add credibility and reliability to financial
reports from the organization to its
stakeholders by giving opinion on the
report
• Internal Audit
Evaluate and improve the
effectiveness of governance, risk
management and control
processes. This provides members
of the boards and senior
management with assurance that
helps them fulfil their duties to the
organization and its stakeholders.
Coverage
• External Audit
• Internal Audit
Financial reports, financial reporting
risks.
All categories of risk, their management,
including reporting on them.
Responsibility for improvement
• External Audit
• Internal Audit
None, however there is a duty to report
problems.
Improvement is fundamental to the
purpose of internal auditing. But it is
done by advising, coaching and
facilitating in order to not undermine the
responsibility of management.
Qualification and special skills
To be effective, the internal audit activity must have qualified, skilled and
experienced people who can work in accordance with the Code of ethics and
the International Standards.
Cadbury Report on Internal Audit
The function of the internal auditors is complementary to, but different from, that of
the outside auditors. It is regarded as good practice for companies to establish
internal audit functions to undertake regular monitoring of key controls and
procedures. Such regular monitoring is an integral part of a company’s system of
internal control and helps to ensure its effectiveness. An internal audit function is
well placed to undertake investigations on behalf of the audit committee and to follow
up any suspicion of fraud. It is essential that heads of internal audit should have
unrestricted access to the chairman of the audit committee in order to ensure the
independence of their position.
Importance of Audit
The annual audit is one of the cornerstones of corporate governance. Directors are
required to report on their stewardship by means of the annual report and financial
statements sent to the shareholders. The audit provides an external and
objective check on the way in which the financial statements have been
prepared and presented, and it is an essential part of the checks and balances
required. The question is not whether there should be an audit, but how to ensure
its 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 method
of ensuring that companies are accountable for their actions is through
open disclosure by boards and through audits carried out against strict
accounting standards.
Internal Control
An effective internal control system is an essential part of the efficient management
of a company.
Directors should report on the effectiveness of their system of internal control, and
the auditors should report on their statement. A great deal of detailed work is now
necessary to develop these proposals, and the accountancy profession, in
conjunction 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 should
report; and
(c) developing guidance for auditors on relevant audit procedures and the form in
which auditors should report.
Fraud
The prime responsibility for the prevention and detection of fraud (and other
illegal acts) is that of the board, as part of its fiduciary responsibility for protecting
the assets of the company. The auditor’s responsibility, as defined in auditing
guidance, is properly to plan, perform and evaluate his audit work so as to
have a reasonable expectation of detecting material misstatements in the financial
statements.
Problem for the auditors is when they suspect that top management itself is
implicated in the fraud, without having the necessary evidence to back up their
suspicions. 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-minded
audit committee is an essential safeguard. It has an important role to play in
considering B AUDITING whether any extra work should be undertaken in
addition to the normal audit procedures to investigate defencess against fraud.
The audit committee also provides a forum in which auditors can discuss at board
level any concern they may have about the possibility of fraud by senior
management. It can then decide whatever investigations are necessary to resolve
the matter.
A group of at least 3 individuals responsible for overseeing all internal and external audit
functions of a company. In addition, at least one member must be a financial expert or
have significant financial expertise.
• Audit committees are responsible for selecting and appraising independent and
external 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 adequate
compliance with SEC and GAPP standards.
Because staff on audit committees report to the board of directors of a company, they
cannot have ties to the company`s management team or be in a position where their
independence can be questioned.
CPA firm – Certified Public Accountant firm
SEC – Security Exchange Commission – Federal government regulatory
GAPP – General Accepted Accounting Principles