Internal and Governmental
Financial Auditing
and Operational Auditing
Chapter 26
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Learning Objective 1
Explain the role of internal
auditors in financial auditing.
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Internal Auditing
 The New York Stock Exchange requires its
registrants to have an internal audit function
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Internal Auditing
It 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.
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Institute of Internal Auditors
Ethical Principles
 Objectivity
 Confidentiality
 Competency
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Institute of Internal Auditors
Rules of Conduct
 Integrity
 Objectivity
 Confidentiality
 Competency
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Relationship of Internal and
External Auditors
Differences:
 The internal auditor is responsible
to management
 The external auditor is responsible
to financial statement users
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Relationship of Internal and
External Auditors
Similarities:
 Competency
 Objectivity
 Methodology
 Audit risk model
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Learning Objective 2
Describe the auditing and
reporting requirements under
Government Auditing Standards
and the Single Audit Act
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Governmental Financial
Auditing
The primary source of authoritative literature
for performance of government audits is
Government Auditing Standards,
which is issued by the GAO.
Because of the color of the cover, it is usually
referred to as the “Yellow Book.”
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Governmental Financial
Auditing
The Yellow Book standards are often called
generally accepted government auditing
standards (GAGAS).
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Financial Audit and Reporting
Requirements – Yellow Book
 Materiality and significance
 Compliance auditing
 Reporting
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Audit and Reporting – Single Audit
Act and OMB Circular A-133
The threshold for requiring a single audit is $500,000.
The office of Management and Budget issued
a revised Circular A-133, Audits of States,
Local Governments, and Non-Profit
Organizations, to provide administrative
guidance for implementing the
single audit requirements.
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Audit Requirements
The audit should be in accordance with
generally accepted government auditing
standards (GAGAS).
The auditor must obtain an understanding
of internal control over federal programs
sufficient to support a low assessed
level of control risk for major programs.
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Audit Requirements
The auditor should determine whether the client
had complied with the laws, regulations, and the
provisions of contracts or grant agreements
that may have a direct and material effect
on each of its major programs.
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Reporting Requirements
 An opinion on whether the financial
statements are in accordance with GAAP
 An opinion as to whether the schedule of
federal awards is presented fairly in all
material respects in relation to the
financial statements as a whole
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Reporting Requirements
 A report on internal control related to the
financial statements and major programs
 A report on compliance with laws,
regulations, and the provisions of
contracts or grant agreements
 A schedule of findings and questioned costs
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Operational Auditing
 The purpose of operational auditing is to
determine the effectiveness or efficiency
of any part of an organization
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Learning Objective 3
Distinguish operational auditing
from financial auditing.
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Differences Between Operational
and Financial Auditing
 Purpose of the audit
 Distribution of the reports
 Inclusion of nonfinancial areas
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Learning Objective 4
Provide an overview of
operational audits.
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Effectiveness Versus Efficiency
 Effectiveness refers to the accomplishment
of objectives
 Efficiency is defined as reducing costs
without reducing effectiveness
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Effectiveness Versus Efficiency
Types of Inefficiency
Example
Acquisition of goods and
services is too costly
Bids for purchases of
materials are not required
Raw materials are not
available when needed
An assembly line was shut
down for lack of materials
A duplication of effort
by employees exists
Production and accounting
keep identical records
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Effectiveness Versus Efficiency
Types of Inefficiency
Example
Work is done that serves
no purpose
Vendors’ invoices and
receiving reports are filed
without being used
There are too many
employees
Office work could be done
with one less assistant
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Relationship Between Operational
Auditing and Internal Controls
 Reliability of financial reporting
 Efficiency and effectiveness of operations
 Compliance with applicable laws and regulations
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Types of Operational Audits
 Functional
 Organizational
 Special assignments
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Who Performs Operational
Audits
 Internal auditors
 Government auditors
 CPA firms
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Independence and Competence
of Operational Auditors
The two most important qualities
for an operational auditor are:
 Independence
 Competence
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Learning Objective 5
Plan and perform an
operational audit.
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Specific Criteria
Questions that might be used to evaluate
plant layouts:
 Were all plant layouts approved by home office
engineering at the time of original design?
 Has home office engineering done a reevaluation
study of plant layout in the past five years?
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Specific Criteria
 Is each piece of equipment operating
at least 60 percent of capacity for
three months or more each year?
 Does layout facilitate the movement of
new materials to the production floor?
 Does layout facilitate the production
of finished goods?
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Specific Criteria
 Does layout facilitate the movement of
finished goods to distribution centers?
 Does the plant layout effectively use
existing equipment?
 Is the safety of employees endangered
by the plant layout?
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Sources of Criteria
 Historical performance
 Benchmarking
 Engineered standards
 Discussion and agreement
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Phases in Operational Auditing
 Planning
 Evidence accumulation and evaluation
 Reporting and follow up
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Planning
 Scope of engagement
 Staffing
 Background information
 Understand internal control
 Decide on appropriate evidence
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Evidence Accumulation
and Evaluation
 Documentation
 Client inquiry
 Analytical procedures
 Observation
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Reporting and Follow Up
Two major differences in operational
and financial auditing reports:
1. In operational audits, the report is
usually sent only to management
2. Tailoring of each report is required
in operational audits
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Examples of Operational
Audit Findings
 Outside janitorial firm saves $160,000
 Use the right tool
 Computer programs save manual labor
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End of Chapter 26
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