Internal and
Governmental
Financial Auditing and
Operational Auditing
Chapter 26
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 1
Learning Objective 1
Explain the role of internal
auditors in financial auditing.
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 2
Internal Auditing
The New York Stock Exchange requires its
registrants to have an internal audit function.
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 3
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.
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 4
Institute of Internal Auditors
Ethical Principles
Integrity
Objectivity
Confidentiality
Competency
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 5
Relationship of Internal and
External Auditors
The external auditor is responsible
to financial statement users.
The internal auditor is responsible
to management.
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 6
Relationship of Internal and
External Auditors
Competency
Objectivity
Methodology
Audit risk model
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 7
Learning Objective 2
Describe the auditing and
reporting requirements under
Government Auditing Standards
and the Single Audit Act
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 8
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.”
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 9
Governmental Financial Auditing
The Yellow Book standards are often called
generally accepted government auditing
standards (GAGAS).
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 10
Financial Audit and Reporting
Requirements – Yellow Book
Materiality and significance
 Quality control
 Compliance auditing
 Reporting
 Audit files

©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 11
Audit and Reporting – Single Audit
Act and OMB Circular A-133
The threshold for requiring a single audit
was raised from $100,000 to $300,000
to exempt many smaller entities
from single audit requirements.
The OMB increased the single audit
threshold to $500,000 beginning in 2004.
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 12
Audit and Reporting – Single Audit
Act and OMB Circular A-133
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.
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 13
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.
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 14
Audit Requirements
The auditor should determine whether the client
had complied with laws, regulations, and the
provisions of contracts or grant agreements
that may have a direct and material effect
on each of its major programs.
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 15
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
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 16
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
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 17
Operational Auditing
The purpose of operational auditing is to
determine the effectiveness or efficiency
of any part of an organization.
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 18
Learning Objective 3
Distinguish operational auditing
from financial auditing.
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 19
Differences between Operational
and Financial Auditing
Purpose of the audit
Distribution of the reports
Inclusion of nonfinancial areas
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 20
Learning Objective 4
Provide an overview of
operational audits.
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 21
Effectiveness Versus Efficiency
Effectiveness refers to the accomplishment
of objectives.
Efficiency is defined as reducing costs without
reducing effectiveness.
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 22
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.
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 23
Effectiveness Versus Efficiency
Types of inefficiency
Example
Vendors’ invoices and
Work is done that serves no
receiving reports are filed
purpose.
without being used.
There are too many
employees
Office work could be done
with one less assistant.
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 24
Relationship between Operational
Auditing and Internal Controls
Reliability of financial reporting
Efficiency and effectiveness of operations
Compliance with applicable laws and regulations
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 25
Types of Operational Audits
Functional
Organizational
Special assignments
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 26
Who Performs Operational Audits
Internal
auditors
Government
auditors
CPA firms
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 27
Independence and Competence
of Operational Auditors
The two most important qualities for
an operational auditor are:
Independence
Competence
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 28
Learning Objective 5
Plan and perform an operational
audit.
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 29
Specific Criteria
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?
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 30
Specific Criteria
Is each piece of equipment operating at
60 percent of capacity or more for at
least three months each year?
Does layout facilitate the movement of new
materials to the production floor?
Does layout facilitate the production of finished
goods?
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 31
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?
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 32
Sources of Criteria
Historical performance
Benchmarking
Engineers standards
Discussion and agreement
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 33
Phases in Operational Auditing
Planning
Evidence accumulation and evaluation
Reporting and follow-up
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 34
Planning
• Scope of engagement
• Staffing
• Background information
• Understand internal control
• Decide on appropriate evidence
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 35
Evidence Accumulation and
Evaluation
• Documentation
• Client inquiry
• Observation
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 36
Reporting Follow-up
• Report usually sent to management
• Tailored reports
• Follow-up on recommendations
with management
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 37
Examples of Operational Audit
Findings
• Outside janitorial firm saves $160,000
• More timely credit memo processing
• Use the right tool
• Computer programs save manual labor
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 38
End of Chapter 26
©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder
22 - 39