ACCA P7 Chapter 14 Internal Audit

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Chapter 14

Considering the work of internal auditors

Internal auditing is an independent appraisal function established within an organisation to examine and evaluate its activities as a service to the organisation. It is a control which functions by examining and evaluating the adequacy and effectiveness of other controls.

The establishment of an internal audit function is seen as good corporate governance.

Types of internal audit

The internal audit department could be involved in the following types of audit:

Compliance auditing

This would be concerned with the compliance of procedures with internal controls as laid down by management.

Efficiency auditing

This would be concerned with determining whether resources are being used efficiently. For example, the auditor would be interested in determining whether costs are being minimised.

Effectiveness auditing

This would be concerned with determining whether resources are being used to proper effect. For example, the auditor might consider whether it would be better for the entity to lease vans rather than purchase them outright.

Operational auditing

This encompasses both efficiency and effectiveness. The idea is that the auditor is concerned with the whole organisation and not just with finance and accounting.

Relationship with external auditors

The external auditor

The objective of the external auditor is to form an opinion on the truth and fairness of the financial statements. Reliance may be placed on the internal controls but this is seen as a short cut to examining all the transactions for the period.

The internal auditor

The prime objective of the internal auditor is to advise the management on whether its major operations have sound systems of internal controls. Therefore, they will test transactions to confirm the evaluation and determine the implications of any systems weaknesses. These systems are designed to ensure the future welfare of the entity rather than accounting for its activities.

Similarities

Both the external and the internal auditor carry out controls testing and both are concerned that the entity complies with its control procedures. However, the external auditor is more focused on financial systems and the financial statements.

Both operate as professionals and both produce formal reports on their activities.

Differences

The external auditor is not an employee of the entity. Internal auditors work for and on behalf of the entity.

Internal audit is not a legal requirement. It is a voluntary function which covers all the entity’s operations, not just the financial ones.

Internal auditors report to the board of directors or the audit committee. The external auditors report to the shareholders.

Example

Explain the reasons why internal auditors should, or should not, report their findings on internal control to the following selection of entity officials:

(a) the finance director

(b) the board of directors

(c) the audit committee

Outsourced internal audit services

Internal audit is not mandatory, so many entities have decided to outsource or contract out the function. This may result in the external audit firm providing both the external and the internal audit function.

The advantages of outsourcing internal audit include the following:

• some organisations are not large enough to warrant a separate internal audit department. Outsourcing is therefore the only means by which they can benefit from the function.
• the independence of the function is enhanced.
• the investigation of sensitive areas such as management fraud are easier if outsourcing is used.
• external providers may have more access to specialist knowledge.

However, there may be disadvantages as well:

• outsourcing internal audit appears to go against the spirit of corporate governance which regards regular monitoring of key controls by internal audit as an integral part of the entity’s system of controls.
• using external providers may be more expensive because they are paid fees which include a profit element.
• external staff may change frequently and the new staff will have to become acquainted with the system. Internal staff usually know the system better and can therefore identify problems more easily. They are also closer to the daily activities of the entity and may get earlier indications of developments or problems.

Example

What are the ethical implications of the external audit firm providing both external and internal audit services to a client?