Chapter 12 - Internal Audit

Question 1

External auditors

Answer 1

External audit
1. Objective
Express an opinion on the truth and fairness of the financial statements in a written report.

2. Reporting
   Report to shareholders.
3. Availability of report
   Publicly available.
4. Scope of work
   Verifying the truth and fairness of the FS.
5. Appointment and removal
   By the shareholders of the company.
6. Relationship with company
   Must be independent of the company.

Question 2

Internal auditors

Answer 2

Internal audit
1. Objective
Improve the company’s operations by reviewing the efficiency and effectiveness of internal controls.

2. Reporting
   Reports to management or those charged with governance.
3. Availability of report
   Not publicly available.
   Usually only seen by management or those charged with governance.
4. Scope of work
   Wide in scope and dependent on management’s requirements.
5. Appointment and removal
   By the audit committee or board of directors.
6. Relationship with company
   May be employees (which limits independence) or an outsourced function (which enhances independence).

Question 3

The role of internal audit

Answer 3

1. Whether the company is demonstrating best practice in corporate governance.
2. Risk identification and management.
3. Effectiveness of internal controls.
4. Reliability of financial and operating information.
5. Economy, efficiency and effectiveness of operating activities.
6. Assessing compliance with laws and regulations.
7. Prevention and detection of fraud.

Question 4

Limitations of internal audit

Answer 4

1. Internal auditors may be employees of the company they are reporting on and therefore may not wish to raise issues in case they lose their job.
2. In smaller organisations, internal audit may be managed as part of the finance function. Therefore they will report on the effectiveness of financial systems and reluctant to say their department has deficiencies.
3. If the internal audit staff have worked in the organisation for a long time, there may be a familiarity threat as they will be audited the work of long standing colleagues and friends.

Question 5

Outsourcing the Internal audit function

Answer 5

Advantages
1. Greater focus on cost and efficiency of the internal audit function.

2. Staff may be drawn from a broader range of expertise.
3. Risk of staff turnover is passed to the outsourcing firm.
4. Specialist skills may be more readily available.
5. Costs of employing permanent staff are avoided.
6. May improve independence.
7. Access to new market place technologies.
8. Reduced management time in administering an in house department.

Disadvantages
1. Possible conflict of interest if provided by external auditors.

2. Pressure on the independence of the outsourced function e.g. Threat by management not to renew contract.
3. Risk of lack of knowledge and understanding of the organisations objectives, culture or business.
4. The decision may be based on cost with the effectiveness of the function being reduced.
5. Flexibility and availability may not be as high as with in house function.
6. Lack of control over standard of service.
7. Risk of blurring of roles between internal and external audit, losing credibility for both.

Question 6

Value for money

Answer 6

Economy - obtaining the best quality of resources for the minimum cost.

Efficiency - obtaining the maximum departmental/ organisational outputs with the minimum use of resources.

Effectiveness - achievement of goals and targets.