Chapter #05 INTERNAL AUDIT

Q: What is an internal Audit ?

Ans : it is an appraisal / monitoring activity established by the entity with in the
entity to provide services to that entity.

Difference between internal and external audit:

Internal audit
 The objective of the internal audit is to improve operation.(not to give
opinion).
 Internal auditors are employees of companies.
 Internal auditors are appointed by & report to management.
 Internal auditors are paid salaries.
 Scope of work of internal audit is defined by management.
 To be an internal auditor no qualification or membership of the professional
body is required.

External audit
 The objective of this is to give opinion on financial statements.
 External auditors are not the employees of the companies.
 External auditors are appointed & reports to share holders of the companies.
 External auditors are paid fees.(Audit fee).
 Scope of work of external audit is defined by ISA’s
 To be an external auditor qualification and membership of the professional
body will be required.
Q: WHAT TASKS ARE CARRIED OUT BY INTERNAL
AUDITORS?
Ans. Since internal auditors are employees of the company they can be asked to
perform any task, however they typically carry out the following tasks:

 VFM(VALUE FOR MONEY) AUDIT:

In VFM audit internal audit department evaluates weather
company is achieving three E’s which is economy (low cost), efficiency (high
output) and effectiveness (achieve objective) on any of its task.

 COMPLAINCE AUDIT:
Compliance means following laws, rules and regulations. In
compliance audit internal audit department is asked to assess what are the laws and
rules which company has to comply & check weather company complies with such
laws and regulations. A compliance report is usually asked.

 BEST VALUE AUDIT:

In best value audit internal audit department is asked to
check weather company is giving best values to it’s customers or not. This is
usually done by comparing our company with other company.

 PREVENTING AND DETECTING FRAUD & ERRORS:

The ultimate and primary responsibility for preventing and
detecting fraud and errors lies with management & those charged with governance.
It is important that management develop a culture which makes it difficult to do
fraud and people avoid fraud due to un ethical things. Internal audit department can
assist management in identifying areas of fraud, they may recommend controls to
reduce chances of fraud. They may carryout fraud investigation however the very
existence of internal audit department act as a deterrence (barrier)to fraud.

 IT AUDITS:
They check if the IT systems have proper controls to protect
data and ensure reliable processing. They identify IT-related risks and suggest
ways to manage them. They ensure the IT systems comply with laws and
regulations. They suggest improvements for IT operations to enhance efficiency
and effectiveness. They find vulnerabilities in the IT systems and recommend
fixes.

 ASSIST IN PREPARATION OF F/S:

Internal auditors review financial records to ensure all
numbers are accurate. They double-check that the financial statements (like
balance sheets and income statements) are correct. They look for any errors or
inconsistencies in the records. If they find mistakes, they help fix them, so the
financial statements are reliable. They make sure the company follows all
accounting and financial regulations. This means the financial statements meet
legal and regulatory standards. Internal auditors watch for any signs of fraud or
dishonest activities. They help create policies to prevent such issues, ensuring the
financial statements are honest and transparent. They suggest ways to improve
financial processes and controls, making the system more efficient and reducing
the risk of errors in financial statements.

 ASSIST IN RISK MANAGEMENT ETC:

Internal auditors help find potential risks that could
affect the organization, such as financial troubles, operational hiccups, or
compliance issues. They evaluate how likely these risks are and what impact they
could have. This helps the organization understand which risks are more critical.
They check the existing measures in place to manage these risks. They assess if
these controls are working well and identify any weaknesses. Based on their
findings, internal auditors recommend ways to improve risk management. This
could include new controls or better practices. They continuously monitor risk
management activities and report their findings to management. This ensures any
issues are addressed promptly.
FACTORS TO CONSIDER BY EXTERNAL AUDITORS
BEFORE PLACING RELIANCE ON WORK OF INTERNAL
AUDIT…

INDEPENDENCE:

Since internal auditor are employees of the company they are

unlikely to be independent. So external auditors first check their independence
before placing reliance on their work.

TECHNICAL COMPETENCE:

Since internal auditors are not required to have professional

qualification or a membership of professional body, they are likely to be
incompetent. So external auditors check their competence before relying on their
work.

SCOPE OF WORK:

Since it is likely that internal auditors work may not be of too much
use for external auditors, therefor they first check scope of work of internal audit
before relying on their work.
ADVANTAGES OF INTERNAL AUDITORS
 No need of external consultants
 Contribution to company (They identify and evaluate potential risks that
could impact the company, helping to minimize or prevent those risks.
Internal auditors review and suggest improvements for business processes,
ensuring efficiency and effectiveness. They ensure that the company adheres
to laws, regulations, and internal policies, avoiding legal issues and
penalties. By auditing financial records, they help maintain accurate and
reliable financial reporting. Internal auditors can detect and prevent fraud by
examining and testing internal controls).
 Exceptional jobs ( simply preferable for exception personnel like in a
company every one is not familiar to check the financial accuracy, identifies
risk and compliance there for persons who are familiar with these matter
should be exception, because only they have the ability to perform that tasks
even in more organized way.
 it ensures organization detailed standards procedures rules & regulation that
adhere to laws and regulation are running smoothly.
 It provides excellent training grounds. (to getting trained and then proceeds
to coy senior executive in near future).

DIS-ADVANTAGES OF INTERNAL AUDITORS

 Independence issues (they are not likely to be independent).

 Highly cost (since they are salaried staff to be hired there for).
 Resistance from other departments. (for the eyesight keeping on other
departments, other departments will not Recommended them to be consider
on day- to- day routine, they don’t like them).
 External parties don’t rely on their work. (like banks and taxation authorities
will don’t trust on their work).
 Creates self-review threats. (when they are called to re-check all financial
data before arrival of the external auditors then they will re check the data
and it will Leads them to self- review threats)
 Qualification issues. (it’s also can be a problem for a Companies to hires the
recruiters who are not qualified for the specific role).
 Note: some companies have their own internal audit departments while
There are also companies which have not yet retain their internal audit
department in their companies but instead they have outsourced their
internal audit function to external audit firms like PWC, E&Y, KPMG,
DELLOITE ETC…. to perform their internal audit as well.

Q: WHAT IS MEANT BY “OUTSOURCING OF INTERNAL AUDIT”?

Ans: outsource of internal audit:

Outsourcing of internal audit means hiring an external

company or firm to perform the internal audit functions for your organization.
Instead of having an in-house internal audit team, you rely on these external
experts. because with these You gain access to specialized skills and knowledge
from professionals outside your organization. It can be more economical,
especially for smaller companies, as you don't need to maintain a full-time internal
audit staff. An external team provides an unbiased and independent assessment of
your operations.

ADVANTAGES THE OUT SOURCING OF INTERNAL AUDIT

DEPARTMENTS:
 Internal audit staff does not need to be permanently recruited or hired. (as
you outsourced your int audit to external firm therefor no need to hired a
staff).
 Internal audit staff can be used for a wider range of services(when you was
your own internal audit function then your work was limited up to some
extent means (limited tasks) that your staff will not performed in more
detailed approach, now when you outsource your internal audit you hold
some experts to work for you, ultimately they will perform the audit in more
organized and detailed approach).
 Outsource are providers of specialist service.
 Outsource are providers of immediate service. (pay on the spot they will
workout immediately).
 Skills required for obvious short period of time in nature can be provided
without incurring excessive cost of maintaining and house developments.
 (since it’s not a salaried staff for the time now whenever you use it you will
only incurred charges for that time, you will not need to maintenance cost or
development).
 Outsourcers could provide access to new techniques without the need of
significant level of investment in house development. (When a company
outsources its internal audit, it can benefit from new techniques and
advanced methods used by external experts. This means that, outsourced
auditors bring specialized skills and innovative approaches that the company
might not have in-house. The company doesn't have to spend a lot of money
developing these techniques internally. The company can quickly tap into
these new methods without delay.
 With a professional outsourced department less management time is required
in our internal audit activities.
 Associated cost such as hiring cost or training cost are eliminated.
 Services can be acquired for the desired period as per the needs of the
company of the Company (not to give a payment for full year, but instead
whenever you need audit no matter either 2 months or three months or 2
years or three years you will only pay charges for that i-e Audit Fee).
 service provider will also indemnifying(defend) case of laws to the
company.
 Outsourcing lays the basic of a permanent functions by setting such policies
and cultures.(by creating just like those cultures and policies if when the
company wish to retain the internal audit function In the house, then they
can easily adopt these policies and cultures that for their internal audit
department in advance).

DIS-ADVANTAGES OF OUTSOURCING OF INTERNAL

AUDIT:
 Conflict of interest and independence In objective issues may arise if
outsource internal audit service has been provided by external auditors. ( for
instance if company xyz have their own internal audit department called
E&Y and they also had outsourced external audit which is also E&Y then
there is issue of independence is likely to arise. Because both are belongs to
E&Y.
  Outsourcing may be expensive for the company as services being acquired
from the professional services i-e external audit firm. Which may charged
a high fee.
 An outsource department may not be as flexible when problem arises, since
it don’t have a permanent presence.(no permanent presence).
 Standard of service may not give to the requirement of the company. (you
have force your internal audit staff to do task or even Pressurized them as
well, but if once you out-source your internal audit to external auditor then
now you will have to be careful and listen and accept all the needs of the
external audit with out any pressure or power).
 Loss of in house skills company staff may oppose outsourcing if it results in
existing staff make redundant.(when you outsource the existing staff will in
opposition because you have make them redundant and they will not be
agree to you with these decision).
 Lack of control over the audit staff of the outsource firm (when you have
your own internal audit then you have power and control over it, but now
you have outsourced it there for care can be taken because your control is
limited now).
 Lack of Loyalty issue (when you have your internal audit deptt your staff are
loyal to you, as you outsourced now perhaps you can’t expect loyalty from
external audit staff.

INTERNAL AUDIT REPORT:

As it is report that will be issued by internal audit department there for no specific
standard of format is required. format will be deciding as per requirement of
company management wing.

However typically the format is likely to be include after supervision:

 Identifying weaknesses in the department.

 Impacts of that weaknesses.
 Finally recommendations of the report.
 For example: ABC company sales department have recently doing the
activity and provide credits to customers.
After performed the audit:
The weakness, impacts and recommendations are given.
Weakness……. (ABC company don’t check credit prior to give further
credits.
Impacts……….(Bad debts likely to be happening).
Recommendations……..(credit should be checked before sales is made).

ATTRIBUTE OF HIGH QUALITY AUDIT REPORTS:

Accurate: Ensuring all data and information in the report is correct and based on
reliable sources.

Complete: Including all necessary information and covering all relevant aspects
of the audit without leaving anything important out.

Concise: Being brief and to the point, avoiding unnecessary details and keeping
the report focused.

User-Friendly: Presenting the report in a way that is easy to read and understand,
using clear language and helpful visuals.

Realistic: Providing practical and achievable recommendations that can be

implemented effectively.

Attainable: Setting feasible goals and suggestions that can be accomplished

within the organization's capabilities.

Time Bounded: Including specific timelines for implementing the

recommendations and addressing the issues.

Earliest: Delivering the report as soon as possible to allow stakeholders to take

prompt action.
PRACTICE QUESTIONS ?
Q1: SPD has been trading for 10 years provides advise on pension and another
financial products to its clients. SPD is not listed on stock exchange but it’s
regulated buy a governing body to ensure financial advices always provides in the
best interest of customer. SPD have seen a rapid growth in revenue over the last 12
months and expects this to continue. In order to meet client demand it opened new
product SPD now offering more complex financial products .SPD has also a need
of additional funding to support it in order to determined weather the additional
fund might be available . the BOD is also considering a bank loan to determine
weather or not we should obtain a listing on stock exchange?

Req 1: what is meant by corporate governance?

Req 2: explain why it’s important?

Answer :

Corporate governance: CG is a system by which entity is directed and

controlled.

CG is important because lack of such system will means CEO and chairman will
be same there will be no committee hence accountability will become difficult.

Question 2:

You are the audit manager of wood industries limited liability companies.the
companies annual revenues is 10 million?

R1) compare the responsibilities of directors and auditors regarding published

financial statements.

R2) briefly explain the difference between reasonable and limited assurance.

Question 3: explain the overall authorities of ISA’S?