The role and nature of internal audit

Efficient and ethical corporate governance and internal audit function became increasingly important for investors after Enron scandal in 2001. This article focuses on the nature of internal audit, shows differences with external audit and provides overview of main audit assignments.

1. The role of internal audit in corporate governance

Internal audit is the process of examining, evaluating and monitoring internal control policies and procedures. Internal auditors provide assurance to management regarding the effectiveness of a company's risk management and internal control systems.

Generally, companies are not required to carry internal audit arrangements; however, it is a part of good corporate governance to establish a separate internal audit department or simply outsource this function if more appropriate. Consequently, internal audit is typically a feature of large corporations.

Main responsibilities of internal auditors include the providing of assurance regarding the following:

  • Internal controls are effective;
  • Financial and key managerial information in the reports is fair and reliable;
  • Systems are running effectively;
  • Implemented internal control procedures are followed.

2. Differences between external and internal audit

Although some of the work carried out by internal auditors is similar to that performed by external auditors, particularly in areas dealing with the internal controls assessment, there are a range of important distinctions:

  • Internal auditors report to the directors or the audit committee, while external auditors report to the shareholders.
  • The objective of the internal audit department is to add value to the company by improving the companyís operations and internal controls, while the aim of the external audit is to provide independent opinion on the financial statements of the company.
  • In relation to the company, internal auditors are usually employees (or the function is outsourced), whereas external auditors are independent of the company.
  • In contrast to external auditors, there are no legal requirements regarding qualification of the internal audit specialists.
  • Regarding publicity, reports produced by internal auditors are private, whereas those of external auditors are publicly available.

Consequently, the work of internal auditors differs from the work of external auditors in term of strategic planning, materiality and procedures used to obtain the required level of evidence. For instance, in order to obtain assurance over a companyís revenue, external auditors are likely to test efficiency of key controls and request several counterparties (based on the materiality level) to confirm annual turnovers with the company. In contrast to that, internal auditors may not set any materiality level, but they are likely to test all relevant controls implemented and review a rather large sample of internal invoices. As the latter may be too time consuming, it may be decided to follow a schedule for internal audit reviews by locations.

3. Internal audit assignments

Internal audit assignments will vary from business to business as these assignments will be determined by management of each company depending on its needs. Namely, a financial audit is conducted to identify errors and detect fraud in both financial and managerial reporting. IT related assignments are carried to ensure that IT systems produce reliable information for report preparation. Value for money audits (often referred to 3Es or Economy, Efficiency and Effectiveness) help to find out the best combination of services for the least amount of resources.

Operational audits provide assurance that polices are appropriate and are adhered to.

For example, if a company is exposed to interest rates risk, the internal auditors should ensure that the risk is managed in accordance with the set procedures, such as involvement of borrowed funds with both fixed and floating interest rates, etc.

Internal auditors may also perform special investigations if fraud is suspended, as well as assist external auditors in obtaining requested information during an audit engagement.

Internal audit increases the quality of information provided to the management. However, care should be taken to ensure that reports of the internal audit department are objective and independent, as internal auditors, on one hand, are employed by management and, on the other hand, they should review managementís work. Consequently, internal auditors may suffer pressure to oversee certain inefficiencies or fraud.

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