Why Do You Need to Conduct Internal Audit in Your Company?

Why Do You Need to Conduct Internal Audit in Your Company?

Businesses can get a decent idea of how they are doing in operations by examining company data on their own. To truly gain a good picture of whether the company is operating well and get fresh ideas of how to improve their businesses, organizations may turn to an internal audit done by the external firm or auditing firms in Dubai, who specializes in this area and can also do benchmarking for its client and give a constructive audit report which makes value addition to the business.

Let us try and understand the meaning of internal audit, its advantages, how internal audit has evolved over a period of time, what is the process followed in internal audit and lastly how to measure the effectiveness and efficiency of internal audit.

Traditional Definition as a control mechanism:

Traditionally Internal Audit functions were set up by corporate management to assess the internal control system that management is responsible for establishing. It acted more as a control mechanism to review the financial controls of the company.  Then the scope of the internal auditor was increased to review internal controls in other areas of the business. It was moreover used as a control mechanism.

The new definition of Internal Audit is given by the “Institute of Internal Auditors” (IIA) the USA as follows: Internal audit 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.  From the above two definitions we can conclude the following:

Traditionally internal audit was used to review the internal controls. However, in view of the changed scenario, Internal Audit is conducted for the following purposes:

a) Tool for business performance analysis.

It can make value addition in a big way by understanding and reviewing operations in-depth and recommending cost reduction in a particular activity or suggesting new ways of earning revenue thereby assisting the top management in achieving its goal of profitability. However, the definition of value addition can vary considerably from one company to another. For many practitioners value addition may be to improve business but for some, it may be compliance with policies and controls. It depends upon the situation. Hence it is essential to ask the stakeholders and the top management to define it.

b) Corporate Laws:

Most businesses need to comply with various corporate laws as non-compliance shall have adverse implications. Internal Auditor will be playing an instrumental role in bringing about good Corporate Governance.

c) Risk Management:

To review the various types of risks that businesses faces and help the top management in managing and mitigating these risks in a better manner.

d) Proactive audit:

Internal audits are now being conducted in proactive manner rather than reactive. It is very important that internal auditor must conduct the audit either before or immediately after the occurrence of transaction rather than conducting audit of the transaction after certain gap of time.

e) Use of technology as an audit tool:

Technology is now being used in business in order to reduce cost and in order to give better service to the customer. However, the use of technology also brings with it the challenge of having internal controls in place as we all know that internal controls are very loose in a computerized environment.  Hence it is essential for the internal auditor to learn and understand the technology and also update himself with it in order to ensure that proper controls are in place and generate good audit findings from it.  There is increasing pressure on internal auditors to perform more efficiently and effectively which is possible by harnessing the use of information Technology tools which allow for more critical analysis and broader coverage of internal audit work.

f) Consulting approach:

Internal audit approach has now become more consulting in nature. Each operational area undertaken for audit is required to be conducted by the auditor who has specialized in that particular. Internal Auditor with multi-disciplinary skills will be preferred. Internal audit now focuses more on process compliance rather than transaction compliance, law compliance and adherence to established corporate policies as the organization grows.  Internal audit must help the top management in its decision-making process.

g) Consulting Assignments –

Mergers and acquisition, Frauds, Outsourcing etc: In view of the increasing global Competition and business processes becoming more complex, internal auditors are being given more and more consulting assignments such as active participation in merger and acquisition activity, cost restructuring, ERP implementation, fraud findings, co-sourcing,  preparation of audit manuals, industry research for diversification of client business, benchmarking etc.

In order to evaluate the function of the internal audit the following needs to be reviewed:

1) Audit Charter Policy on internal audit:

No internal audit function can be conducted effectively unless the top management responds in a positive manner. It is the responsibility of the top management to assess and report on the effectiveness of the company’s internal controls. Internal audit is a part of internal control which can play an effective role in monitoring controls of the company provided it gets proper cooperation of the top management. Hence internal audit should ascertain the objective of carrying out internal audit i.e audit charter which shall reflect the expectations of the stakeholders, audit committee and the top management. The scope of internal audit should be very clear to the internal auditor and the top management.

2) Reporting Aspect:

It is very important that the internal audit report directly to the top management in order to ensure that independence is not compromised.

3) Measuring the effectiveness of Internal Control:

It is observed quite frequently that internal controls are designed and are in existence but are not implemented or are not effective due to various factors. Hence it is important for the internal auditor to ascertain whether internal controls that are in existence are really implemented and are effective. The internal auditor shall be failing in his duties if this aspect is not considered in the scope of the audit.

4) Manner in the Audit report should be presented:

Audit findings to be presented in the Internal Audit report must reflect the following:

The cause of audit findings, Effect of the audit findings – Impact in monetary terms and

• Recommendation – Action required to be taken. The internal audit report must be presented to following authorities:
• Director’s summary – To be prepared for the top management.
• Executive summary – To be prepared for the Operational head.

Detailed audit report – for the operational people who are going to implement the recommendations and for the CFO of the Company.

5) Follow-up procedure:

It is very important that internal auditor follow-up for the audit findings that need to be implemented. Hence follow-up is important for the same.

6) Feedback of the auditee:

It is very important for the internal auditor to take feedback from the client on the audit report which is the final product delivered. It is important to discuss the audit findings with the respective operational dept head and incorporate their response on the audit findings in the audit report before reporting the final audit findings to the top management. Similarly feedback on the quality of the audit report should be taken from the top management.

7) Quality of Audit team:

One of the important factors on which the success of Internal audit is dependent is quality of audit team. It is important for the Chief Audit Executive to ensure that the right people having specified skills are taken for the right assignment of internal audit. For eg if IT area is taken up for audit then it is essential that person having the working knowledge of IT is there in the audit team. It is often observed that due to work pressure experience auditors devote less time to audit and newly appointed personnel are asked to complete the task who do not have knowledge, experience and expertise in that area to complete the task. Such practices may deteriorate the quality of audit and have a deep impact on the reputation of the internal audit department.

8) People management:

In order to generate audit findings data is required to be collected from the operational personnel. This requires a lot of human skills for managing people for various factors such as it demands the time of operational personnel for giving data, negative image of internal audit, conflict of interest, corporate politics etc.

Hence it is essential for the internal auditor to understand the behavior or the psychology of the operational personnel and act accordingly in smart manner in order to obtain data from the operational personnel and his views about a particular policy or procedure followed in the dept which can generate important audit findings.  He needs to give boost to the ego of the operating personnel.

9) Business & Operational Excellence:

It is very important to have an in-depth knowledge of the business and operation for which the internal auditor is conducting the audit. Without understanding the nature of business and its operations it shall not be possible to assess the various risks business faces and controls required in that respect. Similarly, it shall not be possible to generate good value improvements in terms of operational efficiency without this factor.

10) Cost Reduction:

The internal auditor is expected to play a very important role in reducing cost in various operational areas of the client company. The top management expects the internal auditor to perform this role in the light of the competition in the market. Hence it is essential for the internal auditor to have expertise in this area.

11) Proving worth of Internal Audit: -

Return on Investment: In view of the growing concern about the top management to review every cost that it incurred it is essential to justify the cost of internal audit. For this, the internal auditor and the top management must arrive at some consensus about the Criteria on the basis of which returns on the cost invested in operating Internal audit dept can be calculated. One method to calculate returns is to measure the recommendations (audit findings) in monetary terms. If the value of audit findings measured in monetary terms is compared with the cost incurred in conducting internal audit then the efficiency of the internal audit can be measured.

In today’s competitive and complex business environment where businesses face various risks for which effective controls should be in place and there is need to run operations efficiently internal audit can a play a vital role in assessing the effectiveness of internal controls and thereby reduce the possibility of fraud and errors and make value addition by ensuring that resources are being utilized at an optimum level.