©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Internal and Governmental Financial Auditing and Operational Auditing Chapter 26

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Learning Objective 1 Explain the role of internal auditors in financial auditing.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Internal Auditing  The New York Stock Exchange requires its registrants to have an internal audit function

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Internal Auditing It 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.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Institute of Internal Auditors Ethical Principles  Confidentiality  Objectivity  Competency

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Institute of Internal Auditors Rules of Conduct  Integrity  Confidentiality  Objectivity  Competency

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Relationship of Internal and External Auditors  The external auditor is responsible to financial statement users  The internal auditor is responsible to management Differences:

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Relationship of Internal and External Auditors  Competency  Methodology  Objectivity  Audit risk model Similarities:

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Learning Objective 2 Describe the auditing and reporting requirements under Government Auditing Standards and the Single Audit Act

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Governmental Financial Auditing The primary source of authoritative literature for performance of government audits is Government Auditing Standards, which is issued by the GAO. Because of the color of the cover, it is usually referred to as the “Yellow Book.”

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Governmental Financial Auditing The Yellow Book standards are often called generally accepted government auditing standards (GAGAS).

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Financial Audit and Reporting Requirements – Yellow Book  Compliance auditing  Materiality and significance  Reporting

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Audit and Reporting – Single Audit Act and OMB Circular A-133 The threshold for requiring a single audit is $500,000. The office of Management and Budget issued a revised Circular A-133, Audits of States, Local Governments, and Non-Profit Organizations, to provide administrative guidance for implementing the single audit requirements.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Audit Requirements The audit should be in accordance with generally accepted government auditing standards (GAGAS). The auditor must obtain an understanding of internal control over federal programs sufficient to support a low assessed level of control risk for major programs.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Audit Requirements The auditor should determine whether the client had complied with the laws, regulations, and the provisions of contracts or grant agreements that may have a direct and material effect on each of its major programs.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Reporting Requirements  An opinion as to whether the schedule of federal awards is presented fairly in all material respects in relation to the financial statements as a whole  An opinion on whether the financial statements are in accordance with GAAP

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Reporting Requirements  A report on internal control related to the financial statements and major programs  A report on compliance with laws, regulations, and the provisions of contracts or grant agreements  A schedule of findings and questioned costs

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Operational Auditing  The purpose of operational auditing is to determine the effectiveness or efficiency of any part of an organization

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Learning Objective 3 Distinguish operational auditing from financial auditing.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Differences Between Operational and Financial Auditing  Distribution of the reports  Inclusion of nonfinancial areas  Purpose of the audit

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Learning Objective 4 Provide an overview of operational audits.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley  Effectiveness refers to the accomplishment of objectives  Efficiency is defined as reducing costs without reducing effectiveness Effectiveness Versus Efficiency

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Types of InefficiencyExample Acquisition of goods and services is too costly Bids for purchases of materials are not required Raw materials are not available when needed An assembly line was shut down for lack of materials A duplication of effort by employees exists Production and accounting keep identical records Effectiveness Versus Efficiency

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Work is done that serves no purpose Vendors’ invoices and receiving reports are filed without being used There are too many employees Office work could be done with one less assistant Effectiveness Versus Efficiency Types of InefficiencyExample

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Relationship Between Operational Auditing and Internal Controls  Reliability of financial reporting  Efficiency and effectiveness of operations  Compliance with applicable laws and regulations

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Types of Operational Audits  Functional  Organizational  Special assignments

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley  CPA firms  Government auditors  Internal auditors Who Performs Operational Audits

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley The two most important qualities for an operational auditor are: Independence and Competence of Operational Auditors  Independence  Competence

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Learning Objective 5 Plan and perform an operational audit.

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Specific Criteria  Were all plant layouts approved by home office engineering at the time of original design?  Has home office engineering done a reevaluation study of plant layout in the past five years? Questions that might be used to evaluate plant layouts:

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Specific Criteria  Is each piece of equipment operating atleast 60 percent of capacity for three months or more each year?  Does layout facilitate the movement of new materials to the production floor?  Does layout facilitate the production of finished goods?

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Specific Criteria  Does layout facilitate the movement of finished goods to distribution centers?  Does the plant layout effectively use existing equipment?  Is the safety of employees endangered by the plant layout?

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Sources of Criteria  Historical performance  Benchmarking  Engineered standards  Discussion and agreement

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Phases in Operational Auditing  Planning  Evidence accumulation and evaluation  Reporting and follow up

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Planning  Staffing  Understand internal control  Background information  Decide on appropriate evidence  Scope of engagement

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Evidence Accumulation and Evaluation  Documentation  Client inquiry  Analytical procedures  Observation

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Reporting and Follow Up 1.In operational audits, the report is usually sent only to management Two major differences in operational and financial auditing reports: 2.Tailoring of each report is required in operational audits

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley Examples of Operational Audit Findings  Outside janitorial firm saves $160,000  Use the right tool  Computer programs save manual labor

©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley End of Chapter 26