Copyright © 2007 Pearson Education Canada 1 Chapter 24: Assurance Services: Internal Auditing and Government Auditing

Copyright © 2007 Pearson Education Canada 24-2 Chapter 24 objectives  Explain the role of internal auditing  List differences between operational auditing and financial auditing  Define and provide examples of effectiveness, efficiency and economy  Identify the functions of an Auditor General office  Describe the phases in operational auditing

Copyright © 2007 Pearson Education Canada 24-3 Internal auditors  Employed by entities to help improve the organization’s operations  Typically use a risk-based approach in consultation with the audit committee to determine work to be completed  Includes: operational auditing, systems development auditing, fraud auditing, providing assistance with the external audit, and management consulting

Copyright © 2007 Pearson Education Canada 24-4 Practice question 24-2 (p. 672)  Explain the difference in the independence of internal auditors and external auditors in the audit of historical financial statements

Copyright © 2007 Pearson Education Canada 24-5 Professional standards for internal auditors  Internal auditors who are members of other professional organizations (e.g. accounting, information systems audit) would adhere to the standards of those organizations  In addition, the Institute of Internal Auditors (IIA) provides professional practice attribute and performance standards (Figure 24-1)

Copyright © 2007 Pearson Education Canada 24-6 Relationship of internal and external auditors  External auditors rely on internal auditors using the risk model  Fee reduction of the external auditor may be substantial when there is a highly regarded internal audit function  Before relying upon internal auditors, the external auditor must be confident of their competence, independence and objectivity

Copyright © 2007 Pearson Education Canada 24-7 Operational auditing  This term is used to describe the review of an organization or its processes with respect to efficiency and effectiveness  Used synonymously with: management auditing, performance auditing, value-for- money auditing

Copyright © 2007 Pearson Education Canada 24-8 Differences between operational and financial auditing: purpose of the audit FinancialOperational Emphasizes whether historical information was correctly recorded: oriented towards the past Emphasizes effectiveness and efficiency: concerns operating performance for the future

Copyright © 2007 Pearson Education Canada 24-9 Differences between operational and financial auditing: distribution of the reports FinancialOperational Audit report typically goes to many users, e.g. shareholders and bankers. (Report requires well defined wording.) Intended primarily for management. Will be go to operational and executive management and the audit committee. (Wording of report varies considerably from audit to audit.)

Copyright © 2007 Pearson Education Canada Differences between operational and financial auditing: inclusion of nonfinancial areas FinancialOperational Limited to matters that directly affect the financial statements: nonfinancial areas would be addressed only to address issues such as going concern. Cover any aspect of efficiency and effectiveness; involve a wide variety of activities.

Copyright © 2007 Pearson Education Canada The three E’s  Effectiveness: the degree to which the organization’s (or the system’s) objectives are achieved  Efficiency: the extent to which costs are reduced without reducing effectiveness  Economy: the degree to which goods and services of suitable quality are acquired at the lowest price

Copyright © 2007 Pearson Education Canada Examples of effectiveness and efficiency  Effectiveness and efficiency are considered in the context of a goal or objective, using specific criteria. Let’s say that your goal is to “do well” in this course.  Effectiveness criteria: At least a B.  Efficiency criteria: Still able to meet with friends twice a week and get seven hours of sleep.

Copyright © 2007 Pearson Education Canada Was this goal achieved? EffectivenessEconomy Mary: Obtained a B plus. Had one long and one short visit with friends every week. Slept eight hours every night. Mark: Obtained an A plus. Did not visit with friends, only once or twice per term. Slept six or seven hours every night.

Copyright © 2007 Pearson Education Canada Importance of criteria  The above example shows the relationship between objectives (goals) and criteria  The objectives need to be what the person, department, or organization needs to accomplish  Criteria need to be relevant to the goals, and may be difficult to develop

Copyright © 2007 Pearson Education Canada Relationship between operational auditing and internal controls  Recall that the goals of good internal controls include: – Maintaining reliable systems – Safeguarding assets, records – Optimizing the use of resources – Preventing and detecting error and fraud  Operational audits can help evaluate these controls using the three E’s

Copyright © 2007 Pearson Education Canada Purpose of internal control evaluation Financial auditOperational audit To determine the extend of substantive testing. To evaluate the efficiency and effectiveness of internal controls and make recommendations for improvement.

Copyright © 2007 Pearson Education Canada Scope of internal control evaluation Financial auditOperational audit Restricted to matters affecting the financial statements. Concerns any control that management would like to evaluate, or that could result in risks to the organization.

Copyright © 2007 Pearson Education Canada Practice problem (p. 674)  Identify internal control weaknesses and recommendations for improvement for capital assets

Copyright © 2007 Pearson Education Canada Who performs operational audits?  Such audits may be performed by internal auditors, government auditors, or external public accountants/consulting firms  The audit team should be competent in the area being audited, and maintain their independence as best as possible

Copyright © 2007 Pearson Education Canada Auditor General offices  The role of these offices is mandated by provincial and federal legislation  May include: financial statement audits, program (operational) audits, compliance audits

Copyright © 2007 Pearson Education Canada Practice problem (p. 675)  Value-for-money audit of expenditures for the homeless  What criteria would be used?  What recommendations for improvement would you provide?

Copyright © 2007 Pearson Education Canada Operational audit phases  Planning  Evidence accumulation and evaluation  Reporting and follow- up

Copyright © 2007 Pearson Education Canada Operational audit planning steps  Determine the scope of the engagement  Assess risks  Communicate with the organizational unit  Staff the engagement properly  Obtain background information about the organizational unit  Understand internal controls  Decide on the appropriate evidence to accumulate

Copyright © 2007 Pearson Education Canada Differences in components of planning Financial auditOperational audit Criteria used for planning are generally accepted auditing standards (GAAS). Because of diversity: - Difficult to determine specific objectives - Criteria will be linked to objectives -Staffing may require unique specialists -Consensus with management needs to be reached with respect to the criteria

Copyright © 2007 Pearson Education Canada Operational audit evidence accumulation and evaluation  Seven types of evidence used in a financial audit are also used in an operational audit (Chapter 6): – Physical examination – Confirmation – Documentation – Observation – Inquiries of the client – Reperformance – Analytical procedures

Copyright © 2007 Pearson Education Canada Practice problem (p. 675)  Operational audit of a hospital research department  Evaluate objectives  Outline basic procedures and documents

Copyright © 2007 Pearson Education Canada Operational audit reporting  As explained previously, financial audit reports may be circulated widely and have standard wording  As operational audit reports are tailored to the situation, report writing may take a significant amount of time to communicate findings and recommendations clearly

Copyright © 2007 Pearson Education Canada Operational audit follow-up  The purpose of follow-up is to determine whether the recommended changes were made and if not, why not  Follow-up may be after a specified time period, the following year, or even two or three years later

Copyright © 2007 Pearson Education Canada Sources of operational audit findings  The best place to find detailed audit reports that go through the whole operational audit process is the reports of the various Auditor General offices (see text, p. 671 for links)

Copyright © 2007 Pearson Education Canada Practice problem (pp )  Large manufacturing company with multiple locations  Discuss issues for the internal audit department in the audit of capital expenditures