2. 22 - 1 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Internal and Governmental Financial Auditing and Operational Auditing Chapter 26

3. 22 - 2 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Learning Objective 1 Explain the role of internal auditors in financial auditing.

4. 22 - 3 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Internal Auditing The New York Stock Exchange requires its registrants to have an internal audit function.

5. 22 - 4 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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.

6. 22 - 5 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Institute of Internal Auditors Ethical Principles Integrity Confidentiality Objectivity Competency

7. 22 - 6 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Relationship of Internal and External Auditors The external auditor is responsible to financial statement users. The internal auditor is responsible to management.

8. 22 - 7 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Relationship of Internal and External Auditors Competency Methodology Objectivity Audit risk model

9. 22 - 8 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Learning Objective 2 Describe the auditing and reporting requirements under Government Auditing Standards and the Single Audit Act

10. 22 - 9 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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.”

11. 22 - 10 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Governmental Financial Auditing The Yellow Book standards are often called generally accepted government auditing standards (GAGAS).

12. 22 - 11 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Financial Audit and Reporting Requirements – Yellow Book  Materiality and significance  Quality control  Compliance auditing  Reporting  Audit files

13. 22 - 12 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Audit and Reporting – Single Audit Act and OMB Circular A-133 The threshold for requiring a single audit was raised from $100,000 to $300,000 to exempt many smaller entities from single audit requirements. The OMB increased the single audit threshold to $500,000 beginning in 2004.

14. 22 - 13 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Audit and Reporting – Single Audit Act and OMB Circular A-133 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.

15. 22 - 14 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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.

16. 22 - 15 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Audit Requirements The auditor should determine whether the client had complied with laws, regulations, and the provisions of contracts or grant agreements that may have a direct and material effect on each of its major programs.

17. 22 - 16 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Reporting Requirements  An opinion as to whether the schedule of federal awards is presented fairly in all federal awards is presented fairly in all material respects in relation to the material respects in relation to the financial statements as a whole financial statements as a whole  An opinion on whether the financial statements are in accordance with GAAP statements are in accordance with GAAP

18. 22 - 17 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Reporting Requirements  A report on internal control related to the financial statements and major programs financial statements and major programs  A report on compliance with laws, regulations, and the provisions of regulations, and the provisions of contracts or grant agreements contracts or grant agreements  A schedule of findings and questioned costs

19. 22 - 18 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Operational Auditing The purpose of operational auditing is to determine the effectiveness or efficiency of any part of an organization.

20. 22 - 19 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Learning Objective 3 Distinguish operational auditing from financial auditing.

21. 22 - 20 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Differences between Operational and Financial Auditing Distribution of the reports Inclusion of nonfinancial areas Purpose of the audit

22. 22 - 21 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Learning Objective 4 Provide an overview of operational audits.

23. 22 - 22 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Effectiveness refers to the accomplishment of objectives. Efficiency is defined as reducing costs without reducing effectiveness. Effectiveness Versus Efficiency

24. 22 - 23 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Types of inefficiency Example 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

25. 22 - 24 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Types of inefficiency Example 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

26. 22 - 25 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Relationship between Operational Auditing and Internal Controls Reliability of financial reporting Efficiency and effectiveness of operations Compliance with applicable laws and regulations

27. 22 - 26 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Types of Operational Audits Functional Organizational Special assignments

28. 22 - 27 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder CPA firms Governmentauditors Internalauditors Who Performs Operational Audits

29. 22 - 28 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder The two most important qualities for an operational auditor are: an operational auditor are: Independence and Competence of Operational Auditors IndependenceCompetence

30. 22 - 29 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Learning Objective 5 Plan and perform an operational audit.

31. 22 - 30 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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?

32. 22 - 31 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Specific Criteria Is each piece of equipment operating at 60 percent of capacity or more for at least three months each year? Does layout facilitate the movement of new materials to the production floor? Does layout facilitate the production of finished goods?

33. 22 - 32 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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?

34. 22 - 33 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Sources of Criteria Historical performance Benchmarking Engineers standards Discussion and agreement

35. 22 - 34 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Phases in Operational Auditing Planning Evidence accumulation and evaluation Reporting and follow-up

36. 22 - 35 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Planning Scope of engagement Scope of engagement Staffing Staffing Background information Background information Understand internal control Understand internal control Decide on appropriate evidence Decide on appropriate evidence

37. 22 - 36 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Evidence Accumulation and Evaluation Documentation Documentation Client inquiry Client inquiry Observation Observation

38. 22 - 37 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Reporting Follow-up Report usually sent to management Report usually sent to management Tailored reports Tailored reports Follow-up on recommendations Follow-up on recommendations with management with management

39. 22 - 38 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Examples of Operational Audit Findings Outside janitorial firm saves $160,000 Outside janitorial firm saves $160,000 More timely credit memo processing More timely credit memo processing Use the right tool Use the right tool Computer programs save manual labor Computer programs save manual labor

40. 22 - 39 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder End of Chapter 26