Audit Practice and Procedures II - Week 11

Audit Practice and Procedures II

• Course: Audit Practice and Procedures II
• Institution: University of the Commonwealth Caribbean (UCC)
• Week: Eleven
• Topics: Internal and Government Financial Auditing, Operational Audit

Recap of Last Class

• No specific details provided

Internal Financial Auditing

• Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organization's operations.
• Internal auditing helps an organization accomplish its objectives by evaluating and improving risk management, control, and governance processes.
• Internal auditors are expected to provide value through improved operational effectiveness, and perform traditional responsibilities including reviewing the reliability and integrity of information, ensuring compliance with policies and regulations, and safeguarding assets.
• Objectives of internal auditors are broader than external auditors', and flexibility allows for company-specific needs. The extent of internal auditing varies between companies. Internal audit reports are not standardized, and not relied on by external users..

Ethical Principles and Rules of Conduct

• Integrity: Internal auditors exhibit the highest level of professional objectivity and provide a basis for reliance, evaluating, and communicating information without undue influence from personal or external interests.
• Objectivity: Internal auditors are impartial and balanced in their assessments, evaluating relevant circumstances without bias.
• Confidentiality: Internal auditors respect information ownership and confidentiality, releasing information only as legally/professionally required.
• Competency: Internal auditors apply necessary knowledge, skills, and experience for internal auditing services.

Rules of Conduct

• Integrity: Auditors should perform with honesty, diligence, and responsibility; observe the law, avoid discreditable actions, and respect organizational objectives.
• Objectivity: Auditors should avoid any activity potentially impairing unbiased assessment, not accept anything compromising judgment, and disclose facts that could distort reporting.
• Confidentiality: Auditors should properly use and protect acquired information and should not use it for personal gain or detrimental to organizational objectives.
• Competency: Auditors should perform services using necessary knowledge, skills, and experience, following the International Standards for the Professional Practice of Internal Auditing and continually improve proficiency.

International Standards for the Professional Practice of Internal Auditing

• Attribute Standards: Cover purpose, authority, and responsibility of the internal audit activity. The chief audit executive must review and present the internal audit charter to senior management and the board for approval, ensuring independence and objectivity.
• Performance Standards: Detail managing the internal audit activity through appropriate evaluation of governance, risk management, and control processes; developing and documenting engagement plans; performing engagements to achieve objectives; communicating engagement results; and monitoring progress.

Relationship of Internal and External Auditors

• Internal auditors are responsible to management and the board, while external auditors are responsible to financial statement users.
• Both must be competent as auditors and remain objective in performing their work
• Both follow a similar methodology, planning and conducting tests.
• Decisions on materiality and risks may differ due to differing needs of users.

External Auditors' Use of Internal Auditors

• External auditors rely on internal auditors to assess control risk and reduce substantive testing.
• Effective internal audit functions reduce external auditor fees.

Governmental Financial Auditing

• No specific details presented

Operational Auditing

• Operational auditing deals with the efficiency and effectiveness of an organization's operations, extending beyond financial auditing to encompass areas like resource acquisition, protection, and usage.
• Operational auditing uses the terms management auditing or performance auditing interchangeably.

Differences Between Operational and Financial Auditing

• Purpose: Financial auditing focuses on past recording accuracy, while operational auditing focuses on improving future performance and efficiency.
• Distribution of Reports: Financial audit reports usually go to external users (stockholders, bankers), while operational reports are primarily for management.
• Inclusion of Nonfinancial Areas: Financial audits are limited to financial aspects, while operational audits consider all operational aspects, like programs, activities, or functions (e.g., factory employees, advertising programs).

Effectiveness vs. Efficiency

• Auditors must define criteria to measure effectiveness (meeting objectives, producing parts without defects) and efficiency (resources used to achieve objectives, minimum cost)
• Operational audit assesses if an organization has achieved assigned objectives, such as elevator safety in a city.

Types of Inefficiencies

• Excessive cost of acquisition of goods and services
• Unavailability of raw materials
• Duplication of effort by employees
• Work done without purpose
• Excessive number of employees.

Relationship Between Operational Auditing and Internal Controls

• Management implements internal controls to meet goals:
  • Reliability of financial reporting
  • Efficiency and effectiveness of operations
  • Compliance with applicable laws and regulations.

Two Things Distinguishing Internal Control Evaluation and Testing

• Purpose: Operational auditing evaluates efficiency and effectiveness; financial auditing determines audit testing extent and reports on control effectiveness.
• Scope: Operational auditing's scope is broader, encompassing any control that affects efficiency or effectiveness; financial audits focus on control's effect on financial reporting fairness.

Types of Operational Audits

• Functional Audits: Focus on individual functions (e.g., billing, production, payroll).
• Organizational Audits: Look at entire organizational units (e.g., departments, branches).
• Special Assignments: Address specific problems/issues e.g., IT system issues, fraud investigation).

Who Performs Operational Audits

• Internal Auditors
• Government Auditors
• CPA firms.

Government Audit Types

• Economy and Efficiency Audits: Evaluate resource acquisition, protection, and use; causes of inefficiencies/uneconomical practices; compliance with laws.
• Program Audits: Determine if desired results/benefits, effectiveness of organizations and programs are being achieved and compliant with laws/regulations.

Independence and Competence of Operational Auditors

• Operational auditors need independence to report impartially to management.
• Auditors should not operate functions needing improvement/correction.
• Competence needed to understand cause of operational problems.

Criteria for Evaluating Efficiency and Effectiveness

• Specific criteria, e.g., evaluation of equipment layout for a company.
• Criteria may be sourced from past performance, benchmarking (entities similar to the client) or engineered standards.

Phases in Operational Auditing

• Planning: Scoping, proper staffing; background information/internal control understanding.
• Evidence accumulation and Evaluation: Using inspection, client inquiry, analytical procedures and observation.
• Reporting and Follow Up: Tailoring reports to management, with copy to the unit, following up on recommendations.

Examples of Operational Audit Findings

• Outside Janitorial Firm: Savings of $160,000 and better quality achieved from changing to an external vendor.
• Use of the Right Tool: A company saved $25,000 by replacing heavy-duty trucks with light vans, as the previous trucks were predominantly used for service calls.
• Computer Programs: Identifying and fixing errors in profit-sharing plans to improve accuracy.