Independence and Objectivity of Internal Auditors - Essay Example

Independence and Objectivity of internal auditors of the Table of Contents Introduction 3 Analysis 3 Rule 101 of the Sarbanes-Oxley Act 3 IIA Standard – 1100 4 Rule 101 and Standard 1100- Comparison 4 Maintenance of Objectivity and Independence 5 Importance of internal auditors to remain independent 6 Conclusion 8 References 9 Introduction Internal auditors are required to remain independent and perform their work with a clear set of objectives. Independence of the auditors is essential so that they are able to perform their functions effectively and in an unbiased manner. Independence provides auditors with adequate scope to gather any type of important information to develop the audit report. The chief auditor has direct and unrestricted access to the senior management and the board members to gain sufficient data for formulating the internal audit report. It is essential for the audit members to have such independence, so that they can monitor the activities of the organization as per the scope of audit and not be restricted for the same in any manner. Auditors are also required to remain objective towards the manner in which the audit processes are carried out. This includes them to be highly professional and not indulge in the development of personal relations. Internal auditors must diligently maintain the quality of their work by remaining unbiased and impartial with any aspect of the organization. Objectivity also requires mangers to maintain the confidentiality of the audit related matters (Muqattash, 2013). Analysis Rule 101 of the Sarbanes-Oxley Act The Sarbanes-Oxley Act contains a number of provisions which impact the key elements of capital formation and audit. For auditors the Sarbanes-Oxley Act has established a revised set of rules which provides auditors with a new structure of private oversight and a revised set of rules related to independence and public reporting. In case of managers, the act provides adequate scope of safeguarding interests and reporting and exposure of internal control. The disclosure requirements have also been revised for managers. The act also lays emphasis on the ever expanding role of audit committees in respect of corporate reporting framework. The act also states that auditors have a direct responsibility towards supervising the external audit process. It also establishes revised rules in respect of the preapproval of all audit and non-audit services. Financial expertise, independence and monitoring are also covered under different titles of the act. It is expected that the act will improve the manner in which audits are performed and improve financial disclosure, thereby preventing accounting fraud. One of the most important rules established under the section is that which is in respect of auditor independence. Various sections in respect of auditor services and rotation have also been discussed vividly. The rules established under the title of auditor’s independence also address areas such as proxy disclosure, compensation of partners and communication with audit committees (Pricewaterhouse Coopers, 2003). IIA Standard – 1100 The main purposes of the IIA standards are; to describe the basic principles which are associated with internal auditing process, providing a framework for a broad range of audit internal activities, evaluation of the audit performances and to foster improved organizational operations. The standard is establishes rules and formal policies which are associated with the overall manner in which audit procedures are carried out. The standard states specifically that the chief audit executive is required to report his activities to an authority within the organization. This would facilitate the timely and due completion of the internal audit activities. The chief executive is required to report his or her activities to an authority that is capable of discharging responsibilities efficiently. The reporting relationship however does not interfere with the executive’s responsibility towards the board. The standard also specifies that the internal audit activity must be free from interference while audit activities are carried on and reported. There are also no restrictions imposed upon the usage of different resources so as to meet the audit requirements (Ahlawat & Lowe, 2004). The attributes of the standard facilitates addressing the characteristics and interests of the parties and the organization involved in the audit process. The internal audit processes are carried out under a diversified environment with different legal and cultural aspects. Such differences impact the manner in which audit processes are carried out in each organization. However such variations must not influence the compliance with the International Standards of Professional Practice of Internal Auditing. However if the internal auditors are prohibited in meeting certain standards, as per the law, it is essential that they disclose the same in their reports. It is also essential that the internal auditors services remain free from biasness and opinions which have been provided by other members or agencies involved in the audit process. For meeting such requirement it is essential that there exists a suitable auditor assurance service (UCAR, 2014). Rule 101 and Standard 1100- Comparison Evaluation of the Rule 101 and Standard 1100 brings to light that there exists a considerable amount of differences in respect of the manner in which internal auditor’s responsibilities have been laid down. Rule 101 explicitly lays down certain policies which are required to be followed by an internal auditor and provides guidelines in respect of their independence. It lays down in a detailed manner the responsibilities which are required to be fulfilled by the audit committee and the type of requirements which must be met. Standard 1100 however do not have specific guidelines, but broadly states the manner in which the internal auditors are required to meet their responsibilities. Therefore it can be stated that Rule 101 is highly specific while Standard 1100 is generalized and broad. The ideas discussed and policies laid down under both the standards are similar in respect of addressing the activities which are required to be performed by an auditor. Another significant difference observed between Rule 101 and Standard 1100 are that, standard 1100 also address the requirements of the organization which may influence the manner in which the audit process is carried out. The standard understands that every organization operates under differential environment and thus prohibits the compliance with certain rules and policies laid down by the international standards. Rule 101 however does not recognize such aspects. Here the main focus is upon the independence of the auditor in performing his or her roles (Ahlawat & Lowe, 2004). Maintenance of Objectivity and Independence An internal auditor occupies a very unique position within the organization. Although the auditor is appointed by the management, he or she remains independent of the management functions and activities. It is expected that the auditor should review the conduct of the management which is only possible when the auditor remain free from the duties and responsibilities of the management. The internal auditor’s dependence upon the management is created only at the time of employment. The internal auditor is required to report to the management in respect of assistance in developing direction, administrative interface and support. The auditor is also required to report to the audit committee in strategic decision making, accountability, directions and reinforcements. Through such guidance the internal auditor would be able to specifically understand the requirements of internal audit and how to address the same. However the areas of audit and what resources and information must be accessed for conducting the audit is determined by the auditor himself and his opinions are required to remain free from any type of influences from the management. The internal auditor is therefore required to have access to all types of information and employees. The auditor must also be allowed to use probing techniques for developing reports. In order to fulfill the needs of objectivity, the auditor is required to remain free from all personal or professional engagements with the management. The auditor is also required to have an unbiased mindset towards all activities carried out in respect of auditing. This is essential so as to provide accurate and correct understanding of the type of activities carried out in the firm (Stewart & Subramaniam, 2010). In order to remain unbiased, the auditor is required to report directly to the audit committee or the equivalent management. The day to day administrative operations are required to be reported to the senior most executive. The audit committee must provide the internal auditor with all types of support in respect of access to information. Direct communication is also required to be established between the auditor and the committee which reinforces the status of internal auditing. The independence of auditors is further increased when they report to the board through the audit committee on aspects such as planning and results of the audit process. The committee is remains responsible for appointing and remunerating the auditor. The committee must also see that the independence of the auditor is not hampered in any manner. In case of objectivity, the auditor is required to refrain from engaging himself personally with the members of the management and develop any kind of relationship that influences the judgment of the audit report. The auditor is also required to avoid any conflicts of interests as it might influence the manner in which the auditor might reach top conclusions. It is also essential that the auditor’s work must be reviewed by the appointed administrative authority to facilitate assurance of the audit activities. It is essential that the auditor does not carry out any operation based on assumption. All activities performed by the auditor must be assurance with the committee and the established standards of internal audit. The objectivity clause also states that the auditor should not be influenced by the judgments or opinions stated in the previous audit reports. The internal auditor must endorse the code of ethics which exists in the organization (Davidson, Goodwin‐Stewart & Kent, 2005). Importance of internal auditors to remain independent The independence of auditors plays an important role so as to develop an unbiased and accurate audit report. Also the independence of the internal auditors impacts the efficiency of the audit committee. The importance of remaining independent should never be underweighted. The independence of auditor is a statutory requirement as per the regulations of the Securities Exchange Board and the Sarbanes-Oxley Act. The auditor must ensure that that dual reporting relationship gets established. In case of assistance and support, the chief auditor must communicate with the executive management. Similarly for planning, strategic decision making, accountability and communicating results the auditor is required to directly report to the audit committee. The independence of auditors is important for the board and the users of audit reports to gain an unbiased and clear understanding of the manner in which the activities are carried out within the organization and how the management attains the objectives of the firm. Independence of auditors leads to impartial judgment which is crucial for taking different administrative decisions. Although auditors are appointed by the management, they are free from management related functions or responsibilities and functions (Brody & Lowe, 2000). Auditors are required to communicate with the executive managers only for attaining information and access to various resources. However in order to take crucial decisions, the auditor is required to communicate with the audit committee. The committee must provide guidance to the auditors in respect of planning and execution of audit procedures. The audit committee reinforces the status of the organization in respect of internal auditing and therefore the chief auditor executive must directly communicate with the committee. The independent status of the auditor is considered to be important by many users of audit reports such as shareholders, suppliers, government authorities and the board members of the firm. When auditors remain independent, they are not obliged towards any objectives of the firm. It therefore becomes simpler for them to conduct analysis of the different activities and reach adequate and unbiased judgments. If auditors are involved with the management, they often lose their objectivity and develop reports which do not reflect the true state of activities. In order to irradiate the possibility of biased opinions and influence of past audit procedures, the audit team is frequently rotated (Taylor, et al., 2003). This facilitates the auditor to gain information from the bottom rather than observing what the previous audit team had established. The internal audit process is usually carried by a competent chartered audit executive (CAE). The auditor must also possess adequate understanding that his activities are required to remain independent of the functions performed by managers and other executives of the firm. The internal auditor must understand that the reports formulated significantly effects the strategic decisions taken by the external stakeholders. The auditor must therefore remain free from any influence of the management or the administrators to falsify reports. Such actions would be considered as a criminal offence and might lead to the imprisonment of the auditors and concerned managers and administrators. In many cases it is seen that the internal audit activities are outsources to an external provider. However as per the established standards, a firm should refrain from outsourcing the entire internal audit process to an external party. This might cause a firm to put at stake some of the crucial internal information. As per the standards established in respect of auditor independence, it is essential that auditors maintain the confidentiality of information (Swanger & Chewning Jr, 2001). Conclusion Much of the success in the internal audit processes depends upon the efficient planning and strategic audit scope established by the audit committee. The qualifications and the competencies of the internal auditor and the team allocated for this purpose also has a significant impact upon the manner in which the audit gets conducted. The Rule 101 of the Sarbanes-Oxley Act and the IIA Standard – 1100 was mainly developed in order to fulfill the needs of disclosure of relevant organizational information. Accurate and unbiased disclosure of information is important for understanding the actual organizational position and assess whether the management is efficient or not. In order to effectively remain independent and committed towards the audit objectives, it is essential that the CAE to prioritize audit engagements. Audit tasks can be arranged on the basis of the risk assessment. Management competencies, liquidity, internal control mechanism and stability of work are important aspects which are analyzed by the CAE and the audit team. The independence and the objectivity of the audit team are reflected through the ultimate audit results obtained. The ultimate results obtained by the auditor must be based on accurate data. One of the significant constrains faced by the internal auditors is to obtain timely and correct information regarding different resources. Since the auditors operate in an independent manner, they are many at times looked upon as external members. Organizational members on perception of the fact that the auditors have no interest in its goals, they refrain from providing the internal auditors with timely reports. Additionally it is also seen that the information which is required to be provided to the internal audit team is not done on a timely basis due to time constrains and job roles of the executive managers (Hass, Abdolmohammadi & Burnaby, 2006). As a result audit team is required to intervene into the process of functioning themselves to extract reports. During such times, often misunderstandings and conflict of interest gets developed. However organizational members must understand that the needs of internal auditors and cooperate with them. It is also essential to understand the importance of increasing the level of investments made in the overall level of the firm. The auditors must ensure that all the statutory requirements of international auditing are met. Wherever there are discrepancies, the auditor must disclose the same in the report. References Ahlawat, S. S. & Lowe, D. J. (2004). An examination of internal auditor objectivity: In-house versus outsourcing. Auditing: A Journal of Practice & Theory, 23(2), 147-158. Brody, R. G. & Lowe, D. J. (2000). The new role of the internal auditor: implications for internal auditor objectivity. International Journal of Auditing, 4(2), 169-176. Davidson, R., Goodwin‐Stewart, J. & Kent, P. (2005). Internal governance structures and earnings management. Accounting & Finance, 45(2), 241-267. Hass, S., Abdolmohammadi, M. J. & Burnaby, P. (2006). The Americas literature review on internal auditing. Managerial Auditing Journal, 21(8), 835-844. Muqattash, R. S. (2013). Audit Committees Effectiveness and its Impact on the Objectivity of the Internal Auditors: Evidence from United Arab Emirates. Research Journal of Finance and Accounting, 4(16), 23-31. Pricewaterhouse Coopers (2003). Navigating the Sarbanes-Oxley Act of 2002. Retrieved from: http://www.marietta.edu/~johnsong/acct301/Navigating%20S-O%20Act.pdf Stewart, J. & Subramaniam, N. (2010). Internal audit independence and objectivity: emerging research opportunities. Managerial Auditing Journal, 25(4), 328-360. Swanger, S. L. & Chewning Jr, E. G. (2001). The effect of internal audit outsourcing on financial analysts perceptions of external auditor independence. Auditing: A Journal of Practice & Theory, 20(2), 115-129. Taylor, M. H., DeZoort, F. T., Munn, E. & Thomas, M. W. (2003). A proposed framework emphasizing auditor reliability over auditor independence. Accounting Horizons, 17(3), 257-266. UCAR (2014). How does the internal auditor maintain independence and objectivity? Retrieved from: https://www2.fin.ucar.edu/faqs/ia/how-does-internal-auditor-maintain-independence-and-objectivity Read More