Using the Work of Internal Auditors - Essay Example

Using the work of internal auditors School Using the work of internal auditors This material relates to using the work of internal auditor by an external auditor in the audit of financial statements. This helps the external auditor to increase the efficiency and effectiveness of the audit by saving the time and resources which would have been utilized if the work of internal auditor had not been used by the external auditor. Introduction The responsibilities of an external auditor relating to the work of internal auditors when the external Auditor has determined that the internal audit function is likely to be relevant to the audit, is dealt in accordance with this standard. This ISA does not deal with instances when individual internal auditors provide direct assistance to the external auditor in carrying out audit Procedures, and then the provisions and requirements of this Standard are not applicable. Relationship among External Auditor and Internal Audit Function There are few differences between the work of the internal auditor and external auditor i.e. Management and, where applicable, those charged with governance determines the objectives of the internal auditor. Internal auditors do not issue an independent auditors report while external auditors issue an independent auditor report as per the relevant ISA’s. There may be differences in the objectives of the internal and external auditors but in some instances the audit procedures and the way in which both the functions are performed might be the same one. Internal audit function is not independent of the entity as is required of the external auditor when expressing an opinion on financial statements, Irrespective of the degree of autonomy and objectivity of the internal audit function. The external auditor has sole responsibility for the audit opinion expressed. The responsibility of the external auditor is not reduced by the external auditor’s use of the work of the internal auditors because external auditor has the sole responsibility for the audit opinion expressed. Objectives Where an entity has internal audit function and which the external auditor has determined is likely to be relevant to the audit, then the objectives of the external auditor are: (a) To determine whether to use the specific work of the internal auditors and if yes, then to what extent that work may be used; and (b) To determine that whether the work of the internal auditor is adequate for the purposes of the audit. Definitions ISA (ISA 610) provides the following related definitions: (a) Internal audit function –it says an appraisal activity provided or established as a service to the entity. Its functions, amongst other things, include examining, monitoring and evaluating the effectiveness and adequacy of internal control. (b) Internal auditors – they are the individuals engaged in performing the internal audit function activities. The internal auditors may be a person belonging to an internal audit department or other equivalent function. Requirements In determination of whether and if so, then to what extent work of an internal auditor may be used, an external auditor shall determine: (a) Whether the work performed by an internal auditor is likely to be adequate for the objectives of the audit; and (b) If it is so, the planned impact of the work of internal auditors on the timing, nature or extent of the procedure of external auditor. The external auditor, to determine whether the internal auditors have worked adequate enough for the purposes of audit, shall evaluate: (a) The internal audit function’s objectivity; (b) The internal auditors’ technical competence; (c) Whether the effective communication among the external auditor and the internal auditors is likely to be there; and (d) Whether due professional care has been exercised in carried out in work of the internal auditors The external auditor shall consider the following to determine whether the work performed by the internal auditors has planned effect on the timing, nature or extent of the procedures used by external auditor: (a) The scope and nature of specific work performed, or has to be performed, by the internal auditors; (b) The estimated risks of material misstatement of the financial statements at the assertion level for specific classes of account balances, transactions and disclosures; and (c) The amount of subjectivity involved in evaluation of the evidence obtained by the internal auditors with relevance to the relevant assertions. USING THE WORK OF INTERNAL AUDITORS Using the Specific Work of Internal Auditors External audit requires careful attention and care; hence, relying on the work of others’ is a sensitive issue. To rely on or use the work of an internal auditor, the standards require a number of conditions to be met. Standards require external auditor to perform procedures and ensure the sufficiency of audit work carried out in order to draw a conclusion by the interna auditor. To determine the sufficiency of specific work carried out by the internal auditors, there is a need that external auditors confirm if: (a) The internal auditors who have performed the work have appropriate level of training and expertise; (b) Reasonable care, control, monitoring and reporting of the work is carried out; (c) the conclusions made coincide with the process of internal audit and there is sufficient evidence supporting the opinion formed or conclusions drawn; (d) the information produced and reports presented have been carefully constructed as per the audit procedures performed and the situations prevailed are considered while drawing the conclusions and (e) The matters that carry weight in the eyes of the internal auditors have been properly accounted for or not. Documentation If specific work of the internal auditors has been used by the external auditor, the results reached regarding the audit procedures performed by the internal auditor and on the evaluation of the sufficiency of the work of the internal auditors, shall be included in the external auditor’s documentation, Application of the ISA and Other Explanatory Material Scope of this ISA The internal audit function of an entity is likely to be relevant to the audit if the internal audit function’s activities and responsibilities are related to the financial reporting of an entity, and the expectations are there that auditor will use the work of the internal auditors to so as to modify the nature or timing, or reduce the performance of the audit procedures. To perform the procedures in accordance with this ISA it may cause the external auditor to have a re-evaluation of the assessment of the risks of material misstatement external auditor. Consequently, the external auditor’s estimation of the relevancy of the internal audit function to the audit may be affected. Internal audit function’s objectives may vary widely and it depends on the structure and size of the entity and management and those charged with governance requirements. Following may be included as the activities of the internal audit function: • Internal control’s Monitoring. Specific responsibilities may be assigned to the internal audit function for reviewing controls, monitoring their operation and suggesting improvements with respect to those. • Examination of operating and financial information. Internal audit function may be given responsibility to review the methods used to identify, measure, classify and report operating and financial information, so that specific inquiry into individual items, including detailed transaction’s testing, balances and procedures, may be made. • Operating activities review. Internal audit function may be given responsibility to review the efficiency and effectiveness and economy, of operating activities, including an entity’s non-financial activities. • Review of laws and regulations compliance. Internal audit function may be given responsibility to review laws, regulations and other external requirements compliance and also with management directives and policies and other internal requirements. • Risk management. The internal audit function may perform the function to assist the organization by identifying and evaluating the significant vulnerabilities to risk and contributing to the betterment of risk management and its control. • Governance. Internal audit function may assess the process of governance in its achievement of objectives on ethics and values, accountability and performance management, communicating control information and risk to appropriate areas of an organization and effectiveness of communication among external and internal auditors, those charged with governance. USING THE WORK OF INTERNAL AUDITORS To determine the use of the internal auditors’ work and its extent: Factors that may have affects on the determination of the external auditor of adequacy of the work of the internal auditors and may be used for the purposes of the audit include: Objectivity • Any status of the internal audit inside the entity and the effect which such status has on the objectivity of the internal auditors. • Whether internal audit function reports to officer with appropriate authority and those charged with governance or and whether those charged with governance may be directly accessed by the internal auditors. • Whether the internal auditors are not subject to any conflicting responsibilities. • Whether employment decisions related to the internal audit function are oversees by those charged with governance. • Whether there are any restrictions or constraints placed on the internal audit function by those charged with governance or management. • Whether management is acting on the recommendations of the internal audit function and to what extent, and how such action is evidenced. Technical competence • Whether the internal auditors have any membership of relevant professional bodies. • Whether the internal auditors have any sufficient and adequate technical training and proficiency to act as internal auditors. • Whether any established policies are in place for hiring and training internal auditors. Due professional care • Whether internal audit function’s activities are properly planned, supervised, reviewed and documented. • The adequacy and existence of audit manuals or other documents of similar nature, internal audit documentation and work programs. Communication Communication between the internal auditors and external auditor may be most effective when the external auditors and internal auditors are free to communicate openly, and: • Throughout the period, sufficient meetings are held at appropriate intervals; • The external auditor has access to and is advised of relevant internal audit reports and is informed of any important and significant matters that come to the internal auditors attention, when external auditors work may be affected by such matters; and • The internal auditors are informed by the external auditor any significant matters which may have an effect on the internal audit function. (ICAI, 2013) Planned Effect of the Internal Auditors Work on the Nature, Timing or Extent of the Procedures of the External Auditors: Where the internal auditors work is to be a factor in determining the nature, timing or extent of the procedures of the external auditors, it may be useful to have an agreement in advance on the following matters with the internal auditors: • Timing of such work; • Extent of the audit coverage; • As a whole, Materiality for the financial statement (and, materiality level or levels for particular classes of account balances, transactions, or disclosures, if applicable), and performance materiality; • The methods which have been proposed for item selection; • Documentation of work performed; and • Procedures for review and reporting. Using Specific Work of the Internal Auditors: The nature, timing and extent of the performance of audit procedures on specific work of the internal auditors will depend on the (external auditor’s assessment) of the risk of material misstatement, the evaluation of the specific work of the internal auditors and the evaluation of the internal audit function. Such audit procedures may include: • Examination of those items which have been already examined by the internal auditors; • Examination of other items of similar nature; and • Observation of those procedures which have been performed by the internal auditors. Benefits of internal audit Internal audit work cost money and should therefore provide benefits to justify the costs. The justification for internal audit may come from: Improvements in financial controls or operational controls within the entity Improvements in compliance with key laws and regulations, thereby reducing the risk of legal action or action by the regulators against the entity Improvements in the economy, efficiency or effectiveness of operations. There may be other benefits of internal audit: If the internal auditors carry out checks into the effectiveness of financial controls within the entity, the external auditors may decide that they can rely to some extent on the work done by internal audit; this would save time and effort when carrying out their own audit work. If the external auditors do rely to some extent on the work of internal audit, there may be a reduction in the external audit fee. The existence of an internal audit department may enhance the reputation of the entity for sound corporate governance in the opinion of customers and investors. Independence of the internal auditors and other problems with internal audit: Auditors should be independent. However, internal auditors cannot achieve the same degree of independence as that required of the external auditor. Full- time internal auditors are employed by the entity and rely on the entity for their job and salary. Even external firms that carry out internal audit work for a client entity may lack independence, because the audit work is not a regulatory requirement and the firm therefore relies on the client’s attitude for their future fee income. Methods of trying to ensure independence: For full time internal auditors one of the biggest problems with independence is that the auditors must report to someone within the entity and both the independence and the status of the chief internal auditor will depend on who he reports to within the management hierarchy. In order to achieve as much independence as possible it is important that the internal auditor report to the highest level of management or to the audit committee if there is one. However, even if the chief internal auditor reports to the finance director, there is a threat to his independence, because much of the work of the internal auditors will involve investigations into activities and controls for which the finance director is responsible. (ICAP, 2013, p. 270, 272) References Handbook of Quality control, Auditing, Review and Other Assurance, and Related pronouncements, (2012). Vol. 1, International Federation of Accountants. The Institute of Chartered Accountants of Pakistan, (2013). Auditing and assurance, (1st edn,). United Kingdom: Emile Woolf International. The Institute of Chartered Accountants of India (ICAI), (2013). Standards on Auditing. Read More