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INTERNAL AUDIT Internal Audit and Corporate Governance Differences between the External Auditor and the Internal Audit Function The Scope of the Internal Audit Function Outsourcing the Internal Audit Function Internal Audit Assignments
Internal Audit and Corporate Governance
What is the definition of an Internal Audit? Internal audit is an appraisal activity or monitoring activity established within an entity as a service to an entity. What are the functions of an Internal Audit? Special Investigations Monitoring internal controls Review compliance with laws and regulations Examination of financial information Examination of operating information Review of the economy, efficiency and effectiveness of a company’s operations
What are the benefit of an Internal auditor work to the External auditor? Internal auditor will carry out some work that can be useful to external auditors, who may choose to rely on rather than repeat such work. These include: Testing the accuracy of management accounts during the year Control testing throughout the year Attendance at the inventory count
What would the External Auditor need to consider before relying on the work of the Internal Audit? Their experience Their qualifications Whether or not they act on the issues raise Whether or not recommendations are taken seriously by the company and implemented The quality of their work
What is Corporate Governance? Corporate governance is the system by which companies are directed and controlled. These rules and guidelines aim to ensure directors manage the company in the best interest of the owners and other stakeholders. Why is there a need for strong Corporate Governance? High profile corporate failures, the increases in corporate fraud, and unethical business practices have lead to a growing lack of trust in directors and this has lead to the development of corporate governance rules and guidelines. Who set the rules? Globally – Organisation for Economic Co-operation and Development (OECD) Nationally – individual countries develop their own Companies – Many companies develop their own policies on corporate governance
What is the Underlying concept behind Corporate Governance? Fairness: All stakeholders should be treated with equal consideration Openness and transparency: All information should have been made available to stakeholders and in a clear manner. Independence: All those in a position of monitoring should be independent of those whom they are monitoring. (Non-executive directors independent of executive director; external auditors independent of the company) Integrity and Honesty: Directors should always be truthful with stakeholders. They must be fair in their dealings, presenting information without any attempt to bias opinion. Responsibility: Directors should understand their duty to stakeholders and accept the consequences should they fail that responsibility. Accountability: Directors must be willing to be held accountable for their actions Reputation: Directors must protect their own reputation and that of the company, as damage to either is likely to lead to more widespread damage to the company. Judgement: Directors must ensure they have all the necessary information and understanding in order to be able to make sensible business decisions that improve the prosperity of the company.
What are the different types of directors that make up the Board of Directors? Executive Directors Non-Executive Directors
What are the characteristics of an effective Board of Directors? An effective board of directors should: Lead company strategy Include Non-Executive directors Meet regularly Detail it’s membership Ensure that Chairman and NEDs meet without the Executives to consider their performance Ensure that NEDs meet without Chairman to consider the Chairman’s performance
What contributions do Non-Executive Directors provide? Contribute to strategy Assess the performance of Executive Directors Asses the performance of the Chairman Oversee the integrity of Financial Information Oversee the integrity of control systems Oversee the integrity of Risk Management Decide remuneration of Executive Directors
What direction does Corporate Governance provide on the relationship of the CEO and the Chairman of the Board? Should not be the same person Chairman should not be the CEO CEO runs the company Chairman leads the Board and sets Board meeting Chairman is independent of the CEO Chairman is key contact for CEO
What direction does Corporate Governance provide on the Board Balance? No one person or group should be able to dominate the Board At least half the Board excluding the Chairman should be independent NEDs There should be balance of skills and experience The annual report must detail which NEDs are considered independent The Board should appoint a Senior Independent Director
What direction does Corporate Governance provide on appointments to the Board? Appointments should be done by a nomination Committee made up of majority NEDs Have criteria for selection of new Board members Organise introduction and training for all directors
The board, its committees, and individual directors should have performance appraisals annually What direction does Corporate Governance provide on the remuneration of Directors? It should be enough to attract, motivate and retain but not excessive Should consider industry pay levels NEDs’ remuneration should not be performance related Removed directors should not be over-compensated for failure
What direction does Corporate Governance provide on the relationship of the Remuneration Committee? It should be made up of at least three independent NEDs It should set the remuneration package of all executives, the chairman and senior management
What direction does Corporate Governance provide on the relationship of the Audit Committee? It should be made up of at least three independent NEDs At least one member should have recent relevant financial experience Main role is to liaison between the Board of Directors and the internal and external auditors on all matters Shortlist a firm of external auditors for the shareholders vote at the AGM Monitor the independence of the external auditors Negotiate a fee proposal for the external audit Receive the external auditor’s report, management letter, and any other communication Decide on the resources needed for internal audit Decide whether to use in-house internal audit or outsource the role to a third party Recruit the Chief Internal Auditor Receive all internal audit reports Monitor the financial reporting and Internal Control systems of a company
Having auditors liaise with the audit committee rather than with the board directly, the independence and effectiveness of the audit function should be improved. What is a management letter? A management letter is letter from the auditors with recommendation for management in their duty to have effective internal control systems.
Difference between the External Audit and the Internal Audit Function
What is the difference between the External Audit and the Internal Audit? External auditors are appointed by shareholders to perform the Statutory Audit, they report to the shareholders, they check the annual financial statements, statutory audits are a legal requirement, and it is required that they be independent of their client. Whereas with Internal Audit, they are appointed by the directors, they report to the directors, what they audit is determined by the directors but mainly includes internal systems and controls, they are no legal requirements on internal audits and being independent is not a legal requirement.
The Scope of the Internal Audit Function
See the above section Internal Audit.
Outsourcing the Internal Audit Function
What are the Advantages of Outsourcing the Internal Audit? Saves paying full time salaries and other associated staff costs Get the experience of outside specialists who have seen inside other companies Improves the independence of internal audit work
What are the Disadvantages of Outsourcing the Internal Audit? Can be expensive if the company has a lot of internal audit work to do Risk confidentiality breaches May be slower to respond that internal staff Cost of monitoring people outside the company and quality Cost of researching an outside firm Cultural differences
Internal Audit Assignments
See the above section Internal Audit. THE END.