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Chapter 11


Internal Control Internal Audit Financial Audit Management Audit Operational Audit Efficiency Audit Quality Audit Technical Audit

Internal Control
Internal control is the plan, methods and procedures adopted by the management for the efficient conduct of the business, adherence to management policies, safeguarding of the assets, prevention and detection of fraud and error, the accuracy and completeness of records and timely preparation of reliable financial information. ---- ICAI Objectives of Internal Control i) Adherence to managerial policies and directives. ii) Protection of assets against possible losses. iii) Adherence to management policies and authorization. iv) Generation of reliable, complete and accurate accounting records. v) Timely preparation of financial information. vi) Compliance with statutory requirements. vii) Prevention and early detection of error and frauds. Types of Internal Controls (i) Administrative controls: This control deals with the functioning procedures that influence the decision making process and managerial authorization of transaction. Example: Delegation of authority, job descriptions etc. (ii) Accounting controls: This control covers the accounting systems and procedures. This involves recognizing, calculating, posting, analyzing, summarizing and reporting transactions. (iii) Physical controls: This includes providing for protective devices for safeguarding the assets. Five standards for internal control: Control environment: Management and employees should establish and maintain an environment throughout the organization that sets a positive and supportive attitude toward internal control and conscientious management. Risk management: Internal control should provide for an assessment of the risk the agency faces from both internal and external sources. Control activities: Internal control activities help ensure that management directives are carried out. The control activities should be effective and efficient in accomplishing the agencys control objectives. (iii) (ii) (i)

Information and communication: Information should be recorded and communicated to management and other within the entity who need it and in a form and within a time from that enables them to carry out their internal control and other responsibilities. Monitoring: Internal control monitoring should assess the quality of performance over Time and ensure that the finding of audits and reviews are promptly resolved. (v)


Internal Audit
Internal auditing 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. It is an ongoing appraisal of the financial health of a company's operations by its own employees. Employees who carry out this function are called internal auditors. During an internal audit internal auditors will evaluate and monitor a company's risk management, reporting, and control practices and make suggestions for improvement. Internal auditing covers not only an organization's finance function, but all the operations and systems in a firm. While internal auditors are typically accountants, this activity can also be carried out by other professionals who are well-versed with a company's functions and the relevant regulatory requirements. Internal Audit Facilitates Review of internal accounting controls. Scrutiny of all the reports. Safeguarding of assets from losses to damages. Verifying the authenticity of the transactions. Studying the operational efficiencies. Determining whether the operating objectives, targets and related control procedures are promptly instituted and the degree to which the desired results are achieved. Examining and ascertaining the extent to which established policies, plans and procedures are compiled with. Assessing the budgetary standard setting.

Major advantages Having an Internal Audit Department

It dispenses the need to employ external consultants to act as internal auditors hence saving large sum of money. This is even especially true when an internal audit department is properly run with well trained and experienced internal auditors; The internal auditors are intimately acquainted with the business as they are continuously employed in the same concern and have access to much confidential information and to all levels of management. Hence, they really are special personnel who have very in depth inner knowledge which can then contribute to the company; The Internal Audit maintains a group of highly skilled people available to cope with non-recurring and exceptional jobs which no many employee could deal with efficiently and effectively; It ensures that the organization detailed standard policy and procedures are running smoothly. This compared to the external auditors primary role of the ability to express the true and fair view of the clients financial statements audit; Internal auditors are invaluable in areas like operational audits, constant examination of internal check controls, the detailed application of normal auditing method and detailed review of the various type of management reporting; Last but not least, it provides an excellent training ground for future executives. Trainee personnel obtain intimate knowledge of the business which they can study problems of all kinds at different levels.

Internal Auditing means nothing but Policing

An Internal Auditor is a Watchdog not a Bloodhound. An auditor must keep a watch over the activities of the company but he must not be very suspicious of all transactions. The internal audit team must comprises of managers or accountant who are of a balanced mind and not doubtful of others. Internal audit involves policing i.e safeguarding the assets of the company but apart from this features it also perform other functions. An internal auditor is a helpful police officer who rewards good decision & punishes errors and frauds. The internal auditor must make sure that any misappropriation must be brought to notice of the top management but he should also be willing to check management control and help managers to enforce the right control. Functions of Internal Auditor (A) Checking the records to find the degree of reliability of the information. (B) Examining documentary evidence (C) Detection and prevention of errors and frauds. (D) A general examination of the financial statement which give a true and fair view for better efficiencies of the financial record. Therefore internal audit is distinct from authorization and recording. It is not only concerned with examining transactions as recorded in the books of accounts but it is an appraisal of procedures for better efficiencies.

Financial Audit
Financial audit is a historically oriented, independent evaluation performed by the internal auditors or external auditors for the purpose of confirming the Fairness, accuracy and reliability of the financial data, providing protection of the companys assets and evaluating the internal control systems designed to provide fairness and protection. Financial data apart from other data is the primary evidence of the company and the evaluation is performed on a planned basis rather than a request. Examples of Financial Audit: Balance Sheet Audit, Cash Audit, Bank Reconciliation Statement, Revenue Audit, Payments Audit Features of Financial Audit: (a) It is concerned with the financial aspects of the business transactions of the year under audit. (b) The auditors examines the past financial records to record his openion on the truth and fairness of the financial statement. (c) The performance of the management is outside the scope of financial audit. (d) Financial Audit is compulsory in case of certain companies, trusts and societies. (e) The auditor reports to the shareholder of the company

Management Audit
The management audit is An Informed and Constructive analysis, Evaluation and a series of Recommendations regarding Plans, Processes, People and Problems of a Company Management audit is define as investigation of a business form the top levels to the bottom levels to check for proper management and to have an effective relationship with the outside world and smooth running of the company internally. Features of Management Audit: (a) It check performance of all management levels by comparing them to objectives, policies and procedures of the company. (b) The management auditor report on management performance during a particular period and has suggestions to rectify deficiencies and modification of objectives and policies. (c) The management auditor reports to the top level management. (d) Management audit is not legally compulsory and it can cover any number of year longer than the financial year. (e) A management audit is more qualitative rather then quantitative. Examples of Management Audit Strategic Operations Audit, R & D Audit, Time Management Audit, Budget Audit, M&A Audit, IPO Audits.

Difference between Financial Audit & Management Audit

Financial Audit It is concerned with financial aspects of business transactions of the year under Audit The auditor examines the past financial records to report his opinion on the truth and fairness of the representations made in the financial statements. Examination of the performance of the management is beyond his scope Management Audit It is concerned with the review of the past Performance to ascertain whether it is in tune with the objectives, policies and procedures of the enterprise. The management auditor reports on performance of the management during a particular period and suggest ways to remedy the deficiencies, including modification of objectives, policies etc.

No limit as to the period to be covered Past year '(Financial) transactions are Covered Enterprises such as companies, trust and societies etc. Financial audit is compulsory in the case of certain enterprises such as companies, trust and societies etc. The auditor reports to the owner, i.e. shareholders in the Case of a company There is legal compulsion as regards management audit. The auditor reports to the management

Operational Audit
Operational audit can be define as checking each and every operation of the company. It is a type of internal audit, where different operating functions, cost revenues are checked. Operational audits are conducted for various projects to ensure that the criteria for planned expenses are being followed. Operational audit will cover services, wages and salaries, overheads, depreciation, production, WIP, stock record etc. Features of Operational Audit: (a) It covers the cost accounts of the financial year of the company. (b) It checks the internal efficiency by verifying cost records. (c) For enterprises in production, processing/manufacturing the cost/operational audit is compulsory. (d) It can be conducted by cost accountants or chartered accountants or operational experts. Example of Operational Audit Energy audit, efficiency audit, pollution audit, project audit, PERT and CPM

Difference between Financial Audit, Management Audit & Operational Audit

Financial Audit Financial Audit is compulsory Financial audit reports are send to the shareholders in the annual report Financial audit deals with financial aspects Financial audit helps shareholders

Operational Audit Management Audit Operational Audit is compulsory Management Audit is optional Operational audit reports send to Management audit reports are send the government to the top management Management audit evaluates people (HR) Management audit helps the top management. Management audit is subjeective (Qualitative) Management audit Appraises (Evaluates)

Operational audit deals with operational cost and deadlines. Operational audit helps the government. Financial audit are objective Operational audit are objectives (Quantitative) (Quantitative) Financial audit basically Analysis Operational auddit has Suggestions

The best example to explain the difference between Financial, Operational and Management Audit are the Financial Statement i.e The Profit/Loss A/c and the Balance Sheet. The financial auditor will check the Reliability and Accuracy of the Financial Data. The Operational Auditor will compute various Ratios like Stock Turnover, Debtors T/O etc. The Management Auditors will look into VRS, ESOPs, Employee Retention etc.

Efficiency Audit
Efficiency is the ratio of output to input. It is measured as: Efficiency = Output / Input An efficiency audit is carried out in order to ascertain the efficiency levels in an organization. It is a process of ensuring that every rupee invested yields optimum results. At any production system where the output is maximized, this ratio is said to be maximum Efficiency can be of two types namely, economic efficiency and technical efficiency. Economic Efficiency is a measure that considers quantity of input i.e cost of inputs. If the input cost is minimum for a given level, the firm is said to have achieved efficiency. Technical Efficiency is a measure that considers output with respect to input. If the input is minimum for a given level but the output is maximum, the firm is said to have achieved technical efficiency. Objectives of Efficiency audit:

(a) Achive optimum utilization of resources invested (b) Channelize the investment into the most profitable ventures (a) Return on capital employed (b) Utilization of available capacity (c) Optimum utilization of resources (d) Performance in the global market (e) Liquidity position of the firm (f) Payback period of investment made.

Efficiency audit is based on following parameters:

Quality Audit
Quality Audit is Periodic, independent, and documented examination and verification of activities, records, processes, and other elements of a quality system to determine their conformity with the requirements of a quality standard such as ISO 9000. Any failure in their proper implementation may be published publicly and may lead to a revocation of quality certification. The purpose of a quality audit is to determine whether the company is complying with its quality program or whether it needs to make changes to its business practices. Usually, a quality audit is an external audit, meaning it is conducted by an independent auditor or team of auditors who have expertise in the area. A company may also elect to perform an internal audit of its quality control systems on a periodic basis. Members of the audit team are typically professionals who have extensive knowledge about auditing standards, procedures, and principles. In addition, auditors should have hands-on experience with examining, evaluating, and reporting on whether each aspect of a quality system is deficient or satisfactory.

Technical Audit
Systematic analysis of a companys Research & Development activities conducted by an outside expert can be called a technical audit. The audit examines all current R & D activities, to make an honest appraisal of their potential and worthiness. After an audit, priorities on all projects should be clear to all involved. Almost any organizations that conduct R & D and are frustrated with the results go with technical audit. Company wants answer of question Are R&D Department working on the right projects? Th e technical audit addresses this question fully, suggesting which projects to emphasize, which ones to drop and which ones to start. It focuses your attention on the projects that will help your organization. And just as importantly, it eliminates work that wastes precious resources