Interaction between the External Auditor and Internal Auditors: The Canadian Experience

David Rattray, Senior Associate, Parliamentary Centre, Canada

Presentation to a Roundtable on State Financial Control Hosted by the Russian Federation Council within the framework of the IX St. Petersburg International Economic Forum Moscow, Russia, June 2005

and Having sufficient and appropriate evidence to support observations and conclusions. All these entities are internal to the government as a whole. The Legislative Branch of elected officials ( or shareholders ) engage their auditor or an SAI in this case. or management is operating the government. The policies regarding the conduct and examination of the audit should be the same. boards and commissions as a single. In the Canadian private sector this reporting entity would be a legally constituted corporation. Most of the entities. Quite straight forward and fairly universal in its application. The quality and the methodology should not be. By external audit I mean a body of auditors clearly outside or external to a reporting entity. So let us put behind us that internal audit is something different from external audit. The external auditor concept and reporting entity is carried over to the public sector in the Westminster model. These include among others: exercising due care demonstrating professional competency having an audit team that is objective and independent of the program or activity being audited. It doesn’t matter whether it is done by external auditors or by internal auditors. to conduct an audit and report back to them via report tablings in the Legislature how well the Executive. To understand this we must first define the reporting entity.Introduction Thank you for those kind words of introduction. Having clear audit objectives that can be concluded against. each have their own internal audit organizations. We in Canada look at the collectivity of government ministries and its agencies. large reporting entity. with an external auditor appointed by the shareholders to conduct work and report back to the shareholders on how well management is managing the corporation. One point of clarification I feel I need to make at this point in my remarks is to define what we mean in Canada by external versus internal audit. My experience here in Russia over the past three years is that we have similar yet in some instances very different set of definitions we each operate under. The same kind of professionalism is required. Let me first say that “audit is audit”. They can range from Page 2 Prepared under the Accountability Strengthening Program: a project funded by the Canadian International Development Agency . And thank you for inviting me to talk to you today about the relations between the functions of the Office of the Auditor General of Canada and those of internal audit. certainly all the large ministries.

All of these organizations are what I will be referring to as internal audit today. What I will now talk about are three things: First. The Auditor General’s formal duties come only at the end of the whole process – after the accounts for the past year have been prepared describing the financial activity for the past year. Second. That is when the Auditor General conducts her audit and gives an opinion on the fairness of the reporting of the summary financial statements of the government of Canada. which form the basis for preparing the numbers. But the Auditor General does a lot more. the respective roles of the Auditor General of Canada and those of the internal audit function in the government of Canada. Role of the Auditor General of Canada in the Budget Process I would like to cover two elements of budget making – the preparation and audit of the summary numbers and of the detailed departmental information. With regard to the accounting policies for the government. we include all the elements that make up the financial cycle. the role of the Auditor General of Canada in the Canadian budget process. This runs from the planning of annual spending and revenues for the coming year through to the reporting of the financial results and related financial position. Page 3 Prepared under the Accountability Strengthening Program: a project funded by the Canadian International Development Agency . The Summary numbers In Canada when we speak about the budget process. I would also welcome any questions of further clarification at the conclusion of my remarks. I trust this helps in clarifying my remarks which follow. a discussion about what constitutes an effective internal audit function. Third.half a dozen persons to over 100 staff members. they have made a number of comments over the years.

There have been many instances where the government is considering whether to go ahead with an economic event that involves the receipt of revenues or the spending of money. In doing so. In addition to major changes in accounting policies. Page 4 Prepared under the Accountability Strengthening Program: a project funded by the Canadian International Development Agency . each entity prepares and publishes an annual Report on its plans and priorities for the coming year. In addition to accounting issues. This kind of disclosure is very important because it not only specifies clearly what heads of entities plan to spend. the audit office has developed over the years a good working arrangement with the government of Canada regarding the use of accounting policies. the government has also consulted the Auditor General regarding the amendment of laws that relate to the financial management as well as ways to make the disclosure of summary financial information more understandable and useful. Please understand that that this kind of consultation only works if the government knows that the auditor is truly objective. it produces a performance Report indicating how it did against its plans and priorities. after auditing the information. it is consultation only – the government does not have to take the Auditor General’s advice and she has the right to change her mind if. The Departmental information At the departmental or ministry level in Canada. there may be options for the accounting of such transactions that can have an influence on the decision to proceed. but how they expect to be held accountable for the resources entrusted to them. This means going beyond reporting on the use of inputs – how many dollars you were authorized to spend or how many people you employed. Eighteen months later. the audit office reduces the chance of disagreement that might otherwise arise during the audit. and above reproach. to get her Office’s views on what she would consider appropriate accounting. independent.Specifically. By consulting with the Auditor General. Because at the end of the day. needs to draw a different conclusion. they have encouraged the adoption of more appropriate accounting policies befitting a government of the size and complexity as the government of Canada.

and complex corporations. spurred on the need for an internal audit function. the Auditor General expects heads of entities to start explaining results – how they made a difference to Canadian citizens.Are there more hospital beds in place.It also means going beyond outputs like the number of meetings that were held. the two categories of auditors have different masters – The Auditor General reports to Parliament while internal audit reports to the entity deputy head. Along with that. Brief History of Internal Audit Internal audit is a relatively new idea. the proliferation of large. In the beginning of the 20th century in the private sector. is reported to their “master” the parliament of Canada. Periodically the Auditor General will conduct audits on the quality of the performance information contained in the reports. what milestones have been achieved that would suggest that health will be better . Consequently. For example. In the public sector. This is where external audit parts company with internal audit. This kind of audit work. beginning in the late 1940’s. dispersed. While the methodology for audit may be the same. examine and make recommendations on the clarity and usefulness of the reports themselves. the capacity of elected Ministers to be able to oversee and be accountable for the administration of their ministries became increasingly difficult. it would expect the entity deputy head to be able to talk about the health of Canadians . Page 5 Prepared under the Accountability Strengthening Program: a project funded by the Canadian International Development Agency . at least in Canada. They do this because they believe that good accountability begins with good reporting. Before I move to the 2nd part of my presentation.Was their health better? And if they can’t say that. I would like to talk briefly about internal audit and how and why it came about. if the audit office were auditing health. They will on occasion. government organizations began to take on the same form and complexity as private sector companies. are there more doctors and nurses readily available? We also expect that the deputy head will provide a statement of assurance that all the financial information in the performance report is both fair and reliable. deputy heads took on a greater responsibility for the smooth running of their organizations.

who are the representatives of the Canadian people – the real shareholders. financial and operating controls". The Auditor General does not need approval or acceptance from those they audit. And that leads me to my 2nd point Two – Like Parliament. This should not be seen as a kind of policing exercise. Of course. And that leads to the 3rd point. but they also need to have an internal audit function that reports directly to them on the workings of the organization. deputy heads have executive committees. And the deputy head should know what’s going on while there is still time to make corrections before problems get out of hand. Their “master” is parliament and its members. like many corporations are large. Page 6 Prepared under the Accountability Strengthening Program: a project funded by the Canadian International Development Agency . Government ministries.In 1966. adequacy and application of all accounting. but four stand out. but rather as a positive way of proving assurance within the ministry that everything is working in the best interests of the citizens. It argued that as control becomes more decentralized. the government of Canada created an internal audit function to be part of the internal management of ministries. departmental heads and the executive branch needs audits designed specifically to inform them whether resources were being used “legally and effectively”. complex and very widely dispersed. The new government policy went on to say that the audit function "has an important place in all departments to review and appraise the soundness. Auditor General versus Internal Audit But why an internal audit function and not rely solely on the Auditor General of Canada? There are lots of reasons. One – The Auditor General is independent of management and reports to parliament directly. management has the right and the need to know what is working and not working so that they make corrections as they go. No deputy head can know first hand every aspect of the running of the business.

something they may have helped develop themselves. the Office conducted another audit of the internal control mechanisms in place for the federal government. That is the way it works in the financial audit and the way it normally works in performance audits. The Audit Office found that it varied considerably across these organizations. they cannot audit in an objective and independent way.The Auditor General of Canada comes in usually after the fact. Her Office assessed the extent to which internal audit groups in six federal organizations had met professional standards and complied with the then Treasury Board Policy on Internal Audit. the Financial Administration Branch within the Treasury Board Secretariat to strengthen financial administration. was largely ineffective. If they come in while an activity is ongoing and offer advice. not while activities are ongoing. The internal audit function. In 1996. And independence and objectivity are key to a successful legislative audit function. the Auditor General in this case. they weaken and jeopardize their capacity to remain independent.Three . often operates while activities are ongoing. including internal audit. They concluded there was a great deal of variability in the effectiveness of internal audit in government departments and agencies and proposed a number of things the federal government could do to bring about more effective internal audit. and the Office reported that internal audit. In response to these and many other challenges. the government created a special group. and ministry internal auditors to co-ordinate their audit plans in order to avoid inefficiencies and to maximize opportunities for reliance on each others work. where established. There is a strong requirement for both the external auditor. the Auditor General conducted an audit on the financial management and control practices in the federal government. on the other hand. This is the way the Auditor General believes it has to be. What constitutes a good internal audit function In 1976. In November 2004 the Auditor General once again examined internal audit in the federal government. That is. In two organizations (Public Works and Government Services Canada and the Royal Canadian Mounted Police). the internal audit group generally Page 7 Prepared under the Accountability Strengthening Program: a project funded by the Canadian International Development Agency .

Conclusion Page 8 Prepared under the Accountability Strengthening Program: a project funded by the Canadian International Development Agency . 2007. a focus on assurance services. these senior officials needed support from the centre government. Human Resources Development Canada. the government created a Centre of Excellence for Internal Audit at the Treasury Board. One agency did not meet many of the standards (Canadian International Development Agency). One of the main policy initiatives is that all internal audit organizations in government will have to comply with international internal audit standards of the Institute of Internal Auditors by January. if implemented. A Comptroller General of Canada position was created in 2004 with primary responsibility for strengthening internal audit and financial management. Three departments partially met the standards (Foreign Affairs and International Trade. methodology development. a clear human resource strategy at the department. and Natural Resources Canada). which is a Cabinet Committee of senior elected officials. and a strategy to ensure appropriate internal audit coverage and capacity in small entities. a departmental audit committee with external members who are independent of management. To this end in 2003. But even with interested and willing deputy heads. There is a new internal audit policy as of this month that will drive several initiatives to strengthen internal audit. and help in recruiting internal auditors. and government level that sets out the qualifications and appropriate number of staff for the internal audit community.met the International Standards for the Professional Practice of Internal Auditing. This Centre was created to support the internal audit community in a number of ways including policy guidance. The audit report identified a number of important factors that. central agency. could have a positive influence on the quality of internal audit across government: a consistent understanding on the part of senior management of the role that internal audit can and should play. There is currently a great deal of effort being expended on modernizing and capacity building of the internal audit function.

And the need for an internal audit function grew out of the development and growth of large complex and dispersed government organizations. it has everything to do with different roles. But both serve good accountability. let me repeat what I started with – audit is audit. If there is time. Thank you very much. Page 9 Prepared under the Accountability Strengthening Program: a project funded by the Canadian International Development Agency . And the internal auditors give assurance to senior management that they can rely on the management controls that are in place and that the risks are being managed as they relate to financial control. Elected officials needed someone who could provide them with credible financial and performance information to help them hold the unelected officials to account.In conclusion. I would be very pleased to answer any questions that you may have. The issue of external versus internal audit has nothing to do with methodology. The external auditor gives assurance to the shareholders – the owners of the organization – that the managers are managing in the best interests of the owners. And accountability of elected officials to those that elected them. regularity and performance. The need for an independent and credible legislative auditor arose with the birth and development of democratic parliamentary institutions. Both functions come together under the rubric of accountability – accountability of unelected officials to legislators for the responsibilities entrusted to them. I do hope that my remarks have been of interest to you and relevant to your proceedings today.

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