ELEC 2

Internal, Financial Auditing and Operational Auditing

1. Explain the role of internal auditors in financial auditing.

Internal auditing is an independent objective assurance and consulting activity
designed to add value and improve an organization’s operations.
 Risk Management
 Controls
 Governance Processes

INTERNAL AUDITING

Provide value through improved operational

effectiveness while performing traditional
responsibilities.

Reviewing Safeguarding
management assets
information
Ensuring
compliance

INSTITUTE OF INTERNAL AUDITORS ETHICAL PRINCIPLES

Integrity

Ethical
Confidentiality Principles Competency

Objectivity

INSTITUTE OF INTERNAL AUDITORS RULES OF CONDUCT

Integrity

Rules
Confidentiality of Competency
Conduct

Objectivity
RELATIONSHIP OF INTERNAL AND EXTERNAL AUDITORS
 The internal auditor is responsible to management
 The external auditor is responsible to financial statement users
 Both must be competent, objective, use a similar methodology, and consider
risk and materiality

2. Distinguish operational auditing from financial auditing.

Operational Auditing - The purpose of operational auditing is to
determine the effectiveness or efficiency of any part of an organization
Financial Auditing emphasizes whether historical information was correctly
recorded while operational auditing emphasizes effectiveness and efficiency.

3. Provide an overview of operational audits.

EFFECTIVENESS VS. EFFICIENCY

 Effectiveness refers to accomplishing objectives
 Efficiency is defined as reducing cost without reducing effectiveness

INEFFIENCY EXAMPLE

Acquisition of goods and services is too Bids for purchases of materials are not
costly.
Raw materials are not available when
needed
A duplication of effort by employees
exists
Work is done that serves no purpose
There are too many employees
required
An assembly line was shut down for
lack of materials
Production and accounting keep
identical records
Vendors’ invoices and receiving reports
are filed without being used
Office work could be done with one
less assistant

RELATIONSHIP BETWEEN OPERATIONAL AUDITING & INTERNAL

CONTROLS
 Reliability of financial reporting
 Efficiency and effectiveness of operations
 Compliance with applicable laws and regulations
TYPES OF OPERATIONAL AUDITS
 Function
 Organizational
 Special Assignments
WHO PERFORMS OPERATIONAL AUDITS
 Internal Auditors
 Government Auditors
 CPA Firms
INDEPENDENCE AND COMPETENCE OF OPERATIONAL AUDITING

The two most important qualities

for an operational auditor

Competence Independence

4. Plan and perform an operational audit.

SPECIFIC CRITERIA. More specific criteria are usually desirable before starting
an operational audit
Sources of criteria include:
 Historical performance
 Benchmarking
 Engineered standards
 Discussion and agreement

PHASES IN OPERATIONAL AUDITING

Evidence Reporting
gathering and and
Planning
evaluation follow-up

 Staffing  Eight types  Scope

 Scope  Documentation  Findings
 Controls  Recommendations
ECO302
MEASURING DOMESTIC OUTPUT AND NATIONAL INCOME

NATIONAL INCOME
− National income accounting measures the economy’s performance by
measuring the flows of income and expenditures over a period of time.
− National income accounts serve a similar purpose for the economy, as do
income statements for business firms.
− Consistent definition of terms and measurement techniques allows us to use
the national accounts in comparing conditions over time and across
countries.
− The national income accounts provide a basis for of appropriate public
policies to improve economic performance.
GROSS DOMESTIC PRODUCT (GDP)
− GDP is the monetary measure of the total market value of all final goods and
services produced within a country in one year.
− 1. Money valuation allows the summing of apples and oranges; money acts
as the common denominator.

− 2.GDP
includes only final products and services; it avoids double or multiple
counting, by eliminating any intermediate goods used in production of these
final goods or services.
− 3. GDP is the value of what has been produced in the economy over the
year, not what was actually sold.

Value Added in a
Five-Stage
Production Process
GDP EXCLUDES NONPRODUCTION TRANSACTIONS
1. GDP is designed to measure what is produced or created over the current time
period. Existing assets or property that sold or transferred, including used items,
are not counted.
2. Purely financial transactions are excluded. For example:
a. Public transfer payments, like social security or cash welfare benefits.
b. Private transfer payments, like student allowances or alimony payments.
c. The sale of stocks and bonds represent a transfer of existing assets.
(However, the brokers’ fees are included for services rendered.)
3. Secondhand sales are excluded, they do not represent current output.
(However, any value added between purchase and resale is included, e.g. used
car dealers.)

TWO WAYS TO LOOK AT GDP: SPENDING AND INCOME

1. What is spent on a product is income to those who helped to produce and sell
it. (SPENDING)
2. This is an important identity and the foundation of the national accounting
process. (INCOME)

EXPENDITURES APPROACH
GDP = C + Ig + G + (Xn)
C = Personal Consumption Expenditures
Ig = Gross Private Domestic Investment
G = Government Purchases
Xn= Net exports
PERSONAL CONSUMPTION EXPENDITURES ( C )
− That term covers all expenditures by households on durable consumer goods
(automobiles, refrigerators, video recorders), nondurable consumer goods
(bread, milk, vitamins, pencils, toothpaste), and consumer expenditures for
services (of lawyers, doctors, mechanics, barbers)
GROSS PRIVATE DOMESTIC INVESTMENT (Ig)
A. All final purchases of machinery, equipment, and tools by businesses.
B. All construction (including residential).
C. Changes in business inventory.
a) If total output exceeds current sales, inventories build up.
b) If businesses are able to sell more than they currently produce, this entry
will be a negative number.
D. Noninvestment transactions – despite how the term “investment” is used
by the general public, investment does not include transfers of ownership of
paper assets (stocks and bonds) or real assets (houses, jewelry, art). Only
newly created capital is counted as investment.
GROSS V. NET PRIVATE DOMESTIC INVESTMENT
Gross investment includes investment in replacement capital and in added
capital. In contrast, net private domestic investment includes only investment
in the form of added capital. The amount of capital that is used up over the
course of a year is called depreciation.
Net investment = gross investment - depreciation
 If more new structures and capital equipment are produced in a given year
than are used up, the productive capacity of the economy will expand.
 When gross investment and depreciation are equal, a nation’s productive
capacity is static. ZERO NET INVESTMENT
 When gross investment is less than depreciation, an economy’s production
capacity declines. (disinvesting)
GOVERNMENT PURCHASES (G)
Also known as “government consumption expenditures and gross
investment.” These expenditures have two components:
1) expenditures for goods and services that government consumes in providing
public services and
2) expenditures for publicly owned capital such as schools and highways, which
have long lifetimes.
Government Purchases (of consumption goods and capital goods) – (G)
 Includes spending by all levels of government (federal, state and local).
 Includes all direct purchases of resources (labor in particular).
 This entry excludes transfer payments since these outlays do not reflect
current production.
NET EXPORTS ( Xn )
Exports are by definition goods and services produced within the borders of the
country. Thus, foreign spending on our exports must be included in GDP.
a. All spending on final goods produced in the U.S. must be included in GDP,
whether the purchase is made here or abroad. (Exports)
b. While the goods purchased and measured in the U.S. are produced
elsewhere (Imports).
c. Therefore, net exports, (Xn) is the difference: (exports minus imports) and
can be either a positive or negative number depending on which is the larger
amount.
NET EXPORTS (Xn) = EXPORTS (X) - IMPORTS (M)
INCOME APPROACH

National income xx
Less: Net foreign factor income xx
Plus: Statistical discrepancy xx
Plus: Consumption of fixed capital xx
Gross Domestic Product xx

National income is all income earned by citizens supplied resources, whether

here or abroad, plus taxes on production and imports.

NATIONAL INCOME
The sum of the following entries makes up NATIONAL INCOME:
a. Compensation of employees includes wages, salaries, fringe benefits, salary
and supplements, and payments made on behalf of workers like social security
and other health and pension plans.
b. Rents: payments for supplying property resources (adjusted for depreciation
it is net rent).
c. Interest: payments from private business to suppliers of money capital.
d. Proprietors’ income: income of incorporated businesses, sole
proprietorships, partnerships, and cooperatives.
e. Corporate profits: After corporate income taxes are paid to government,
dividends are distributed to the shareholders, and the remainder is left as
undistributed corporate profits (also referred to as retained earnings).
f. Taxes on production and imports: general sales taxes, excise taxes,
business property taxes, license fees, and customs duties.

ADJUSTMENTS TO INCOME INCOME

1. Net foreign factor income: National income measures the income of
Americans both here and abroad. GDP measures the output of the
geographical U.S. regardless of the nationality of the contributors. Net foreign
factor income measures American income earned abroad minus the income
of foreign nationals producing in the U.S. To make the final adjustment from
national income to GDP (thereby only measuring what is produced within
 U.S. borders), net foreign factor income must be subtracted from national
income. This removes the income earned by Americans outside the borders,
but adds in what foreign workers produced on U.S. soil. Sometimes net
foreign factor income is negative, making the net contribution to GDP
positive. (Without this adjustment you have GNP.)
2. Statistical discrepancy: NIPA accountants add a statistical discrepancy to
national income to equalize the income and expenditures approaches.
3. Depreciation/Consumption of Fixed Capital: The firm also regards the
decline of its capital stock as a cost of production. The depreciation
allowance is set aside to replace the machinery and equipment used up. In
addition to the depreciation of private capital, public capital (government
buildings, port facilities, etc.), must be included in this entry.
EXAMPLE: INCOME APPROACH

OTHER NATIONAL ACCOUNTS

− Net domestic product (NDP) is equal to GDP minus depreciation allowance
(consumption of fixed capital).

−
N
ational income (NI) is income earned by American owned resources here or
abroad. Adjust NDP by adding net foreign factor income. (Note: This may
be a negative number if foreigners earned more in U.S. than American
resources earned abroad.)
− Personal income (PI) is income received by households. To calculate, take
NI minus payroll taxes (social security contributions), minus corporate profits
taxes, minus undistributed corporate profits, and add transfer payments.

Disposable income (DI) is personal income less personal taxes.

NOMINAL versus REAL GDP
− A GDP based on the prices that prevailed when the output was produced is
called unadjusted GDP, or nominal GDP.
− A GDP that has been deflated or inflated to reflect changes in the price level
is called adjusted GDP, or real GDP.

A. Nominal GDP is
the market value of all final goods and services produced in a year.
1. GDP is a (P x Q) figure including every item produced in the economy. Money
is the common denominator that allows us to sum the total output.
2. To measure changes in the quantity of output, we need a yardstick that stays
the same size. To make comparisons of length, a yard must remain 36 inches.
To make comparisons of real output, a dollar must keep the same purchasing
power.
3. Nominal GDP is calculated using the current prices prevailing when the output
was produced but real GDP is a figure that has been adjusted for price level
changes.
PRICE INDEX
− A price index is a measure of the price of a specified collection of goods and
services, called a “market basket,” in a given year as compared to the price
of an identical (or highly similar) collection of goods and services in a
reference year. That point of reference, or benchmark, is known as the base
period or base year.
MGT 202
INTRO TO MANAGEMENT
− Management is knowing exactly what you want men to seeing that they do it best &
cheapest way.
− Management is defined as the creation & maintenance environment in an enterprise
where individuals working together in groups can perform efficiently & effectively
towards the attainment of a goal.
NATURE OF MANAGEMENT
− The study and application of management technique in managing the affairs of the
organizations have changed its nature over the period of time.
MULTIDISCIPLINARY
− This implies that although management has been developed as a separate
discipline it draws knowledge and concepts from various discipline.
− Management integrates the ideas and concepts taken from these disciplines and
present newer concepts which can be put into practice for managing the
organization.
DYNAMIC NATURE OF PRINCIPLES
− Based on integration and supported by practical evidences, management has
formed certain principles. However, these principles are flexible in nature and
change with the changes in the environment in which an organization exists.
RELATIVE, NOT ABSOLUTE PRINCIPLES
− Management principle are relative not absolute, and they should be applied
according to the need of the organization. Each organization may be different from
others. The difference may exist because of time, place, sociocultural factors, etc.
MANAGEMENT SCIENCE OR ART
− There is a controversy whether management is a science or art. However,
management is both a science and art.
− Art means managers has to handle the person and things tactfully. Science means
achieving objectives through procedures.
MANAGEMENT AS A PROFESSION
− Management has been regarded as profession by many while many have
suggested that it has not achieved the status of a profession.
SETTING GOALS FOR ORGANIZATIONS
− Goals differ from organization in business, the basic economic goal is to earn max
profit, while in service organization like hospital and education institution for a basic
goal is to provide better service and better education.

AWARENESS OF OPPORTUNITIES AND RESOURCES

− Management have awareness of opportunities and resources like men, materials,
money which assembles and integrates by management.

MANAGEMENT IS TRANSFORMATION PROCESS

− Management is a transformation process consisting of planning, organization,
staffing, directing and controlling.
MANAGEMENT IS UNIVERSAL
− The principles and techniques of management are universally applicable to all group
activities performed at any level of organization.
“efficient management can not remain static it must adopt itself to changing conditions”

SYSTEM OF AUTHORITY
− Means a hierarchy of command and control. Managers at different levels
possess varying degrees of authority.
− You have the capability to assess and control things depending on what you
to be done with the current resources that you have.
IMPORTANCE OF MANAGEMENT
− No ideology, no ism, or political the greater output with less efforts from a
given complex of human and materials resources, only sound management.
And it is on that such greater output, a higher standard of life, more leisure,
more amenities for all is achieve.
A. Effective utilization of resources
B. Development of resources
C. To incorporate innovations
D. Integrating various interest groups’
E. Stability in the society

LEVELS OF MANAGEMENT

TOP
MANAGEMENT
Directors/CEO/Owners/
Shareholders
UPPER MIDDLE
MANAGEMENT
Executives

MIDDLE MIDDLE MIDDLE

MANAGEMENT MANAGEMENT MANAGEMENT
Superintendent Branch Manager Area Supervisor/ Inspector

LOWER LOWER LOWER

MANAGEMENT MANAGEMENT MANAGEMENT
Team Leaders
Team Leaders Team Leaders
OPERATING OPERATING OPERATING
FORCE FORCE FORCE
Workers Workers Workers