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CHAPTER 1

Chapter 1:
Introduction to
Internal
Auditing

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Chapter 1: Introduction to Internal

Auditing
LEARNING
OBJECTIVES
◼ Understand the value proposition that
stakeholders expect from the internal
audit function.
◼
Obtain a basic understanding of
internal auditing and the internal audit
process.
◼
Understand the relationship between
auditing and accounting.
◼
Distinguish between financial reporting
assurance services provided by
internal auditors and those provided
by independent outside auditors.
◼
Become familiar with the internal audit
profession and The IIA.
◼ Understand the competencies needed
to excel as an internal auditor.
◼
Be aware of the various internal audit
career opportunities it is possible to

Internal Auditing: Assurance & Advisory Services, 4th Edition © 2017 by the Internal Audit
Foundation.

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Chapter 1: Introduction to Internal

Auditing
THE VALUE
PROPOSITION
 Assurance = Governance,
Risk, & Control
 Insight = Catalyst,
Analyses, & Assessments
 Objectivity = Integrity,
Accountability, &
Independence

Internal Auditing: Assurance & Advisory Services, 4th Edition © 2017 by the Internal Audit
Foundation.

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Chapter 1: Introduction to Internal

Auditing
DEFINITION OF INTERNAL AUDITING

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.
The IIA’s Definition of Internal Auditing states the
fundamental purposes, nature, and scope of internal
auditing:
Helping the organization accomplish its objectives.
Evaluating and improving the effectiveness of risk management,
control, and governance processes.
Assurance and consulting activity designed to add value and improve
operations.
Independence and objectivity.
A systematic and disciplined approach
Internal Auditing: Assurance & Advisory Services, 4th Edition © 2017 by the Internal Audit
Foundation.

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Chapter 1: Introduction to Internal

Auditing
OBJECTIVES

An organization’s objectives define what the

organization wants to achieve, and its ongoing
success depends on the accomplishment of its
objectives.
 Strategic objectives are those goals that
management sets specifically related to
stakeholder interests. Throughout this
textbook, the term objectives will be used
when discussing what an organization wants
to achieve and the term strategy when
discussing the way management intends to
achieve those objectives.
 Operations objectives pertain to the
effectiveness and efficiency of the entity’s
operations, including operational and
financial performance goals, and
safeguarding resources against loss.
 Reporting objectives pertain to internal
and external financial and nonfinancial
reporting
Internal Auditing: Assurance & Advisory Services, 4th Edition © 2017 by the Internal Audit
Foundation.

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Chapter 1: Introduction to Internal

Auditing
RISK MANAGEMENT, CONTROL,
AND GOVERNANCE

An organization cannot achieve its objectives and sustain success

without effective risk management, control, and governance
processes.

 Risk management is the process conducted by management to

understand and deal with uncertainties (risks and opportunities)
that could affect the organization’s ability to achieve its
objectives.

 Governance is the process conducted by the board of directors to

authorize, direct, and oversee management toward the
achievement of the organization’s objectives.

 Control is the process conducted by management to mitigate

risks to acceptable level
Internal Auditing: Assurance & Advisory Services, 4th Edition © 2017 by the Internal Audit
Foundation.

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Independence and Objectivity

◼ Independence ◼ Objectivity
◼ The freedom of conditions ◼ An unbiased mental
that threaten objectivity or attitude that allows
the appearance of internal auditors to
objectivity. Such threats to perform engagements in
objectivity must be such a manner that they
managed at the individual have an honest belief in
auditor, engagement, their work product ant that
functional and no significant quality
organizational levels. compromises are made.
Objectivity requires
internal auditors not to
subordinate their judgment
on audit matters to that of
Internal Auditing: Assurance & Advisory Services, 4 Edition © 2017 by the Internal Audit
th

Foundation. others

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Chapter 1: Introduction to Internal

Auditing
A SYSTEMATIC AND
DISCIPLINED APPROACH
To truly add value and improve operations, internal assurance and consulting
engagements must be performed in a systematic and disciplined manner. There are
three fundamental phases in the audit engagement process:
 Planning
• Obtaining an understanding of the auditee or costumer
• Setting the engagement objectives
•
Determining the required evidence
•
Deciding the nature, timing, and extent of the audit tests

 Performing
• Making inquiries, observing operations, inspecting documents, Gathering evidence, and
analyzing the reasonableness of information
•
Evaluating the evidence gathered and reaching logical conclusions

 Communicating
• Providing the results of the assessments made of the information and documentation
gathered

Internal Auditing: Assurance & Advisory Services, 4th Edition © 2017 by the Internal Audit
Foundation.

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Chapter 1: Introduction to Internal

Auditing

Auditing is not a subset of accounting.

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THE DIFFERENCE BETWEEN EXTERNAL
AND INTERNAL AUDITORS
EXTERNAL AUDITOR
◼ Is an independent
contractor
◼ Serves third parties who
need reliable information.
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INTERNAL AUDITOR
◼ Is an organization’s
employee or can be a
independent entity
(outsourced or co-
sourced)
◼ Serves the needs of the
organization, though the
function must be managed
by the organization
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THE DIFFERENCE BETWEEN
EXTERNAL AND INTERNAL AUDITORS
• EXTERNAL AUDITOR
◼ Focuses on the accuracy and
understandability of
historical events as
expressed in financial
statements.
◼ Is incidentally concerned
with the prevention and
detection of fraud in general,
but is directly concerned
when financial statements
may be materially affected.
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INTERNAL AUDITOR
◼ Focuses on future events
by evaluating controls
designed to assure the
accomplishment of entity
goals and objectives.
◼ Is directly concerned with
the prevention of fraud in
any form or extent in any
activity reviewed.
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THE DIFFERENCE BETWEEN EXTERNAL AND
INTERNAL AUDITORS
• EXTERNAL AUDITOR
◼ Is independent of
management and the
board of directors both in
fact and in mental attitude.
◼ Reviews records
supporting financial
statements periodically –
usually once a year.
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INTERNAL AUDITOR
◼ Is independent of the
activities audited, but is
ready to respond to the
needs and desires of all
elements of management
and the board.
◼ Reviews governance, risk
management, and control
processes as needed.
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Ancient Times

In 3500 BC in
Mesopotamia records
show dots, checks
and tick marks
besides numbers
involved in financial
transactions which
portray a system of
verification.
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Ancient Times

Origin of the word

‘Audit’
Ancient Rome
employed the
‘hearing of
accounts’. The
Latin word auditus
means a hearing.
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The Middle Ages

When Rome fell, so

did monetary systems
and financial controls.
When Italian commerce
expanded in the 13th
century more
sophisticated record
keeping was needed.
Double entry
bookkeeping was
invented.
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The Middle Ages

An auditor
representing
Queen Isabella’s
interests
accompanied
Columbus to the
New World.
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The Industrial
Revolution

IN ENGLAND, ORGANIZATIONS
HIRED ACCOUNTANTS TO CHECK
FINANCIAL RECORDS.
AUDITING, ALONG WITH
BRITISH INVESTMENTS
CROSSED THE SEA TO
BRITAIN’S COLONIES IN THE
19 TH CENTURY.

18 Internal Auditing: Assurance & Advisory Services, 4th Edition © 2017 by the Internal Audit
Foundation.

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The 20th Century

After World War I, the

U. S. economy,
unaffected by the war
escalated. Auditing
was for the benefit of
the bankers who
feared the overly
optimistic balance
sheets and needed an
independent
verification.
18 Internal Auditing: Assurance & Advisory Services, 4th Edition © 2017 by the Internal Audit
Foundation.

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The 20th Century

Railroads were the first

organizations to use
internal auditors.
Management needed
assurances that
receipts were handled
properly at the
stations, external
audits were
inadequate for this
purpose Internal Auditing: Assurance & Advisory Services, 4th Edition © 2017 by the Internal Audit
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Foundation.

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The 20th Century

In 1941, Victor Z.
Brink, authored the
first major book on
internal auditing.

A small band of 24
charter members held
the inaugural IIA
meeting in New York City
on December 9, 1941.
Internal Auditing: Assurance & Advisory Services, 4th Edition © 2017 by the Internal Audit
20 Foundation. Internal Auditing: Assurance & Advisory Services, 4th Edition © 2017 by the Internal Audit
Foundation.

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The 20th Century

The first edition of The

Practice of Modern
Internal Auditing, by
Lawrence “Larry” B.
Sawyer, was released in
1973, comprising 531
pages that painted the
first comprehensive
picture of the profession
as a value-added asset in
the business arena.
Internal Auditing: Assurance & Advisory Services, 4th Edition © 2017 by the Internal Audit
21 Foundation. Internal Auditing: Assurance & Advisory Services, 4th Edition © 2017 by the Internal Audit
Foundation.

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Chapter 1:
Introduction to
Internal
Auditing

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Chapter 1: Introduction to Internal

Auditing

The IIA is the internal audit profession’s global voice, standard-

setter, and resource for professional development and certification.

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Chapter 1: Introduction to Internal Auditing

The IIA offers many certifications that help internal

auditors become more proficient and advance their
careers.

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Chapter 1: Introduction to
Internal Auditing
COMPETENCIES NEEDED
BY INTERNAL AUDITORS

Characteristics of successful
internal auditors:
 Competence
 Credibility
 Connectivity
 Communication
 Courage

Internal Auditing: Assurance & Advisory Services, 4th Edition © 2017 by the Internal Audit
Foundation.

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Exhibit 1-
6

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IA Competency Framework 10
Core Competencies

◼ Professional ethics
◼ Internal Audit Management

◼ IPPF

◼ Governance, Risk and Control

◼ Business Acumen

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IA Competency Framework 10
Core Competencies

◼Communication
◼Persuasion and collaboration

◼Critical thinking

◼Internal audit delivery

◼Improvement and

Innovation
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Chapter 1: Introduction to Internal

Auditing
INTERNAL AUDIT CAREER PATHS

Pathways into Internal Auditing

 Directly out of college, particularly schools with IIA endorsed
internal audit programs
 From public accounting
 As a rotational part of a management trainee program

Pathways out of Internal Auditing

 Into financial or nonfinancial management positions
 Into a position with a professional services firm that provides internal
assurance and consulting services

Careers in Internal Auditing

 Move up the ladder into a management position within one
organization
 Move up the ladder into management positions across different
organizations

Internal Auditing: Assurance & Advisory Services, 4th Edition © 2017 by the Internal Audit
Foundation.

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Discussion Questions

1. Define “value proposition.” Explain why it is important

for internal auditors to have a value proposition.
Describe the three components of the internal audit
value proposition set forth by The IIA.
2. Juan Dela Cruz has a 7:00 a.m. class each day. The
professor has instilled in the students the importance
of getting to class on time, so Juan has made this one
of her objectives for the semester. What risks threaten
the achievement of Juan’s objective? What controls can
Juan implement to mitigate these risks?

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