6/17/2023

CHAPTER 9:
INTERNAL AUDIT
Instructor: Doan Thanh Nga, PhD, CPA (Australia)

CHAPTER 9 LEARNING OBJECTIVES

- Define internal audit

- Distinction between internal and external audit
- Understand the internal audit function

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1. WHAT IS INTERNAL AUDIT?

Definition

Internal audit function: An appraisal activity established or provided as

a service to the entity. Its functions include, amongst other things, examining,
evaluating and monitoring the adequacy and effectiveness of internal control.

1. WHAT IS INTERNAL AUDIT (cont.)

Internal audit function
• Internal audit function provided either by employees of the entity or
sourced from an external organisation to assist management in achieving
corporate objectives.

• The codes of corporate governance that indicate good practice for

companies, such as the UK Corporate Governance Code (mandatory for
UK listed companies) highlight the need for businesses to maintain good
systems of internal control to manage the risks the company faces.

• Internal audit can play a key role in assessing and monitoring internal
control policies and procedures.
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1. WHAT IS INTERNAL AUDIT (cont.)

The internal audit function can assist the board in other ways as well:
• By, in effect, acting as auditors for board reports not audited by the external auditors.
• By being the experts in fields such as auditing and accounting standards and
assisting in implementation of new standards.
• By liaising with external auditors => reduce the time and therefore cost of the
external audit.
o There are limits on the extent to which internal audit work can be used,
however, the use of internal auditors to provide direct assistance to the
external auditor is prohibited in an audit conducted under ISAs (UK).
o Internal auditors can check that external auditors are reporting back to the
board everything they are required to under auditing standards.

1. WHAT IS INTERNAL AUDIT (cont.)

The UK Corporate Governance Code highlights the importance of internal audit

by stipulating that directors of companies that do not have an internal audit
department should reconsider the need for one annually

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1.1. Distinction between internal and external audit

Internal audit External audit

The internal audit function is an
An exercise to enable auditors to
activity designed to add value and
Reason express an opinion on the financial
improve an organisation’s
statements.
operations.
Internal auditors report to the
The external auditors report to the
Reporting to board of directors, or the audit
shareholders of a company
committee
Relating to Operations of the organisation. The financial statements.
Internal auditors are very often External auditors are independent of
Relationship with employees of the organisation, the company and its management.
the company although sometimes the internal They are appointed by the
audit function is outsourced. shareholders.

2. WHAT DOES THE INTERNAL AUDIT FUNCTION DO?

The activities of the internal audit function usually involve:

 Monitoring internal controls
 Examining financial and operating information
 Reviewing the economy, efficiency and effectiveness of operations
 Reviewing compliance with laws, regulations and other external requirements
 Conducting special investigations, for instance, into suspected fraud
 Identifying and evaluating significant exposures to risk and contributing to the
improvement of risk management and control systems
 Assessing the governance process in its accomplishment of objectives on
ethics and values, performance management and accountability

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2. WHAT DOES THE INTERNAL AUDIT FUNCTION DO? (cont.)

2.1. Risk

The internal audit function has a two-fold role in relation to risk management:

• Monitoring the company's overall risk management policy to ensure it

operates effectively

• Monitoring the strategies implemented to ensure that they continue to

operate effectively.

2. WHAT DOES THE INTERNAL AUDIT FUNCTION DO? (cont.)

2.2. Internal controls
• The internal audit function’s key role will be in monitoring the overall process and in
providing assurance that the systems which the departments have designed meet objectives
and operate effectively.
• Internal audit function retains objectivity
 not be involved in the assessment of risks and the design of the system.
 testing (and therefore monitoring) controls is likely to be an important part of their role.
 The tests that they carry out will be on the same lines as the tests outlined in the
previous three chapters that external auditors will carry out. However, as internal
auditors are focused on all the operations of the company, they are focusing on all
controls, not just ones linked ultimately to the financial statements, so the scope of their
testing will be far greater than that of the external auditors.
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2. WHAT DOES THE INTERNAL AUDIT FUNCTION DO? (cont.)

2.2. Internal controls (cont.)

The work that internal auditors carry out on controls can be termed operational audits.
There are two aspects of an operational assignment:
• Ensure policies are adequate
• Ensure policies work effectively

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2. WHAT DOES THE INTERNAL AUDIT FUNCTION DO? (cont.)

2.2. Internal controls (cont.)
 Adequacy:
The internal auditor will have to review the policies of a particular department by:
• reading them
• discussing them with members of the department
Then the auditor will have to assess whether the policies are adequate, and possibly
advise the board of improvement.
 Effectiveness:
The auditor will then have to examine the effectiveness of the controls by testing
them.

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2. WHAT DOES THE INTERNAL AUDIT FUNCTION DO? (cont.)

2.3. Other functions
• The internal audit function may also carry out other work for the directors in a
company.
• However, the key issue: retain objectivity
 Internal auditors will not become involved in the operational activities of
the company.

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Summary

The internal audit function is an appraisal activity established or provided as a

service to the entity. Its functions include, amongst other things, examining,
evaluating and monitoring the adequacy and effectiveness of internal control

Monitoring for adequacy and effectiveness

Therefore, must stay objective. Not involved in operational activities.

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