INTERNAL AND

GOVERNMENTAL
FINANCIAL AUDITING AND
OPERATIONAL AUDITING
CHAPTER 26

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 CHAPTER 26 LEARNING OBJECTIVES

26-1 Explain the role of internal auditors in financial auditing.

26-2 Describe the auditing and reporting requirements under
Government Auditing Standards and the Single Audit Act.
26-3 Distinguish operational auditing from financial auditing.
26-4 Provide an overview of operational audits.
26-5 Plan and perform an operational audit.

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 OBJECTIVE 26-1
Explain the role of internal auditors
in financial auditing.

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 INTERNAL FINANCIAL AUDITING
Institute of Internal Auditors: Professional guidance for internal
auditors is provided by the Institute of Internal Auditors (IIA).
The Institute of Internal Auditors provides the following definition
of internal auditing:

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 INTERNAL FINANCIAL AUDITING (CONT.)

Internal auditors are expected to provide value to the organization

through improved operational effectiveness, while also performing
traditional responsibilities, such as:
• Reviewing the reliability and integrity of information
• Ensuring compliance with policies and regulations
• Safeguarding assets
The Institute of Internal Auditor’s Code of Ethics is shown in Figure
26-1 on page 828.

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 INTERNAL FINANCIAL AUDITING (CONT.)

Relationship of Internal and External Auditors:

• Internal auditors are responsible to management and the board,
whereas
• External auditors are responsible to financial statement users.
• External auditors rely on internal auditors when using the audit
risk model to assess control risk.
• If internal auditors are effective, the external auditors can
significantly reduce control risk and thereby reduce substantive
testing.

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 OBJECTIVE 26-2
Describe the auditing and reporting
requirements under
Government Auditing Standards and
the Single Audit Act.

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 GOVERNMENTAL FINANCIAL AUDITING

The primary source of authoritative literature for doing

governmental audits is Government Auditing Standards, which
is issued by the Government Accountability Office (GAO).
• These standards are often called generally accepted
government auditing standards (GAGAS).
• Because of the color of cover, it is usually referred to as the
“Yellow Book” rather than its formal name.
• The initial Yellow Book was similar to the GAAS standards, but
it has been expanded to provide guidance standards for
performance audits.

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 GOVERNMENTAL FINANCIAL AUDITING (CONT.)

Financial Audit and Reporting Requirements—Yellow Book:

The financial auditing standards of the Yellow Book are consistent
with the principles of the AICPA auditing standards, and also
contain extensive additional guidance, including the following:
• Materiality and significance
• Quality control
• Compliance auditing
• Reporting

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 GOVERNMENTAL FINANCIAL AUDITING (CONT.)
Audit and Reporting Requirements—Single Audit Act and OMB
Circular A-133:
The Single Audit Act of 1984 provides for a single coordinated audit to
meet the audit requirements of all federal agencies. Entities that receive
more than $750,000 in federal funds are subject to a single audit.
Audit Requirements:
• The audit should be in accordance with GAGAS.
• The auditor must obtain an understanding of internal control over federal
programs sufficient to support a low assessed level of control risk for
major programs.
• The auditor should determine whether the client has complied with laws,
regulations, and the provisions of contracts or grant agreements that may
have a direct and material effect on each of its major programs.

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 GOVERNMENTAL FINANCIAL AUDITING (CONT.)
Single Audit Act and OMB Circular A-133 (cont.):
Reporting Requirements:
• An opinion on whether the financial statements are presented fairly in all material
respects in accordance with GAAP
• An opinion as to whether the schedule of federal awards is presented fairly in all
material respects in relation to the financial statements as a whole
• A report on internal control related to the financial statements and major programs
• A report on compliance with laws, regulations, and the provisions of contracts or
grant agreements, where noncompliance could have a material effect on the
financial statements
• A schedule of findings and questioned costs
AICPA Guidance for Auditors: Two relevant sources are the AICPA audit guide,
Government Auditing Standards and Single Audits, and the auditing standard,
Compliance Audits.

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 OBJECTIVE 26-3
Distinguish operational auditing
from financial auditing.

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 OPERATIONAL AUDITING
Major Differences Between Operational and Financial
Auditing:
• Purpose of the Audit: Operational auditing emphasizes
effectiveness and efficiency.
• Distribution of the Reports: Operational reports are intended
primarily for management.
• Inclusion of Nonfinancial Areas: Operational audits cover any
aspect of efficiency and effectiveness.

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 OBJECTIVE 26-4
Provide an overview of operational
audits.

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 EFFECTIVENESS VERSUS EFFICIENCY
Effectiveness: Refers to meeting objectives.
Efficiency: Defined as reducing cost without reducing
effectiveness.
Relationship Between Operational Auditing and Internal
controls: Management establishes internal controls to help
meet its goals. One goal of internal controls is to help achieve
operational efficiency and effectiveness:
• Purpose: The purpose of operational auditing of internal
control is to evaluate efficiency and effectiveness.
• Scope: The scope of operational auditing concerns any control
affecting efficiency or effectiveness.

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 EFFECTIVENESS VERSUS EFFICIENCY (CONT.)
Types of Operational Audits:
• Functional Audits: Deal with one or more functions in an
organization, concerning, for example, the efficiency or
effectiveness of the payroll function.
• Organizational Audits: Emphasize how efficiently or effectively
functions within an organization interact.
• Special Assignments: Arise at the request of management for a
wide variety of reasons, such as determining the cause of an
ineffective IT system.

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 EFFECTIVENESS VERSUS EFFICIENCY (CONT.)

Who Performs Operational Audits:

• Internal Auditors
• Government Auditors
• CPA Firms
Independence and Competence of Operational Auditors:
• Independence: The auditor should report to the appropriate level of
management to ensure that investigation and recommendations are
made without bias.
• Competence: Necessary to determine the cause of the operational
problems and to make appropriate recommendations.

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 OBJECTIVE 26-5
Plan and perform an operational
audit.

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 CRITERIA FOR EVALUATING EFFICIENCY
AND EFFECTIVENESS
A major challenge of operational auditing is in selecting
specific criteria for evaluating whether efficiency and
effectiveness have occurred.
Specific Criteria: More specific criteria are desirable before
starting an operational audit.
Sources of Criteria:
• Historical performance
• Benchmarking
• Engineered standards
• Discussion and agreement

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 CRITERIA FOR EVALUATING EFFICIENCY
AND EFFECTIVENESS (CONT.)
Phases in Operational Auditing:
• Planning: Similar to planning for financial audits, but the main
difference is the diversity created by the breadth of operational
audits.
• Evidence Accumulation and Evaluation: Operational auditors must
accumulate sufficient appropriate evidence to provide a basis for a
conclusion about the objectives.
• Reporting and Follow-Up:
1. In operational audits, the report is usually sent only to management.
The lack of third-party users reduces the need for standardized
wording.
2. The diversity of operational audits requires tailoring of each report to
address the scope of the audit, findings, and recommendations.

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