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Internal Audit

Last updated : July 9th, 2021 03:39 pm

Internal Audit

Internal audit may be defined as an evaluation and analysis of a business operation that is conducted by the internal audit staff of the same business entity. Internal audits are considered as a part of the overall system of internal control that is established in an organisation and is conducted by professional internal auditors present in the company. This gives the management an assurance concerning the control process in the organisation and helps detect inefficiencies or fraud early. This article talks about the Internal Audit of Companies and the various aspects surrounding the same.

In large organisations, an internal audit is carried out by a team of professionals who are employed within the organisation. Although not mandatory, it is generally conducted with the aim to evaluate the effectiveness of internal control, the soundness of the financial system, efficiency of business processes, and so on. Internal Auditing is an independent, assurance, objective and consulting activity that is formulated to add value to and improve a particular organisation’s operations. Further, internal audits also help a company to accomplish its goals by bringing about a systematic and disciplined approach to improve the effectiveness of an organisation’s risk management, corporate governance and internal control processes.

Characteristics of Internal Audit

• An internal audit is an audit which is performed to ensure that the system of internal controls instituted by the management of a company is functioning in the manner intended by the key managerial personnel of the company and also for the welfare of the members of the company.
• An internal audit takes into consideration the question of whether the business practices deployed by the officers of the company are helpful in prudently managing the business and meeting the strategic objective of the organisation.
• An internal audit can cover both operational as well as financial issues. However, the process of internal audit is generally understood to be a limited one and managed by any qualified person who can audit the governance of an organisation and the methodology by which it assesses and manages the risks faced by it in the dynamic business environment. The internal auditor by means of the internal audit process is responsible for reporting to the management or audit committee of the company.
• Internal audit is a function that, even though operating independently from other departments and involves reporting directly to the audit committee, remains within an organisation, i.e. the company’s employees.
• Internal audits involve performing audits of both financial and non-financial nature within a wide of areas of operation in business, including those that are directed by the annual audit plan.
• Internal audit deals with the main risks facing the business and the action being taken to manage those risks in an effective manner so that the organisation can achieve its various objectives. For example, the internal audit process evaluates the risks threatening a company’s reputation such as the employment of cheap labour in foreign countries, or the strategic risks such as producing too many products in comparison to available resources.
• The internal audit is limited to the governance of an organisation, management controls over the operations of an organisation and risk management.
• The internal audit is conducted based on the personal resolve of the business owners to measure the operation’ efficiency as conducted by the business.

Objectives of Internal Audit

The following are the primary objectives of conducting an internal audit in an organisation.

• Proper Control: Conducting an internal audit would keep adequate control over all the business activities. This, in turn, would result in maximum efficiency. Internal control would be able to determine the degree of control overwork.
• Accounting System: It would evaluate the accounting system of the organisation. Internal audits include checking the proper authority for transactions such as purchase, retirement and disposal of fixed assets. It checks against the result against entries in order to determine the actual facts and figures.
• Help Management: It helps management in significant ways. An internal auditor would be able to point out the weaknesses of an organisation. Internal audits may be used as a tool to make the necessary corrections. This would enable the management to perform correctly.
• Working Review: Internal audits comes with the purpose to review the working of a business. The functioning of the current year could be examined in detail. With the help of internal auditing, weak points could be located, and the corrective measures could be taken to ensure proper functioning.
• Asset Protection: The protection of assets is ensured with the conduction of an internal audit. With the proper record of assets, an internal auditor would be able to examine the valuation, verification and possession of assets belonging to the company. It would confirm that the purchase or sale of assets would be made under proper authority.
• Internal Check: Internal audits can evaluate the internal check system. With the division of duties amongst employees and when every member of the organisation works appropriately, an effective internal check system would exist, and the auditor’s work is decreased. The internal auditor is then only required to apply test checks in order to complete audit duty.
• Fair Statements & Error Scrutiny: An internal audit detects the errors in the accounting records. This would help the management to access the accounting record in order. This would also minimise the chances of errors occurring in the records. The accounting team of an organisation would be able to rectify mistakes to prepare accounts at the end of the year to help the external auditor.
• Detection of Fraud: Conducting an internal audit can detect frauds in the books of accounting. Internal audits begin when the work of the accounting team is done. The accounts team often remains alert as there is not enough time between recording and checking. Therefore, the detection of fraud is possible with internal audits.
• Determine Liability: Conducting an internal audit could determine the liabilities of employees. As the duties in an organisation are divided amongst the employees, it is easier to notice the negligence on the part of employees. An internal audit can put a pin on the individual responsible for the error.
• Help in Independent Audit: An internal audit can help an independent audit. The external auditor has the option to rely on an internal auditor instead of conducting another cent per cent check, saving both money and time.
• Performance Appraisal: An internal audit can check performance appraisal. It can be used as a tool to evaluate the working of each management function in order for the organisation to achieve the targets fixed in budgets and plans.
• Provide Suggestions: Conducting an internal audit would provide suggestions for the improvement of the business activities. The internal audit staff would be able to suggest ways and means by which the difficulties could be overcome. However, an internal auditor cannot compel the management to implement the suggestions.
• New Ideas: Internal audits can bring about new ideas concerning the procedures, marketing, financing and other matters of the business. The auditors would be able to offer new insights about various business matters which could be implemented for the betterment of the business.
• Use of Resources: The purpose of an internal audit is to determine the right use of resources. Misusing resources would naturally increase the cost of doing a particular business. The proper use of resources goes hand in hand with the efficiency on the part of the management.
• Accounting Policies: An internal audit would be able to examine the accounting policies of an organisation. The understanding of the accounting system and its procedures would be helpful to formulate effective audit plans and procedures. The internal auditor would be able to find weaknesses in the internal control and help fix the accounting policies.
• Special Investigation: The purpose of an internal audit may be to conduct a special investigation concerning any business matter. An internal audit may be used as a tool to find the effectiveness of the function of the management.

Benefits of Internal Audit

The following are the benefits of conducting an internal audit in an organisation.

• Proper Accounting Systems: Internal audits introduce an appropriate system of accounting. An accounting system comprises of a chain of activities in a company by which transactions are processed in order to maintain financial records. To achieve desirable results, a need for orderly devices is required, and that can be achieved through internal auditing.
• Better Management: Internal audit ensures that there is better management of the business in the organisation. An auditor would be able to point out the areas of weakness in the management. The objectives of the business can be achieved if there is a proper internal control, internal check and internal audit. It should be noted that the management has the option to rely on internal audit for the best results completely.
• Progressive Review: The progress of the business can be reviewed with the help of an internal audit. The figures from the previous years are compared to those of the present year. The performance result of various other similar companies can be considered and compared to in order to determine the progress of the entity. An internal audit helps the management to review the growth of the entity.
• Effective Control: An internal audit is essential in order to retain effective control over business activities. Control comes under the functions of management and is related to the supervision and direction of ongoing operations. The concerned manager can make the necessary changes according to the internal audit and remove the difficulties for the smooth working of a business.
• Assets Protection: The protection of assets is possible through an internal audit. The management has the option to only use the assets for the benefit of the business and not for private purposes. Internal auditing keeps an eye on embezzlement of cash, misappropriate use of stock and misuse of other assets from ever occurring.
• Division of Work: An internal audit can be conducted to apply the division of labour. This is necessary in order to watch the activities of every employee, including the members of the management. The auditor may choose to suggest a way and means on how to improve the performance of the business.
• No Error and Fraud: Internal audits can be conducted to protect the accounting records from errors and fraud. Accounting and auditing in a company go hand in hand as the latter begins when the former is done. In such situations, the mistakes and deceptions committed by accounting personnel would be detected and rectified easily.
• Fixing Responsibility: Internal audits would be able to set the responsibilities of employees having poor performances. The management would establish performance standards, and the internal auditor can evaluate the result of all the employees. This way, the concerned individuals can be held responsible for their work that does not meet the standards of the company, and appropriate changes could be taken.
• Helps External Auditing: The work performed by an internal auditor would be a great help to an external auditor in conducting the audit. The audit procedure of the internal and external audit is very similar. However, an external auditor would be responsible for an external audit even if they choose to go through the internal audit report.
• Improved of Performances: An internal auditor would be helpful in improving the performance of the organisation. The company’s achievements in the previous year would be the basis of the budget preparations for the present year by drawing up income statements and balance sheets. Therefore, an internal audit improves the performance of a business and its employees.
• Proper Use of Resources: The check on the appropriate use of resources is maintained through an internal audit. The misuse of resources would undoubtedly lead to an increase in costs for the organisation. The optimum use of resources in a company could be determined with the control of the cost of output. Internal audits can be considered as a tool to use the resources of a company in the best interests of the business.
• Investigation: Internal audits help to investigate various matters of the business. In situations that bring doubts, the internal auditor can be given the responsibility to examine the facts and figures to confirm. Such investigations can be conducted at the request of the management of the company.

Limitations of Internal Audit

The following are the limitations of an internal audit.

• Staff Shortage: One of the few limitations of an internal audit is the shortage of staff. A reasonable audit staff is required to examine the records and conduct a proper internal audit. The lack in the team would restrict the organisation from reaping the benefits of the internal audit.
• Time Lag: As internal audits begin when accounting end, there is a significant time lag between the recording and the checking of the entries.
• Error: The limitation of an internal audit is that there may be undetected errors that remain in the books of accounts as it depends upon the expertise of the internal audit staff. If an audit staff is experienced and competent, the chances for an error to go undetected would be very less. In the case of poor audit staff, there would be no guarantee if the audited accounts are free from errors.
• Responsibility: The limitation of an internal audit is that management does not feel that it is their responsibility to complete the formalities of the audit. The audit staff could offer suggestions for the proper functioning of a business. However, the top-level management would not necessarily pay attention to the suggestions offered, which would be of no help or a loss to the company.
• Duties: The whole purpose of an internal audit may fail if the duties of the audit staff are not adequately divided and implemented by using a method that would ensure the optimum utilisation of organisational resources.

To know about the different types of opinion which can be issued by an auditor, click here.