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ACCA Paper F 8AUDIT AND INTERNAL REVIEW INTERNATIONAL STREAM

Lecture 1

DATE: Autumn 2008

TUTOR:

Learning Objectives

At the end of this session students should be able to:-

Appreciate the purpose of assurance services Have an understanding of the nature of assurance services

Distinguish between an audit, a review and agreed upon procedures.

Understand the concept of Corporate Governance including the FIRCsCombined Code on corporate governance and the regulatoryenvironment in which auditing takes place.

Have knowledge and understanding of the statutory requirements ofan audit, the rights and duties of auditors and the regulatoryframework which applies to auditors.

Distinguish between the role of the internal and external auditors.

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Introduction to Paper F 8 Examination

The aim of Paper F8, Audit and Assurance is to develop knowledge and

understanding of the process of carrying out the assurance engagement and

its application in the context of the professional regulatory framework.

It will be assumed that candidates have knowledge of Paper F3, Financial

Accounting and Paper F4, Corporate and Business Law. The accounting

standards examined in Paper F3 could form the basis of questions on how to

apply auditing procedures in respect of those standards. Going forward,

candidates will take knowledge of Paper F8 into Paper P1, Professional

Accountant, and Paper P7, Advanced Audit and Assurance. It will be assumed

that candidates understand why an audit is required (for Paper P1), and

already know the basics of audit procedures (for Paper P7).

Examination Structure

All 5 Questions must be answered

1. Audit procedures, and the application of these procedures to a specific

scenario ( 30 marks)

This question will always be based on a scenario, and will be broken down

into a series of sub-questions, which will examine a range of audit

procedures. Candidates will need to analyse the scenario to identify the

appropriate points to make in their answers.

The use of computers will be present and questions on this area will be based

on computerised systems. Detailed knowledge of how to use computer-

assisted audit techniques (CAATs) will not be expected. Questions will focus

on specific income statement and balance sheet entries. Possible questions

will cover audit procedures, identification of system weaknesses, writing of

management letters, and whether systems meet their objectives (internal

audit focus).

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2. Short factual questions based on International Standards on Auditing

(ISAs) and other key areas (10 marks)

Do not rote learn ISAs, but understand the key principles underlying auditing.

3. Risk and audit approach (20 marks)4. More specialised audit areas (20 marks)

5. Collection of audit evidence, closedown, reporting (20 marks)

Examination answer style required:

A structured answer with clearly identifiable and separable points is

preferable to a continuous flow of text. However, answers in note form are

not acceptable.

Use columnar format where appropriate and break down answers into

manageable sections.

If the question requirement specifically requested a memo format please do

so.

The volume of writing does not necessarily mean a pass standard.

Candidates presenting two or three supplementary answer books do not

achieve a pass standard, but candidates presenting just over half a main

answer book can achieve a pass.

If asked to specify audit tests, candidates must also provide an explanation

and reason for these tests, and state for example, checking from the invoice

back to the order to ensure completeness of invoicing.

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The purpose of assurance for financial and non-financial information.

An assurance engagement as opposed to an audit is one in which the

professional accountant evaluates or measures a subject matter that is the

responsibility of another party, against suitable criteria and expresses an

opinion that provides the intended user with a level of assurance about the

subject matter.

Subject matter could include data, systems, processes or behavior. The

subject matter must be identifiable, capable of measurement and of being

subject to procedures.

Levels of assurance

1. Reasonable Assurance: The subject matter materially conforms to the

criteria.

. Limited Assurance: There is no reason to believe that the subject matter

does not conform with the criteria. (Negative assurance).

What is an audit?

An exercise whose objective is to enable auditors to express an opinion

whether the financial statements are prepared in all material respects, in

accordance with an identified financial reporting framework. The auditor hasto an express an opinion, whether or not the financial statements give a true

and fair view or present fairly, in all material respects.

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True = information is

1. Factual and conforms with reality, is not false.

2. Conforms with required standards and laws.

3. The accounts have been correctly extracted from accounting records.

Fair = Information is

1. Free from discrimination and bias.

2. Is in compliance with expected standards and rules.

3. The accounts reflect commercial substance.

It is not the auditors responsibility to prepare and present the financial

statements. This is the responsibility of the directors. There are certain

misconceptions about the role of the auditor and this gap between what

the auditors actually do and what people think they do is known as the

expectations gap.

The opinion is expressed to the shareholders. An audit provides a high

but not absolute level of assurance, expressed in the audit report as

reasonable assurance. Reasonable assurance is not a guarantee of

correctness but an assurance of truth and fairness within a reasonable

margin of error.

Materiality:

An item is said to be material if its omission or misstatement would

reasonably influence the economic decisions of the individuals to whom the

audit report is addressed. The item can be qualitative or quantitative.

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Materiality depends on the size of the item or error judged in the particular

circumstances of its omission or misstatement.

It is important that the auditors ensure that the financial statements are free

from material error for the following reasons:

There is a legal requirement to audit financial statements and present an

opinion on those financial statements. If the auditors do not detect a material

error then their opinion on the financial statements could be incorrect

The auditor has a responsibility to the members to ensure that the financial

statements are materially correct.

There are also other users of the financial statements who will include the

taxation authorities and the bank that may have may have made a loan to

the company. They will want to see true and fair accounts. The auditors

must therefore ensure that the financial statements are free from material

misstatement to avoid any legal liability to third parties if they audit the

financial statements negligently.

The limitations of an audit are:-

1. Not objective

2. Items checked on a sample basis.

3. Provides opportunity for collusion or fraud.

4. There is a time lag between preparation of financial statements and

the audit report.

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Types of Audits

1. External audit:

Gives confidence in the integrity of corporate reporting for the benefit of

stakeholders and society as a whole by providing an external and objective

view on the reports given by management. The auditors report is usually

addressed to the shareholders as the principal stakeholders.

Purpose of external audit

(i) The external audit derives from the separation of the ownership and

management of

assets. Those who own assets wish to ensure that those to whom they have

entrusted control are using those assets efficiently. This is known as the

stewardship function.

(ii) The requirement for an independent audit helps to ensure that financial

statements are free of bias and manipulation for the benefit of users of

financial information.

(iii) Companies are owned by shareholders but they are managed by

directors (in very small companies, owners and managers are the same, but

many such companies are not subject to statutory audit requirements.)

(iv) The requirement for a statutory audit is a public interest issue: the public

is invited to invest in enterprises, it is in the interests of the capital markets

(and society as a whole) that those investing do so in the knowledge that

they will be provided with true and fair information about the enterprise.

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This should result in the efficient allocation of capital as investors are able to

make rational decisions on the basis of transparent financial information.

(v) The requirement for an audit can help prevent investors from being

defrauded, although there is no guarantee of this because the external audit

has inherent limitations. Reducing the possibility of false information being

provided by managers to owners is achieved by the requirement for external

auditors to be independent of the managers upon whose financial statements

they are reporting.

(vi) The purpose of the external audit under International Standards on

Auditing is for the auditor to obtain sufficient appropriate audit evidence on

which to base the audit opinion. This opinion is to the effect that the financial

statements give a true and fair view (or present fairly in all material

respects) of the position, performance (and cash flows) of the entity. This

opinion is prepared for the benefit of shareholders.

2. Internal audit:

An independent, objective assurance and consulting activity designed to add

value and improve and organisations operation. Objective is to assist

management and staff in the effective discharge of their duties.

3. Value for money audit:

An investigation into whether or not the use of resources is economic,

efficient and effective. To identify and recommend ways in which the return

for resources employed may be maximised.

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An audit is distinguished from the following engagements:-

1. Review engagement. Provides moderate level of assurance, expressed

as negative assurance. Negative assurance is a statement of what the

auditor does not know as opposed to what he believes (positive

assurance.) The objective of a review is to enable the auditor to give

an opinion whether the anything has come to his attention that would

mean that the financial statements are not properly prepared (do not

give a true and fair view) on the basis of the procedures which do

not constitute an audit.

2. Agreed upon procedures or compilations. No assurance is provided. It

is only a report on factual findings. A compilation presents in the form

of financial statements information that is the representation of

management without expressing assurance. Compilation of a financial

projection involves assembling prospective statements based on

assumptions of a responsible party, considering appropriateness of

presentation, and issuing a compilation report. No assurance is

provided on the statements or underlying assumptions.1

2

3 Stages of an audit process:

1 1. Agree the terms of engagement.

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2 2. Understand the entity being audited.

3 3. Assess risk.

4 4. Plan the audit and make assessments of materiality.

5 5. Gather Audit evidence.

6 6. Make judgements and express opinion.

Audit Committee

- The board should establish an audit committee of at least three

members, who should all be independent non-executive directors. The

board should satisfy itself that at least one member of the audit

committee has recent and relevant financial experience.

The main roles and responsibilities of the audit committee include

Monitoring the integrity of the financial statements of the company.

Review the companys internal financial controls and the companysinternal control and risk management systems.

Monitoring and reviewing the effectiveness of the companys internal

audit function.

Making recommendations to the board.

Reviewing and monitoring the external auditors independence and

objectivity and the effectiveness of the audit process.

The audit committee should have primary responsibility for making a

recommendation on the appointment, reappointment and removal of

the external auditors.

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The advantages of an audit committee:

1. Provide increasing public confidence in the creditability and objectivity

of published financial information. This will be particularly important if

listing arrangements are planned.

2. Assistance in Financial reporting. Supports the directors in fulfilling

their financial reporting obligations. The directors have to prepare

financial statements and the committee can assist by checking the

financial statements to ensure that they comply with appropriate

reporting requirements. This is especially important where the board

do not have detailed knowledge of accounting requirements.

3. Use of the audit committee will enable the external auditor to discuss

issues with the financial statements with the internal auditor, prior to

providing a final summary of key points to the board.

4. The audit committee will monitor the work of the board and provide

helpful guidance, where corporate governance requirements do not

appear to be being met. The audit committee should have detailed

knowledge of corporate governance as part of its monitoring function

of the company and can share this with the board who may not have

the time to obtain detailed information.

The disadvantages of an audit committee:

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1. As the audit committee will be made up mainly from non-executive

directors, the board may see this as a means of decreasing their power

and possibly letting other people run the company. Or the audit

committee must be seen as fulfilling a supporting role for the main

board.

2. Cost. The audit committee will increase the expenditure of the

company as the non-executive directors will require some

remuneration due to their additional responsibilities.

STATUTORY AUDIT REGULATION

1. Appointment of auditors

- The directors may appoint the first auditor until the next AGM.

- The directors have a power to fill any casual vacancy before the next

AGM as a result of death, removal or resignation of the auditors.

- The shareholders are ultimately responsible for appointing auditors at

each AGM.

- The directors of the company on behalf of the shareholders fixes the

auditors remuneration.

2. Removal of auditors:

- Only the shareholders can legally remove the auditors.

- The directors cannot remove the auditors from the office.

- The procedure to follow to remove auditors is as follows:

1 (i) Those shareholders wishing to remove the auditors must give special

notice of an ordinary resolution.

2

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3 (ii) The auditor has the right to speak at the meeting.

1

2 (iii) On removal, the auditors have a duty to make a written statement of the

circumstances connected with the removal which they think should be

brought to the attention of the shareholders and creditors.

3

4 (iv) The directors must circularise this to all shareholders and file a copy with

the regulatory authority.

5 (v) The ex-auditor has the right to attend the AGM at which their office would

normally have ended.

3. Resignation and retirement of auditors:

1 - The auditor may resign or retire for office at anytime by sending a

notice to the companys registered office. This is not effective unless

accompanied by a statement of circumstances.

2 - The company must file a copy of the notice of resignation to the

registrar of companies.

3 - On ceasing to act, the auditors have a duty to make a written

statement.

4 - The auditors have a right to require an Extraordinary General Meeting

(EGM) at which they may speak and explain the circumstances of

their resignation.

4. Auditors duties:

- Give a true and fair view of the companys financial statements and also the

going concern of the company.

- The auditor should consider whether the directors report is consistent with

the information in the financial statements.

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- The financial statements are properly prepared in accordance company

legislation and relevant accounting standard.

- The auditor must form an opinion on whether:

1. The company maintains proper accounting records.

2. The auditor has access to all relevant information and

explanation.

3. The auditor has adequate information of the other branches of

the company (if any) not visited.

4. The auditor has ensured that the financial statement agree with

the underlying records.

5. Directors transactions have been completely and accurately

disclosed.

5. The auditors rights:

- Access to all relevant records of the company at anytime

- To request of any information/explanations considered necessary.

- Rights to receive notice attend and speak at the companys general

meeting.

- To make a written representation on removal.

- On resignation, to require an EGM.

6. Qualifications of auditors:

The auditor must be members of one of the members of International

Federation of Accountants (IFAC) include:

1 1. Association of Chartered Certified Accountants (ACCA)

1 2. Institute of Chartered Accountants of England and Wales, Scotland

and Ireland (ICA )

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2

3

4 - Individual should hold appropriate qualification.

5 - The audit practice should be controlled by qualified accountants who

are the members of ACCA or ICA.

6 - Must be registered as an auditor with the ACCA or ICA.

7 - The auditor should be a fit and proper person and comply with

professional rules of conduct.

Fundamental Ethical Principles -THE ACCA RULES OFPROFESSIONAL CONDUCT

In order to achieve the objectives of the accountancy profession,

professional accountants has to observe a number of prerequisites or

fundamental principles.

The fundamental principles are:

1. Integrity

A professional accountant should be straightforward and honest in

performing professional services. Members should behave with integrity in all

professional, business and personal financial relationships.

2. Objectivity

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A professional accountant should be fair and should not allow prejudice or

bias, conflict of interest or influence of others to override objectivity.

Objectivity principle requires that members objectivity must be beyond

question and this can only be assured if the member is and is seen to be

independent.

To be and be seen as independent and objective, the auditor or his family

must not have:

Financial interest in clients such as shareholdings either beneficial or

non beneficial, not trade with clients, must not make loans to or take

loans from the client. Note that overdue fees are equivalent to loans.

Family include spouse, minor children, brothers and sisters and their

spouses, adult children and their spouse, relatives to whom regular

financial assistance is given and ex-employees.

The objectivity of the external auditor may be threatened or appear to be

threatened where:

1 1. There is undue dependence on any audit client or group of clients;

1 2. The firm, its partners or staff have any financial interest in an audit

client;

1 3. There are family or other close personal or business relationships

between the firm, its partners or staff and the audit client;

1 4. The firm provides other services to audit clients.

2

3 5. There is undue dependence on any one audit client. Total recurring

fees as a % of gross practice income should be less than 15% for

client/group and less than 10% for public interest companies.

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4 6. There are overdue fees.

5 7. There is actual or threatened litigation.

6 8. Goods, services and hospitality accepted from the client.

ACCAs requirements that reduce the threats to auditor objectivity include

clients to have

1. Quality control procedures

2. Audit committees.

3. Rotate auditors every 5 years.

The client will thereby ensure increased confidence in the transparency of

reporting.

3. Professional Competence and Due Care.

A professional accountant should perform professional services with due

care, competence and diligence and has a continuing duty to maintain

professional knowledge and skill at a level required to ensure that a client or

employer receives the advantage of competent professional service based on

up-to-date developments in practice, legislation and techniques.

Members should carry out their professional work with due skill, care,

diligence and expedition and with proper regard for the technical and

professional standards expected of them.

4. Confidentiality of client information.

A professional accountant should respect the confidentiality of information

acquired during the course of performing professional services and should

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not use or disclose any such information without proper and specific authority

or unless there is a legal or professional right or duty to disclose.

ACCAs Code of ethics Obligatory disclosure

If the member auditor knows or suspects that client is involved in

treason, drug trafficking or terrorist offences.

Under IAS250, when non-compliance with laws and regulations will

cause material mis-statements in the financial statements.

The actual disclosure will depend on the laws of the jurisdiction where the

auditor is located.

The auditor may also be obliged to provide information where a court

demands disclosure. Refusal to provide information is likely to be considered

contempt of court with the auditor being liable for this offence.

ACCA Code of ethics voluntary disclosure

A member may also disclose client confidential information voluntarily, that is

without client permission

To protect a members interest e.g. to allow a member to sue a client for

unpaid fees or defend an action for negligence.

Where there is a public duty to disclose e.g. the client has committed an

action against the public interest such as unauthorised release of toxic

chemicals.

5. Adopt Professional Behaviour

1 - A professional accountant should act in a manner consistent with the

good reputation of the profession and refrain from any conduct which

might bring discredit to the profession.

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2 - The obligation to refrain from any conduct which might bring discredit

to the profession requires IFAC member bodies to consider, when

developing ethical requirements, the responsibilities of a professional

accountant to clients, third parties, other members of the accountancy

profession, staff, employers, and the general public.

3

4 Technical Standards professional accountant should carry out

professional services in accordance with the relevant technical and

professional standards.

6. Conflicts of interest

ACCAs Rules of Professional Conduct state that auditors should avoid

conflicts of interest (both conflicts between the firm and clients, and conflicts

between clients) wherever possible.

If such conflicts are unavoidable:-

(i) Full disclosure is important both client companies should be fully

aware that the firm is acting for the other party.

(ii) One or both companies may object to the firm acting for the other

company and the auditor may be forced to make a decision as to

which company to resign from. However, this is not an attractive

course of action because the audits may already have commenced

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and it may be difficult for one of the companies to find a new

auditor, quickly.

(iii) The auditor should not resign unless forced to do so this might be

prejudicial to the interests of one of the clients.

(iv) It is important in such cases that different teams of staff, and

different engagement partners work on the respective audits.

(v) Internal procedures within the firm should be set up to prevent

confidential information from one client being transferred to the

other and the interests of one firm damaging the interests of the

other. Such procedures are known as Chinese Walls.

Six Potential threats to auditors independence:

1. Self review threat: occur when results of a previous engagement needs

to be re-evaluated in reaching conclusion on the present assurance

engagement or when a member of assurance team is previously was

an employee of the assurance client(director) in a position to exert

influence over current audit matters.

Examples of circumstances that may create this threat include:

1 (1). A member of the assurance team being, or having recently been, a

director or officer of the assurance client;

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1 (ii). A member of the assurance team being, or having recently been,

an employee of the assurance client in a position to exert direct and

significant influence over the subject matter of the assurance engagement;

1 (iii). Performing services for an assurance client that directly affect the

subject matter of the assurance engagement; and

1 (iv). Preparation of original data used to generate financial statements

or preparation of other records that are the subject matter of the

assurance engagement.

Example of self review threat: If the auditors are to implement new control

systems then they will also be auditing those systems as part of the statutory

audit. They must therefore ensure that different staff implement and audit

the systems. Preferably different departments in the firm should undertake

the work. If insufficient staff are available then the audit firm must refuse the

additional systems work.

2

2. Familiarity threat: occurs when, by virtue of a close relationship with

an assurance client, its directors, officers or employees, a firm or a

member of the assurance team becomes too sympathetic to the

clients interests.

1 Circumstances that may create familiarity threat include:

1 (i) A member of the assurance team having an immediate family member

or close family member who is a director or officer of the assurance client.

2

3 (ii) A member of the assurance team having an immediate family member

or close family member who, as an employee of the assurance client, is in

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a position to exert direct and significant influence over the subject matter

of the assurance engagement.

4 (iii) A former partner of the firm being a director, officer of the assurance

client or an employee in a position to exert direct and significant influence

over the subject matter of the assurance engagement.

5 (iv) Long association of a senior member of the assurance team with the

assurance client.

6 (v). Acceptance of gifts or hospitality, unless the value is clearly

insignificant, from the assurance client, its directors, officers or

employees.

3. Self interest threat: occurs when an auditor could be from financial

interest in or other self interest conflict with assurance client.

1 Examples of circumstances that may create self interest threat include:

1 (i). A direct financial interest or material indirect financial interest in an

assurance client.

1 (ii). A loan or guarantee to or from an assurance client or any of its

directors or officers.

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1 (iii). Undue dependence on total fees from an assurance client.

1 (iv) Concern about the possibility of losing the engagement.

1 (v) Having a close business relationship with an assurance client.

2

3 (vi) Potential employment with an assurance client.

1 (vii) Contingent fees relating to assurance engagements.

4. Intimidation threat: This occurs when a member of audit team may be

deterred from carrying audit work or exercising professional scepticism

by threat from the directors of the audit client.

1 Examples of circumstances that may create intimidation threat

include:

1 (i). Threat of replacement over a disagreement with the application ofan accounting principle; and

1 (ii). Pressure to reduce inappropriately the extent of work performed in

order to reduce fees.

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5. Advocacy threat: This arises when member of the audit team promotes

or seems to promote an audit client opinion or position (for example

selling or underwriting in financial matters for audit client or acting as

the clients advocate in a legal proceeding).

1 Examples of circumstances that may create this threat include to:

1 (i). Dealing in, or being a promoter of, shares or other securities in an

assurance client.

1 (ii). Acting as an advocate on behalf of an assurance client in litigation

or in resolving disputes with third parties.

6. Association Threat: This arises when the audit firm is likely to associate

itself with a client whose business has yet to be confirmed as being legal or

ethical. If the client is extending their product line, the auditors will have to

determine the likelihood that the product is legal. The audit firm may not

wish to be associated with a company producing illegal products.

Appointment Ethics of External Auditors

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Before accepting an appointment, the auditor should ensure that they

Are professionally qualified to act The firm has existing resources

that are adequate to meet the needs of the engagement in terms of

time, staff and technical expertise. For example if the client is growing

quickly and has poor internal controls providing high risk of financial

misstatement, the auditors should ensure that they have sufficient

staff of appropriate experience available and that enough time is

allocated to the audit to complete all audit procedures.

Obtain references and make independent inquiries if directors are not

personally known.

Communicate with present auditors to find out whether there are any

circumstances behind the change that the new auditors need to be

aware of.

After accepting the appointment the auditors should ensure that

Outgoing auditors removal or resignation has been properly

conducted.

New auditors appointment is valid.

Submit a letter of engagement.

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Letter of Engagement

ISA 210 The letter of engagement must define the terms of Audit

Engagement

Purpose:

To define clearly the extent of the auditors responsibilities.

Minimise misunderstandings between audit firm and client.

Confirm in writing verbal arrangement.

Confirm acceptance by the auditor of his engagement.

To inform and educate the client.

When to send a letter:

To all new clients before commence of audit work.

To all existing clients who have not previously had such a letter.

If there are changes in circumstances in the clients company for

example a major change in ownership or management.

In the case of groups an engagement letter should be sent to each

company member of the group that is to be audited by the firm.

Steps:-

On or before acceptance of a new client discuss the precise terms with

the management.

Draft and sign the letter before commencing any part of the

assignment.

Receive the clients written acceptance.

Every year review and update the letter and consider if nature of the

engagement has changed.

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Contents of letter of engagement:

1. Addressed: To the directors of:.

2. The responsibilities of the directors:

1 (i). Keep proper accounting records

2 (ii). Prepare the financial statements that show true and fair view.

3 (iii). The financial statement should comply with national companys

legislation and the relevant accounting standards.

3. The responsibilities of the auditors:

(i). Report to the members whether the financial statement prepared by the

directors is showing true and fair view.

(ii). To check whether the directors keep books and records adequately and

that relevant information is received from the directors with regards to the

branches not visited.

(iii). To check whether the financial statements are in agreement with

accounting records and returns.

1 (iv) To ensure that they have received all the relevant information and

explanation from the directors of the company before an opinion is formed.

2

3 (v) To check the directors report is consistent with the financial statements.

4. The scope of the auditors work:

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(i). Audit work must comply with auditing standards.

(ii). Review the accounting systems.

1 (iii) Collection of audit evidence.

2

3 (iv) Review of internal controls and test.

1

2 (v) Prepare a letter of weakness.

3

4 (vi). It is the directors primary responsibilities are to safeguard company

assets and the prevention of fraud and irregularities.

Notes:

1

Any agreement with auditors for other services should be stated in a

separate engagement letter. When external auditors provide non-audit

services to their audit clients, it is essential that the auditors make a

clear distinction between their audit and non-audit responsibilities.

The fees and the basis on which they are charged (based on time and

expertise used in client affairs).

State the applicable law.

Request for written acknowledgement of the letter creates a

contractual obligation. In the case of a company the board of directors

should sign the letter of engagement.

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Internal Audit Function

Internal audit is an appraisal or monitoring activity established within a

company or an entity as a service to the entity. Its functions include

examining, evaluating and monitoring the adequacy and effectiveness of the

internal control. It is a key part of effective corporate governance since

corporate governance objectives include the management of the risks to

which the entity is subject and that would prevent it achieving its overall

objectives such as profitability.

The internal activity is designed to add value to and improve the operations

of an organisation. The internal auditor reports to management.

The internal auditor is normally an employee of the organisation but often

their work is outsourced.

On the other hand, the external auditor expresses an opinion on the financial

statements and reports to the shareholders.

Internal Auditors should be assumed to members of the ACCA and are bound

by the rules of professional conduct.

Roles of Internal Audit Department:-

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1. Risk Management Role this involves monitoring the overall process of

risk management and in providing assurance that the systems have

been designed to meet objectives and that they operate effectively. A

large part of the management of risks, and the proper exercise of

stewardship, involves the maintenance of proper controls over the

business. Controls over the business as a whole, and in relation to

specific areas, include the effective operation of an internal audit

function.

Fraud is a key business risk and internal auditor can assist in prevention

and detection of fraud.

The internal auditor must:-

(a) Determine company policy in respect of the risks identified.

(b) Implement strategy and ensure that strategies implemented

operate effectively and continue to match risk as intended.

Internal audit can help management manage risks in relation to fraud and

error, and exercise proper stewardship by:

1. Commenting on the process used by management to identify and classify

the specific fraud and error risks to which the entity is subject and help

management to develop and implement that process.

2. Commenting on the appropriateness and effectiveness of actions taken by

management to manage the risks identified and help management to

develop appropriate actions by making recommendations.

3. Periodically auditing or reviewing systems or operations to determine

whether the risks of fraud and error are being effectively managed.

4. Monitoring the incidence of fraud and error, investigate serious cases and

make recommendations for appropriate management responses.

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2. Monitoring Role - Value for money audit (VFM): is an assignment that

internal audit can undertake on behalf of management as part of the

monitoring role. VFM audit can be carried out on any area of the business.

Since a VFM audit is concerned with obtaining the best possible combination

of products/services for the least resources, it measures three qualities:-

Economy - Economy relates to least cost. The organisation should

attain the appropriate quantity and quality of physical, human and

financial resources at the lowest cost. The systems in an organisation

should operate at a minimum cost associated with an acceptable level

of risk.

Efficiency- This is a measure of the relationship between goods and

services produced (outputs) and the resources (inputs) used.

Therefore, efficiency relates to the best use of resources. The goals

and objectives of an organisation should be accomplished accurately

and on a timely basis with the least use of resources.

Effectiveness involves determining how well an activity is achieving its

objectives and therefore effectiveness provides assurance that

organisational objectives will be achieved.

Monitoring role for local authorities:-

Besides VFM, internal audit can also monitor best value to ensure that the

authority has systems in place to achieve best value. Best value implements

4 Cs instead of the 3 Es of a VFM audit.

Challenge monitor how well and why a service is provided.

Compare to other authorities.

Consult targets should be set in consultation with tax payers andservice users.

Compete involve in fair competition.

3. Role of performing information technology audits by monitoring and

testing controls in the areas of database management, system

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development process, change management, networks, asset

management, capacity management, access control, operational

system and E-business.

4. Perform operational audits

Operational audits are audits of the operational process of the

organisation. These are also known as management audits or efficiency

audits. Their main objective is to monitor managements performance and

ensure that company policy is adhered to.

The two main aspects of an operational assessment is to ensure that the

policies are adequate and that they work effectively.

Outsourcing the Internal Audit Function to an outside source. Audit firms offer

internal audit services as part of their portfolio.

Advantages of outsourcing:-

1. Service provider can provide the necessary expertise for internal audit

work. They may be able to provide a broader range of expertise and

specialist skills and as they serve many different clients therefore staff

may be available for specialist work that the company may not be able

to afford.

2. If internal audit is only required for specific functions or particular jobs

each year then the expertise can be purchased as required. This will

minimise the companies in-house costs.

3. They can direct their own work and educate management as to the

service required.

4. Provides an immediate team.

5. Can be appointed for a specific timescale

6. Outsourcing will remove the need for training internal staff. Effectively

training will be provided for free as the outsourcing firm will be

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responsible for keeping staff up-to-date with new auditing techniques

and processes.

7. An independent view will be provided that may identify control

weaknesses that the internal audit department may miss.

Disadvantages of outsourcing

1. Fee pressure. The relationship needs to be managed carefully to

ensure that the service provider does not decrease the quality of their

work due to insufficient fees.

2. The outsourced firm may not have any prior knowledge of the

company and will need time to ascertain the accounting systems and

controls before commencing work.

3. Continuity of service of staff at the service provider. Depends on the

retention rate. Larger internal auditing firms will be able to offer their

staff better career progression which should assist staff retention.

Internal Audit Department and Corporate Governance

Internal audit department can assist the directors with the implementation of

good corporate governance in an organisation through:

(i) Reviewing reports to the board and reports produced by the board

to ensure that they do present a balanced assessment of the

companys position and prospects. The internal audit department

will have good knowledge of the operations of the company as well

as access to accounting information. The department can

effectively audit board reports to ensure they are accurate and

understandable.

(ii) Internal controls. The board need to maintain a sound system of

internal control. The internal audit department will be able to

review existing controls and recommend improvements to ensure

this objective is met.

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(iii) Application of ISA and IASs. The board need to have a policy for

applying appropriate International Statements on Auditing (ISA) and

International Accounting Standards (IAS) to the organisation.

Internal audit will be aware of new auditing standards and will have

the technical expertise to identify changes required by accounting

standards.

(iv) Amendments to control systems for new auditing standards and

financial accounting systems for new accounting standards can

therefore be recommended.

(v) Communication with external auditors. The corporate governance

code requires communications with external auditors normally be

via the audit committee, although the board must maintain an

appropriate relationship with the external auditors. However,

internal and external auditors can also work together to ensure that

the internal control system is sufficient; possibly by external audit

delegating work to internal audit, and each auditor reviewing the

work of the other auditor. The board will therefore receive reports

from both sets of auditors which will be accurate because they have

been properly checked.

(vi) Communication to the board. The internal auditor can also check

that appropriate information is provided to the board from the

external auditor. ISA 260 Communications of audit matters with

those charged with governance provides a list of matters which

should be communicated to the board and the internal auditor can

work with the external auditor to ensure that this information is

provided.

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Role of external auditor in respect to evaluating and testing the work of the

internal auditor include:

They external auditor must:-

Check that the work is performed by persons having adequate technical

training and proficiency as internal auditors, by ensuring that appropriate

training programmes are in place and the auditor has appropriate

qualifications.

Ensure that the work of assistants is properly supervised, reviewed and

documented by reviewing the procedure manuals of internal audit and the

audit working papers produced.

Determine that sufficient and appropriate audit evidence is obtained to

afford a reasonable basis for the conclusions reached, by reviewing the

internal auditors working papers.

Check that the conclusions reached are appropriate in the circumstances

and that any reports prepared are consistent with the results of the work

performed by reviewing the work performed and the reports produced.

Ensure that any exceptions or unusual matters disclosed by internal audit

are properly resolved by the external auditor and management.

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