[caption id="attachment_65518" align="alignright" width="235"] Dada Adefolami[/caption] By Dada Adefolami 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 Internal Auditor Responsibilities. Include: Performing the full audit cycle including risk management and control management over operations’ effectiveness, financial reliability and compliance with all applicable directives and regulations. Determining internal audit scope and developing annual plans. Internal audit may be defined as an independent appraisal function established within an organization to examine and evaluate its activities as a service to the organization. Internal audit supports management in the effective discharge of their responsibilities. To this end, internal audit furnishes management with analyses, appraisals, recommendations, counsel and information concerning the activities reviewed. The importance of internal audit was highlighted by the Turnbull Report. It states that listed public companies that do not have an internal audit function should review the need to have such a function at least annually. Turnbull goes on to state that listed public companies that do have an internal audit function should review the scope, authority and resources of this function at least annually. Turnbull suggests that the need for the internal audit function will depend on several factors. These include: 1. The scale, diversity and complexity of the organization’s activities 2. The number of employees – the need for an internal audit function increases as the number of employees increases, or if employee interrelationships become more complex 3. Where the benefits of such a function will outweigh the costs of implementation and operation 4. When changes occur over time in the organization’s structures, reporting processes or underlying information systems 5. The nature of risks, changes to risks and emerging risks 6. Problems and issues arising with internal control systems, both actual and perceived 7. The occurrence of an increasing number of unexplained or unacceptable events. International Standard on Auditing (ISA) 610, Using the Work of Internal Auditors has been revised and published in 2013. This standard focuses on whether the external auditor can use the work of the internal audit function for purposes of audit, and the revised version of the standard, clarifies whether the internal auditors can be used to provide direct assistance to the external auditor. The material pertaining to direct assistance is effective for audits of financial statements for periods ended on or after 15 December 2014. External and Internal Auditors An external auditor performs an audit, in accordance with specific laws or rules, of the financial statements of a company, government entity, other legal entity, or organization, and is independent of the entity being audited. The main difference between internal audit and external audit is that internal audit is restricted to the organization’s governance, management controls over organization’s operations and risk management while the scope of external audit is wider than internal audit as it involves the auditing of both financial and non-financial areas as well. One need to familiarize themselves with this revision to the standard as they are expected to be able to discuss the extent to which external auditors are able to rely on the work of internal auditors Much of the work performed by a company’s internal audit function can overlap with the work conducted by the external auditor, specifically in areas dealing with the assessment of control processes. It is likely that in carrying out detailed work evaluating and reviewing the company’s internal control framework internal audit perform procedures on financial controls relevant to the external audit. As such, the external auditor, rather than duplicating these procedures, may be able to place reliance on the work carried out by the internal auditor. The International Standards on Auditing (ISAs) now highlight three ways in which internal auditors may be utilized by the external auditor in the audit of financial statements: Focuses on the provision of direct assistance by the internal auditors, which to date has been a very controversial issue. Internal auditors are the employees of the entity, which could result in threats to independence either in fact or perceived if direct assistance is provided by the internal auditors. On the other hand, the following benefits relating to provision of direct assistance by the internal auditors cannot be ignored: 1. There will be a strengthened relationship between the external and internal auditors through a more effective dialogue 2. With the knowledge of the internal auditors, the external auditor can gain additional insights into the entity 3. The external auditor can use internal auditors who may have relevant expertise in particular areas, and 4. The external audit team can focus on the more significant audit issues. The IAASB released ISA 610 (Revised 2013), which includes new requirements and guidance addressing the external auditor’s use of internal auditors to provide direct assistance. Where such use is not prohibited by law or regulation, the ISA provides a robust framework to ensure that direct assistance is obtained only in appropriate circumstances, that the external auditor considers the relevant limitations and safeguards, and that the auditor’s responsibilities are clearly set out. Accounting auditors. Accountants also perform the role of auditor, with internal, external, or government auditing responsibilities. Internal auditors report to their own firm’s board of directors or corporate officers. They are primarily responsible for checking for fraud, waste, and financial mismanagement can Internal auditors be Used to Provide Direct Assistance The formal objectives of internal audit may include some or all of the following: 1. Review of accounting and internal control systems 2. examination of financial and operating information 3. review of the ‘three E’s (economy, efficiency and effectiveness) 4. review of compliance with laws and regulations 5. review of arrangements for the safeguarding of assets 6. review of implementation of corporate goals and objectives 7. identification of significant risks to the organisation, and monitoring risk management policy and risk management strategies 8. special investigations as required. The external auditor, in the course of discharging their responsibilities must decide if it is appropriate in the circumstances to use internal audit to provide direct assistance. The ISA identifies a number of steps that the external auditor should work through when determining to what extent, if any, direct assistance can be provided. 1: Prohibition by law or regulation The external auditor may be prohibited by law or regulation from obtaining direct assistance from internal auditors; therefore, the first task is to understand the law or regulation of the jurisdiction in which the auditor is operating. In the United Kingdom for example, the Financial Reporting Council (FRC) prohibits external auditors from using internal auditors as ‘direct assistance’ members of the audit team in order to enhance the principle of auditor independence. Consequently, the guidelines in relation to direct assistance are irrelevant to audits conducted in accordance with ISAs (UK and Ireland). 2A: Evaluation of the existence and significance of threats to objectivity of the internal auditors This is considered as an important element in the external auditor’s judgment as to whether internal auditors can provide direct assistance. Objectivity is regarded as the ability to perform the tasks without allowing bias, conflict of interest or undue influence of others to override professional judgment. The following factors are relevant to the external auditor’s evaluation of objectivity: It should be noted that the main purpose here is to evaluate threats to objectivity. Take the first factor as an example – if evidence shows that the internal audit function’s organizational status supports the objectivity of the internal auditors, the external auditor will feel more comfortable using direct assistance from the internal auditors. The following situations are likely to support the objectivity of the internal auditors: 1. The internal audit function reports to those charged with governance e.g. the audit committee rather than solely to management e.g. the chief finance officer 2. The internal audit function does not have managerial or operational duties that are outside of the internal audit function 3. The internal auditors are members of relevant professional bodies obligating their compliance with relevant professional standards relating to objectivity. [caption id="attachment_65518" align="alignright" width="235"] Dada Adefolami[/caption] 2B: Evaluation of the level of competence of the internal auditors Competence of the internal audit function is likely to be deemed satisfactory where it can be evidenced that the function as a whole operates at the level required to (i) enable assigned tasks to be performed diligently and (ii) in accordance with applicable professional standards. To make such evaluation, the external auditor can take into consideration the following factors: 1. Whether there are established policies for hiring, training and assigning internal auditors to internal audit engagements 2. Whether the internal auditors have adequate technical training and proficiency in auditing (e.g. with relevant professional designation and experience) 3. Whether the internal auditors possess the required knowledge relating to the entity’s financial reporting and the applicable financial reporting framework 4. Whether the internal audit function possesses the necessary skills (for example, industry-specific knowledge) to perform work related to the entity’s financial statements. Points to note in the evaluation The above evaluation regarding the internal auditors’ objectivity and competence should not be new to candidates as it forms the basis for any assessment by the external auditor when determining if reliance can be placed on the work of internal auditors and as such the requirement for these evaluations has been present in previous versions of ISA 610. The external auditor should bear in mind that the assessment of competence and objectivity are of equal importance, and should be assessed individually and in aggregate. For example, if the internal auditors are deemed appropriately competent but the external auditor identifies significant threats to objectivity it is unlikely that the external auditor will be able to use the internal auditors to provide direct assistance and vice versa. Finally Following the above detailed evaluation, if the external auditor determines that internal auditors, can be used to provide direct assistance for purposes of the audit, the next decision to be made by the external auditor is to determine the nature and extent of work that can be assigned to internal auditors. This is a matter that requires the auditor to exercise professional judgment, due to the fact that extensive use of direct assistance could affect perceptions of the independence of external auditors. ISA 610 (Revised 2013) limits the circumstances in which direct assistance can be provided. The external auditor is advised to consider the following factors in such determination: The external auditor should have performed the assessment of the first two factors when determining whether the internal auditors can provide direct assistance in the first instance. The less persuasive the evidence regarding the internal auditors’ objectivity and competency, the more restrictive the nature and extent of work that can be assigned. As a starting point the external auditor should consider the amount of judgment needed in (i) Planning and performing relevant audit procedures and (ii) Evaluating audit evidence gathered. The greater the level of judgment required, the narrower the scope of work that can be assigned to internal auditors. The following activities are deemed to involve significant judgment and therefore are not expected to be assigned to internal auditors providing direct assistance: 1. Assessing risks of material misstatements 2. Evaluating the sufficiency of tests performed 3. Evaluating the appropriateness of management’s use of the going concern assumption, and 4. Evaluating significant accounting estimates. For any particular account balance, class of transaction or disclosure, the external auditor has to take into consideration the assessed risk of material misstatement when determining the nature and extent of work that they propose to assign to internal auditors. The higher the assessed risk, the more restricted the nature and extent of work that should be assigned to internal auditors. If the risk of material misstatement is considered to be anything other than low, the more judgment that has to be involved and the more persuasive the audit evidence required. Therefore, in these circumstances, in order to reduce audit risk to an acceptably low level it is expected that the external auditor has to perform more procedures directly and place less reliance on assistance provided by internal auditors when collecting sufficient appropriate evidence. The ISA provides some specific examples of areas where reliance should be restricted. ISA 610 (Revised 2013) states that internal auditors cannot carry out procedures when providing direct assistance that: 1. Involve making significant judgment in the audit 2. Relate to higher assessed risks of material misstatements where the judgment required in performing the relevant audit procedures or evaluating the audit evidence gathering is more than limited 3. Relate to decisions the external auditor makes in accordance with ISA 610 (Revised 2013) regarding the internal audit function and the use of its work or direct assistance 4. Relate to work with which the internal auditors have been involved and which has already been or will be reported to management or those charged with governance by the internal audit function. This restriction intends to minimize self-review threats. ISA 610 (Revised 2013) also states that the following should not be assigned to or involve internal auditors providing direct assistance: 1. Discussion of fraud risks 2. Determination of unannounced or unpredictable audit procedures as addressed in ISA 240, The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements, and 3. Maintaining control over external confirmation requests and evaluation of results of external confirmation procedures. • Dada Suraju Adefolami, FIMC, CMC. Professor of Finance, School of Business Administration, UNEM University Costa Rica, is a Finance / Management Consultant and Certified Forensic Accountant. You can reach him via: surajudada@yahoo.com; 08052043855