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The director of one of your growing clients have decided to create an internal audit function in their organizational structure

      

The director of one of your growing clients have decided to create an internal audit function in their organizational structure

Required:
a) List and briefly describe the duties you would expect the internal audit staff to perform.
b) List and explain the criteria which you would consider before deciding to rely on the work of the internal audit function.
c) State the extent to which you, as an external auditor, can rely on the work of the internal audit function.

  

Answers

Wilfred
a) Internal audit is an appraisal or monitoring activity established by management for the review of accounting and internal control systems as a service to the entity. It examines, evaluates and reports to management on the adequacy and effectiveness of the systems.
Other activities include:-
a) Review of the accounting and internal control systems. Management is responsible for establishing an internal control system. These systems demand proper attention and continuous review, a function that is usually assigned to internal audit. The internal audit function designs a work plan that shows the areas and control procedures that will be reviewed during the year.
b) Carrying out examination of financial and operating information. This may include detailed testing of transactions and accounting and operating procedures.
c) Review of the economy, efficiency and effectiveness of operations including non financial controls of an entity.
d) Review of the entity‘s compliance with laws and regulations. The internal audit function reviews whether the company has put in place appropriate procedures to ensure that all the relevant laws and regulations are adhered to. This will
include review of adherence to laws such as taxation legislation, stock exchange listing regulations among others.
e) Review of the entity‘s compliance with management policies and other internal requirements
f) Carrying out independent investigations into the affairs of the company as required by management. The internal audit function will carry out investigations e.g. where frauds are suspected, where there is suspected inefficiency in the use of the company resources e.t.c


b) Before deciding whether to rely on the work of the internal audit function with the intention of reducing audit procedures the external auditor should evaluate the internal audit function to determine the scope of the function, its independence and hence how much reliance can be placed on the work that it carries out. The external auditor can only rely on the work of the internal auditor as one element of the internal control system.
In evaluating this function the external auditor should consider the following factors:
1. Organization status
Since internal audit function is part of the entity it cannot be totally independent. To boost it‘s independence the status of the function within the organization should be such that the internal auditor reports to the highest level of management. The internal auditor should also be free of any other operating responsibility such as performing accounting functions, which may conflict with his role as an independent watchdog of controls and operations of the entity. There should be no restrictions placed upon his work by management. Such restrictions could impair the effectiveness of the function.
2. Scope of the function
The external auditor should ascertain the nature and depth of coverage of internal audit assignments. He should also ascertain whether management considers and acts upon internal audit recommendations. Where the recommendations are not acted upon this represents a weakness in the function and hence the level of reliance should consequently be reduced.
3. Technical competence
The external auditor should ascertain whether internal audit work is performed by persons having adequate technical training and proficiency as auditors. Qualifications and experience of the internal audit staff should be considered.


c) When an auditor decides that he can place reliance on the internal auditors work, the extent of his reliance will be influenced by the results of his evaluation of the internal auditors work.
This evaluation will involve:-
(i) Discussion with the clients internal auditor about the timing of internal work, test levels, sample selection and the form of documentation to be used.
(ii) Consideration of:-
a. The materiality of the items or areas to be tested, and also of the information that can be obtained from internal
audit.
b. The level of audit risk inherent in the areas or items to be tested or in the information to be obtained.
c. The level of judgment required
d. The sufficiency of complementary audit evidence
e. Specialist skills possessed by internal audit staff
(iii) Setting out the extent of planned reliance on internal audit, together with reasons for deciding on that extent, in a planned memorandum.
(iv) Review of the manner in which the internal audit work is being controlled particularly:-
a) Consider whether work has been properly supervised and also reviewed in detail when it has been completed.
b) Compare the results of the work with those of external auditors staff on similar audit areas or items
c) Satisfy himself that any exceptions or unusual matters that have to come to light as a result of the work have been
properly resolved.
d) Examine reports relating to the work produced by internal audit and management‘s response to those reports.
e) From time to time, determine whether internal audit will be able to complete the program that it has agreed to undertake
and if not make appropriate arrangements.
(v) Ensuring that the working papers relating to the work of internal audit, on which reliance is being placed, are up to an acceptable standard

Conclusion: Since the internal auditor cannot meet the prime criteria of independence, the external auditor cannot fully rely on the work of the internal auditor. The extent of reliance will be determined by applying judgement.
Wilfykil answered the question on February 21, 2019 at 09:51

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