Internal audits evaluate a company’s internal controls, including its corporate governance and accounting processes. These types of audits ensure compliance with laws and regulations and help to maintain accurate and timely financial reporting and data collection. Internal auditors are hired by companies who work on behalf of their management teams. These audits also provide management with the tools necessary to attain operational efficiency by identifying problems and correcting lapses before they are discovered in an external audit.
Internal Audit
An internal audit occurs within an organization. So an independent auditor or team of auditors, who are actually employees of the organization, will review the financing, accounting and operating activities of the organization. It is actually a part of the internal control system of the company.
For most organizations, the appointment of an internal auditor is completely mandatory. However, according to Rule 13 of the Companies (Accounts) Rules 2014 the following classes of companies are required by law to carry an internal audit,
- Every company listed on the stock market
- Every unlisted public company that has
- Paid up capital exceeding 50 crores in the previous year
- Turnover greater than 200 crores in the previous year
- If at any point in the previous year if outstanding loans and liabilities exceeded 100 crores
- Outstanding deposits exceeds 25 crores in the previous year
- And every private company that,
- Has a turnover of more than 200 crores in the previous year
- If at any point in the previous year if outstanding loans and liabilities exceeded 100 crores
Objectives of Internal Audit
1. Proper Control
One of the main objectives of an internal audit is to keep stringent control over all the activities of an organization. The management needs assurance of the authenticity of the financial records and the efficiency of the operations of the firm. An internal audit helps establish both.
2. Perfect Accounting System
An internal audit keeps a very close check on the accounting system of an organization. It checks everything from the vouchers, to the authority of transactions to mathematical accuracy. All entries are verified against documents and other proof. Chances of mistakes or frauds are greatly reduced.
3. Review of Business
The purpose of an internal audit is to keep a check on the financial and operational aspects of a business. So as the current financial year is ongoing, internal audit can point out the mistakes, weak points, and strengths of the business. This will allow an ongoing review, instead of waiting till the year-end.
4. Asset Protection
In the process of internal audit, there is always a valuation and verification of an asset. There is also a physical verification of the ownership and possession of the asset.
And in case of special transactions like sale, purchase or revaluation of the asset, the authorization of this is also audited in an internal audit. So the assets enjoy complete protection.
5. Keeps a Check on Errors
In a financial audit, the auditor will be able to determine if any mistakes were made in the financial records. But this only happens at the end of the financial year.
And the mistakes are corrected thereafter. But in case of an internal audit, the mistakes are spotted as soon as they are made, and corrected immediately.
6. Detection of Fraud
In case the company has an internal audit in place, the detection of fraud becomes much easier. This is because there is a year-round check on the employees.
In fact, an employee is less likely to attempt fraud in the presence of an internal auditor. He will not have any time gap between the occurrence of fraud and its detection to cover it up. This will dissuade employees from committing fraud.
Characteristics of Internal Audit
- An internal audit is performed to ensure that the system of internal controls instituted by a company’s management is functioning as intended by its key managerial personnel and for the welfare of its members.
- It considers whether the business practices deployed by the company’s officers help to manage the business prudently and meet the organisation’s strategic objectives.
- It can cover both operational as well as financial issues. However, the internal audit process is generally understood to be limited 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 it faces in the dynamic business environment. The internal auditor using this process is responsible for reporting to the management or audit committee of the company.
- Even though operating independently from other departments and involves reporting directly to the audit committee, internal audit is a function that remains within an organisation, i.e., the company’s employees.
- It involves performing audits of both financial and non-financial nature within a wide range of business areas, including those directed by the annual audit plan.
- It deals with the main risks facing the business and the action being taken to manage those risks effectively so that the organisation can achieve its various objectives. For example, the internal audit process evaluates risks threatening a company’s reputation, such as the employment of cheap labour in foreign countries, or strategic risks, such as producing too many products in comparison to available resources.
- It is limited to an organisation’s governance, management controls over its operations, and risk management.
- It is conducted based on the personal resolve of the business owners to measure the operation’s efficiency as conducted by the business.
Benefits of Internal Audit
- 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 to maintain financial records. To achieve desirable results, orderly devices are required, which can be achieved through internal auditing.
- Better Management: It ensures better business management in the organisation. An auditor can point out areas of weakness in management. The business objectives can be achieved if there is proper internal control, internal check, and internal audit. It should be noted that management has the option to completely rely on internal audit for the best results.
- Progressive Review: It can help review the progress of the business. The figures from previous years are compared to those of the present year. The performance results of various similar companies can be considered and compared to determine the progress of the entity. An internal audit helps the management review the growth of the entity.
- Effective Control: It is essential to retain effective control over business activities. Control comes under management’s functions and is related to the supervision and direction of ongoing operations. The manager can make the necessary changes according to the internal audit and remove the difficulties for a business’s smooth functioning.
- Assets Protection: The protection of assets is possible through an internal audit. The management can only use the assets for the benefit of the business and not for private purposes. Internal auditing keeps an eye on embezzlement of cash, misappropriation use of stock and misuse of other assets from ever occurring.
- Division of Work: It can be conducted to apply the division of labour. This is necessary to monitor the activities of every employee, including the management. The auditor may choose to suggest ways to improve the business’s performance.
- No Error and Fraud: Internal audits can be conducted to protect 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 can be detected and rectified easily.
- Fixing Responsibility: Internal audits can establish the responsibilities of employees who perform poorly. Management establishes performance standards, and the internal auditor evaluates the results of all employees. This way, the concerned individuals can be held responsible for their work that does not meet the company’s standards, and appropriate changes can be made.
- Helps External Auditing: The work performed by an internal auditor would be very helpful to an external auditor in conducting the audit. The internal and external audit procedures are 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 help improve the organisation’s performance. 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 a business’s and its employees’ performance.
- Proper Use of Resources: An internal audit checks the appropriate use of resources. The misuse of resources would undoubtedly increase the organisation’s costs. The optimum use of resources in a company could be determined by controlling the cost of output. Internal audits can be considered a tool for using a company’s resources 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 responsible for examining the facts and figures to confirm. Such investigations can be conducted at the request of the management of the company.
Types of Internal Audit
Financial/Controls Audits
This core internal audit type evaluates the effectiveness of an organization’s internal controls over financial reporting. Internal auditors assess whether financial records are accurate and reliable, transactions are correctly recorded, and safeguards are in place to prevent fraud or errors. This helps ensure the integrity of the company’s financial statements and protects against financial risks.
Compliance Audits
These audits ensure the organization adheres to relevant laws, regulations, industry standards, and internal policies. This can involve environmental regulations, data privacy laws, human resource policies, or occupational safety standards. Compliance audits identify potential areas of non-compliance and recommend corrective actions to mitigate risks associated with fines, penalties, or reputational damage.
Operational Audits:
Operational audits assess the efficiency and effectiveness of an organization’s business processes. Internal auditors examine how well these processes are designed, implemented, and controlled. They identify areas for improvement, redundancies, or bottlenecks impacting performance. The goal is to optimize processes for increased efficiency, cost savings, and overall organizational performance.
IT Audits:
With increasing reliance on technology, IT audits assess the organization’s information technology (IT) infrastructure, controls, and security measures. This includes reviewing data security protocols, access controls, disaster recovery plans, and the overall effectiveness of IT systems. IT audits identify vulnerabilities and recommend improvements to safeguard sensitive data, ensure business continuity, and mitigate cyber security risks.
Additional Specialized Audits:
Beyond these core types, internal audits can be tailored to address specific areas of concern within an organization. Examples include:
- Construction Audits: These audits focus on construction projects, reviewing project management practices, contract compliance, cost controls, and potential schedule delays.
- Environmental Audits: These audits assess an organization’s environmental compliance and impact. They may review waste management practices, energy consumption, and pollution control measures.
- Investigative Audits: These audits investigate specific allegations of fraud, misconduct, or irregularities within the organization.
Internal Audit vs External Audit
| Feature | Internal Audit | External Audit |
| Who Performs It | Employees of the organization or an internal audit department | Independent accounting firm hired by the company |
| Purpose | Improve operations, identify areas for improvement, and ensure effectiveness of internal controls | Provide an independent opinion on the fairness and accuracy of the company’s financial statements |
| Scope | Broad range of areas including financial reporting, operational processes, compliance, risk management, and governance | Primarily focuses on financial records, transactions, and accounting practices |
| Focus | Forward-looking, identifying potential risks and opportunities for improvement | Historical, providing assurance on past financial performance |
| Reporting | Reports to senior management and the board of directors | Reports to shareholders and regulatory bodies |
| Impact on Financial Statements | Does not directly impact published financial statements | May result in adjustments to the financial statements |
| Independence | May have some familiarity with the company’s operations, potentially impacting objectivity | Completely independent of the company, ensuring objectivity |
| Frequency | Can be conducted continuously or periodically throughout the year | Typically conducted annually |
| Regulation | Not mandatory for all companies, but may be required by some regulations or good governance practices | Mandatory for publicly traded companies and some private companies based on size or risk profile |
Internal Audit Process
Planning and Risk Assessment
- Identify Audit Needs: The internal audit department or chief audit executive (CAE) works with management and the board to identify areas requiring audit focus. This may involve analyzing risk assessments, industry trends, and past audit findings.
- Develop the Audit Plan: Based on the identified needs, the internal audit team creates a detailed plan outlining the specific objectives, scope, methodology, and resources needed for each audit.
- Risk Assessment: A risk assessment prioritizes audit areas based on their potential impact on the organization. This helps ensure the internal audit focuses on areas with the highest risk of issues.
Fieldwork
- Gather Information: The internal audit team gathers information through various techniques, including:
- Interviews: Discuss processes and controls with relevant personnel.
- Document Review: Examining policies, procedures, financial records, and other relevant documents.
- Observation: Witnessing processes firsthand to understand their practical application.
- Testing of Controls: Performing tests to assess the effectiveness of internal controls in mitigating risks.
- Analyze Findings: The team analyses the information gathered to identify potential weaknesses, inefficiencies, or areas of non-compliance.
Reporting and Communication
- Draft Audit Report: The internal audit team prepares a comprehensive report outlining the audit objectives, scope, methodology, findings, conclusions, and recommendations for improvement.
- Management Response: Management reviews the report and provides a written response outlining their plan to address the identified issues.
- Communication with Stakeholders: The internal audit department communicates the audit findings and recommendations to senior management and the board of directors. This may involve presenting the report and discussing its implications.
Follow-Up
- Monitoring Action Plans: The internal audit team monitors the implementation of management’s action plan to address the audit findings. This ensures corrective actions are taken and identified weaknesses are addressed.
- Continuous Improvement: The internal audit process is cyclical. The findings and recommendations from previous audits inform future risk assessments and audit planning, promoting continuous organisational improvement.
FAQs
What Is the Internal Audit Process?
The internal audit process entails planning the audit, performing the audit procedures, compiling the audit report, and monitoring post-audit changes. Management may choose to expand the scope of an audit at any point of the audit if findings during the audit cause the scope to shift a different direction.
What Are the 5 C's of Internal Audit?
Internal audit reports often outline the criteria, condition, cause, consequence, and corrective action. These five areas report why the audit was performed, what caused the reason for the audit, how the audit will be performed, what the auditor aims to achieve, and what steps will be taken after the audit findings are presented.