Internal audits evaluate a company’s internal controls, including its corporate governance and accounting processes. These audits ensure compliance with laws and regulations, maintain accurate financial reporting and data collection, and identify and correct problems before they are discovered in an external audit. Internal auditors are hired by companies to work on behalf of their management teams to provide necessary tools for operational efficiency.

Key Takeaways

• Internal audits offer risk management and assess the effectiveness of the company’s various aspects.
• Types of internal audits include financial, operational, compliance, environmental, IT, or specific-purpose audits.
• Internal audits enable management and the board of directors to correct process flaws before external audits.
• The audit process involves planning, auditing, reporting, and monitoring steps.
• Internal audits promote operational efficiency, encourage adherence to company policy, and explore specific operational areas.

Understanding Internal Audits

Internal audits play a crucial role in a company’s operations and corporate governance. Since the Sarbanes-Oxley Act of 2002, managers are legally responsible for the accuracy of their company’s financial statements, and internal controls must be documented and reviewed as part of external audits.

Apart from ensuring that a company complies with laws and regulations, internal audits also offer risk management and protect against fraud, waste, or abuse. These audits highlight improvements in company processes including IT systems and supply-chain management.

Internal audits can occur daily, weekly, monthly, or annually, and specific departments may be audited more frequently based on necessity. For instance, manufacturing processes might be audited daily for quality control, while the HR department might be audited annually. Audits can be scheduled or surprise, especially if unethical activities are suspected.

Types of Internal Audits

Compliance Audit

A company must adhere to local laws, compliance needs, government regulations, or external policies. An internal audit committee reviews and compiles information to offer an opinion on compliance requirements.

Internal Financial Audit

Public companies undertake external financial audits, but companies might perform internal audits to delve deeper into findings or pre-empt external audits. Internal and external financial audit tests may be similar, but internal auditors focus on diving deeper within greater operational flexibility.

Environmental Audit

Companies aiming for environmental consciousness initiate audits reviewing their impact on the planet. This includes resource sourcing, greenhouse gas minimization, eco-friendly distribution methods, and energy consumption.

Technology/IT Audit

An IT audit assesses controls, security, documentation, and system accuracies. Objectives can vary from becoming more efficient to responding to a lawsuit or a specific complaint.

Performance Audit

Focused on performance outcomes rather than processes, this audit ensures company objectives and performance metrics are met efficiently.

Operational Audit

Triggered by sudden changes like key personnel or management shifts, this audit assesses how resources match company goals and values to ensure operational efficiency.

Construction Audit

For real estate or construction companies, this audit ensures adherence to contractor agreements and appropriate project billing, verifying all payments and project reports.

Special Investigations

For unique, infrequent circumstances like mergers or specific complaints, special investigative audits ensure expertise and independence in evaluating and reporting.

Internal Audit vs. External Audit

Both internal and external audits aim to review and offer opinions on company aspects. However, in internal audits, teams are often more flexible and management-selected, which differs from externally dictated external audit teams.

• Internal Audits: Enhances operations with self-selected teams, allowing for in-depth, less formal analysis.
• External Audits: Independent assessment adhering to strict benchmarks, often used by external stakeholders for formal reporting.

Internal Audit Process

Step 1: Planning

Develop an audit plan outlining audit requirements, objectives, timeline, and responsibilities. Includes check-ins with management and a kickoff meeting.

Step 2: Auditing

Using direct and indirect assessment techniques ensures a constant check, requiring adjustments if circumstances or findings shift.

Step 3: Reporting

Includes formal and interim reports detailing audit activities, findings, suggestions, and next steps for management evaluations and future monitoring.

Step 4: Monitoring

Ensuring proposed changes are implemented effectively and frequently revisited assures ongoing improvements.

Internal Audit Reports: The 5 C’s

1. Criteria: Identifies why the audit was necessary.
2. Condition: Specifies which company benchmarks or policies were unmet.
3. Cause: Deduces reasons behind the issue and how to prevent it.
4. Consequence: Determines outcomes and potential risks of unresolved issues.
5. Corrective Action: Lays out specific steps and monitoring solutions to address findings.

Importance of Internal Audits

Internal audits provide immense value. They help preempt external audit findings, potentially saving costs, while optimizing process efficiencies and reinforcing adherence to policies. This promotes a stronger, more compliant company culture.

• Identify deficiencies early to correct them without external pressures.
• Tailor audits to the company’s critical areas and compliance requirements.
• Provide thorough operational insights enhancing internal control environments.
• Ensure tailored, efficient corrections informed by firsthand internal knowledge.

Conclusion

An internal audit is a process that allows a company to proactively examine and improve its own operations. The value lies in identifying problems before external audits, ensuring compliance, enhancing efficiencies, aiding risk management, optimizing processes, and providing management a head start on corrections, ultimately contributing to a robust operational framework.

Related Terms: internal controls, corporate governance, audit, risk management, SOX compliance.

References

1. Cornell University, Legal Information Institute. “Sarbanes-Oxley Act”.
2. Congressional Research Service. “Corporate Responsibility: Sarbanes-Oxley Act of 2002”. Pages 5-8.
3. U.S. Securities and Exchange Commission. “All About Auditors: What Investors Need to Know”.

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