WHAT IS INTERNAL AUDIT

The article attempted to list down the objectives and importance of internal audit. It deliberated on the functions associated with internal auditing. The conclusion part is crafted considering the importance of internal audit for an exemplary corporate governance implementation.
Estimated Reading Time: 10 minutes

Introduction

Internal audit is defined as a review and assessment of the financial transactions and records which the company performs and is offered by professionals specifically assigned by the Board of directors within a business. It acts as an assessment tool to check the internal financial control facilitated through a set of rules of procedures. Those procedures reflect accounting standard systems and carry out a review and reporting mechanisms to maintain a corporation’s accounts accurately. It is primarily introduced to ensure that a business’s accounts are appropriately maintained without any mismanagement and oriented to ensure that a corporation’s accounts contain credible and reliable information.

The internal audit mechanism also helps eliminate the possibility of frauds and errors within and outside the corporation by performing a thorough examination of all the company’s financial activities and recording its findings in a report, and submitting it to the audit committee to receive its recommendations advice. It reassures the transparency of the safeguards’ financial transactions and adequacy to mitigate revenue leakage or misappropriation of the property or assets. The procedures and operations carried out in the internal audit will be based on government rules and company policies. It fixes a routine check-up of audits and regular intervals of reporting. But internal audit often differs in its scope and emphasis; it is more managerial than accounting; its form is varied, depending on the organization’s size.

For instance, whereas a professional auditor is primarily concerned with the legality or validity of transactions entered into by a business, an internal auditor is expected to ensure that the economy and efficiency standards are maintained. 

Internal auditing ascertains the stock operations and determines the finance charges associated with it; they lay importance to the company tenders, sales, and the standards of procedures followed, its staffing and the future risk assessment. It also evaluates the number of losses suffered in manufacturing and compares and contrast the previous losses and gains. The audit process should also check into the leakage of stocks, revenue mismanagement, misappropriation of assets, and frame a balance sheet on the expenditure, incorporating technical and physical accounts.

Internal audit’s nature and scope are fixed concerning the type of company; it prepares rules and procedure appropriately; it may also appoint an internal auditor, a chartered accountant, cost accountant, or other professional as determined by the Board of directors. The manner of conduct, procedures involved, the type of financial accounts to be taken into auditing, and the Central government’s audit intervals will be fixed accordingly. 

What is Internal Audit

“Internal audit is an independent management function, which involves a continuous and critical evaluation and assessment of the financial functioning of an entity intending to suggest improvement to that and add value to and strengthen the overall government mechanism of the amity, including the entity’s risk management and internal control system.”

The institute of internal auditors in the USA has framed a definition for internal audit concerning the modern approach; they define internal auditing as an “independent appraisal function, established within an organization to examine and evaluate its activities as a service to the organizations. Internal auditing’s objective is to assist members of the organization in the effective discharge of their responsibilities. To this end, internal auditing furnishes them with analyses, appraisals, recommendations, counsel and information concerning the activities reviewed“. 

This modernized approach on defining internal audit embrace the operational audits and the management activities concerning it in the organization. A revised definition was also released by the Institute of Internal Audit, where it re-emphasizes the increasing scope and effectiveness of the internal audit. It defines internal auditing as an independent, objective assurance and consulting activity designed to add value and improve its operations. It helps an organization accomplish its adjectives by bringing a systematic, disciplined approach to evaluating and enhancing risk management, control, and Governance.

This revised definition emphasized increasing internal audit scope to achieve maximum organizational effectiveness. It is felt that if such an activity is an integral part of the organization, it shall maximize the organizational goals in a company. 

It is further noted that internal auditors also play a prime role in internal audits; they are the qualified accountants who provide exceptional assistance to the management in the process of auditing the accounts; apart from it, they also assist in fields other than accounting because of their training and experience. They can observe facts and situations of both financial and non-financial activities and notify the management authorities and facilitate eradicating the short-term. They critically appraise various management policies and draw their attention to any deficiencies, wherever it is required to be reviewed. 

Objectives of Internal Audit

The objectives of internal audit are stated as follows;

  1. Verify the correctness and authenticity of the financial accounts and the statistical records of the management.
  2. Determine whether the company has adhered to the standard accounting practices.
  3. Authorize a proper authority to carry out all its financial activities concerning the assets and stocks. 
  4. Confirm that the company has adhered to the legal obligation for all the activities carried out.
  5. Analyze and improve the internal check system concerning its working, efficiency, and correctness with economic standards.
  6. Facilitate the prevention and detection of frauds.
  7. Examine the protection afforded to assets and its uses for company actions
  8. Make special investigations on misappropriation and mismanagement.
  9. Provide a channel whereby to bring new ideas to the attention of management.
  10. Review the overall internal control system’s operation and bring material departures and non-compliances to the notice of the appropriate management level; the review also generally aims at location unnecessary and weak controls for making the entire control system effective and economical.

Importance of Internal Audit

Risk assessment

The primary importance of internal audit can be witnessed in its power of assessing the future financial threats to the company; it furnishes the corporation with a risk-based governance strategy by identifying and evaluating the possible financial and non-financial risk to be faced by the organization and also provide insight on mitigating the same.

Enhancing internal control and monitoring

Internal control may be defined as the plan of organization and all the methods and procedures adopted by the management of an entity to assist in achieving management’s objective of ensuring the orderly and efficient conduct of its business, including the adherence to the management policies; concerning the concept of internal audit about internal control of management, it indeed contributes to its enhancement.

Achieving company objectives

The objectives mentioned in the memorandum form the company’s base; internal auditing enhances the company’s accountability and transparency: it directly impacts achieving the company objectives more efficiently.

Compliance with company policy and government rules 

Internal audit enhances the companies adherence to legal obligations; it causes to motivate the management to the government regulations and other corporate governance codes and policy.

Detect fraudulent activities inside the company

Internal audit’s primary objective is to detect the fraudulent activities happening within the company management; the random sampling, review and reporting of the financial accounts would detect the possible insider frauds and financial mismanagement.

Helps to determine the organization’s efficiency

Internal audit acts as a tool for measuring the organisation’s efficient functioning; it helps determine its financial stability and market performances.

Increase the productivity of the company

Internal audit acts as a catalyst for productivity increase in the company. The inter-relation between internal audit and company performance is vast; it affects every section; employee’s performance, firms credibility, commitment, transparency etc. all these results in the increase of productivity. 

Good corporate Governance

An effective internal system fortifies the company’s financial and corporate approaches, comprising the internal audit in an essential role, which raises the internal control system’s credibility and reliability. It forms the backbone for an excellent corporate governance mechanism within the company.

Confidence of shareholders

The internal audit system enhances the management responsibility towards shareholders; the transparency in the accounts, accountability of executive directors and employees towards the company affairs, boost stakeholders’ confidence.

Functions associated with Internal Audit

Internal audit is an arithmetic evaluation of the company’s financial accounts, attempted to ensure proper corporate governance and internal control facilitated through adequate reporting and recommendations. It involves different functions initialized from collecting financial sample reports, assessing the procedures, determining its weaknesses, and proposing modifications and enhancements in their techniques for handling finances in the company. Considering the activities involved, the Board of directors establishes an audit committee and a group of professional auditors. It provides them with access to the company’s financial details to perform the internal audit. The committee will be entrusted with a duty to show commitment to the company policies and procedures and implement an excellent auditing technique standard. Apart from maintaining records, internal auditing is expected to provide armour for safeguarding the company from financial frauds and misappropriation. 

The following are the functions performed under internal audit:

Monitoring of internal control: Internal audit is assigned with specific function and responsibility to review the rules, monitor the operation, and recommend improvements in the company affairs.

  • Examination of financial and operational information: Internal audit is assigned to review the means used to identify, measure, classify and report financial and operating data, and make a specific inquiry into individual items, including detailed testing of the financial transaction.
  • Review of operating activities: The internal audit review the corporation’s efficiency in the scale of economic activities comprising both financial and non-financial actions
  • Review on compliance with laws and regulations: The conduction of internal audit functions to review the extent of its adherence to the laws and regulations. It checks the compliance of policies and rules in every financial and management activity.
  • Risk management: the internal audit function performed to identify and evaluate significant exposures of the company to risks and contribute to the improvement of risk management and control systems.
  • Governance: Its pivotal function is to assess the company governance process’s effectiveness in accomplishing its objectives and values. It evaluates its performance, transparency, accountability, mitigation of risks and internal control of information to appropriate areas of the organization, and communication effectiveness among those charged with Governance, external and internal auditors, and management.

Internal Audit and Corporate Governance

Corporate Governance is a set of code prescribed to shape the company management both internally and externally; it is a technique within which the companies operate and manage their affairs more effectively to attract investors and outsiders. Encompassing various codes of practice accomplished by different market players has become a tool that promotes sustainable growth in the business environment. The internal audit department is the most crucial system inside a company; it is a critical element that applies accounting standards and techniques to evaluate its financial and non-financial managerial functions.

Under the corporate governance code, internal audit is considered the backbone of the business; it is the division that records all the financial and non-financial aspects of trade and businesses related to the sector. Internal audit efficiency helps develop the company’s management as the financial reports reflect the internal audit department’s quality, directly impacting its profile in the market. Moreover, an internal audit is a significant part of the Corporate Governance structure in a company which incorporates an overlook upon the activities taken by the Board of directors and audit committees to ensure that the financial reporting process is credible and legally obliged. 

Internal audit strengthens corporate Governance by providing risk-based audits reports which supplement the management with insights on the financial risks, its mitigation techniques etc.; it includes process and structures for the corporation towards excellent corporate Governance. According to the complexity of the risks involved, the audit process change provides a profound sense of sustainability through risk-based governance reporting measures. As the companies are working in a highly competitive ground with a wide array of chances created by technology, geography, politics, cybersecurity, etc., a vigil and a highly organized internal audit function is indispensable for sound Corporate Governance.

Audit Committee

Clause 49 of SEBI Listing agreement made it mandatory for all listed company to form an Audit Committee:

A qualified and independent audit committee should be set up, providing the following terms of reference: 

  1. The audit committee shall have a minimum of three directors as members. Two- thirds of the members of the audit committee shall be independent directors.
  2. All audit committee members shall be financially literate, and at least one member shall have accounting or related financial management expertise.

 Powers and functions of Audit Committee as per the clause

  1. review the company’s financial reporting and ensure its disclosure to check its correctness and credibility
  2. investigate the economic activities and order for reports and information from the employees
  3. review the management annual and quarterly financial statements
  4. providing recommendations to the Board on the enhancement of management risks mitigation and accounting standards
  5. Reviewing the internal audit function’s adequacy, including the internal audit department’s structure, staffing and seniority of the official heading the department, reporting structure coverage, and internal audit frequency.

Conclusion

Through this article, you can find the critical role of internal audit in the corporation; by tracing the emergence of internal auditing over time since the early days of the twentieth century, its scope and usage have increased considerably from financial to non-financial activities. Its immense importance on the management’s internal control was created to prevent financial fraud and bring a speedy detection of frauds and management errors.

The internal audit system is generally based on the principle that when the performance of each individual in an organization, ordinarily and specifically, is checked by another, the chances of occurrence of errors, or the remaining undetected are significantly reduced; also that, when two one more persons essentially must combine either to receive or to make a payment, there will be a lesser possibility of a fraud being perpetrated by them. Internal audit may play such a role in management, and it is closely associated with knowledge and skill. It creates a significant impact on company objectives and business policies. With time, the internal audit can be recognized as a valuable resource to achieve the organization’s overall growth objectives.

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