Internal Audit Internal Audit

AKGVG & ASSOCIATES

IntroductionIntroduction Recent events including global financial crises have emphasised need for internal

auditing within corporate governance structures

Internal audit function is now mandatory by most stock exchanges

Donors increasingly demand improved accountability & financial transparency in development projects

IFAD procedures do not specifically require internal audit, however, IFAD Operational Procedures for Project Audits (for use by IFAD & CIs) require that “as part of the assessment of the borrower’s capacity to implement and manage the project effectively, the appraisal mission will evaluate any internal audit (IA) mechanism for the project/ PMU”

Furthermore, internal audit is considered good practice & advisable as part of underlying control framework & financial management capacity of a project, particularly if complex &/ or decentralised

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DefinitionDefinition

““Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organization's operations. It helps an organisation accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes. ”

The Institute of Internal Auditors

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IA – Code of EthicsIA – Code of EthicsPrinciplesPrinciples

Internal auditors are expected to apply & uphold the following principles:

Integrity The integrity of internal auditors establishes trust & so provides the basis for reliance on their judgment

Objectivity

Internal auditors exhibit the highest professional objectivity in gathering, evaluating & communicating information. Internal auditors make a balanced assessment of all relevant circumstances & are not unduly influenced by their own interests or others in forming judgments

ConfidentialityInternal auditors respect the value and ownership of information they receive & do not disclose information without appropriate authority unless there is a legal or professional obligation to do so

Competency Internal auditors apply knowledge, skills, & experience needed

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What is Internal Audit?What is Internal Audit?Internal Audit is a professional activity which helps organisations to achieve their stated objectives by: Analysis of key processes, procedures & operations

Identification of key controls in every process, procedure & operation

Evaluation of the adequacy of these controls Testing of the compliance of sample transactions against the controls

Reporting of the results of the compliance testing of transactions and evaluation of controls

Recommendation of stronger controls

Suggestions of methods for improvement of compliance with key controls

Follow up of action taken on recommendations made in previous reports

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What are Internal Controls?What are Internal Controls?

Important checks instituted by the management to have reasonable assurance that:

Operations are carried out in an effective & efficient manner

Transactions are recorded completely & accurately

Assets are properly safeguarded & recorded

Laws are complied with

Reliable reports are generated

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Some examples of Internal ControlSome examples of Internal Control

► Budgetary Control

► Fixed Assets Register

► Bank & Special Account Reconciliations

► Reconciliation of Financial & Physical Monitoring & Evaluation

Reports

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How are Internal Audit & External Audit different?How are Internal Audit & External Audit different?

Internal audit is focused at internal management support and improving systems, procedures and processes

⇉ External audit (EA): normally statutory requirement, unlike internal audit (IA)

⇉ EA reports are addressed to stakeholders: IA reports are addressed to Management

⇉ EA reports express an opinion on the financial statements prepared by the entity for a specified period: IA reports evaluate and check compliance against key internal controls

⇉ EA reports are usually public documents which are available to all stakeholders. IA reports are for use only by Management

⇉ EA reports do not make recommendations, although may have a Management Letter: IA reports are incomplete without

⇉ EA is basically a review of financial statements for compliance: IA seeks to ensure value for money to Management

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Why should IFAD funded projects be subject to IA?Why should IFAD funded projects be subject to IA?

IFAD funded projects may be subject to Internal Audit because:

External audit checks overall compliance to internal controls related to financial transactions.

Supervision Missions conduct only spot checks.

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Internal audit is inherent in government structures in most developing countries.

Sample IA Terms of Reference enclosed

IA has a key role in Risk management of IFAD Projects

What are key concerns from a FM viewpoint?What are key concerns from a FM viewpoint?

► Is the accounting system capable of recording financial transactions in an accurate & timely manner? tracking the expenditure of the project by component & category? ► comparing actual expenditure to budget on a real time basis?► Are withdrawal applications properly prepared? project assets properly recorded &

safeguarded? Special Accounts & Project Accounts properly and timely operated & reconciled? audit arrangements proper and in place? audit reports properly followed up?

► Does the project generate reliable & accurate financial statements & reports? project funds flowing timely and smoothly to the intended beneficiaries?

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Internal Audit (IA) MandateInternal Audit (IA) Mandate

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What does it not do?

Perform management’s activities/ responsibilities (these include establishing internal controls)

Compliance & Advisory Compliance & Advisory rolesroles

What does it do?

improves accuracy, reliability, internal control & integrity of information including operational and financial reporting

Monitors & evaluates the effectiveness of the processes

Formulates corporate’s oversight, safeguards the assets, helps in economical & efficient usage of the resources, maintains compliance with laws & regulations, deters fraud

Internal Control Myths and FactsInternal Control Myths and FactsMYTHS: FACTS:

Internal control doesn’t have strong set of policies and procedures

Internal control not only has a strong set of policies and procedures but also starts with the same

We have internal auditors for managing the entire Internal control!

Internal auditors play an important role in controlling the system. The responsibility of the internal control lies with the management.

Internal control is related to the finance of the company

Internal control is important for every aspect of the operation/business

Internal controls are necessarily negative, like a list of “thou-shalt-nots”

Internal control is responsible for making the right things happen

Internal controls do not make the business processes change

Internal controls built “into,” the business processes does make the business processes change

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Internal Control PracticesInternal Control PracticesHow?

Internal control is a process. It's a means to an end, not an end in itself

Internal control is effected by people as a team, not by internal auditor. It's not merely policy manuals & forms, but people at every level of an organization

Internal control can be expected to provide only reasonable assurance, not absolute assurance, to an entity's management and governing bodies/ committees

Uses systematic methodology for analysing business processes, procedures & activities

The cost of IA should not exceed expected benefits to be derived

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An internal control structure is simply a different way of viewing operations – a perspective that focuses on doing the right things in the right way

MONITORING

INFORMATION AND COMMUNICATION

CONTROL ACTIVITIES

CONTROL ENVIRONMENT

CONTROL ACTIVITIES

RISK ASSESSMENT

INFORMATION &COMMUNICATION

Internal Control StructureInternal Control Structure

In many cases, you perform controls and interact with the control structure every day, perhaps without even realising it

• Monthly reviews of performance reports

• Supervisory activities

• Reporting• Corporate

communications (e-mail, meetings)

• Purchasing limits• Approvals/ segregations• Security• Reconciliations• Proper operating &

accounting procedures

• Based on identification & analysis of risks to achievement of objectives

• Corporate Policies• Tone at the top, ethics• Organisational authority • Skilled personnel

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Role in Risk ManagementRole in Risk Management

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Focuses on risks that can prevent the project from attaining the goals

There are many types of risks – credibility, human capital, ineffective usage of resources, strategic, operational, fraud, financial reporting, legal/regulatory, etc.

Focuses on areas where there is high risk & high probability of controls not being in place or being weak

Let’s not forget the positive risks – opportunities!

Adds value through elimination of unnecessary controls!

RoleRole in in InternalInternal Control Control

1. Compliance audit: review of financial & operating controls & transactions for conformity with laws, regulations & procedures, e.g.,

• Access to IT system appropriate to user’s role

• Segregation of duties in high risk areas

• Balancing & reconciliation between systems

• Systems back up & recovery

• Physical safeguard & access restriction controls

• Reconciliations, comparison budget of actual

2. Operational audit: review of various functions within project to evaluate efficiency, effectiveness, & economy

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IA Role in Corporate OversightIA Role in Corporate Oversight

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Four pillars – internal audit, executive management, external audit, & Board of directors/ steering committee

Combination of processes & organisational structures implemented by management to inform, direct, manage and monitor the project’s resources, strategies & policies towards the achievement of its objectives

Public sector governance Principles transparency, integrity, accountability

May include review of sufficiency of human resources, training needs, policies, etc.

Nature of Internal Audit ActivityNature of Internal Audit Activity

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Establish Scope & activities for audit to Management Describe key risks facing the business activities within scope of audit Identify control procedures used to ensure each key risk is properly

controlled & monitored Develop & execute risk based sampling & testing approach to

determine whether most important controls are operating as intended (NB: input from Management required – e.g. 100% sampling of WA review)

Report issues/make recommendations/negotiate action plans with Management to address issues

Follow up on reported findings periodically

Contents of Audit PlanContents of Audit Plan

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Updated annually

Risk based audit plan developed with input from project staff including Management

Summary of key goals, risks & corresponding major audits, to illustrate alignment

Based on risk assessment & available resources

Appendix materials, such as planning approach, assumptions & brief descriptions of all planned audits & related prioritization

Approved by management/ appropriate oversight Committee

Contents of Audit Report Contents of Audit Report

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Observations

Narration/ description

Remedial action

Consequences/ fall out

Recommendation for improvement (prioritized between “high” and “normal”)

Response (action plan) – who, when and how

IA’s Proactive RoleIA’s Proactive Role

Identify Risks

Find Better Ways and Best Practices

Partner With Management to Find Solutions

Prevent Problems

Provide training

Respond to policy & technical accounting questions

Offer suggestions for improvement

Advisory role

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Additional Resources Additional Resources

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ConclusionConclusionWhy all this trouble?Why all this trouble? Additional comfort and “tightness” that the project is doing the right thing, the first time,

communicating right information internally, to external auditors, donors, ministries, etc.

More formal control structures reduce possibility that risks become real issues

External Auditor may receive additional assurance to provide unqualified report on accounts

Donor & government confidence increased, affecting financing flows

What are the next steps?What are the next steps? Identify areas of high risk & opportunities

Validation of process documentation & controls

Communication, with PCs & project staff

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THANKSTHANKS 

AKGVG & Associates

Corporate Head Office 307 Pearl Corporate, Mangalam Place,Sector-3, Rohini, New Delhi, India - 110085Contact No - +91- 9811118031Email ID - info@akgvg.comWebsite - http://www.akgvg.com

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