MANDATORY INTERNAL AUDIT FOR

COMPANIES

TM

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- When Is It Applicable?

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The name reflects our objective of Accelerating Growth. “ ”Floraison India Compliances Private Limited is a Bangalore-based business consulting organization. As a company which provides integrated consulting services, we partner our clients from the stage of inception to assist them in successfully commencing their operations and further hand-hold them to run their company efficiently.

At Floraison, we strive to cultivate strong relationships with our clients by providing them with solutions, which cater to their precise requirements. Customizability is therefore the essence of all the services provided by us. We believe true success is not just fulfilling our clients' requirements, but exceeding their expectations. And, to be successful, we work as an cohesive team all the way, using the best of tools and methodologies.

Floraison is a member of:» Confederation of India Industry

» Bangalore Chamber of Industry and Commerce » Indo-German Chamber of Commerce

For more information on the company, Please visit us at www.floraison.in

floraison in French means 'flowering'.

DisclaimerThis publication is a product of Floraison India Compliances Private Limited. The items contained herein are provided for general information purposes only. Floraison strives to maintain up-to-date information from its own and other reliable sources; however, no responsibility is accepted for any errors and/or omissions or results of any actions based upon this information, without consulting Floraison first. Though all efforts have been made to ensure the accuracy of the content, the same should not be construed as a statement of law or used for any legal purposes. The information is for reference purposes only and should not be dealt with as advice.

About Floraison...

MANDATORY INTERNAL AUDIT FOR COMPANIES

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“ hecking the results of a decision

against its expectations shows executives

what their strengths are, where they

need to improve, and where they lack

knowledge or information.”

C

Peter Drucker

MANDATORY INTERNAL AUDIT FOR COMPANIES

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In this issue...

MANDATORY INTERNAL AUDIT FOR COMPANIES

Introduction... 1

Scope and Objectives... 2

Mandatory Applicability of Internal Audit... 3

General Evaluation of Internal Audit Function... 4

Relying upon the Work of an Internal Auditor... 5

Standard on Internal Audit: Basic Principles

Governing Internal Audit... 6

Conclusion... 7

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Introduction...Internal Audit refers to an independent appraisal of activity within an organization for the

review of accounting, financial and other business practices. It consists of a continuous

and critical review of financial and operating activities by a staff of auditors. It is a

separate part of internal control system.

Internal audit is a vital tool that helps modern organisations to manage risks. It helps to

focus on key areas such as the identification and management of risks.

There is a great deal of ambivalence when it comes to internal and external audits.

Therefore it is to be mentioned that both have significant differences.

Internal Audit External Audit

It involves all the risks faced by an

organisation and the procedure by

which they are managed.

This, on the other hand deals with

financial accounts.

Therefore the role of internal audit is much broader than that of external audit.

1MANDATORY INTERNAL AUDIT FOR COMPANIES

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Scope and Objectives...It is almost clear from the brief introduction above that the primary objective of internal

audit lies in helping the management attain maximum efficacy by providing an important

source of review of operations and records for the assistance of all levels of management.

However, the scope and objectives have been explained point wise in the following table

for better understanding.

The establishment of an adequate accounting

system and the related controls is the responsibility

of management which demands proper attention on

a continuous basis. The internal audit function is

often assigned specific responsibility by

management for reviewing the accounting system

and related internal controls, monitoring their

operation and recommending improvements

thereto.

This may include review of the processes used to

identify, measure, classify and report such

information and specific inquiry into individual items

including detailed testing of transactions, balances

and procedures.

Generally, the external auditor is interested in the

results of such audit work only when it has an

important bearing on the reliability of the financial

records.

This would generally include examination and

verification of physical existence and condition of the

tangible assets of the entity.

To ascertain that the standard accounting practices,

as have been decided to be followed by the

organization, are being adhered to.

This is mainly to establish the fact that there is a

proper authority for every acquisition and disposal of

assets.

It is necessary to implement such techniques while

conducting the internal audit so that it can detect

and prevent frauds in the accounts.

Review of

accounting system

and related

internal controls

Examination for

management of

financial and operating

information

Examination of the

economy, efficiency and

effectiveness of operations

including non-financial

controls of an organisation

Physical examination

and verification

Adoption of standard

accounting practices

Proper authority on

the acquisition and

disposal of assets

Prevention and

detection of fraud

2MANDATORY INTERNAL AUDIT FOR COMPANIES

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Mandatory Applicability of Internal Audit...

All companies except certain categories of companies

specifically exempted from the application of the

Companies (Auditor's Report) Order, 2003

Foreign Companies incorporated outside India

establish a place of business within India ***

Foreign Companies incorporated outside India which

have established a place of business within India and

continue to have an established place of business

within India at the commencement of the Act ***

Charitable Trust / Companies

Internal

Audit

applies to

*** In respect of foreign companies, an established place of business in India would

include a liaison office.

Companies with paid-up capital and reservesof Rupees Fifty Lakh or less

Companies with outstanding loan of Rupees Five Lakhor less from any bank or financial institution

Companies with turnover less than Rupees Five Crore

Exempted

Companies

3MANDATORY INTERNAL AUDIT FOR COMPANIES

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General Evaluation ofInternal Audit Function...The external auditor's general evaluation of the internal audit function assists him in

determining the extent to which he can place reliance upon the work of the internal

auditor. The external auditor should document his evaluation and conclusions in this

respect. The important aspects to be considered in this context are:

1. Organisational Status: Whether internal audit is undertaken by an outside agency or

by an internal audit department within the entity itself, the internal auditor reports to

the management. In an ideal situation he reports to the highest level of

management and is free of any other operating responsibility. Any constraints or

restrictions placed upon his work by management should be carefully evaluated. In

particular, the internal auditor should be free to communicate fully with the external

auditor.

2. Scope of Function: The external auditor should ascertain the nature and depth of

coverage of the assignment which the internal auditor discharges for management.

He should also ascertain to what extent the management considers and where

appropriate, acts upon internal audit recommendations.

3. Technical Competence: The external auditor should ascertain that internal audit

work is performed by persons having adequate technical training and proficiency.

This may be accomplished by reviewing the experience and professional

qualifications of the persons undertaking the internal audit work.

4. Due Professional Care: The external auditor should ascertain whether internal audit

work appears to be properly planned, supervised, reviewed and documented. An

example of the exercise of due professional care by the internal auditor is the

existence of adequate audit manuals, audit programmes, and working papers.

4MANDATORY INTERNAL AUDIT FOR COMPANIES

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Relying upon the Work of anInternal Auditor...External auditor should, as part of their audit, evaluate the internal audit function to the

extent they consider that it will be relevant in determining the nature, timing and degree

of their compliance and substantive procedures. Depending upon such evaluation, the

external auditor may be able to adopt less extensive procedures than would otherwise be

required. The external auditor’s general evaluation of the internal audit function will

assist them in determining the extent to which s/he can place reliance upon the work of

the internal auditor. Important aspects to be considered in this context are -

Organisational status of the entity;

Nature and depth of the internal audit assignment;

Technical competence of the internal audit staff and

Degree of due professional care taken by internal audit staff.

External auditor must ascertain the internal auditor’s tentative plan for the year and

discuss it with them at an early stage to determine areas where they could consider

relying upon the work of the internal auditor.

Co-ordination with internal auditor is usually more effective when meetings are held at

appropriate intervals during the year. Where, following the general evaluation, external

auditor intends to rely upon specific internal audit work, s/he should review the internal

auditor’s work, considering the following:

Scope of work and related audit programmes;

Whether the work was properly planned and the work of assistants was properly

supervised, reviewed and documented;

Whether sufficient appropriate evidence was obtained to afford a reasonable basis

for the conclusions reached;

Whether conclusions reached are appropriate in the circumstances and

Whether any exceptions or unusual matters disclosed by the internal auditor’s

procedures have been properly resolved.

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5MANDATORY INTERNAL AUDIT FOR COMPANIES

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Standard on Internal Audit: BasicPrinciples Governing Internal Audit...The Standard on Internal Audit (SIA) 2 “Basic Principles Governing Internal Audit” is

issued by the Council of Chartered Accountants of India.

The purpose of this Standard is to establish standards and provide guidance on the

general principles governing internal audit. Following is a brief overview of those

principles:

The internal auditor should have a straightforward, honest and sincere approach to his

professional work. The audit report must be fair and must not allow prejudice or bias to

override his objectivity. He should maintain an impartial attitude. He should not only be

independent in fact but also appear to be independent. The internal auditor should not,

therefore, to the extent possible, undertake activities, which are or might appear to be

incompatible with his independence and objectivity.

The internal auditor should maintain confidentiality of the information acquired in the

course of his work and should not disclose any such information to a third party, including

the employees of the entity, without the specific authority of the management/client or

unless there is a legal or a professional requirement to do so. The internal auditor,

therefore, needs to ensure that there are well laid out policies and controls to protect

confidentiality of the information.

The internal auditor should exercise due professional care, competence and diligence

expected of him while carrying out the internal audit. Due professional care signifies that

the internal auditor exercises reasonable care in carrying out the work entrusted to him in

terms of deciding on aspects such as the extent of work required to achieve the objectives

of the engagement, relative complexity and materiality of the matters subjected to

internal audit, assessment of risk management, control and governance processes and

cost benefit analysis.

The internal auditor should maintain the documents, which are important in providing

evidence that the audit was carried out in accordance with the Standards on Internal

Audit and support his findings or the report submitted by him. In addition, the working

papers also help in planning and performing the internal audit, review and supervise the

work and most importantly, provide evidence of the work performed to support his

findings or the report(s).

Integrity, Objectivity and Independence

Confidentiality

Due Professional Care, Skills and Competence

Documentation

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Evidence

Internal control and risk management systems

Reporting

The internal auditor should, based on his professional judgment, obtain sufficient and

appropriate evidence to enable him to draw reasonable conclusions based on his opinion

or findings. Factors affecting the professional judgment include the activity under audit,

possible errors and their materiality and the risk of occurrence of such errors.

While the management is responsible for establishment and maintenance of appropriate

internal control and risk management systems, the role of the internal auditor is to

suggest improvements to those systems. For this purpose, the internal auditor should:

a. Obtain an understanding of the risk management and internal control framework

established and implemented by the management.

b. Perform steps for assessing the adequacy of the framework developed in relation to

the organisational set up and structure.

c. Review the adequacy of the framework.

d. Perform risk based audits according to the risk assessment process.

Internal auditor may, however, also undertake work involving identification of risks as

well as recommend design controls or gaps in existing controls to address those risks.

The internal auditor should carefully review and assess the conclusions drawn from the

audit evidence obtained, as the basis for his findings contained in his report and suggest

remedial action. However, in case if the internal auditor comes across any actual or

suspected fraud or any other misappropriation of assets, it would be more appropriate for

him to bring the same immediately to the attention of the management.

7MANDATORY INTERNAL AUDIT FOR COMPANIES

It is extremely essential for the internal auditor to have the independence in terms of

organisational status and personal objectivity which permits the proper performance of

his duties. The internal auditor should ensure that findings, conclusions and

recommendations arising from each internal audit assignment are communicated

promptly to the appropriate level of management. The reports must be fair and should

not allow prejudice or bias.

Conclusion...

TM

Credits: Roopa J. Ved

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Tel: + 91-80-26538257 / 58 / 59Fax: + 91-80-26538273E-mail: inflo@floraison.in

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