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Internal and Internal and GovernmentalGovernmentalFinancial Auditing and Financial Auditing and Operational AuditingOperational Auditing
Chapter 26Chapter 26
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Learning Objective 1Learning Objective 1
Explain the role of internalExplain the role of internal
auditors in financial auditing.auditors in financial auditing.
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Internal AuditingInternal Auditing
The New York Stock Exchange requires itsThe New York Stock Exchange requires itsregistrants to have an internal audit function.registrants to have an internal audit function.
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Internal AuditingInternal Auditing
It is an independent, objective assuranceIt is an independent, objective assuranceand consulting activity designed to addand consulting activity designed to addvalue and improve an organization’s operations.value and improve an organization’s operations.
It helps an organization accomplish its objectivesIt helps an organization accomplish its objectivesby bringing a systematic, disciplined approach toby bringing a systematic, disciplined approach toevaluate and improve the effectiveness of riskevaluate and improve the effectiveness of riskmanagement, control, and governance processes.management, control, and governance processes.
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Institute of Internal Auditors Institute of Internal Auditors Ethical PrinciplesEthical Principles
IntegrityIntegrity
ConfidentialityConfidentiality
ObjectivityObjectivity
CompetencyCompetency
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Relationship of Internal and Relationship of Internal and External AuditorsExternal Auditors
The The externalexternal auditor is responsible auditor is responsibleto financial statement users.to financial statement users.
The The internalinternal auditor is responsible auditor is responsibleto management.to management.
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Relationship of Internal and Relationship of Internal and External AuditorsExternal Auditors
CompetencyCompetency
MethodologyMethodology
ObjectivityObjectivity
Audit risk modelAudit risk model
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Learning Objective 2Learning Objective 2
Describe the auditing andDescribe the auditing and
reporting requirements underreporting requirements under
Government Auditing StandardsGovernment Auditing Standards
and the Single Audit Actand the Single Audit Act
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Governmental Financial AuditingGovernmental Financial Auditing
The primary source of authoritative literatureThe primary source of authoritative literaturefor performance of government audits isfor performance of government audits isGovernment Auditing StandardsGovernment Auditing Standards,,which is issued by the GAO.which is issued by the GAO.
Because of the color of the cover, it is usuallyBecause of the color of the cover, it is usuallyreferred to as the referred to as the ““Yellow BookYellow Book.”.”
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Governmental Financial AuditingGovernmental Financial Auditing
The Yellow Book standards are often calledThe Yellow Book standards are often calledgenerally accepted government auditinggenerally accepted government auditingstandards (GAGAS).standards (GAGAS).
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Financial Audit and Reporting Financial Audit and Reporting Requirements – Yellow BookRequirements – Yellow Book
Materiality and significanceMateriality and significance Quality controlQuality control Compliance auditingCompliance auditing ReportingReporting Audit filesAudit files
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Audit and Reporting – Single AuditAudit and Reporting – Single AuditAct and OMB Circular A-133Act and OMB Circular A-133
The threshold for requiring a single auditThe threshold for requiring a single auditwas raised from $100,000 to $300,000was raised from $100,000 to $300,000to exempt many smaller entitiesto exempt many smaller entitiesfrom single audit requirements.from single audit requirements.
The OMB increased the single auditThe OMB increased the single auditthreshold to $500,000 beginning in 2004.threshold to $500,000 beginning in 2004.
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Audit and Reporting – Single AuditAudit and Reporting – Single AuditAct and OMB Circular A-133Act and OMB Circular A-133
The office of Management and Budget issuedThe office of Management and Budget issueda revised Circular A-133, a revised Circular A-133, Audits of States,Audits of States,Local Governments, and Non-ProfitLocal Governments, and Non-ProfitOrganizationsOrganizations, , to provide administrativeto provide administrativeguidance for implementing theguidance for implementing thesingle audit requirements.single audit requirements.
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Audit RequirementsAudit Requirements
The audit should be in accordanceThe audit should be in accordancewith generally accepted governmentwith generally accepted governmentauditing standards (GAGAS).auditing standards (GAGAS).
The auditor must obtain an understandingThe auditor must obtain an understandingof internal control over federal programsof internal control over federal programssufficient to support a low assessedsufficient to support a low assessedlevel of control risk for major programs.level of control risk for major programs.
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Audit RequirementsAudit Requirements
The auditor should determine whether the clientThe auditor should determine whether the clienthad complied with laws, regulations, and thehad complied with laws, regulations, and theprovisions of contracts or grant agreementsprovisions of contracts or grant agreementsthat may have a direct and material effectthat may have a direct and material effecton each of its major programs.on each of its major programs.
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Reporting RequirementsReporting Requirements
An opinion as to whether the schedule ofAn opinion as to whether the schedule of federal awards is presented fairly in allfederal awards is presented fairly in all material respects in relation to thematerial respects in relation to the financial statements as a wholefinancial statements as a whole
An opinion on whether the financialAn opinion on whether the financial statements are in accordance with GAAPstatements are in accordance with GAAP
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Reporting RequirementsReporting Requirements
A report on internal control related to theA report on internal control related to the financial statements and major programsfinancial statements and major programs
A report on compliance with laws,A report on compliance with laws, regulations, and the provisions ofregulations, and the provisions of contracts or grant agreementscontracts or grant agreements
A schedule of findings and questioned costsA schedule of findings and questioned costs
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Operational AuditingOperational Auditing
The purpose of operational auditing is toThe purpose of operational auditing is todetermine the effectiveness or efficiencydetermine the effectiveness or efficiencyof any part of an organization.of any part of an organization.
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Learning Objective 3Learning Objective 3
Distinguish operational auditingDistinguish operational auditing
from financial auditing.from financial auditing.
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Differences between OperationalDifferences between Operationaland Financial Auditingand Financial Auditing
Distribution of the reportsDistribution of the reports
Inclusion of nonfinancial areasInclusion of nonfinancial areas
Purpose of the auditPurpose of the audit
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Learning Objective 4Learning Objective 4
Provide an overview ofProvide an overview of
operational audits.operational audits.
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EffectivenessEffectiveness refers to the accomplishment refers to the accomplishmentof objectives.of objectives.
Efficiency Efficiency is defined as reducing costs withoutis defined as reducing costs withoutreducing effectiveness.reducing effectiveness.
Effectiveness Versus EfficiencyEffectiveness Versus Efficiency
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Types of inefficiencyTypes of inefficiency ExampleExample
Acquisition of goods andAcquisition of goods andservices is too costly.services is too costly.
Bids for purchases ofBids for purchases ofmaterials are not required.materials are not required.
Raw materials are notRaw materials are notavailable when needed.available when needed.
An assembly line was shutAn assembly line was shutdown for lack of materials.down for lack of materials.
A duplication of effort byA duplication of effort byemployees exists.employees exists.
Production and accountingProduction and accountingkeep identical records.keep identical records.
Effectiveness Versus Efficiency
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Types of inefficiencyTypes of inefficiency ExampleExample
Work is done that serves noWork is done that serves nopurpose.purpose.
Vendors’ invoices andVendors’ invoices andreceiving reports are filedreceiving reports are filedwithout being used.without being used.
There are too manyThere are too manyemployeesemployees
Office work could be doneOffice work could be donewith one less assistant.with one less assistant.
Effectiveness Versus Efficiency
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Relationship between OperationalRelationship between OperationalAuditing and Internal ControlsAuditing and Internal Controls
Reliability of financial reportingReliability of financial reporting
Efficiency and effectiveness of operationsEfficiency and effectiveness of operations
Compliance with applicable laws and regulationsCompliance with applicable laws and regulations
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Types of Operational AuditsTypes of Operational Audits
FunctionalFunctional
OrganizationalOrganizational
Special assignmentsSpecial assignments
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CPA firmsCPA firms
GovernmentGovernmentauditorsauditors
InternalInternalauditorsauditors
Who Performs Operational AuditsWho Performs Operational Audits
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The two most important qualities forThe two most important qualities for an operational auditor are:an operational auditor are:
Independence and CompetenceIndependence and Competenceof Operational Auditorsof Operational Auditors
IndependenceIndependence CompetenceCompetence
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Learning Objective 5Learning Objective 5
Plan and perform an operationalPlan and perform an operational
audit.audit.
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Specific CriteriaSpecific Criteria
Were all plant layoutsWere all plant layouts approved by home office approved by home office engineering at the time of original design?engineering at the time of original design?
Has home office engineering done a reevaluationHas home office engineering done a reevaluationstudy of plant layout in the past five years?study of plant layout in the past five years?
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Specific CriteriaSpecific Criteria
Is each piece of equipment operating atIs each piece of equipment operating at60 percent of capacity or more for at60 percent of capacity or more for atleast three months each year?least three months each year?
Does layout facilitate the movement of newDoes layout facilitate the movement of newmaterials to the production floor?materials to the production floor?
Does layout facilitate the production of finishedDoes layout facilitate the production of finishedgoods?goods?
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Specific CriteriaSpecific Criteria
Does layout facilitate the movement of finishedDoes layout facilitate the movement of finishedgoods to distribution centers? goods to distribution centers?
Does the plant layout effectively use existingDoes the plant layout effectively use existingequipment?equipment?
Is the safety of employees endangered by theIs the safety of employees endangered by theplant layout?plant layout?
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Sources of CriteriaSources of Criteria
Historical performanceHistorical performance
BenchmarkingBenchmarking
Engineers standardsEngineers standards
Discussion and agreementDiscussion and agreement
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Phases in Operational AuditingPhases in Operational Auditing
PlanningPlanning
Evidence accumulation and evaluationEvidence accumulation and evaluation
Reporting and follow-upReporting and follow-up
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PlanningPlanning
• Scope of engagementScope of engagement
• StaffingStaffing
• Background informationBackground information
• Understand internal controlUnderstand internal control
• Decide on appropriate evidenceDecide on appropriate evidence
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Evidence Accumulation and Evidence Accumulation and EvaluationEvaluation
• DocumentationDocumentation
• Client inquiryClient inquiry
• ObservationObservation
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Reporting Follow-upReporting Follow-up
• Report usually sent to managementReport usually sent to management
• Tailored reportsTailored reports
• Follow-up on recommendationsFollow-up on recommendations with managementwith management
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Examples of Operational Audit Examples of Operational Audit FindingsFindings
• Outside janitorial firm saves $160,000Outside janitorial firm saves $160,000
• More timely credit memo processingMore timely credit memo processing
• Use the right toolUse the right tool
• Computer programs save manual laborComputer programs save manual labor