ACCA Paper F 8 AUDIT AND INTERNAL REVIEW Lecture 1 Introduction to Paper F 8 Examination The aim of Paper F8, Audit

and Assurance is to develop knowledge and understanding of the process of carrying out the assurance engagement and its application in the context of the professional regulatory framework. It will be assumed that candidates have knowledge of Paper F3, Financial Accounting and Paper F4, Corporate and Business Law. The accounting standards examined in Paper F3 could form the basis of questions on how to apply auditing procedures in respect of those standards. Going forward, candidates will take knowledge of Paper F8 into Paper P1, Professional Accountant, and Paper P7, Advanced Audit and Assurance. It will be assumed that candidates understand why an audit is required (for Paper P1), and already know the basics of audit procedures (for Paper P7). Examination Structure All 5 Questions must be answered Q1. Audit procedures, and the application of these procedures to a specific scenario ( 30 marks) This question will always be based on a scenario, and will be broken down into a series of sub-questions, which will examine a range of audit procedures. Candidates will need to analyse the scenario to identify the appropriate points to make in their answers. The use of computers will be present and questions on this area will be based on computerised systems. Detailed knowledge of how to use computer- assisted audit techniques (CAATs) will not be expected. Questions will focus on specific income statement and balance sheet entries. Possible questions will cover audit procedures, identification of system weaknesses, writing of management letters, and whether systems meet their objectives (internal audit focus). Q2. Short factual questions based on International areas (10 marks) Standards on Auditing (ISAs) and other key

Do not rote learn ISAs, but understand the key principles underlying auditing. Q3. Q4. Q5. Risk and audit approach (20 marks) More specialised audit areas (20 marks) Collection of audit evidence, closedown, reporting (20 marks)

Examination answer style required: A structured answer with clearly identifiable and separable points continuous flow of text. However, answers in note form are not acceptable. is preferable to a

Use columnar format where appropriate and break down answers into manageable sections. If the question requirement specifically requested a memo format please do so. The volume of writing does not necessarily mean a pass standard. Candidates presenting two or three supplementary answer books do not achieve a pass standard, but candidates presenting just over half a main answer book can achieve a pass. If asked to specify audit tests, candidates must also provide an explanation and reason for these tests, and state for example, checking from the invoice back to the order to ensure completeness of invoicing.

The purpose of assurance for financial and non-financial information. What is assurance? An engagement in which a practitioner expresses a conclusion designed to enhance the degree of confidence of the intended users other than the responsible party about the outcome of the evaluation or measurement of a subject matter against criteria." An assurance engagement as opposed to an audit is one in which the professional accountant evaluates or measures a subject matter that is the responsibility of another party, against suitable criteria and expresses an opinion that provides the intended user with a level of assurance about the subject matter. In simple terms, giving assurance means offering an opinion about specific information so that the users of that information are able to make confident decisions. Subject matter could include data, systems, processes or behavior. The subject matter must be identifiable, capable of measurement and of being subject to procedures. The elements of an assurance engagement There are 5 elements of an assurance engagement: 1. A three party relationship involving practitioner, a responsible party and intended users The practitioner (for example an auditor). The practitioner is responsible for determining the nature, timing and extent of procedures and is required to pursue anything that leads to leads the practitioner to question whether a material modification should be made to the subject matter information. A responsible party: the person responsible for the information and assertions The intended users are the person(s) for whom the practitioner prepares the assurance report. The responsible party can be one of the intended users.

2. Appropriate Subject Matter The appropriate matter can take any form, such as: Financial performance Non-financial performance, for example the key indicators for efficiency and effectiveness Physical characteristics, for example, capacity of facility System and process, for example, an entitys internal control and IT system Behaviour, for example, corporate governance, compliance with regulations

An appropriate subject matter is: Identifiable, and capable of evaluation or measurement against the identified criteria, and Such that the information about it can be subjected to procedures for gathering sufficient appropriate evidence.

3. Suitable criteria Suitable criteria against which to judge the reliability and accuracy of the subject matter. Criteria are benchmarks used to evaluate or measure the subject matter. For example: When reporting on financial statements; The IFRS When reporting on internal control; the criteria may be an established internal control framework When reporting on compliance; the criteria may be applicable law, regulation or contract Without the frame of reference provided by suitable criteria, any conclusion is subject to individual interpretation and misunderstanding. Suitable criteria exhibit the following characteristics: I. II. III. IV. V. Relevance: relevant criteria contribute to conclusion that assist decision-making by intended users Completeness: criteria are sufficiently complete when the include all relevant factors that could affect the conclusions Reliability: reliable criteria allow reasonably consistent evaluation of subject matter Neutrality: neutral criteria so that conclusions that are free from bias Understandability: conclusions that are clear, comprehensive, and not subject to significantly different interpretations

The evaluation or measurement of a subject matter on the basis of practitioners own expectations, judgment and individual experience would not constitute suitable criteria. Criteria need to be available to intended users to allow them understand how the subject matter has been evaluated or measured. 4. Evidence Sufficient appropriate evidence to substantiate an opinion. The practitioner plans and performs an assurance engagement with an attitude of professional skepticism to obtain sufficient appropriate evidence about whether the subject matter information is free of material misstatement. An attitude of professional skepticism means the

practitioner questions the validity of evidence and is alert to evidence that brings into question the reliability of documents or representations. Sufficiency is the measure of quantity of evidence. Appropriateness is the measure of the quality of evidence its relevance and its reliability. The reliability of evidence is the influenced by its source and by its nature, and is dependent on the individual circumstances under which it is obtained, eg documentary better than oral, directly obtained better than inquiry.

5. Assurance Report A practitioner provides a written report containing a conclusion. In a reasonable assurance engagement the practitioners conclusion is worded in positive form, for example, In our opinion the internal control is effective, in alla material respects, based on XYZ criteria. In a limited assurance engagement the conclusion is worded in negative form, for example, based on our work described in this report, nothing has come to our attention that causes us to believe that internal control is not effective, in all material respects, based on XYZ criteria.

Levels of assurance a. Reasonable Assurance: The subject matter materially conforms to the criteria. b. Limited Assurance: There is no reason to believe that the subject matter does not conform with the criteria. (Negative assurance).

What is an audit?

An exercise whose objective is to enable auditors to express an opinion whether the financial statements are prepared in all material respects, in accordance with an identified financial reporting framework. The auditor has to an express an opinion, whether or not the financial statements give a true and fair view or present fairly, in all material respects. True = information is Factual and conforms with reality, is not false. Conforms with required standards and laws. The accounts have been correctly extracted from accounting records.

Fair = Information is Free from discrimination and bias. Is in compliance with expected standards and rules. The accounts reflect commercial substance.

It is not the auditors responsibility to prepare and present the financial statements. This is the responsibility of the directors. There are certain misconceptions about the role of the auditor and this gap between what the auditors actually do and what people think they do is known as the expectations gap. The opinion is expressed to the shareholders. An audit provides a high but not absolute level of assurance, expressed in the audit report as reasonable assurance. Reasonable assurance is not a guarantee of correctness but an assurance of truth and fairness within a reasonable margin of error. Materiality: An item is said to be material if its omission or misstatement would reasonably influence the economic decisions of the individuals to whom the audit report is addressed. The item can be qualitative or quantitative. Materiality depends on the size of the item or error judged in the particular circumstances of its omission or misstatement. It is important that the auditors ensure that the financial statements are free from material error for the following reasons: There is a legal requirement to audit financial statements and present an opinion on those financial statements. If the auditors do not detect a material error then their opinion on the financial statements could be incorrect The auditor has a responsibility to the members to ensure that the financial statements are materially correct.

There are also other users of the financial statements who will include the taxation authorities and the bank that may have made a loan to the company. They will want to see true and fair accounts. The auditors must therefore ensure that the financial statements are free from material misstatement to avoid any legal liability to third parties if they audit the financial statements negligently.

The limitations of an audit are: Not objective Items checked on a sample basis. Provides opportunity for collusion or fraud. There is a time lag between preparation of financial statements and the audit report.

Types of Audits 1. External audit: Gives confidence in the integrity of corporate reporting for the benefit of stakeholders and society as a whole by providing an external and objective view on the reports given by management. The auditors report is usually addressed to the shareholders as the principal stakeholders.

Purpose of external audit I. The external audit derives from the separation of the ownership and management of assets. Those who own assets wish to ensure that those to whom they have entrusted control are using those assets efficiently. This is known as the stewardship function. The requirement for an independent audit helps to ensure that financial statements are free of bias and manipulation for the benefit of users of financial information.

II.

III.

Companies are owned by shareholders but they are managed by directors (in very small companies, owners and managers are the same, but many such companies are not subject to statutory audit requirements.

IV.

The requirement for a statutory audit is a public interest issue: the public is invited to invest in enterprises, it is in the interests of the capital markets (and society as a whole) that those investing do so in the knowledge that they will be provided with true and fair information about the enterprise. This should result in the efficient allocation of capital as investors are able to make rational decisions on the basis of transparent financial information.

V.

The requirement for an audit can help prevent investors from being defrauded, although there is no guarantee of this because the external audit has inherent limitations. Reducing the possibility of false information being provided by managers to owners is achieved by the requirement for external auditors to be independent of the managers upon whose financial statements they are reporting. The purpose of the external audit under International Standards on Auditing is for the auditor to obtain sufficient appropriate audit evidence on which to base the audit opinion. This opinion is to the effect that the financial statements give a true and fair view (or present fairly in all material respects) of the position, performance (and cash flows) of the ent ity. This opinion is prepared for the benefit of shareholders.

VI.

2. Internal audit: An independent, objective assurance and consulting activity designed to add value and improve and organisations operation. Objective is to assist management and staff in the effective discharge of their duties.

3. Value for money audit: An investigation into whether or not the use of resources is economic, efficient and effective. To identify and recommend ways in which the return for resources employed may be maximised.

An audit is distinguished from the following engagements:1. Review engagement. Provides moderate level of assurance, expressed as negative assurance. Negative assurance is a statement of what the auditor does not know as opposed to what he believes (positive assurance.) The objective of a review is to enable the auditor to give an opinion whether the anything has come to his attention that would mean that the financial

statements are not properly prepared (do not give a true and fair view) on the basis of the procedures which do not constitute an audit. 2. Agreed upon procedures or compilations. No assurance is provided. It is only a report on factual findings. A compilation presents in the form of financial statements information that is the representation of management without expressing assurance. Compilation of a financial projection involves assembling prospective statements based on assumptions of a responsible party, considering appropriateness of presentation, and issuing a compilation report. No assurance is provided on the statements or underlying assumptions.

Stages of an audit process: I. II. III. IV. V. VI. Agree the terms of engagement. Understand the entity being audited. Assess risk. Plan the audit and make assessments of materiality. Gather Audit evidence. Make judgements and express opinion.

Audit Committee The board should establish an audit committee of at least three members, who should all be independent non-executive directors. The board should satisfy itself that at least one member of the audit committee has recent and relevant financial experience.

The main roles and responsibilities of the audit committee include Monitoring the integrity of the financial statements of the company. Review the companys internal financial controls and the companys internal control and risk management systems. Monitoring and reviewing the effectiveness of the companys internal audit function. Making recommendations to the board. Reviewing and monitoring the external auditors independence and objectivity and the effectiveness of the audit process.

The audit committee should have primary responsibility for making a recommendation appointment, reappointment and removal of the external auditors. The advantages of an audit committee:

on the

Provide increasing public confidence in the creditability and objectivity of published financial information. This will be particularly important if listing arrangements are planned. Assistance in Financial reporting. Supports the directors in fulfilling their financial reporting obligations. The directors have to prepare financial statements and the committee can assist by checking the financial statements to ensure that they comply with appropriate reporting requirements. This is especially important where the board do not have detailed knowledge of accounting requirements. Use of the audit committee will enable the external auditor to discuss issues with the financial statements with the internal auditor, prior to providing a final summary of key points to the board. The audit committee will monitor the work of the board and provide helpful guidance, where corporate governance requirements do not appear to be being met. The audit committee should have detailed knowledge of corporate governance as part of its monitoring function of the company and can share this with the board who may not have the time to obtain detailed information.

The disadvantages of an audit committee: As the audit committee will be made up mainly from non-executive directors, the board may see this as a means of decreasing their power and possibly letting other people run the company. Or the audit committee must be seen as fulfilling a supporting role for the main board. Cost. The audit committee will increase the expenditure of the company as the non-executive directors will require some remuneration due to their additional responsibilities.

STATUTORY AUDIT REGULATION 1. Appointment of auditors

 The directors may appoint the first auditor until the next AGM. The directors have a power to fill any casual vacancy before the next AGM as a result of death, removal or resignation of the auditors. The shareholders are ultimately responsible for appointing auditors at each AGM. The directors of the company on behalf of the shareholders fixes the auditors remuneration.

2. Removal of auditors: Only the shareholders can legally remove the auditors. The directors cannot remove the auditors from the office.

The procedure to follow to remove auditors is as follows: I. II. III. Those shareholders wishing to remove the auditors must give special notice of an ordinary resolution. The auditor has the right to speak at the meeting. On removal, the auditors have a duty to make a written statement of the circumstances connected with the removal which they think should be brought to the attention of the shareholders and creditors. The directors must circularise this to all shareholders and file a copy with the regulatory authority. The ex-auditor has the right to attend the AGM at which their office would normally have ended.

IV. V.

3. Resignation and retirement of auditors: The auditor may resign or retire for office at anytime by sending a notice to the companys registered office. This is not effective unless accompanied by a statement of circumstances. The company must file a copy of the notice of resignation to the registrar of companies. On ceasing to act, the auditors have a duty to make a written statement. The auditors have a right to require an Extraordinary General Meeting (EGM) at which they may speak and explain the circumstances of their resignation.

4. Auditors duties: Give a true and fair view of the companys financial statements and also the going concern of the company. The auditor should consider whether the directors report is consistent with the information in the financial statements. The financial statements are properly prepared in accordance company legislation and relevant accounting standard. The auditor must form an opinion on whether: The company maintains proper accounting records. The auditor has access to all relevant information and explanation. The auditor has adequate information of the other branches of the company (if any) not visited. The auditor has ensured that the financial statement agree with the underlying records. Directors transactions have been completely and accurately disclosed.

5. The auditors rights: Access to all relevant records of the company at anytime To request of any information/explanations considered necessary. Rights to receive notice attend and speak at the companys general meeting. To make a written representation on removal. On resignation, to require an EGM.

6. Qualifications of auditors: I. The auditor must be members of one of the members of International Federation of Accountants (IFAC) include: Association of Chartered Certified Accountants (ACCA) Institute of Chartered Accountants of England and Wales, Scotland and Ireland (ICA ) Individual should hold appropriate qualification. The audit practice should be controlled by qualified accountants who are the members of ACCA or ICA. Must be registered as an auditor with the ACCA or ICA.

II. III. IV.

V.

The auditor should be a fit and proper person and comply with professional rules of conduct.

Fundamental THE ACCA

Ethical Principles RULES OF PROFESSIONAL CONDUCT

In order to achieve the objectives of the accountancy profession, professional accountants has to observe a number of prerequisites or fundamental principles. The fundamental principles are: 1. Integrity A professional accountant should be straightforward and honest in performing professional services. Members should behave with integrity in all professional, business and personal financial relationships. 2. Objectivity A professional accountant should be fair and should not allow prejudice or bias, conflict of interest or influence of others to override objectivity. Objectivity principle requires that members objectivity must be beyond question and this can only be assured if the member is and is seen to be independent.

To be and be seen as independent and objective, the auditor or his family must not have: Financial interest in clients such as shareholdings either beneficial or non beneficial, not trade with clients, must not make loans to or take loans from the client. Note that overdue fees are equivalent to loans. Family include spouse, minor children, brothers and sisters and their spouses, adult children and their spouse, relatives to whom regular financial assistance is given and exemployees.

The objectivity of the external auditor may be threatened or appear to be threatened where: There is undue dependence on any audit client or group of clients; The firm, its partners or staff have any financial interest in an audit client; There are family or other close personal or business relationships between the partners or staff and the audit client;

firm, its

The firm provides other services to audit clients. There is undue dependence on any one audit client. Total recurring fees as a % of gross practice income should be less than 15% for client/group and less than 10% for public interest companies. There are overdue fees. There is actual or threatened litigation. Goods, services and hospitality accepted from the client.

ACCAs requirements that reduce the threats to auditor objectivity include clients to have Quality control procedures Audit committees. Rotate auditors every 5 years.

The client will thereby ensure increased confidence in the transparency of reporting. 3. Professional Competence and Due Care. A professional accountant should perform professional services with due care, competence and diligence and has a continuing duty to maintain professional knowledge and skill at a level required to ensure that a client or employer receives the advantage of competent professional service based on up-to-date developments in practice, legislation and techniques. Members should carry out their professional work with due skill, care, diligence and expedition and with proper regard for the technical and professional standards expected of them.

4. Confidentiality of client information. A professional accountant should respect the confidentiality of information acquired during the course of performing professional services and should not use or disclose any such information without proper and specific authority or unless there is a legal or professional right or duty to disclose. ACCAs Code of ethics Obligatory disclosure If the member auditor knows or suspects that client is involved in treason, drug trafficking or terrorist offences. Under IAS250, when non-compliance with laws and regulations will cause material mis-statements in the financial statements.

The actual disclosure will depend on the laws of the jurisdiction where the auditor is located.

The auditor may also be obliged to provide information where a court demands disclosure. Refusal to provide information is likely to be considered contempt of court with the auditor being liable for this offence.

ACCA Code of ethics voluntary disclosure A member may also disclose client confidential information voluntarily, that is without client permission To protect a members interest e.g. to allow a member to sue a client for unpaid fees or defend an action for negligence. Where there is a public duty to disclose e.g. the client has committed an action against the public interest such as unauthorised release of toxic chemicals.

5. Adopt Professional Behaviour A professional accountant should act in a manner consistent with the good reputation of the profession and refrain from any conduct which might bring discredit to the profession. The obligation to refrain from any conduct which might bring discredit to the profession requires IFAC member bodies to consider, when developing ethical requirements, the responsibilities of a professional accountant to clients, third parties, other members of the accountancy profession, staff, employers, and the general public. Technical Standards: professional accountant should carry accordance with the relevant technical and professional standards. 6. Conflicts of interest ACCAs Rules of Professional Conduct state that auditors should avoid conflicts of interest (both conflicts between the firm and clients, and conflicts between clients) wherever possible. If such conflicts are unavoidable: Full disclosure is important both client companies should be fully aware that the firm is acting for the other party. One or both companies may object to the firm acting for the other company and the auditor may be forced to make a decision as to which company to resign from. However, this is not an attractive course of action because the audits may already have commenced and it may be difficult for one of the companies to find a new auditor, quickly. The auditor should not resign unless forced to do so this might be prejudicial to the interests of one of the clients. It is important in such cases that different teams of staff, and different engagement partners work on the respective audits. out professional services in

Internal procedures within the firm should be set up to prevent confidential information from one client being transferred to the other and the interests of one firm damaging the interests of the other. Such procedures are known as Chinese Walls.

Six Potential threats to auditors independence: 1. Self review threat: Occurs when results of a previous engagement needs to be re-evaluated in reaching conclusion on the present assurance engagement or when a member of assurance team is previously was an employee of the assurance client(director) in a position to exert influence over current audit matters. Examples of circumstances that may create this threat include: A member of the assurance team being, or having recently been, a director or officer of the assurance client; A member of the assurance team being, or having recently been, an employee of the assurance client in a position to exert direct and significant influence over the subject matter of the assurance engagement;

Performing services for an assurance client that directly affect the subject of the assurance engagement; and

matter

Preparation of original data used to generate financial statements or preparation of other records that are the subject matter of the assurance engagement. Example of self review threat: If the auditors are to implement new control systems then they will also be auditing those systems as part of the statutory audit. They must therefore ensure that different staff implement and audit the systems. Preferably different departments in the firm should undertake the work. If insufficient staff are available then the audit firm must refuse the additional systems work. 2. Familiarity threat: Occurs when, by virtue of a close relationship with an assurance client, its directors, officers or employees, a firm or a member of the assurance team becomes too sympathetic to the clients interests. Circumstances that may create familiarity threat include: A member of the assurance team having an immediate family member or close family member who is a director or officer of the assurance client. A member of the assurance team having an immediate family member or close family member who, as an employee of the assurance client, is in a position to exert direct and significant influence over the subject matter of the assurance engagement.

 A former partner of the firm being a director, officer of the assurance client or an employee in a position to exert direct and significant influence over the subject matter of the assurance engagement. Long association of a senior member of the assurance team with the assurance client.

Acceptance of gifts or hospitality, unless the value is clearly insignificant, from the assurance client, its directors, officers or employees.

3. Self interest threat: Occurs when an auditor could be from financial interest in or other self interest conflict with assurance client. Examples of circumstances that may create self interest threat include: A direct financial interest or material indirect financial interest in an assurance client. A loan or guarantee to or from an assurance client or any of its directors or officers. Undue dependence on total fees from an assurance client. Concern about the possibility of losing the engagement. Having a close business relationship with an assurance client. Potential employment with an assurance client. Contingent fees relating to assurance engagements.

4. Intimidation threat: This occurs when a member of audit team may be deterred from carrying audit work or exercising professional scepticism by threat from the directors of the audit client. Examples of circumstances that may create intimidation threat include: Threat of replacement over a disagreement with the application of an accounting principle; and Pressure to reduce inappropriately the extent of work performed in order to fees. reduce

5. Advocacy threat: This arises when member of the audit team promotes or seems to promote an audit client opinion or position (for example selling or underwriting in financial matters for audit client or acting as the clients advocate in a legal proceeding). Examples of circumstances that may create this threat include to: Dealing in, or being a promoter of, shares or other securities in an assurance client Acting as an advocate on behalf of an assurance client in litigation or in resolving disputes with third parties.

6. Association Threat: This arises when the audit firm is likely to associate itself with a client whose business has yet to be confirmed as being legal or ethical. If the client is extending their product line, the auditors will have to determine the likelihood that the product is legal. The audit firm may not wish to be associated with a company producing illegal products.

Appointment Ethics of External Auditors Before accepting an appointment, the auditor should ensure that they Are professionally qualified to act The firm has existing resources that are adequate to meet the needs of the engagement in terms of time, staff and technical expertise. For example if the client is growing quickly and has poor internal controls providing high risk of financial misstatement, the auditors should ensure that they have sufficient staff of appropriate experience available and that enough time is allocated to the audit to complete all audit procedures. Obtain references and make independent inquiries if directors are not personally known. Communicate with present auditors to find out whether there are any circumstances behind the change that the new auditors need to be aware of. After accepting the appointment the auditors should ensure that Outgoing auditors removal or resignation has been properly conducted.

New auditors appointment is valid. Submit a letter of engagement.

Letter of Engagement

ISA 210 The letter of engagement must define the terms of Audit Engagement Purpose: To define clearly the extent of the auditors responsibilities. Minimise misunderstandings between audit firm and client. Confirm in writing verbal arrangement. Confirm acceptance by the auditor of his engagement. To inform and educate the client.

When to send a letter: To all new clients before commence of audit work. To all existing clients who have not previously had such a letter. If there are changes in circumstances in the clients company for example a major change in ownership or management. In the case of groups an engagement letter should be sent to each company member of the group that is to be audited by the firm. Steps: On or before acceptance of a new client discuss the precise terms with the management. Draft and sign the letter before commencing any part of the assignment. Receive the clients written acceptance. Every year review and update the letter and consider if nature of the engagement has changed.

Contents of letter of engagement: 1. Addressed: To the directors of:. 2. The responsibilities of the directors: Keep proper accounting records

Prepare the financial statements that show true and fair view. The financial statement should comply with national companys legislation relevant accounting standards.

and the

3. The responsibilities of the auditors: Report to the members whether the financial statement prepared by the directors is showing true and fair view. To check whether the directors keep books and records adequately and that relevant information is received from the directors with regards to the branches not visited. To check whether the financial statements are in agreement with accounting records and returns. To ensure that they have received all the relevant information and explanation from the directors of the company before an opinion is formed. To check the directors report is consistent with the financial statements. 4. The scope of the auditors work: Audit work must comply with auditing standards. Review the accounting systems. Collection of audit evidence. Review of internal controls and test. Prepare a letter of weakness. It is the directors primary responsibilities are to safeguard company assets and the prevention of fraud and irregularities. Notes: Any agreement with auditors for other services should be stated in a separate engagement letter. When external auditors provide non-audit services to their audit clients, it is essential that the auditors make a clear distinction between their audit and non-audit responsibilities. The fees and the basis on which they are charged (based on time and expertise used in client affairs). State the applicable law. Request for written acknowledgement of the letter creates a contractual obligation. In the case of a company the board of directors should sign the letter of engagement.

Internal Audit Function Internal audit is an appraisal or monitoring activity established within a company or an entity as a service to the entity. Its functions include examining, evaluating and monitoring the adequacy and

effectiveness of the internal control. It is a key part of effective corporate governance since corporate governance objectives include the management of the risks to which the entity is subject and that would prevent it achieving its overall objectives such as profitability. The internal activity is designed to add value to and improve the operations of an organisation. The internal auditor reports to management. The internal auditor is normally an employee of the organisation but often their work is outsourced. On the other hand, the external auditor expresses an opinion on the financial statements and reports to the shareholders. Internal Auditors should be assumed to be members of the ACCA and are bound by the rules of professional conduct. Roles of Internal Audit Department:1. Risk Management Role this involves monitoring the overall process of risk management and in providing assurance that the systems have been designed to meet objectives and that they operate effectively. A large part of the management of risks, and the proper exercise of stewardship, involves the maintenance of proper controls over the business. Controls over the business as a whole, and in relation to specific areas, include the effective operation of an internal audit function. Fraud is a key business risk and internal auditor can assist in prevention and detection of fraud. The internal auditor must: Determine company policy in respect of the risks identified. Implement strategy and ensure that strategies implemented operate effectively and continue to match risk as intended.

Internal audit can help management manage risks in relation to fraud and error, and exercise proper stewardship by: Commenting on the process used by management to identify and classify the specific fraud and error risks to which the entity is subject and help management to develop and implement that process. Commenting on the appropriateness and effectiveness of actions taken by management to manage the risks identified and help management to develop appropriate actions by making recommendations. Periodically auditing or reviewing systems or operations to determine whether the risks of fraud and error are being effectively managed.

 Monitoring the incidence of fraud and error, investigate serious cases and make recommendations for appropriate management responses.

2. Monitoring Role - Value for money audit (VFM): is an assignment that internal audit can undertake on behalf of management as part of the monitoring role. VFM audit can be carried out on any area of the business. Since a VFM audit is concerned with obtaining the best possible combination of products/services for the least resources, it measures three qualities:Economy - Economy relates to least cost. The organisation should attain the appropriate quantity and quality of physical, human and financial resources at the lowest cost. The systems in an organisation should operate at a minimum cost associated with an acceptable level of risk. Efficiency- This is a measure of the relationship between goods and services produced (outputs) and the resources (inputs) used. Therefore, efficiency relates to the best use of resources. The goals and objectives of an organisation should be accomplished accurately and on a timely basis with the least use of resources. Effectiveness involves determining how well an activity is achieving its objectives and therefore effectiveness provides assurance that organisational objectives will be achieved. Monitoring role for local authorities:Besides VFM, internal audit can also monitor best value to ensure that the authority has systems in place to achieve best value. Best value implements 4 Cs instead of the 3 Es of a VFM audit. Challenge monitor how well and why a service is provided. Compare to other authorities. Consult targets should be set in consultation with tax payers and service users. Compete involve in fair competition. 3. Role of performing information technology audits by monitoring and testing controls in the areas of database management, system development process, change management, networks, asset management, capacity management, access control, operational system and E-business. 4. Perform operational audits Operational audits are audits of the operational process of the organisation. These are also known as management audits or efficiency audits. Their main objective is to monitor managements performance and ensure that company policy is adhered to. The two main

aspects of an operational assessment is to ensure that the policies are adequate and that they work effectively.

Outsourcing the Internal Audit Function to an outside source. Audit firms offer internal audit services as part of their portfolio. Advantages of outsourcing 1. Service provider can provide the necessary expertise for internal audit work. They may be able to provide a broader range of expertise and specialist skills and as they serve many different clients therefore staff may be available for specialist work that the company may not be able to afford. 2. If internal audit is only required for specific functions or particular jobs each year then the expertise can be purchased as required. This will minimise the companies in-house costs. 3. They can direct their own work and educate management as to the service required. 4. Provides an immediate team. 5. Can be appointed for a specific timescale 6. Outsourcing will remove the need for training internal staff. Effectively training will be provided for free as the outsourcing firm will be responsible for keeping staff up-todate with new auditing techniques and processes. 7. An independent view will be provided that may identify control weaknesses that the internal audit department may miss. Disadvantages of outsourcing 1. Fee pressure. The relationship needs to be managed carefully to ensure that the service provider does not decrease the quality of their work due to insufficient fees. 2. The outsourced firm may not have any prior knowledge of the company and will need time to ascertain the accounting systems and controls before commencing work. 3. Continuity of service of staff at the service provider. Depends on the retention rate. Larger internal auditing firms will be able to offer their staff better career progression which should assist staff retention.

Internal Audit Department and Corporate Governance Internal audit department can assist the directors with the implementation of good corporate governance in an organisation through: I. Reviewing reports to the board and reports produced by the board to ensure that they do present a balanced assessment of the companys position and prospects. The internal audit

II.

III.

IV. V.

VI.

department will have good knowledge of the operations of the company as well as access to accounting information. The department can effectively audit board reports to ensure they are accurate and understandable. Internal controls. The board need to maintain a sound system of internal control. The internal audit department will be able to review existing controls and recommend improvements to ensure this objective is met. Application of ISA and IASs. The board need to have a policy for applying appropriate International Statements on Auditing (ISA) and International Accounting Standards (IAS) to the organisation. Internal audit will be aware of new auditing standards and will have the technical expertise to identify changes required by accounting standards. Amendments to control systems for new auditing standards and financial accounting systems for new accounting standards can therefore be recommended. Communication with external auditors. The corporate governance code requires communications with external auditors normally be via the audit committee, although the board must maintain an appropriate relationship with the external auditors. However, internal and external auditors can also work together to ensure that the internal control system is sufficient; possibly by external audit delegating work to internal audit, and each auditor reviewing the work of the other auditor. The board will therefore receive reports from both sets of auditors which will be accurate because they have been properly checked. Communication to the board. The internal auditor can also check that appropriate information is provided to the board from the external auditor. ISA 260 Communications of audit matters with those charged with governance provides a list of matters which should be communicated to the board and the internal auditor can work with the external auditor to ensure that this information is provided.

Role of external auditor in respect to evaluating and testing the work of the internal auditor include: They external auditor must: Check that the work is performed by persons having adequate technical training and proficiency as internal auditors, by ensuring that appropriate training programmes are in place and the auditor has appropriate qualifications. Ensure that the work of assistants is properly supervised, reviewed and documented by reviewing the procedure manuals of internal audit and the audit working papers produced. Determine that sufficient and appropriate audit evidence is obtained to afford a reasonable basis for the conclusions reached, by reviewing the internal auditors working papers.

 Check that the conclusions reached are appropriate in the circumstances and that any reports prepared are consistent with the results of the work performed by reviewing the work performed and the reports produced. Ensure that any exceptions or unusual matters disclosed by internal audit are properly resolved by the external auditor and management.