Audits, Internal

• Pages: 65-70

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Internal auditing is an independent appraisal function that is performed in a wide variety of companies, institutions, and governments. What distinguishes internal auditors from governmental auditors and public accountants is the fact that they are employees of the same organizations they audit. Their allegiance is to their organization, not to an external authority. Because internal auditing has evolved only within the last few decades, the roles and responsibilities of internal auditors vary greatly from one organization to another. Internal audit functions have been structured based on the differing perceptions and objectives of owners, directors, and managers. Since the passage in 2002 of the Public Company Accounting Reform and Investor Protection Act, commonly called the Sarbanes-Oxley Act, the function of the auditor has been highlighted in compliance with the new regulations. In publicly held corporations, the internal auditing function has been greatly expanded as a part of fulfilling the requirements of Sarbanes-Oxley.

The structure given to the internal auditing function within a company depends to a great extent on four things: 1) the size of the company; 2) the type of business

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it carries out; 3) the philosophy of the management group, and 4) the level of interest or concern placed on auditing by the chief executive and the board of directors. In a very small business, the owner-manager will usually perform the role of internal auditor by continuously monitoring all of the business's activities. In larger companies, employees who fulfill internal auditing functions are known by a wide variety of titles—control analysts, systems analysts, business analysts, internal consultants, evaluators, and operations analysts.

The Institute of Internal Auditors (IIA) is an international governing body for internal auditors that brings some uniformity and consistency to the practice. The IIA provides general standards for performing internal audits and serves as a source for education and information. In its Standards for the Professional Practice of Internal Auditing, the IIA defines the internal auditing function as "an independent appraisal function established within an organization to examine and evaluate its activities as a service to the organization. The objective of internal auditing is to assist members of the organization in the effective discharge of their responsibilities. To this end, internal auditing furnishes them analysis, appraisals, recommendations, counsel, and information concerning activities reviewed."

There is theoretically no restriction on what internal auditors can review and report about within an organization. In practice, internal auditors work within the parameters of the company's overall strategic plan, performing internal auditing functions so that they are coordinated with the larger goals and objectives of the organization. Internal auditors perform a variety of audits, including compliance audits, operational audits, program audits, financial audits, and information systems audits. Internal audit reports provide management with advice and information for making decisions or improving operations. When problems are discovered, the internal auditor serves the organization by finding ways to prevent them from recurring. Internal audits can also be used in a preventative fashion. For example, if the internal auditor communicates potential problems and risks in business operations during his/her review, management can take preemptive action to prevent the potential problem from developing.

DEVELOPMENT AND CURRENT STATUS OF INTERNAL AUDITING PRACTICES

Prior to the twentieth century, companies and other institutions relied on external auditing practices for financial and other information on their operations. The growing complexity of American companies after World War I, however, required better techniques for planning, directing, and evaluating business activities. These needs, coupled with the stock market crash of 1929 and increased evidence of questionable accounting practices by corporations, led to the creation of the Securities and Exchange Act of 1934. This legislation established the Securities and Exchange Commission (SEC) as a monitor of corporate financial reporting. In the wake of these developments, the new thrust for internal auditing was to verify financial statements, as well as to continue testing transactions. World War II led internal auditors into the assurance of compliance with government regulations. The boom that followed, with the growth of conglomerates and international subsidiaries, imposed further responsibility upon the auditors requiring them to review the adequacy of corporate procedures and practices in operational evaluations, as well as performing the financial audit.

The importance of quality internal auditing was further underlined with the passage of the Foreign Corrupt Practices Act and the establishment of the Financial Accounting Standards Board. While these developments did not specifically call for an internal auditing function, internal auditors were poised to help management fulfill the additional requirements implicit therein. In the 1980s, highly publicized business failures and fraudulent financial statements that went undetected by external auditing firms gave further merit to the concept of internal auditing.

In December of 2001, the Enron Corporation, which had ranked as the seventh largest U.S. corporation in terms of revenue just one year earlier, filed for bankruptcy protection. A string of similar high-profile bankruptcies of very large corporations followed. Serious allegations of accounting fraud were made and extended well beyond the bankrupt corporations to include some of the nation's...