How successful internal audit departments are evaluated.

• Author: Albrecht, W. Steve

How successful internal audit departments are evaluated

Because of such recent unveilings as the Treadway Commission Study and the Foreign Corrupt Practices Act, internal auditors have become more important to businesses. Most corporations have increased both the size and visibility of their internal auditors. Bank of America, for example, now has 380 internal auditors, and General Electric has a staff of 120, both companies nearly doubling in the last 10 years the number of auditors they have on staff.

With this increased attention, a practical issue many companies are facing is how to evaluate the effectiveness of their internal auditors. Line management can be evaluated on the basis of profitability or success in meeting a budget, but such measures may not be appropriate for auditors.

In many companies, there is a tendency to evaluate auditors on the basis of quantifiable costs and benefits, such as whether or not they follow their audit plan or produce cost savings. However, an internal audit department may not be effective even when the plan is followed or when actual costs are less than budgeted costs.

To determine how companies with outstanding internal audit groups evaluate their auditors, we conducted personal interviews with the CFO, CEO, and a member of the audit committee of 13 companies reputed to have excellent internal audit departments. These companies were: 3M Company, Aluminum Company of America (ALCOA), American Can Company, Florida Power Corporation, Ford Motor Company, General Electric Company, IBM Corporation, ITT Corporation, Marine Midland Bank, PepsiCo, Security Pacific National Bank, Southern California Edison, and Southern New England Telephone Company. Top management and audit committees in all 13 companies perceived their auditors to be very effective.

How do these companies evaluate their successful internal auditors? The criteria used by top management and the audit committees were of three types: quantitative, qualitative, and feedback.

Quantitative criteria are those measures of effectiveness that are measurable and documentable. They include such factors as the dollars saved versus the cost of operating the internal auditing department; the number of reports and findings; the percent of time spent auditing; the number of auditors per dollar of assets or revenues; the actual costs versus budgeted costs; and the completion of the audit plan.

Qualitative criteria are not strictly measurable and usually are not documentable. They include such gauges as meaningful audit comments, the professionalism of the department, the absence of surprises, and the development of people.

Feedback measures include comments about the effectiveness of the audit by auditees, external auditors, other management people, and the audit committee.

The figure on page 40 identifies the criteria used to...