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  3. 3. 3 3 Section A  Section A comprises approximately 15% to 25% (15 to 25 questions) of the Part 1 exam.  There are six primary sections in Section A, including: 1) Purpose, Authority and Responsibility, 2) Organizational Independence & Objectivity, 3) Proficiency and Due Professional Care, 4) Continuing Professional Development, 5) Quality Assurance & Improvement Program, and 6) The IIA’s ‘Code of Ethics’.
  4. 4. 4 4 The Development of Internal Auditing  The concept of internal auditing goes back as far as 5,000 years. Early civilizations had to verify what they had, particularly verifying the amount of grain they had.  The formal development of internal auditing as a profession was started by the railroads.  Railroad executives had to have some assurance that their stationmasters in many distant places were properly handling receipts and submitting all of the money that they should.  Railroad executives felt that the external auditors did not adequately address this issue because of a focus on the financial statements.
  5. 5. 5 5 DifferencebetweenExternal & Internal Auditors The Internal Auditor…  Is employed by the organization.  Focuses on futureeventsby evaluating controls designed to assure the accomplishment of entity goals and objectives.  Is notindependentof the activities audited but is ready to respond to the needs and desires of management.  Behaves with objectivity even though they are not independent.  Is directlyconcernedwith the prevention of fraud in any form or extent in all aspects of the business.  Reviews activities continually. The External Auditor…  Is an independent contractor.  Serves third parties who need reliable financial information.  Focuses on the accuracy and understandability of historical eventsas expressed in the financial statements.  Is independentof management and the board of directors both in fact and in mental attitude.  Is incidentallyconcernedwith the prevention and detection of fraud in general, but is directly concerned when financial statements may be materially affected.  Reviews records supporting financial statements periodically – usually annually.
  6. 6. 6 6 The Definition of Internal Auditing  Over the past few decades, the profession of internal auditing has undergone major changes.  The IIA defines Internal Auditing as: “An independent, objective assurance and consulting activity designed to add value and improve an organization’s operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control and governance processes.”
  7. 7. 7 7 IIA Professional Standards  The Standards are the criteria by which internal auditors perform their work.  The Standards are intended to represent the best practices of internal auditing.  The Standards have the following four purposes: 1) Delineate basic principles that represent the practice of internal auditing as it should be. 2) Provide a framework for performing and promoting a broad range of value-added internal audit activities. 3) Establish the basis for the evaluation of the internal audit performance. 4) Foster (support) improved organizational processes and operations.
  8. 8. 8 8 Professional Standards  The professional Standards consist of Attribute Standards, Performance Standards and Implementation Standards.  Attribute Standards are concerned with the characteristics of the organization and the parties who will be performing the auditing activities.  Performance Standards describe the internal audit activities and criteria against which the performance of these services can be evaluated.  Implementation Standards apply to the specific types of engagements, whether assurance or consulting.
  9. 9. 9 9 1000: Purpose, Authority and Responsibility  According to the Standards, “the purpose, authority, and responsibility of the internal audit activity (IAA) must be:  Formally defined in a charter,  Consistent with the Definition of Internal Auditing, the Code of Ethics, and Standards, and  Approved by the board.”  The IAA should encompass every part of the organization’s operation, and should have access to the company’s documents, records or properties.  Internal auditing has developed to assist management in carrying out its monitoring responsibilities effectively and efficiently.  The IAA should promote effective control at a reasonable cost.
  10. 10. 10 10 Organizational Status of the IAA  In order for the IAA to accomplish its responsibilities it must have the necessary status within the organization.  To have the necessary status the IAA should report to the board of directors through the audit committee.  Along with organizational status the IAA must also have organizational independence.  This means that the IAA should not have relationships with the various departments it will be auditing.  Status and independence can be achieved by having a properly designed Internal Audit Charter.
  11. 11. 11 Review Text Questions Q1-3, page 8
  12. 12. 12 12 The Internal Audit Charter  It is the Charter that provides the IAA with the formal mandate to do its work.  The Charter should be written by and come from the board of directors and senior management.  The Charter should include:  The scope of the services and work to be performed,  The objectives of the IAA,  The authority that the IAA has to access records, personnel and physical properties in the organization,  The accountability of the IAA, and  The responsibility of the IAA.
  13. 13. 13 13 The Charter  The IAA should report to an organizational level that is high enough to be effective, and independent of the functions that will be audited.  This means that the Chief Audit Executive (CAE) should report to the Chief Executive Officer (CEO), or board of directors.  The accounting department, chief accountant or finance director would not normally be a good level to report to.  Ideally the CAE should:  Functionally report to the audit committee or its equivalent and  Administratively to the CEO.
  14. 14. 14 14 The Audit Committee  The audit committee is a subcommittee of the board of directors.  The members of the audit committee should be external directors.  The audit committee itself should have its charter approved by the board.
  15. 15. 15 15 The Audit Committee, continued  The primary duties and responsibilities of the audit committee are:  To ensure that the external auditors are completely independent.  Discuss with management and external auditor the effects of changes in accounting standards, and the implications of these proposed changes.  Ensure that both internal and external auditors have sufficient resources to carry out their functions.  Act as a mediator between management and the auditors if there is a dispute.  Appoint or replace the external auditor, who shall report directly to the Audit Committee.  Be directly responsible for the compensation and oversight of the work of the external auditor.
  16. 16. 16 16 The Audit Committee, continued  Other functions of the Audit Committee include:  Review copies of all external and internal audit reports and communications, and management’s response to them.  Review all financial communications and statements to be publicly issued.  Review the strategy, activity and work plan of the IAA.  Review evaluations of risk management, control and governance reported by the auditors.  Communication as necessary with the CEO.  Review policies to eliminate illegal and unethical practices.
  17. 17. 17 Review Text Questions Q4-7, page 10
  18. 18. 18 Consulting Services 18
  19. 19. 19 19 ConsultingServices  As we have seen in the beginning, internal auditing has expanded to include consulting services.  Consulting services are defined as “advisory and related client services, the nature and scope of which are agreed upon with the client and which are intended to add value and improve an organization's operations.”  Examples include counsel, advice, facilitation, process design and training.
  20. 20. 20 20 ConsultingServices, continued  Consulting services undertaken by the IAA may be formal or informal, and they may or may not be connected to an assurance engagement.  There are 12 principles to help guide the internal auditor.  Valueis addedby the IAA when they perform both assurance and consulting services. The IAA is in a very good position to provide consulting services to the company because of its professional standards and its knowledge of the company and its operations.  The fact that the IAA is able to provide consulting services (and any other appropriate services) should be includedin theinternalaudit charter. Additionally, any rules or standards applicable to the consulting services should also be included in the charter.
  21. 21. 21 21 ConsultingServices, continued  Principles, continued.  The IAA may also provide other services besides assurance and consulting, i.e., investigating fraud, and due diligence.  Consulting servicesdo not impair the objectivityof either the individual internal auditor or the IAA (objectivity is addressed in more detail separately). However, the auditor needs to remember that his/her first duty is as an auditor and so all actions need to be governed by the applicable internal audit guidelines and standards as applicable. Objectivity is not impaired as long as the internal auditor provides advice and does not take ownership of a specific process.
  22. 22. 22 Independence and Objectivity 22
  23. 23. 23 23 1100: Independence andObjectivity  Independence is an issue for the internal auditor, as well as the external auditor.  Because internal auditors are auditing the company that employs them, it is impossible for the internal auditors to be independent in the same manner as external auditors.  Therefore, internal auditors use a different term to refer to the way they act in the performance of their work. The term is “objective.”  Internal auditors must be objective in their work, and the IAA needs to be independent with the organization.  Considered independent and objective if they perform their work freely and objectively.
  24. 24. 24 24 Independence and Objectivity, continued  Independence is achieved largely through the organizational status of the IAA.  The independence of the IAA is enhanced if it reports directly to the board of directors.  If they report to the chief accountants and it is perceived that they do not add value to the organization, or are not viewed as important by the board, the IAA will have less independence and their work will be less useful to the organization.
  25. 25. 25 25 1110: Organizational Independence  The ideal reporting line is for the CAE to report administratively to the CEO of the organization, and functionally to the audit committee, board of directors, or some other appropriate governing authority.  Functional reporting is the ultimate source of independence and authority for the IAA.  Administrative reporting is the reporting relationship within the organization’s management structure that facilitates the day-to-day operation of the IAA.
  26. 26. 26 26 1120: Individual Objectivity  In addition to independence, the IAA as a whole has to remain objective.  Remaining objective means  Being impartial,  Having an unbiased attitude, and  Avoiding conflicts of interest.  Conflicts of interest should be minimized.  For example, someone involved in an engagement should not audit an area where that person’s friend works.  In addition, the acceptance of a gift or money from a client will impair the objectivity of the auditor, even if the auditor maintained objectivity.
  27. 27. 27 27 1130: Impairments to Independence or Objectivity  Any time that there is a conflict of interest, or objectivity has been impaired, the auditor should inform the CAE and the auditor should be removed from that particular engagement.  If impairment arises during an engagement, it should be reported immediately to the manager of the engagement.  Objectivity is not considered impaired if the auditor recommends standards of control or review procedures before being implemented.  Objectivity is considered to be impaired if the auditor designs, installs, or draft procedures for, or operates such systems.
  28. 28. 28 28 Impairment to Objectivity, continued  Objectivity is assumed to be impaired if an auditor performs an assurance review of any activity over which he or she recently had responsibility.  Individuals who are assigned to or transferred to the IAA should not audit areas that worked unit a reasonable period of time has elapsed (at least one year).
  29. 29. 29 29 Objectivity in ConsultingEngagements  For a number of reasons it is more common for internal auditors to provide consulting services relating to operations for which they had previous responsibility.  This is not forbidden, but the internal auditor should still act in an independent and objective manner.  To assess objectivity, the internal auditor should consider:  The appropriate requirements of the standards of the profession.  Expectations of the stakeholders, directors, the audit committee and legislative bodies.  Restrictions that are in the charter.  Disclosures that may be required by standards.  Subsequent audit work, its scope and coverage.
  30. 30. 30 Review Text Questions Q8-9, page 14
  31. 31. 31 Proficiency and Due Professional Care 31
  32. 32. 32 32 1200: Proficiency and Due Professional care  The Standards states that “Engagements must be performed with proficiency and with due professional care.”
  33. 33. 33 33 1210: Proficiency  Proficiency is when an individual possesses the knowledge, skills and other competencies needed to perform their individual responsibilities.  The skills and knowledge necessary for the internal auditor to perform his or her job will depend on the work needed to be performed. For example, if an internal auditor does a lot of financial statement work, then he or she needs skills related to the appropriate GAAP (IFRS, US GAAP…).  On the other hand, if an internal auditor works in the area of internal controls, then detailed knowledge of GAAP would probably not be necessary.
  34. 34. 34 Proficiency, continued  Related to proficiency are two other terms that you have to understand. These terms are understanding and appreciation.  Understanding is the ability to  Apply broad knowledge to situations likely to be encountered,  Recognize material deviations, and  Be able to perform research to arrive at conclusions.  Appreciation is the ability to:  Recognize the existence of problems and potential problems, and  Determine if further work is required. 34
  35. 35. 35 35 Proficiency, continued  If the internal auditor does not have the needed skills and competencies to perform the engagement, the CAE has to either decline the engagement or go outside the department to get the skills.  If using the services from an outside service organization, the CAE also needs to consider the independence and objectivity of the outside organizations.  Any work done by an outside organization needs to be reviewed by either the CAE or other internal person with sufficient experience and understanding to review the work.
  36. 36. 36 Review Text Questions Q10-14, page 16
  37. 37. 37 37 1220: Due Professional Care  Due professional care means that internal auditors need to apply the skill and care expected of a reasonable competent and prudent internal auditor.  This means that an internal auditor is not expected to perform a detailed review of every statement or document they receive, but are expected to examine and verify the documents as appropriate given the information contained in them.  Material items will be examined in more detail than immaterial items.
  38. 38. 38 Review Text Questions Q15-17, page 20
  39. 39. 39 39 1230: Continuing Professional Development  Certified Internal Auditors (CIA) are required to maintain the skills and knowledge necessary to successfully complete their tasks, which is done through Continued Professional Development, referred to as Continuous Professional Education (CPE).  CPE is a method of helping keep the internal auditor informed about improvements and current developments in internal audit standards, procedures, and techniques.  CIAs must obtain sufficient CPE credits in order to satisfy requirements related to the professional certification held.
  40. 40. 40 Quality Assurance and Improvement Program 40
  41. 41. 41 41 1300: Quality Assurance and ImprovementProgram  A function of the CAE is to be assured of the quality of the work performed by the internal audit activity.  Based on the Standards, the CAE must develop and maintain a Quality Assurance and Improvement Program (QAIP) that covers all aspects of the IAA and continuously monitors its effectiveness.  The QAIP should include both  Periodic internal and external quality assessments and  Ongoing internal monitoring.  In essence, the IAA is really auditing itself.
  42. 42. 42 42 1310: Requirement of QAIP  The CAE is responsible to implement a quality program that monitors and assesses the overall effectiveness of the quality program.  Quality program must include both internal and external assessments.  The purpose of the quality program is for the company’s stakeholders to feel comfortable with the services the IAA is providing to the organization.
  43. 43. 43 43 1311: Internal Assessments  Internal reviews should be carried out periodically to assure the CAE that subordinates are complying with the Standards and other applicable criteria.  Internal assessment must include ongoing review of performance of the IAA, as well as a periodic review of the program from an independent person within the organization who is familiar with the internal auditing program.  Ongoing review could include:  Supervising the internal auditor’s work during an engagement,  Feedback from audit customers and other stakeholders,  Analyses of performance metrics (e.g., cycle time and recommendations accepted), and  Project budgets, cost recoveries, etc.
  44. 44. 44 Internal Assessments, continued  Periodic internal assessments may:  Be more in-depth interviews and surveys of stakeholder groups,  Be performed by members of the IAA (self-assessment),  Be performed by CIAs, or other competent audit professionals,  Encompass a combination of self-assessment and preparation of materials subsequently reviewed by CIAs, or other competent professionals, and  Include benchmarking of the IAA practices and performance metrics against relevant best practices of the internal audit profession.
  45. 45. 45 45 External Assessments  External assessments are performed by an external party.  It is recommended that an external assessment is conducted at least once every five years.  External reviewers must be independent of the organization and of the IAA.  External assessor will tend to focus on:  The adequacy of the IAA charter,  The goals, objectives, policies and procedures of the IAA,  Whether or not the IAA complies with the Definition of Internal Auditing, Code of Ethics, and Standards,  The skills and work performed by the individuals in the IAA, and  Whether or not the IAA adds value and improves operations.
  46. 46. 46 46 External Assessments, continued  There are two approaches to conducting an external assessment: 1. Have a full external assessment conducted by an external assessor, or review team, or 2. Have an independent validation of the internal self- assessment and a report completed by the internal audit activity.  You would prefer to have the full external assessment, but might not always be possible, or practical. Examples, might include:  Be in an industry that is subjected to strict regulation and supervision,  Have been subjected to an external review in which there was extensive benchmarking with best practices, and
  47. 47. 47 47 1320: Reportingon the QAIP  The results of the external assessment must be reported to the board.  The assessor issues a formal, written report that contains an opinion on the IAA’s compliance with the Standards.  The report should also address compliance with the IAA charter and other applicable standards and include appropriate recommendations for improvement.  Appropriate follow-up is the responsibility of the CAE.
  48. 48. 48 48 1321: “Conforms withthe Standards”  Internal auditors are encouraged to report that their activities conforms with the International Standards for the Professional Practice of Internal Auditing.  This statement can be used only if the quality assessments demonstrate that the internal auditors are, in fact, in compliance with the Standards.  In case full compliance is not possible due to lack of skilled and qualified personnel, or for some other reason, disclosure of noncompliance should be made to senior management and the board. Noncompliance might be due to the lack of skill and qualified people, or for some other reason.
  49. 49. 49 Review Text Questions Q18-23, page 22
  50. 50. 50 The IIA ‘Code of Ethics’ 50
  51. 51. 51 51 The IAA‘Codeof Ethics’  The ‘Code of Ethics’ is intended to be an ethical guide of conduct for internal auditors.  The IAA ‘Code of Ethics’ applies to both individuals and entities that provide internal auditing services.  The two essential components of the Code are:  Principles are the values that internal auditors are expected to uphold, and  Rules of Conduct are an aid for interpreting the Principles into practical applications and are intended to guide the ethical behavior of the internal auditors.
  52. 52. 52 52 Principles  There are four principles that internal auditors are expected to follow: 1. Integrity – The integrity of the internal auditors establishes trust and thus provides the basis for reliance on their judgment. 2. Objectivity – The internal auditors are expected to exhibit the highest level of professional objectivity in gathering, evaluating, and communicating information about the activity or process being examined. 3. Confidentiality – Internal auditors respect the value and ownership of information they receive and do not disclose information without appropriate authority unless there is a legal or professional obligation to do so. 4. Competency - Internal auditors apply the knowledge, skills, and experience needed in the performance of internal auditing.
  53. 53. 53 53 Rulesof Conduct 1. Integrity - Internal auditors:  1.1. Shall perform their work with honesty, diligence, and responsibility. [In other words, the auditor does the right thing.]  1.2. Shall observe the law and make disclosures expected by the law and the profession.  1.3. Shall not knowingly by a party to any illegal activity, or engage in acts that are discreditable to the profession of internal auditing or to the organization.  1.4. Shall respect and contribute to the legitimate and ethical objectives of the organization.
  54. 54. 54 54 Rulesof Conduct 2. Objectivity – Internal auditors:  2.1. Shall not participate in any activity or relationship that may impair or be presumed to impair their unbiased assessment. This participation includes those activities or relationships that may be in conflict with the interests of the organization.  2.2. Shall not accept anything that may impair or be presumed to impair their professional judgment. [For example, a material gift (use of beach house) is considered to impair objectivity.]  2.3. Shall disclose all material facts known to them that, if not disclosed, may distort the reporting of activities under review. [For example, there may be some items that were capitalized instead of expensed. This fact needs to be disclosed to management and the Audit Committee.]
  55. 55. 55 55 Rulesof Conduct 3. Confidentiality – Internal auditors:  3.1. Shall be prudent in the use and protection of information acquired in the course of their duties.  3.2. Shall not use information for any personal gain or in any manner that would be contrary to the law or detrimental to the legitimate and ethical objectives of the organization. 4. Competency – Internal auditors:  4.1. Shall engage only in those services for which they have the necessary knowledge, skills, and experience.  4.2. Shall perform internal auditing services in accordance with the International Standards for the Professional Practice of Internal Auditing.  4.3. Shall continually improve their proficiency and the effectiveness and quality of their services.
  56. 56. 56 Review Text Questions Q24, page 29
  58. 58. 58 58 Section B  Section B covers the topics of planning, communications, resource management, policies and procedures, and coordination.  This section will account for approximately 15 – 25% (15 – 25 questions) of the Part 1 Exam.  The main topics within this section are:  Planning and Communication,  Resource Management,  Policies and Procedures, and  Coordination.
  59. 59. 59 59 2000: Managingthe IAA  The CAE must manage the IAA to ensure that it adds value to the organization as a whole.  The CAE’s responsibility is to ensure that:  The engagement work fulfills the general purposes and responsibilities described in the charter that was approved by senior management and accepted by the board of directors (or audit committee).  The resources of the IAA are efficiently and effectively employed.  Engagement work that is performed conforms to the Standards for the Professional Practice of Internal Auditing.
  60. 60. 60 60 2010: Planning  The CAE must establish risk based plans to determine the priorities of the IAA, and make certain that they are consistent with the organization goals.  Planning includes the establishment of:  Goals,  Engagement work schedules,  Staffing plans and financial budgets, and  Activity reports.  Now we want to discuss next category in more depth.
  61. 61. 61 61 Goals  The goals that are set for the IAA should be:  Specific - Goals should be specifically defined.  Measurable - The method of measuring the goals should be defined.  Agreedto – All interested parties should agree on the stated goals. Interested parties include senior management and the board.  Realistic andAchievable– Goals must realistic and they should be attainable. If they’re not, then they are superfluous.  Timely- Goals should be specific as to when they are to be achieved. As we can see, the goals of the IAA should be SMART.
  62. 62. 62 62 Engagement WorkSchedule  The engagement work schedule is a critical responsibility and is relevant at both the larger IAA level as well as each individual engagement.  Specific work schedule should include:  What engagements should be performed,  When they will be performed,  The estimated time required to perform the engagements, and  Which engagements should be given higher priority.  Once these questions have been answered, it is then possible for the individual work program for a specific engagement to be developed.
  63. 63. 63 63 Engagement WorkSchedule, continued  The CAE makes the final decision regarding which engagements will be performed.  The consideration of risk is one of the most important elements in determining which engagements have the highest priority.  But, risk is not the only factor in prioritizing the engagements. Other important factors are:  The length of time since the last engagement was performed.  Request from senior management, audit committee, etc.  Changing circumstances in the business, programs, etc.  Changes in risk environment.  Potential benefits that could be achieved.  Changes in the skills of the staff.
  64. 64. 64 64 Long-termPlanning  The CAE needs to look beyond the short or immediate term.  The CAE needs to establish a longer term strategic plan.  The purpose of this plan is to make sure that all areas of the business are audited at least periodically.  Some areas (based on risk assessment) might need annual auditing, or even more often, while other areas may be addressed once every two or three years.  Without a long-term plan, it could be possible that one area of the business would never be audited because it would never meet the requirements for the short-term audit.
  65. 65. 65 Review Questions 25-31, pg. 35
  66. 66. 66 66 2030: Resource Management  The CAE has to make sure the internal audit staff are professional. This means the “right people are in the right positions.”  According to the Standards, “the CAE must ensure that internal audit resources are appropriate, sufficient, and effectively deployed to achieve the approved plan.”  The CAE needs to oversee the assignment of individual staff to the engagements (both short and long term).  In the short term, engagements should be staffed by auditors who can get the job done at the highest level.  However, in the long term, staff might be assigned to jobs that will allow them to grow so they can become senior auditors.
  67. 67. 67 67 Resource Management, continued  Some of the things to consider when assigning staff to individual engagements.  The complexity of the engagement,  The resources that are available in IAA,  The experience (skill level) of the staff, and  The training and developmental needs of the audit staff.
  68. 68. 68 68 Recruitingand Promoting  A big issue for the IAA is its ability to recruit qualified audit staff and keeping them within the organization.  This is something that both the CAE and the HR function will be involved in.  When recruiting, the most important criterion is the education and experience of the candidate.  This does not mean that every candidate needs to be a CIA, but they should be able to provide some indication that they can get the job done.  Not every staff member needs to be a trained accountant.  Candidates should be good communicators (both written and oral).
  69. 69. 69 69 Recruitingand Promoting, continued  Once the staff has been hired, the next HR issue relates to staff promotion and filling of higher-level positions in the IAA.  When a higher-level position become available, there are two basic options in filling the position.  Hire someone from inside the organization, or  Hire someone outside the organization.  The advantage of hiring someone from inside the organization are:  It is often done quicker and requires less ‘start-up’ time for the person.  The person knows the company, so there is less risk involved.  It is also a good motivating factor.
  70. 70. 70 70 Recruitingand Promoting, continued  Hiring someone from outside the organization is riskier, but it also has its advantages.  The outside person could bring new ideas and new perspective to the job.  It is also possible that management training costs could be lower since it is assumed that the person is already trained.  An important basis for recruitment and promotion of staff is the job description.  The job description lists the necessary skills and requirements for the position.  Having detailed and complete job descriptions makes it easier for the CAE to determine if the IAA is properly staffed.
  71. 71. 71 71 Training, Staff Development and Performance Evaluations  The CAE is also responsible for the training, counseling and performance evaluations of the staff.  Training should have the goal of providing the staff with the necessary skills to perform their jobs in the short term, and broaden skills in the long term.  A well-developed training program is an excellent recruiting tool for the company.  Counseling and mentoring program is an excellent way of developing staff.
  72. 72. 72 72 Training, Staff Development and Performance Evaluations  Performance appraisals should be conducted at least annually, and more often if needed.  Performance reviews give employees the opportunity to identify their weaknesses and give them an opportunity to improve their performance.  The evaluation should not be based on likes or dislikes, or other non-job related factors.  There should be sufficient time for everyone to prepare for the evaluation.  The evaluation can be a standard form (and will be standard form in large companies).
  73. 73. 73 Review Questions 32-33, pg. 40
  74. 74. 74 74 2060: Reportingto Senior Management and Board  “The CAE must periodically report to senior management and the board on the IAA’s purpose, authority, responsibility, and performance relative to its plan.”  “Reporting must also include significant risk exposures and control issues, corporate governance issues, and other matters needed or requested by senior management and the board.”
  75. 75. 75 75 ActivityReports  The CAE must submit and activity report to senior management and the board at least once a year.  This should be done if the work volume or nature of the work requires closer involvement of the board. This may be the case if there are high-risk areas that are being audited.  Activity reports should:  Be communicated in writing (preferably),  Highlight significant engagement observations,  Identify recommendations that have arisen from the engagement,  Compare actual performance with the IAA’s goals,  Compare expenditures to financial budgets.
  76. 76. 76 76 Significant Engagement Observations  Significant observations are those conditions that, in the judgment of the CAE, could adversely affect the organization.  Examples might include: illegal acts, errors, inefficiency, waste, ineffectiveness, conflicts of interest, and others.  After discussion with senior management, the CAE should communicate these significant engagement observations and recommendations with the board, whether or not they have been satisfactorily resolved.
  77. 77. 77 77 Management Responsibility for Significant Engagement Observations  Management is responsible to make decisions on the appropriate action to take regarding significant engagement observations and recommendations.  Management may decide to assume the risk of not correcting the reported condition because of cost and other considerations.  Management needs to inform the board of their decision on all significant observations and recommendations.  Internal auditors should only provide the information and alternative courses of action.
  78. 78. 78 78 CAE Considerations on ReportingSignificant Engagement Observations  The CAE should consider whether it is appropriate to inform the board regarding previously reported, significant observations and recommendations in those instances where senior management and the board assumed the risk of not correcting the reported condition.  If the board is aware of the risks and has chosen to not address them, the item probably does not need to be reported each year.  However, if there has been significant changes in the organization, board, or senior management, the item should probably be reported again.
  79. 79. 79 79 Relationship withAudit Committee  Internal auditors are the “eyes and ears” of the audit committee.  Internal auditors should be the committees’ trusted advisors.  Keys to the relationship are:  Assisting the audit committee to ensure that its charter, activities, and processes are appropriate to fulfill its responsibilities.  Ensuring that the charter, role, and activities of internal audit are clearly understood and responsive to the needs of the audit committee and the board.  Maintaining an open, effective communications with the audit committee and the chairperson.
  80. 80. 80 80 Communications withthe Audit Committee  To a great extent, the effectiveness of the CAE will revolve around the communications between the CAE and the audit committee.  Good communications is fostered by:  Meeting regularly with the committee to discuss sensitive issues.  Providing annual summary reports.  Issuing periodic reports summarizing results of the IAA.  Keeping the audit committee informed of emerging trends, etc.  Discussing fulfillment of committee information needs.  Reviewing information submitted to the committee for completeness and accuracy.  Confirming there is an effective and efficient work coordination of activities between internal and external auditors.
  81. 81. 81 Review Questions 34-37, pg. 44
  82. 82. 82 82 2020: Communication and Approval  CAE needs to ensure that the plans and resources requirements are communicated to senior management and to the board for review and approval.  Communications should include any significant interim changes, and the impact of resources limitations.  Engagement plans and resource requirements must be submitted on an annual basis and should include a summary of the IAA’s work schedule, staffing plan and financial budget.  This type of information will ascertain whether the IAA objectives and plans are congruent with the organization.
  83. 83. 83 83 2040: Policies and Procedures  The CAE must also establish policies and procedures to guide the IAA and the individual internal auditors in their work.  The extent, depth and formalization of the policies and procedures will depend upon the size and structure of the IAA and the complexity of the IAA’s work.  A small IAA will be managed much more informally with a lot of personal and daily contact.  A larger IAA will be managed much more formally with a more formal set of policies and procedures.
  84. 84. 84 Review Questions 38-39, pg. 46
  85. 85. 85 85 2050: Coordination of Activities  The CAE has the responsibility to share information and coordinate activities with other internal and external providers of relevant assurance and consulting services to ensure proper coverage and minimize duplication of efforts.  Internal and external participants might include:  External auditors,  Regulatory oversight bodies (e.g., government auditors, etc.), and  Other internal assurance functions (e.g., health and safety dept.)
  86. 86. 86 86 Coordination withExternal Auditor  Coordination with external auditor is important because of the potential to increase the efficiency of both audit areas and reduce the cost of the external audit.  Two main reasons why the level of coordination between the external and internal auditors is growing and becoming more of an issue for companies:  The internal auditing profession has become increasingly professional with more internal auditors being former external auditors or professional internal auditors.  The cost of external audit has grown so much in recent years that companies are looking for any way to reduce the costs.
  87. 87. 87 87 Assistance Provided by the Internal Auditor  This is the area where the CAE can reduce the cost of the external audit by providing support, direction and do some of the testing for the external auditor.  Before the external auditor will rely on any of the work of the internal auditor, the external auditor needs to assess the competence and objectivity of the internal auditor.  Competence is whether or not the IAA has the needed skills and abilities to perform acceptable work.  Objectivity is whether or not the IAA performs its work without any influence from management or others in the organization.  Even if the the external auditor relies on the work done by the IAA, the external auditor will still need to review the work of the IAA.
  88. 88. 88 88 Assistance Provided by the External Auditor  There might be cases where the work of the external auditor will be beneficial and useful to the internal auditor.  In these cases, the internal auditor can rely on some of the work performed by the external auditor, as long as the CAE is comfortable with the work that was done by the external auditor.  Just as the external auditor reviewed the work of the internal auditor, the internal auditor will want to review the work that was done and the conclusions drawn.  Review of the external’s work will require the permission of the external auditor.
  89. 89. 89 89 Control andUse of the Auditors’ Working Papers  Working papers contain all of the work and tests that were performed during the engagement and they will be the basis for the conclusions drawn by the internal auditor.  Working papers belong to the party that developed them.  This means that the working papers of the external auditor belong to the external auditor.  Likewise, the working papers of the internal auditor belong to the internal auditor.  The CAE should not provide the external working papers to anyone without the permission of the external auditor.
  90. 90. 90 Review Questions 40-42, pg. 48
  91. 91. 91 91 Coordination withRegulatoryBodies  Some industries such as banking and insurance are heavily regulated. Thus, they will be audited by a government agency.  In these cases, the CAE should coordinate audits with the regulatory body that is responsible for the oversight of the company.  This coordination should be done with the approval of the board.  A benefit to the organization is that the internal auditor would be given the chance to provide of compliance testing through its internal working papers and other documents.
  92. 92. 92 92 Coordination withother Internal Assurance Functions  It is possible that there are other dept within the organization are equally concerned with control.  Even though, their interest might be only on the technical aspect, it is highly probably that these control measures may complement the internal auditor’s interest in the administrative forms of controls. Examples might be:  Security dept is concerned with control over specific irregularities.  Quality control dept is concerned with control over product reliability and conformance to specifications.  Safety and health dept is concerned with control over accidental prevention.  Industrial engineering dept is concerned with control over operating practices and procedures.
  93. 93. 93 Review Questions 43-45, pg. 51
  94. 94. 94 Sarbanes-Oxley Act
  95. 95. 95 95 Sarbanes-Oxley Act  The Public Company Accounting Reform and Investor Protection Act of 2002, or more commonly referred to as the Sarbanes-Oxley Act (SOX) was enacted in response to the accounting scandals of Enron, WorldCom and others.  The primary purpose of SOX is to:  Improve quality and transparency of financial reports.  Enhance the standard setting process for accounting practices.  Strengthen the independence of public accounting firms.  Increase corporate responsibility.  Protect the objectivity and independence of securities analysts.
  96. 96. 96 96 SOX provisions  Many of the act’s provisions had to do with the external auditor, but many had to do with internal control issues, particularly in regard to the audit committee and board.  These provisions include:  Audit committees are to be directly responsible for the appointment (subject to shareholder approval), compensation, and supervision of the registered public accounting firm. This overview includes resolution of any disagreements between management and the auditor regarding financial reporting.  Audit committees are to be provided with the proper authority and funding to engage independent counsel and advisors.  Auditors (both internal and external) are required to report to the audit committee.  Members of audit committee have to be independent.
  97. 97. 97 97 SOX provisions  The audit committee should have at least one financial expert. If not, then the fact should be disclosed.  Audit committee should adopt written procedures to receive and address complaints regarding accounting, internal controls and auditing issues, including procedures to maintain the confidentiality of the whistle blower.  It is unlawful for any corporate officers or director to knowingly to manipulate or mislead any accountant engaged in preparing an audit for the purpose or rendering the audit report materially misleading.  There should be a statement saying management is responsible the company’s internal controls.  The company is required to disclose whether it has adopted a Code of Ethics.
  98. 98. 98 Review Questions 46-47, pg. 53
  100. 100. 100 100 Section C  In Section C we start to discuss the nature of the internal auditor’s work, including what it entails and how it contributes to the improvement of an organization’s risk management, control and governance processes.  Control and control processes will be discussed in Section D.  This section will account for approximately 15 – 25% (15 – 25 questions) of the Part 1 Exam.
  101. 101. 101 101 2100: Nature of the Internal Auditor’s Work  The work that the internal auditor is going to be doing is diverse and covers all of the different areas of the business.  The function of the IAA is to contribute to the improvement of risk management, control and governance processes.  “The adequacy of risk management, control, and governance processes is present if management has planned and designed for these items in a manner, which provides reasonable assurance that the organization’s objectives and goals will be achieved efficiently and economically.”
  102. 102. 102 102 Nature of Work  Management is responsible:  For the sustainability of the whole organization, and  Accountability for the organization’s actions, conduct and performance to the owners, other stakeholders, regulators, and general public.  Primary purpose of the overall management process are to achieve:  Relevant, reliable and credible financial/operating information,  Effective/efficient use of the org. resources,  Safeguarding of assets,  Compliance with laws, regulations, etc.,  Identification of risk exposures and use of strategies to control them, and  Establish objectives and goals for operations or programs.
  103. 103. 103 103 Nature of Work, continued  Control is any action taken by management to enhance the likelihood that established objectives and goals will be achieved.  Controls may be:  Preventive – to deter undesirable events from occurring,  Detective – to detect and correct undesirable events which occur, or  Directive – to cause or encourage a desirable event to occur.
  104. 104. 104 Review Questions 48-53, pg. 55
  105. 105. 105 105 Information Security  It is management’s responsibility to ensure that company information is properly safeguarded.  Internal auditors should also work to ensure that any potential problems related to information security will be reported to management and the board.  The CAE has to make certain that the IAA has the necessary skills and resources to evaluate the information security.  Internal auditors need to assess the effectiveness of the controls in place.  This assessment should be made periodically, including recommendations for improvement.
  106. 106. 106 106 The Internal Auditor’s Role in Risk Management  Risk management is the responsibility of management.  The role of the IA is to assist both management and the board, i.e., audit committee by examining, evaluating, reporting and recommending improvements on the adequacy and effectiveness of management’s risk processes.  The role of the IA is likely to be determined by such factors as culture in the organization, ability of the IA staff, and local conditions and customs of the country.  If IA’s come across risk exposures in any engagement, this should be addressed and evaluated further as necessary.
  107. 107. 107 107 IA’s Role without a Risk Management Process  Possible that the company does not have an established risk management process.  If this is the case, than the IA needs to bring this to the attention of management.  It is generally acceptable for IA to play a proactive role in the development of such system.  However, caution must be taken to ensure that the IAA is not too closely involved as this might impair their independence for future work regarding risk.
  108. 108. 108 108 Compliance Programs  All companies in all countries have to be in compliance with something.  Compliance programs provide guidance for individuals within the organization to prevent inadvertent employee violations, detect illegal activities and discourage intentional employee violations.  In addition, these compliance programs can also help prove insurance claims, determine director and officer liability, create or enhance corporate identity, and decide the appropriateness of punitive damages.  Regarding compliance, organizations should develop a written business code of conduct.
  109. 109. 109 109 Compliance Programs, continued  In addition, there should be an organizational chart that outlines who is responsible for compliance issues.  The code of conduct must be communicated to all members of the organization once it is created.  Important that the code is enforced in the same manner for all individuals, regardless of level.  When a violation occurs, it must be documented and kept in the individual’s personal file. This is necessary to support why the individual was fired.  The violation should be documented even if not significant disciplinary action is taken.
  110. 110. 110 Review Questions 54-59, pg. 58
  111. 111. 111 111 Control & Audit Implications of E-commerce Activities  E-commerce is defined as “conducting commercial activities over the Internet.” E-commerce can be B2B (business to business), B2C (business to consumer), and B2E (business to employee).  Major elements of auditing E-commerce are:  Assess the internal audit structure, including the tone at the top,  Provide reasonable assurance that goals and objectives can be achieved,  Determine if the risks are acceptable,  Understand the information flow,  Review interface issues,  Evaluate the business continuity and disaster recovery plans.
  112. 112. 112 112 E-commerce, continued  The CAE needs to assess whether the IAA has the necessary skills and capacity to conduct an E-commerce engagement.  Factors that constrain the IAA are:  Does the IAA have the sufficient skills to conduct the engagement?  Are training or other resources necessary?  Is the staffing level sufficient for the near-term and long-term?  Can the expected audit plan be delivered?
  113. 113. 113 113 E-commerce, continued  The difference between auditing a regular business system and an e-commerce system are that  There may not be any hard copies,  Some data may exist for a very short period of time, or  There is no paper trail at all.  The critical risk and control issues that the IA must address are:  General project risk,  Specific security threats, such as denial of service, physical attacks, viruses, identity theft, and unauthorized access or disclosure of data,  Maintenance of transaction integrity under complex network of links to legacy systems and data warehouses,
  114. 114. 114 114 E-commerce, continued  Website content review and approval when there are frequent changes and sophisticated customer features and capabilities that offer around-the-clock service,  Rapid technology changes,  Legal issues, such as increasing regulations throughout the world to protect individual privacy; enforceability of contracts outside of the organization’s country; and tax and accounting issues, and  Changes to surrounding business processes and organizational structures.
  115. 115. 115 115 Audit Objectives forE-commerce Audit  The audit objectives for an E-commerce engagement may include:  Evidence of E-commerce transactions,  Availability and reliability of security systems,  Effective interface between E-commerce and financial systems,  Security of monetary transactions,  Effectiveness of customer authentication process,  Compliance with common security standards,  Effective use and control of digital signatures,  Adequacy of systems policies and procedures,  Adequacy and timeliness of operating data and information,  Documented evidence of an effective system of internal control.
  116. 116. 116 Review Questions 60-62, pg. 63
  117. 117. 117 117 Environmental Risks  Internal auditors should include risks in the areas of the environment, health and safety (EH&S).  This is particularly important where there are very high fines and penalties for environmental damages, employees rights lawsuits, and safety liability.  The CAE needs to determine that these risks have been assessed and addressed as needed.  In larger companies, this may be done by a separate environmental audit function.  When there is a separate function, the org. needs to make sure that it does not report to the group or individuals responsible for these areas.
  118. 118. 118 118 Privacy  Privacy includes “individuals’ rights to be left alone and for any pertinent information of an individual not to be disclosed by other parties that happen to possess such information. This means that a company must keep control over the personal information it has about its customers and may not release this information to third parties without parties without the individual’s agreement.”  The privacy of information is also maintained and not distributed to unauthorized people, even within the organization. Example, the company’s database should not be disclosed to a third party without the proper consent of the customer.
  119. 119. 119 119 Privacy, continued  Implications to the organization for these vulnerabilities are numerous.  To the individual, this could be embarrassment, inconvenience, unfairness, and others.  To the organization, these negative implications could include lawsuits, penalties, fines and of particular importance, negative goodwill and negative publicity.  There are no guarantees, but organizations have the responsibility to ensure that all reasonable measures have been enacted to safeguard data and information.
  120. 120. 120 120 2110: Risk Management  The IAA must assist the organization by identifying and evaluating significant exposures to risk and contributing to the improvement of risk management and control systems.  Risk is the probability that some future envent or action could adversely impact the organization. Risk is based in terms of impact (in dollars) and likelihood (probability).  Risk assessment is the process of assessing and integrating professional judgment about probable adverse conditions and/or events.  Risk management is the process to identify, assess, manage, and control potential events or situations, to provide reasonable assurance regarding the achievement of the organizations
  121. 121. 121 121 Roles in Risk Management Process  The responsibility of assessing the potential risks falls on the shoulders of management.  This is an on-going process and management has the responsibility to review and make necessary changes in order to mitigate potential risks that can hinder the achievement of objectives.  The board of directors (and audit committee) have the responsibility to provide an oversight role, making sure that the proper level of risk management is in place and effective.
  122. 122. 122 122 Roles, continued  Internal Auditors assist management, board, and/or committee by examining, evaluating, testing, reporting and recommending improvements in the adequacy of the organization’s risk management system.  The IAA’s role in the risk management process can range from:  No role, to  Auditing the risk management process as part of the internal audit plan, to  Active, continuous support and involvement in the risk management process.  Managing and coordinating the risk management process. In this case, the IA is not taking ownership of the risk, only the process.
  123. 123. 123 123 Assessing the Adequacy of Risk Management Process  The IAA should evaluate risk exposures relating to the organization’s governance, operations, and information systems regarding the:  Reliability and integrity of financial and operational information,  Effectiveness and efficiency of operations,  Safeguarding of assets, and  Compliance with laws, regulations, and contracts.  The five key objectives of a risk management process are: 1. Risks that arise are identified and prioritized. 2. Management and the board have determined the level of risk that is acceptable to the organization.
  124. 124. 124 124 Risk Management Processes 3. Risk mitigation activities are designed and implemented to reduce risk at levels that are acceptable. 4. Risk is periodically reassessed on an ongoing basis. 5. Reports are given periodically to the board and management on the results of the risk assessment process.  The IAA needs to assess whether or not these five objectives have been met in order to form an opinion on the adequacy of the risk management processes.  Internal auditors need to continuously look for things that may indicate a problem or cause for concern related to risk management.
  125. 125. 125 125 Assessing the Adequacy of Risk Management ProcessesforFormal ConsultingServices  Consulting service is defined as advisory and related client service activities, the nature and scope of which are agreed upon with the client, i.e., counsel, advise, facilitation and training.  Internal auditors should address risk consistent with the engagement’s objectives and should be alert to the existence of other significant risks.  With consulting services, the internal auditor should:  Determine the significance of exposures or weaknesses and the actions taken or contemplated to mitigate or correct these exposures or weaknesses; and  Ascertain the expectations of management, the audit committee and board in having these matters reported.
  126. 126. 126 Review Questions 63-66, pg. 65
  127. 127. 127 127 Business Continuity Process  Business continuity process has to do with the organization’s ability to continue to operate during some sort of crisis or disaster, and its ability to restart operations after having been interrupted.  It is not a matter if a crisis will occur, but when.  Internal auditors can assist in the planning for disasters and other interruptions to the business; evaluate the design and comprehensiveness of the plan after it has been drawn up; and perform periodic assurance engagements to verify that the plan is kept up-to-date.
  128. 128. 128 128 Business Continuity Process, continued  Need to be aware that disaster recovery plans can become quickly outdated.  Coping with and responding to changes is an inevitable part of the task of management.  Turnover of managers and executives and changes in system configurations, interfaces, and software can have a major impact on these plans.  The IAA needs to determine whether the recovery plan:  Is structured to incorporate important changes that could take place over time, and  The revised plan will be communicated to the appropriate people, inside and outside the organization.
  129. 129. 129 129 Internal Auditor’s Role aftera Disaster  Once there has been a disaster, the internal auditor can play an important role immediately after a disaster occurs.  This is when the company is most vulnerable to lapses in controls and procedures, and could possibly lead to exploitation (internally and externally).  During recovery process the internal auditor should:  Supervise the effectiveness of the recovery and control of operations;  Identify areas where controls and mitigating actions can be improved;  Recommend improvements to the plan; and  Possibly provide support during the recovery activity.
  130. 130. 130 Review Questions 67-68, pg. 71
  131. 131. 131 131 2130: Governance  The IIA defines governance as the system by which organizations are directed and controlled.  Governance also includes the rules and procedures for making decisions on corporate affairs to ensure success while maintaining the right balance with the stakeholders’ interest.  The four cornerstones of corporate governance are the board, management, internal auditors and external auditors.  Effective governance means making sure that inappropriate and unethical behavior is not tolerated.  Review the 10 basic principles necessary in the development of sound corporate governance (pg. 72).
  132. 132. 132 132 Role of the IAA in the Governance Process  The IAA serves as the “eyes and ears” of management, audit committee and external auditors.  As such, the IAA should assess and make appropriate recommendations for improving the governance process in its accomplishment of the following objectives:  Promoting appropriate ethics and values within the organization,  Ensuring effective organizational performance management and accountability,  Effectively communicating risk and control information within the organization, and  Effectively coordinating the activities of and communicating information among the board, external and internal auditors and management.
  133. 133. 133 133 Role of IAA in the Ethical Culture of an Org.  Corporate culture of the organization is very important in the creation of the ethical climate of the organization.  Ethical climate starts at the top, but all people should assume the role of ethics advocates.  Organizations use various forms, structure, strategies, and procedures to ensure that it:  Complies with society’s legal and regulatory rules,  Satisfies the generally accepted business norms, ethical precepts, and social expectations of society,  Provides overall benefit to society and enhances the interest of the specific stakeholders in both long term and short term, and  Reports fully and truthfully to its owners, regulators, other stakeholders, and general public to ensure accountability for its decisions, actions, conduct, and performance.
  134. 134. 134 134 IAA as Ethical Advocate  Internal auditors and the IAA should take an active role in support of the organization’s ethical culture.  They possess a high level of trust and integrity within the organization and the skills to the effective advocates of ethical conduct.  They have the competence and capacity to appeal to the enterprise’s leaders, managers, and the other employees to comply with the legal, ethical, and societal responsibilities of the organization.
  135. 135. 135 135 Assessment of the Organization’s Ethical Climate  Occasionally, the IAA should assess the state of the ethical climate of the organization and the effectiveness of its strategies, tactics, communications, and other processes in achieving the desired level of legal and ethical compliance.  Having written well-stated code of ethics does not necessarily guarantee that an organization will not have a higher standard of ethical behavior.  Nor does not having a code of conduct prevent the internal auditor from conducting a successful audit of ethical behavior since this behavior may already be documented in the company’s protocols.
  136. 136. 136 Review Questions 69-70, pg. 76
  137. 137. 137 137 SECTION D CONTROL
  138. 138. 138 138 Section D  In Section D we will be covering topic of control, what it is, what are the components of control, and what are the tools used for controlling.  This section will account for approximately 20 – 30% (20 – 30 questions) of the Part 1 Exam.
  139. 139. 139 139 2120: Control  It is through control that management is able to accomplish its wishes.  As defined by the IIA, control is “any action taken by management, the board, and other parties to enhance risk management and increase the likelihood that established objectives and goals will be achieved. Management plans, organizes, and directs the performance of sufficient actions to provide reasonable assurance that objectives and goals will be achieved.”
  140. 140. 140 140 DefiningControl  Control can also be defined as “any action taken by management to enhance the likelihood that established objectives and goals would be achieved. Controls may be preventive (to deter undesirable events from occurring), detective (to detect and correct undesirable events which occurred), or directive (to cause or encourage a desirable event to occur). The concept of a system of control is the integrated collection of control components and activities that are used by an organization to achieve its objectives and goals.”
  141. 141. 141 141 Benefits of Control  Controls are meant to provide assurance on the following:  Reliability and integrity of financial and operational information,  Effectiveness and efficiency of operations,  Safeguarding assets, and  Compliance with laws, regulations, and contracts.  Other benefits of control are:  Lower external audit costs,  Better control over and usage of company assets, and  More reliable information that may be used for decision making by managers and others in the company.
  142. 142. 142 142 Who Benefits fromHavinga StrongInternal Control System?  There are a number of diverse parties that are interested in the internal control system of a company:  Potential investors rely on the IC system to be able to evaluate management and the performance of the company.  External auditors will base the amount of work that they perform in part on the effectiveness of the IC system.  Legislative and regulatory bodies rely on the IC system to help ensure that the company is operating in compliance with applicable laws and regulations.  Management uses the information that comes out of the internal systems so management needs to make certain that the information that they receive is correct.  Customers benefit with reduced costs.
  143. 143. 143 143 Who is Responsible for Internal Controls  The Board of Directors is responsible for overseeing the internal control system.  The CEO is responsible for the “tone at the top.”  Senior management delegates the responsibility for the implementation of the IC system to the appropriate departments and personnel.  Financial and accounting officers and staff are the people with the most close contact with the IC system.  External parties such as independent auditors often provide information useful to effective internal control.
  144. 144. 144 144 The Internal Auditor’s Role in the Control Process  Internal auditors is to evaluate the effectiveness of the organization’s systems of controls based on the aggregation of many individual assessments.  These assessments might come from the internal auditors own engagements, or from management’s self-assessment, or from the external auditors.  During the course of the internal auditor’s own engagement, the internal auditor should communicate to the appropriate level of management any, and all control discrepancies and weaknesses.  If discrepancies or weaknesses are found, this does not necessarily mean that it is pervasive and poses an unacceptable risk to the company.
  145. 145. 145 145 Internal Auditor’s Role, continued  A report of the CAE on the state of the organization’s control processes should be presented, at least, once a year. More if deemed necessary.  The report should include major recommendations for improvement and information about current control discrepancies or weaknesses.  In addition the report can include information about current control issues and trends, such as technology and information security exposures, patterns of control discrepancies or weaknesses.  This information can add value to the report and minimize potential difficulties in complying with laws or regulations.
  146. 146. 146 146 Internal Auditor’s Role, continued  In regards to the internal auditors role, there is a term to be familiar with. This term is “expectancy gap.”  Expectancy gap is where on the one hand management and the board usually have high expectations as to the level of assurance that is provided by the IAA.  But, on the other hand, there is the reality of what the IAA can actually provide assurance on. The IAA can only provide reasonable assurance but not a guarantee.
  147. 147. 147 Reviewquestion 71, pg. 81
  148. 148. 148 Control Self-Assessment (CSA)
  149. 149. 149 149 Control Self-Assessment (CSA)  Control Self-Assessment (CSA) is an examination and assessment process of the effectiveness of the control system within an organization performed by the organization’s personnel with the help of facilitators.  This process is shared among all employees of the organization and responsibility for control is expanded to include all individuals of the organization.  The employees thereby become the process owners.  An important aspect of CSA is when people are able to identify their own problems, they are more committed to resolving them than they are if the same problems are identified for them in an audit.
  150. 150. 150 150 CSA, continued  Assessments are performed through a series of workshops or meetings or by means of questionnaires.  Assessments can be applied to any area of the organization: projects, processes, business units, or functions.  Whatever format is used, the goal is to help organizations assess the likelihood of achieving their objectives by using the knowledge of the workers who are responsible for making it happen.
  151. 151. 151 151 CSA Procedures  CSA procedures include the following:  Identifying potential risks and exposures,  Assessing the control processes that mitigate or manage those risks,  Developing action plans to reduce risks to acceptable levels, and  Determining the likelihood of achieving the business objectives.
  152. 152. 152 152 Advantages of CSA  For an organization the primary advantages of a CSA program are that it:  Enhances employee understanding of the company’s risk and controls.  Enhances employee control consciousness.  Provides a mechanism for early risk detection.  Encourages more open communication, teamwork and continuous improvement.  Empowers the employees and enhances accountability.
  153. 153. 153 153 Approachesto CSA  Each CSA program that is implemented by an organization should be customized to fit that organization.  This means that the program should be dynamic and be able to change as the organization changes.  The three primary approaches to CSA are:  Facilitated team workshops,  Surveys / Questionnaires, and  Management-produced, or self-auditing/self certification.  Organizations often combine more than one approach to accommodate their self-assessment.
  154. 154. 154 154 Facilitated TeamWorkshop  The facilitated team workshop is the process of gathering information from work teams that represent different levels in the organization.  For a facilitated team workshop, there needs to be a facilitator who brings the team together, and in essence, facilitates the process.  It is crucial for the facilitator to have no hidden agenda.  The team members need to be very truthful about what is working well and what is not working well.
  155. 155. 155 155 Facilitated TeamWorkshop formats  There are four basic CSA-facilitated meeting formats:  Control-based. This format reviews how well the control in place are working. The purpose of the workshop is to produce an analysis of the gap between how controls are working and how well management expects those controls to work.  Objective-based. This format focuses on the best way to accomplish the organization’s objectives. The aim of the workshop is to decide whether the necessary controls are in place and working effectively and are resulting in residual risks within an acceptable level.
  156. 156. 156 156 Facilitated TeamWorkshop formats, continued  Risk-based. This format focuses on listing the risks to achieving the organization’s objectives. The aim of the workshop is to determine significant residual risk. This workshop starts by listing all possible barriers, obstacles, threats and exposures that might prevent the organization from achieving its objects.  Process-based. This format focuses on selected activities that are elements of the process chain. The general aim of this workshop is to evaluate, update, validate, improve and even streamline the whole process and its component activities.
  157. 157. 157 157 Surveysand Questionnaires  Surveys or questionnaires tend to ask simple “Yes-No” or “Have-Have Not” questions.  The questions may be customized for the unit’s regulatory environment or other specific needs.  The questions relate to the primary internal controls and how the controls are monitored.
  158. 158. 158 158 Management-produced Analysis  This approach does not use a facilitated meeting or survey.  Through this approach, management produces a staff study of the organizational processes.  The CSA specialist (who is generally an internal auditor) combines the results of the study with information gathered from sources such as other managers and key personnel.  The specialist then synthesizes the information and develops an analysis that process owners can use in their CSA efforts.
  159. 159. 159 Internal Auditor’s Role in Quarterly Financial Reporting, Disclosures, and Management Certification
  160. 160. 160 160 IA’s Role in QuarterlyFinancial Reporting, Disclosures, and Management Certification  Because of the recent accounting scandals, internal auditors are now playing an even more important role.  The role the internal auditor plays may range from  The initial designer of the process, participant on a disclosure committee, coordinator, or  Liaison between management and its auditors, to  Independent assessor of the process.
  161. 161. 161 161 Recommended Actionsfor Internal Auditors  Summary of recommendations of the IA’s role, including:  Be involved in some capacity in the quarterly reporting and disclosure process.  Ensure that the organizations have written policies and procedures that govern the quarterly financial reports.  Encourage the establishment of a disclosure committee. This disclosure committee’s help with transparency.  Periodically review and evaluate the quarterly reporting and disclosure processes.  Recommend appropriate improvement in the policies, etc.  Compare processes for compliance with SOX.
  162. 162. 162 The Control Process
  163. 163. 163 163 Establishingthe Control Process  The control process is established by management.  Without any control process, the planning process becomes much less valuable and less useful to the organization than it should.  Three main steps in the control process are:  Setting the standards (objectives) that are to be achieved,  Measuring the performance against a standard, and  Evaluating the results and then correcting, or regulating the performance as a result of what was measured.
  164. 164. 164 164 Setting the Standards  Setting Standards (Objectives) – When setting standards that are expected to be achieved in terms of something (Quantity – number of units produced, Quality – number of defects, Time – the length of time required, Cost – cost of materials), it is critical to use the item that is most responsible for the incurrence of additional costs.  After the achievable standards are determined, it is important to select the time (or point) in the process at which you will measure performance compared to the standard. These points are called Control Points.
  165. 165. 165 165 Setting the Standards, continued  Whatever standards an organization sets, the organization must remember that these are the standards for a moment in time.  The standards need to be reviewed on an ongoing basis and revised (or even eliminated) based on changes in the circumstances or processes.  It is important to get the people involved in the measurement process to also be involved in the process of developing the standards and methods used. By being involved, the employees will feel more ownership of the process and should be more motivated to achieve something that they contributed setting up.
  166. 166. 166 166 MeasuringPerformance  Every product or service can be measured in some way against some standard.  It is management’s job to determine what measurement is to be used.  For example, if management is simply trying to increase production, then efficiency measurements might not be appropriate.  Another important part of the measuring process is determining who is going to do the measurement.  Self-measurement is preferable in it builds employee morale and empowerment and it is cheaper.  Second party measurement is more expensive, but may lead to better and more pertinent results.
  167. 167. 167 167 MeasuringPerformance, continued  A performance report should be aligned with the objectives of the firm and include a specific time frame. This report should also be limited to items that are controllable by the person responsible. The report should not get into items that are outside the scope of the timeframe or the responsibilities of the person.
  168. 168. 168 168 Evaluation and Correction  This is the critical part of the control process. Without this last part the control process is useless.  There are a number of items that you must keep in mind when making the evaluations of results.  Need to make sure you are comparing like items to like items.  If there are significant changes in the process from one period to the next, it is not accurate or effective to compare to prior periods.  It is easier to measure something that is either yes or no. For example, something like defects will be measured and evaluated this way.
  169. 169. 169 169 Evaluation and Correction, continued  However, some things are measured in a more subjective manner, for example, “How well does the person complete his or her tasks?”  These are trait-based decisions, and more care must be taken in the evaluation of the results and it may be best to have more than one person involved in the decision process.  Trait-based decisions are more subjective and more easily influenced by the emotions of the people involved.
  170. 170. 170 170 Systems of Control  A control system is designed so it will help the company achieve or maintain the desired actions, behaviors or results.  There are three elements to any control system: input, processing, and output.  Systems may be classified as either open or closed.  Open system is impacted by its environment. System may receive uncontrollable input information from the outside and this information will affect the system.  Closed system does not receive any uncontrollable inputs. Example of a closed system is the one to regulate the temperature in your house.
  171. 171. 171 171 Feedback Element of the Control System  Feedback plays an important part in any control system.  Feedback ensures that a desired state is attained and maintained.  The five components to a feedback system are:  A control object – this is the element or variable that is being monitored,  The detector – this is what is happening in the control object,  The reference point – this is the standard that the control object is measured against,  The comparator (analyzer) – this is comparing what is happening and what should be happening, and  The activator – this is the decision-maker in respect to the decision.
  172. 172. 172 172 The Timingof Controls  It is better to prevent mistakes than to detect them after they have occurred.  There are three types of controls that are classified depending on when in the production process the control identifies the defective unit.  Feedforward controls detect the problem before it occurs.  Concurrent controls operate at the same time as the production process.  Feedback controls identify when something has already gone wrong.
  173. 173. 173 Reviewquestion 72, pg. 86
  174. 174. 174 174 Characteristics of Effective Controls  An effective control system has the following characteristics.  Economical - there is a positive cost/benefit, meaning that the organization saves more than it costs to implement the control.  Meaningful – it is important to only control important items.  Appropriate – the control system should actually reflect what we are trying to measure and control.  Congruent – the control should be in line with what it is measuring.  Timely – the information must be available in enough time to act upon it.  Simple – the control must be understandable.  Operational – the control should provide benefit to real operations.
  175. 175. 175 Reviewquestion 73, pg. 87
  176. 176. 176 176 Control andTechnology  Computer technology has made it easier and cheaper to have control systems that cover many areas and that are able to provide real-time feedback.  Has lead to the increased popularity of Total Quality Management (TQM) and Reengineering.
  177. 177. 177 177 Total Quality Management (TQM)  The premise of TQM is that quality improvement is a way of increasing revenues and decreasing costs.  It is based on producing a product “right the first time.”  Another feature of TQM is quality circles. Quality circle is a small group of employees who work together and meet regularly to discuss and resolve work-related problems.  With TQM, every person in the organization is responsible for finding errors and correcting problems.
  178. 178. 178 178 Reengineering  Reengineering is when a company is determined to find a new way of doing something.  Reengineering is NOT simply improving an existing system, but developing a completely new system or approach.  Because of effort and time involved, reengineering should only be done for the most important processes.
  179. 179. 179 Reviewquestions 74-76, startingon pg.89
  180. 180. 180 Means of Achieving Control
  181. 181. 181 181 Means of Achieving Control  There are a number of different ways that internal controls can be set up. Some of the different means are discussed below:  Organizational methods is where responsibilities are split up so no one individual controls more than one part of a transaction (segregation of duties).  Policies are stated principles that provide guidance in behavior. Policies are directive controls. Policies should be clearly written and communicated to all employees. Policies should be occasionally reviewed to make sure they are still relevant.  Procedures are the actions for carrying out the policies.
  182. 182. 182 182 Means of Achieving Control, continued  Pre-numbered forms is another method to control and safeguard documents. Need to remember that no pre-numbered form should be disposed of, even if the form is not correct. In these cases, the pre-numbered form should be kept and stated that it was cancelled.  Personnel is making sure that good people are hired and there is a high standard of supervision. Employees should be trained and reviewed on a periodic basis.  Accounting is a crucial part of the system because this is where the financial information is accumulated and produced.  Budgeting is done so actual results can be compared with anticipated results. People who will be held responsible for the achievement of the budget should be involved in creating it.
  183. 183. 183 183 Means of Achieving Control, continued  Reporting has to do with management receiving the reports that are relevant to their responsibilities. Reports should not only include actual results, but compared against the budget. Reports have to be provided in a timely manner so management can act upon the information. This timeliness is control function that helps management identify potential problems.
  184. 184. 184 Reviewquestion 77, pg. 93
  185. 185. 185 Internal Controls Models
  186. 186. 186 186 Internal Control Models  A series of control models were developed during the 1990s. The models we will be looking at are:  Internal Control – Integrated Framework (COSO),  CoCo model, and  The IIA model.  For the most part, these controls have the same goal as to provide management with a better understanding of their control systems so they can make judgment about their effectiveness.
  187. 187. 187 187 The COSOModel  During the 1980s there was a private sector initiative, sponsored by five organizations, that attempted to identify the causes of fraudulent financial reporting and to make recommendations to reduce its incidence.  The five sponsoring organizations are:  American Institute of Certified Public Accountants (AICPA),  American Accounting Association (AAA),  Institute of Internal Auditors (IIA),  Institute of Management Accountants (IMA), and  Financial Executives International (FEI).
  188. 188. 188 188 Componentsof Internal Control  There are five components that make up internal control  The Control Environment,  Risk assessment,  Control activities,  Information and communication, and  Monitoring.  You can remember these components by the mnemonic CRIME (bolded letters).
  189. 189. 189 Control Environment, continued  This is the most important element of internal controls because it is the basis on which the other elements are built.  This element sets the tone for the entire organization.  Control environment factors include:  Integrity, ethical values and the competence of the company’s people.  Management’s commitment to competence.  Human Resource policies and procedures.  Assigning authority and responsibility (assigning decision rights).  Management’s philosophy and operating style.  Board of directors and audit committee oversight.
  190. 190. 190 Control Environment, continued  The control environment is set by management by the actions, deeds and behaviors. If management communicates and behaves in such a way to indicate that controls are important, employees are more likely to follow the controls in place.  Management plays the most important role in establishing the control environment.  Management’s commitment to competence is another factor influencing the control environment. All personnel need to be competent enough to accomplish their duties.
  191. 191. 191 191 Control Environment,continued  Controls are more likely to work if management believes controls are important and communicate that support to all employees.  Organizations with effective controls set a positive “tone at the top.”  Transmit guidance both verbally and by example.  Foster a “control consciousness” by setting formal and clearly communicated policies and procedures that are followed at all times, without exception.  Making sure employees are in the right positions can be done through training, as well as providing counseling, and performance evaluations.  Board of directors is responsible for setting corporate policy and for seeing that the company is operated in the best interest of shareholders.
  192. 192. 192 Control Environment, continued  A company’s organizational structure plays an important role in internal controls.  Factors that need to be properly addressed are:  Defining authority and responsibility, as well as the corresponding delegations,  Matching a structure with the needs of the business, and  Creating an atmosphere of accountability within the company
  193. 193. 193 193 Risk Assessment  This is management’s assessment of the risks that the agency faces. Risks may be internal or external.  Internal Risks include employee embezzlement accompanied by falsification of records to conceal theft; lack of compliance with governmental regulations; or other illegal acts by employees, such as taking a bribe. These risks can include disruption in computer systems, poor management decisions, errors, or accidents.  External Risks include changes in technology, changes in federal legislation, natural disasters, economic changes, or being defrauded, or robbed.
  194. 194. 194 194 Risk Assessment, continued  A pre-condition of risk assessment is the establishment of objectives.  Once risks have been identified, management needs to analyze their possible effect. Risk analysis includes:  Estimating the likelihood of the risk’s occurrence,  Deciding how to best manage the risk, and  What actions can be taken to mitigate the risk.  If management is unable to identify the risks that the agency faces, they are much less likely to be able to address those risks.
  195. 195. 195 195 Control Activities  These are the policies that are developed to address the risks of the agency. These risks may be fraudulent reporting or theft (misappropriation of assets).  Control activities should be designed to mitigate risk, wherever risk exposure is determined to exist, for the purpose of protecting the organization’s ability to achieve its objectives.  Controls that are implemented must have a benefit that is greater than the cost of that control.  Because of this, not all controls are implemented and the control environment cannot provide a guarantee that all risks are eliminated.
  196. 196. 196 196 Classifications of Control Activities  Control activities may be classified by their objective  Preventive controls attempt to prevent the mistake from ever occurring in the first place. Examples would include segregation of duties, suitable authorization of transactions, checking the credit worthiness of a customer before goods are shipped.  Directive controls attempt to ensure the occurrence of a desirable event. Examples would include managers of a construction company instruction their project managers to hire local workers in order to create a favorable image in the community in which the company operates.
  197. 197. 197 197 Classifications of Control Activities, continued  Detective controls attempt to find the mistake after it has occurred. Examples would include bank reconciliations, check for missing document numbers in pre-numbered documents, performance reporting with variances.  Corrective controls attempt to fix the problem after it has occurred. Examples of corrective control would be finding an error when doing a bank reconciliation, etc.  Compensating controls attempt to address a weakness in controls in one place by setting up additional controls in a related area. We look at compensating controls in more detail a bit later.
  198. 198. 198 198 Examples of Control Activities  Top level review of actual performance  Reviews by management at the functional or activity level  Management of human capital  Controls over information processing  Physical controls to protect assets (cash and other assets)  Various performance indicators  Documents and record protection and authorization  Pre-numbered documents  Performance evaluations  Hiring controls to ensure that qualified personnel are hired  Control over system modifications  Segregation of Duties
  199. 199. 199 199 Segregation of Duties  By dividing specific duties (listed on the next slide) between different individuals, the likelihood of errors or inappropriate behavior (theft or fraud) is greatly reduced.  The separation of duties can be done in the following steps:  Identify a function that is indispensable, but potentially subject to abuse.  Divide that function into separate steps, each of which is necessary for the function to work, or for the power that enables that function to be abused.  Assign each step (or duty) to a different person or organization.
  200. 200. 200 200 Dutiesto be Segregated  The following duties need to be segregated between different people:  The authorization of a transaction,  The recording (record keeping) of the transaction,  Keeping physical custody of the asset, and  The periodic reconciliation of the records of the asset (how much there should be) to the actual amount of the asset (how much there is).
  201. 201. 201 201 Dutiesto be Segregated, continued  More examples of Segregation of Duties:  One person has authority to adjust accounts receivable, while a different person posts payments on customer accounts. Without segregation here, one person could divert cash receipts and then falsify the account balances of the customers who paid the cash in order to conceal the diversion.  One person is responsible for preparing the bank deposit, while a different person reconciles the checking account. Without segregation, one person could divert cash receipts and cover the activity by creating “reconciling items” in the account reconciliation.
  202. 202. 202 202 Dutiesto be Segregated, continued  Examples of Segregations of Duties:  One person has custody of cash receipts, while a different person has the authority to authorize account write-offs. Without segregation, one person could authorize a false write-off while diverting the collection on the account.  One person authorizes issuance of purchase orders, while a different person is responsible for recording receipt of inventory. Without such segregation, one person could issue a purchase order to a fictitious vendor using a post office box rented for the purpose, then prepare a fictitious receiving record and mail an invoice to the company using a post office box personally rented for the purpose, resulting in the company’s paying for something it never ordered or received.
  203. 203. 203 203 Limitationsof Segregation of Duties  No system is perfect and no system can eliminate all of the risks that a company faces.  Some of the reasons that risk can not be completely eliminated are:  Collusion - when two or more people work together to get around the controls in place. If the people whose duties are segregated collude, the benefit of the segregation of duties is lost.  Human judgment - decisions are made by humans, often under pressure and time constraints, based only on information at hand. If this is not enough information, then poor decisions will be made and controls may not be maintained.
  204. 204. 204 Reviewquestions 78-83, pg. 97
  205. 205. 205 205 Information and Communication  Information needs to be obtained and communicated to people to allow them to perform their duties.  Information needs to be  Relevant,  Reliable, and  Timely.  Information needs to be available before a decision needs to be made.  Duties and responsibilities need to be communicated to all effected parties.  Communication needs to be both internal and external.
  206. 206. 206 206 Information and Communication, continued  Communication must be on-going, both within and between the various levels and activities of the organization.  Effective communications flows up, down and across the organization.  Program managers use reports containing operational and financial information in order determine whether they are meeting their objectives.  Operational information is also necessary to determine whether the agency is in compliance with various laws and regulations.  Financial information is needed for periodic external reporting, and, on a day-to-day basis.