INTERNAL AUDIT

It is a review of the operations and records, sometimes continuously undertaken, within a business, specially assigned staff. But internal audit must not be confused with internal check. Internal check consists of a set of rules or procedures that are part of the accounting system, introduced so as to ensure that accounts of a business shall be correctly maintained and the possibility of occurrence of frauds and errors eliminated. On the other hand, internal audit is a thorough examination of the accounting transactions as well as that of the system according to which these have been recorded, with a view to reassuring the management that the accounts are being properly maintained and the system contains adequate safeguards to check any leakage of revenue or misappropriation of property
or assets and the operations have been carried out in conformity with the plans of the management. However, the routine process which an internal audit is carried out are broadly the same as those followed for professional audit. But internal audit often differs in its scope and emphasis : it is more managerial than accounting; also its form is varied, depending on the size of the organisation. For instance, whereas a professional auditor is primarily concerned with the legality or validity of transactions entered into a business, an internal auditor in addition is expected to ensure that the standards of economy and efficiency are being maintained. On that account, the internal auditor must ascertain that orders for the purchase of stock are placed only after inviting tenders, sales are effected
at the highest ruling rates, standard procedures as regards requirement of staff are followed, losses in manufacturing process suffered during the period under review are not higher than those in the earlier periods and so on. He must further confirm that there has been no leakage of stocks or revenue, overpayment of expenditure or pilferage or misappropriation of stocks or of any other asset, reconciling the physical accounting records and physical balance. The nature and extent of checking, that he should carry out, also would depend on the size and type of the business organisation.
“Internal Audit is an independent management function, which involves a continuous and critical appraisal of the functioning of an entity with a view to suggest improvements thereto and add value to and strengthen the overall governance mechanism of the entity, including the entity’s risk management and internal control system.”

The objects of internal audit can be stated as follows:
(1) To verify the accuracy and authenticity of the financial accounting and statistical records presented to the management.
(2) To ascertain that the standard accounting practices, as have been decided to be followed the organisation, are being adhered to.
(3) To establish that there is a proper authority for every acquisition, retirement and disposal of assets.
(4) To confirm that liabilities have been incurred only for the legitimate activities of the organisation.
(5) To analyse and improve the system of internal check ; in particular to see

  • that it is working ;
  •  that it is sound ;
  • and that it is economical.

(6) To facilitate the prevention and detection of frauds.
(7) To examine the protection afforded to assets and the uses to which they are put.
(8) To make special investigations for management.
(9) To provide a channel wherenew ideas can be brought to the attention of management.
(10) To review the operation of the overall internal control system and to bring material departures and non-compliances to the notice of the appropriate level of management ; the review also generally aims at locating unnecessary and weak controls for making the entire control system effective and economical.
As per AAS-7 The scope and objectives of internal audit vary widely and are dependent upon the size and structure of the entity and the requirements of its management.
Normally, however, internal audit operates in one or more of the following areas :

  1.  Review of accounting system and related internal controls : The establishment of an adequate accounting system and related controls is the responsibility of management which demands proper attention on a continuous basis. The internal audit function is often assigned specific responsibility management for reviewing the accounting system and related internal controls, monitoring their operation and recommending improvements thereto.
  2.  Examination for management of financial and operating information : This may include review of the means used to identify, measure, classify and report such information and specific inquiry into individual items including detailed testing of transactions, balances and procedures.
  3.  Examination of the economy, efficiency and effectiveness of operations including non-financial controls of an organisation : Generally, the external auditor is interested in the results of such audit work only when it has an important bearing on the reliability of the financial records.
  4.  Physical examination and verification : The would generally include examination and verification of physical existence and condition of the tangible assets of the entity.It is also worthwhile to know the modern concept of internal auditing.

The Institute of Internal Auditors, USA defined internal auditing “as an independent appraisal function, established within an organisation to examine and evaluate its activities as a service to the organisation. The objective of internal auditing is to assist members of the organisation in the effective discharge of their responsibilities. To this end, internal auditing furnishes them with analyses, appraisals, recommendations, counsel and information concerning the activities reviewed”. According to proponents of modern internal auditing, it embraces not only the operational audit of various operating activities in the organisation but also includes the audit of management itself. Recently, the Institute of Internal Auditors revised the definition of Internal Auditing as under: “Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organisation’s operations. It helps an organisation accomplish its objectives bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control and governance process.”
The main thrust of the revised definition is to remphasise the increasing scope of internal audit with a view to achieving maximum organisational effectiveness. It is felt that if such an activity is an integral part of the organisation, it shall go a long way to maximise the organisational goals. As students, if you trace the emergence of internal auditing over a period of time since early forties in the twentieth century, the scope of internal auditing increased considerably from financial to non financial activities. With the passage of time, the internal audit came to be recognised as a valuable resource to achieve overall growth objectives of the organisation.
To be effective, the internal auditor must be regarded as part of the management and not merely as an assistant thereto. He must have authority to investigate from the financial angles, every phase of the organisational activity under any circumstances. In recent years, there has been a growing tendency in Western countries to make the internal auditor responsible directly to the Board of Directors for the maintenance of adequate accounting procedures and for the preparation of financial statements and reports as regards the functioning of the business. His main responsibility, however, must be to maintain adequate system of internal control a continuous examination of accounting procedures, receipts and disbursements and to provide adequate safeguards against misappropriation of assets. In carrying out these functions, he must operate independently of the accounting staff and must not in any way divest himself of any of the responsibilities placed upon him. He should also not involve himself in the performance of executive functions in order that his objective outlook does not get obscured the creation of vested interest.
It may be further pointed out that internal auditors who are qualified accountants, because of their training and experience, can be of great assistance to the management even in fields other than accounting. They can observe facts and situations and bring them to notice of authorities who would otherwise never know them ; also, they critically appraise various policies of the management and draws its attention to any deficiencies, wherever these require to be corrected. In order that an internal auditor may be able to play such a role in the field of management, he must be closely associated with it and his knowledge must be kept up to date his being kept informed about all important occurrences and events affecting the business, as well as the changes that are made in business policies. Also, he must enjoy an independent status.

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