Audits, Internal

Under some circumstances, however, experts contend that a firm may be able to claim a legal foundation for withholding particular internal audit reports. According to Compliance Reporter, "If a specific report has been prepared under the supervision of legal counsel and for the purpose of providing legal advice to the firm and not for more routine business purposes, or the report has been specifically prepared at the direction of attorneys in anticipation of threatened litigation, then the report may be protected by either the attorney-client privilege or the attorney work product doctrine."

DIFFERENCES BETWEEN INTERNAL AND EXTERNAL AUDITING

Internal auditors and external auditors both audit, but have different objectives and a different focus. Internal auditors generally consider operations as a whole with respect to the five key internal control objectives, not just the financial aspects. External auditors focus primarily on financial control systems that have a direct, significant effect on the figures reported in financial statements. Internal auditors are generally concerned with even small incidents of fraud, waste, and abuse as symptoms of underlying operational issues. But the external auditor may not be concerned if the incidents do not materially affect the financial statements—which is reasonable given the fact that external auditors are engaged to form an opinion only of the organization's financial statements. The external auditor does perform services for management, including making recommendations for improvement in systems and controls. By and large, however, these are financially oriented, and often are not based on the same level of understanding of an organization's systems, people, and objectives that an internal auditor would have. It should be recognized, however, that the traditionally limited role of the external auditor has broadened in recent years to include an increased operational review facet.

This comparison of internal auditing to external auditing considers only the external auditors' traditional role of attesting to financial statements. During the 1990s a number of the large public accounting firms began establishing divisions offering "internal auditing" services in addition to existing tax, actuarial, external auditing, and management consulting services. Predictably, the event has caused a flurry of debate among auditors about independence, objectivity, depth of organizational knowledge, operational effectiveness, and true costs to the organization.

One option available to small business enterprises is to investigate the possibility of "co-sourcing" its internal audit functions with an outside vendor. "Co-sourcing arrangements with outside vendors allow the in-house auditors to retain responsibility for the internal audit process while relying on the outside entity for specialized technical skills and personnel," wrote C. William Thomas and John T. Parish in Journal of Accountancy. "By contract, a company that outsources loses day-to-day control over its activities to the vendor—usually a professional service firm."

As Thomas and Parish note, the relative autonomy of the internal audit function makes it an ideal candidate for co-sourcing. Under such an arrangement, the outside vendor can attend to specialized elements of the internal audit function, such as "reconciliation of specialized accounts; valuation, disclosure and Environmental Protection Agency compliance issues for certain types of inventory; and reconciliation of foreign accounts where business customs pose review problems." In return, the company saves expenses on permanent staff, gains greater in-house flexibility in evaluating projects and practices, and garners the ability to maximize its access to specialized knowledge by selecting vendors for each functional area.

There are potential drawbacks to the co-sourcing arrangement, however. Thomas and Parish cite staff worries over long-term job security, the possibility of "turf battles" between in-house auditors and vendors, and loss of in-house focus on "big picture" issues of company-wide profitability and efficiency as stumbling blocks. But they charge that "a cost-conscious, proactive internal audit group with custom-designed co-sourcing programs retains the advantages of outsourcing along with the benefits of having an in-house internal audit staff, such as knowledge of management methods, accessibility, responsiveness, loyalty, and a shared vision for the organization's strategic business goals."

TYPES OF INTERNAL AUDITS

Various types of audits are used to achieve particular objectives. The types of audits briefly described below illustrate a few approaches internal auditing may take.

Operational Audit

An operational audit is a systematic review and evaluation of an organizational unit to determine whether it is functioning effectively and efficiently, whether it is accomplishing established objectives and goals, and whether it is using all of its resources appropriately. Resources in this context include funds, personnel, property, equipment, materials, information, space, and whatever else may be used by that unit. Operational audits can include evaluations of the work flow and propriety of performance measurements. These audits are tailored to fit the nature of the operations being reviewed. "Carefully done, operational auditing is a cost-effective way of getting a higher return from the audit function by making it helpful to operating management," wrote Hubert D. Vos in What Every Manager Needs to Know About Finance.

System Audit

A system analysis and internal control review is an analysis of systems and procedures for an entire function such as information services or purchasing.

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