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How Does Internal Auditing Maintain Its Independence And Objectivity

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Category: Business

Autor: anton 18 June 2011

Words: 2043 | Pages: 9

Table of Contents

I. Introduction

II. The purpose of internal auditing

III. Profession guidance on independence and objectivity

IV. Consulting services: a challenge to audit independence?

V. Independence vs. Objectivity

VI. Conclusion

VII. Bibliography

I. Introduction

‘The internal auditor occupies a unique position he or she is employed by the management but is also expected to review the conduct of management which can create significant tension since the internal auditor's independence from management is necessary for the auditor to objectively assess the management’s action, but the internal auditor's dependence on the management for employment is very clear.’

-------Institute of Internal Auditors (IIA)

Although recently the focus of internal auditing is on Sarbanes-Oxley compliance, the importance of maintaining the independence and objectivity of internal audit should never be underweighted. In fact, if the independence and objectivity of internal auditing is impaired, Sarbanes-Oxley compliance is impaired at the same time.

INDEPENDENCE: The freedom from conditions that threaten objectivity or the appearance of objectivity. Such threats to objectivity must be managed at the individual auditor, engagement, functional, and organizational levels (IIA).

‘Audit independence is essentially a state of mind’. Internal auditors can not be physically independent from the organization they are working for, but they can always stay objective.

OBJECTIVITY: An impartial, unbiased mental attitude and avoidance of conflicts of interest, allowing internal auditors to perform engagements in such a manner that they have an honest belief in their work product and that no significant quality compromises are made (IIA).

In order to stay objective, internal auditors should not assume any management responsibilities and should avoid auditing anything that they have direct or indirect authority or responsibility for. Internal auditors are not supposed to receive any gifts, cash, or special treatment from any employees, business associates, or clients. Staff auditors should have job rotations periodically.

II. The purpose of internal auditing

‘Internal auditing is 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.’

--- IIA’s internal audit definition

Any discussion of the independence and objectivity of internal audit should begin with the purpose of internal audit function in an organization.

In a small entity, the employer or the boss knows every employee by name. And most of the time, the employer owns the entity. He or she is the one who supervises everything in the entity. Since the entity is small and has limited people to govern, there is no need for internal auditing. The boss knows everything.

In a large entity, the owners include a group of stakeholders and the entity is managed by executives. There are more employees in the entity, business transactions are more sophisticated, and there are more departments and management levels. It is impossible for the stakeholders or executives to supervise everything. Therefore, there is a need for internal auditors to assume internal control and risk management responsibilities for those stakeholders and executives. And sometimes the internal auditors will also serve as consultants for management regarding a certain project or management issue. The purpose of having internal audit function in a large entity is to improve efficiency, control risk, manage risk, and eventually add value to the organization.

Therefore, the internal audit function must be independent from management responsibilities, and report directly to executives and board of directors. Unlike external auditors who serve mainly to third party users, internal auditors work for the company and assume internal control responsibilities for board of directors and executive management. They also provide consulting, recommendations, appraisals, and analysis to top management executives that is independent from the line of management.

III. Profession guidance on independence and objectivity

1) Practice Advisory 1100 ---- Independence and Objectivity

Internal auditors are independent when they can carry out their work freely and objectively. Independence permits internal auditors to render the impartial and unbiased judgments essential to the proper conduct of engagements. It is achieved through organizational status and objectivity.

2) Practice Advisory 1110 ---- Organizational Independence

The IIA's Standards for the Professional Practice of Internal Auditing

(Standards) require that the chief audit executive (CAE) report to a level

within the organization that allows the internal audit activity to fulfill its

responsibilities. The Institute believes strongly that to achieve necessary

independence, the CAE should report functionally to the audit committee or its equivalent. For administrative purposes, in most circumstances, the CAE should report directly to the chief executive officer of the organization.

3) International Standards for the Professional Practice of Internal Auditing (ISPPIA) ---

a) The board and executive management require reasonable assurance the entity’s mission and objectives can be achieved. To that end, they are responsible for monitoring the actions subordinate line managers take to design and implement a sound control system capable of providing the required reasonable assurance.

b) Under the general direction of executive management, it is the subordinate line manager's responsibility to manage the operation and achieve the objectives and desired outcomes established by the board and the members of executive management.

c) Internal auditing under the ISPPIA is performed on behalf of the board and management. The internal auditor is an integral part of the entity whose primary role is to form an opinion about the state of control, report that opinion to the board and executive management, and offer advice and counsel to members of the entity.

d) Under the ISPPIA, the internal auditor can advise on, but not design, implement or operate, systems of control. The internal auditor may choose to make recommendations. It is the line manager's responsibility to take corrective action, or accept the related risk. The responsible line manager thus is free to accept, reject, or propose alternative courses of action in accordance with the wishes of the board and executive management.

e) The internal auditor is independent if s/he reports to a level of governance sufficient to permit: adequate consideration of audit reports; appropriate consideration of audit recommendations; and accomplishment of audit responsibilities free from interference. The internal auditor is objective when s/he does not subordinate professional judgment to the judgment of others on audit matters, when s/he has an honest belief in the audit work product, and when no significant compromises are made in audit quality.

IV. Consulting services: a challenge to audit independence?

In recent years, consulting service has emerged as an important component of internal auditors’ practice. Consulting services are advisory and related client service activities, the nature and scope of which are agreed with the client and which are intended to add value and improve an organization's governance, risk management, and control processes without the internal auditor assuming management responsibility. Examples include counsel, advice, facilitation and training (IIA). How far can internal auditors go when providing consulting services without sacrificing independence for future assurance engagements? Practice advisory 1130 discusses about this issue.

Practice Advisory 1130 ---- Impairments to Independence or Objectivity

If independence or objectivity is impaired in fact or appearance, the details of the impairment should be disclosed to appropriate parties. The nature of the disclosure will depend upon the impairment.

1) 1130.A1 – Internal auditors should refrain from assessing specific operations for which they were previously responsible. Objectivity is presumed to be impaired if an internal auditor provides assurance services for an activity for which the internal auditor had responsibility within the previous year.

2) 1130.A2 – Assurance engagements for functions over which the chief audit executive has responsibility should be overseen by a party outside the internal audit activity.

3) 1130.C1 – Internal auditors may provide consulting services relating to operations for which they had previous responsibilities.

4) 1130.C2 – If internal auditors have potential impairments to independence or objectivity relating to proposed consulting services, disclosure should be made to the engagement client prior to accepting the engagement.

So is consulting service provided by internal auditors a challenge for audit independence? To some extent it is. In fact, in some organizations the level of consulting service is strictly limited due to the concern of the external parties or the board that the independence and objectivity of internal auditing may be impaired.

In order to maintain maximum independence, there are mainly three principles internal auditors should follow when conducting consulting services. The guest speaker Ted Flom from the Institute of Internal Auditors mentioned those principles in Dr Odom’s class too. First, internal audit should not assume management responsibilities. It is highlighted in the definition for consulting services that they ‘are intended to add value and improve an organization's governance, risk management, and control processes without the internal auditor assuming management responsibility’. Second, internal auditors should not audit their own work. Although this is different from assuming direct responsibility, it is still important and if not prohibited would impair independence and objectivity too. The auditors are not supposed to audit the work they have provided consulting services on before. In addition to that, the internal auditors should also avoid auditing works that create a mutual of interest or place auditors in the role of advocate for the company. Third, if independence or objectivity is impaired (in appearance or fact), proper disclosure is needed.

It is the CAE’s responsibility to maintain the balance between the assurance and consulting services and periodically review the nature and scope of the internal audit function within the organization.

V. Independence vs. Objectivity

Recently, IIA has placed significant emphasis on ‘objectivity’ and less on the concept of ‘independence’. In the lecture by Continental Airline CAE Steve Geopfert during Dr. Odom’s class, Mr. Geopfert mentioned that it is difficult for internal auditors to be completely independent since they are employees of the corporation but it is definitely possible for them to be objective. In fact, absolute independence would impair the internal auditor’s role to contribute to the corporation’s success. As mentioned before, ‘audit independence is essentially a state of mind’. Internal auditors can never be as independent as external auditors but it is possible for them to stay objective. After all, the main goal for internal auditing is too add value to the organization.

Furthermore, as the consulting services become internal auditors’ big part of responsibility, the most important thing to internal auditors is try to stay objective rather than to stay independent. After all, as long as the internal auditors maintain their objectivity and integrity, absolute independence is not necessary and probably impossible to achieve.

VI. Conclusion

Unlike external auditor, the internal auditor occupies a unique position s/he is employed by the organization but is also expected to render unbiased and impartial judgment when conducting assurance engagements within the organization. It is extremely important for internal auditors to maintain the independence and objectivity. The purpose of having internal audit function in an entity is to improve efficiency, control risk, manage risk, and eventually add value to the organization. Unlike external auditors which serve mainly to third party users, internal auditors assume internal control responsibility for board of directors and executive management.

The internal auditor’s scope of work also includes consulting services to management executives. However, there is concern that the independence and objectivity of internal auditing may be impaired because of the consulting services it provides. Therefore, in order to maintain maximum independence, internal auditors should not assume management responsibilities and should not audit their own work. It is the CAE’s responsibility to maintain the balance between the assurance and consulting services and allocate recourses to both engagements accordingly.

As to the question which is more important between independence and objectivity. In my opinion, as long as the internal auditors maintain their objectivity and integrity, absolute independence is not necessary and impossible to achieve and would probably impair the internal auditor’s role to add value to the corporation’s success. IIA has put more emphasis on the concept of ‘objectivity’ than ‘independence’ too.

VII. Bibliography

Kurt F. Reding, Paul J. Sobel, Urton L. Anderson, Michael J. Head, Sridhar Ramamoorti, Mark Salamasick, 2007, Internal Auditing: Assurance & Consulting services

Mark R. Simmons, 1999, Reflections on Independence and Objectivity http://www.facilitatedcontrols.com/internal-auditing/auditindependence.htm

The Institute of Internal Auditors, How does internal auditing maintain its independence and objectivity?

http://www.theiia.org/theiia/about-the-profession/internal-audit- faqs/?i=1084

Larie Brannen, Business Finance, August 2005, Preserving Internal Auditor’s Independence

www.businessfinancemag.com

Arthur A. Schulte, Jr., The Accounting Review, Vol. 41, No. 4 (Oct., 1966), pp. 721-728, Management Services: A Challenge to Audit Independence?

http://links.jstor.org/sici?sici=0001-4826(196610)41%3A4%3C721%3AMSACTA%3E2.0.CO%3B2-W

The Institute of Internal Auditors, International Standards for the Professional Practice of Internal Auditing

http://www.theiia.org/guidance/standards-and-practices/professional-practices-framework/standards/standards-for-the-professional-practice-of-internal-auditing/

The Institute of Internal Auditors, Practice Advisories

Practice Advisory 1100 ---- Independence and Objectivity

Practice Advisory 1110 ---- Organizational Independence

Practice Advisory 1130 ---- Impairments to Independence or Objectivity

http://www.theiia.org/guidance/standards-and-practices/professional-practices-framework/practice-advisories/

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