Session 8

[Annie]

Hi all,

Catch Me is a camera manufacturing company owned by Williams which gained a lot of popularity in a short span of time. Williams is also thinking of manufacturing other electronic products but needs finance. For this he thinks of going in for an IPO and then later on getting listed. He seeks advice from his friend Marshal who is a certified accountant. Marshal analyses Williams growing popularity and his business prospects and the changes the organisation would have to undergo in view of getting listed. Marshall also takes into account the view of the external auditor about the appointment of an internal audit team to improve on the irregularities in the controls. However, Williams is of the opinion that the work performed by both the external and internal auditors is the same, and appointment of an internal auditor would be duplication. In this discussion the finance manager is convinced about the requirement for an internal audit function in the organisation. He suggests that the internal auditor should report to him since he is fully aware of the existing control systems.


Required:
a)Critically evaluate Williams view point about the work performed by the internal auditors.

b)Critically evaluate the finance manager’s suggestion.


Annie

[Acid]

a) Williams claim of appointing the external auditor as the internal auditor as well is inappropriate because If that happens then the essence of internal and external auditor will be lost.

An external auditor should be independent to the organization i.e. shouldnt have any interest in the organization to enable him to perform his work obectively and give an appropriate audit opinion. Large companies are required usually by statute to perform the external audit under the companies act.

An internal auditor is a part of management whos purpose is to report on the effectiveness of the companies internal control system and to ensure that strategies implemented are operative.

The scope of internal audit and external audit are different which will determine the audit procedures which the auditor will use.

The scope of internal audit includes :


Examination and evaluation of adequacy and effectiveness of ICS.
Review of realibility , integrity , adequacy and timeliness of financial and reporting information
review of the systems established for
compliance with laws and legilsations , safequarding of assets against various losses like theft , fire etc.The external auditor is only responsible to ensure the financial statements give a true and fair view and are free from material misstatements.

The scope of EA is limited to Financial information while IA scopes Non Financial information too e.g. procurement , marketing , production policies etc.


b) Financial manager may have good information about the operating knowledge of internal control systems , but according to good corporate governance the internal auditor should be reporting to the senior management or to audit committe which will cordinate with all business functions rather then only the finance dept.

If IA report only to finance manager then it may have problems with other departments as they will feel that they are not being given enough thought.

however , Finance manager can be of great source of information as he have the good knowledge of financial information which may help in determining the current operative controls and how better controls can be implemented.


Acid

[Vanessa]

Hi all,

A tip to answer the question:

Read the verb in the question carefully and answer the question. The question asks you to "critically evaluate". This means give a brief explaination of the proposals put forward, write the advantages and disadvantages for each of the proposals. Also for each advantage / disdavantage, explain why it is an advantage / disadvantage.

[sash_lar]

To be a listed company there are certain criteria that have to be meet, one of those criteria is to adhere to the Combine Code on Corporate Governance. It stipulates that listed companies must maintain a sound system of internal controls and directors should annual reviews those internal controls.

Internal auditors and external auditors both perform internal audit and review engagements and provide reports to management. These reports are important as they provide document any evidence of the annual reviews of the control system. Also they provide information on the state of the controls and recommendation of what controls should be changed or put in place to add value.
However there are difference in the work and report done by the External Auditors and Internal Auditors.
Internal Audit does extensive and detail reviews of the controls in place. This is reported in a detail easy to understand report. On the other hand External Auditors review the control to ascertain whether reliance can be place on the system and therefore the figures on the financial statement.
External audit provide a statutory function and so their audit is for the purpose of a wider audience and the report is more geared towards the financial statement, which will be seen by the public. Therefore an assessment of the internal control is to provide information for the reliance of the information produced in the financial statement.

External auditors deal with issues relating to the design and implementation of internal controls that would affect the correctness of the financial statement. External Auditors report on the weaknesses detected and potential consequence for action and make recommendations, while Internal Audit has a more wholesome approach. It have pre-planned program of areas to cover with a variety of objectives. The objectives can be related to the risks faced by the business internally and externally and the effectiveness of performance. An Internal Audit function includes identifying risks, assessing risks and dealing with risks identified.


b)
Internal Auditor as External Auditor should conduct their assignment without fair or favor therefore a level of independence should be in place.
Internal Auditor unlike External Auditor reports to the management of the company therefore there is not much independence. However a board usually consist of more than one member this provides a level of confidence to the Internal Auditors in the conduct of their assignment.

Internal Audit function is to evaluate the controls of a company that is, to assess the current control and create a plan of the areas to be audited base on the risk level. Internal Audit area of assessment is of the entire business operation and does not gear towards finance only. Therefore information will be gathered from members of each unit inorder to evaluate the control and risks relating to the unit and report this to the members of the board.

[Vivienne]

I nternal auditors are appointed by management hence they are employess of the organisation.every organisations has inherent risks that is risks that a company has owing to the type of business that it does.management sets controls to ensure that those risks are minimised.The work of the internal auditor is to now check if those controls are in palce and they are being followed.they also check if these controls remain effective and if not if there is any need to review them.
Arising from these internal auditors report to management.they check for the minute details of the financial statements and are therefore concerned with the detecting of fraud and error.

External auditors are auditors who are not employed by the organisation.external auditors come in because the share holders would want to know if their investment that is being run on their behalf by the directors is being run smoothly and that by no chance are the directors defrauding them.
This means that the directors are employed to take good sterwardship of the investements.inorder to check the work of the directors and seek assurance ,the shareholders appoint external auditors who are not part of the organisation to do this.
The role of the external auditor is therefore to form an opinion on the financial statements prepared by the directors,to see whether they show a true and fair view of the copmany s position.they also seek to know wether these financial statements have been prepared in accordance with the relevant accounting standards.
External auditors are do not occupy themselves with the detecting of fraud and error(ISA 240) they only become concerned if the fraud or error has a material effect on the financial statements and will not enable them make a fair oponion.
If they find that the internal controls that have been set in an organisation are strong then they will seek to rely on them in the gathering of their evidence but if the internal controls are weak then they will palce less reliance on them.
From the above explanation,it van therefore be seen that these two auditors(internal and external)do not do the same type of work.
The advantages of having an internal audit is that they work within the organisation therefore they have enough time to examine all the accounting records in detail and can easily spot any irregularities.
Internal auditors report to managment and therefore it is a good check for management to be able to review if tehre are any weaknesses in the set controls and work on them.
If the internal controls of an organisation are strong then it will make the wortk of the external auditor easy as they will seek to rely on them.

b)Internal auditors report to management and not the share holders.this raises a lot of questions as to whether thier independence is guaranteed.Corporate gorvernance which is the way in which a company is run and controlledrecommends that in order for independence to be achieved the internal auditors should report to an audit comittee.an audit comittee comprises of directors of the comp[any and non execitive directors who may not be employees of the company or may not be actively involved in the running of the company.this provides an assurance of some kind.the finance manager is the one who is preparing the accountinfg systems in the organisation and if the internal auditors report to himthen their independence will be compromised as they will not report effectively on the failures and weaknesses for fear of their jobs.
The adnvantage of having an audit comittee is that there is an independent check withinn the organisationof how the set controls are working and if there is any need to review them.
The other advantage is that they act as a go between management and the external auditors when it comes to extermnal audits.

The disadvantage is that the audit team comprises of non executive directors who may not be part of the organisation.this is like exposing the company s business dealings and profits to the outsiders most especially to the competitors.

[Annie]

a) Scope of external auditor’s work

An external auditor has to provide opinion on the published financial statements of an organisation and gives a reasonable assurance that the statements provide a “true and fair” picture of the financial position and performance of the organisation for the given period of time.

Scope of internal auditor’s work

Whereas internal audit provides opinion on the reliability and effectiveness of the organisations risk management and internal control along with corporate governance systems.

Internal auditing is an independent appraisal function. The main objectives of internal auditing is

Is the management effective and efficient in its responsibilities towards operations
Are all the laws and regulations complied with
Are all the internal control policies and procedures complied with
Is the size and scope of internal control system sufficient
Reporting unidentified risks & internal control weaknesses, non compliance with laws & regulations and
Recommending improvements / changes to the internal control system

Williams should definitely appoint a internal audit team as he is planning to get his entity listed as internal audit will build up his internal controls adequately and effectively.

Therefore, Williams opinion that the work performed by both the external and internal auditors is the same and appointment of an internal auditor would be duplication, is completely wrong.

b) The finance manager may be a good source of tapping information as he is fully aware of the existing control system. The finance manager may not pass on all the information forward or would send only half information which would be misleading to the management for his own benefits. There should not be lot of concentration of control with one person so that it could give scope for fraud or errors, here in this case it would be the finance manager. If the internal auditor has to report to the finance manager, then he would have to work under the finance managers perview and so some things which need the boards attention would never come to light if it is against the interest of the finance manager. Therefore the internal auditor should report to the board or audit committee, where each aspect and point would be taken care of by the relevant authority in the best interest of the organisation and the shareholders. Therefore the framework lays down that an Internal auditor should ideally report to the audit committee or the board of directors in good corporate governance practices.

Annie

[Pixiefeet]

Vivienne would you consider taling about the audit committee a "mind dump" if the question specifically asked about Internal and External Auditors??