Internal and Governmental Financial Auditing and Operational Auditing

Internal and Governmental Financial Auditing and Operational Auditing Chapter 25 © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 1

Learning Objective 1 Explain the role of internal auditors in financial auditing. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 2

Internal Auditing It 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. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 3

Institute of Internal Auditors Ethical Principles Integrity Confidentiality Objectivity Competency © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 4

Relationship of Internal and External Auditors The external auditor is responsible to financial statement users. The internal auditor is responsible to management. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 5

Relationship of Internal and External Auditors Competency Methodology Objectivity Audit risk model © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 6

Learning Objective 2 Describe the auditing and reporting requirements under Government Auditing Standards and the Single Audit Act. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 7

Governmental Financial Auditing The primary source of authoritative literature for performance of government audits is Government Auditing Standards, which is issued by the GAO. Because of the color of the cover, it is usually referred to as the “Yellow Book. ” © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 8

Governmental Financial Auditing The Yellow Book standards are often called generally accepted government auditing standards (GAGAS or GAS). © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 9

Financial Audit and Reporting Requirements – Yellow Book Ø Materiality and significance Ø Quality control Ø Compliance auditing Ø Reporting Ø Working papers © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 10

Audit and Reporting – Single Audit Act and OMB Circular A-133 The threshold for requiring a single audit was raised from $100, 000 to $300, 000 to exempt many smaller entities from single audit requirements. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 11

Audit and Reporting – Single Audit Act and OMB Circular A-133 Statutory coverage of the single audit was extended to not-for-profit organizations as well as to state and local governments. A risk-based approach is to be used in selecting programs for testing. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 12

Audit Requirements The audit should be in accordance with generally accepted government auditing standards (GAGAS). The auditor must obtain an understanding of internal control over federal programs sufficient to support a low assessed level of control risk for major programs. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 13

Audit Requirements The auditor should determine whether the client had complied with laws, regulations, and the provisions of contracts or grant agreements that may have a direct and material effect on each of its major programs. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 14

Reporting Requirements v an opinion on whether the financial statements are in accordance with GAAP, and an opinion as to whether the schedule of federal awards is presented fairly in all material respects in relation to the financial statements as a whole © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 15

Reporting Requirements v a report on internal control related to the financial statements and major programs v a report on compliance with laws, regulations, and the provisions of contracts or grant agreements v a schedule of findings and questioned costs © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 16

Operational Auditing The purpose of operational auditing is to determine the efficiency and effectiveness of any part of an organization. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 17

Learning Objective 3 Distinguish operational auditing from financial auditing. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 18

Differences between Operational and Financial Auditing Purpose of the audit Distribution of the reports Inclusion of nonfinancial areas © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 19

Learning Objective 4 Provide an overview of operational audits. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 20

Effectiveness Versus Efficiency Effectiveness refers to the accomplishment of objectives. Efficiency refers to the resources used to accomplish those objectives. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 21

Effectiveness Versus Efficiency Types of Inefficiency Acquisition of goods and services is excessively costly. Raw materials are not available when needed. A duplication of effort by employees exists. Example Bids for purchases of materials are not required. An assembly line was shut down for lack of materials. Production and accounting keep identical records. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 22

Relationship between Operational Auditing and Internal Controls Reliability of financial reporting Efficiency and effectiveness of operations Compliance with applicable laws and regulations © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 23

Types of Operational Audits Functional Organizational Special assignments © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 24

Who Performs Operational Audits Internal auditors Government auditors CPA firms © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 25

Independence and Competence of Operational Auditors The two most important qualities for an operational auditor are: Independence Competence © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 26

Learning Objective 5 Plan and perform an operational audit. © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 27

Criteria for Evaluating Efficiency and Effectiveness Were all plant layouts approved by home office engineering at the time of original design? Has home office engineering done a reevaluation study of plant layout in the past five years? © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 28

Criteria for Evaluating Efficiency and Effectiveness Is each piece of equipment operating at 60% of capacity or more for at least three months each year? Does layout facilitate the movement of new materials to the production floor? Does layout facilitate the production of finished goods? © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 29

Criteria for Evaluating Efficiency and Effectiveness Does layout facilitate the movement of finished goods to distribution centers? Does the plant layout effectively use existing equipment? Is the safety of employees endangered by the plant layout? © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 30

Sources of Criteria Historical performance Benchmarking Engineers standards Discussion and agreement © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 31

Phases in Operational Auditing Planning Evidence accumulation and evaluation Reporting and follow-up © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 32

Planning • Scope of engagement • Staffing • Background information • Understand internal control • Decide on appropriate evidence © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 33

Evidence Accumulation and Evaluation • Documentation • Client • Observation © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 34

Reporting Follow-up • Report usually sent to management • Tailored reports • Follow-up on recommendations with management © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 35

Examples of Operational Audit Findings • Outside janitorial firm saves $160, 000 • More timely credit memo processing • Legislative auditors detect $1 million per year insurance overcharge • Use the right tool • Computer programs save manual labor • Timely depositing © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 36

End of Chapter 25 © 2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley 25 - 37