ZHRCHTI Financial Management Training Session 4 Auditing Learning

ZHRC/HTI Financial Management Training Session 4: Auditing

Learning Objectives • By the end of this session, participants will be able to: • Define auditing • Describe internal and external audits • Explain the roles and functions of internal auditors in the ZHRCs/HTIs • Describe internal controls • Describe types of substantive tests for asset and stores management

What is an Audit? • An independent examination of records, procedures and activities of an organization, resulting in a report on the findings

Why do Organizations Need an Audit? • An audit demonstrates a commitment to transparency and accountability and brings credibility to an organization • In most countries, it is also a legal requirement to have the financial statements reviewed by an independent auditor once a year

Auditing in ZHRCs/HTIs • Tanzania National Audit Office (NAO) is the responsible organization for auditing the government and all entities • NAO was established under Article 143 of the Constitution of United Republic of Tanzania (URT) • Statutory duties and responsibilities of Controller and Auditor General (CAG) are given in Public Finance Act (PFA) No. 6 of 2001 Section 30 (1) and 37 (1). Section 31 (2) d and 33 (i) of the PFA No 6 (2001) empowers the CAG to conduct Value for Money audits in ministries, departments and local government authorities

Legal Framework for Auditing • Legal and statutory authorities which stipulate the need for ZHRCs/HTIs to have an Internal Audit Function (IAF) are: • Public Finance Act No 6 of 2001 • Treasury Financial Memorandum and circulars • The Public Finance Regulations (2001)

Types of Audit Internal Audit • Main purpose: to evaluate the effectiveness of systems, procedures and internal controls • Also called Compliance Audit or Operational Audit External Audit • Main purpose: to verify that the annual financial statements provide a true and fair view of the organization • Also called Financial Audit

Definition of Internal Audit (1) • 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 in evaluating and improving effectiveness of risk management, control, and governance processes

Definition of Internal Audit (2) • Involves a structured review of an organization’s systems and procedures • It reviews the adequacy of the design of financial controls and processes • Checks whether the procedures and controls are implemented appropriately • Internal audit report highlights the findings and makes recommendations for corrective action • Internal audit findings and reports are usually presented to management and the governing body

Key Issues in the Definition • The definition points out the following key issues of Internal Audit Function (IAF): • It is an objective activity • It is an assurance and consulting activity • Its scope is not just financial but is concerned with key issues in control, risk management and governance

Internal Auditing Flow Chart

Roles and Functions of Internal Auditors in ZHRCs/HTIs (1) • Review and report on controls over revenue, custody of receipts and utilization of financial resources • Assess compliance with financial and operational policies and procedures • Review the reliability and integrity of financial and operating data

Roles and Functions of Internal Auditors in ZHRCs/HTIs (2) • Review and report on the systems in place for the safeguarding assets • Review and report on operations and programmes of ZHRC/HTI compared with budgets • Review and report on actions by Heads of Departments (Ho. Ds) on audit reports • Review and report on controls over computerized operations

Why Internal Controls Interest the Internal Auditor • Internal audit’s objective is to review the organization's system of internal control and provide assurance to Finance, Administration and Planning Committees and Management • Therefore, internal auditors have to check: • That controls in place are adequate to guard against risks • The controls are operating effectively

Categories and Types of Internal Controls • Preventive Controls • Prevent risks from occurring • Detective Controls • Detect if problems have occurred • Corrective Controls • Address problems that have occurred

Characteristics of an Effective Internal Control System • Honest, capable employees in place • A clearly defined formal plan of operation • Separation or segregation of operations (authorization, custody and recording) • An appropriate system of authorization • Sound accounting practices • Adequate physical controls over assets and records • Independent checks on performance

Limitations on the Effectiveness of Internal Controls • Controls will not perform as expected if: • Management sees that cost of implementing a control is far greater than its benefits (cost versus benefits) • There is collusion between staff operating separate control functions • There is human error or carelessness

External Audit: Definition and Purpose • An external audit is an independent examination of the financial statements prepared by the organization • Purpose is to verify that: • The annual accounts provide a true and fair picture of organisation’s finances • Use of the funds is in accordance with organizational aims and objectives

External Audit (1) • An audit of financial statements • It is the examination by an independent third party of financial statements of an organization • It results in the publication of an independent opinion on whether or not those financial statements are relevant, accurate, complete, and fairly presented

External Audit (2) • An external audit exists to add credibility to financial transactions undertaken by the ZHRCs/HTIs • It assures stakeholders that the financial statements fairly represent the ZHRC's/HTIs position and performance during a stated period

Appointment of External Audit Firm • An external audit is conducted by a firm of accountants with recognized professional qualifications • Auditors are independent of the organization employing them: • An auditor must not be involved in keeping the accounting records • Not personally connected in any way with the organization he or she is auditing

What is involved in an External Audit? • Testing validity of a sample of transactions and results rather than vigorously checking everything • An auditor’s independence must be respected, but they are nonetheless providing the organization a service for a fee • You have a right to expect value for your money

External Audit Report (1) • An audit results in a report which gives an audit opinion as to the true and fair view of the organization reported in financial statements • If auditors do not agree with the financial results presented by the organization, they may issue a report stating the accounts are not satisfactory

External Audit Report (2) Types of Audit Opinions 1. Unqualified 2. Qualified: Subject to 3. Qualified: Disagreement 4. Qualified: Disclaimer

How Can Your ZHRC/HTI Receive a Good Audit? • Evaluation of the ZHRCs/HTIs control systems by using the following objectives: • Completeness - is everything there? • Existence/occurrence - is it real? • Valuation/measurement - is it properly valued? • Title - does it relate to the ZHRC/HTI? • Disclosure - is it properly described?

Group Work: Types of Audit Opinions

Auditing of Fixed Assets (1) • Check authorization of purchases with Board minutes and capital expenditure budgets • Check authorizations for disposal of significant assets • Confirm existence of a fixed asset register which identifies assets and comments on their current condition

Auditing of Fixed Assets (2) • Test evidence of reconciliation of register to physical checks of existence and condition of assets • Check authorization of depreciation rates and changes in rates • Examine evidence of checking correct calculations of depreciation

Auditing of Stores and Stocks (1) • Observe physical security of stocks and the environment in which they are held • Test procedures for recording of stock movement in and out of stock • Test authorizations for adjustments to stock records • Test for authorizations for write-off or scraping of stocks

Auditing of Stores and Stocks (2) • Test controls over recording of stock movement belonging to third parties • Test procedures for authorization for stock movements • Check the sequence of dispatch and goods received notes for completeness • Assess adequacy of stock taking procedures and attend physical count to ensure they are carried out

Auditing of Development Partners Funds in the ZHRCs/HTIs • Development partners may request an independent external audit of records and activities and will appoint a qualified person to undertake a review • The primary purpose of such a review is to check that grants are being used as intended and in accordance with the budget in original funding agreement

Group Work: Role of Internal Audit Dept. in ZHRC/HTI

Key Points (1) • An audit is an independent examination of records, procedures and activities of an organization, resulting in a report on the findings • There are two types of audit: internal and external • The main purpose of an internal audit is to evaluate effectiveness of systems, internal controls and procedures • The main purpose of an external audit is to verify that financial statements provide a “true and fair” view of the organization

Key Points (2) • The roles and function of internal auditors in the ZHRCs/HTIs include: • Review controls over revenue, custody of receipts and utilization of financial resources • Assess compliance with policies and procedures • Report on the systems for safeguarding of assets

Key Points (3) • Audit tests for store inventory include: • Observe physical security of stocks • Test procedures for recording movement in and out of stock • Test authorization for adjustments to stock records