Internal auditing is a profession and activity involved in helping organizations achieve their

stated objectives. It does this by using a systematic methodology for analyzing business
processes, procedures and activities with the goal of highlighting organizational problems and
recommending solutions. Professionals called internal auditors are employed by organizations to
perform the internal auditing activity.

The scope of internal auditing within an organization is broad and may involve topics such as the
efficacy of operations, the reliability of financial reporting, deterring and investigating fraud,
safeguarding assets, and compliance with laws and regulations.

Internal auditing frequently involves measuring compliance with the entity's policies and
procedures. However, Internal auditors are not responsible for the execution of company
activities; they advise management and the Board of Directors (or similar oversight body)
regarding how to better execute their responsibilities. As a result of their broad scope of
involvement, internal auditors may have a variety of higher educational and professional
backgrounds.

Role in internal control

Internal auditing activity is primarily directed at improving internal control. Under the COSO
Framework, internal control is broadly defined as a process, effected by an entity's board of
directors, management, and other personnel, designed to provide reasonable assurance regarding
the achievement of objectives in the following internal control categories:

 Effectiveness and efficiency of operations.

 Reliability of financial reporting.
 Compliance with laws and regulations.

Management is responsible for internal control. Managers establish policies and processes to
help the organization achieve specific objectives in each of these categories. Internal auditors
perform audits to evaluate whether the policies and processes are designed and operating
effectively and provide recommendations for improvement.

In the United States, internal auditors may assist management with compliance with the
Sarbanes-Oxley Act (SOX).

Role in risk management

Internal auditing professional standards require the function to monitor and evaluate the
effectiveness of the organization's Risk management processes. Risk management relates to how
an organization sets objectives, then identifies, analyzes, and responds to those risks that could
potentially impact its ability to realize its objectives.

Under the COSO enterprise risk management (ERM) Framework, risks fall under strategic,
operational, financial reporting, and legal/regulatory categories. Management performs risk
assessment activities as part of the ordinary course of business in each of these categories.
Examples include: strategic planning, marketing planning, capital planning, budgeting, hedging,
incentive payout structure, and credit/lending practices. Sarbanes-Oxley regulations also require
extensive risk assessment of financial reporting processes. Corporate legal counsel often prepares
comprehensive assessments of the current and potential litigation a company faces. Internal
auditors may evaluate each of these activities, or focus on the processes used by management to
report and monitor the risks identified. For example, internal auditors can advise management
regarding the reporting of forward-looking operating measures to the Board, to help identify
emerging risks.

In larger organizations, major strategic initiatives are implemented to achieve objectives and
drive changes. As a member of senior management, the Chief Audit Executive (CAE) may
participate in status updates on these major initiatives. This places the CAE in the position to
report on many of the major risks the organization faces to the Audit Committee, or ensure
management's reporting is effective for that purpose.

Internal auditors may help companies establish and maintain Enterprise Risk Management
processes.[3][4] Internal auditors also play an important role in helping companies execute a SOX
404 top-down risk assessment. In these latter two areas, internal auditors typically are part of the
project team in an advisory role.

Role in corporate governance

Internal auditing activity as it relates to corporate governance is generally informal,
accomplished primarily through participation in meetings and discussions with members of the
Board of Directors. Corporate governance is a combination of processes and organizational
structures implemented by the Board of Directors to inform, direct, manage, and monitor the
organization's resources, strategies and policies towards the achievement of the organizations
objectives.[5] The internal auditor is often considered one of the "four pillars" of corporate
governance, the other pillars being the Board of Directors, management, and the external auditor.
[6]

A primary focus area of internal auditing as it relates to corporate governance is helping the
Audit Committee of the Board of Directors (or equivalent) perform its responsibilities
effectively. This may include reporting critical internal control problems, informing the
Committee privately on the capabilities of key managers, suggesting questions or topics for the
Audit Committee's meeting agendas, and coordinating carefully with the external auditor and
management to ensure the Committee receives effective information.

Role in corporate governance

Internal auditing activity as it relates to corporate governance is generally informal,
accomplished primarily through participation in meetings and discussions with members of the
Board of Directors. Corporate governance is a combination of processes and organizational
structures implemented by the Board of Directors to inform, direct, manage, and monitor the
organization's resources, strategies and policies towards the achievement of the organizations
objectives.[5] The internal auditor is often considered one of the "four pillars" of corporate
governance, the other pillars being the Board of Directors, management, and the external auditor.
[6]

A primary focus area of internal auditing as it relates to corporate governance is helping the
Audit Committee of the Board of Directors (or equivalent) perform its responsibilities
effectively. This may include reporting critical internal control problems, informing the
Committee privately on the capabilities of key managers, suggesting questions or topics for the
Audit Committee's meeting agendas, and coordinating carefully with the external auditor and
management to ensure the Committee receives effective information.

[edit] Nature of the internal audit activity

Based on a risk assessment of the organization, internal auditors, management and oversight
Boards determine where to focus internal auditing efforts. Internal auditing activity is generally
conducted as one or more discrete projects. A typical internal audit project [7] involves the
following steps:

1. Establish and communicate the scope and objectives for the audit to appropriate management.
2. Develop an understanding of the business area under review. This includes objectives,
measurements, and key transaction types. This involves review of documents and interviews.
Flowcharts and narratives may be created if necessary.
3. Describe the key risks facing the business activities within the scope of the audit.
4. Identify control procedures used to ensure each key risk and transaction type is properly
controlled and monitored.
5. Develop and execute a risk-based sampling and testing approach to determine whether the
most important controls are operating as intended.
6. Report problems identified and negotiate action plans with management to address the
problems.
7. Follow-up on reported findings at appropriate intervals. Internal audit departments maintain a
follow-up database for this purpose.

Project length varies based on the complexity of the activity being audited and Internal Audit
resources available. Many of the above steps are iterative and may not all occur in the sequence
indicated.

By analyzing and recommending business improvements in critical areas, auditors help the
organization meet its objectives. In addition to assessing business processes, specialists called
Information Technology (IT) Auditors review information technology controls.

[edit] Internal audit reports

Internal auditors typically issue reports at the end of each audit that summarize their findings,
recommendations, and any responses or action plans from management. An audit report may
have an executive summary; a body that includes the specific issues or findings identified and
related recommendations or action plans; and appendix information such as detailed graphs and
charts or process information. Each audit finding within the body of the report may contain five
elements, sometimes called the "5 C's":

1. Condition: What is the particular problem identified?

2. Criteria: What is the standard that was not met? The standard may be a company policy or other
benchmark.
3. Cause: Why did the problem occur?
4. Consequence: What is the risk/negative outcome (or opportunity foregone) because of the
finding?
5. Corrective action: What should management do about the finding? What have they agreed to
do and by when?

The recommendations in an internal audit report are designed to help the organization achieve its
goals, which may relate to operations, financial reporting or legal/regulatory compliance. They
may relate to effectiveness (i.e., whether goals were met or compliance with standards was
achieved) or efficiency (i.e., whether the outputs were generated with minimum inputs).

Audit findings and recommendations also relate to particular assertions about transactions, such
as whether the transactions audited were valid or authorized, completely processed, accurately
valued, processed in the correct time period, and properly disclosed in financial or operational
reporting, among other elements.

[edit] Developing the plan of engagements

Internal auditing standards require the development of a plan of audit engagements (projects)
based on a risk assessment, updated at least annually. The input of senior management and the
Board is typically included in this process. Many departments update their plan of engagements
throughout the year as risks or organizational priorities change.[8]

This effort helps ensure the audit activity is aligned with the organization’s objectives, by
answering two key questions: First, what goals are the organization trying to accomplish in the
upcoming period? Second, how can the Internal Audit Department assist the organization in
achieving these goals?

Internal auditors often conduct a series of interviews of senior management to identify potential
engagements. Changes in people, processes, or systems often generate audit project ideas.
Various documents are reviewed, such as strategic plans, financial reports, consulting studies,
etc. Further, the results of prior audits and resolution of open issues are considered. For example,
even if a business area is important, prior audit work and the nature and status of open issues
may render further audit effort unnecessary. If the organization has a formal enterprise risk
management (ERM) program, the risks identified therein help limit the amount of separate risk
assessment performed by Internal Audit.

The preliminary plan of engagements is documented and prioritized. Audit resources and
expertise are then considered and a final plan is presented to senior management and the Audit
Committee. The presentations vary based on the needs of the stakeholders and may include the
following:

 Summary of key goals, risks and corresponding major audits, to illustrate alignment;
 Analyses of audit effort along a variety of dimensions (e.g., by business segment, COSO objective
category, IT, Sarbanes-Oxley, vs. prior year, etc.) along with commentary regarding changes;
 Brief description of critical projects identified;
 Projects requested but not planned for execution due to prioritization and resources;
 Required co-sourcing effort, typically where outside expertise is required or during peak periods;
 Coordination with other risk functions, such as legal, compliance or insurance, to ensure
coverage of key organizational risks;
 Update on audit staffing levels, experience and certification; and
 Appendix materials, such as planning approach, assumptions (e.g., days per auditor and staffing
level) and brief descriptions of all planned audits and related prioritization.

[edit] Best Practices in Internal Auditing

[edit] Measuring the internal audit function

The measurement of the internal audit function can involve a balanced scorecard approach.[9]
Internal audit functions are primarily evaluated based on the quality of counsel and information
provided to the Audit Committee and top management. However, this is primarily qualitative
and therefore difficult to measure. “Customer surveys” sent to key managers after each audit
project or report can be used to measure performance, with an annual survey to the Audit
Committee. Scoring on dimensions such as professionalism, quality of counsel, timeliness of
work product, utility of meetings, and quality of status updates are typical with such surveys.
Understanding the expectations of senior management and the audit committee represent
important steps in developing a performance measurement process, as well as how such
measures help align the audit function with organizational priorities.[10]

Quantitative measures can also be used to measure the function’s level of execution and
qualifications of its personnel. Key measures include:

Plan completion: This is a measure of the degree to which the annual plan of engagements is
completed, measured at a point in time. This may be measured using the number of projects
completed, weighted by the planned size of each project, with estimates for projects in-progress.
Measured throughout the year, it is compared against the percentage of the year elapsed.

Report issuance: This is a measure of the time elapsed from completion of testing to issuance of
the final audit report, including management’s action plans. This can be measured in average
days or percentage of reports issued within a certain standard, such as 30 days. Establishing
expectations for the timing of management’s response to report recommendations is critical. In
addition, the scope and degree of change involved in the report’s action plans are key variables.
For example, a report for a single retail store requiring only the store manager’s action might
take 3–5 days to issue. However, a report consolidating findings from 20 retail stores, with action
plans with national implications determined by top management, may take 30–60 days in
complex organizations.

Issue closure: Reported audit findings are often called “issues” or “deficiencies.” Professional
standards require audit functions to track reported findings to resolution, which effectively
requires the maintenance of an issues follow-up database. The number of days that reported
issues remain open, or open after their agreed-upon closure date, are key measures. In addition,
reporting database statistics such as the number of issues open (unresolved), closed (resolved),
and issues opened/closed during a given period are useful statistics.

Staff qualifications: This can be measured through the percentage of staff with professional
certifications, graduate degrees, and overall years of experience.

Staff utilization rate: This is measured as the percentage of time spent on projects, as opposed to
administrative time such as training or vacation. Many internal audit departments track time by
audit project. This is typically captured in a database or spreadsheet.

Staffing level: The number of positions filled relative to the authorized staffing level. Due to the
challenge of finding qualified staff, departments may have rotational programs to bring in
management to complete tours in the function or be "guest" auditors. Audit departments also
"co-source," meaning they obtain contract auditors from service providers.

[edit] Developing and retaining staff

Developing and retaining quality professionals is a key concern in the profession.[11] Key
methods for developing and retaining internal audit staff personnel include:

 Providing challenging, varied assignments

 Ensuring quality supervision
 Ensuring staff participates in projects from start to finish, to learn all phases of the audit process
 Providing opportunities to lead (in-charge) projects, starting with more structured projects such
as Sarbanes-Oxley work
 Participating on departmental improvement task forces, such as preparation for quality
assurance review
 Participating in the recruiting and interviewing process for new hires
 Rotating through various audit teams (in larger departments) or audits of various businesses
 Providing both outside training (e.g., seminars) and in-house training (e.g., company systems)
for two weeks/year
 Participation in annual risk assessment activities, whether asking key questions or just taking
notes

[edit] Reporting of critical findings

The Chief Audit Executive (CAE) typically reports the most critical issues to the Audit
Committee quarterly, along with management's progress towards resolving them. Critical issues
typically have a reasonable likelihood of causing substantial financial or reputational damage to
the company. For particularly complex issues, the responsible manager may participate in the
discussion. Such reporting is critical to ensure the function is respected, that the proper "tone at
the top" exists in the organization, and to expedite resolution of such issues. It is a matter of
considerable judgment to select appropriate issues for the Audit Committee's attention and to
describe them in the proper context.