1. Internal and Governmental Financial Auditing and Operational Auditing
Chapter 26
محمد أبو طواحينة
شاكر الغلاييني
أحمد إسليم

2. Learning Objective 1
Explain the role of internal auditors in financial auditing.

3. Internal Auditing Internal auditing is an independent objective
assurance and consulting activity designed
to add value and improve an organization’s
operations.
Risk Management
Controls
Governance Processes
The New York Stock Exchange requires its
registrants to have an internal audit function

4. Internal Auditing Provide value through improved operational
effectiveness while performing traditional
responsibilities.
Reviewing
management
information
Safeguarding
assets
Ensuring
compliance

5. Institute of Internal Auditors Ethical Principles
Integrity
Ethical
Principles
Confidentiality
Competence
Integrity establishes trust and provides the basis for reliance on their judgment.
Internal auditors make a balanced assessment of all the relevant circumstances and are not influenced by their own interests or by others in forming judgments.
Internal auditors respect the value of information they receive and do not disclose information without appropriate authority.
Internal auditors apply knowledge skills and experience needed in performing internal audit services.
Objectivity

6. Institute of Internal Auditors Rules of Conduct
Integrity
Rules of
Conduct
Confidentiality
Competency
Internal auditors shall perform their work with honesty, diligence and responsibility.
Internal auditors shall not participate in any activity or relationship that may impair their unbiased assessment.
Internal auditors shall be prudent in the use of information acquired in the course of their duties.
Internal auditors shall engage only in those services for which they have the necessary knowledge, skills, and experience.
Objectivity

7. Relationship of Internal and External Auditors
The internal auditor is responsible
to management
The external auditor is responsible
to financial statement users
Both must be competent, objective,
use a similar methodology, and
consider risk and materiality

8. Learning Objective 2
Describe the auditing and reporting requirements under Government Auditing Standards and the Single Audit Act

9. 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.”

10. Governmental Financial Auditing
The Yellow Book standards are often called
generally accepted government auditing
standards (GAGAS).
The financial auditing standards of the Yellow Book are consistent with the 10 generally accepted auditing standards of the AICPA.

11. Financial Audit and Reporting Requirements – Yellow Book
Financial Auditing Standards of the Yellow Book
Consistent with GAAS/
Provide additional guidance…
Materiality
and
significance
Compliance
auditing
Reporting

12. Audit and Reporting – Single Audit Act and OMB Circular A-133
The threshold for requiring a single audit is $500,000.
The Single Audit Act and OMB Circular A-133
contain requirements for the scope of the audit.
Compliance
with GAGAS
Internal Control
Risk
Legal
Compliance
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.
The auditor should determine whether the client had complied with the laws, regulations, and the
provisions of contracts or grant agreements that may have a direct and material effect
on each of its major programs.

13. Reporting Requirements
An opinion on …
Statements
in accordance
with GAAP
Schedule of
federal awards
A report on …
An opinion on whether the financial statements are in accordance with GAAP
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
A report on internal control related to the financial statements and major programs
A schedule of findings and questioned costs
A report on compliance with laws,
regulations, and the provisions of
contracts or grant agreements
Internal
controls
Legal
Compliance
Findings and
Questioned
costs

14. Learning Objective 3
Distinguish operational auditing from financial auditing.

15. Operational Auditing The purpose of operational auditing is to
determine the effectiveness or efficiency
of any part of an organization
Financial Auditing emphasizes whether
historical information was correctly
recorded while operational auditing
emphasizes effectiveness and efficiency
The limited distribution of operational reports and the diverse nature of audits for efficiency and effectiveness allow operational reports to vary considerably from audit to audit.

16. Learning Objective 4
Provide an overview of operational audits.

17. Effectiveness Versus Efficiency
Effectiveness refers to accomplishing
objectives
Efficiency is defined as reducing cost
without reducing effectiveness

18. Effectiveness Versus Efficiency
Inefficiency
Example
Acquisition of goods and
services is too costly
Bids for purchases of
materials are not required
Raw materials are not
available when needed
An assembly line was shut
down for lack of materials
A duplication of effort
by employees exists
Production and accounting
keep identical records

19. Effectiveness Versus Efficiency
Inefficiency
Example
Work is done that serves
no purpose
Vendors’ invoices and
receiving reports are filed
without being used
There are too many
employees
Office work could be done
with one less assistant

20. Relationship Between Operational Auditing and Internal Controls
Reliability of financial reporting
Efficiency and effectiveness of operations
Compliance with applicable laws and regulations
Internal control evaluation for financial auditing has two primary purposes: to determine the extent of substantive audit testing required and to report on the effectiveness of internal control over financial reporting.
The scope of operational auditing concerns any control affecting efficiency or effectiveness while the scope of internal control evaluation for financial audits is restricted to the effectiveness of internal control over financial reporting and its effect on the financial statements.

21. Types of Operational Audits
Functional
Organizational
A functional audit deals with one or more functions in an organization concerning the efficiency and effectiveness of the payroll function for a division or for the company as a whole.
An organizational audit emphasizes how efficiently and effectively functions interact.
Special assignments arise at the request of management for a wide variety of audits such as determining the cause of an ineffective IT system or investigating the possibility of fraud.
Special
assignments

22. Who Performs Operational Audits
Internal
auditors
Government
auditors
Non-public companies often engage their CPA firm to do operational audits of one or more specific parts of its business. An example would be the efficiency and effectiveness of its computer systems. Public companies cannot engage their financial statement auditing firm to perform operational audits.
Different federal and state government auditors perform operational audits as part of doing financial audits.
Many internal audit departments do both operational and financial auditing. To maximize effectiveness, the internal audit department should report to the board of directors or president.
CPA firms

23. Independence and Competence of Operational Auditors
The two most important qualities
for an operational auditor
Competence
Independence
The independence of internal auditors is enhanced by having the internal audit department report to the board of directors or president.
The auditor should not be responsible for operating functions in a company or for correcting deficiencies when ineffective or inefficient operations are found.
While it is acceptable for auditors to recommend changes in operations, operating personnel (not the auditors) must have the authority to accept or reject those recommendations.

24. Learning Objective 5 Plan and perform an operational audit.
A major challenge of operational auditing is in selecting specific criteria for evaluating whether efficiency and effectiveness have occurred.

25. Specific Criteria More specific criteria are usually desirable
before starting an operational audit
Sources of criteria include:
Historical performance
Benchmarking
Engineered standards
Discussion and agreement
More specific criteria are usually desirable before starting an operational audit.

26. Phases in Operational Auditing
Planning
Evidence
gathering and
evaluation
Reporting
and
follow-up
The operational auditor must determine the scope of the engagement and communicate it to the organizational unit.
The eight types of evidence are equally applicable to operational auditing.
In operational audits, the report is usually sent only to management with a copy to the unit being audited. The diversity of operational audits requires a tailoring of each report to address the scope of the audit, findings, and recommendations.
Eight types
Documentation
Staffing
Scope
Controls
Scope
Findings
Recommendations

27. End of Chapter 26