1. ⓒ 2013 J CSR. All Rights Reserved. “T RUE ” V ALUE OF I NTERNAL A UDIT AND D EVELOPMENT OF “C APABLE ” I NTERNAL A UDITOR IRCA Forum 2013 2013/06/23 Keizo Tsuchiya President Japan Registration Organization for Corporate Social Responsibility

2. ⓒ 2013 J CSR. All Rights Reserved. S IGNIFICANT I NTEREST IN I NTERNAL A UDIT Amount of Information Uploaded to the Internet Importance of Internal Audit:1,210,000 hits Credibility of Internal Audit: 1,260,000 hits Value of Internal Audit:1,500,000 hits Effectiveness of Internal Audit:1,860,000 hits Are they a large number or small number? 2  Corporate Value ： 1,260,000 hits (the same as “Credibility of Internal Audit”)  Computer Virus (including virus) ： 889,000 hits, which is far less than the above ！！  Akashiya Sanma ： 1,850,000 hits Search results of “Yahoo! JAPAN“ on May 5, 2013

3. ⓒ 2013 J CSR. All Rights Reserved. V ALUE OF I NTERNAL A UDIT

4. ⓒ 2013 J CSR. All Rights Reserved. V ALUE OF I NTERNAL A UDIT Cost vs. Effectiveness (Value)  Calculate internal audit costs Annual cost of training to develop internal auditors or use of external personnel as internal auditor Mandays of internal audit - Mandays for audit planning, Mandays for audit execution (auditors/auditees), Mandays for analysis/wrap-up and reporting 4 Example ： An organization with 200 employees and 10 Departments to be audited 5 internal auditors (appointed from different Departments in the organization) 3 internal audit teams (including 1 observer) Pre-audit training: 1 day （ by an external tutor)  5 mandays + Tutor fee Preparation for internal audit (Collection of information and preparation of internal audit plan): 1 day/team (6 mandays in total) ） Internal audit: 3 days  Mandays on the auditor side: ６ mandays  Mandays on the auditee side: 6 mandays Analysis/Wrap-up: 1 day/team (6 mandays in total) Reporting: 0.5 day/team (3 mandays in total) Total mandays + External tutor fee and all other expenses: 1.3 million yen

5. ⓒ 2013 J CSR. All Rights Reserved. V ALUE OF I NTERNAL AUDIT Effectiveness (Value)  Level of usefulness of information acquired by internal audit Level of usefulness for top management・・How well does internal audit report meet expectations of top management? Example: Internal Audit Report Nonconformity: Record of xxx training was not kept in Department Y. Summary: 3 concerns and 8 opportunities for improvement It was found that training records were not kept in some Departments; e.g. Study session about accidents taking place in competitors. Interesting information Not interested was delivered 100806040200 (%) Value of internal audit for top management: 1.3 million yen x 30%＝390,000 yen 5

6. ⓒ 2013 J CSR. All Rights Reserved. V ALUE OF I NTERNAL A UDIT Value to provide top management with useful information 6 Matured Audit results containing more than 80％ of information that top management wanted Value: 1.04M～1.3M yen Valuable information that top management can use as useful information Acceptable Audit results containing 60%~80％ of information that top management wanted Value: 780,000～1.04M yen Less valuable information that top management can use just as reference Immature Audit results containing 20%~60％ of information that top management wanted Value: 260,000～780,000 yen Limited quality of internal audit that may overlook risks of accidents and miss opportunities for improvement in operations Not Established Audit results containing less than 20% of information that top management wanted Value: 0～260,000 yen 80% of information collected in internal audit is extremely low in value for the use of business management.

7. ⓒ 2013 J CSR. All Rights Reserved. V ALUE OF I NTERNAL A UDIT contribute to achievement of objectives and targets of an organization. Internal audit must contribute to achievement of objectives and targets of an organization. appropriately report changes in risks Internal audit must appropriately report changes in risks relating to management of an organization. satisfy expectations of top management Internal audit must satisfy expectations of top management in correctly reporting current status of an organization. an effective means to implement a management system. Internal audit is not a means for certification, but an effective means to implement a management system. to demonstrate validity of autonomous management Internal audit is also an activity to demonstrate validity of autonomous management of an organization.  Valid in terms of customer (public) expectations, competitiveness and efficiency ⇒ Internal audit also provides useful information for communication with the third party. those who are highly ethical and trusted. Internal audit is a professional work, but anyone can conduct it if he/she is familiar with an organization. It is not difficult to create value. It is necessary, however, to appoint those who are highly ethical and trusted. ⇒ Enhance quality of assessment！ Enhance quality of analysis and evaluation！ 7

8. ⓒ 2013 J CSR. All Rights Reserved. D EVELOPMENT OF I NTERNAL A UDITOR ~ A M EANS TO D IRECTLY E NHANCE V ALUE OF I NTERNAL A UDIT ~ D EVELOPMENT OF I NTERNAL A UDITOR ~ A M EANS TO D IRECTLY E NHANCE V ALUE OF I NTERNAL A UDIT ~

9. ⓒ 2013 J CSR. All Rights Reserved. H OW TO D EVELOP I NTERNAL A UDITOR ? The quickest way is to have a candidate internal auditor experience a good internal audit. But opportunities to practice internal audits are limited in number. ⇒ The limited opportunities must be effectively organized. 9 To organize a good internal audit → To put in place the four conditions: Condition 1 ： Top management’s support and commitment to the public, people and business Condition 2 ： Training of internal auditors Condition 3 ： Cooperation of Departments to be audited Condition 4 ： Establish PDCA of internal audit which facilitates development of internal auditors Utilizing the limited opportunities of internal audit effectively, an organization, based on the above conditions, encourages a candidate internal auditor to experience a good and successful internal audit.

10. ⓒ 2013 J CSR. All Rights Reserved. C ONDITIONS TO O RGANIZE A G OOD I NTERNAL A UDIT Condition１：Top management’s support and commitment to the public, people and business 10 Organization in which internal audit makes a valuable contribution Organization in which internal audit does not make a valuable contribution Top management recognizes benefits of internal audit and actively supports internal audit. Top management is not interested in internal audit. Top management commits to address all the problems. Top management does not address problems. Top management does not distort the truth. Top management disguises facts Good internal auditors are developed as internal audit is respected as precious information source. Internal audit will become effective in providing information that top management wants. Top management approach to internal audit accelerates departments’ uncooperative response to internal audit. When being appointed as internal auditor, people try to find a reason to decline the appointment.

11. ⓒ 2013 J CSR. All Rights Reserved. C ONDITIONS TO O RGANIZE A G OOD I NTERNAL A UDIT Condition２：Training of internal auditors Participate in practical training  Lectures, no matter how much they are, do not yield a positive effect.  Practical training is essential to develop a good internal auditor. Understand a practical image of internal audit - How to conduct interview - Audit trail - Collection of evidences Respond to information obtained in internal audit to deepen understanding about internal audit - Workload has increased suddenly・・・What would you assess? - The organizational structure has ben changed ・・・ What would you assess? - Customer requirements have been changed・・・ What would you assess? - Processes have been changed・・・ What would you assess? 11

12. ⓒ 2013 J CSR. All Rights Reserved. C ONDITIONS TO O RGANIZE A G OOD I NTERNAL A UDIT Condition 3：Cooperation of Departments to be audited Internal auditor must make maximum use of limited opportunities of internal audit and identify “key to success.” It is important for an internal auditor to improve his/her own ability and brush up auditing skills, but Condition 3 helps him/her compensate for the lack of the skills.  Make it a priority to give an internal audit “successful experience” Enjoying delicious dishes is essential for a cook to develop his/her skills. 12 Cooperation of Departments to be audited  Actively participate in identification of problems  Provide sufficient information on both positive and negative facts  Trust internal auditors

13. ⓒ 2013 J CSR. All Rights Reserved. C ONDITIONS TO O RGANIZE A G OOD I NTERNAL A UDIT Condition 4：Establish PDCA of internal audit which facilitates development of internal auditors Plan－ Preparation of internal audit Do－ Execution of internal audit ⇐ Carry out internal audit based on Conditions １~４・・ (Wishing for success) － Analysis/reporting of internal audit results Check－ Evaluation of quality of internal audit Act－ Feedback of the evaluation results leads to development of capable internal auditors 13

14. ⓒ 2013 J CSR. All Rights Reserved. P REPARATION OF I NTERNAL A UDIT (E SSENTIAL TO E NHANCE E FFECTIVENESS OF I NTERNAL A UDIT ) Preliminary information collection  Understand objectives of the internal audit・・・(Support of top management) Define information that needs to be collected from Departments to be audited and relevant Departments in order to satisfy the internal audit objectives  Changes, targets, processes/procedures, events (incidents/accidents, what is done well/what is not done well/what is concerned), challenges ・・・（Cooperation of Departments to be audited）  Organize preliminary information so as to make it useful in internal audit Identification of key processes Sub-processes, conditions, criteria, qualification and training which affect the key processes Risks and expected problems What needs to be assessed? - What will be sampled and how much samples will be taken? - What information needs to be extracted? 14

15. ⓒ 2013 J CSR. All Rights Reserved. A NALYSIS /R EPORTING OF I NTERNAL A UDIT R ESULTS Try to produce an internal audit report to have people say “Good Job!!” Analyze internal audit results as much as possible and examine the analysis results Example of Analysis:  Internal audit results generally have the following two aspects: 1. Management system (procedures and rules） 2. Performance (degree of achievement of targets）  Analyze and examine the results based on the combination of the above two aspects: A) Rules are strictly observed and targets are achieved. B) Rules are strictly observed but targets are not achieved. C) Although rules are not observed, targets are achieved. D) Rules are not observed and targets are not achieved. 15

16. ⓒ 2013 J CSR. All Rights Reserved. E XAMPLE OF A NALYSIS : A) Rules are strictly observed and targets are achieved. B) Rules are strictly observed but targets are not achieved. C) Although rules are not observed, targets are achieved D) Rules are not observed and targets are not achieved. 16 Targets Achieved Targets not Achieved Rules Violated Rules Observed C) ＋ α possible cases ： 1.May not have achieved targets if rules were observed 2.May have set too easy targets 3.May disregard rules 4.May turn to “D” when some specific conditions are added D) ＋ α possible cases ： 1.May have achieved targets if rules were observed 2.May not have achieved targets even if rules were observed 3.May have set too aggressive targets compared with capability 4.May have problems in awareness 5.May have problems in equipment capability A) ＋ α possible cases ： 1.May be able to find more effective processes 2.May have set too easy targets 3.May turn to B, C or D when some specific conditions are added B) ＋ α possible cases ： 1.May have flaws in rules 2.May have set too aggressive targets compared with capability 3.May have problems in equipment capability 4.May have problems in willingness to achieve targets 5.May turn to A when some specific conditions are added

17. ⓒ 2013 J CSR. All Rights Reserved. R EPORTING OF I NTERNAL A UDIT R ESULTS Report isolated failure of achievement or violation as a deficiency  Top management does not pay attention／It is Departments that are expected to address such deficiency／It is not necessary to report each one of such deficiency Also report magnitude of impacts  Top management becomes aware of need for prioritization. Also report analysis results  Top management understands a need to take initiative; e.g. allocation of resources. Also report those areas focused in the internal audit  Top management understands credibility of the results and problems in the process to derive conclusion. Also report considerations on risks  The report helps top management develop a next strategy. → “Good Job!!” 17 Drill down and Sort out

18. ⓒ 2013 J CSR. All Rights Reserved. E VALUATION OF Q UALITY OF I NTERNAL A UDIT Self-Evaluation Quality of preparation  Was preliminary information acquired effectively?  Was the organized preliminary information useful?  Were key processes identified correctly?  Were risks to an organization identified properly?  Was practical image of internal audit useful? ： Quality of internal audit  Was progress of target achievement in audited Departments assessed?  Was degree of process maturity assessed?  Were strength and weakness of an organization assessed?  Was sufficient assessment conducted to meet the objective of the internal audit?  Was cooperation of audited Departments sufficient? ： Quality of analysis/reporting  Was the information obtained in the internal audit analyzed based on facts to identify relevance and risks?  Was the internal audit report compiled in a way to effectively communicate what needs to be communicated? ： 18

19. ⓒ 2013 J CSR. All Rights Reserved. E VALUATION OF Q UALITY OF I NTERNAL A UDIT Evaluation of internal audit by audited Departments → Questionnaire survey, etc.  Internal audit is a service to Departments to be audited, and therefore quality of internal audit can be regarded as service quality.  Such a technique as “Servqual” that is widely used to evaluate service quality is considered to be used to evaluate quality of internal audit. 19 SERVQUAL  SERVQUAL is a technique to evaluate service quality by measuring a gap between a service “expected” by users and an actual service “perceived” by users. In this technique, 22 questions are asked for five dimensions determining perceived quality (evaluation on the scale of one to seven).  Five dimensions Tangibles: physical facilities, appearance of equipment and employees Reliability: capability to execute a committed service accurately Responsiveness: willingness to assist customers and promptly provide a service Assurance: employees’ knowledge, politeness and capability to provide confidence and trust Empathy: consideration given to customers and care for each individualSERVQUAL  SERVQUAL is a technique to evaluate service quality by measuring a gap between a service “expected” by users and an actual service “perceived” by users. In this technique, 22 questions are asked for five dimensions determining perceived quality (evaluation on the scale of one to seven).  Five dimensions Tangibles: physical facilities, appearance of equipment and employees Reliability: capability to execute a committed service accurately Responsiveness: willingness to assist customers and promptly provide a service Assurance: employees’ knowledge, politeness and capability to provide confidence and trust Empathy: consideration given to customers and care for each individual

20. ⓒ 2013 J CSR. All Rights Reserved. S UMMARY Significance of enhancing internal audit  Raise value of input to top management Development of internal auditors is a key to the enhancement of internal audit. Organizing a good internal audit is essential for development of internal auditors. Condition 1: Top management’s support and commitment to the public, people and business Condition 2: Training of internal auditors Condition 3: Cooperation of Departments to be audited Condition 4: Establish PDCA of internal audit which facilitates development of internal auditors A good internal auditor is developed by utilizing limited opportunities of internal audit, experiencing a good and successful internal audit based on the organized good internal audit conditions, and receiving feedback of internal audit quality evaluation results. 20

21. ⓒ 2013 J CSR. All Rights Reserved. A SSISTANCE TO E NHANCE I NTERNAL A UDIT V ALUE Use of the IRCA’s OEA (Organisations employing auditors) program  http://www.irca.org/ja/OEAs/ 21 J CSR provides information on audit of organizations through the website of Auditor Bank. Thank you very much for your kind attention. http://www.auditorbank.com/