Comprehensive Overview of Internal Audits and Internal Checks

Internal audits and internal checks are essential components of a company’s internal control system, ensuring compliance, efficiency, and fraud prevention. While they are closely related, they serve distinct purposes and have different scopes. Internal checks ensure ongoing fraud prevention and process accuracy, while internal audits provide periodic independent evaluations of these processes.

This comprehensive overview will provide a cohesive understanding of internal audits and internal checks, their types, processes, and the benefits they offer to an organization.

Related: What is an EDD Audit?

Understanding Internal Audits

Internal audits play a critical role in evaluating a company’s internal controls, corporate governance, and accounting processes. These audits ensure compliance with laws and regulations, maintain accurate and timely financial reporting, and provide management with tools to improve operational efficiency by identifying and correcting issues before external audits.

Key Takeaways

1. Risk Management: Internal audits offer risk management by evaluating various aspects of the company.
2. Types of Audits: These include financial, operational, compliance, environmental, IT, and special-purpose audits.
3. Value-Added Service: Internal audits help identify and correct process flaws before external audits.
4. Process Steps: Similar to external audits, internal audits involve planning, auditing, reporting, and monitoring.
5. Operational Efficiency: They enhance operational efficiency, motivate adherence to company policies, and allow management to explore specific operational areas.

Types of Internal Audits

Compliance Audit

Compliance audits ensure that a company adheres to local laws, regulations, and external policies. An internal audit committee reviews and compiles appropriate information to provide an overall opinion on the compliance status.

Internal Financial Audit

Public companies are required to undergo external financial audits. However, internal financial audits can be conducted to delve deeper into findings or prepare for external audits, providing insights into the company’s financial records.

Environmental Audit

With growing environmental consciousness, companies may conduct internal audits to review their impact on the planet. This includes evaluating how raw materials are sourced, minimizing greenhouse gas emissions, and reducing energy consumption.

Technology/IT Audit

An IT audit reviews controls, hardware, software, security, and documentation to assess the accuracy and efficiency of IT processes. This audit can stem from external lawsuits, company complaints, or efforts to improve efficiency.

Performance Audit

Performance audits focus on outcomes rather than processes. These audits assess whether performance objectives or metrics tied to incentives are met, such as the use of diverse suppliers.

Operational Audit

Operational audits assess whether resources are used efficiently and if processes align with the company’s mission statement and objectives. This is common when key personnel leave or new management takes over.

Construction Audit

Construction audits ensure the proper development of a building and adherence to project billing terms with contractors. This includes verifying payments, project completion reports, and compliance with contract terms.

Special Investigations

Special investigation audits are conducted for one-time circumstances, such as evaluating a recent merger or a staff complaint. These require auditors with appropriate expertise and independence.

Internal Audit vs. External Audit

While both internal and external audits aim to analyze and form an opinion on various aspects of a company, there are key differences:

1. Audit Team Selection: Internal audits allow the company to select its own team, representing management’s interests. In external audits, the audit firm is chosen, but the specific audit team members are not.
2. Licensing Requirements: External financial audits require CPAs to certify financial statements, whereas internal audits do not have such requirements.
3. Audit Report Usage: Internal audit reports are used by management to improve operations, while external audit reports satisfy external reporting requirements.
4. Engagement Nature: Internal audits are often less formal, allowing for more fluid consulting, while external audits have defined boundaries and strict guidelines.

Internal Audit Process

Step 1: Planning

The audit plan is developed, outlining audit requirements, objectives, timeline, schedule, and responsibilities. It includes a checklist to ensure adherence to expectations and often ends with a kick-off meeting.

Step 2: Auditing

Auditing procedures involve assessment techniques to understand internal controls and compliance. These include reviewing documentation, transaction matching, physical inventory counts, audit trail calculations, and account reconciliation.

Step 3: Reporting

Internal audit reporting includes formal reports and interim reports. The final report summarizes procedures, findings, and suggestions for improvements. It also outlines next steps for implementing changes and future monitoring.

Step 4: Monitoring

Follow-up steps ensure that post-audit changes are implemented. This may involve limited reviews to verify the resolution of identified issues. Monitoring is agreed upon at the final report delivery stage.

Internal Audit Reports: The 5 C’s

1. Criteria: Identifies the issue and the reason for the audit.
2. Condition: Assesses how the issue relates to company targets or expectations.
3. Cause: Determines why the issue arose and who was involved.
4. Consequence: Analyzes the outcome and potential external risks.
5. Corrective Action: Outlines steps to resolve the issue and monitoring plans.

Importance of Internal Audits

Internal audits are valuable for several reasons:

1. Targeted Exploration: Management can focus on specific areas of concern.
2. Cost Savings: Strong internal processes can reduce external audit time and fees.
3. Enhanced Control Environment: Audits motivate adherence to company policies.
4. Efficiency Improvements: Internal audits identify inefficient processes for improvement.
5. Pre-emptive Corrections: Management can address issues before external audits.
6. Departmental Oversight: Provides focused reviews for departments needing enhanced oversight.

Understanding Internal Checks

Internal checks are processes that ensure and prevent fraud within a company’s operations. They are a subset of internal audits, forming the foundation for effective internal controls and ultimately leading to successful internal audits.

Examples of Internal Checks

1. Segregation of Work: Different individuals handle finance and procurement to prevent conflicts of interest.
2. Reconciliation: Monthly bank reconciliations are performed by someone who does not directly handle cash.
3. Approval and Validation Systems: Processes have approval and validation steps to ensure accuracy.
4. Asset Security: Security measures ensure the protection of company assets.

Difference Between Internal Check and Internal Audit

Scope

• Internal Check: Ensures and prevents fraud within processes.
• Internal Audit: Provides independent assurance of internal controls and processes.

Duration

• Internal Check: An ongoing process.
• Internal Audit: Conducted periodically.

System

• Internal Check: Lacks official statutory benchmarks.
• Internal Audit: Follows statutory procedures and systems.

Relation

• Internal Check: Good internal checks lead to effective internal audits.
• Internal Audit: Does not necessarily lead to good internal checks.

Advantages of Internal Checks

Internal checks offer several advantages:

1. Fraud Detection: Helps detect fraud within processes.
2. Efficiency: Increases operational efficiency.
3. Profit Margins: Improves margins and profits.
4. Compliance: Leads to better audits and compliance.

Conclusion

Both internal audits and internal checks are crucial for maintaining a company’s integrity, efficiency, and compliance. While internal checks focus on preventing fraud and ensuring process accuracy, internal audits provide an independent evaluation of these processes. Together, they form a robust internal control system that enhances a company’s overall governance and operational effectiveness.