1-1

ACE450 Management
Audit
Chapter 1:
Introduction to Internal Auditing
Ali Nawari Hasan
Department of Accounting
School of Management
McGrawHill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

21-2

The Rise of Internal Audit Profession

THEN

NOW

Concentrates on attesting to Provides services that include

the accuracy of financial examination and appraisal of
matters.
control and performance of an
organization.
Functions as junior sibling to Establishes
itself
independent
accounting distinctive discipline.
profession.
Once acted
adversary.

McGrawHill/Irwin

as

as

auditees Guides to improve operations;

seeking
to
maintain
a
cooperative
working
relationship with clients and
auditees.
Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

21-3

IA is about
Building relationship (team-mates, managers,
auditees etc.)
Meet the people, talk to them, know what all the
people in the organization do, understand their
concern
No longer a desk job

Communication
You have done a good job but you
cant communicate, then its no point

Continuous learning
Technical skills, soft skills
Creative thinking
re
o
m
h
c
u
3
An d m
McGrawHill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

21-4

Overview of Internal And External

Auditors
External Auditors - independent auditors practicing
accountants or accounting firms that perform audits
of commercial and non commercial entities
Serves third parties who need information.
Focuses on the historical events as expressed in
the financial statements.
Reviews records supporting financial statements
periodically.

McGrawHill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

21-5

Overview of Internal And External

Auditors
Internal Auditors - auditors employed by company to audit
for the companys board of directors and management
Focuses on the future events by evaluating control
events.
Reviews activities continuously.
Line of reporting.
Serves the organization, and the function normally is
managed by the organization.

McGrawHill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

21-6

Internal Auditing
Traditional definition of internal auditing:
an independent appraisal activity established within an
entity as a service to the entity. Its functions include
examining, evaluating and monitoring the adequacy and
effectiveness of internal control
Internal auditing is therefore a component of internal control,
whose role is to examine and evaluate:
i. internal control and information systems
ii. financial and operating information
iii. the economy, efficiency and effectiveness of
operations
iv. whether or not the entity has complied with relevant
legislation, etc. etc. etc
McGrawHill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

21-7

Internal Auditing
Institute of Internal Auditors defines internal auditing as
follows:
Internal auditing is an independent, objective assurance
and consulting activity designed to add value and
improve an organizations operations.

It helps an organization accomplish its objectives by

bringing a systematic, disciplined approach to evaluate
and improve the effectiveness of risk management,
control, and governance processes.
McGrawHill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

21-8

How can IA serve management?

Monitoring activities top management cant itself

monitor.
Identifying and minimizing risks.
Validating reports to senior management.
Protecting senior management in technical areas
beyond its knowledge.
Provide information for the
decision making process.
Helping line managers manage
by pointing to violations of
procedures and
of management
principles.

McGrawHill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

Internal Auditors
Duties
Operational /
Performance audit

Information
Technology audit

These are not

all, but should
cover most of
the internal
audit activities
undertaken by
the internal
auditors

Financial Audit

Program /
Management audit

Control selfassessment audit

Fraud audit

Compliance audit

Ethical business
practices audit

21-10

History of IA
Ancient times
The Middle Ages
The Industrial Revolution
Recent times
Auditing in the US
IA in Malaysia

10

McGrawHill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

21-11

History of IA
Ancient times
Began far back as 3,500 B.C.
Shows the record of mesopotamian civilisation
show tiny marks at the side of numbers involved
in the financial transactions
Internal controls, systems of verification, and the
concept of division of duties probably originated
at that time
Early Egyptian, Chinese, Persian, and Hebrew
records show similar systems
11

McGrawHill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

21-12

History of IA
Ancient times
The Greeks were strong believers in control over
finances that their records show that transaction
required authorisation and verification
Ancient Rome employed the hearing accounts

12

McGrawHill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

21-13

History of IA
The Middle Ages
Baron and justices made the first audits
An expanding Italian commerce during the 13th
century
Double entry system of bookkeeping
Auditing was taken more seriously

13

McGrawHill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

21-14

History of IA
The Industrial Revolution
Begin during the industrial revolution and
organisation starts to hire accountants
More than hearing
Recent Times
19TH century with British investment crossed the
sea to the United States, due to investment made
in the US.

14

McGrawHill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

21-15

History of IA
Recent Times
The British requirements arose under the
statutory dictates of the British Companies Act
calling for accountability to investors
The United States had no such requirements,
hence auditing served the needs of the
entrepreneur

15

McGrawHill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

21-16

Auditing In the United States

After World War 1, the United States economy
escalated, many large corporations published
their financial statement
Continue development of IA can be contributed
to the increased complexity and sophistication of
business and government operations and
because growth limited managements ability to
monitor its operation

16

McGrawHill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

21-17

The IAs Achievement of Identity

Evolved in 1941 when the IIA was formed
IA expands the scope of internal auditing to
appraising all operations of the enterprise

17

McGrawHill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

21-18

IA in Malaysia
1970- Implementation of IA in the Federal Ministries and
Department in the country was first initiated.
1979-the Federal Government issued a circular
expanding the establishment of internal audit to other
ministries and department.
1977- the formalization of The Institute of IA has
encouraged the enhancement of internal audit
profession in Malaysia
1993- the Malaysian Ministry of Finance issued a circular
to request all government owned companies to set up
audit committees and at the same year Bursa Malaysia
formerly known as KLSE also made it mandatory for all
public listed companies to set up audit committees.

18

McGrawHill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

21-19

Legislation
With respect to banking, finance and insurance
industries, under the supervision of the Central
Banking and Financial Institution Act (BAFIA)internal auditing is essential as per statutory
requirement.
For Public Listed Companies-mandatory of BOD
to disclose their compliance to the Malaysian
Code of Corporate Governance. Internal audit is
the best practice

19

McGrawHill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

21-20

The IIA in Malaysia (IIAM)

Formed as a chapter in 1977 and subsequently
became a National Institute in 1988.
1999 it was incorporated to become company
limited by guarantee
Affiliated to the IIA in US which has more than
90,000 members
1994-CIA examination

20

McGrawHill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

21-21

Roles of IIAM
Services provided:
Certification offering certification for Certified Internal Auditors (CIA),
Certification in Control Self-Assessment (CCSA), Certified Financial
Services Auditor (CFSA), Certified Government Auditing Professional
(CGAP)
Professional development providing quality and "value for money"
internal audit training
Guidance and advisory providing research, technical advisory and
responding to technical enquiries
Surveys conducting surveys on various topics in collaboration with,
among others, Bursa Malaysia, MICG, KPMG and Ernst & Young.
Quality assurance services providing assistance and expertise for
Quality Assurance and Improvement Program (QAIP)

IIA Research Foundation

Research arm of the Institute of Internal Auditors Inc. (USA)
Conducting research related to IA
Disseminate information to internal auditors in Malaysia to keep
abreast with latest news, best practices and development of IA in Malaysia
and internationally.
McGrawHill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

21-22

Differences between an internal and an

external auditor
Reporting responsibility
External auditor reports to the shareholders or members of the
company. Audit reports are contained within the f/s and hence
publicly available.
Internal auditor reports to the management or those charged with
governance. The internal audit reports are not publicly available
and are intended to be seen only by the addressee of the report.

McGrawHill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

21-23

Differences between an internal and an

external auditor
Scope of work
External auditor limited to verifying the truth and fairness of
the f/s of the company
Internal auditor can have a wide scope of work as determined
by the management or those charged with governance.
Commonly IAs focus on the companys internal control, but any
other area of the companys operations can also be reviewed.

McGrawHill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

21-24

Differences between an internal and an

external auditor
Rules and regulations, roles and duties
External auditor determined by statute,
Companies Act 1965
Internal auditor determined by management

Status (Relationship with the company)

External auditor independent from the company
Internal auditor most of the time, employees of
the company. Harder to achieve independence.
McGrawHill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

21-25

Differences between an internal and an

external auditor
Fraud
External auditor material fraud
Internal auditor any fraud

Professional qualification
External auditor Compulsory to be a member of
the MIA before can be granted an audit license
Internal auditor Not necessary (but preferable to
be an effective internal auditor)
McGrawHill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

21-26

The growing importance of

Internal Auditing
Many examples can be given to reflect the growing
importance of internal auditing. One of the most important
benefits that concerns many stakeholders in todays
business environment is:

Good internal auditing can help detect fraud

McGrawHill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

21-27

Company

What happened

Adelphia
Communications

Organizational funds used by founding

family officers as personal piggy bank.

Enron

Massive accounting fraud discover through

improper off balance sheet accounting.

WorldCom

$3.8 billion in overstated earnings.

Xerox

Masked billions of losses through creative

accounting

Parmalat

At least 14 billion in fictitious cash reported

for this Italian dairy products corporation.

Tyco

Accounting fraud coupled with the CEO

using the corporate funds for personal gain.

Fine Host Corporation

CFO resigned because of financial fraud.

Health South

Earnings fraudulently misstated over many

years to satisfy analyst expectation.

27

McGrawHill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

21-28

Good internal auditing can help

detect fraud
Some of these scandals could have been prevented
or detected earlier had the company properly
maintained their internal audit division

McGrawHill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

21-29

McGrawHill/Irwin

Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.