sawyer's internal auditing chapter 08

8/6/2019 Sawyer's Internal Auditing Chapter 08

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T346 Part 2: Techniques of Internal Auditing _ Chap te r 8: Audi t F in dings 347

58. Which of the following would not be conside red a primary obiec ti f a closi .conference? J ve 0 a c osmg or exita . To resolve confl ic ts .b . To di sc us s the a ud it f in ding s.c . To iden ti fy c onc erns fo r fu tu re a ud it s.d . To identify management' s act ions and responses to the f indings.

Chapter 8Audit F ind ings

The nat ur e of audi t fi nd ings. S tandards. Sugges tions fo r improvemen t.Reportable audit f indings. Approach tof inding const ruct ion. Adding value .Degrees of s igni fi cance. Elements of an audit f inding. Discuss ing f indings.Record o f audi t f indi ngs. Commun ication s ki lls . Supe rv is or y r ev iews .Reporting audit findings. Follow-up. Adequacy of corrective action.Authori ty and audit s tatus ......... .............................................

The Nature of Audit FindingsDuring the course of the ir work, interna l aud itors identify conditions tha t require correct iveaction. These dev ia tions f rom norms or accep table c ri te ria a re cal led audit f indings.Audi t f in ding s co rn e in al l sh ap es and s iz es . For e xamp le , t he y ca n d esc ribe :

Actions that should have been taken, but were not, such as shipments that weremade but not b il led.Prohibited actions , such as an employee' s d iversion of ren ted equipment to a persona lcon trac ting f irm for h is own benef it .

Improper actions, such as paying for goods and supplies at rates that had beensuperseded by a more favorab le con trac t specify ing lower rates .Uns at is fac to ry s ys tems, su ch a s proc es se s whereby uncol le ct ed insu ra nce cl aimsreceive equal fol low-up action despite wide variances in amount and s ignificance.

R isk e xpos ures tha t sh ould b e c ons id ered .A lthough audi t f in ding s a re s omet imes ref er re d to a s "de fi ci enc ie s, " many int ernal audi to rgan izat ions f ind tha t term too negative; and the origina l Standards se emed to ag re e ( see430 .04.). In fac t, even the term "find ings" is conside red too negative in some environments.Words l ik e "cond it io ns " are c on side re d to b e l es s threa te ning and much less l ike ly to evokea de fe ns iv e at ti tud e on the p ar t o f the cl ien t.


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r348 Part 2: Techniques of Internal Auditing ~ _ Chap te r 8: Audi t F in dings 349

W?ile the appella tions ma~ v.a ry .f rom one organ izat ion to another, the bas ic concepts a reumversaL Whatever name 11 ISgrven, an audit finding desc ribe s s omething that was o r i sw rong, o r some th in g tha t i s l ik ely to go wrong .

Cau se: The rea son fo r the d iffe re nce be tween the expe ct ed a nd a ctua l c ond it io ns(why the d if fe rence exists) .

Internal auditors should identify sufficient, reliable, relevant, and useful informationto achieve the engagements objective.

Effect: The ri sk or exposure the organi zati on and/or other s encounter becausethe condi ti on i s not t he same as t he cri teri a ( the impact of the difference). I ndetermining the degree of risk or exposure, interna l aud itors should conside r thee ffe ct the ir engag emen t obse rv at io ns a nd rec ommendat io ns may have on theorganization's financial statements.

StandardsThe Standards for the Professional Practice of Internal Auditing in Standard 2310 s ta te :

The Standards' Practice Advisory 2410-1, "Communication Criteria," expands this directivein the following:

Observat ions and recommendati ons may al so incl ude engagement cl ienta cc ompl is hmen ts , r el at ed i ss ue s, a nd s uppor ti ve info rmat ion i f no t inc lu dedelsewhere.

2. Engagement final communi cati ons may i nclude background i nformation andsummar ies . Background info rmat ion may ide nt if y the orga nizat io na l u ni ts a nd~ctiv it ie s rev iewed and provide relevan t exp lana tory information . They may a lsoinc lude the s ta tus of observa tions, conclus ions , and recommendations f rom priorr epor ts . The re may al so b e a n ind ic at io n of whe th er the repo rt c ov er s a sc heduledengagement or the response to a request Summaries , i f inc luded, should be balancedrepresentat ions of the engagement communica tion 's con tent .

Relati ve to t he actual report ing, the Standards' Practice Advisory 2420- 1, "Qual ity ofCommunica tion Crite ria," has this to say :

1. Object ive communicat ions are factual , unbi ased, and fr ee from di st or ti on.Obs erva tion s, c on clusion s, a nd recommendat io ns should be inc lu ded withoutprejudice.

5. Re~ults should include observations, conclusions (opinions), recommendations, andaction plans.

2 . C le ar c ommun ic at io ns a re e as ily und er stood and logica l. C lar it y c an be improvedby avoiding unnec es sa ry t ec hn ic al l angu ag e and p roviding s uf fi ci en t su ppo rt iv einformation.

6. Observations are pertinent stat~ments of fact. Those observations necessary to supportor prevent m.isunder stand ing of the internal auditor's conclusions andrecommendations should be inc luded in the f inal engagement communica tions. Lesss ignificant observa tions or recommendations may be communica ted informally.

7 . Engagement obse_rvations .and recommendations emerge by a process of comparingwha t should be WIthwhat IS. Whether or not the re is a d if fe rence, the interna l aud itorha s a found at io n on which to bu ild the repor t. When condi ti on s meet the c ri ter iaacknowledgment in the engagement communica tions of sat is factory performancemay be approp ri at e. Obse rv at ion s and rec ommendat io ns should be b as ed on thefollowing attributes:

3. Concise communica tions a re to the point and avoid unnecessa ry detaiL They expressthoughts completely in the fewes t possible words .

4. Construct ive communica tions a re those which , as a r es ul t o f thei r content and tone ,h elp the e ng agement c li en t a nd the organ iz at io n and lead to imp rov emen ts whe reneeded.

5. T imely communica tion s a re tho se tha t a re i ss ue d w ithou t undu e d elay and enab leprompt effective action.

Suggestions for Improvement

Crite ria: The s tandards , measures, o r expec ta tions used in making an eva luationand/or verif icat ion (what should exist).Aud itor s a ls o en coun ter t ra ns act io ns or condi ti on s tha t may not be int ri ns ic al ly wrong, bu tcould be impr oved. Paying for products that were never r eceived is j ust plain wrong, fore xamp le . I f e nough money i s invo lv ed, i t i s c le ar ly a repor ta bl e a udi t fi nd in g. On the othe rh and , a rec eiving memo f orm that c ould b e s impl ifi ed shou ld not b e c ons id ered de fe ct iv e -and hence is not an audit finding - especi al ly when the i nt er nal audit or cannot poi nt toe rrors in the process ing of receipts.

Cond it io n: The fa ctua l e viden ce that the int erna l a ud itor f ound in the c ou rs e ofthe examina tion (what does exist).


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350 Part 2 : Techniques of Interna l Audit ing - - - - - - - - - - - - - - - - - - - - -Opera ting managers would f ind it hard to d ispu te tha t payments for goods not received mus tbe cons~dered as.val i~ audit f indings. I t would be unfair, however, to app ly the same label tosuggestions for simplifying the receiving memo that had caused no errors. Such improvements~ ,h ould c ome un~e r a se parat e cl as si fi ca ti on. In s ome o rg an iz at ion s thes e a re repor ted a ssuggest ions for Improvement." They do not warrant recommendations for the correct ion of

defec ts and do not carry the fau ltfind ing connota tion of aud it f indings.In d is ti ngui sh in~ ~ud~t finding s f rom sugges tion s fo r imp rovemen t, t he a udi to r must a skwhe ther t .hecondit ion IScontrary to some accep table c ri te ria, o r if i t is accep table but capab leof bemg Improved because new knowledge about the sub ject has come to light . The d iv id inghne .between th~ two ISnot a lways easy to draw. Opera ting managers may seek to persuadethe mt~ rna l a ~d ltor tha t a p~icu la r f in ding merely rep re se nt s a n oppo rtuni ty to imp rove anotherwi se sa~l sf ac t? ry c ondi ti on , whe re as the int ernal a ud itor may s ee i t as a d efe ct andhence an audit f inding . The dec is ion is a matte r of profess iona l judgment, and tha t judgmentmay not be rel inqu ished to opera ting managers.

Chapter 8: Aud it F in dings 351

Approach to Finding ConstructionDevelop ing fac ts and detai ls into a s ignificant , reportable aud it f inding is an acquired skill .I t r equi res d isc rimina tion b as ed on expe ri enc e. Wha t may se em l ik e a se rious s hor tc omingto a l aype rs on may be a t ri fl ing d ev ia ti on to a p rof es siona l int ernal a ud itor .F ind in g minor d eviat io ns in any ongo ing p ro ces s i s r el at ive ly simp le . P er fe ct io n i s r are a ndi ts p ri ce i s o ft en f ar too h igh. The ef fo rt ne eded to ac hieve the l as t f iv e p ercen t of pur it y ca nwel l e xce ed the c os t o f a ch ie ving the f ir st 95 p ercen t. Int erna l audi tor s mus t b e rea li st ic a ndfair in their judgments and conclusions. They must bring good business sense to thedevelopment of the ir f indings. As they pursue the development and reporting of aud it f indings,interna l aud itors should conside r these fac to rs :

Aud it f in dings requi re c or re ct ive a ct io n. The op erat ing manager c an b e g iv en no opt ion onwhethe r or no t to t ak e the a ct io n. On the o th er h and, a s ugges tion to imp rove a c ond it io n,one tha t does not VIo la te some estab lished rule or c ri te rion , is ano ther matte r. In such casesmanage rs should have the r ig ht to de cide whe th er o r no t to imp lement the sugge st ion .Rep or ta b le Aud it F i nd ing s

App ly in g h indsight to manag ement d ec is io ns ca n b e unf ai r a nd unreal is ti c. Int erna laud itors should conside r the c ircums tances exist ing a t the t ime the defec t occurred.Management dec is ions a re based on currently ava ilab le fac ts . Interna l aud itors shouldnot c ri ti ci ze a de ci sion merely b ec au se the y d isa gree w ith i t o r b eca use the y h av enew information tha t was not ava ilab le to the dec is ion maker. Interna l aud itors shouldnot subst itute aud it judgment for management judgment.

Not ev ery d efe ct ide nt ifi ed by an int ernal audi tor s hould be repo rt ed. Some a re mino r a ndnot worthy of management a tten tion . AU reportable aud it f indings should be:

The audi to r, n ot the cl ie nt , mus t as sume the bu rde n o f p roof. I f a n audi t fi nding h asnot b ee n tho rough ly proved to the s at is fa ct io n of an objec tive, r ea sonable p er son, i tis not r eportable. .

S ignificant enough to deserve being reported to management.Documented by fac ts , not opinions, and by evidence tha t is suf ficien t, competent ,and relevant.Objec tive ly developed without b ias or preconceived ideas .Relevan t to the issue involved.Convinc ing enough to compel act ion to correct the defec tive condition .

Obviously these c.har.acteristics will be interpreted subjectively. What seems to be a significantdev la tlo? to one ind iv idua l may appear to be ins ignificant to another. Words l ike objec tive ,convmcmg, reasonable, and log ical have d if fe rent connota tions to d if fe rent people.The tes t i s t o p ro jec .t l~ow the d ef ec t wou ld be reg arde d by a reas on ab le , p ru den t p er sonunder the same o r si rn i l nr c ir cums ta nce s. As the y app ra ise a d ef ic ie nt c ond it io n, int ernalauditor s must. ask t hemselves: "If this were my organi zati on or agency, and if I wer e i tsp resident or d irec to r appra is ing this condition , wha t would I do about i t?"

Interna l aud itors should certa in ly be interes ted in improvements in performance , butpe rfo rmance do es not n ece ss ar il y d ese rv e repo rt ed c ri ti ci sm bec aus e i t i s l es s tha n100 percent.Int ernal a ud itor s should p la y the d ev il 's advoc at e w ith d ev eloped audi t f in ding s.They should scrutin ize the ir d iscovery for possible f laws and fal lacious reasoning .Interna l aud itors, l ike any other proponents of a proposition , a re tempted to rat iona lizeint erpret at io ns tha t w il l su ppo rt t hei r f in ding s. A ft er inv est in g a g rea t d eal o f t imeand effort, the auditor tends (0pro tect the inves tment and defend the f inding aga instper fect ly logical quest ions. But those fi ndi ngs may not st and t he t est of t ime orrigorous questioning.

Adding ValueI n ever y aspect of business, t he concept of adding val ue has taken on new and emphat icm eaning. The r ecent definit ion of i nternal audit ing i s speci fi c in its menti on of addingv alue . Fun ct io ns that are pe rce iv ed as non -v alue-adding are at r is k of b eing downs iz ed, o r


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352 Part 2: Techniques of Internal Auditing _ _ Chapter 8: Audit Findings 353

eve~ e limina ted. One of ~heways in ter nal aud ito rs add value is by maki ng sure that t hefindings and re~ommendatl~ns they present clearly have a positive impact on the organization.Not only must internal auditors be. cer ta in that their work contr ibutes in meaningful ways tothe goals and success of the orgaruzat ion, they must also be sure that those contributions areunderstood and valued by others.

This i s not to suggest that random clerical errors should never be repor ted. I f those errors aresymptomat ic o f a l ar ge r p rob lem, repor ti ng might be warrant ed. The e rro rs might indi cat epoor employee tr ai ni ng, i ne ffect ive superv isi on , o r unc lear wri tt en i ns tr uct ions. I n suchcases i t i s these control def ic iencies that const itute the audit f inding. The random errors aremerely evidence that the def ic iency exist s and needs management attention.

Fin~ings that result from "front-end" reviews are likely to be especially beneficial. Ifinternalaudlt .ors are able to detect potential control . ~robl~ms in a new computerized inventory-tra.ckin~ sys~e~ before - rather than after - ItISdesigned and implemented, the organizationgains big dividends , Fin.d~ngs that generate the greates t value often unleash the power oftechnology, promote positive change, and are future-oriented. They help the organization tomove forward and attain i ts goals .

Minor Findings

~ound audit f i~di~gs can resul t in hard dol lar recover ies, or improved service, or they canIm~r~ve organizational structures and processes. In both cases, internal auditors will enhancetheir Ima~e.as value-add~rs, rather than as resource consumers. Throughout the audit findingphase, It~sImportant for internal auditors to maintain focus on providing high-value activitiesand. services.

A minor audi t f indi ng r equir es repor ti ng because it is more than a random human e rr or . Ifno t corr ec ted, i t wi ll conti nue to have adver se ef fects ; and whil e it may not t hwa rt a ma jo roperating objective of the organizat ion, i t i s of sufficient s igni ficance to bring to the attentionof management. Some minor findings would be better reported in what is termed aManagement Letter.An employee who has commingled personal and organization petty cash violates botho rgan izat ion r ul es and good busines s pr ac tic e. Ce rt ai ul y t he mat te r shou ld be r eport ed andcorrected; otherwise, i t might continue or become widespread.

Degrees of Significance Major Findings

No tW? findings a~e exactl~ the same. Each will represent a unique degree of actual orpotential loss or nsk. Placmg the same emphasis on random clerical errors as on anoverpayment of $~OO,OOO is clearly illogical. So internal auditors should consider the degreeof damage a deficient condition can cause or has caused before communicating that conditionto ma?agement. For most purposes, audit f indings can be class if ied as ins igni ficant minoror~oc ' ,

A major fi ndi ng is one t hat would p reven t an o rgan iza ti on or a uni t wit hi n an organ iza ti onfrom meet ing a maj or object ive. For example , a ma jo r ob jec ti ve f or an accoun ts payabledepar tment i s to pay only what i s r ight fully due. A defective system of control that resul tedin, or could resul t in, payment errors total ing $500,000 represents a defect that could bar thedepar tment f rom meeting a major objective. Therefore , i t i s a major audit f inding and shouldbe so reported.

Insignificant Findings The line between major and minor findings can become exceedingly fine. Good auditjudgment i s requi red to discr iminate between the two. But i f the benchmarks jus t descr ibedar e reasonab ly appli ed , i nt er nal aud ito rs shou ld be able to de fend their c la ssi fi ca ti on o ffindings. And si nce audi t j udgment is i nvolved, the f inal dec is ion abou t whether a fi nd ingshould be classified as major or minor lies with the internal auditor. This is not a determinationto be relinquished to management.

An insigni ficant f inding - t .hesort of cl: rical misstep that all organizat ions exper ience _does not war rant f orma l ac ti on . I n f ac t, mcl udi ng such a f inding in a f orma l audit r eportwould be co~nterproducti .ve because . it would tarnish the t ruly s igni ficant f indings in therepor t, implying that the internal auditor could not discern the dif ference between a mereflyspeck and a s~reading blot. It would also perpetuate an undesirable stereotype: the internalauditor as a nitpicker.

Elements of an Audit Finding

Ins igni ficant i tem~ should not be hidden or overlooked. The acceptable course of act ion isto ( I) diSCUSShe I tem with the individual responsible; (2) see that the s ituation is corrected '(3 ) not: t he ma tte r. in the worki ng pape rs ; and (4) keep such s li gh t devi at ions out o f theformal internal audit repor t. The fai lure of an accounts payable clerk, who knows bet ter, totake a few random discounts here and there could be considered an insigni ficant error .

Internal auditors are not omniscient, and they cannot be expected to know all there is toknow abou t the oper ations being aud it ed . Knowledge abou t a repor table audit f inding issome th ing e ls e agai n, si nce the i nt ernal audi to rs a re di sputi ng the p rop rie ty o f the s ta tu squo. They are s ingl ing out some system or t ransaction that did not meet acceptable operatingst andards. I nte rnal audit or s can expec t to be chal lenged , howeve r; and t hey shoul d know as


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354 Part 2: Techniques of Internal Auditing _ Chap ter 8 : Audi t F in ding s 355

much about the ir f indings as anyone e lse. Interna l aud itors' f ac ts should be unassai lable'their criteria should be acceptable; and their logic should be convincing. ' ha ve yards ti ck s - st anda rd s o f mea su remen t. Th ey mus t ide nt if y v al id s tandards o r c ri ter iao f pe rf ormanc e. Be fo re they c an c ri ti ci ze wha t i s, t hey must know wha t s hould b e.The propriety of any action i s best measur ed by compari ng it wit h some cri ter ion ofaccep tabili ty . The development of an audit f inding is no dif fe rent . If the developed f indingmee t.s a ll a~cep table aud it . s ta~dards , i t wil l be log ical , reasonable, and compell ing. I t wil lpro~lde ~ stimulus f~r motrvating corrective action. If something is missing from the reportedfinding , I t may be d is pu te d and res ul t i n grudging ac tion or ev en no a ct ion at al l.

Ope ra ting s tanda rd s may al rea dy exi st i n s ome area s of the orga niza tion. For ex ample,management may have decreed tha t the rejec tion rate for certa in products should not exceedtwo percent . Before accep ting the s tandard, however, the interna l aud itor should appra ise i tsv al idi ty . The b as is fo r the st anda rd may need to be rese arch ed ; a nd the audi to r may wan t tocompare s tandards with those in s imilar organ izat ions and examine the ir reasonableness inmeeting enterprise goals.Most.~eportable audit findings should include certain elements, including background, criteria,

~ondJtlon, cause, effect, c~nclusions, and recommendation. Any audit f inding that properlymclud~s thes~ e lemen~s, e ithe r exp lici tly or implici tly, wil l p resent a s trong argument forcorrective action. It.Will dem~nstra te tha t no s tone was lef t untumed in demonstra ting theprob le ~ and proposmg a s olut ion . In s ome uniqu e c as es, t he el ement , " cau se " may not b eappropnate. A problem may be the result o f a specific condition .

On the other hand, management may not yet have establi shed st andards. I n that case, theinterna l aud itors can be guided by a former s tandard which suggested :

Background

Due p ro fe ssion al ca re inc lu de s ev alua ting es ta bl ish ed ope ra ting s ta nd ards andd etermining whethe r thos e s tanda rd s are a cce ptab le and are be in g met . When su chstandards are vague, authoritative interpretations should be sought. If internal auditorsa re required to interpret o r selec t opera ting s tandards , they should seek agreementwith c lien ts as to the s tandards needed to measure opera ting performance .

The read er must b e prov id ed w ith e nough gen eral i nf orma tion rel at iv e to the si tu at ion tocompletely understand. the ~easons why the auditor believes the f inding shonld be reported.Background ~an a lso Identify the p layers , the organ izat ion' s relat ionships , and even, to adegree, objectives and goals concerned. It should describe, in a general sense, the environmentsurrounding the opera tion and the gravity of the s itua tion tha t prompts the auditor to reportthe finding.

Sources of s tandards may inc lude engineered, indus try, h is to rica l, o r manda ted s tandards .In addition, expert opinions and cost accounting studies may provide standards. The followingexample illustrates an established operating standard:

CriteriaWater meter s in a commun ity are inst al led to meas ure wa te r. To ob ta in the rev enueneeded to maintain the water d is tr ibution sys tem, the meters should be accurate andch arge c us tomers f or the r ig ht amount of water u se d. Water meter s in us e shou ld no tvary from a master meter by more than a stated percentage. In this case, thepercentage was set forth in legal requirements.he development of an audit f inding mus t inc lude two key e lements in the concept of c ri te ria:

(1) Goa ls a nd ob je ct ive s, p os sibly inc lu ding ope ra ting st and ards , t ha t r ep re se nt wha tmanagement wants the audited opera tion to accomplish.

St anda rd s a re clos ely l ink ed wi th proc edures and pract ic es . Proc edures a re managemen tinst ruc tions , which a re g en eral ly in wri tt en fo rm , whi le p ra ct ice s are the way thing s a rebe in g done , whe th er r igh t or wrong . Poor proc edures may con tr ibu te to a n uns at isf ac to rycondition , o r poor pract ices may vio la te an adequate procedure . In develop ing audit f indings,i nt ernal audi to rs shou ld s ee k to de te rm in e wha t the p rac ti ce s a nd p ro ce du re s are or shou ldbe.

(2) The quality of the accomplishment.No t und .e rst anding t~e go al s o r objec tives o f an ope rat io n i s l ike apprai sing a sc ulpturewhile blindfolded. It s pos sibl e to ha ve some apprec iat io n f or the p ar t t ou ch ed , bu t the re i sno sense of con t.ex t. . In develop ing an audit f inding , interna l aud itors mus t c learly see andunderstand the b ig p ic tu re , as well as i ts e lements.

The exi st enc e o f fa ul ty proc edures or the ab se nc e of p roper proc edures may be the reas onbehind the ne ed fo r co rrect iv e ac tion . Yet i t t ake s cons id erab le s ki ll t o wri te abou t themwithout making dull reading . Only the h ighlights should be reported, leaving out unessen tialdetail. For example:~n~y audit o f an activ ity, the goa ls of proprie ty , e ff ic iency, economy, and effec tiveness a re

Imphed: . All resources should be used with a min imum of was te . To determine how proper,h ow ef fi ci ent , h ow economica l, a nd how e ff ec tive a n ope ra tion i s, i nt ernal audi to rs mu st


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358 Part 2: Techniques of Internal Auditing _ Chapter 8 : Aud it F in ding s 359

The following example shows a s ignificant e ff ec t:Th e int erna l a ud itor s were ab le to demons tr at e by the ir samp le that $2 mil li on inrev enu es were b eing los t e ach yea r. They were a ls o ab le to s how that water r at eswere unnecessarily high, resulting in excess revenue of at least $1.5 million annually.

w ith othe r poss ib le c ou rse s. Int erna l a udi to rs do no t d ic tat e to managemen t; a nd , in the end,management, not the interna l aud itor , mus t l ive with the correct ive action.

ConclusionsThe most s at isf ac to ry mean s o f res olving an aud it fi nd in g i s to di sc us s i t w ith ope ra ti ngmanag emen t b ef ore the wri tt en a udi t r epo rt i s publ is hed . A t tha t t ime, a greement s hould b ereached on the fac ts and on some reasonable course of act ion to correct the defec t. Thereaf te r,t he f orma l repor t c ould c ontain a st at ement a lo ng the se l in es : "We d is cu ss ed ou r find in gsw ith manag emen t; a nd, as a res ul t, a ct io n was t ak en that we be li ev e i s c al cul at ed to co rrectthe c ond it io n d esc ribe d (or a ct io n was t ake n tha t c or re ct ed the c ond it io n de scr ib ed ). " Th isapproach takes nothing away f rom the auditor , and it builds a problem-solving partnersh ipbetween auditor and c lien t.

Conc lu sions mus t b e bu tt re ss ed by the fa ct s; b ut they are p ro fe ss io nal judgmen ts , n ot areci ta ti on o f d et ai ls . In d ev eloping the ir c on clusion s, i nt ernal audi to rs c le ar ly h av e anopportunity to demonstra te the ir unique contributions to the organ izat ion. When interna lauditors consistently present conclusions that can lead to new and higher levels of performance,reduce cos ts and improve production qua li ty , e limina te needless work, exp lo it the power oftechnology, e leva te cus tomer sat is fact ion, improve service , and enhance the competi tiveposi ti on o f the organ iz at io n, the v alue of int erna l a udi ti ng i s obvious . Conclusion s ca nunderscore the auditor's understanding of the business of the organization and the relationshipof the audited function to the entire enterprise.

We are firmly convinced that this form of reporting is preferable to a set of auditrecommendations tha t seem to emphasize c lien t derel ic tions and display the auditor as somesuperio r, omniscien t c reature issuing proclamations engraved in granite . For example :

Conclus ions can and should present poten tial courses of act ion and point out tha t the cos t ofc or rec tiug the d efe ct s w il l b e e xce ed ed by the b en ef it s. Th e e xtent of loss es shown in theeffec ts a re a springboard to the need for correct ive action. For example :

We discussed our f indings and conclus ions with management personneL As a result,manag emen t took a ct io n to repl ac e 25,000 ag ing or inop erat ive meter s a t a co st o f$1 mil li on . Management was sa ti sfi ed tha t thi s a ct io n wou ld yield $2 mil li on a y ea ri n addi ti onal revenue and, at the same time, r educe water r at es revenue by about$1.5 million annually.

The f indings Jed the auditors to conclude tha t the procedures should be improved.Meters over a certa in age should be monitored , and those tha t do not mee t s tandardsshould be rep laced. Ins truc tion and surve il lance should be provided for inspectorsso the ir performauce can be boosted .

A lso , manag emen t took s te ps to d is pa tc h a t eam to se ve ra l u ti li ty organ iz at io ns,whe re the y were to s tu dy the methods employed in ins pe ct in g meter s, s upe rv is in gmeter i nspecti on, and monit or ing met er s to detect t hose that were beginni ng t odeteriorate.

Recommendations Discussing FindingsRecon~mendat io ns d es cr ib e the c our se o f ac tion managemen t migh t c on sider to rec ti fycondit inns that have gone awry, and t o st rengthen weaknesses i n systems of control .Recommendations should be pos it ive and as specific as possible. They should a lso identifywho i s to ac t o n them.

When they d ev elop thei r audi t fi nd in gs and contemplat e the ir r ec ommendat io ns , i nt erna la udi to rs must b e awa re of the ir own fa ll ib il it y. They may no t ha ve int erpret ed condi ti on sc or re ct ly , o r the y may not h ave rea d p ro ce dures as int ended. To check the ir under st andingo f wha t they found , int erna l audi tor s shou ld t alk w ith thos e mos t l ik ely to know the f act s.They s hou ld s eek the c li en t' s i nt erpret at io ns and note them in the working p ap er s.Aud it r ec ommendat io ns ca rry the se eds o f d anger , h owever . I f managemen t i s told tha t the

cour se rec ommeuded hy the audi to rs i s the cour se to t ak e, t he a ct io n when tak en ca n returnto haunt the auditors. Identifying an unsatis factory condition is an audit respons ib il ity.Correcting that condition is a management responsibility.

The opinions of managers and experienced employees concerning the results of recommendedaction are espec ia lly welcome. The experienced interna l aud itor wil l seek out knowledgeab lep eople in the o rg aniza tion - p eople w ith a w id e- ra nging gras p o f the op erat io ns in ques tion- and say: "Her e's the pr oblem. The condit ion needs cor rect ion or impr ovement. Whatwould happen if we recommeuded this course of act ion?" Many a veteran auditor can recounttales of how such quest ions saved them embarrassment.

I t is p re fe rable tha t interna l aud itors propose methods of correct ive action for management' sconside ra tion . Audit recommendations should not be b lind ly taken , but conside red, a long


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362 Part 2: Techniques of Internal Auditing _ Chap te r 8: Aud it F in dings 363

~o:z :

~s~r-is:::J_Jza:urr-z

.0

Exhibit 8-2Internal Audit Activity

Record of Audit FindingComments and Action

Management Comments

CUse reverse side for additional comments)Name: Title: Date:

Corrective action:

Effec tive date of correct ive action

Name: Title: Date:

Auditor's appraisal: UnsatisfactoryProposed action satisfactory

Auditor: Date:

Follow-up of correct ive action:

Auditor: Date:

Results of correct ive action (evalua ted during subsequent aud it)

Auditor Supervisor: Date:

Eo"


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Exhibit 8-3Abstract of Findings Some organizations issue a memorandum for each significant audit f inding to report condition,c ri te ria, cause , e ff ec t, and management' s response. The "Abstract o f Finding ," reproduced

in Exhibi t 8-3, fo r ex ample, was ad ap te d from a governmen t ag en cy repor t o n a c on tr actoraud it . These memorandums are g iven wide d is tr ibution throughout the agency. Proponentsof such abs trac ts report tha t they offer many benef its:

364 Part 2 : Techniques of Interna l Audit ing - - - - - - - - - - - - - - - - - - - - - -

Office:SUbject: Travel ExpensesReport Title: Fiscal Accounting

Sen io r manag er s a re give n a qu ic k means o f l earning about c ur re nt p roblems andthe ac tion t ak en o r n ee ded to reso lv e them.ondition:

Criteria:

Cause:

Effect:

Management'sresponse

Chapter 8 : Aud it Find in gs 365

Northeast District

Th e ab st rac ts are a na ly ze d p er io di ca lly to d isc lo se t rends . When b rought to se niormanag ement 's a tt ent io n, o veral l a ct ion ca n be tak en to rev er se a dv er se t re nd s. Arelat ively minor pr oblem in one office may become seri ous if it crops up in manyoffices.

Trave l advances exceeded presc ribed maximum amounts a llowed . Wefound that 133 of 175 ac coun ts e xc ee ded the a llowab le max imumadvanc e o f $2,500. The se e xces sive b al anc es ranged f rom $2,640 to$4,750. The excess totaled about $300,000.

Manag er s in f ield of fi ces a re ke pt info rmed o f p roblems l ike ly to a ffe ct them as wel l;t hus , i nt ernal audi ti ng i s ab le to rea ch se ve ra l a re as w ith the s ame expendi ture o fresources.

Company policy provides advance travel funds to employees authorizedto trave l. Advances a re not to exceed expenses antic ipated for a periodof 45d ay s. Normal pe r d iem rat es a re $50 . Thu s, t he maximum for 45d ays IS~2,250 . A~ addi ti on al amoun t up to $250 may be inc lu ded toov er es tJ .mated mJlea ge when t ra ve le rs u se thei r p er sona lly ownedautomobtles.

Th e di sc ip line o f p re pa ring a bs tr act s b ef ore wri ti ng the a ud it r epor t h elps int erna laud itors p inpoin t any shortcomings in the development of the ir aud it f indings. Carein preparing abs trac ts eases the subsequent prepara tion of the f inal aud it report.Company proce~ures do not require specific justification for large traveladvanc.es. The FIscal Accounting Office relies primarily on employees '

supervisors to make sure advances do not exceed needs. Inconsistenciescan occur because requests a re approved by dif fe rent supervisors andnone of them follow the same rules. '

A cent ral r evi ew of a bs tr act s he lp s to maint ain a qua li ty as su ran ce prog ram des ig nedto improve internal auditing,

Employee s ca n and do ac cumulat e l arge , u nn eed ed advanc es . The sea ccm: rmlat ion s c~n adv er se ly a ff ec t the company 's c as h posi ti on. InaddItIOn, collect ions become dif ficu lt when employees holding largeadvances leave the company. Fisca l Accounting is now in the processof t rying to c ol le ct o ve r $15 ,0 00 f rom employe es no longe r w ith thecompany.

Communication SkillsEven br ief statement s such as those that appear in the RAP should be wel l writ ten, andp roblems must be c lea rly d ef in ed in c on ci se , prec ise t erms. When pos sibl e, t he l anguage o fthe RAP shou ld b e c ou ch ed in po si ti ve ton es, a nd terms tha t inci te emot io na l or d ef en sivereact ions should be avoided . Of course, the same a tt itude should a lso preva il in day-to-dayverba l communica tion and interim presentat ions of aud it results .The accounting ~ctiv ity wil l compare trave l c la ims with outstanding

advances to identify employees with advances in excess ofneeds. Thoseemployee s w il l be requ ir ed to jus ti fy the amoun ts a dv an ced to them o rre~uce th~ advance~ ~o~heamounts of their actual expenses. SupervisorsWill be grven specific ins truc tion about the amounts of advances theyare authorized to approve.

A t the same t ime, audi to rs must o ft en de al wi th s en si ti ve, ne ga tive i ssu es . S er iou s c on trolp roblems, f raud , or i llegal acts wil l a lways be regarded asbad news, regardless of the auditor 'scommunica tion abili ties or the objec tivi ty of the RAP.

Audit Manager


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TChap te r 8: Aud it Find in gs 367

366 Part 2 : Techniques of Interna l Audit ing - - - - - - - - - - - - - - - - - - - - - - - - -

Supervisory Reviews I s the rec ommenda tion us ef ul a nd s pec ifi c, o r d oes i t merely sa y " improv e cont ro ls" ?

I s i t t oo r ig id , i ns is ti ng on the int erna l a ud itor 's c our se o f a ct ion ? Does i t a ddres s thepas t but ignore the future? Is i t pun it ive rathe r than construct ive? Is i t out ofharmonywith the c au se ? Does i t i nclud e a means o f moni to ring condi ti on s s o tha t the adve rs ee ffec ts wil l not recur?

Audit supervision rel1_1ainshe key contr?1 over the professional development of audit findings.Each re~ortable f indll1~ should be subjected to c lose supervisory rev iew, e ithe r manua l or~le :tro~lc, and the rev iew should be evidenced by the supervisor' s s igna ture or e lectronicindication of approval. Do the methods of pres en ta ti on a gree w ith the Standards?Not~ing reduces the c redibi li ty of an interna l aud it act iv ity so much as an ineptly developedf indm~ tha t collapses under a ttack. An audit f inding is by def in it ion a cri ticism. The naturaldefe~slve mechanism of those c ri ticized often prompts a counterat tack on the cri tic. Audit~ndmgs mus t the re fore be beyond reproach. Audit supervisors can see tha t the des ired endIS accomplished by approaching any audit f inding with these quest ions :

Reporting Audit Fiudings

~e ~ny elements of the finding missing? Why? What can be done t o seek out t henus~ll1g e lements? AIe these defec ts a result o f poor presentat ion or of incompleteaudit work?

RAPs and abs tr ac ts h av e b een put to us es beyond rec ording a find in g o r c ommun ic at in g i tto the c lien t. In fac t, some audit o rgan izat ions have made these summaries the primary bas isfo r the int ernal a udi t r epor t. Th ey a re a cc umulat ed in a logica l o rd er g roup ed by SUbjec t,locat ion, o r aud ited unit and then submitted to management by means of a one-page execu tivesummary. The summar y br iefly descr ibes the scope of the audit, offers an overall audi to pinion, and p rovide s the a udi to r' s a ss es sment of the op erat io n a ud it ed . The exe cu tivesummary a lso brief ly l is ts the reportable f indings. The documented f indings a re representedby the RAPs or abs trac ts .AIe t he el emen ts so mix ed up that cl ar it y i s c lo ud ed? Are opinion s s ub st it ut ed fo r

f ac ts ? AIe ca us es c on fu se d w ith e ffe ct ? Are recommendat io ns simply a rec it al o ffacts?

This form of reporting concentrates on defects. Itdoes offer the advantage of prompt reportingaf te r the fi eld work h as b een complet ed, b ut what i s g aine d in s pe edy repo rt in g may be losti n un fa vorab le a ud itor -c li ent r el at ion s. Th e audi to r may take on the a sp ect o f a ca rp in gcr it ic, r ather than an objec tive obse rv er who i s conce rn ed w ith both the good and the bad.Thi s adverse effect could be bal anced by overall objecti ve comments i n the executivesummary. I t could al so b e n eu tr al ize d by int er im d is cu ss io ns of the RAP with the c li en t.

When p ro ce du res h av e not be en f ol lowed , a re rec ommenda tion s merely a l amestatement that the procedures should be followed? Or do they show why theprocedu .res wer~ not fol lowed? In o ther words , would it be more use fu l to recommendc learer ins truc tions, c lose r supervision , more constan t monitoring, o r o ther means ofcon trol tha t wil l p romptly identify dev ia tions f rom procedures?AIe the audit c ri te ria c redible, c lear , convinc ing, and objec tive? AIe they des igned tomee t a manag emen t goa l? Do the y make good se ns e?

Follow-up

I s info rmat io n on the c aus es c omplet e, o r i s i t su pe rf ic ia l? I s the c au se a log ic alc on clus io n? Does i t go t ? the h ea rt o f the problem? Wil l t he ca us e t ri gg er the sameundes irab le e ffec t each orne? Is the cause superficial , o r is i t bas ic?

V iews a re no t unan imous a bou t a udi to rs ' r es ponsibi li ty w ith reg ard to f ol low-up. Somewrite rs and pract lt ioners take the pos it ion tha t interna l aud itors identify def ic ient conditionsa nd that i t i s u p to manag ement to t ak e the c or re ct iv e a ct io n, d et ermine i ts a de qu acy , andmonitor i ts e ff ec tiveness . However, this v iew is not consisten t with the broader descrip tionof interna l aud it respons ib il it ie s as s ta ted in the introduction to the Standards:

Is th: e ff ec .t exaggerated? Is i t log ical? Is i t understated? Is i t suf ficien tly quantif ied?Are intangibles adeq~ately recognized and suf ficien tly expla ined? Does opera tingmanagement agree with the reported effec t? If not , wha t is i ts pos it ion?Are the !e mitigat ing c ircums tances tha t cou ld render the f inding null and void? Canthese circumstances be neutralized?

Int ernal audi ti ng i s a n independent , o bjec tive a ss uran ce a nd consu lt ing ac tivi tydes igned to add value and improve an organ izat ion' s opera tion .

Implici t in tha t s ta tement is the respons ib il ity to identify and report onboth actua l and poten tialr is ks to the en te rp ri se . Int erna l a ud itor s who are aware o f d ef ec ts a nd r is ks a re requ ir ed toreport them to appropria te levels of management.


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The chief audi t executi ve should establ ish a fol low-up pr ocess t o monit or andensure tha t management act ions have been effec tive ly implemented or tha t sen iormanagement has accep ted the risk of not tak ing action.

Chapter 8 : Aud it F in dings 36968 Part 2: Techniques of Internal Auditing _

The current Standards 2500.Al s ta te tha t: Respons ive to the reported defec t.Complete in correct ing a ll materia l aspec ts of the defec t.Continuing in its effectiveness.Monitored to prevent recurrence.

2. Fol low-up by int ernal audi to rs i s d ef in ed as a proce ss by which they d etermine theadequacy, e ff ec tiveness , and timeliness of act ions taken by management on reportedengagement observations and recommendations. Such observations andrecommendations a lso inc lude those made by externa l aud itors and others. (Source:Red Book 440.01.1)

In the following example , correct ive action d id not mee t these four c ri te ria:The Standards' Practice Advisory 2500.Al-l , "Fo llow-up Process ," further s ta tes: An orga nizat io n us ed va riou s fo rms o f explosives in i ts o pe ra ti ons . The h andl ing o f

explosi ves, as one might expect, requi red car e and experi ence. That lesson wasl earned when a c arel es s, un tr aine d worke r bl ew of f h is own a rm and b lind ed a c o-worker.

3 . Respons ib il ity for fol low-up should be def ined in the interna l aud it act iv ity' s wri ttenc har te r. The na tu re, t im ing, and ex te nt o f fo llow-up s hould be d etermined by thechief aud it execu tive . Fac tors tha t should be conside red in determining appropria tefollow-up procedures are:

Therea ft er i t b ecame organizat io n pol ic y f or a ll e xplos iv es ha nd ler s to c omplet e acourse on the sub ject , acquire certifica tion in explosives handling, and carry a cardat te st in g to the ir c er ti fi ca ti on . The h and le rs were to b e rece rt ifi ed e ac h yea r a ft erbeing tes ted for the ir knowledge and abili ty in dea ling with explosives.

The s ignificance of the reported observa tion or recommendation.The degree of e ffort and cos t needed to correct the reported condition . Th e r isk s tha t may oc cur shou ld the co rrec tive a ct io n f ai l.

The complex ity of the c or rec tive a ct io n. The time per iod involved.

Internal auditors examined the certif ication procedures and the status of certif icationfor a number of the handlers. They found that no system existed to inform thehandlers or the ir supervisors tha t the ir annua l examina tions were dne . In addit ion,they qu est io ne d 30 of the 100 explosive s ha ndler s and f ound tha t two had no t b ee nce rt ifi ed a t al l and that the ce rt if ic at io n o f three o th er s h ad expi re d. A ll f iv e wereengaged in daily explosives handling.

A reported def ic iency, accep ted as valid by management, has obvious ly described a risk tothe enterprise. Thecondition remains a risk until it has been fully corrected. Failing to monitort hat r isk unt il it is corr ected, or until senior management or the board has st at ed it wi lla ssume the risk, mus t be regarded as the abandonment of an audit respons ib il ity.

The interna l aud itors promptly reported the ir f indings. In response, the productionmanager had the five employees tested and certified. He then reported thatinformation to the interna l aud itors, s ta ting tha t he had the reby corrected the def ic ientcondition.

Another a rgument aga inst a llowing auditors to fol low up on correct ive action is tha t they arest af f a nd not l in e. The s ta temen t i s obvious ly t rue , and int erna l a ud itor s s hould not t ak e online functi ons. But following up on cor rect ive action is not a li ne funct ion. It is a st afffunction des igned to assess the actions of the l ine functions . Interna l aud itors a re carry ingout the ir own respons ib il ity by appra is ing the performance of the l ine function in rednc ingrisks to the enterprise.

The correct ive action was inadequate on a ll counts and was rejec ted by the interna l aud itorsfor the following reasons:

Itwas not responsive. Itdid not dea l with the controls over certifica tion .Itwas not c omplet e. Only the h and le rs in the audi tor 's t es ts were c ons id ered .

Adequacy of Corrective Action Itwas no t cont inu in g. No sy st em had been inst al le d to make s ure that h andler s a ndthe ir supervisors were notif ied about pending expirat ions of the ir certifica tes.Audit fi ndings and the act ion needed to implement them come in such a great vari ety ofshapes and s izes tha t no rig id rules for the appropria teness of correct i ve action would applyin a ll ins tances . In general , correct ive action should be:

Itwas not mon itored . The re was no prov is io n, o th er tha n pe riodi c int ernal a ud it s, t omake sure tha t people handling explosives were tra ined and certified .


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370 Part 2: Techniques of Iuternal Auditing ~ _ _ Chapter 8: Audit Findings 371

The aud itor s e xp la in ed the d ef ec ts in the c or re ct iv e ac tion to operat in g management . As aresult, the following addit iona l s teps were taken :A card record lis ting the names and the certifica tion expirat ion dates for each handlerwas set up in a date "tick le r f ile" in the personnel department, which was respons ib lefor training and certif ication. The card was then placed in a "pending" file and removedonly upon receipt of evidence of recertif ication.

In the f in al audi t r epor t, p rominent not ic e s hou ld b e give n to any cor re ct iv e ac tion st ar te d o rcompl et ed. No audi t finding should be given any mor e weight or str ess than i t deserves.Insign if ic an t find in gs s hou ld uot be f orma lly repor ted at a ll , s o long a s they a re p roper lycorrected.

All 100 handlers were checked for valid , up-to -date certifica tion cards .

The d es ir ab il it y o f s el li ng a f in ding to the c li en t sh ou ld n eve r d et er the a ud itor s from the irp rimary pu rpo se , which i s to se e tha t the c ondi ti on i s c or rec te d. Desp it e the .b est ef fo rt s o fthe audit or s, some operati ng manager s, may be recalcit rant and unconvinced, In . suchc ircums tances , the auditors may have to contact the c lien t' s superio rs . Very often , the h igherthe a ud itor s ha ve to cl imb up the management l adder , t he more objec tive ly thei r fi nd in gswill be regarded.n e mon th b efo re the e xp ir at io n of a handler 's ce rt if ic at io n, the manag er o f ea chhandler was to be notif ied tha t recertifica tion was due . They were a lso to be notif ied

if any handler 's certifica tion had been a llowed to expire even though notif icat ion ofrecertifica tion dates had been given . Aud itor s s hould p rep are the ir c as es f or the h igh er l eve ls o f manag emen t w ith s pe ci al c are.Sen ior management may not have the opera ting managers' int imate knowledge of conditions;so the presentat ion should be c lear, understandable, and convinc ing. F lip-chart and e l~ctronicp re se ntat io ns h av e be en f ound u sef ul in explaining the prob lems an~ demon st ra ti ng t~eneed for correct ive action. It is espec ia lly important tha t the presentat ion properly explamthe goa ls a nd the s ta nd ards of the op erat io n in qu es tion , the condi ti on s, t he p ro cedures a ndpract ices , the cause and effec t, and the conclus ions and recommendations .

The chief safety engineer ins truc ted h is eng ineers , who toured the p lant in sea rch ofsafety v io la tions, to verify tha t anyone seen handling explosives had a current cardevidencing certification.

Authority and Audit StatusResponsi~il~ty cannot be carried out without corresponding authority. The audit responsibilityfo r . app~al smg the ~dequ acy and e ff ec tive ne ss o f c or re ct iv e a ct io n i s meaning les s i f t heaudlto~ IS not authonzed to do so. Busy opera ting managers a re l ikely to respond to auditors'ob J. ect lOns by sa ying: "1'm runn ing my shop. I took the ac tion I f el t was a pprop ri at e. I tsat is fies me. Who are you to tel l me dif fe rently?"

Interna l aud itors wil l be assured tha t they have done the ir job profess iona lly if e ithe r opera tingmanagers or sen ior management request add it iona l aud its or special s tudies .Supplementary Readings

These are the responses internal auditors will hear unless senior management clearly providesthem with the a uthor it y to judg e whe th er a ctua l or p ropos ed co rrect iv e a ct io n w il l c or re ctreported def ic ienc ies. This authori ty mus t be spe lled out c learly in the interna l aud it charter .All operating managers should be fully aware that corrective action must be real and effective.The audi to rs w il l a lway s h av e the au th or it y to rev iew the a ct io n a nd , i f i t d oe s no t p rope rlycorrect the condition , to report i t.

Aldridge, Ashlee, "Just Another Audit F inding"," Internal Auditor, August 2000, 77-79:Bossie, Franc is X., and Alf red R. Michenz i, "The Single Page Audit Report," Internal Aud,tor,

April 1997, 37-41.Didis , S tephen K., "Communicat ing Audit Results ," Internal Auditor, October 1997, 37-38.Flaherty, J.J ., and Judy Stein, "Solution-Focused Audit Reporting," Internal Auditor, October

1991, 58-61.Hubba rd , Lar ry D ., "What 's a Good Aud it Find ing ," Internal Auditor, February 2001, 104.Jacka, 1. Mike, "Door Number Three ," Internal Auditor, December 1997, 54-57.Johns , G.F ., "Audit Recommendations : Overcoming Implementat ion Frustra tion ," Internal

Auditor, April 1989, 30-33.Marks , Norman, "Dismissed Audit F indings," Internal Auditor, June 2001, 69-7l. .Qureshi, Anique Ahmed, "How to Evaluate a Specialist's Findings," Internal Auditing, Spnng1996, 48-53.Ratliff, Richard L., and I.Richard Johnson, "Evidence," internal Auditor, August 1998, 56-

61.Sawyer, L .B., "The Human Side of Interna l Audit ing," Internal Auditor, Augus t 1988, 4 0-44.

However, i t is more des irab le to sel l than to tel l. And the seIling process should s ta rt early on.At the pre liminary mee ting , aud itors should assure c lien ts tha t: (I) they wil l be told promptlyo f e ve ry find in g the audi tor s e nc oun te r; (2) b oth the find in g and the suppor t fo r i t w il l b ethoroughly d iscussed ; (3) any quest ions regarding the fac ts wil l be resolved before the matte ris rep~rted; ~4) the ~lien t wil l be a llowed to present a pos it ion adverse to the f inding ; and (5)the client WIll be given every opportunity to ini tiate correct ive action.


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372 Part 2: Techniques of Internal Auditing _

Schwartz, Brian M., "Documenting Audit Findings," Internal Auditor, April 1999, 48-49 .Sears, BrianP., Internal Auditing Manual (New York: RIA, 2003). (See ChapterDl, "Evidential

Matter.")Sprakman, Gary, and Mohamed Ibrah im, "Cost-Economizing Superio ri ty of Opera tional

Audit Findings to Financial Audit Findings," Internal Auditing, May/June 1998, 34-43.Walz, Anthony, "Adding Value," Internal Auditor, February 1997, 51-54.Mult ip le -cho ic e Ques tions1 . Which of the following s itua tions bes t describes an appropria te role for interna l aud it ing?

a . The ch ie f a udi t ex ecu tive i s r espons ib le f or the int erna l a ud it b udg et a s wel l as thebudgetary program o f hi s o r h er o rg an iz at io n a s a whole.

b . Interna l aud itors suggest a lterna tives for dec is ion makers, and management selec tsthe best alternative.

c . Int ernal audi to rs d eve lo p and inst al l t he o rg an iz at io n' s sy st em o f int ernal cont ro l,and the control le r' s o ff ice rev iews the adequacy of those sys tems .

d . The chief aud it execu tive is respons ib le for ins ta ll ing the accounting sys tem used bythe finn , and the cont ro ll er i s r espon sibl e fo r as su ring the se sy st ems a re p rope rlyimplernented.

2. If an internal auditor finds that no corr ecti ve acti on bas been t aken on a pr ior audi tf inding tha t is s ti ll val id , the Standards s ta te tha t the interna l aud itors should:a . Rest at e the pr io r find in g along with the f in dings of the cu rren t audi t.b. Determine whether management or the boar d has assumed the r isk of not taki ng

corrective action.c . Se ek the boa rd 's a pp rov al to ini ti at e c or re ct iv e a ct io n.d . Sc hedule a f uture audi t of the s pec if ic a re a invo lve d.

3 . Acco rd in g to the Standards, audit f indings a re the result o f:a . Compa ring what s hou ld b e w ith what i s and analyz in g the impact .b . Determining the impa ct o n the o rg aniza tion of wha t s hou ld b e.c. Communica ting the impa ct o n the orga nizat io n o f wha t s hould b e.d . Ana lyzing dif fe rences between organ izat iona l and departmenta l objec tives.

4. Management is beginning to take corrective action on personnel department deficienciestha t were reported during the las t intemal aud it . According to the Standards, the internalauditor should:a . Ove rs ee the co rrec tive ac tion .b . Postpone the n ex t a ud it of the pe rs onn el d ep ar tmen t unt il t he co rrect iv e ac tion i s

completed.c . Ref ra in f rom judging whe ther the correct ive action wil l remedy the def ic ienc ies.d . Fol low up to se e that the ac tion co rrec ts the d efi ci en ci es .

_ Chapter 8: Audit Findings 373

'Use the following audit finding to answer questions 5 and 6:PARAGRAPH 1: The production department has the newes t production equipment ava ilab leb ec aus e of a f ir e tha t r equ ir ed the rep la cemen t of al l e quipmen t.PARAGRAPH 2: The member s of the pr oduct ion depar tment have become compl et el ycomfortab le with the s ta te -of-the-art technology over the pas t yea r and a half. As a result, theproduction department has become an industry leader in production efficiency andeffectiveness.PARAGRAPH 3: The p roduct io n depar tment produce s an averag e o f 25 un it s p er worke rp er s hi ft . The d ef ec t r at e i s o ne pe rc ent .PARAGRAPH 4: The indus try average productiv ity is 20 units per shift . The indus try defec trate is three percent .5 . Which p arag ra ph wou ld b e ch aract er iz ed as the at tr ibu te d esc ribe d in the Standards as

"Criteria" ?a. 1.b. 2.c. 3.d. 4.

6 . Which p aragraph would be c ha ra ct er iz ed as the a tt ri bu te de scr ib ed in the Standards as"Condition"?a. 1.b. 2.c. 3.d. 4.

7. In beginning an audit, an internal auditor reviews written procedures that detailsegrega tions of respons ib il ity adopted by management to s trengthen interna l con trols.The se wri tt en p ro cedures should be v iewed a s the f ol lowing a tt ri bu te of a find in g:a . Cri te ria.b. Condition.c. Cause.d . E ffe ct .


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374 Part 2: Techniques of Internal Auditing _ _ Chapter 8: Audit Findings 375

8. According to the Standards, the chief aud it execu tive should ensure follow-up of properaudit f indings and recommendations:a . To d etermine if correct ive action was taken and is ach ieving the des ired results .b . Unless management rejec ted the recommendation in i ts ini tial response.c. Unles s the audi t sc hedule does not a ll ow t ime f or fo llow-up.d . Unless management has accep ted the recommendation.

13. An interna l aud it supervisor, when rev iewing a s ta ff member' s working papers, identif iedan unsupported s ta tement tha t " the c lien t unit was opera ting ine ff ic iently ." What act ionshould the supervi so r d ir ect t he audi tor to t ake ?a. Remove the comment from t he wor king paper file.b . Obtain the c li en t' s c oncur ren ce w ith the st at emen t.c . Resea rch and identify c ri te ria to measure opera ting eff ic iency.d . Exp la in tha t i t i s t he opinion o f the s ta ff membe r.9 . Dur in g an operat io nal a udi t, t he a udi to r compares the c ur re nt st affi ng o f a d epa rtmentwith estab lished indus try s tandards to:

a . Identify bogus employees on the department' s payro ll .b. Assess the current performance of the department, and make appropriaterecommendations for improvement.c . Eva luate the adequacy of the estab lished interna l con trols for the department.d. Det ermine whet her t he departm ent has compli ed wi th al l laws and r egulationsgoverning its personnel.

1 4. Manag emen t a ss er te d tha t the p er fo rmance s ta nd ards the audi to rs u se d to e va lu at eopera ting performance were inappropria te . Written performance s tandards tha t had beene st ab li she d by manag emen t were v ague and had to b e int erpret ed by the audi tor . In s uc hc ase audi to rs may meet the ir du e ca re res ponsibi li ty by :a . Assuring themselves tha t the ir interpretat ions a re reasonable.b . Ass ur in g themse lv es that the ir i nt erpret at io ns are in l in e w ith indust ry p ra ct ic es .c. Establishing agreement with clients as to the standards needed to measure

performance.d. Inc orporat in g manag emen t's o bject io ns in the a ud it r epor t.0 . The Standards require that internal auditors discuss conclusions and recommendationsa t a pp rop ri at e l ev el s of managemen t b ef ore i ss uing fina l w ri tt en repor ts . Which o f the

fo llow ing i s the p rima ry reas on that a c lo sing c on feren ce s hould b e do cumen te d by theauditor?a. The inf orma tion may be n eeded i f a di spute ar is es .b. The Standards require that closing conferences be documented.c . The info rmat io n may be ne eded to revi se f uture a ud it programs.d . Closing confe rence documenta tion becomes a bas is for future audits.

11. Why should organ izat ions require c lien ts to promptly rep ly and outline the correct iveaction tha t has been implemented on reported def ic ienc ies?a . To remove i tems from the "pending " l is t as soon as po ss ib le.b. To e ff ec t sa vings o r to inst it ut e c ompl ia nc e a s e ar ly as po ss ib le.c. To ind ic at e c oncur ren ce w ith the a ud it fi nding s.d. To insur e that the audi t schedule is kept up to date.

15. When audit f indings a re cha llenged, aud itor 's f ac tual rebutta l is bes t f ac il itated by:a. Summa ri es in the a ud it p ro gram .b. Pro forma working papers.c. C ros s- re fe ren cing the find in gs to the working p ape rs .d. Exp li ci t p ro ce dures in the a ud it p rog ram.

Use the following information to a nswer qu est io ns 16 through 19.The f ol lowing da ta was ga th ered dur ing a n int erna l a ud itor 's i nve st ig at io n of the rea son fo ra mater ial i nc re ase in bad debt s expen ses . In prep ar ing a repor t o f the find in g, e ac h o f thei tems might be c lass if ied as c ri te ria, cause , condition , e ff ec t, o r background information .

1 . Very l arge order s requ ir e managemen t' s a pp roval o f c red it .2 . Audit tes ts showed tha t sales personnel regularly d is regard credit guide lines when dea ling

with established customers.3. A monthl y repor t of wri te-offs i s prepared but distr ibut ed only to the accounting

department.4 . C red it r epor ts a re u se d on ly on n ew ac count s.5 . Account ing d epa rtment rec ords s ugg est that u nco ll ec ti bl e a cc ount s could inc re as e by

f ive percent for the current yea r.6 . The bad d ebt s loss inc re as ed by $100,000 dur in g the l ast f is ca l ye ar .7 . Even though proc edu re s a nd cr it er ia were ch ang ed to reduc e the amount of b ad-de bt

wri te -o ff s, t he loss of c ommiss io ns due to wri tt en -o ff a cc oun ts h as inc re as ed f or s omesales personnel.

12. The pr el imi nary survey shows t hat a pr ior audit defi ci ency was never corr ected.Subsequent f ie ld work confirms tha t the def ic iency s ti ll exists. Which of the followingcourses of act ion should the interna l aud itor pursue?a. Tak e no a ct io n. To do o th erwi se wou ld b e a n exe rc is e o f operat io na l c ont ro l.b. Discuss t he issue wi th the chief audit execntive. The probl em r equires an ad hocsolution.c . D is cu ss the i ss ue w ith the p er son (s ) r es pon sibl e f or the p roblem . They s hould know

how to solve the problem.d . O rd er the p er son (s ) r es pon sibl e to co rrect the p roblem . They have h ad long enoughto do so.


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11.

8 . Credit department policy requires the rev iew of c redit references for a ll new account9. Curr ent payment r ecor ds are to be reviewed before ext endi ng addit ional credit t s.accounts. 0 open

T? reduce cos ts , the u~e of o~lts ide c redit reports was suspended on several occas ions .Since several staff positrons int he cr edit depar tment wer e el iminat ed to r educe t ssome n~w accounts have received only cursory review. cos ,According to the new credit manager, s tr ic t adherence to estab lished credit policy is notnecessary.

Chap te r 9 ; Working Pap er s 377376 Part 2 ; Techniques of In te rnal Audit ing - - - - - - - - - - - - - - - - - - - - - -

10.

Chapter 9Work ing Paper s

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16. Criteria are best illustrated by items numbered;a. 1,8,9.b. 2, 10, 11.c. 3,4, 12 .d . 5 ,6 ,7 .

What w orki ng paper s ar e, w ha t they do . Documen ta tion. Work ing pape rsummar ie s. Index ing and cros s- re fe renc ing. Pro fo rma w ork ing papers .Automat ing w ork ing pape rs . N ations Bank. E lec tr on ic w ork ing paper s.Supervisory reviews of working papers. Control over working papers. Sampleworking papers. Ownership of working papers.

Introduction

17. Cause is bes t i llus trated by items numbered:a. 2, 10, 11.b. 3,4, 12.c. 5,6,7.d. I, 8,9.

W hat T hey A re

18.Condition is bes t i llus trated by items numbered:a. 5,6,7.b. 1,8,9.c. 2, 10, 11.d. 3, 4, 12.

Working papers document the audit . They record the information obtained and the ana lysesmade du ring the audi t p ro ces s. Working pape rs a re prep ared f rom the t ime the a ud itor s fi rstlaunch the ir ass ignment until they rev iew correct ive action and c lose the audit p ro ject . Theydocument the following s teps in the audit p rocess :

The plans for the audit , inc luding the audit p rogram.The examina tion and the eva luation of the adequacy and effec tiveness of the sys temsof internal control.The audit procedures followed, the information obtained, and the conclusions reached.The supervisory reviews.The audit reports.The follow-up of correct ive action.

19. Effec t is bes t i llus trated by items numbered:a. 3,4, 12 .b . 5,6,7.c. 1,8,9.d. 2, 10, 11. Thi s c hapter inc lu des a nd bu ilds on the gu id el in es fo r a ud it working pape r prep arat io n se tforth in Pract ice Advisory 2330-1, "Record ing Information ," of the Standards.

20. According to the Standards, the findings in an internal audit report should' I d .a St t t f .. me u e.. a e men s a opmion about the cause of a finding.b . S ta temen ts of f ac t conce rn in g the c on trol weaknes se s which were ide nt if ed d .the course of the audit . I unngc. S ta temen ts of both fa ct and opinion develop ed dur in g the cour se o f the a udi td. S tat .emen ts that may de al w ith poten ti al fu tu re e ven ts and might b e he lp fu l to theaudited department.

What They DoInterna l aud itors prepare working papers for a number of d if fe rent purposes:

To provide support for aud it reports . Well-structured working papers make it eas ie rto trans fe r the materia l wri tten during the audit to the pages of interim and f inal aud itreports . Bes ides , the experienced auditor keeps one eye on the f inal report throughoutthe e nt ir e audi t proj ec t. Thi s k ee ps the fi eld work rel eva nt a nd point ed in the r ig htd irec tion . Whatever is not suitable for reporting may not be relevan t for rev iew.

sawyer's internal auditing chapter 08

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