Internal Audit
Introduction
Recent events including global financial crises have emphasised need for
internal auditing within corporate governance structures
Internal audit function is now mandatory by most stock exchanges
Donors increasingly demand improved accountability & financial
transparency in development projects
IFAD procedures do not specifically require internal audit, however, IFAD
Operational Procedures for Project Audits (for use by IFAD & CIs) require
that “as part of the assessment of the borrower’s capacity to implement and
manage the project effectively, the appraisal mission will evaluate any
internal audit (IA) mechanism for the project/ PMU”
Furthermore, internal audit is considered good practice & advisable as
part of underlying control framework & financial management capacity of a
project, particularly if complex &/ or decentralised
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Definition
“Internal auditing is an independent, objective
assurance and consulting activity designed to add
value and improve an organization's operations. It
helps an organisation accomplish its objectives by
bringing a systematic, disciplined approach to
evaluate and improve the effectiveness of risk
management, control, and governance processes. ”
The Institute of Internal Auditors
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IA – Code of Ethics
Principles
Internal auditors are expected to apply & uphold the following principles:
The integrity of internal auditors establishes trust & so provides the
Integrity basis for reliance on their judgment
Internal auditors exhibit the highest professional objectivity in
gathering, evaluating & communicating information. Internal auditors
Objectivity
make a balanced assessment of all relevant circumstances & are not
unduly influenced by their own interests or others in forming judgments
Internal auditors respect the value and ownership of information they
Confidentiality receive & do not disclose information without appropriate authority
unless there is a legal or professional obligation to do so
Competency Internal auditors apply knowledge, skills, & experience needed
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What is Internal Audit?
Internal Audit is a professional activity which helps organisations to achieve their
stated objectives by:
Analyzing key processes, procedures & operations
Identifying key controls in each such operation, procedure & process
Evaluating the adequacy of these controls
Testing compliance of sample transactions against these controls
Reporting results of the evaluation of controls and compliance testing of
transactions
Recommending stronger controls wherever necessary
Suggesting methods to improve compliance with key controls
Follow up of action taken on recommendations made in previous reports
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What are Internal Controls?
Internal Controls are important checks instituted by management to have
reasonable assurance that:
Operations are carried out in an efficient & effective manner
Transactions are recorded accurately & completely
Assets are properly recorded & safeguarded
Laws are complied with
Reliable reports are generated
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Some examples of Internal Control
► Budgetary Control
► Fixed Assets Register
► Bank & Special Account Reconciliations
► Reconciliation of Financial & Physical M & E Reports
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How are Internal Audit & External Audit different?
Internal audit is focused at internal management support and improving
systems, procedures and processes
⇉ External audit (EA): normally statutory requirement, unlike internal audit (IA)
⇉ EA reports are addressed to stakeholders: IA reports are addressed to
Management
⇉ EA reports express an opinion on the financial statements prepared by the
entity for a specified period: IA reports evaluate and check compliance
against key internal controls
⇉ EA reports are usually public documents which are available to all
stakeholders. IA reports are for use only by Management
⇉ EA reports do not make recommendations, although may have a
Management Letter: IA reports are incomplete without
⇉ EA is basically a review of financial statements for compliance: IA seeks to
ensure value for money to Management
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Why should IFAD funded projects be subject to IA?
IFAD funded projects may be subject to Internal Audit because:
External audit does not evaluate adequacy of internal controls.
External audit checks overall compliance to internal controls related
to financial transactions.
Supervision Missions conduct only spot checks.
Internal audit is inherent in government structures in most developing
countries.
Sample IA Terms of Reference enclosed
IA has a key role in Risk management of IFAD Projects
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What are key concerns from a FM viewpoint?
► Is the accounting system capable of recording financial transactions in a timely &
accurate manner?
► Is the accounting system capable of tracking project expenditure by category &
component?
► Is the accounting system capable of comparing actual expenditure to budget as
per approved AWPB on a real time basis?
► Are withdrawal applications prepared properly & do they contain ineligible
expenditures?
► Are procurement transactions undertaken as per Schedule 4 &/or LTB of the
financing agreement?
► Are project assets properly recorded & safeguarded from misuse and abuse?
► Are Special Account & Project Account operated & reconciled properly & timely?
► Are proper audit arrangements in place?
► Are audit reports properly followed up?
► Does the project generate reliable & accurate financial statements & reports?
► Are project funds flowing smoothly, timely & transparently to intended
beneficiaries?
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Internal Audit (IA) Mandate
Compliance & Advisory roles
What does it do?
Primary role in improving internal control, accuracy, reliability &
integrity of information including financial & operational reporting
Monitoring & evaluation of effectiveness of risk management
processes
Role in corporate oversight, safeguarding of assets, economical
& efficient use of resources, compliance with laws & regulations,
deterring fraud
What does it not do?
Perform management activities/ responsibilities (these include
establishing internal controls)
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Internal Control Myths and Facts
MYTHS: FACTS:
Internal control starts with a strong set Internal control starts with a strong set
of policies and procedures of policies and procedures
While internal auditors play a key role
Internal control: That’s why we have
in the system of control, management
internal auditors!
has responsibility for internal control
Internal control is integral to every
Internal control is a finance thing
aspect of business/operations
Internal controls are essentially Internal control makes the right things
negative, like a list of “thou-shalt-nots” happen the first time
Internal controls take time away from
Internal controls should be built “into,”
our core activities of implementing
not “onto” business processes
development objectives
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Internal Control Practices
How?
Internal control is a process. It's a means to an end, not an end
in itself
Internal control is effected by people as a team, not by
internal auditor. It's not merely policy manuals & forms, but
people at every level of an organization
Internal control can be expected to provide only reasonable
assurance, not absolute assurance, to an entity's management
and governing bodies/ committees
Uses systematic methodology for analysing business
processes, procedures & activities
The cost of IA should not exceed expected benefits to be
derived
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Internal Control Structure
An internal control structure is simply a different way of viewing operations – a
perspective that focuses on doing the right things in the right way
• Reporting
• Monthly reviews of
• Corporate
performance reports MONITORING communications
• Supervisory activities
(e-mail, meetings)
INFORMATION &
INFORMATION AND
• Purchasing limits COMMUNICATION
• Based on identification
COMMUNICATION
• Approvals/ segregations & analysis of risks to
• Security CONTROL ACTIVITIES
CONTROLACTIVITIES achievement of
• Reconciliations objectives
• Proper operating &
RISK ASSESSMENT
accounting procedures
• Corporate Policies
CONTROL • Tone at the top, ethics
ENVIRONMENT • Organisational authority
• Skilled personnel
In many cases, you perform controls and
interact with the control structure every day,
perhaps without even realising it
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Role in Risk Management
Focus on risk of occurrences that could prevent the project from
achieving its goals
There are many types of risk – strategic, operational, financial
reporting, legal/regulatory, fraud, ineffective/inefficient use of
resources, technological, human capital, credibility, etc.
Focus on areas with high risk & high probability that controls are
not in place or are weak
Don’t forget positive risks – opportunities!
Add value by eliminating unnecessary controls, if
underlying risks are minimal/within project’s risk
appetite!
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Role in Internal Control
1. Compliance audit: review of financial & operating controls &
transactions for conformity with laws, regulations & procedures,
e.g.,
• Access to IT system appropriate to user’s role
• Segregation of duties in high risk areas
• Balancing & reconciliation between systems
• Systems back up & recovery
• Physical safeguard & access restriction controls
• Reconciliations, comparison budget of actual
2. Operational audit: review of various functions within project to
evaluate efficiency, effectiveness, & economy
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IA Role in Corporate Oversight
Four pillars – internal audit, executive management, external audit, &
Board of directors/ steering committee
Combination of processes & organisational structures implemented
by management to inform, direct, manage and monitor the project’s
resources, strategies & policies towards the achievement of its objectives
Public sector governance Principles
- transparency, integrity, accountability
May include review of sufficiency of human resources,
training needs, policies, etc.
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Nature of Internal Audit Activity
Establish scope & activities for audit to Management
Describe key risks facing the business activities within scope of audit
Identify control procedures used to ensure each key risk is properly
controlled & monitored
Develop & execute risk based sampling & testing approach to
determine whether most important controls are operating as intended (NB:
input from Management required – e.g. 100% sampling of WA review)
Report issues/make recommendations/negotiate action plans with
Management to address issues
Follow up on reported findings periodically
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Contents of Audit Plan
Updated annually
Risk based audit plan developed with input from project
staff including Management
Summary of key goals, risks & corresponding major audits, to illustrate
alignment
Based on risk assessment & available resources
Appendix materials, such as planning approach, assumptions & brief
descriptions of all planned audits & related prioritization
Approved by management/ appropriate oversight Committee
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Contents of Audit Report
Observations
Narration/ description
Remedial action
Consequences/ fall out
Recommendation for improvement (prioritized between
“high” and “normal”)
Response (action plan) – who, when and how
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IA’s Proactive Role
Identify Risks
Find Better Ways and Best Practices
Partner With Management to Find Solutions
Prevent Problems
Provide training
Respond to policy & technical accounting questions
Offer suggestions for improvement
Advisory role
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Additional Resources
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Conclusion
Why all this trouble?
Additional comfort and “tightness” that the project is doing the right thing, the
first time, communicating right information internally, to external auditors,
donors, ministries, etc.
More formal control structures reduce possibility that risks become real
issues
External Auditor may receive additional assurance to provide unqualified
report on accounts
Donor & government confidence increased, affecting financing flows
What are the next steps?
Identify areas of high risk & opportunities
Validation of process documentation & controls
Communication, with PCs & project staff
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Thank You