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Factors influencing the effectiveness of internal audit as an important element of enterprise management

Olga IRODENKO
Audit Semi-Senior at RSM Poland

In today's article I would like to introduce, mainly on the basis of an analysis of world literature and research of American scientists, factors affecting the effectiveness of internal audit in enterprises.

Evolution of the role of internal audit

Currently, an internal audit is considered an integral part of management and an essential element of strong corporate company governance. Dynamic changes in the global economy, the complexity of regulations and technological advances in recent years have set new tools and directions of development of internal audit, which support management and create added value to the organisation. These capabilities also resulted in the new image of an internal auditor with an extended set of skills and best practices adapted to the requirements of the environment.

With the rising demand for audit services, there are scientific and practical deliberations on the evaluation of the effectiveness of internal audit in the company. Scientists from different countries and members of the Association of the Institute of Internal Auditors in a number of studies try to find proper measures to evaluate the audit work both from the theoretical and practical point of view.

Financial and accounting aspects were emphasised in the first definition of internal audit of the Institute of Internal Auditors (IIA). Next, the changes concerned the extension of the scope of evaluation and review of management. They stressed the control and evaluation functions concerning the operation and development of the organisation, to approve in 2001 the final version of the definition of internal audit.[1]

A fundamental change in the approach to the role of internal audit in the organisation was associated with the global Enron and WorldCom scandals that used "creative accounting" (e.g. concealment of losses and debts, falsifying financial records), hiding the true financial position from investors.

After the huge financial scandals, the basic task of an internal auditor was to restore confidence and independence, to provide investors and shareholders with the assurance of the transparency of financial data and compatibility of the control mechanisms with the strategic development of the organisation.

The consequence of these scandals was the adoption in 2002 by the Congress of the United States of the Sarbanes-Oxley Act which changed the position of internal auditors first in the United States, and later around the world. This Act introduced a requirement for documenting and testing the company's control mechanisms over the financial reporting process (documentation describing the processes, risks and controls in accordance with the applicable requirements). It also imposed a requirement to monitor the quality of audit services, additional financial and criminal sanctions against corporate authorities in case of detecting errors in the financial statements, and introduced the absolute requirement of independence of the auditor.

Internal audit is currently expanding the scope of its activities to all areas of operations and is becoming a valued part of management.

Performance measures of internal audit

The responsibility and the role assigned to internal auditors determined the need to measure the effectiveness of their work. The value and effectiveness of audit services have been the subject of many studies on the international arena of management science since the outstanding work of Simunic of 1980, in which the author described the model of formation of audit services, comparing it to the amount and quality of the audit work.

The analysis of previous studies of the factors influencing the effectiveness of internal audit in enterprises in different countries showed no big differences in this respect.

The factors influencing the effectiveness of internal audit are as follows:

Determinant Term
Membership in the sector

- private,

- public;

Quality of audit services Conducting internal audit in accordance with international standards improves the quality of audit services and thus increases the efficiency of the internal audit;
Professionalism of the audit team Experience, training, skills, high professional qualifications;
Independence The relationship between the internal audit department and the management board. There are three dimensions of independence: independent planning (internal audit cannot be exposed to any attempt at imposing the scope of the audit), independent study (the management board cannot have influence on the method of work, limit access to records, personnel, reduce financing) and independent reporting (informing about the results of the audit directly to the supervisory board);
Personal development opportunities and building the career of internal auditor Availability of internal auditor for the position on the board after acquiring relevant knowledge and experience;
Level of support for the auditor from the board Cooperation with the company's management, willingness to provide information.

 

The results of some research have shown that a lower effectiveness of the audit at companies was caused by a reduction in compensation paid to auditors. However, the results of the analysis of the effectiveness of audits through the prism of compensation paid to auditors may be influenced by the pricing policy of companies and competitive factors. The measures applied in a limited way allow evaluating the effectiveness of the audit because they do not take into account the basic objectives of internal audit.

Effectiveness of the audit in practice

In practical terms, in essence effectiveness is reduced to the analysis of the relationship of the total effects (results) of actions to the related outlays using the quotient formula (ratio of outcomes to inputs) or the differential formula (comparison of effects and costs, the net effect).

According to L.B. Sawyer, the author of numerous works on audit, the effectiveness of an audit unit is determined through the prism of its ability to formulate findings and make recommendations in the framework of the audit work. However, the measure of effectiveness of the audit is the number of audit recommendations implemented by the audited entities.

Morrill in the study "Internal auditors and the external audit of a transaction cost perspective" describes the use of the results of internal audits conducted by auditors as a tool to add value in the form of reduction of internal audit cost.

The report of the Institute of Internal Auditors published in 2015 shows the practical side of various models of effective internal audit in the private sector in the UK and Ireland. The study of various organisational systems of internal audit showed an increase in added value to organisations as well as raising the skills and qualifications of auditors. The study has identified elements of effective internal audit:

  1. Excellent knowledge of the organisation and the specifics of the sector in which it operates;
  2. Experience and expertise allowing to increase the scope of functions in the areas of finance, IT, project management, customer relations (knowledge of regulations, national and international regulations, current standards and best practices);
  3. Flexibility and ability to respond quickly to new risks and threats;
  4. Confidence and trust on the part of management;
  5. Independence and objectivity;
  6. Planning risk-oriented internal audit with transparent audit methodology;
  7. Preparation of recommendations and acting as an advisory oriented at the objectives of the organisation;
  8. High level of quality of services provided;
  9. Coordination and cooperation with other departments that perform control and assurance functions;
  10. Effective teamwork;
  11. Career development opportunities;
  12. Continuous improvement of qualifications and the duty to conscientiously perform the audit work.

Internal audit of the 21st century

When analysing the approaches of different researchers to determine the performance measures of internal auditors, it can be assumed that these indicators were developed with the evolution of the role of internal audit as well as the increasing requirements and expectations of the audit’s users. Extending the scope of internal audit from the strictly financial function to the assurance and advisory function, which plays an important role in managing the company, has also resulted in the need to increase the efficiency of audit services. Internal audit of the twenty-first century should respond to emerging problems in the economy and new threats to business operations, referring to the achievements of economic and social sciences, using the latest developments in management theory and methodology, at the same time becoming a new management tool.


[1] "Internal audit is an independent and objective activity, which aims at adding value and improving operations of the organisation. It involves a systematic and orderly evaluation of process: risk management, control and organisational governance, and contributes to the improvement of their operation. It helps organisations achieve the objectives, providing assurance of the effectiveness of these processes, also by giving advice." (Association of Internal Auditors IIA Poland, 2011).

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