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Interdependence of Audit Committees and Internal Audit
Audit Committees and Internal Audit functions are inescapable adjuncts in the modern organization. Over the last twelve months we have been informed that high profiled accounting entities have used fraudulent financial reporting to gain unfair advantages in the market place. Clearly, fraudulent reporting is a wrongdoing that is unacceptable to the accounting profession.
In order to uproot any deliberate deception in financial reporting and by extension minimizing inadvertent errors, the gatekeepers of the accounting profession are forced to strengthen the effectiveness of Audit Committees and Internal Audit functions. In North America Audit Committees are universal. Stock exchanges require the existence of Audit Committees and in December 1999 the Security of Exchange Commission (SEC) and the Auditing Standard Board issued rules based on the recommendation of Blue Ribbon Committee (BRC). Notwithstanding, this best practice dealing with matters of independence, qualifications, and outside auditors involvement we have Enron, Worldcom and others.
Malfeasance in financial reporting has some antecedents. By listening to the smooth talkers an experienced auditor can detect over optimistic earnings projections. When news releases carry these over optimism it is time to analyze annual and interim earnings trends. Auditors and Auditing Firms possess vast knowledge on industry trends and industry accounting practices. When an entity within an industry deviates too much from the norm it is time to perform an analytical review. By nature auditors are skeptical so that rapid growth figures, significant changes in accounting policies and the system of internal control will get ‘the eye of scrutiny look’.
Here in Jamaica trade data on specific industries are largely unpublished. STATIN (The Statistical Institute of Jamaica) publishes economic data on a sector basis. These data are non-specific compared with the more refined accounting classification. Auditors within their office can pull industry data together based on their clientele. These data provide a springboard to effective analysis. Given the vast experiences of auditors and audit firms it seems that the independent audit firm is poised to take on the role of Internal Auditors. Such independent firms would be different from the external auditors. This situation would allow a cross check between auditors and the assurance required by the audit committee.
Effective Audit Committee operation is best positioned between senior management and the external auditors. This structure allows the committee to question management’s judgments and see to the implementation of recommendations from the internal auditors. This structure will strive to eliminate any limitation of scope. Scope restrictions can be placed by management on both internal and external auditors. Provided the rules of selection of internal auditor is as stringent as for external auditors, independent audit firms as internal auditors will resolve the notion of ethical conflicts and ethical dilemma and in a straightforward manner eliminate management overrides. The matters of ethical conflict and ethical dilemma are adequately dealt with by Margaret Mendes and Margaretta Pearce in their book ‘Essentials of Professional Ethics for Accountants’.
Competent internal auditors must be able to provide operational, financial and compliant audits. Effective audit committees must be vigilant and get adequate responses from probing questions about the propriety of the reporting process and the quality of a company’s financial reports.
Ø An operational audit is a comprehensive examination and evaluation of the performance of an operating unit. The measurement is usually done against management objectives.
Ø A financial audit determines the accuracy and propriety of the financial transactions of an organization.
Ø A compliant audit determines the degree to which an organization confirms to certain specific requirements of policy, procedures, law and government regulations.
According to Louis Braiotta Jr., MBA, CPA, and Associated Professor of Accounting at the State University of New York at Binghamton “Audit Committee members should be highly attuned to the potential of fraudulent financial reporting. Failure on the part of the audit committee to question management’s representations may be the basis for audit committee malfeasance, since the audit committee and the board may be held liable for failure to know what they were responsible for recognizing”.
If Louis is correct, then managers better get accustom to a group of professional looking at what they are doing or what they have done. Directors and board members should not delay in getting information to assist them in their oversight responsibilities. Audit Committees and Internal Auditors are inextricable bound.
Prepared By: Neville Robinson
Neville Robinson is a partner in Robinson Davis and Company
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