Advantages and disadvantages of outsourcing the internal audit functions

Internal auditing is an appraisal or monitoring activity established within an entity as a service to the entity. It functions are, among other things, examining, evaluating and reporting to the management and the directors on the adequacy and effectiveness of components of the accounting and internal control systems.

An internal audit department in an organization is set by the management or appointed by the board of directors to whom it is answerable. It is headed by the chief internal auditor assisted by the internal audit staff to help cater for the following:

To ensure that the business is operating in an efficient and orderly manner.

Ensure adherence to management policies.

Safeguard the fixed assets of the company and control the current assets.

Determine the accuracy and reliability of the company records and accounts.

Ensure adherence to company’s statutory requirements.

Reasons for internal audit function

Due to increase in business size, which has reduced the efficiency of the management to have full control of the business, it has become increasingly important for large businesses to have an internal audit function. There is need for improved controls in large companies with branches/subsidiaries as it is hard for the management to supervise such companies. Dynamism in business due to economic, social and technical environment all call for change in the management attitudes and constant appraisal for a change.

Responsibilities

Regularly examine the accounts to determine their accuracy and reliability.

Independent appraisal of the business activities to determine their reliance, accuracy and completeness.

Review the company policies, operations and procedures to agree with expectations and standards.

Establish and programme adequate accounting system and effective forms of control.

Report to management regularly in respect to ICS, e.g., adequacy of staff and development of computerized systems.

Act as a consulting department to other user departments e.g. sales, accounting, purchases etc.

Provide advice to the management in respect to the changes in the economy and their changes in economy and their changes impact on the industry where the client business does operate.

Prepare and present the company’s budget. Supervise the progress of the company.

Other services to the management.

Communication between staff and management

Coming up with staff welfare strategies e.g. staff promotion circles for the client.

Advantages of internal audit

Facilitate the achievement of company policies such as budget targets etc.

Enhances the presence of a strong internal control system.

Acts as a preventive measure against errors and fraud through constant checking of accounts.

Enables external audit to be completed in time i.e. with strong internal control system external auditor will rely on an internal auditor’s work.

Ensures that the company assets are safeguarded against misuse or theft by dishonest employees.

Being an employee of the company, an internal auditor is more knowledgeable with the problems facing the company which he will try to solve by advising the party responsible for the proper management of the company.

Internal audit ensures compliance with statutory requirements within the organization.

Internal audit ensures as far as possible the completeness and accuracy of the records.

Disadvantages of having internal audit

Over reliance by the management will make the staff take advantage of perpetrating frauds.

It is ideal for large companies as it may be very expensive to maintain and thus unaffordable by small companies.

Lack of support by management kills the morale and ability to perform its duties effectively.

Internal audit reports may be misleading because they do not have liability to the owners of financial statements.

Internal auditors may collude with staff leading to misappropriation of resources.

Outsourcing the internal audit functions

This is the process whereby the management purchases the services of auditing from outside. This is because monitoring and reviewing required by certain companies could be done in a small amount of time and full time employees cannot be justified or it may be expensive to maintain an internal audit function consisting of employees.

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Advantages

Service providers have good quality staff i.e. have specialized skill and assess what management wants them to do. Also they have a high degree of professionalism since the service providers are trained in many areas enhancing the quality of advice to the management on best practices.

Outsourcing can provide an immediate audit department instead of employing audit staff thereby cutting costs e.g. salaries to the employees, benefits and allowances.

Outsourcing enhances independence and there is minimal room for collision thereby giving value added reports i.e. there is real value for money.

Outsourcing enhances the auditor in understanding the business environment policies and procedures thereby increasing the credibility of the financial reports and reducing their liability.

Disadvantages

The cost of outsourcing the internal audit functions might be high to make the directors not to have the internal audit functions at all.

The company might use the same firm for internal and external audit services leading to inferior reports.

Outsourcing leads to duplication of efforts if the same procedures are used in gathering evidence in the final audit.

Outsourcing is not ideal for small businesses with few transactions.

External audits may bring leads to interior reports. I.e. Influence or cause unwanted changes in the way the organization operates.

Assessment of internal auditor’s work

Before placing any reliance on the work of the internal auditor, the external auditor must assess the internal auditor and his work in the following areas:

1. Independence:

The internal auditor may be an employee of the organization but may be able to organize his own activities and report his findings to high-level management i.e. directors.

2. The scope and objective of the internal audit functions

This includes reviewing accounting systems and internal controls, also examining financial and operating information by management including resting of transactions and balances.

3. Due professional care to be useful to an external auditor

The internal auditor’s work must be done in a professional manner i.e. properly planned, controlled, supervised, recorded and reviewed.

4. Technical competence

Internal auditors should be members of professional bodies and follow professional ethics in performing their work. Also they should have computer knowledge in performing audit in computerized systems.

5. Reporting standards

A useful internal auditor will provide a high standard of reports which are acted upon by management.

6. Resources available

An internal audit department that is starved of resources will not be very useful to the external auditor.

Factors that influence the external auditor in deciding on the extent to which he may rely on the work of the internal auditor

The materiality of the areas or the items to be tested or the information to be obtained in the audit exercise.

The level of audit risk inherent in the areas or items to be tested or in the information to be obtained.

Specialized skills possessed by the internal audit staff i.e. the level of experience and qualification.

Independence of the internal auditor i.e. whom they report to.

The level of judgment required i.e. how the internal auditor has gathered and arranged the report and quality of working papers.

How the internal auditors have acquired evidence e.g. seeking legal advice from advocates, seeking information from valuers, etc.

The efficiency and strength of internal control system.

Ways in which the internal audit department can assist the external auditor during his audit work

The external auditor can use the internal auditor’s working papers to gather evidence concerning the company’s operations, programs etc. Also the internal auditor can explain technical operations or controls used by the company.

He can undertake verification of assets in particular mobile assets, assets held by third parties and branches or subsidiaries which the external auditor may not have a chance to physically verify during his presence.

Internal auditors can prepare schedules relating to items in their accounts e.g. asset schedules, debtors schedule, creditors schedules etc which are important for comparison to be made by the external auditor.

Internal auditor will pin point the weak areas in control systems which the external auditor will concentrate on.