Operational and Internal Auditing

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Internal auditing is involved in helping organizations achieve their objectives. This can be done by using a systematic methodology for analyzing your business processes, procedures and activities with a goal of highlighting any organizational problems and recommending solutions in order to fix or correct any of these organizational problems found (Wikipedia). In our textbook, "Auditing and Assurance Services: An Integrated Approach," written by Alvin Arens, the author states that an operational audit evaluates the efficiency and effectiveness of any part of an organization's operating procedures and methods. Operational audits are performed by the internal audit department to help a business increase their level of productivity. These audits can determine what a business needs to change in their operation procedures in order to become more effective. Operational and internal auditing has many benefits to companies, can be done by outsourcing or internally within the company, and is developing throughout a lot of companies today.

Internal auditing began in the 1940s. The American Institute of Internal Auditors was set up in 1941. Bao Guoming states in his article, "The Developing Trend and Prospects of Internal Auditing," that internal auditing was developed in order to help businesses evaluate their company and better coordinate so that their company can gain more and more economic benefits. He also states that internal auditing has developed from verifying any mistakes in a company's financial statements or business procedures and to prevent any fraud by examining and evaluating all business activities from operational and managerial perspectives to improve management and increase financial effectiveness. Guoming believes it is the internal auditor's responsibility to serve its company by taking and possible economic benefit given to them and to use it as their key task in playing an active role in the process of transforming operational mechanisms and participating in market competition.

In Robert Barr's article, "Outsourcing Internal Audits: A Boon or Bane," he discusses all the benefits, reasons and disadvantages of outsourcing internal audits. Barr states that by outsourcing internal audits it enables the expansion of internal audit services into organizations where such a function did not exist before. He believes the major reasons for outsourcing are no internal audit function, ineffective or unpopular internal audit function, non-productive time, ineffective or inefficient training, small companies, and turnover at the director position. The advantages of outsourcing are that it is cost effective, the cost conversion, provides flexibility, and gives quality assurance. Outsourcing contracts such as internal auditing allows for some opportunities with possible enormous new revenue potential. Barr explains that the disadvantages of outsourcing are loyalty, understanding of environment, loss of a training ground, and lack of long range development. These disadvantages exist, because when outsourcing internal audits the auditor no longer knows as much information needed about the company. Also, with outsourcing, training usually lacks, because they are jobs performed by people who are less educated and paid less than a normal internal auditor would if these audits were not outsourced. These outsourced internal auditors also may not be as reliable as someone from your company, because they do not have as much stake in the company. They are getting paid either way so sometimes they may report that a company's financial statements are fairly reported when they really are not. Barr says in his article that contracting these internal auditing services, or outsourcing, may appear in three major forms. This includes supplementation, audit management consultation, and total outsourcing. Supplementation has outside contractors work together with the internal audit department. Audit management consultation usually leads to further assistance in the determination of audit resource requirements and their allocations. Total outsourcing is usually for small or mid-size public companies that have no existing internal audit departments but seek reasonable operational audit coverage.

In Mary Brady Greenawalt's article, "Operationalizing the Operational Audit Course," she discusses how the internal audit function is very broad, encompassing financial, compliance, and operational audits. The operational audit is a significant area in which an internal audit frequently provides a unique service too. Guoming believes that an internal audit should continually adjust and improve its organizational structure. This can be done by including personnel structure, with different types of knowledge and providing more formal education as well as working experience. Businesses should also pay more attention to collecting and analyzing different information and data needed to ensure better service and to strengthen quality control and evaluation to increase the service quality in practice. Greenawalt thinks that auditing should be taught in school with hands-on experience rather than just reading it out of the textbook. He believes that case analyses are an excellent means of exposing these students to such operational audit situations and exercising their critical thinking ability.

Arens states that operational audits can cover many different aspects and areas in a business that it is not possible to classify and characterize a typical operational audit. One business may review information used to make decisions to acquire new assets while another may evaluate the efficiency of processing their sales. Operational auditing is more like management consulting rather than what you would typically consider a normal audit. Internal auditors perform audits for management. Some companies only have one or two people completing these internal audits while others have over one hundred people performing these internal audits. Many of these internal auditors are also involved in operational audits as well which is why it is very important that an internal audit must report directly to the head of the company to prevent any redundancy or errors. Internal auditors are different than Certified Public Accountants (CPA), because they lack independence.

Ralph Dawn indicates the changes in operational and internal auditing in his exposure draft of this year's Government Auditing Standards. These include the improvement and consistency of footnote usage, updated terminology, ethical principles of government auditing, and the use and application of Government Auditing Standards. The term "field work" has been replaced by "performance." Footnotes are now used more strictly to refer to sections of the Government Auditing Standards as well as other auditing standards. Some other footnotes that previously existed have been eliminated. Dawn also reports on the auditing requirements which include being competent and having the skills and knowledge that is needed in order to perform the evaluations and come to an informed conclusion. Auditors must also be knowledgeable with national and international auditing standards. They need to have an understanding of each individual company that they are evaluating and the industry that each company is in. Auditor's main purpose is to determine whether a company's objectives are being achieved while still following all government regulations and standards.

It is important that an audit is performed to ensure that the companies are abiding by all laws and regulations to fairly report their financials. The major advantage of an audit is that it makes it easier to compare several different companies based on the conclusions given in each audit performed. If a company is given a good conclusion, then it means that the company is following all laws and regulations current at that time. Audits help prevent managers from any temptation of fraudulent behavior or practices. It provides a means of accountability, reliability, and integrity of the company. One disadvantage of an audit are the costs involved, because a company has to pay the auditors to perform these audits and also to ensure that you maintain detailed records of every transaction that takes place in a business.

Operational and internal auditing has many benefits to companies, can be done by outsourcing or internally within the company, and is developing throughout a lot of companies today. Guoming believes that internal auditing has modernized companies and will continuously be developed and become perfected in the environment of the socialist market economy. If more businesses performed these operational and internal audits, then their company's would more than likely be better off. We probably would have fewer businesses fail, and we would more than likely be able to prevent, stop, or catch earlier on any fraudulent behavior. They would be better off if the government made a regulation requiring all businesses to perform a set number of audits. Greenawalt wants operational auditing to deserve special emphasis in the classroom. He wants students to be exposed to operational auditing by means of journal articles, reading and discussion of cases, and analysis of GAO audit reports.