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This essay will examine the responsibility of internal auditors in the current economic condition. Generally, in companies, internal auditors provide assurance to management to ensure that company is running well. Then, what is internal audit? How does it relate to economic downturn? Recently, there are some people think that poor internal auditing is a reason that causes a failure of company, internal auditors are suspect of failing to advise management with regard to high levels of risk and related corporate governance issues. Based on the question, this essay provides a set of processes in the following part to provide evidences and prove my opinion. First, there will be some relevant theories related to the definition and responsibility of internal auditors. Besides, two examples of Word Com and Enron about audit challenges faced in performing the internal auditor's role. Moreover, how the internal audit role has changed, as well as providing some standard theories or journal articles for discussion and analysis.
The role of the internal auditors has changed significantly within decades. Those people who try to find and understand what has caused the current economic turmoil, they have pointed to a range of elements that are suspect, such as ineffective external auditors, deficient risk management systems, and so on. These are easily been realized. However, to date, no one in the world can announce that there is a problem of internal auditors. Are internal auditors truly innocent? In my point of view, I think they are not. I believe, to some extent, they have avoided the blame for the current economic downturn. Then, is that good for internal audit profession for not being blamed in the economic situation? Unfortunately, I do not think so. I think if the internal audit can assess and report on the effectiveness of their client's risk management systems, it will help prevent catastrophic risk and control governance failures. Therefore, I advocate that internal auditors should take some of the responsibility for the current financial downturn.
First of all, it is important to understand the definition and responsibility of internal auditing. Here is the definition issued by the Institute of Internal Auditors: "Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organization's operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes" (Gray and Manson, 2008:582). The definition of internal auditing also provides the basic understanding of the roles and responsibilities of internal audit function. The internal auditing department is an integral part of an organisation. Internal auditing is an independent appraisal function established within an organisation to examine and evaluate its activities as a service to the organisation. The objective of internal auditing is to assist members of the organisation in the effective discharge of their responsibilities. Besides, internal auditing provides them with analyses, appraisals, recommendations, counsel, and information concerning the activities reviewed.
In addition, who are internal auditors? What are the responsibilities of internal auditors? Generally, internal auditors are either employees of the organisation they are auditing, or contracted to provide internal audit services through an outsourcing arrangement. Therefore, the responsibilities of internal auditors will be defined by whoever determines the objectives of the assignments they conduct. The following are the responsibilities of internal auditors. First, they need to monitor internal control. Second, they are supposed to examine financial and operating information. Third, review the economy, efficiency and effectiveness of operations including non-financial controls of organisations. Forth, review compliance with laws, regulations and other external requirements and management policies and directives and other internal requirements. Final one is internal auditors need to do some special investigations into particular areas, for example, suspected fraud. As assurance professionals, internal auditors are responsible for conducting their work, and they need to fulfil the three important elements, independence, objectivity, and compliance with the ethics rules.
This is an example of the risk of corporate governance which causes a failure of the organization. World com scandal is because of the abuse of knowledge and power. World com was in Fortune 500 status. The danger signal commenced in the late 1990's, World com was reporting a profit in its financial statement in the midst of the telecommunication decline, even though most components of the organisation were reporting losses. Basically, there are about $2 billion liability reserve were transferred to revenue. However, no documentation had been reported about the questionable $2 billion profit by the audit committee. Accordingly, there are $3.85 billion expenses had been misallocated in total. Cynthia Cooper, the head of internal audit of World com found the report is questionable. She took this matter into her own hands ignore higher management and external auditors. Inevitably, by using her experience with the organisation's operations and personnel, she found and exposed the scandal. Eventually, the counterfeiter was pleaded guilty to fraud.
Another example is the most infamous accounting scandals in the world, which involves a set of ethical standards and fiduciary responsibility. The internal auditors of this example played completely different roles in the organisation by comparing with the first one. Enron Corporation and Arthur Anderson. Enron was an energy industry. Arthur Anderson was both Enron's internal and external audit organisation. However, Enron's top management and Anderson's heads of the audit team violated independence and objectivity by socializing on a regular basis. Although Anderson had much to lose by dropping Enron with fees in excess of $100 million, Enron overlooked and signed-off on by Anderson's auditors. The relationship between those two parties has led to an irreparable situation. Enron's former CFO, Andrew Fastow, was pleaded guilty to fraud, money laundering, and conspiracy, which tried to conceal the company's massive losses. At last, after litigation and much negative publicity, Enron and Arthur Anderson had been stripped of their reputations and positions in the business world.
Combining with these two examples above, it is obvious to know that in the former example, the internal auditor doubted about the reality of the organization's report, and was able to use knowledge to find evidences to prove her thoughts. The latter one, the internal auditors of Enron had failed to accomplish its responsibilities, and the conspiracy between two organizations caused a serious scandal. It seems that the need for a strong, ethical internal audit organisation becomes more and more important.
How has the role of internal auditors changed? According to the Institute of Internal Auditors issued new global professional standards in 2000, it intended to govern the conduct of the profession of internal auditing. Section 2110 A1 of the Standards stated: "the internal audit activity should monitor and evaluate the effectiveness of the organization's risk management systems." Hence, it is clear that internal auditors should review the risk management system as part of their assurance activities for the board and senior management. Moreover, there are some organisations have established processes for assuring the adequacy and effectiveness of risk management procedures. Nevertheless, the standards have been improved in January 2009. The newest Institute of Internal Auditors International Professional Practices Framework was modified in few important ways. Section 2120 of the Standards stated:"the internal audit activity must evaluate the effectiveness and contribute to the improvement of risk management process." The improvements includes the change of word "should" to "must", "monitor" to "evaluate" and the term of "risk management systems" to "risk management processes". Based on my understanding of the Standards, the responsibility of internal audit, such as monitoring, evaluating, and reporting on the effectiveness of risk management systems, has been further amplified. Additionally, it is clear to know how important is the internal audit is to an organization.
Personally, I agree with the improvement of the Standards, it provides guarantee for organisations in current economic downturn. If these two organizations complied with the newest standards, I believe the internal auditors will think highly of its responsibilities, the related risk will be much lower, and these scandals may not happen. Therefore, Evaluating and reporting on the effectiveness of risk management systems represents a tremendous opportunity to make the internal auditing profession and its members more relevant, more valuable, better paid and, most importantly, more respected.
Turning to the question listed in the title at the beginning. My conclusion is that internal auditors should shoulder some of the responsibility for the current economic turmoil. As a result of the analysis before, it turns out that internal audit profession plays an important role in preventing the major corporate governance breakdown in organisations. In my opinion, internal auditors can help organisations reduce their corporate governance risk if they pay more attention to assess and report on risk management system and make sure they are competently and reliably.