MBA Semester III MB 0051 Legal Aspects of Business Roll No 1302011493

MBA - Finance Semester IIIMF-0013 Internal Audit & Control

Question 1: General audits are classified into independent audit, internal audit and government audit. Give a brief introduction of general audit. Explain all the three types of audit covering all the important things under each audit.

Answer 1: General Audit: A general audit covers all areas of management & is company focused. A general audit is usually done on a routine, pre determined schedule.

Types of General Audit are:

Independent Audit: An independent audit is conducted by an independent, professionally qualified auditor. The auditor should not be in the employment of the enterprise for which he is conducting the audit. Only Practicing Chartered Accountant or people certified under the restricted auditors certificate rule, 1956 can be selected as a Cos auditor. An independent auditor is given the responsibility to ensure that the financials reflect a true & fair view of the financial health of the company. An independent audit is further classified into statutory audit and other audits.

Statutory Audit: An audit which is mandatory under a law in force is called a statutory audit. The scope of statutory audit, qualifications required of the auditor rights, duties, liabilities and the board of methodology are prescribed by the concerned enactment.

Internal Audit: Internal Audit is another type of general audit. The preface to the standards and guidance notes on internal audit issued by the ICAI defines it as an independent management function which involves a continuous and critical appraisal of the function of the entity. The objective of internal audit is to suggest improvements to the function of the entity and add value to and strengthen the overall governance mechanism of the entity including the risk management and internal control system.

Government Audit: Government Audit: Government audit is another variety of General audit.

Audit of Govt departments: The Audit of govt departments & undertakings not registered under cos act 1956 are governed by article 149 of the constitution. The Controller and Auditor General shall perform such duties and exercise the power in relation to accounts.

Audit of statutory Corporations: The CAG performs to audit the accounts of the corporation but the accounts are also audited by the independent Chartered Accountants at times. LIC, SBI are examples of statutory corporations.

Audit of Government Companies: Under Sec 619 of Cos act the auditor of Government Company is to be appointed by Co Law board on advice of CAG.

Question 2: Internal Audit and External Audit There are similarities and dissimilarities between internal and external audit.

Answer 2: A) Point of similarity

Evaluation of the internal control system of the entity Correctness of accounting, documentation, book keeping and financial reporting. Verification of assets.

B) Points of dissimilarity:

Statutory Status: External audit is usually mandated by law, But internal audit is not mandatory except for companies to which companies (Auditors report) Order, 2003 Applies.

Independence: The statutory auditor is independent of the organization which appoints him. But the internal auditor is an employee of the organization reporting to a divisional of functional head and so his freedom might be limited. Even if an outside firm or person is appointed as internal auditor. Independence may not be assured as he is appointed by the management and has no legal authority.

Scope: The scope of an external audit is well defined by the statute that mandates the audit. The scope of the internal audit is determined by the management and may be expanded or restricted depending upon the peculiarities of the particular situation being audited.

Responsibility: The responsibility of external auditor is mainly towards the shareholder, who have appointed him, and the other external stake holder of the company. The internal auditor is responsible directly to the internal management and to the board. He is also answerable to the external auditor and must share his audit findings with him.

Powers: The external auditor has statutory powers under the companies act and related statues. The internal auditor is given his terms of reference and powers by the management. His powers depend upon the requirements of the management.

Submission of reports: The external auditor submits his report to the owners or shareholders. The internal auditor submits his report to the management.

Periodically: External Audit is conducted perdiocally usually once a year, internal audit is done throughout the year on the basis of a time bound program.

Question 3: Explain the qualities of an internal audit personnel.

Answer 3: The ICAI has issued standards on audit (SA-220)- Quality control for an audit of financial statements with the objective control for an audit of financial statement with the objective of establishing standards on quality control, policies and procedures to be followed in audit work and process and controls regarding delegation of work to assistants in the course of an external audit.

The Qualities of internal audit personal can be summarized as follows:

They should posses required qualification, training, experience and competence. They should have a continuous awareness of developments in the field of account and auditing especially internal audit. They should perform their duties with due professional care and paying due attention to the role assigned to them by the management. They should maintain their professional independence. They should completely impartial and unbiased in their reporting. They should possess the highest quality of ethics and integrity.

Audit Firm: The Quality control policies to be adopted by an audit firm will usually include the following:

Professional Requirements: The Firms personnel have to follow the principles of independence, objectivity. Confidentiality, integrity and professional behavior.

Skills and competence: The firm is staffed only with personnel who posses and are able to maintain the technical standards and professional competence required to enable them to fulfill their responsibilities with due care.

Assignment: Only personnel who possess the degree of technical training and proficiency necessary for the circumstances should be assigned audit work.

Delegation: To ensure that the performed work meets appropriate standards of the quality, there should be sufficient direction, supervision and revision of work at all levels.

Consultation: Whenever required consultation outside or within the firm should take place with those who have the appropriate expertise.

Monitoring: The continued adequacy and operational effectiveness of quality control policies and procedures should be monitored.

Direction & Supervision: Appropriate direction and supervision is required for assistants to whom work is delegated .Audit directions are communicated through an a tool called audit program.

Review: The work performed by each assistant needs to be reviewd by the personnel of at least equal competence to evaluate.

Question 4: Planning is the key to an effective and efficient audit. Explain the importance of Internal Audit Planning and factors to be considered in Internal Audit Planning.

Answers 4: The Importance of Internal Audit Planning are as follows:

Fine tuning the specific method to be adopted for difference segments of the audit Selecting staff that would ideally suit each segment. Coordinating the programmed with that of the statutory auditors. Establishing clear and realistic timelines. Identifying and giving priority in the audit programme for critical areas to be audited. Using computer resources and statistical sampling techniques appropriately.

Factors to be considered in Internal Audit Planning.

Audit Objectives: The detailed audit plan largely depends upon the specific objectives to be achieved by the audit.

Examination of the correctness of the financial and accounting records. Making sure that the financial accounting and reporting should be in line with the GAAP. Verifying the valuation of assets of the enterprise Ensuring the liabilities incurred by business are correctly reported. Verify compliances in every function with the statutory requirements laid down under different legislations.

Internal Audit Framework: The Frame work for the internal audit programme cannot be the same for every organization and the details are substantially different from company to company. Here we will draw out broad framework that would be applicable across all orangnisations.

Audit Procedures: Audit procedures are the specific sets of actions to be performed to ensure the quality of the audit in line with benchmark auditing standards. It is important to plan as far as practicable the precise scheduling and timing of each audit procedure both to give advance information to the function being audited and to utilize audit staff efficiently and without overlap or wastage of time.

Staffing: Determining the staff strength required for the audit programme is an important aspect of planning internal audit. This is to be done both at the overall department strength level and at the level of teams for individual audits. Is the size of the structure of the internal audit team adequate to meet its established objectives? What are the experience levels of the internal audit personnel? Does planning include written audit plans and programs?

Reporting: The internal audit reporting structure is an important aspect of the programme and has to be planned in some detail with the respect to the following questions: What type of Internal audit report are to be issued? What should be the timing and frequency of the reports?

Question 5: Write down the objectives of internal check with an example. Explain the advantages of internal check.

Answer 5: The objectives of Internal Check:

Appropriate division of work: Proper division of work based on the requirements of the job and the qualification and experience of the employees is an important outcome of internal check systems.

Clear Cut demarcation of authority and responsibility: Clear cut demarcation of authority and responsibility makes an employee know what tasks are expected of him and what authority he is given to accomplish those tasks.

Prevention of errors and frauds: As every task passes through several checkpoints in the regular course there is an effective guard against carelessness or dishonesty of individual employees.

Early defection of errors and frauds: The involuntary checking of a persons work by another helps in identifying errors in the flow itself unless all employees are in collusion.

Increase reliability of book keeping: Internal checks system goes right through to the entry in the books of accounts and so accounting becomes more exact. Statutory auditors can confine themselves to only test-checking without having to worry about errors.

Separation of custodial and recording functions: The separation of functions of custodian and record keeper is an important purpose of internal check systems like cash and bank clerk being different persons from the cashier.

Increased profitability with reduced Costs: The objective of an effective internal check system is to reduce overlap and inefficiency at clerical levels and to prevent unintended and intended errors by which the profitability gets a boost.

Advantages of Internal Check:

Clear Definition of responsibility: Internal check system ensures a proper division of responsibilities among the employees of an organization.

Efficiency and cost savings: Well set processes with internal checks promote efficiency of employees faster work throughput and overall cost savings.

Prevention of errors and frauds: No single person is allowed to handle a transaction end to end and errors or frauds are prevented and if committed they are detected quickly.

Reliability of MIS: The information and data generated in the organization which has an effective internal check system are normally more reliable and accurate.

Early Preparation of final accounts: It is easy to place reliance on the financial report of an enterprise with an effective internal check system.

Question 6: Write short notes on:a) Accounting system and internal controlb) Review and preliminary evaluation of internal controlc) Compliance procedures of internal control

Answer 6: Accounting system and internal control: The Statement on Standard auditing practices are guided by the ICAI. Management is responsible for maintaining an adequate accounting system incorporating various internal controls to the extent appropriate to the size and nature of the business. The auditor assesses the reliability and sufficiency of the information contained in the underlying accounting records and other source data. The objective of this statement is to discuss the procedure to be followed to company with the basic principles described above in connection with the audit of financial information. The term financial information in this statement embraces financial statements. The system of the internal control is the plan of organization and all the methods and procedure adopted by the management of an entity to assist in achieving managements objective of ensuring as far as practicable the orderly and efficient conduct of its business including adherence to management policies the safeguarding of assets prevention and detection of fraud and error the accuracy and completeness of the accounting records and timely preparation of reliable financial information.

Review & Preliminary Evaluation:

The auditor should review the accounting system and related internal controls to gain an understanding of the flow of transaction and the specific control procedure. The review of internal control consist of enquires of employees within organization at various levels together with reference to documentation such as procedure manuals which the auditor has identified as significant to his audit. To understand the accounting system and its related internal controls it may be useful to trace a few transactions through it. The Auditor should base the preliminary evaluation of the internal controls on the assumptions that the controls operate generally as described and that they function effectively throughout the period of intended reliance.

Compliance Procedure for Internal Control: The auditor conducts compliance procedure to obtain evidence that those internal controls are identified by him and they function through the period of intended dependence effectively. The auditor should evaluate if the internal controls are adequate for required purposes based on the compliance procedures. The auditor should select transactions from those of the whole period under examination in order to apply the compliance procedures. Changes in key personal and significant seasonal fluctuations in volume of transactions may be the cause for deviations from prescribed controls.

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