How Does Internal Auditing Maintain Its Independence And Objectivity

Table of Contents

I. Introduction

II. The purpose of internal auditing

III. Profession guidance on independence and objectivity

IV. Consulting services: a challenge to audit independence?

V. Independence vs. Objectivity

VI. Conclusion

VII. Bibliography

I. Introduction

'The internal auditor occupies a unique position he or she is employed by the management but is also expected to review the conduct of management which can create significant tension since the internal auditor's independence from management is necessary for the auditor to objectively assess the management's action, but the internal auditor's dependence on the management for employment is very clear.'

-------Institute of Internal Auditors (IIA)

Although recently the focus of internal auditing is on Sarbanes-Oxley compliance, the importance of maintaining the independence and objectivity of internal audit should never be underweighted. In fact, if the independence and objectivity of internal auditing is impaired, Sarbanes-Oxley compliance is impaired at the same time.

INDEPENDENCE: The freedom from conditions that threaten objectivity or the appearance of objectivity. Such threats to objectivity must be managed at the individual auditor, engagement, functional, and organizational levels (IIA).

'Audit independence is essentially a state of mind'. Internal auditors can not be physically independent from the organization they are working for, but they can always stay objective.

OBJECTIVITY: An impartial, unbiased mental attitude and avoidance of conflicts of interest, allowing internal auditors to perform engagements in such a manner that they have an honest belief in their work product and that no significant quality compromises are made (IIA).

In order to stay objective, internal auditors should not assume any management responsibilities and should avoid auditing anything that they have direct or indirect authority or responsibility for. Internal auditors are not supposed to receive any gifts, cash, or special treatment from any employees, business associates, or clients. Staff auditors should have job rotations periodically.

II. The purpose of internal auditing

'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.'

--- IIA's internal audit definition

Any discussion of the independence and objectivity of internal audit should begin with the purpose of internal audit function in an organization.

In a small entity, the employer or the boss knows every employee by name. And most of the time, the employer owns the entity. He or she is the one who supervises everything in the entity. Since the entity is small and has limited people to govern, there is no need for internal auditing. The boss knows everything.

In a large entity, the owners include a group of stakeholders and the entity is managed by executives. There are more employees in the entity, business transactions are more sophisticated, and there are more departments and management levels. It is impossible for the stakeholders or executives to supervise everything. Therefore, there is a need for internal auditors to assume internal control and risk management responsibilities for those stakeholders and executives. And sometimes the internal auditors will also serve as consultants for management regarding a certain project or management issue. The purpose of having internal audit function in a large entity is to improve efficiency, control risk, manage risk, and eventually add value to the organization.

Therefore, the internal audit function must be independent from management responsibilities, and report directly to executives and board of directors. Unlike external auditors who serve mainly to third party users, internal auditors work for the company and assume internal control responsibilities for board of directors and executive management. They also provide consulting, recommendations, appraisals, and analysis to top management executives that is independent from the line of management.

III. Profession guidance on independence and objectivity

1) Practice Advisory 1100 ---- Independence and Objectivity

Internal auditors are independent when they can carry out their work freely and objectively. Independence permits internal auditors to render the impartial and unbiased judgments essential to the proper conduct of engagements. It is achieved through organizational status and objectivity.

2) Practice Advisory 1110 ---- Organizational Independence

The IIA's Standards for the Professional Practice of Internal Auditing

(Standards) require that the chief audit executive (CAE) report to a level

within the organization that allows the internal audit activity to fulfill its

responsibilities. The Institute believes strongly that to achieve necessary

independence, the CAE should report functionally to the audit committee or its equivalent. For administrative purposes, in most circumstances, the CAE should report directly to the chief executive officer of the organization.

3) International Standards for the Professional Practice of Internal Auditing (ISPPIA) ---

a) The board and executive management require reasonable assurance the entity's mission and objectives can be achieved. To that end, they are responsible for monitoring the actions subordinate line managers take to design and implement a sound control system capable of providing the required reasonable assurance.

b) Under the general direction of executive management, it is the subordinate line manager's responsibility to manage the operation and achieve the objectives and desired outcomes