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Evaluation of Internal Audit Functions by External Auditor: The external auditor’s general evaluation of the internal audit function will assist him in determining the extent to which he can place reliance upon the work of the internal auditor. The external auditor should document his evaluation and conclusions in this respect. The important aspects to be considered in this context are: (a) Organisational Status - Whether internal audit is undertaken by an outside agency or by an internal audit department within the entity itself, the internal auditor reports to the management. In an ideal situation, his reports to the highest level of management and are free of any other operating responsibility. Any constraints or restrictions placed upon his work by management should be carefully evaluated. In particular, the internal auditor should be free to communicate fully with the external auditor. (b) Scope of Function - The external auditor should ascertain the nature and depth of coverage of the assignment which the internal auditor discharges for management. He should also ascertain to what extent the management considers, and where appropriate, acts upon internal audit recommendations. (c) Technical Competence - The external auditor should ascertain that internal audit work is performed by persons having adequate technical training and proficiency. This may be accomplished by reviewing the experience and professional qualifications of the persons undertaking the internal audit work. (d) Due Professional Care - The external auditor should ascertain whether internal audit work appears to be properly planned, supervised, reviewed and documented. An example of the exercise of due professional care by the internal auditor is the existence of adequate audit manuals, audit programmes and working papers.
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Applicability of Internal Audit: Section 138 of the Companies Act, 2013 states that every private limited company is required to conduct internal audit if its outstanding loans or borrowings from banks or public financial institutions exceeding one hundred crore rupees or more at any point of time during the preceding financial year. In view of the above provisions, AB Pvt. Ltd. is mandatorily required to conduct an internal audit as its loans or borrowings are falling under the prescribed limit. Who can be appointed as Internal Auditor- The internal auditor shall either be a Chartered Accountant or a Cost Accountant, whether engaged in practice or not, or such other professional as may be decided by the Board to conduct an internal audit of the functions and activities of the companies. The internal auditor may or may not be an employee of the company. Work to be reviewed by Internal Auditor- Refer Para 2.
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(a) Direct Assistance from Internal Auditor: As per SA 610, “Using the Work of Internal Auditor”, the external auditor shall not use internal auditors to provide direct assistance to perform procedures that Involve making significant judgments in the audit. Since the external auditor has sole responsibility for the audit opinion expressed, the external auditor needs to make the significant judgments in the audit engagement. Significant judgments include the following: • Assessing the risks of material misstatement; INTERNAL AUDIT • Evaluating the sufficiency of tests performed; • Evaluating the appropriateness of management’s use of the going concern assumption; • Evaluating significant accounting estimates; and • Evaluating the adequacy of disclosures in the financial statements, and other matters affecting the auditor’s report. In view of the above, Mr. A cannot ask for direct assistance from internal auditors regarding evaluating significant accounting estimates and assessing the risk of material misstatements. (b) Direct Assistance from Internal Auditor in case of External Confirmation Procedures: SA 610, “Using the Work of Internal Auditor”, provide relevant guidance in determining the nature and extent of work that may be assigned to internal auditors. In determining the nature of work that may be assigned to internal auditors, the external auditor is careful to limit such work to those areas that would be appropriate to be assigned. Further, in accordance with SA 505, “External Confirmation” the external auditor is required to maintain control over external confirmation requests and evaluate the results of external confirmation procedures, it would not be appropriate to assign these responsibilities to internal auditors. However, internal auditors may assist in assembling information necessary for the external auditor to resolve exceptions in confirmation responses.
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HR Head needs to evaluate multiple options and identify the most suitable option in light of the relevant provisions, guidance and overall governance of the organization. HR head also needs to evaluate different options for his administrative reporting and various options for functional reporting of Chief Internal Auditor. The possible options to be considered and evaluated include the Board of Directors, Audit Committee, Managing Director of the Company and Chief Executive Officer or Chief Financial Officer. As per section 138 of the Companies Act 2013, the internal auditor shall either be a Chartered Accountant or a Cost Accountant (whether engaged in the practice or not), or such other professional as may be decided by the Board to conduct an internal audit of the functions and activities of the company. As per the revised definition of the term ‘Internal Audit’ as per para 3 of the ICAI’s Framework Governing Internal Audits, “Internal audit provides independent assurance on the effectiveness of internal controls and risk management processes to enhance governance and achieve organisational objectives”. Refer para 3.1, The Internal Auditor shall be free from any undue influences which force him to deviate from the truth. This independence shall be not only in mind but also in appearance. Also, the internal auditor shall resist any undue pressure or interference in establishing the scope of the assignments or the manner in which these are conducted and reported, in case these deviate from set objectives. As per the requirement of the above stated provision, Chief Internal Auditor needs to be independent of the operational activities and report of Audit Committee / Board of Directors to enjoy his true status of independent auditor. He may administratively report to CEO or Managing Director for his administrative reporting purpose or any other similar authority till the time it is approved by Board of Directors, and it does not impact his independence to be able to perform his duties and report to audit committee / Board of Director independently.
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Refer para 2.0. The internal auditor should, in consultation with those charged with governance, including the audit committee, develop and document a plan for each internal audit engagement to help him conduct the engagement in an efficient and timely manner. Internal audit plans should be developed in such a manner that all the business processes covering both financial as well as operational activities are reviewed by internal audit function within a defined time cycle. Also, ensuring that appropriate consideration is made, and adequate balance is ensured to the following: Risk underlying the business process Value that the internal audit can provide to the organization Effort involved in conducting the internal audit for a particular business process Risk Appetite of the organization Coverage of all auditable areas within the defined time range
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Refer para 5.0. INTERNAL AUDIT 16.39
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Refer para 6.0. As per Standard on Internal Audit (SIA) 370 Reporting Results, reporting of internal audit results is generally undertaken in two stages: At the end of a particular audit assignment, an “Internal Audit Report” covering a specific area, function or part of the entity is prepared by the Internal Auditor highlighting key observations arising from those assignments. This report is generally issued with details of the manner in which the assignment was conducted and the key findings from the audit procedures undertaken. This report is issued to the auditee, with copies shared with local and executive management, as agreed during the planning phase. On a periodic basis, at the close of a plan period, a comprehensive report of all the internal audit activities covering the entity and the plan period is prepared by the Chief Internal Auditor (or the Engagement Partner, in case of external service provider). Such reporting is normally done on a quarterly basis and submitted to the highest governing authority responsible for internal audits, generally the Audit Committee. Some part of the aforementioned Internal Audit Reports may form part of the periodic (e.g. Quarterly) report shared with the Audit Committee. Accordingly, a typical internal audit report should include the following: • Audit Scope performed; • Audit period Covered; • Executive Summary; • Summary of the critical findings; • Detailed audit findings with elaboration on business impact and root cause of such issues; • Rating of the highlighted issues (E.g High / Medium / Low) in accordance to the rating criteria approved by Audit Committee; • Audit recommendation to improve control environment and address the highlighted finding; • Response received from the responsible functional authority containing action plan and target timelines for action. 16.40
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Refer para 6.1. As per SIA 390 Monitoring and Reporting of Prior Audit Issues, the Chief Internal Auditor is responsible for continuously monitoring the closure of prior audit issues through timely implementation of action plans included in past audits. This shall be done with a formal monitoring process, elements of which are pre-agreed with management and those charged with governance. The responsibility to implement the action plans remains with the management. In monitoring and reporting of prior audit issues, the responsibility of the Internal Auditor is usually in the form of an “Action Taken Report (ATR) of previous audits”. To address the requirement of Audit Committee in the given situation, Internal Auditor should assess the action taken against the previous audit findings and report a summary of the action taken by the management. Typical Action Taken Report may include the following: Reference to the previous audit reporting containing the reported issues Implementation Action agreed by the management along with target implementation date Status of action taken by management. The same may be classified under Implemented / Not Implemented Residual risk and rating for any unimplemented action Audit findings not implemented for long period of time Any critical audit finding that requires immediate action for action or implementation.
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As per section 138 of the Companies Act, 2013, following class of companies (prescribed in Rule 13 of the Companies (Accounts) Rules, 2014) shall be required to appoint an internal auditor or a firm of internal auditors, namely:- (A) every listed company; (B) every unlisted public company having- (1) paid up share capital of fifty crore rupees or more during the preceding financial year; or (2) turnover of two hundred crore rupees or more during the preceding financial year; or INTERNAL AUDIT (3) outstanding loans or borrowings from banks or public financial institutions exceeding one hundred crore rupees or more at any point of time during the preceding financial year; or (4) outstanding deposits of twenty five crore rupees or more at any point of time during the preceding financial year; and (C) every private company having- (1) turnover of two hundred crore rupees or more during the preceding financial year; or (2) outstanding loans or borrowings from banks or public financial institutions exceeding one hundred crore rupees or more at any point of time during the preceding financial year. In the given case, XYX Limited is a listed company. As per section 138 of the Companies Act, 2013, every listed company is required to appoint an internal auditor or a firm of internal auditors. Thus, in view of the above, XYX Limited is required to appoint an internal auditor. Further, MNM Limited is unlisted public company. The company is having ₹ 60 crore as equity share capital which is exceeding the prescribed limit of rupees fifty crore as per section 138. Thus, MNM Limited is required to appoint an internal auditor as per section 138 of the Companies Act, 2013. GFG Limited is unlisted private company and having ₹ 70 crore as equity share capital, ₹ 180 crore as turnover and ₹ 80 crore loan from Bank and PFI. In view of provisions of section 138 of the Companies Act, 2013 discussed above, all the limits are below the prescribed limit for a private company. Therefore, GFG Limited is not required to appoint an internal auditor. It can be concluded that XYX Limited and MNM Limited are required to appoint the internal auditor as per the provisions of the Companies Act, 2013 whereas GFG Limited is not required to do the same.
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(a) In the given case, Rishi notices several discrepancies in the disbursement records and suspects there might be weaknesses in the internal control system. He is concerned about maintaining his independence and objectivity while ensuring that management is aware of these issues. Responsibilities of Rishi as an Internal Auditor with respect to the accounting function and financial records of the organisation include: • to ascertain adequacy of system of internal control by a continuous examination of accounting procedures, receipts and disbursements, and to provide adequate safeguards against misappropriation of assets. • to operate independently of the accounting staff and must not in any way divest any of the responsibilities placed upon him. • not to involve in the performance of executive functions in order that the objective outlook does not get obscured by the creation of the vested interest. • to observe facts and situations and bring them to notice of authorities who would otherwise never know them; also, critically appraise various policies of the management and draw its attention to any deficiencies, wherever these require to be corrected. • to associate closely with management and keep knowledge up to date by being informed about all important occurrences and events affecting the business, as well as the changes that are made in business policies. • at all times, the internal auditor must enjoy an independent status. (b) As per SA 610, “Using the Work of Internal Auditor”, the external auditor shall not use internal auditors to provide direct assistance to perform procedures that involve making significant judgments in the audit. Since the external auditor has sole responsibility for the audit opinion expressed, the external auditor needs to make significant judgments in the audit engagement. Significant judgments include the following: • Assessing the risks of material misstatement; • Evaluating the sufficiency of tests performed; • Evaluating the appropriateness of management’s use of the going concern assumption; • Evaluating significant accounting estimates; and • Evaluating the adequacy of disclosures in the financial statements, and other matters affecting the auditor’s report. INTERNAL AUDIT In view of the above, CA Nitin cannot ask direct assistance from internal auditors regarding evaluating the appropriateness of management’s use of the going concern assumption in accordance with SA 610.
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In the given situation, CA Sanjana has recently joined as Chief Internal Auditor in Up Scale Limited, a listed company. As a Chief Internal Auditor, CA Sanjana is responsible for continuously monitoring the closure of prior audit issues through timely implementation of action plans included in past audits. This shall be done with a formal monitoring process, elements of which are pre-agreed with management and those charged with governance. The responsibility to implement the action plans remains with the management. In monitoring and reporting of prior audit issues, the responsibility of the CA Sanjana as internal auditor is usually in the form of an “Action Taken Report (ATR) of previous audits”. The term “Monitoring and Reporting” refers to the periodic tracking of issues raised during prior audits and evaluation of the corrective actions undertaken by the auditee to resolve them and to report any open and pending matters to the management and those charged with governance. CA Sanjana should review whether follow-up action is taken by the management on the basis of his report. If no action is taken within a reasonable time, she should draw the management’s attention to it. Where the management has not acted upon the suggestions or not implemented the prescribed recommendations, she should ascertain the reasons thereof. Where the management has accepted recommendations of the CA Sanjana and initiated the necessary action, she should periodically review the manner and the extent of implementation of the recommendations and report to the management highlighting the recommendations which have not been implemented fully or partly.
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SA 610, "Using the Work of Internal Auditor” states that in determining the nature of work that may be assigned to internal auditors, the external auditor is careful to limit such work to those areas that would be appropriate to be assigned. Examples of activities and tasks that would not be appropriate to use internal auditors to provide direct assistance include the discussion of fraud risks, determination of unannounced audit procedures as addressed in SA 240 etc. In the above case, engagement partner had designed certain substantive procedures on some selected assertions in response to assessed risk of material misstatements in year under audit. Such assertions were not tested by him in the previous years due to materiality or risk considerations. It is being done now for incorporating an element of unpredictability in audit procedures to be performed as individuals within the company who are familiar with the audit procedures normally performed on engagements may be more able to conceal fraudulent financial reporting. Therefore, in such matters, using an internal auditor to provide direct assistance could prove to be counter-productive and defeat the very purpose of designing such substantive procedures. Hence, decision of senior engagement team member to use Mr. X to provide direct assistance on above said matters is not in accordance with SA 610 and is not proper. Prior to using internal auditors to provide direct assistance for purposes of the audit, the external auditor shall: - (a) Obtain written agreement from an authorized representative of the entity that the internal auditors will be allowed to follow the external auditor’s instructions, and that the entity will not intervene in the work the internal auditor performs for the external auditor; and (b) Obtain written agreement from the internal auditors that they will keep confidential specific matters as instructed by the external auditor and inform the external auditor of any threat to their objectivity.
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