Defining Internal Audit: Types, Importance, 5 c’s and FAQs

What is an internal audit?

Internal audit is an independent and objective activity within an organisation that evaluates and improves the effectiveness of risk management, control and governance processes. This function operates as the eyes and ears of the organisation, providing valuable insights to the management.

Internal Audit also provides a degree of risk management and safeguard the company from fraud, abuse and exploitation. The results of internal audits provide management along with the suggestion for improving current processes which aren’t functioning as intended or desired.

Internal audits may take place on a daily, weekly, monthly or on an annual basis. Some departments get audited on a regular basis or more frequently than other departments. For example, the human resources department might get audited once a year while on the other hand manufacturing processes may be audited on a day-to-day basis to ensure quality control.

Internal audits are similar to external audits that are conducted and initiated by planning, reporting, and monitoring steps.

What are the Responsibilities of an Internal Auditor?

Assess and evaluate risk management in a company.
Ensuring ethical conduct in the workplace and identifies improper conduct.
Safeguarding assets and protecting the organisation's resources.
Studying and learning company’s guidelines and policies.
Provides opinion on the overall result of Internal audit.
Checking accuracy of financial reports.

Why is Internal Audit necessary?

The Internal audit is necessary in an organisation due to the following reasons:

To enhance company’s control environment: Internal auditing is beneficial because it improves control environment by evaluating the efficiency and operations effectiveness. The employees must be aware of the fact that their work will get analysed and reported on.
Protecting assets and managing risk: An internal audit program evaluates and assists by recognizing and prioritising risk through a systematic risk assessment. Risk assessment identifies the gap in the environment and allows rectifying the plan that takes place.
Save Companies money: If the company’s processes are strong, it will create less chances of spending expenses on external audits which will result in saving the company's financial expenditure.
Some departments may need enhancement: Whether it is lack of expertise, any problem with current personnel, shortage of staff, etc. a company should earn benefits by targeting specific areas and formally reviewing the workflow and the process.
Makes companies more efficient: External audits are not often intended to make the process better, it is intended to review the system, whether they are working accurately or not. This distinction is important because a company can maybe “just get by” with not enough efficient processes that require the bare minimum.

Types of Internal Audit

The most important types of internal audit are:

Compliance Audit:The compliance audit is an internal audit to ensure whether the organisation is working within the external laws, company guidelines, following essential rules and regulations. In a compliance audit, an internal auditor checks whether the company complies with the rules and regulations of the region, state, or country it operates.
Internal Financial Audit: Some of the public companies are required to perform certain levels of external auditing whereas a completely independent third party provides an opinion on the company's financial record. Although companies keep conducting internal audits in preparation of external audits.
Environmental Audit: It is necessary to have an eco-friendly environment in a company. This results in another internal audit for evaluating and covering the safety of resources, raw material, minimising greenhouse gases production while working, reducing energy consumption,etc.

When the auditor asks to conduct an environmental audit, he/she makes sure that none of the environmental law is being violated.

Technology or IT Audit: An IT audit can have various different objectives. A type of internal audit mainly focused on technology review controls, hardware, software,security, documentation, recovery or backup of the system. It also covers the raised cyber issues that require immediate attention.
Performance Audit: The management sets some standards expecting employees to work overall to strengthen their performances. This internal audit is centred towards performance rather than paying attention towards the process or final result.

As a result, an internal auditor assesses the outcome of objectives that may not be that significant.

Operational Audit: Operational Audit mostly occurs when a key personnel leaves or any new personnel joins in. The company assesses your way of handling and working with the assigned project along with spectating whether the resources are being used more efficiently.

Starting from quality control, human resources functions and account management, they assess every aspect of the company.

Construction Audit: Construction companies or real estate companies conduct construction audits to not only ensure the appropriate physical development of the company but also relevant billing of the project. This mostly includes the contract terms with general contractors, sub-contractors, or other vendors.

This also includes reviewing whether the company has collected the payments, dues timely or not.

Special Investigations: Above mentioned audits may or may not recurring each year but there are a few internal audits that occur once a year under special circumstances. This investigation gathers reports on efficiency of the new manager, complaints from the staff, hiring key personnels, etc.

Internal Audit Report: The 5C’s

Internal Audit Reports are generally known for adhering to the 5 C's of reporting requirements. A complete, sufficient and fulfilled internal audit ends with the summary report that communicates answers of the following questions.

Criteria: Identifying the cause and answering why internal audit is necessary?Who requested the internal audit and why did that party requested an internal audit? Is internal audit preparation for a future external audit?
Condition: Under what conditions does the company requested an internal audit? Has any of the company policies been broken or any benchmark was set that was not met or any other condition has not been satisfied?
Cause: Why did that issue arise? Who is responsible for that? What processes were broken? Who was involved?
Consequence: What are the possible outcomes/ consequences? Are the aroused issues limited to internal matters or there are risks of external consequences?
Corrective Action: What specific steps should be taken by the management to resolve the issue? What can be done to resolve the issue ? What type of monitoring or reviewing will occur after solutions have been put in place to ensure the problem has been fixed?

Conclusion

Internal Audit serves as a critical component of the organisation’s success by providing independent and objective evaluations of its operations, risks, and controls. By focusing on risk assessment, compliance, efficiency, internal controls,fraud detection, and performance evaluation, internal audit helps the organisations navigate uncertainties and challenges.

Embracing the insights and recommendations of internal auditors leads to improved governance, greater operational efficiency, and enhanced resilience, positioning organisations to achieve sustainable growth and success in the long run.

As business continues to evolve and adapt to new challenges, the role of internal audit remains paramount in encouraging effective governance and driving performance excellence.

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Frequently Asked Questions

Why is it called Internal Audit?

Internal audit helps in assessing the internal control including the process of accounting and governance within the company’s boundary. These types of audits help in maintaining financial reporting and collecting data timely.

What is known as Internal audit?

Internal Audit is an independent service that is conducted within an organisation to evaluate its operations, controls, and government practices. The primary purpose of internal auditing is to provide assurance to management and the director that the organisation’s systems and processes are functioning effectively.

Who conducts internal audits?

Internal audits are conducted by internal auditors who are the employees appointed as auditors of the organisation they are auditing. These auditors are independent of the areas they are auditing, which means they do not have operational responsibilities for the processes or the functions they are examining.

Who prepares an audit?

The Auditor prepares an audit depending upon its type. The auditor reviews financial records, transactions, and internal controls to assess the organisation's financial health, compliance, and risk management.