Internal Audit

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Reliance on Internal Audit Case Example: ABC Manufacturing Company

Context

ABC Manufacturing Company has a well-established internal audit department that conducts regular reviews of internal controls, compliance with policies and procedures, and certain areas of financial reporting. The external auditors need to assess whether and to what extent they can rely on the work performed by this department to support their audit opinion.

Audit Objective

To evaluate the internal audit function’s objectivity, competence, and systematic approach to determine the extent of reliance the external auditors can place on the work performed by the internal audit team.

Types of Audit Evidence and Documentation for Reliance on Internal Audit

1. Evaluation of Internal Audit Function

• Case: Assess the internal audit function’s organizational status and objectivity, the qualifications and competence of the internal audit staff, and the effectiveness of its performance.

• Documentation: Document the assessment of the internal audit function, including details on its organizational independence, the professional qualifications of staff, and the quality of its audit work.

2. Review of Internal Audit Plan and Work

• Case: Examine the internal audit’s work plan, including the scope of their audits, the basis for selecting audit areas, and the methodologies used. Review selected internal audit reports to evaluate the thoroughness of investigations and the adequacy of findings and recommendations.

• Documentation: Summarize the review of the internal audit plan and specific internal audit reports, noting the areas covered, the audit methodologies applied, and the relevance to the external audit objectives.

3. Coordination with Internal Audit

• Case: Establish a formal or informal arrangement for coordination with the internal audit team. This includes determining the areas of focus, timing, and extent of work that can be used for the purposes of the external audit.

• Documentation: Document the arrangements made for coordination with the internal audit team, including any specific areas where reliance on internal audit work is planned and the basis for such reliance.

4. Assessment of Work Performed by Internal Audit

• Case: Evaluate specific internal audit work that is relevant to the external audit objectives. This includes considering the adequacy of the scope of work, the testing methodologies applied, and the appropriateness of conclusions reached.

• Documentation: Prepare an evaluation of the work performed by the internal audit function that the external audit plans to rely upon, detailing the reasons for reliance and any limitations identified.

5. Determination of Extent of Reliance

• Case: Based on the evaluations made, determine the extent to which the external audit can rely on the work performed by the internal audit function. This determination affects the nature, timing, and extent of further audit procedures to be performed by the external auditors.

• Documentation: Document the conclusion regarding the extent of reliance on the internal audit function, including how this reliance impacts the external audit procedures.

6. Communication with Those Charged with Governance

• Case: Communicate with those charged with governance regarding the external auditor’s reliance on the internal audit function, including any significant findings from the evaluation of the internal audit work and how this reliance affects the audit approach.

• Documentation: Summarize the communications with those charged with governance concerning reliance on the internal audit function, noting any discussions about the effectiveness of the internal audit function and its impact on the audit strategy.

Conclusion

Reliance on the internal audit function can significantly enhance the efficiency and effectiveness of the external audit process. By thoroughly documenting the evaluation of the internal audit function’s objectivity, competence, and work, external auditors establish a basis for determining the extent of reliance they can place on this work. This documentation is crucial for ensuring that such reliance is justified and for supporting the overall audit opinion on the financial statements.