What is an internal audit?
Internal audits identify a company’s procedural shortcomings to maintain financial integrity. The audits ensure businesses comply with laws and regulations to safeguard against fraudulent activities.
As an independent and objective activity, internal audits equip financial leaders with the data and tools needed to improve a company’s operations. These audits establish and enforce accurate financial reporting by adding value through problem identification and lapse corrections. Having the right financial information early saves time and money during external audits.
To navigate the auditing process successfully, companies leverage technology such as audit management software and auditing service providers to further assist them with creating compliant financial statements. As most auditing services are implemented by finance and accounting departments, they are key to ensuring that finances are in order and accounting information is recorded accurately.
Importance of internal audits
Internal audits are crucial for maintaining financial, corporate, and operational governance. Regular internal audits provide actionable insights into improving business performance and accounting processes.
Because they safeguard against potential financial frauds and resource waste, internal audits play a vital role in risk management. Data collected from internal audits also offers recommendations for process improvements other than accounting, such as IT systems and supply chain management.
Types of internal audits
Since internal auditing is an integral financial function for any business, it is important to understand its different types to employ the one that is best suited for the organization.
There are four main types of internal audits:
1. Compliance audits: Financial compliance refers to regulating and enforcing financial laws. Compliance audits examine the conformity and adherence of these rules in a specific financial area, process, or system.
These audits are necessary to understand whether a business has compliant-friendly policies, plans, and contracts to govern and justify the conduct of the activities subject to internal audits.
2. Operational audits: A company’s internal accounting controls for financial processes, procedures, and systems are reviewed by operational audits. Improving productivity and operational efficiency is the primary objective of these internal audits.
3. Financial audits: The main goal of financial audits is to evaluate an organization’s financial statements. This auditing process is critical for accurately representing all financial records and transactions.
4. Information technology audits: Most modern businesses have some IT infrastructure that helps keep them running and current. IT audits examine IT applications, operating systems, and database management controls. IT audit reviews can be implemented exclusively on IT assets or in conjunction with other types of internal audits.
Internal audit process
Internal auditors typically identify a specific department, collect information about its current internal controls, conduct fieldwork testing, follow up with relevant department members, and prepare audit reports with recommendations.
Internal audit checklist for auditors:
- Compliance with state and federal policies and law
- Analysis and assessment of financial risks and controls
- Recommendations for improving operations and processes
An internal audit plan generally consists of five main steps:
- Information collection: Observing procedures, taking notes, reviewing existing documentation, and interviewing employees are ways that auditors gain a better understanding of a company’s operations.
- Security assessment: Monitoring and assessing an organization's financial risks and security controls are part of this auditing stage. Assessments are carried out by testing safety standards and employee knowledge.
- Compliance assessment: Reviewing organizational compliance with state and federal policies and laws is part of the auditor's assessment.
- Information verification and consultation: During this stage, the internal auditor verifies all the information and recommends ways to improve.
- Follow-ups and reviews: Once the report is complete, auditors follow up with the company’s management to check on progress made per their advice.
Internal audits can be held daily, weekly, monthly, quarterly, or annually. The frequency of the audits differs depending on the department. The audits can either be scheduled to give management time to prepare documents or randomly in case fraudulent activities are suspected.
Assessment and analysis of internal audits
Assessment and analysis techniques differ depending on the type of business being audited and the working methods of the auditors.
Internal auditors may use indirect or direct assessment techniques to fully understand a company's internal controls and financial procedures. A combination of techniques may be used by auditors to get an overview of a business's financial performance.
Assessment techniques for internal audits:
- Indirect: These techniques try to avoid disrupting daily workflows. Examples include flowchart reviews, instruction manuals, and documentation about departmental and organizational control policies.
- Direct: If there isn’t enough financial and accounting documentation, internal auditors hold discussions with staff members and employees to gather information about existing processes and procedures.
Internal audit analysis is important as it enables auditors to test random or specific data to improve existing financial control processes. Auditors use fieldwork procedures to analyze the collected data. Some examples include transaction matching, physical inventory reporting, audit trail calculations, and account reconciliations as required by law.
Internal audits reporting
Reporting on internal audit outcomes provides information about a business’s financial transactions' inefficiencies. Audit reports serve as important guides regarding the integrity of owner and shareholder management.
Two kinds of audit reports are essential to the reporting process:
1. Interim report: This is a preliminary, memo-style report that includes sensitive and urgent information.
2. Final report: An essential component of internal auditing is a formal report with a summary of procedures and techniques and a description of the findings, suggestions, and improvements for internal controls.
Internal audits vs. external audits
Internal and external audits differ concerning their main objectives and procedures.
Internal audits are conducted internally within a company, usually by its employees or a consultant hired by the organization. The primary goal of implementing an internal audit is to highlight financial information essential to educate employees about security, manage risks, guarantee compliance, and improve operational efficiency.
External audits are carried out by auditors outside the organization whose only responsibility to the company is to determine financial information accuracy. These are highly regulated, and the results are reported to shareholders not governed by the business being audited. The primary goal of implementing an external audit is to provide credibility to financial reports.
Aayushi Sanghavi
Aayushi Sanghavi is a Campaign Coordinator at G2 for the Content and SEO teams at G2 and is exploring her interests in project management and process optimization. Previously, she has written for the Customer Service and Tech Verticals space. In her free time, she volunteers at animal shelters, dances, or attempts to learn a new language.
