Chapter 8: Internal Auditors Roles and Responsibilities Chapter 9: External Auditors Roles and Respo

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Chapter 8 Internal Auditors Roles and
Responsibilities Chapter 9External Auditors
Roles and Responsibilities

• L. Murphy Smith
• Texas AM University

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Chapter 8 Internal Auditors Roles and
Responsibilities
Chapter Objectives Review the qualities of an
effective internal audit department. Discuss
the role of internal auditors as assurance
providers and consultants. Review the trends of
the internal auditing profession. Discuss the
relationship of internal audits and the audit
committee. Analyze the determinants of an
effective internal audit. Discuss the
professional practices framework (PPF) adopted by
The Institute of Internal Auditors (IIA).
Promote the best practices and internal audit
framework.
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Chapter 8 Internal Auditors Roles and
Responsibilities
Comparison of Internal Audit (Pre- and
Post-corporate Governance Reforms)
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Chapter 8 Internal Auditors Roles and
Responsibilities

• Internal Auditors Consulting Services
• Consulting services to the board of directors and
  audit committee.
• Consulting services to management.
• Internal auditor training services.

• Trend and Relevance of Internal Auditors
• The Foreign Corrupt Practices Act (FCPA) 1977
• COSO Report of the National Commission on
  Fraudulent Financial Reporting (1987)
• The IIA redefined internal auditing in 1999
• SOX Sections 302 and 404 (keep in mind that SOX
  does not directly address internal auditor
  responsibilities or internal audit function.)
• The PCAOB in its AS No. 2

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Chapter 8 Internal Auditors Roles and
Responsibilities

• Authorities and Responsibilities
• The internal audit function should have (1) full
  and free access to the companys audit committee
  (2) unrestricted access to the companys records,
  documents, property, and personnel and (3)
  authority to discuss initiatives, policies, and
  procedures regarding risk assessment, internal
  controls, compliance, financial reporting, and
  governance processes with management and other
  corporate governance participants.

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Chapter 8 Internal Auditors Roles and
Responsibilities

• Internal Audit Outsourcing
• The decision of whether to establish and maintain
  an internal audit function or outsource the
  function should be made by the companys board of
  directors and its representatives.
• The SEC rule permits internal audit outsourcing
  to the clients independent auditor in the
  following areas
• 1. Operational internal audits that are not
  related to internal accounting controls,
  financial systems, or financial statements.
• 2. Nonrecurring assessment of discrete items or
  other programs unrelated to outsourcing of the
  internal audit function.
• Teamwork DQ6 What are the benefits and
  negative results of outsourcing the internal
  audit function?

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Chapter 8 Internal Auditors Roles and
Responsibilities

• IIAs Performance Standards

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Chapter 8 Internal Auditors Roles and
Responsibilities

• IIAs Ethics Code

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Chapter 8 Internal Auditors Roles and
Responsibilities

• Internal Audit Education
• The Institute of Internal Auditors Research
  Foundation (IIARF) is in the process of
  establishing the Common Body of Knowledge (CBOK)
  for internal auditors.
• The IIA has established the Internal Auditing
  Education Partnership (IAEP) program to promote
  internal auditing in colleges and universities in
  educating the next generation of auditors.
• Teamwork DQ8 Explain how internal auditors
  expertise in internal control can help ensure
  effectiveness of the corporate governance
  process.

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Chapter 8 Internal Auditors Roles and
Responsibilities

• Summary
• The internal audit function of corporate
  governance provides objective and independent
  assurance and consulting services designed to add
  value and improve the companys sustainable
  performance in the areas of operations, risk
  management, internal controls, financial
  reporting, and government processes.
• Internal auditors are well trained and
  positioned to provide numerous assurance services
  to their organization. The emerging trend toward
  more emphasis on MBL of governance, economic,
  ethical, social, and environmental performance
  requires organizations to provide assurance on a
  variety of their performance measures and
  achievements.
• SOX does not directly address internal auditor
  responsibilities or internal audit function.
• The internal audit function should have (1) full
  and free access to the companys audit committee
  (2) unrestricted access to the companys records,
  documents, property, and personnel and (3)
  authority to discuss initiatives, policies, and
  procedures regarding risk assessment, internal
  controls, compliance, financial reporting, and
  governance processes with management and other
  corporate governance participants.

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Chapter 9External Auditors Roles and
Responsibilities

• Chapter Objectives
• Recognize the role independent auditors play in
  achieving effective corporate governance and
  reliable financial reports.
• Understand the history of auditing, the
  traditional roles of auditors, and regulations
  recently placed on them.
• Address the expectation gap regarding what
  auditors can provide in the way of reasonable
  assurance and the expectations of investors for a
  higher level of assurance.
• Identify the roles and responsibilities of the
  PCAOB, and discuss the auditing standards
  published by the PCAOB.
• Demonstrate the importance of auditor
  independence both in fact and in appearance.
• Discuss an integrated audit of both financial
  statements and ICFR.
• Address the issue of a liability cap for
  independent auditors and understand the rationale
  on both sides of the issue.

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Chapter 9External Auditors Roles and
Responsibilities
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Chapter 9External Auditors Roles and
Responsibilities

• Auditor Competency
• Professional competencies. To audit public
  companies, auditors should register with the
  PCAOB and meet all registration and inspection
  requirements.
• Technical competencies. Auditors should be
  knowledgeable in professional standards, rules,
  laws and regulations, and understand their
  clients industry and business, corporate
  governance, financial reporting process, and
  internal controls.
• Process competencies. Auditors ability to choose
  appropriate evidence-gathering procedures (tests
  of controls, substantive tests) and execute
  auditing procedures.
• Reporting competencies. Reporting competencies
  refer to auditors ability and willingness to
  discover and report material misstatements.
• Teamwork DQ3 Confidence and public trust in
  auditors have been reduced due to concern that
  auditors serve the interests of management who
  write their checks rather than the shareholders
  who eventually pay their fees. Do you agree or
  disagree? Why?

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Chapter 9External Auditors Roles and
Responsibilities

• List of the initiatives that have been suggested
  to improve audit quality as well as the
  transparency.
• Publication of audit engagement letters
• Shareholders rights to question auditors
• Publication of auditor resignation statements
• Lead audit partners signature on audit reports
• Active audit committee participation in
  evaluating the scope and results of the
  integrated audit of both ICFR and financial
  statements.
• Mandatory rotation of the audit firm every seven
  to twelve years in the context of the quality of
  audit work performed by the firm and the audit
  efficacy.
• Mandatory shareholder vote on the ratification of
  the independent auditor each year.
• Teamwork DQ13 How do external auditors lend
  credibility to public financial information and
  the effectiveness of the corporate governance
  structure?

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Chapter 9External Auditors Roles and
Responsibilities

• The PCAOB created by SOX to regulate the
  auditing profession.
• The PCAOBs primary functions are to
• 1. Register public accounting firms that audit
  public companies.
• 2. Inspect the registered public accounting
  firms on a regular basis.
• 3. Establish auditing, attestation, ethics,
  quality control, and independence standards.
• 4. Conduct investigations and disciplinary
  proceedings.

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Chapter 9External Auditors Roles and
Responsibilities

• The PCAOB has issued five auditing standards as
  of September 2007
• 1. PCAOB Auditing Standard No. 1 (audit is
  conducted in accordance with auditing standards
  of PCAOBUS, the city and state has to be
  disclosed)
• 2. PCAOB Auditing Standards No. 2 and 5 (New
  PCAOB AS No. 5 superseded AS No. 2 and requires
  the independent audit to opine only on the
  effectiveness of ICFR, not the management
  processes and assessments concerning ICFR) .
• 3. PCAOB Auditing Standard No. 3 ( auditors are
  required to maintain the audit documentation is
  sufficient manner and keep the records for at
  least seven years).
• 4. PCAOB Auditing Standard No. 4 (voluntarily
  engagement for the auditors report on the
  companys elimination of previously reported
  material weaknesses in its ICFR).

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Chapter 9External Auditors Roles and
Responsibilities

• The new rules restrict public accounting firms
  in performing a variety of tax services to their
  audit clients the new rules
  are intended to prevent the selling of abusive
  tax shelters.

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Chapter 9External Auditors Roles and
Responsibilities
The extended oversight responsibilities for the
audit committee are 1. Appointment,
compensation, and retention of registered public
accounting firms 2. Preapproval of audit services
and permissible nonaudit services 3. Review of
the independent auditors plan for an integrated
audit of both ICFR and annual financial
statements 4. Review and discussion of financial
statements audited or reviewed by the independent
auditor 5. Monitoring the auditors
independence 6. Auditor rotation requirement
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Chapter 9External Auditors Roles and
Responsibilities
Disclosing Auditor Changes SEC rules require
public companies that change their public
accounting firms to file a Form 8-K, Item 4.01,
to disclose changes within four days, whereas
auditors are required to provide standard letters
within ten days stating whether they agree with
the companys disclosure without specifying any
reasons.
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Chapter 9External Auditors Roles and
Responsibilities
Integrated Audit Approach
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Chapter 9External Auditors Roles and
Responsibilities

• Summary
• The audit function should be regarded as an
  external corporate governance mechanism that
  serves to protect investors from receiving
  incomplete, inaccurate, or misleading financial
  information and thus adds value to the
  effectiveness of corporate governance.
• SOX drastically changed the characteristics of
  the accounting profession by connecting the audit
  function to the corporate governance structure by
  requiring that the audit committee be directly
  responsible for not only hiring, compensating,
  and firing external auditors, but also overseeing
  their work, monitoring their independence, and
  avoiding potential conflicts of interest.
• In the auditing profession, the so-called
  expectation gap is referred to as the difference
  between (1) what the investing public and other
  users of audited financial statements believe the
  responsibilities of auditors are, and (2) what
  auditors are willing to assume as
  responsibilities according to their professional
  standards.
• New PCAOB AS No. 5 superseded AS No. 2 and
  requires the independent audit to opine only on
  the effectiveness of ICFR, not the management
  processes and assessments concerning ICFR.

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Chapter 9External Auditors Roles and
Responsibilities

• Summary -- Continued
• Sections 201 and 202 of SOX require that all
  audit and permissible nonaudit services to be
  performed by the companys independent auditor be
  approved by the audit committee.
• Auditor independence is the backbone of the
  auditing profession, affecting the auditors
  planning, evidence-gathering procedures,
  findings, judgment, and credibility, and public
  trust in the auditors opinion.\
• Auditor independence is derived and guided by the
  three principles of (1) independent auditors may
  not audit their own work, (2) independent
  auditors may not function in the role of their
  clients management, and (3) independent auditors
  may not serve in an advocacy role for their audit
  clients.
• Tests of controls must be broadened to include
  understanding of ICFR, and provide reasonable
  assurance about the effectiveness of both the
  design and operation of internal controls.
• Any contractual provisions that limit the
  external auditors liability or require waiving
  the right to a jury trial may have detrimental
  effects on auditor impartiality, objectivity, and
  quality.

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Chapter 9External Auditors Roles and
Responsibilities