A Strategy for Restructuring

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Keeping on Track Internal Control and Internal
Audit
Public Expenditure Financial Accountability
Course PREM Learning Week April 9, 2003
Presented by Richard Allen, PEFA Program
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Internal Control and Internal Audit
Control systems involve
Internal Control Audit
Identification of Risk
Development of Internal Audit
Development of Internal Controls
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Risks
Going off the rail -- risks
Lack of timely and reliable financial and
resource management information
Misuse and waste of financial, human and
technical resources, including external aid
Fraud and error
Unsatisfactory accounting records
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Internal Control Internal Audit Professional
Standards
INTOSAI Guidelines for Internal Control
Standards
Standards for the Professional Practice of
Internal Auditing
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See INTOSAI at http//www.intosai.org/ and IIA
at http//www.theiia.org/
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Definition of Internal Control

• The reliability and integrity of information
• Compliance with policies, plans, procedures, laws
  and regulations
• The safeguarding of assets
• The economical and efficient use of resources
• The accomplishment of established objectives and
  goals of operations and programs

A process within an organization to provide
reasonable assurance regarding the following
primary objectives
Definition of Internal Control
Internal control is a management tool the
organization, policies and procedures used to
help ensure that government programs achieve
their intended results that the resources used
to deliver these programs are consistent with the
stated aims and objectives of the organizations
concerned that programs are protected from
waste, fraud and mismanagement and that reliable
and timely information is obtained, maintained,
reported and used for decision making. --
INTOSAI, Guidelines for Internal Control, June
1992
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Source The Institute of Internal Auditors
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Key Concepts of Internal Control
Internal control is
a process
affected by people. Its not merely policy
manuals and procedures, but people at every level
of the organization
can be expected to provide only reasonable
assurance, not absolute assurance to an entities
management stakeholders
geared to the achievement of objectives
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Source Committee of Sponsoring Organizations of
the Treadway Commission (COSO)
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Importance of Internal Control in Government
The average Ministry has a number of
responsibilities (committing funds, recruiting
staff, contracting for supplies and services,
approving actions, registering transactions and
events, deploying resources and controlling,
supervising and reporting on implementation of
policies).
If these responsibilities are fulfilled properly,
the result will be effective control over
resources, decisions and activities and the
achievement of ministry objectives.
Ministries
If not, abuses will proliferate and efficiency
decline.
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Two Principles of Internal Control
Governing bodies of public sector entities need
to ensure that a framework of control is
established and operates in practice and that a
statement on its effectiveness is included in the
entitys annual report.
Governing bodies of public bodies need to ensure
that effective systems of risk management are
established as part of the framework of internal
control.
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Source IFAC, Corporate Governance in the Public
Sector, 2000
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Control Procedures

• Clear instructions to staff and appropriate
  training on the objectives, policies and code of
  conduct of the ministry or agency
• An unambiguous definition of the responsibilities
  of staff
• Clear separation of function and duties between
  staff members in handling financial transactions
  or resources issues, e.g., contracts
• Development of an open culture to encourage
  staff at all levels to draw attention to
  non-compliance and irregularity
• Requirements that staff at all levels are aware
  of and apply all relevant instructions
• Support from effective internal audit procedures

Procedures
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Role of the Ministry of Finance
2. To ensure that the regulations are complied
with spending ministries (internal audit)
1. To establish a framework of regulations and
operational standards and guidelines, on internal
control, for spending ministries
3. In Francophone countries To participate in
the exercise of internal control in spending
ministries
Ministry of Finance
Note In some Anglophone countries also,
officials who perform the internal control
function in spending ministries are employees of
the internal audit department of the Ministry of
Finance (e.g., Kenya, Uganda, Malawi)
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Francophone System of Internal Control
Four Stages
Controleur financier (MoF)
Checks regularity and conformity of commitment
against budget appropriations
Ordonnateur (Commitment Officer)
Issues a payment order to the Treasury
Issues a second visa (approval) to make
commitment legally binding
Controleur financier
Treasury Accountant (Directeur de la Comptabilite
Publique)
Makes the payment
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Categories of Internal Control
Procurement Controls e.g., rules for advertising
and tendering major contracts
Physical e.g., security procedures intended to
control access to documents and records
Accounting Controls e.g., requirement for all
cash receipts to be deposited daily in a bank,
internal procedures to detect and report anomalies
Separation of Duties Both a control measure and
an indispensable element of many control systems
at least two officials should be involved in
any transaction to avoid risk of improper actions
Process Controls e.g., issuance of a purchase
order or the approval of a sizeable contract may
require documentation from the requesting
official, review by a purchasing clerk, and
approval by a supervisor
Management of Financial Other
Records Essential to establish audit trail
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Limitations of Internal Control
No system of internal control can provide an
absolute guarantee against the risk of wronging
or error. The proper goal of internal control is
to provide reasonable assurance that
improprieties will not occur, or if they do
occur, they will be revealed, reported and
appropriate action taken.
Wrongdoing by top managers
Collusion
Poor response to reported anomalies
Poor implementation
Design flaws
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Definition of Internal Audit
Internal Audit
Definition of Internal Audit Internal
auditing is an independent, objective, assurance
and consulting activity designed to add value and
improve an organizations operations. It helps an
organization accomplish its objectives by
bringing a systematic, disciplined approach to
evaluate and improve effectiveness of risk
management, control, and governance processes.
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Source The Institute of Internal Auditors
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Internal Audit Different Approaches

• In the Anglophone tradition, internal audit is
  usually reflected in internal audit units of
  individual ministries or agencies, reporting
  directly to top management
• Mixed internal/external audit systems,
• Germany internal audit is part of the Federal
  Court of Audit (external)
• US Inspector General of each agency reports to
  agency management and to the Congress

• Most Francophone countries have an internal audit
  unit LInspection des Finances located in the
  Ministry of Finance
• Generally have wide powers of inspection and
  review, and in many cases a prosecutorial role
• Some Anglophone countries also have an inspection
  department in the MoF, with similar powers

Note There are many different models in
developing countries, e.g., Anglophone Africa,
Francophone Africa, Latin America (Controloria),
FSU countries, former SFR Yugoslavia. See J.
Diamond, The Role of Internal Audit in
Government Financial Management An International
Perspective, IMF Working Paper, WP/02/94.
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What does the Internal Auditor Look For?
Procurement
Systems Procedures
In the procurement field, has there been adequate
publicity for calls to tender, are there
satisfactory procedures for receiving and
evaluating tenders, is the justification for
contract awards in accordance with national
requirements?
How well do the systems and procedures of
internal control function?
Resource use
Achievement of Objectives
Are the systems and procedures in place to ensure
that resources are used in accordance with the
relevant rules and regulations?
Have programs and actions achieved their intended
objectives?
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Audit Trail

• An audit trail is necessary to keep under review
  the timely and adequate flow of funds and the
  procedures for efficient accounting and the
  reconciliation of expenditure reports with funds
  received or claimed. It is necessary to trace or
  check

To trace and evaluate the systems and procedures
through which approval for payment to the
contractor or beneficiary will be required to pass
To check the transfer of funds authorized by the
treasury to the line ministry or agency
To locate completed payment files with evidence
that payment has, or has not, been made in
accordance with rules and regulations
To trace the budget provision that authorized
payment
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Reforming Internal Audit in Developing
Transitional Countries
The overall design of the IA function should be
geared to the specific priorities of a country.
For those countries with governance problems, the
first and foremost objective should be to ensure
compliance with the financial laws and
regulations. For those developing and
transitional economies faced with a high degree
of fiscal stress, the need to ensure
macroeconomic objectives will be paramount. For
those countries that can ensure compliance with
the law and have reached a fair degree of
macro-economic stability, more attention can be
paid to ensuring efficiency and effectiveness of
resource use, as currently emphasized in the OECD
countries. A fundamental design issue that
usually has to be faced is the degree of
centralization in the organization of the IA
function The centralized approach has often
been viewed as better from a capacity building
viewpoint. However, disadvantages of
centralization are also evident, namely
weakening accountability of line ministry
management, limited effectiveness because of weak
transparency, and failure to foster close
cooperation with other departments.
Source J. Diamond, The Role of Internal Audit
in Government Financial Management An
International Perspective, IMF Working Paper,
WP/02/94.
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Duties and Responsibilities of Internal Audit

• Reviewing the compliance with the existing
  Government financial regulations
• Evaluating the effectiveness of the Internal
  Control Systems.
• Appraising the economy and effectiveness with
  which financial and other resources are being
  used.
• Reviewing the reliability and integrity of record
  keeping and reporting on financial and operating
  information systems.
• Pre-audit of payments documents and of all
  documents used in initiating commitments, as well
  as contract agreements.
• Verifying and certifying periodical financial
  returns such as pending bills returns,
  expenditure returns, revenue returns, staff
  returns, vehicle returns, etc.
• Investigation of irregularities identified or
  reported and reporting on cases leading to
  wastage of resources cases of general misuse or
  misappropriation of financial resources and
  Government property.
• Ensuring that revenue and other receipts
  collection points, projects, supply, and delivery
  sites to ensure compliance with procedures and
  regulations.
• Reviewing budgetary controls on issuance of
  warrants, commitments, expenditures, revenue
  collection, and accounting from time to time.
• Ensuring that government physical assets are
  appropriately recorded and are kept under safe
  custody.
• Reviewing the budgetary reallocation process to
  ensure legislative and administrative compliance
  and advising when commitments are entered into
  when there is no budgetary provision or adequate
  cash.

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Source J. Diamond, The Role of Internal Audit
in Government Financial Management An
International Perspective, IMF Working Paper,
WP/02/94.
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Recommended Coordination Between Internal
External Audit

• There should be proper coordination to ensure
  adequate audit coverage and to minimize
  duplication of effort.
• There should be access to each others audit
  plans and programs.
• Periodic meetings should be organized to discuss
  matters of mutual interest.
• There should be an exchange of audit reports.
• Institutional mechanisms should be created to
  ensure common understanding and sharing of audit
  techniques and methods.
• Sharing of training and exchange of staff for
  two-three years in each case.
• The external auditor should review the
  performance of internal auditors (I.e., are they
  performing according to their objectives and
  plans?). A quality assessment of their work
  should be included.
• The external auditor should strengthen the
  position of the IA by reviewing and commenting on
  lack of action on IA reports.

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Source J. Diamond, The Role of Internal Audit
in Government Financial Management An
International Perspective, IMF Working Paper,
WP/02/94.
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QA Discussion