164

CHAPTER18
ComprehensiveAuditing:PublicSectorandInternalAudits
LEARNINGOBJECTIVES
Review
Checkpoints
1. Describethepublicsectorand
internalauditinstitutions(IIA,
OAG),andtellhowgovernmental
andinternalauditworkinteracts
withindependentaudits.

1,2,3

2. Definepublicsectorauditingand
internalauditing.

3. Compareaspectsofpublicsector,
internalandexternalauditors'
independenceproblems.

5,8

4. Specifytheelementsofexpanded
scopeauditinginbothpublic
sectorandinternalaudit
practice.

6,7

5. Describethecoverageofpublic
sectorandinternalaudit
standards.

9,10

6. Describeasequenceofworkin
governmentalandinternalaudits
intermsofpreliminarysurvey,
evaluationofadministrative
control,evidencegatheringfield
work,andreportpreparation.

11,12,13,
14,15,16,
17,18

7. Explainthefunctionofstandards
andmeasurementsineconomyand
efficiencyandeffectiveness
audits.

19

8. Listandexplainseveral
requirementsforgovernmentaland
internalauditreports.

20,21

Exercises
andProblems

Cases

33,37
40

34,35,36

38,39

38,39

POWERPOINTSLIDES
PowerPointslidesareincludedonthewebsite.Pleasetakespecialnoteof:
*

ScopeofService

SOLUTIONSFORREVIEWCHECKPOINTS
18.1

InternalauditorscanbecomeCertifiedInternalAuditors,aswellasPAs,and

165
otherdesignations.OAGauditorshavenospecialcertificationprogram,but
theycanbecomeCIAs,PAs,andothers.
18.2

Theindependentauditorsmustinvestigatethecompetenceandobjectivityof
theinternalauditors.Ifthesearesatisfactory,theexternalauditorsmust
stillsupervise,review,evaluate,andtesttheworkperformedbythe
internalauditors.Theexternalauditorscannotshareresponsibilityfor
auditdecisionswiththeinternalauditors.Thisrequirementappliesbothto
theworkofobtaininganunderstandingoftheinternalcontrolstructureand
theworkofusinginternalauditors'evidenceaboutfinancialstatement
balances.

18.3

WhileexternalauditorshaveresponsibilitiesundertheCICAgenerally
acceptedauditingstandardsfordetectingmaterialerrors,irregularities,
andcertainillegalactsinconnectionwiththeindependentauditsof
commercialandnotforprofitfinancialstatements,governmentalentitiesand
governmentfundrecipientscontendwithmanymorelawsandregulations.It's
amatterofdegree.
It'salsoamatterofreporting.In"normal"audits,externalauditorsdonot
reportseparatelyoncomplianceoroninternalcontrol.TheOAGrequires
reportsoncompliance.Theauditorscangivepositiveassuranceonareas
testedwithcomplianceproceduresandnegativeassuranceonareasnottested.

18.4

Operationalauditing(performanceauditingandmanagementauditing)refersto
auditors'studyofbusinessoperationsforthepurposeofmaking
recommendationsabouteconomicandefficientuseofresources,effective
achievementofbusinessobjectivesandcompliancewiththecompanypolicies.
AnAICPAcommittee,havingdefinedHASinmuchthesameterms,thus"claims"
operationalauditingasatypeofMASakindofmanifestdestinyforpublic
accountantstolayclaimtoallservices.

18.5

Internalauditors'independenceisenhancedbyhavingtheauthorityand
responsibilitytoreporttoahighexecutivelevelandtotheauditcommittee
oftheboardofdirectors.Theyaremostindependent,inapracticalsense,
whentheyarenotunderthecontrolordirectinfluenceofoperatingmanagers
whosefunctions,operationsandresultstheymaybeassignedtoaudit.

18.6

Theservicesprovidedbyinternalauditorsinclude:(1)auditsoffinancial
reportsandaccountingcontrolsystems,(2)reviewsofcontrolsystemsthat
ensurecompliancewithcompanypolicies,plansandproceduresandwithlaws
andregulations,(3)appraisalsoftheeconomyandefficiencyofoperations,
and(4)reviewsofeffectivenessinachievingprogramresultsincomparison
withpreestablishedobjectivesandgoals.

18.7

TheOAGsharewithinternalauditorsthesameelementsofscopeofservices
citedintheanswertomultiplechoicequestion18.24.TheOAG,however,
emphasizestheaccountabilityofpublicofficialsfortheefficient,
economicalandeffectiveuseofpublicfundsandotherresources.TheCICAs
publicsectorpronouncementsdefineanddescribeexpandedscopegovernmental
auditingincludingnotonlyworkdonebyaccountantsandauditorsin
examiningfinancialstatements,butalsoworkdoneinreviewing(a)
compliancewithapplicablelawsandregulations,(b)economyandefficiency
ofoperationsand(c)effectivenessinachievingprogramresults.

18.8

Publicsectorindependencestandardsspeaktosubstantiveissuesofintegrity
andobjectivityaswellastotheindependencedamagingappearanceof

166
financialandmanagerialinvolvement.Governmentauditorsmustbeawarethat
personalfactorssuchaspreconceivedideasaboutprograms,politicalor
socialconvictions,andloyaltytoalevelofgovernmentmayimpairthe
integrityandobjectivitythatisthefoundationofrealindependence.Like
internalauditors,governmentauditorsmustbewaryofexternalsourcesof
independenceimpairment,suchasinterferencebyhigherlevelofficialsand
threatstojobsecurity.
Auditorsofgovernmentalunitsarepresumedindependentwhentheyare:(1)
freefromsourcesofpersonalimpairment,(2)freefromsourcesofexternal
impairment,(3)organizationallyindependent,(4)independentunder
ProvincialRulesofProfessionalConduct,(5)electedorappointedand
reportingtoalegislativebodyofgovernment,or(6)auditinginalevelor
branchofgovernmentotherthantheonetowhichtheynormallyareassigned.
18.9

AccordingtotheCCAFthe12attributesofeffectivenessareasfollows:
1.
ManagementDirection
2.
Relevance
3.
Appropriateness
4.
AchievementofResults
5.
Acceptance
6.
Secondaryimpacts
7.
Costsofproductivity
8.
Responsiveness
9.
Financialresults
10. Workingenvironment
11. Protectionofassets
12. Monitoringandreporting

18.10 AcomprehensiveauditisaCCAFumbrellaconceptthatisusedtodesignatean
audithaveallofthefollowingelements: 1.
Afinancialstatementaudit
2.
Acomplianceauditand,3.
AVFMaudit.
18.11 Complianceauditsarenarrowerinfocusinvolvingtestsofcompliancewith
legislativeandrelatedauthorities.VFMauditsontheotherhandconsider
broaderconceptsofeconomy,efficiency,andeffectivenesstoevaluate
whetherbroaderobjectivesarebeingachieved.
18.12 Economyrelatestoobtainingthelowestpriceforgoodsofacceptance
quality.Efficiencyrelatestoobtainingthemaximumoutputforgiven
inputs.Effectivenessrelatestothedegreetowhichexplicitorimplicit
objectivesarebeingmet.
Effectivenessisthemostdifficultattributetoauditbecauseobjectivesmay
notbereadilyapparent,orsuitablecriteriamaybedifficulttodevelop
(e.g.,howtomeasuretheeffectivenessofapolicedept.,firedept.,
hospital,oruniversity?).
18.13 PAsinpublicpracticemostoftengetinvolvedingovernmentalauditsasa
resultofrespondingtoanagency'srequestforproposal(RFP).Wellprepared
RFPsspecifytheauditworkrequested,makingitclearwhatextentof
expandedscopeauditingisneeded.TheresponsetoaRFPwillspecifythe
engagementobjectivesandnatureofservices,theengagementscopeand
limitations,theroleandresponsibilitiesoftheauditee'spersonneland
otherconsultants,theengagementapproachandmethods,themannerandtiming
ofreporting,theworkschedulesandthefee.TheRFPresponsecontainsthe
samepointsregardingconsultingservicesrelatedtounderstandingwith

167
client.
18.14 Theevidencegatheringfieldworkcanbestbedescribedingeneraltermsas
anapplicationoftheanalyticalapproach.Thegeneralstepsofananalytical
approachcanbeassociatedwiththegeneralauditmethod.
1.

Problemrecognition.Ascertainthepertinentfactsandcircumstances.
Identifyspecificobjectivesinmoredetailthantheoverallengagement
objectives.
a.
Defineproblemareasoropportunitiesforimprovement.
b.
Defineprogramgoals.

2.

Evidencecollection.Selectandperformproceduresdesignedtoproduce
informationrelatedtoproblemareas,opportunitiesforimprovementor
achievementofprogramgoals.

3.

Evidenceevaluation.Evaluateactivitiesintermsofeconomy,efficiency
andgoalachievement.Decidethefindingsandrecommendationstoreport.

18.15 1.

Apreliminarysurveyisanauditor'sfamiliarizationprocessof
gatheringinformation,withoutdetailedinvestigationorverification
procedures,ontheorganization,programoractivitybeingaudited.It
isdesignedtoidentifyproblemareasneedingadditionalreviewinorder
toplanandaccomplishtheaudit.

2.

Auditorsstudyandevaluatetheadministrativecontrolsbecausethey
directlyaffecteconomy,efficiencyandprogramresults.Administrative
controlisabroadconceptinvolvingalltheactivitiesofmanagement,
suchasresponsibilitiesforproduction,qualitycontrol,
transportation,researchanddevelopment,personnelrelations,andmany
otherareas.Thefocusisnotlimitedtoaccountingrelatedactivities.

3.

Auditorsperformauditprocedurestoobtainevidence.Thegeneral
evidencegatheringproceduresingovernmentalandinternalauditsare
aboutthesameastheonesusedbyexternalauditorsintheauditof
financialstatements.Governmentalandinternalauditorsmustbeas
objectiveaspossiblewhendevelopingconclusionsaboutefficiency,
economyandprogramresults.Theobjectivityofauditingproceduresis
achievedby(1)findingstandardsforevaluationand(2)using
measurementsofactualresults,so(3)theactualresultscanbe
comparedtothestandards.Findingstandardsanddecidinguponrelevant
measurementstakesimagination.

4.

Reporting.Governmentalandinternalauditreportsarenotstandardized
asareexternalauditors'reportsonfinancialstatements.Eachreport
isdifferentbecausegovernmentalandinternalauditorsneedto
communicatefindingsonavarietyofassignmentsandauditobjectives.
Thekeycriterionforsuchareportisitsabilitytocommunicate
clearlyandconcisely.

18.16 Inapreliminarysurvey,auditorscanlearnaboutthenatureoftheentity
underauditanditsprogramgoals,theorganizationalstructureofthe
entity,itspoliciesandprocedures,itsadministrativeandinternal
accountingcontrolsystems,itsfinancialdataanditsnonfinancial
measurementsystem.
18.17 Somestandardsforgovernmentagenciescanbefoundinlaws,legislative

168
committeereports,legislativeoradministrativeordersandresolutions,
localordinancesandresolutions,grantproposalsandcontractsmadebya
granteeoragency.
Businessunitsmaybeunderordersfromtheboardofdirectorsormaybe
undertakingaprojectresultingfromaninternalproposalthatsetsforth
budgetsandobjectives.
AnAICPAcommitteehasidentifiedthepublicationsoftheUrbanInstitute,
theInternationalCityManagementAssociationandtheNationalPlanning
Associationassourcesofstandardsrelatedtovariouscityservicesand
socialservices,transportation,energyandenvironmentalprotection
programs.
18.18 AdministrativecontrolhasbeendefinedbytheAICPAas"...theplanof
organizationandtheproceduresandrecordsthatareconcernedwiththe
decisionprocessesleadingtomanagement'sauthorizationoftransactions.
Thismanagementfunctionisdirectlyassociatedwiththeresponsibilityfor
achievingtheorganization'sobjectives.Itisthestartingpointfor
establishingaccountingcontroloftransactions."
18.19 Governmentalandinternalauditorsmustbeasobjectiveaspossiblewhen
developingconclusionsaboutefficiency,economyandprogramresults.This
objectivityisachievedby(1)findingstandardsforevaluationand(2)using
measurementsofactualresults,so(3)theactualresultscanbecomparedto
thestandards.Findingstandardsanddecidinguponrelevantmeasurements
takesimagination.
Whendealingwithstandards,measurementsandcomparisons,auditorsmustkeep
inputsandoutputsinperspective.Evidenceaboutinputspersonnelhoursand
cost,materialsquantitiesandcost,assetinvestmentareimportantin
connectionwithreachingeconomyandefficiencyconclusions.Foreconomy,
efficiencyandprogramresultsconclusions,however,outputmeasurementsare
equallyimportant.Managementhastheresponsibilityfordevisinginformation
systemstomeasureoutput.Suchmeasurementsshouldcorrespondtoprogram
objectivessetforthinlaws,regulations,administrativepolicies,
legislativereportsorothersuchsources.Auditorsmustrealizethatoutput
measurementsusuallyarenotexpressedinfinancialterms.
Manyeconomyandefficiencyauditsandmostprogramresultsauditsare
outputoriented.Auditorsneedtobecarefulnottoequateprogramactivity
withprogramsuccess,withoutmeasuringprogramresults.Thesefeaturesare
significantlydifferentfromauditors'roleswithrespecttofinancial
statementauditswheretheprimaryconcerniswithreportingonthe
accountingforinputs.
18.20 Auditors'reportsonfinancialstatementsarestandardizedwithwordingthat
allauditorsshoulduseallthetime.Theyare"onesizefitsall"report
forms.
Internal,publicsector,andMASreportsoneconomyandefficiencyand
programresults,however,needtobeadaptedtotheproblemandthe
circumstances.Theyneedtostandontheirownforreadability,clarity,and
informativeness.Theyusegoodwritingstyletoconveytheessenceofthe
problem,theinvestigation,theresults,andtherecommendations.Managers
getachancetorespondtocriticismandpraise,balancingthepresentation
sothehigherlevelsofmanagement(boardofdirectors)canbefully

169
informed.Internalandgovernmentalauditrecommendationsaremeanttobe
followedupforprogressreportsonimplementationofrecommendations.As
partofthefeedbackloopformanagement,internalandgovernmentalauditors
cankeepalive("open")theirgoodsuggestionstoseewhethermanagersfollow
them,especiallywhenmanagershaveagreedtodoso.
18.21 Pertinentviewsofresponsibleofficialsoftheorganization,program,
activityorfunctionauditedaswellastheauditors'findings,conclusions
andrecommendationsmaybeincludedinapublicsectorreport.Publicsector
conclusionsaboutcontrolweakness,managerialinefficiency,orfailureto
achieveprogramresultsmaybeargumentative.Officialsandmanagersmight
needtogivecontraryanalysesormakestatementsaboutactionsalreadytaken
tocorrectproblems.
SOLUTIONSFORMULTIPLECHOICEQUESTIONS
18.22 a.
b.
c.
d.

Incorrect.
Incorrect.
Incorrect.
Correct.

Operationalauditinghasbroadobjectives.
Performanceauditinghasbroadobjectives.
Managementauditinghasbroadobjectives.
Operational,management,andperformanceauditingare
consideredsynonyms.Theirobjectivesgobeyondfinancial
statements.

18.23 c.

Correct.

Bydefinition,operationalauditingisaconsultingservice
formakingrecommendations.(Itisthemoregeneral
response.Conceivably,responsesbanddcouldbe
operationalauditingassignments.)

18.24 a.

Correct.

Amanagerialjobintheorganizationbeingauditingimpairs
independenceinamannersimilartotheimpairmentwhenan
externalauditorhasamanagerialpositionwithanaudit
client.
Electionandreportingtothelegislatureprotects
independence.
Auditingoutsidethenormalassignmentnormallyprotects
independence.
Appointmentandreportingtothelegislatureprotects
independence.

b.

Incorrect.

c.

Incorrect.

d.

Incorrect.

18.25 a.
b.
c.

Incorrect.
Incorrect.
Incorrect.

Auditorscannotusurpthefunctionofthecourts.
Evaluationofpersonalskillsisprobablytoosubjective.
Publicopinionstandardsarenotobjectiveenoughforaudit
evaluation.
Thisis"programresults"auditingtiedtogoalssetforthe
agency.

d.

Correct.

18.26 a.

Correct.

Internalauditingtypicallyisbroaderinscopeand
objectivesthanexternalauditlimitedtofinancial
statements.

18.27 a.
b.
c.

Incorrect.
Incorrect.
Correct.

d.

Incorrect.

PSASisthepropersetofstandards.
Areportoncomplianceisrequired.
Commentarybyauditeemanagersisrecommendedfor
performanceauditreportsbutnotforreportsonfinancial
statements.
Aninternalcontrolreportisrequired.

170
18.28 a.
b.
c.

Incorrect.
Incorrect.
Correct.

d.

Incorrect.

18.29 a.

Correct.

Anopiniononfinancialstatementsisrequired.
Aninternalcontrolreportisrequired.
Performanceauditingregardingachievementofprogramgoals
isnotrequiredbytheSingleAuditAct.(TheActrequires
theotherreports.)
Acompliancereportisrequired.
Determiningapplicableaccountingprinciplesisimportant
forfinancialstatementauditsbutnotforperformance
audits.(Theotherresponsesaretheelementsoftheaudit
methodofdefiningtheproblem,gatheringtheevidence,and
evaluatingtheevidence.)

18.30 c.

Correct.

Themostimportantconsiderationsare(d)determine
standards,(a)measuretheoutput,and(b)compareoutputto
standards.Thereviewofadministrativecontrolsisameans
ofanalysisratherthanawaytoachieveobjectivity.

18.31 a.

Incorrect.

b.

Incorrect.

c.

Incorrect.

d.

Correct.

Seed.Investigatinginternalauditors'competenceand
objectivitygoesbeyondtheminimumrequiredforan
understandingoftheclients'controlstructure.
Seed.Investigatinginternalauditors'education,
experience,andcertificationispartoftheinvestigation
ofcompetence.
Seed.Investigatingtheemploymentofinternalauditors'
relativesinmanagementpositionsisdoneinconnectionwith
investigatingtheirobjectivity.
Thisistheminimumunderstandingrequired.Furtherwork
involvesinvestigatingtheinternalauditors'competenceand
objectivitybutonlyiftheexternalauditorsplantouse
theinternalauditorsortheirwork.

18.32 a.

Incorrect.

b.

Correct.

c.

Incorrect.

d.

Incorrect.

Auditorscanreportoninternalcontrolwithoutcompliance
tests.
Reportsoncomplianceobservanceoflawsandregulations)
requirescompliancetests.
Compliancetestsarenotrequiredforopinionsonfinancial
statements.
Compliancetestsarenotnecessaryforthesimplelistingof
federalassistanceprogramsandamounts.

SOLUTIONSFOREXERCISESANDPROBLEMS
18.33 IdentificationofAuditsandAuditors
Theresponsestothismatchingtypeofquestionareambiguous.Theengagement
examplesweretakenfromrealexamplesofexternal,internalandgovernmental
auditsituations.Youmightpointouttostudentsthatthedistinctionsamong
compliance,economyandefficiencyandprogramresultsauditsarenotalways
clear.The"solution"isshownbelowinmatrixform,showingsomeengagement
numbersintwoorthreecells.Therequiredschedulefollows.
TypeofAudit
Financial
KindofAuditor Statement

Compliance

Economy,
Efficiency

Program
Results

6,8
3
5
7

4,8
1,3,9
X
X

1,3
X
X

IndependentPA
2,10
InternalAuditor
Governmental(PSAS)
TaxAuditor
X
BankExaminer
X
1.
2.
3.

FGLloaninterest
equity
Advertisingagency
financialstatements
MNRpolicies

EconomyandEfficiency
orProgramResults
Financialstatement

Governmental(PSAS)

ComplianceorEconomy
andEfficiencyor
ProgramResults

Governmental(PSAS)

IndependentCPAs

4.
5.
6.
7.
8.

Municipalservices
Taxshelters
Testpilotreporting
Banksolvency
Materialsinspection
bymanufacturer
9. Drugenforcement
vehicleseizures
10. Sportscomplex
forecast
18.34 OrganizingaPreliminarySurvey

EconomyandEfficiency
Compliance
Compliance
Compliance
ComplianceorEconomy
andEfficiency
EconomyandEfficiency

Internalauditors
IRSauditors
Internalauditors
Bankexaminers
Internalauditors

Financialstatement

IndependentCPAs

Governmental(PSAS)

TO:

SeniorInternalAuditor

FROM:

DirectorofInternalAuditing

DATE:

November31,200X

SUBJECT:

Preliminarysurveyofaccountsreceivableaccounting

Thesequestionsareforyourguidanceinperformingthepreliminaryreview.
TheProblem
Totalpatientaccountsreceivablehaveincreasedsteadilyandrapidlyfor
eightmonths.ourlastauditofthisareawas10monthsago.Afavorable
reportisintheworkingpaperfile.Icanseenoapparentreasonforthe
increasebecausethenumberofbeds,theoccupancyrate,thebillingrates
andtheinsurancecontractshavenotchanged.
WhatFinancial/EconomicEventsHaveOccurredintheLast10Months?
1.
Areagreaternumberofpatientsuninsured?
2.
Isalargernumberorgreaterdollaramountoverdue?
3.
Haveanyaccountsbeenwrittenoffinthelast10months?Number?Dollar
amount?
4.
Whichaccountsarepresentlyconsidereddoubtfulofcollection?Why?
5.
Havepatientscomplainedabouttheirbills?
WhoDoestheAccounting?
1.
Arenewpeopledoingtheaccounting?
2.
Whoistheaccountingmanagernow?
3.
Didresignedemployeesgivereasons?
WhatDataProcessingProceduresandPoliciesAreinEffect?
1a. Whatarethecurrentproceduresforbillingpatients?
1b. Whatchangeshavebeenmadeinthelast10months?
2a. Whatarethecurrentproceduresforrecordingchangesandcollections?
2b. Whatchangeshavebeeneffectedinthelast10months.
3a. Whatarethecreditandcollectionpolicies?
3b. Aretheybeingfollowed?
3c. Whatchangeshavebeeneffectedinthelast10months?
HowistheAccountsReceivableAccountingDone?
1.
Hastheaccountingbeenputoncomputerwithinthelast10months?
2.
Howmanyemployeeshandletheaccounting?
Computer
Noncomputer

____________________
____________________

18.35 StudyandEvaluationofAdministrativeControl
TO:
FROM:
DATE:
SUBJECT:

InternalAuditStaff
SeniorInternalAuditor
July
Comparisonstandardsforstudyandevaluationofadministrative
controlpolicies

Inordertoaudittheperformanceofadministrativecontrols,youwillneed
toknowquantitativestandardsofacceptableperformance.Standardsfortwo
policiesaredescribedinthismemo.
I.
Salesarebilledtocustomersaccuratelyandpromptly.
A.

Accuracy
PolicyStandard:

Nomorethanthreepercentofthesalesinvoicesare
figuredwitherrorsofeitherquantityorunitprice
orextensionerroramountingtoover$1perinvoice.

AuditProcedures:
1.

2.
3.

B.

Auditforaccuracybyselectingasampleofrecordedsalesinvoices
and(a)vouchthecustomernametosupportingpurchaseordersand
shippingdocuments,(b)vouchthequantityshippedtosupporting
shippingdocuments,(c)tracetheunitpricetotheapprovedprice
list,and(d)recalculatetheextensions,includingshipping
chargesandsalestax.Documentallerrorsover$1perinvoice.
Auditforcompletenessbyselectingasampleofshippingdocuments
andtracingtorecordedsalesinvoices.
Auditforaccuracy(relatedtoshippingquantities,primarily)by
confirmingasampleofcustomers'balances(orindividualunpaid
invoices)andlookforcustomerdisagreements.

Promptness
PolicyStandard:

Salesinvoicesaretobeenteredinthesalesjournal
andincustomers'accountswitha(mailing)dateno
laterthanonedayaftershipment.

Auditprocedure:
Usingthesamplesinprocedures#1and#2above,comparethesales
journalrecorddateandthedateshownincustomers'accountswiththe
shipmentdate.Documentthenumberandextentoftimelagsexceedingone
day.Inquireaboutthemailingdate.
II.
A.

Accountsreceivableareagedandfolloweduptoensureprompt
collection.
AccountsReceivableAging
PolicyStandard: Acompleteandaccurateagedtrialbalanceisprepared
monthlyshowingreceivablesincategories(a)Current,
(b)3159daysoverdue,(c)6089daysoverdueand(d)
morethan90daysoverdue.
(Memo,page2follows)

18.35 StudyandEvaluationofAdministrativeControl,page2
AuditProcedures:
1.
Inspecttheagedtrialbalancestodeterminewhethertheywere
actuallypreparedeachmonth.
2.
Auditforcompletenessbycomparingthetrialbalancetotaltothe
generalledgercontrolaccount.(Footeach,ifnecessary.)
3.
Auditforaccuracybyselectingasampleofcustomeraccountsand
tracingageddatafromthecustomers'ledgeraccountstotheaged
trialbalance.Thisistheimportantdirectionfortheprocedures
becauseincorrect"underaging"thwartsthecollectioneffort.
(Selectingasampleofnoncurrentagingdatafromthetrialbalance
willnotenableyoutodetectnoncurrentamountsincorrectlyaged
ascurrent.)
B.

FollowupForPromptCollection
PolicyStandard: Creditdepartmentpersonnelaresupposedtoreceive
thetrialbalancewithinfivedaysaftereachmonth
end,andsenddifferentletterswithinfivebusiness
daysofreceivingtheagedtrialbalanceforaccounts
astheybecomelongeroverdue,andturnaccountsover
toanoutsidecollectionagencywhentheyareover90
dayspastdue.After60days,furthercreditiscut
offandcustomersareputonacashbasis.
AuditProcedure:
1.
2.

3.
4.
5.

Inspecttheagedtrialbalancesforindicationofpreparationdate
ora"datereceived"stampbythecreditdepartmenttodetermine
promptnessoftransmittalwithinfivedaysaftereachmonthend.
Forasampleofpastdueamountsindifferentmonths,inspect
copiesoftheletterssenttocustomersand(a)observewhetherthe
rightstandardletterwassentand(b)thedate.Document
exceptionstotypeofletterandmailingdelay.
Inspectcorrespondencerelevanttodeterminingdatethatover90
dayaccountswereturnedovertoanoutsideagent.
Inspectnoticesofcreditcutoffforcustomerswithover60day
balancesandinspectthetrialbalanceforevidenceofnewcredit
mistakenlyextendedtosuchcustomers.
Usingthesampleof#2,verifytheaccuracyofthesubsequent
collectionsreportpreparedbythecreditdepartmentbyvouching
thedatathereintocashreceiptsrecords.

18.36 AnalyticalReviewofInventory
Thedataintheproblemarebasedonahypotheticalelectronicsmanufacturer
withamixedproductline.Thelinesincludecomputergames(shadesofthe
198283Atarigamesdebacle),personalcomputeraddons(floppydiskdrives
andsemiconductorpartshelpedbythe1982+microcomputerboom)andastodgy
lineofstandardelectrictypewriters(competingwithcomputerizedword
processingequipment).
Thematerialsandpartscategoryistrendedtoshowmodestefficiency
improvementinturnover,withaninvestmentjustlargeenoughtodampthe
moredramaticratiochangesinthefinishedgoodscategory.Theworkin
processcategoryistrendedtoshowablipdownwardin20X3withareturnto

the20X1X2productivitylevelin20X4currentyear.
Hypothetically,thecompanyhascurrentyearsalesof$10million,withcost
offinishedproductssoldamountingto$7.4millionfora26percentgross
profitmargin.Youmighttellstudentsthatthegrossprofitmarginhasnot
changedmateriallyoverthe20X1currentyearperiod,sotheywon'tconfound
theprofitabilityvariablewiththeinventoryturnoverratioanalysis.
However,theconditionofnooverallchangemaskssignificantchangeswithin
theproductlines.
Asolutiontotheproblemispresentedonthefollowingpagesintheformof
amemosummarizingtheresultsoftheanalysis.Studentsshouldlearnto
thinkbeyondthecrankedoutnumbersandwritesomeinterpretationoftheir
meaninginrelationtoeconomyandefficiencyoftheuseofinventoryassets.
18.36 Memo:AnalyticalReviewofInventory
TO:
FROM:
DATE:
SUBJECT:

VicePresident,Production
InternalAuditManager
January10,20X6
PreliminaryreportAnalysisofinventoryturnover

Atthebeginningofmyeconomyandefficiencyauditofinventory,Icomputed
turnoverratiosasshownbelow.Thispreliminaryreportisforthepurposeof
alertingyoutocertaininventoryinvestmentconditions.Iwillsetupa
meetingwithyoutodiscussyourinsightsontheconditionsandyour
suggestionsforfurtherwork.
InventoryTurnoverfortheYear

FinishedProducts:
Computergames
Floppydiskdrives
Semiconductorparts
Electrictypewriters
WorkinProcess
Materialsandparts
TotalInventory

20X1

20X2

20X3

20X4

20X5

6.0
8.0
4.0
3.0
12.0
4.0
2.1

7.0
7.2
3.5
2.5
12.5
4.1
2.0

10.0
7.7
4.5
2.0
11.5
4.3
2.1

24.0
8.5
7.0
1.9
11.7
4.5
2.1

5.0
11.0
10.0
1.8
12.1
4.0
2.5

TotalInventory
Overall,theinventorymanagementappearstobeundercontrol.Turnoverisa
littlebetterthanpastyears.However,theoverallturnovermasksspecific
conditions.
ComputerGames
Competitionhasbeendeadly.Despitepricecutting,theinventoryincreased
31.5percentfrom$380,000to$500,000.Thegross"profits"turnedinto
losses.Thissegmentofinventoryprobablyoughttobewrittendowntoa
marketvaluelowerthanthe$500,000cost.Aquestionforinvestigationis:
Areproductionresourcesbeingusedforgameswhichcouldbetterbeusedfor
otherproducts?
DiskDrivesandSemiconductors
Theinventorieshaveincreasedalottokeepupwithsalesdemand.Increases
were$236,000(468percent)fordiskdrivesand$320,000(500percent)for
semiconductorparts.Bothratesofincreaseareexaggeratedbecauseofthe

smallbeginninginventories.Evenwithstablebusinessnextyear,the
turnoverwillprobablydeclinebecauseofthelargerinventories.Aquestion
forinvestigationis:Howwelldoinventoryholdingandproductionplans
matchwithsalesprojections?Theseproductlinesmaybevulnerabletoa
sharpdeclineliketheoneexperiencedincomputergames.
ElectricTypewriters
Thetypewriterinventorieshaveneverhadahighturnover.Theinventory
reductionof$88,000(22percent)appearstoindicategreaterefficiency
sincesalesvolumedeclinedbyonlythreepercent.Aquestionfor
investigationis:Caninventorybereducedstillfurtherwithoutlosingsales
becauseofstockouts?
AnalysisofInventoryTurnoverMemo,page2
WorkinProcess
Theproductionthroughoutappearstobeefficientintermsofturnover,
turnoverimprovementandthelevelofinventoryinvestment.Thesmall
inventorydeclineof$74,000(11percent)seemstobeproductofgreater
efficiencythanlastyear.Aquestionforinvestigationis:Dophysical
productionrecordsconfirmtheapparentefficiency,oristheimprovement
merelyanartifactoftiming(e.g.,transferringgoodsthatwerealmost
finishedat1231X4andworkingovertimetotransfergoodsattheendof
20X5)?
MaterialsandParts
Theturnoverisaboutinlinewithprioryears,buttheinventorydeclinedby
$745,000(55percent).Purchasesofmaterialsandpartswereobviouslylower
thanlastyear.Questionsforfurtherinvestigationare:Aresomematerials
andpartsinshortsupply?Hasthereducedinventorycreatedanysubsequent
productiondelays?Werebeginninginventoriesmerelybloatedbyalate20X4
stockpiling?
Summary
Ournextdiscussionshouldbefruitful.Yourknowledgeofproduction
conditionswillhelpdirecttheinternalauditeffortrelatedtothe
questionsraisedinthismemo.
18.37 PAInvolvementinExpandedScopeAudit
a.
Thefinancialandcomplianceauditworkshoulddetermine:
1.
ThefinancialstatementsarepresentedinconformitywithGAAPor
anothercomprehensiveorrequiredbasisofaccounting.
2.
GAAPhasbeenappliedconsistently.
3.
Disclosuresinthefinancialreportsareadequatelyinformative.
4.
Theprogrammanagementmaintainseffectiveinternalaccounting
control.
5.
Theprogramanditsmanagementarecomplyingwithapplicablelaws
andregulation.
b.
JonesandToddshouldtrytofindstandardsforevaluatinguneconomical
orinefficientpracticesinareassuchasthese:
1.
Purchaseoffoodcommoditiesinmoreexpensivesmallsizepackages
insteadofinlessexpensivebulkquantities.
2.
Employmentofmorepeoplethannecessarytoaccomplishthepurposes
oftheprogram.
3.
Unnecessaryinvestmentintrucksorotherequipmentwhen
alternativemeanswouldbelesscostly.
4.
Failuretocoordinateadministrativepracticeswithregional
offices(ifany).

c.

Standardsforjudgingprogramresults:
1.
Sources
*
Legislation
*
Legislativecommitteereports
*
MinistryofAgricultureregulations,ordersandrulings
*
Contractualorgrantproposalstatementsofobjectives
2.
Standardsmayrelateto
*
Numberofinstitutionsorpeopleserved
*
Costsavingscomparedtomarketpricesoffoodstuffs
*
Qualityoffooddistributed
*
Timelinessofdistribution
*
Improvementinhungerrelatedstatistics

SOLUTIONSFORDISCUSSIONCASES
18.38 OperationalAudit:CustomerComplaints
(a) Theproblemliesinthefactthatseveraldepartmentsmustperformtheir
functionsbeforethecustomer'scheckorcreditnoticeisprocessed.The
companymadethepromiseofpromptness,butdidnotsetupanyprocedures
forachievingit.
AnalysisofTimeLags
Buyersexaminationandreportpreparation.............23days
CustomerRelationsDepartmentapproval................23days
Accountingdepartmentweeklybatchprocessing.........25days
(fivedayswhenthereceiptarrivesonthefirstdayoftheweek)
Checkapprovalbytreasurer...........................23days
Total(notconsideringtimelaginvolvedinwaitingtosendmonthly
statementfornoticeofcredit......................814days
(b)

RecommendationReport
TO:

LarryMcMurray,President
SallyGodwin,DirectorofCustomerRelations

FROM:

DannyDeck,DirectorofInternalAuditing

DATE:

Monday

SUBJECT:

Timelyresponseformerchandisereturncredits

TheProblem
Larryinformedmeofthelevelofcomplaintsfromcustomersabout
waitingtoolongforustofulfillourpromiseof"promptcreditwhen
youchangeyourmind."Eventhoughwemadethepromise,weestablished
noexpeditingprocedurestomeetthegoalofsendingacheckoracredit
noticewithinfiveworkingdays.Iselectedasampleofcreditmemosand
foundthetimelagtoaverage10days,witharangeof8to14days
betweenthedateonthereturnedmerchandisereceiptandthedateon
refundchecks.Thereisnoprovisionatallforsendingacrediton

accountnoticebeforethenextmailingofmonthlystatements,sothe
delaywaitinguntilthenextmonthlystatementmaybeevenlonger.
Recommendations
Thereturnedmerchandisereceiptdoesnotneedtofollowthepath
tothebuyers,thentoSally'sdepartmentforapproval,thenceto
accounting.Fourtosixdayscanbecutbyhavingtheclerkssendthem
directlytoaccounting.Acopycanbeusedfortheotherworkwithout
interferingwiththetimeschedule.
Theaccountingdepartmentneedstoeither(a)processthesereturns
dailyinsteadofwaitingforaweeklybatchtoaccumulate,or(b)setup
aspecial,perhapsmanual,checkwritingandcreditmemomailing
procedure.
Amanualprocedureisappealingbecause(a)itwillgivecustomers
theknowledgethattheirproblemisnot"beingrunthroughthe
computer,"(b)checksandcreditnoticeswillgetmailedwithin5days,
and(c)itmaycostlessthanrearrangingthecomputerprocessing
schedule.
Asanalternative,wecouldsetupaspecialdeskforimmediate
cashrefunds.Theclerkscouldsendthemerchandiseandthereturned
merchandisereceipttothedesk,wherewecouldmakeashowofhanding
overthecash.Thecashfundcouldentertheaccountingsystemlike
anotherpettycashfund,andallthedataprocessingwillfitinour
establishedsystemofcontrolanddataprocessing.Afterthecustomeris
satisfied,wecouldperformalltheproceduresnowspecifiedandachieve
controlbymonitoringthetransactionsaftertheyarecompleted.
18.39 PublicsectorAuditorIndependence
TheOAGauditor,withrespecttopotentialimpairmentofindependence,might
beinapositionsimilartotheindependentauditoroffinancialstatements
whomakesarecommendationtoaclientforimprovinginternalcontrol.
Alternatively,thePublicsectorauditrecommendationsmaybemoreinthe
natureofsuggestionssimilartothosemadeinamanagementservice
engagement(thatis,havingimpactbeyondtechnicalinternalcontrol
procedures).
Thepotentialforimpairmentofindependenceresultsfromthepossibilityof
havingtoauditthesubsequentimplementationorbetterenforcementof
contractrequirementsanddevelopmentofamastercartestplanbythe
managementoftheMetropolitanAreaTransitAuthority.SinceOAGmadethese
recommendations,theycouldbeperceivedasauditing"theirownwork";
however,theimplementationeffortisnottheirownwork.Alackof
independencewouldresultifthesameordifferentpublicsectorauditors,in
asubsequentaudit,werereluctantorfailedtofindfaultbecausetheyhad
beeninvolvedwiththeearlierrecommendationsforimprovement.Theauthors
believeastrongerperceptionofindependencewouldbecreatedbyassigning
subsequentauditworktodifferentpersonnel.
Thewaysinwhichthepublicsectorcanresistimpairmentofindependenceare
essentiallythesameasthoseoftheindependentexternalauditor:(1)the
OAGauditorshouldrefrainabsolutelyfrommakingmanagementdecisionsand
(2)heshouldremainalerttohisprofessionalandethicalresponsibilityto
conducttheauditinaccordancewithestablishedauditingstandards.

18.40
Thisquestionisintendedtoteststudentsfamiliaritywithmanagementaudit
ofmarketingwithparticularemphasisonpricingandadvertising,andtheir
abilitytoadaptthematerial:thehighlycompetitivepharmaceutical
industry.
Answersshouldbeginwithanoverviewoftheroleofmarketing.TheLesson
Notesgivesthedefinition:marketingistheprocessidentifyingmarket
opportunities,thendevelopingandimplementingstrategiestoallowthe
organizationtotakeadvantageofthem.Broadly,marketingencompasses:
marketresearchoncustomerssneeds,productdemand,competitorbehaviour,
pricing,distribution,etc.;marketstrategieswhichdeterminewhichproducts
willbeofferedindifferentmarkets;pricing,inassociationwithproduction
andfinance;promotionandadvertisingwhichtellthestoryaboutproductsto
selectedcustomersegmentsalesanddistributionwhichdeterminewhereand
howproductswillbeprovidedtocustomers;andcustomerservicewhich
addressescustomersneedsaftersale.
Answersshouldthenturntoabriefdiscussionofauditobjectives.Inthe
broadestsensetheobjectiveistodeterminewhethermarketingactivitiesare
beingcarriedouteconomicallyefficientlyandeffectively.More
specifically,theauditobjectiveistodeterminewhetherthesearesystems
andpracticestoprovidecontrolofpricingpoliciesandadvertising
expenditureswithdueregardtoeconomy,efficiencyandeffectiveness.Note
thateffectivenessisverydifficulttomeasurelinesofcausalityare
complexinbothcases.
Discussionshouldthenturntoadiscussionofhowtheauditwouldbe
conducted,discussingbackgroundinformation,identificationofweaknesses,
thedeterminationofwhichsystemsandpracticestoauditintheexamination
phaseandappropriatecriteriatobeused,andhowthereportwouldbe
preparedandpresented.
Inplanningtheaudit,theauditorwouldfirstobtainbackgroundinformation
onthemanagementdepartmentssystemsandpracticesbylookingatsuch
thingsasorganizationcharts,jobdescriptions,documentationofpolicies
andprocedures,previousauditreports,etc.Theauditorwouldalsolook
forindicatorsofweaknessinmarketingsystemssuchasdecliningsales,
decliningmarketshare,decliningprofitmargins,customercomplaints,etc.
Theauditorwouldreviewgenerallytheoverallorganizationformarketing
beforestartingonpricingandadvertising,usingsuchcriteriaas:

Formalpoliciesandproceduresformarketingshouldbedocumented.

Responsibilitiesformarketingmanagementshouldbeclearlydefinedand
communicated

Thereshouldbeproceduresforreviewingandevaluatingmarketing
activities.
Theauditorwouldreviewsystemsandpracticesformakingpricingdecisions.
Pricingsystemsandpracticeswouldbereviewedbyexaminingasampleofthe
pricesusedespeciallyinkeyproducts,andreviewingtheinformationand
analysisusedtomakepricingdecisions.
Criteriainclude:

VPIshouldhaveaformalpricingpolicy.
Themarketing,finance,andproductiondivisionsshouldparticipatein
pricingdecisions.

Marketresearchinformationonthepriceelasticityofdemandinvarious
marketsegmentsshouldbeobtained.
Theinformationusedtomakepricingdecisionsshouldbecomplete,
accurateandrelevant.
Proceduresandcontrolsoverpricelistsandpricechangesshouldbe
adequate.
Pricingalternativesshouldbeconsideredandtested.

Theauditorwouldthenreviewsystemsandpracticesforadvertisingincluding
thedeterminationofobjectivesandstrategiesforadvertisingactivities,
preparationandmonitoringofbudgetsforadvertisingexpenditures,policies
forcontractingwithadvertisingagencies,financialcontroloveradvertising
expenditures,andevaluationoftheresultsofadvertisingactivities.
a.

Advertisingobjectivesandstrategies
Criteriainclude:

specificandmeasurableobjectivesshouldbeestablishedfor
advertisingactivities

advertisingstrategiesshouldbeadaptedtospecificproductsand
markets

b.

Budgeting
Criteriainclude:

eachestablishedadvertisingstrategyshouldhaveadetailed
implementationbudget

foralladvertisingstrategiesbudgetcontrolsshouldbeinplace
whichmonitoractualandbudgetedexpenditureoverthelifeofthe
strategy

c.

Contracting
Criteriainclude:

allcontractswithagenciesshouldincludeclearspecificationsof
theagencysresponsibilities

competitivebidsshouldbesolicitedandthemethodofselection
documented

d.

Financialcontroloverexpenditure
Criteriainclude:

VPIshouldpayonlyforservicesrendered

VPIshouldpayonlytherightamountforservicesrendered

e.

Evaluationofresults
Criteriainclude:

therelationshipbetweenadvertisingexpenditureandsalesby
productandmarketshouldbemeasuredanddocumented

therelationshipbetweenadvertisingexpenditureandthe
achievementofmarketingobjectivesshouldbemeasuredand
documented

Studentsshouldend,asrequestedbytheclient,byobservingthattheywill
developfindingsandconclusionsintheexaminationsphaseandwillusethese
asabasisforareporttobediscussedwithmanagement,priortopreparing

andsubmittingtotheAuditCommitteeoftheBoardthefinalreport,
includingarrangementsforfollowup.
Marksshouldalsobeassignedfortheclarity,logic,impactand
persuasivenessoftheproposal.
18.41
Thisisachallengingquestionintendedtoteststudentsunderstandingof
theconceptofevidenceinanauditofefficiencywithasideagendaoffraud
intrainingorganizationwhicharerecipientsofpublicsectorpayments.
Answersshouldbeginwithademonstrationofstudentsunderstandingonthe
conceptsofappropriateness(isthistherightkindofevidenceandisitof
therightquality?dealingwithvalidity,reliabilityandacceptability),
sufficiency(dowehaveenoughappropriateevidence?dealingwithrisk,
materialityandcostofcollection)andtimeliness(withrespecteitherto
thetimewhenevidenceisgatheredortheperiodcoveredbytheaudit)in
relationtoevidence.
Answersshouldalsodealwithhowtogetevidence,andanswersshouldmention
inspectionofwrittenmaterialofallkinds,includingreportsandprocedures
manuals,analysisoffiguretrends,processes,etc.,interviews,replication
ofoperationalsteps,physicalobservationparticularlytocheckonthe
existenceofassets,andconfirmationbywhichtheauditorgathersevidence
fromthirdparties,usuallyinwriting.
Theanswershouldthenengagethequestionofefficiencyandshouldhave
examplesofwhatsortofevidencewouldbecollected,howmuchwouldbe
collected,andhowitwouldbecollected.Obviously,itwouldnotbe
reasonabletoexpectstudentstohavedetailedtechniquesknowledge,andthe
emphasisshouldbeonlogicandcreativity,andonaclearapplicationthe
conceptsofappropriateness,sufficiencyandtimeliness.Toillustrate,
employeewagessalariesandbenefitsarealwaysthebiggestexpenseitem,and
studentswouldprobablyincludeevidenceofhowthisitemhasbehavedover
time,andhowitcomparestocomparableinstitutions.Theremightevenbe
someindustrystandardsstudentscanconjureup.Thereare,ofcourse,two
sidestoefficiency,andinformationondollarsspentmustbeseenin
relationtooutputsofvariouskindsstudentsshouldnotventureinto
outcomeswhichrelatetoeffectiveness.Usingthenumberoftrainees
completingcoursesasanoutputmeasure(perhapsweightedbytypeanduration
ofcourses)studentscouldcomeupwithefficiencymeasuresdefined,sayas
cost/weightedcoursecompleter,andcomparethiswithstatedintentionsin
fundingproposals,andwithperformanceincomparableinstitutions.
Studentscouldalsoanticipatetheirclandestinefraudinterestbyinsisting
oncompleteinformationofallparttimeandcontractualwork,andby
requiringdetailedevidenceorinventories,paymentstosuppliers,etc.
Thereshouldalsobesomediscussionofhowtheevidenceisobtained
inspection,analysis,interview,etc.Studentsmightforinstancesuggest
whomtheywouldinterviewaboutwhat.
Answersshouldthenturntothefraudissue,first,withrelevantconceptsof
fraudand,second,withtheevidenceoffraudtobeobtainedinthecourseof
theefficiency
Thereismuchscopeforcreativityintheconceptsoffraudwhichare
relevant.ActionsnotplausiblearethoseasdefinedinReading22under
2a(saleorassignmentoffictitiousmisrepresentedassets),2e(intentional,
improperrelatedpartytransactionsinwhichonereceivessomebenefitsnot
obtainableinanarmslengthtransaction),2f(intentionalfailuretorecord

ordisclosesignificantinformationinordertoimprovethefinancialpicture
oftheorganizationtothirdparties),3c(embezzlement,astypifiedbyhe
misappropriationofpropertyormoney,andfalsificationoffinancialrecords
tocoveruptheact),3d(intentionalconcealmentormisrepresentationof
eventsordata),and3e(claimssubmittedforserviceorgoodsnotactually
provided).
Thelastsectionofthepapershoulddealwithwhatevidenceorfraudwould
beneeded,andhowitwouldbecollected.Theobjectivehereistograft
thefraudauditontotheefficiencyaudit,andstudentsmightbeexpectedto
relyheavilyonparagraphs6through11ofReading22.Thefocusshouldbe
onindicatorsoffraudandoncontrolweaknessesthatmightpermitfraud.
Forinstance,canoccasionalparttimeworkersbepaidincashwithoutnormal
documentation?
Marksshouldalsobeassignedfortheclarity,logic,impact,and
persuasivenessofthepresentation.
18.42 ThisquestionisintendedtoteststudentsunderstandingofIIAStandard200
(ProfessionalProficiency)andtheirabilitytointerpretthevarious
relevantsubstandardsinthecircumstanceofDracuLaband,further,to
reflectinthelightoftheStandardontheuseofcontractualspecialists.
PracticaladaptationtoDracuLabisimportant.
AnswersshouldbeginwithastatementofStandard200:
Internal(management)auditsshouldbeperformedwithproficiencyanddue
care.
Paragraph200.01thenelaboratesthebasicstatementbypointingoutthat
professionalproficiencyistheresponsibilityoftheinternalauditing
departmentandeachinternalauditorandthatthedepartmentshouldassignto
eachauditthosepersonswhocollectivelypossessthenecessaryknowledge,
skillsanddisciplinestoconducttheauditproperly.
Answersshouldthengoontoprovideassurancetothenewdirectors
colleaguesbydiscussingthesetofsubstandardsaddressedtotheinternal
auditdepartment.Withrespectstaffing,substandard210states:
Theinternalauditdepartmentshouldprovideassurancethatthetechnical
proficiencyandeducationalbackgroundofinternalauditorsareappropriate
fortheauditstobeperformed.Theelaborationofthissubstandardin
210.01and210.02stressesthedirectorsresponsibilitytoestablish
criteriaofeducationandexperienceandtoverifyqualifications.
Substandard220turnstothenecessaryknowledge,skillsanddisciplines,
andstates:
Theinternalauditingdepartmentshouldpossessorshouldobtainknowledge,
skillsanddisciplinestocarryoutitsauditresponsibilities.
Theelaborationofthissubstandardin220.01and220.02raisestwoissues:
first,itstressesthatstaffshouldcollectivelypossesstheknowledgeand
skillsessentialtothepracticeoftheprofessionwithintheorganization,
andthattheseattributesincludeproficiencyinapplyinginternalauditing
standards,proceduresandtechniques;and,second,itstatesthatthe
departmentshouldhaveemployeesoruseconsultantswhoarequalifiedinsuch
disciplinesasaccounting,economics,finance,etc.,asneededtomeetaudit
responsibilities.Thewordscollectivelypossessmeanthateachmemberof

thedepartmentneednotbequalifiedinallthesedisciplines.For
DracuLab,thenewdirectorshoulddiscussusinghisnewregularslotsand
contractualslotstoaddressskillsnotcurrentlyavailable.
Substandard230relatestosupervision,andstates:
Theinternalauditingdepartmentshouldprovideassurancethatinternal
auditsareproperlysupervised.
Elaborationofsubstandard230in230.01through230.05discussthe
responsibilityofthedirectorforappropriatesupervision,thedocumentation
ofsupervision,andthevaryinglevelsofsupervisiondependingonthe
proficiencyofauditorsandthedegreeofdifficultyoftheassignment.
CarefulsupervisionofstaffandconsultantsatDracuLabwillclearlybe
essential.
Answersshouldthenturntothesubstandardsrelatingtotheindividual
internalauditor.
Studentsshouldnotethatsubstandard240requirescompliancewith
professionalstandardsofconduct,andthengoontosubstandard250which
dealswithknowledge,skillsanddisciplines,andstates:
Internalauditorsshouldpossesstheknowledge,skillsanddisciplines
essentialtotheperformanceofaudits.
Thisisanimportantareasinceitestablishesbenchmarksforeachindividual
inadditiontothecollectivelypossessquestiondealtwithforthe
departmentasawhole.Theelaborationofsubstandard250in250.01notes
theneedforproficiencyinapplyinginternalauditingstandards,procedures,
andtechniques,proficiencyinaccountingtechniques,andunderstandingof
managementprinciples,andanappreciationofthefundamentalsofarangeof
subjectssuchaseconomics,commerciallaw,taxation,etc.Thedirector
needstoprovideassurancethathiscurrentandnewregularstaffmembersare
soqualified.
Thenextmajorissueisthecommunicationskillsofthestaff.Answers
shouldcitesubstandard260onhumanrelationsandcommunications,which
states:
Internalauditorsshouldbeskilledindealingwithpeopleandin
communicatingeffectively.
Thisiselaboratedin260.01and260.02,andthedirectorshouldstressthe
importanceofeffectivecommunicationwithtechnicalprofessionalmanagers.
Answersshouldalsoincludereferencetosubstandards270(Continuing
Education),540(PersonnelManagement),560(QualityAssurance),and280(Due
ProfessionalCare).
Studentsshouldthenturncreativelytoadiscussionoftheuseof
contractualspecialists.Creditshouldbegivenforreasonableefforts.
Thefollowingpointsareillustrative.Specialistsbringcosteffective
expertisetothedepartmentwherespecificskillsarenecessary.They
obviouslyserveinthemostbasicsenseasawayofsupplementing
departmentalresourceandtheycanprovidespecializedtrainingtoregular
staff.Theyalsoprovideanoutsideperspectiveregularstaffarealways
wrestlingwiththeindependenceissue.Butnotesomedisadvantages:

unfamiliaritywiththeorganizationanditsculture:theeffectonthemorale
oftheregularmanagementauditteam:theissueofconfidentiality;the
potentialforfeeexplosion;therisktoquality;thequestionof
intellectualpropertyrights;andthepossibilityofconflictofinterestif
specialistsareinvolvedinmorethanonecapacity.Thedirectorshould
pointoutthatheretainsfullresponsibilityforsupervisingspecialistsand
thattheymaybepartoftheauditteamiftheyhavethebroadskills
requiredbysubstandardormaysimplybyusedasadvisorstothedirector.
Marksshouldalsobeassignedfortheclarity,logic,impactand
persuasivenessofthepresentation.
18.43 Thisquestionisintendedtoteststudentsknowledgeabouttheroleofco
ordinationofinternalandexternalaudit,andthehelpprovidedbythe
standards,andthentotesttheircreativityindevisinganapproachto
maximizingtheusefulnessofinternalauditworktotheexternalauditor.
Answersshouldbeginasrequiredwithanintroductionontheroleofco
ordination,citingsuchbenefitsasexpandedauditcoverage,betteraudit
quality,moreeffectivefollowup,andamoreefficientoverallaudit
process.
ThissectionshouldfocusonthehelpprovidedbytheIIAStandards.
Specifically,Standard550requirestheDirectorofInternalAudittoco
ordinateinternalandexternalauditefforts.Standard550.01states:the
internalandexternalauditworkshouldbecoordinatedtoensureadequate
auditcoverageandtominimizeduplicateefforts.Standards550.02states:
coordinationofauditeffortsinvolves:periodicmeetingstodiscussmatters
ofmutualinterest;accesstoeachothersauditprogramsandworkingpapers;
exchangeofauditreportsandmanagementletters;andcommonunderstandingof
audittechniques,methods,andterminology.
Studentsshouldearnthisadditionalmarkonthestandardsissueifthey
discussbrieflythestatutoryrequirementforrelianceintheFAA(thisis
givenintheQuestion),andalsonotethatintheU.S.theAICPAissuedSAS
65in1992whichgreatlyexpandstheguidancetoexternalauditorsontheuse
ofinternalauditworkandcoordinationwithinternalauditorsinfinancial
statementaudits.
Thisiswhereconsiderablecreativityshouldbeexpected.Broadly,students
shoulddeal,asrequested,withthescopeofinternalauditandwhatthe
internalauditdepartmentcandoineachareatomaximizehelpfulnesstothe
externalauditorinthethreeareasidentifiedinthequestion.
Todothis,studentsshouldstartwithareferencetothescopeofinternal
audit(for2marksofthetotalof12)reliabilityandintegrityoffinancial
andoperatinginformation;compliance;safeguardingofassets;economyand
efficiency;andeffectiveness.Theanswershouldnotethatthisbroad
scope,andtheassociatedrequirementsforcompetence,and,ofcourse,
independence,equiptheinternalauditdepartmenttobeveryhelpfultothe
externalauditor.
For3marksofthetotalof12,studentsshouldthendiscusswhatinternal
auditorsdo,andwhatmoretheyplantodo,thatwillbehelpfulinthe
financialattestaudit.Emphasisherecouldbeonthenatureand
functioningofinternalcontrols;documentationandtestingherearevital.
Anotherareaisriskassessment;theinternalauditorcancontributetothe
externalauditorsassessmentofatleasttwomajorareastheriskof

materialmisstatements,andthecontrolriskforeachsignificantassertion.
Substantiveprocedures,forexampletoconfirmreceivables,wouldalsohelp.
Foranother3marks,studentsshouldpointtotheexistingtestingof
compliancedone,forexample,onenvironmentalquestionsandconformityto
governmenthiringregulationsandstatutoryreporting,andcouldgoonto
suggest,forinstance,acomprehensivedocumentationoftheregulatory
frameworkandinternalmonitoringofthepartsoftheframeworkasawayof
minimizingcomplianceworkbytheexternalauditor.
Forthefinal4marksoutof12,studentsshouldpointtoexistingworkin
economy(internalmonitoringofpurchasingpolicy),efficiency(internal
monitoringofprogramtotalandunitcosts,productivityandperformance
measurementwork)andeffectiveness(customersatisfactionsurveys,etc.)and
shouldcommentontheinvitationinthequestiontooffertohelpmanagement
inshapingeffectivenessassertions,say,byhelpingdesignappropriate
criteria,andfurthertooffertodopreliminaryattestworkonthese
assertions.
Marksshouldalsobeassignedfortheclarity,logic,impactand
persuasivenessofthepresentation.

18.44 Thisisachallengingquestionwhichinvitesstudentstodemonstratetheir
familiaritywithStandard100,buttodosoinawaythatwouldserveasa
departmentalpolicystatementintheinterestingcircumstancesofTechNet,
andthatstressesthemoreelusiveconceptofobjectivity.
Answersshouldbeginbystating,inpolicystatementform,arecognizable
versionofStandard100anditselaborationin110.Internalauditorsare
tobeindependentoftheactivitiestheyaudit.Theyareindependentwhen
theycancarryouttheirworkfreelyandobjectively.Independencepermits
internalauditorstorendertheimpartialandunbiasedjudgementsessential
totheproperconductofaudits.Itisachievedthroughorganizational
statusandobjectivity.
Thenextsectionoftheanswershoulddealwiththequestionof
organizationalstatus,includingpurpose,authorityandresponsibility.A
sampleisasfollows:
Ourorganizationalstatuspermitstheaccomplishmentofouraudit
objectives.Wemusthavethesupportofmanagementandtheboardofdirectors
sothatwecangainthesupportofauditeesandperformourworkfreefrom
interference.WereportdirectlytotheCEOwhohassufficientauthorityto
ensurebroadauditcoverageandappropriateactiononourrecommendations.
Further,IhavedirectaccesstotheChairoftheAuditCommitteeofthe
boardIsubmitannually,totheCEOforapprovalandtotheboardfor
information,asummaryoftheManagementAuditDepartmentsauditwork
schedule,staffingplan,andfinancialbudget;andIsubmitactivityreports
totheCEOandtheboardannuallyormorefrequentlyasnecessaryindeedI
provideamonthlysummaryofsignificantauditfindings,andimmediatenotice
ofanythingthatplacesTechNetatrisk.
Thepurpose,authority,andresponsibilityoftheManagementAuditDepartment
aredefinedinaformalCharter,whichhasbeenapprovedbytheCEOandthe
board.OurCharterestablishesourpositioninTechNet,authorizesaccess
torecords,personnel,andphysicalpropertiesrelevanttotheperformanceof
audits,anddefinesthescopeofmanagementauditingactivities.

Thesecondhalfoftheanswer,asrequired,shoulddealwithobjectivity.
ThisisaverychallengingissueparticularlyinTechNetwheredivisionsare
competitive,andthedepartmentisusedtotrainandrotatemanagers.
Seriousandinnovativeattemptsshouldberewarded.Answersshouldtryto
addressthespecificcircumstancesofTechNet.
Weareobjectiveinperformingaudits.Objectivityisastateofmindand
anindependentmentalattitude.Itrequiresustoperformauditssothatwe
haveanhonestbeliefinourworkproductsandmakenosignificantquality
compromises.Auditstaffarenotplacedinsituationswheretheyareunable
tomakeobjectiveprofessionaljudgements.
Acriticalcomponentofobjectivityisabsenceofconflictofinterest.
Staffassignmentsaremadesothatpotentialandactualconflictsofinterest
areavoided.Allauditstaffarerequiredtoinformmeofanyactualor
potentialconflicts,realorperceivedsuchasfinancialconflicts,
personalinvolvements,andpersonalrelationships;ifanysuchconflicts
arises,staffareimmediatelyreassigned.
Toensureobjectivity,auditstaffassignmentsarerotatedregularly.
Further,thedepartmentisusedrotationallytointroduceandupdatesenior
stafftoacorporateperspective,andauditstaffhavenot,anddonotlook
for,tenureintheirauditjobs.MypositionasVicePresidentistheonly
continuingone,anditisonafiveyearcontractbasis,withclear
performancecriteria.
Auditstaffdonotassumeoperatingresponsibilities.Ifonoccasionstaff
aredirectedtosuchwork,theyarespecificallynotfunctioningas
managementauditors.
Obviously,auditstaffdonotauditareasforwhichtheyhaveauthorityor
responsibility.Staffshouldanddo,ofcourse,drawontheirexperience
acrosstheorganization,butImakeaspecialpointofnotassigningstaffto
organizationalareasinwhichtheyhaverecentlyworkedortowhichtheyare
scheduledtogoontheirnextrotationtoanoperatingmanagementrole.
Auditorsrecommendstandardsofcontrolforsystemsorreviewprocedures
beforetheyareimplemented.Designing,installingandoperatingsystems
areNOTauditfunctions.Ourfocusisoncontrols.
Weserveallareasofthecorporationandrespecttheconfidentialityof
informationprovidedtous.Ourreports,andallthesupporting
documentation,goonlytotheCEOandtheChairoftheAuditCommittee.
Marksshouldalsobeassignedfortheclarity,logic,impactand
persuasivenessofthepresentation.
18.45 Thisquestionisintendedtoteststudentsunderstandingofthecurrentrole
ofthepurchasingdepartmentinUnitedMetroHospitals(UMH),howtoconduct
amanagementauditofthedepartment,includingillustrativeauditcriteria,
andhowthedepartmentsroleshouldchange.
Answersshouldbeginwithashortdiscussionoftheroleofpurchasingin
UMH.Normally,purchasinggoodsandservicescanbeseenasafivestep
processwhichis:determineneeds;acquiregoodsandservices;monitor
suppliersperformance;receivegoodsandservices;andpayforgoodsand
services.Goodanswersmightnotesomeoftheimportantareasofgoodsand

servicespurchasesforUMH(afewexamplesareactuallygiveninthe
question).
Answersshouldthengoontotheproposedmanagementaudit.Studentsmay
feelthatallmanagementsystemsinthedepartmentshouldbeaudited,ormay
select,andjustifytheselectionof,onlysomeofthesystems.
Theauditbeginswiththeplanningphase.Thisinvolvesobtainingknowledge
ofthedepartmentinordertounderstanditsenvironment.Answersshould
includedeterminingthedepartmentsorganization,activities,andrelated
managementsystemsandpractices.Referenceshouldbemadetoorganization
charts,jobdescriptions,policiesandprocedures,roleandresponsibilities
ofuserdepartments,itemspurchased,characteristicsofsupplymarkets,
purchasingstrategies,risksandimpactassociatedwitheachmajorsupplyor
servicepurchased,andpreviousmanagementauditreports.
Illustrativecriteriadeterminedattheplanningstagecouldinclude:
DeterminationofNeeds:
Needshouldbewelldefinedandrelatedtoapprovedserviceobjectives.
acquisitionofGoodsandServices:
Systemsandpracticesfortheacquisitionofgoodsandservicesshould
providereasonableassurancethatgoodsandserviceswillbeacquiredinthe
rightquantity,attherightquality,onatimelybasis,andatthebest
possibleprice.
MonitoringSuppliersPerformance:
SuppliersPerformanceshouldbemonitoredtoensurethatgoodsandservices
orderedaredeliveredinaccordancewiththepurchaseorderagreement.
ReceiptofGoodsandServices:

Goodsandservicesarecheckedonreceiptintermsofthe
purchaseagreement.