A Paradigm Shift in Audit Process

Author: PADMAPRIYA V 1
A PARADIGM SHIFT INA PARADIGM SHIFT IN
INTERNAL AUDITINTERNAL AUDIT

The Institute of Internal Auditors of UK and Ireland
defines Internal Audit as:
“Internal Auditing is an independent, objective
assurance and consulting activity designed to
add value and improve an organisation's
operations. It help objectives by bringing a
systematic, disciplined approach to evaluate
and improve the effectiveness of risk
management, control, and governance
processes.”
Historically it was always held that internal
auditing is confined to merely ensuring that the
accounting and allied records have been
properly maintained, the assets management
system, policies and procedures are in place
and are duly being complied with.
With changing times this concept has undergone a
change with regard to its definition and scope
of coverage. Modern approach suggests that it
should not be restricted to financial issues
alone but also on issues such as cost benefit
analysis, resource utilization and their
deployment, internal controls, effectiveness of
the management, identification of fraud etc.
• All organisations are subject to fraud risks.
Senior Management is considered the most
susceptible to committing fraud by virtue of
their ability to override existing controls.
• Large frauds have led to the downfall of
entire organisations, massive investment
losses, significant legal costs, incarceration of
key individuals, and erosion of confidence in
capital markets. Publicized fraudulent
behavior by key executives has negatively
impacted the reputations, brands, and images
of many organisations around the globe.
• Reactions to recent corporate scandals have
led the public and stakeholders to expect
organisations to take a “no fraud tolerance”
attitude. The Board/Management are also
now increasingly concerned about the
vulnerability and exposure of their
organisations to frauds and whether or not
they are adequately protected.
The focus of the audit has been changing
from Transaction audit to Value addition....

The role of internal audit in fraud risk management
• "How could this have happened?" is the
usual response when fraud is discovered.
"Where were the auditors?" is often the
next question.
• Because of the “expectation gap” , many
investors expect a foolproof audit with a
guarantee as to the non-existence or
absence of fraud or misstatements,
irrespective of how immaterial they are,
whereas audit firms have taken it upon
themselves to educate the public as to
their actual role in the audit, which does
not include guaranteed fraud detection.
Because auditors do not examine every
transaction or event that occur in a
company’s fiscal year, there is no
guarantee that all material misstatements,
whether caused by error or fraud, will be
detected.
• Closing the expectation gap requires
efforts from all the involved parties.
Management should be held
accountable for the effectiveness of
the internal controls, shareholders
need to accept the fact that it is
neither the auditors’ responsibility
nor capability to uncover all
incidents of fraud and finally the
auditors themselves should conduct
their audit whilst keeping an eye out
for fraudulent activity.
• This entails investigating any warning
signs and red flags that may appear
during the course of the audit and
reporting them in a timely manner.
Part of the audit scope should
include assessing the control
environment in place and its
effectiveness for the purpose of
designing the audit approach.

• Internal auditors should consider the
organisation’s assessment of fraud risk
while developing their audit plan and
review management’s fraud
management capabilities periodically.
They should interview and
communicate regularly with those
conducting the organisation’s risk
assessments, as well as others in key
positions throughout the organisation,
to help them ensure that all fraud risks
have been considered appropriately.
• When performing engagements, internal
auditors should spend adequate time
and attention in evaluating the design
and operation of internal controls
related to fraud risk management. They
should exercise professional skepticism
when reviewing activities and be on
guard for the signs of fraud. Potential
frauds uncovered during an
engagement should be treated in
accordance with a well-defined
response plan consistent with
professional and legal standards.
• Internal auditors should also take an
active role in support of the
organisation’s ethical culture. The
importance an organisation attaches to
its internal audit function is an
indication of the organisation’s
commitment to effective internal
control.
• Specific internal audit roles in relation
to fraud risk management could include
initial or full investigation of suspected
fraud, root cause analysis and control
improvement recommendations.
Effective internal audit teams are
adequately staffed and trained with
appropriate specialized skills, given the
nature, size, and complexity of the
organisation and its operating
environment.

• Internal auditor’s main fraud
responsibilities during an engagement
include:
• Help management identify, assess risk and
determine the adequacy of the control
environment
• Be alert to fraud opportunities
• Identify red flags
• Recommend investigation when
appropriate
• The Institute of Internal Auditors (IIA)has
released guidance notes to help
organisations deal with fraud risks.
The first guide – Internal Auditing and
Fraud – is aimed at increasing the internal
auditors’ awareness of fraud and provides
guidance on how to address fraud risks
during internal audit engagements.
The second – Fraud Prevention and
Detection in an Automated World – is
specific to fraud within the technology
environment.
• To help organisations and internal
auditors combat fraud, the guide
discusses:
• Fraud awareness (e.g., reasons and
examples for fraud and potential fraud
indicators).
• Fraud roles and responsibilities.
• Internal audit responsibilities during
audit engagements (e.g., execution
responsibilities and communicating
with the board).
• Fraud risk assessment (e.g.,
identifying relevant fraud risk factors
and mapping existing controls to
potential fraud schemes and
identifying gaps).
• Fraud prevention and detection.
• Fraud investigation.
• Forming an opinion on internal
controls related to fraud.

• This focus shift is a response to
emerging technology risks,
notably those arising from
adoption of social media, cloud
computing, and “big data”
collection and analytics as well as
the increasingly common practice
of allowing employees to use their
smartphones and other devices to
access business networks and
data.
In this regard the most desirable Audit
skills have emerged as,
• Analytical Thinking
• Effective Communication
• Data Mining and Analytics
• General Information Technology
• Business Acumen
• Industry-specific Knowledge
• Accounting
• Risk Management Assurance
• In PwC’s State of the Profession
survey , data privacy and security is one
of the main risks identified by senior
executives and heads of internal audit.
• The bi-annual KPMG Fraud Survey -
surveying 281 private and public sector
organisations across Australia and New
Zealand pinpoints a lack of objective
and independent internal audit,
inadequate oversight of senior
management’s activities by the audit
committee, and weak regulatory
environment as culprits for the spike in
financial statement frauds.
• According to KPMG’s India Fraud
Survey , “71% of respondents believe
that Fraud is an inevitable cost of
business. Bribery and corruption(83%)
is perceived to be a major concern
followed by cyber related frauds(71%)
and Diversion/theft of funds(65%).”

• Use of data analytics on a
continuous or real-time basis, helps
the auditing team to identify and
report fraudulent activity more
rapidly.
For example, Benford’s Law
analysis can examine expense
reports, general ledger accounts,
and payroll accounts for unusual
transactions, amounts, or patterns
of activity that may require further
analysis.
• Similarly, continuous monitoring of
transactions subject to certain
“flags”may promote quick
investigation of higher-risk
transactions.
• Various softwares are available for
this purpose like ACL and
TeamMate solutions.
• With data breaches in the headlines
these days,organisations are
increasingly concerned about
• data privacy and security issues and
hence are turning to internal audit
seeking for help on managing the
seemingly new and specific risks of
emerging technologies.
• In the course of their role, internal
auditors now-a-days work across all
areas of an organisation. In addition to
core areas of financial control and IT,
they review the tangible aspects of
operations such as an organisation’s
supply chain,IT systems as well as
more intangible aspects such as
organisational culture and ethics.
• In fact, any system that has an impact
on the effective operation of an
organisation may be included in the
internal audit’s scope.

Areas to focus....
• Data analysis, data mining, and
digital analysis tools/softwares can,
• Identify suspicious transactions
• Assess the effectiveness of internal
controls
• Monitor fraud threats and
vulnerabilities
• Consider and analyze thousands
or millions of transactions
• Information Technology
• Compliance/Regulatory
• Risk Management Effectiveness
• Operational /Business Strategy
• Corporate Governance
• Cost Reduction/Crisis Mgt
• Fraud /Financials
. Sarbanes-OxleyTesting/Support

THANK YOU

A Paradigm Shift in Audit Process

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