What Is Internal Auditing?

What do internal auditors do and why? Why is internal auditing needed?

Internal auditing is a function that can take a variety of forms and internal auditors can perform many different services. Internal auditing has come into the public eye in recent years due to Sarbanes-Oxley regulation and business’ effort to comply with the new regulations. Broadly speaking, internal auditing is a discipline that addresses a wide range of assurance and consulting services. Internal auditing services can be thought of as a general control function for businesses that are becoming increasingly decentralized. The Institute of Internal Auditors (IIA) is the organization that leads the internal auditing field and certifies accountants as Certified Internal Auditors (CIA).

The Purpose of Internal Auditing

While the form taken for internal auditing can vary somewhat by organization, the general purpose of internal auditing is to provide control and feedback on business operations. According to the standards for internal auditing, internal auditors must remain as independent and objective as possible to perform their job correctly. Some of the duties engaged in by an internal auditor include:

  • Evaluation of a company or department’s compliance with laws and regulations
  • Assessing the reliability of financial information,
  • Determining the efficiency and usefulness of operations,
  • Detection of fraud,
  • Prevention of fraud and,
  • Working with external auditors to ensure that all auditing needs are being met but not overlapping where unnecessary.

Objectivity and Independence for Internal Auditors

Objectivity and independence are just as important for internal auditors and they are for external auditors. To maintain these directives, internal auditing departments and the auditors themselves must have the support of upper-level management and internal auditors must be selected and assigned carefully to avoid situations where conflicts of interest could occur. For example, an internal auditor should not be assigned to evaluate a department or position that he or she was recently assigned to.

The Span of Internal Auditing

While the first area of expertise that may come to mind when a person considers the span of an internal auditor’s responsibility may be financial, internal auditors are also responsible for other areas of auditing. These areas include operational and compliance responsibilities. These responsibilities can range from evaluating quality control procedures to making sure that all documentation is in order for applicable environmental regulations, to ensuring that contracts are not being violated by auditing financial information. Internal auditors may also be utilized for miscellaneous consulting services.

While Sarbanes-Oxley and other issues may have brought what internal auditors do to the public eye, the profession itself is quite broad and reaches into more areas than a person might think. With businesses becoming decentralized, the importance of internal auditors will only continue to increase, as will the need for individuals with the specialized training needed to become Certified Internal Auditors (CIA).

The Field of Business Accounting

Differences between Financial Accounting and Managerial Accounting

The field of business accounting is divided into financial accounting and managerial accounting. They are different by purpose, target audience, and standards.

The purpose of business accounting is to provide the company’s management with valid and up-to-date information regarding the company’s operations and financial performance. This information is needed for the decision-makers to have a firm ground for designing the strategies for future operations.

The major purposes of business accounting are identifying, measuring, recording, classifying and summarizing financial transactions and events as well as further analyzing, interpreting and communicating the gathered financial information. All this is needed for a business to have enough information to base strategic decisions upon. In addition, financial accounting information is required to be issued according to Generally Accepted Accounting Principles.

Financial Accounting

Financial accounting works mostly for external users. They may be investors, creditors, auditors or analysts. This type of business accounting is supposed to correspond to specific principles and guidelines – Generally Accepted Accounting Principles (GAAP). These principles outline the major rules according to which the company’s accounting processes should be conducted and managed. Besides, they define the standards and terms for issuing reports on the company’s financial information.

The information provided by financial accounting has a general informative purpose. It does not contain many estimates, is used mostly for investment and credit decisions, and is issued on a regular basis - annually or quarterly. In particular, financial accounting provides financial statements that include information about the loss and profit of an organization, balance sheets, and cash flow statements for the reporting periods.

Managerial Accounting

Unlike financial accounting, managerial accounting is aimed at internal users, such as the company’s management or board of directors. Its purpose is to provide information which will help to control the company’s operations and make decisions.

Managerial accounting reports are prepared on an as-needed basis, and contain more detailed information than those for financial accounting. Such information is needed for the management to have a full picture of the current state of the whole organization or a specific project. In addition, managerial accounting statements do not have to comply with GAAP or any other regulations, and internal cost/benefit evaluation determines what kind and how much information they should report. Examples of managerial accounting reports are sales forecasting or budget analysis reports.

So, an important feature that differentiates the two types of business accounting is that financial accounting provides historical data and current financial information of the company for a wide range of users, while managerial accounting includes analysis and estimates for the future, focuses on providing confidential data for taking decisions to influence upcoming decisions and future operations.

Basic Bookkeeping Concepts

Tracking your income and expenses are most business owners' primary concern in the business. Therefore basic bookkeeping knowledge is useful, regardles of the size of your business. While bookkeeping and accounting are more complex than they may first appear, this knowledge willhelp you to understand what your bookkeeper or accountant is talking about, and it can even help you start to do the books yourself in a smaller business.

The Business Income

Tracking your income is important. You do want to know how much you make, and how much you should be taking in. This is your revenue. It is the sum of all of the money that you take from your clients, before taxes. Your revenue is not your actual income, since it does not yet account for the costs of running your business. It is simply the money you take in, whether it be cash, cheques, credit cards, or on invoice to your clients. Add these all up and you have your total revenue. Some businesses will count this with sales taxes, but that is incorrect and sales taxes need to be accounted for separately.

The Costs of Running Your Business

The costs associated with operating a business are called the expenses. These are any cost that is required to make the business work and are associated directly with the business. It is your payroll expenses (including any benefits and government taxes that the business is responsible for – not the employee deductions that are taken off their cheques). It is the rent and operating expenses of your building or office. It is the cost of all the goods you produce or sell. It is also the costs of advertising, licensing, cleaning, and so-forth. These all together make up your expenses.

Direct expenses are those that can be tied directly into the sale of your product or service, whatever it might be. These could be the wholesale cost of a product (or its manufacturing cost), commissions on selling the product, and any maintenance and repairs needed on a product before it is sold (say it was damaged on your sales floor and you had to fix it). Once you subtract the direct expenses from your revenue, then you are left with your Gross Income. This means your income before your indirect expenses.

Indirect expenses are those that cannot be tied to the product itself. These can include your rent, professional fees (lawyer, consultant, accountant), administrative salaries, sales promotions and advertising that are general to the whole business (rather than one specific product), and so forth. Once these are accounted for, you should have all of the expenses of your business and any amount that is left over on your Income Statement is your Net Income (or Loss). Don’t feel bad if you are just starting out and there is a loss. It’s quite common to have a loss in the first couple of years of a business, but to have a loss past three years is something you seriously need to look at.