Internal Auditor Part 2

Question 1

11 jan

Answer 1

Let’s break down the concept of using internal auditors to provide direct assistance to external auditors.

Key Considerations
1. Objectivity and Competence: External auditors must evaluate internal auditors’ objectivity and competence before assigning tasks.
2. Significant Threats: External auditors cannot use internal auditors if there are significant threats to objectivity or competence.
3. Prohibited by Laws and Regulations: External auditors cannot use internal auditors if prohibited by laws or regulations.
4. Nature and Extent of Work: External auditors must consider the amount of judgment involved, assessed risk of material misstatement, and internal auditors’ objectivity and competence when assigning tasks.

Practical Example
Suppose an external auditor, XYZ & Co., is auditing a large manufacturing company, ABC Ltd. The external auditor wants to use the internal audit team to provide direct assistance with testing inventory valuation.

The external auditor evaluates the internal audit team’s objectivity and competence and determines that they are suitable for the task. However, the external auditor decides not to assign the internal audit team to test inventory valuation at a specific warehouse, as the warehouse manager has a close relationship with the internal audit team lead.

Instead, the external auditor assigns the internal audit team to test inventory valuation at other warehouses, where they do not have any close relationships with the warehouse managers.

Mathematical Example
Let’s say the external auditor wants to test inventory valuation at 10 warehouses. The internal audit team will assist with testing at 6 warehouses, and the external auditor will test the remaining 4 warehouses.

The external auditor evaluates the internal audit team’s work and determines that they have tested 80% of the inventory valuation at the 6 assigned warehouses. The external auditor then tests the remaining 20% and also tests 100% of the inventory valuation at the 4 remaining warehouses.

Prohibited Tasks
Internal auditors cannot perform the following tasks:

1. Discussion of fraud risks (although external auditors can inquire about fraud risks)
2. Determination of unannounced audit procedures
3. External confirmation requests and evaluating results (although internal auditors can assist with assembling information)

Communication with Those Charged with Governance
The external auditor must communicate the planned use of internal audit in providing direct assistance to those charged with governance. This includes:

1. The tasks assigned to internal auditors
2. The evaluation of internal auditors’ objectivity and competence
3. The nature and extent of work assigned to internal auditors

Here’s a simplified explanation:

Using Internal Auditors for Direct Assistance
Before using internal auditors, external auditors must:

1. Obtain written agreement from the entity, allowing internal auditors to follow external auditor instructions without entity intervention.
2. Obtain written agreement from internal auditors to maintain confidentiality and inform the external auditor of any objectivity threats.

Direction, Supervision, and Review
External auditors must:

1. Direct, supervise, and review internal auditors’ work, considering judgment, risk, and objectivity/competence threats.
2. Recognize internal auditors’ lack of independence and adjust direction/supervision accordingly.
3. Review procedures must include checking underlying audit evidence.

Documentation
External auditors must document:

1. Evaluation of internal auditors’ objectivity and competence threats.
2. Basis for deciding on the nature and extent of internal auditors’ work.
3. Review details (who, date, extent).
4. Written agreements from the entity and internal auditors.

By following these steps, external auditors can effectively use internal auditors for direct assistance while maintaining audit quality and independence.

Here’s a simplified explanation of ISA 620, which deals with the auditor’s use of experts:

Objective of ISA 620
The objective is to enable the auditor to decide whether to use an expert’s work and assess its adequacy.

Examples of Expert Use
Experts may be used for:

1. Legal opinions
2. Valuation of complex assets (e.g., financial instruments, art)
3. Estimation of oil and gas reserves
4. Interpretation of contracts, laws, and regulations
5. Analysis of complex tax compliance issues

Key Considerations
1. Cost-benefit analysis: Weigh the costs of using an expert against the benefits.
2. Nature, significance, and complexity: Consider the complexity of the issue and its significance to the financial statements.
3. Risk of material misstatement: Assess the risk of material misstatement and whether an expert’s work can help mitigate that risk.
4. Alternative sources of evidence: Consider whether alternative sources of evidence are available, such as management’s expert.

Assessing the Expert’s Work
When assessing the expert’s work, the auditor should consider:

1. Expert’s qualifications and experience
2. Expert’s objectivity and independence
3. Expert’s work and methodology
4. Relevance and reliability of the expert’s findings

I’ll break down each point and provide more details:

Assessing the Expert’s Competence and Objectivity
1. Personal experience: The auditor should consider their previous interactions with the expert, including any work they’ve done together.
2. Discussions with the expert: The auditor should have open and honest conversations with the expert to understand their approach, methods, and conclusions.
3. Feedback from other auditors or familiar parties: The auditor may seek input from colleagues or others who have worked with the expert to gain a more comprehensive understanding of their competence and objectivity.
4. Review of qualifications, licenses, and publications: The auditor should verify the expert’s credentials, including their education, certifications, and relevant publications.

Understanding the Expert’s Field of Expertise
1. Nature, scope, and objectives: The auditor should understand the expert’s role, responsibilities, and goals in relation to the audit.
2. Evaluating the adequacy of the expert’s work: The auditor should assess whether the expert’s work is sufficient, reliable, and relevant to the audit.

Agreeing Terms of Engagement
1. Nature, scope, and objectives: The auditor and expert should agree on the specific tasks, deliverables, and timelines.
2. Respective responsibilities: The auditor and expert should clearly define their roles and responsibilities.
3. Form of the expert’s report: The auditor and expert should agree on the format, content, and structure of the expert’s report.
4. Confidentiality requirements: The auditor and expert should ensure that all confidential information is protected.

Evaluating the Adequacy of the Expert’s Work
1. Relevance and reasonableness of conclusions: The auditor should assess whether the expert’s conclusions are logical, supported by evidence, and relevant to the audit.
2. Reasonableness of assumptions and methods: The auditor should evaluate whether the expert’s assumptions and methods are reasonable, appropriate, and consistent with industry standards.
3. Relevance, completeness, and accuracy of source data: The auditor should verify that the expert’s source data is relevant, complete, and accurate.

Consequences of Inadequate Expert Work
1. Agree on additional work: If the expert’s work is inadequate, the auditor may agree on additional work or modifications to the original scope.
2. Perform other additional audit procedures: The auditor may need to perform additional procedures to compensate for the inadequate expert work.
3. Consider expressing a modified opinion: In extreme cases, the auditor may need to express a modified opinion in the audit report due to the inadequate expert work.

Auditor’s Responsibility
1. Sole responsibility for the audit opinion: The auditor remains solely responsible for the audit opinion, regardless of the expert’s involvement.
2. No reference to expert’s work unless required: The auditor should not reference the expert’s work in the audit report unless required by law or regulation.
3. Clarify responsibility if referenced: If the expert’s work is referenced, the auditor must clarify that the reference does not reduce their responsibility for the audit opinion.