INTERNATIONAL AUDIT |

UNIT 3: INTERNAL CHECK, INTERNAL AUDIT AND INTERNAL CONTROL AND INVESTIGATION

Topics Included:
 (A) Internal Check, Internal Audit And Internal Control
o Meaning, Characteristics, Objectives of Internal Check and Internal Audit.
o Auditor’s duties regarding internal check and Internal Audit.
o Difference between Internal Check, Internal Control and Internal Audit.
 (B) Investigation
o Meaning and definition and Objectives of investigation.
o Difference between Auditing and Investigation.
o Points to be considered while conducting Investigation.
o Investigation on behalf of purchaser of business and on institution for granting a
loan

(A) Internal Check, Internal Audit and Internal Control

Meaning of Internal Control

It involves various methods and procedures, adopted in an organisation with a view to
safeguard its assets, to ensure that the accounting and statistical data produced are reliable
and accurate; to promote greater efficiency in operation; and to carry out effectively general
policies as laid down by the management. It is to be recognised that the major issues in
relation to control are fast developing. It involves even keeping the administrator posted with
the up-to-date information which reflects the result of policy and which would also provide a
sound basis for ascertaining the future course of action.

“Internal control, as defined in accounting and auditing, is a process for assuring

achievement of an organization’s objectives in operational effectiveness and efficiency,
reliable financial reporting, and compliance with laws, regulations and policies. A broad
concept, internal control involves everything that controls risks to an organization” From
Wikipedia, the free encyclopedia

It is a means by which an organization’s resources are directed, monitored, and

measured. It plays an important role in detecting and preventing fraud and protecting the
organization’s resources, both physical (e.g., machinery and property) and intangible (e.g.,
reputation or intellectual property such as trademarks).

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At the organizational level, internal control objectives relate to the reliability of

financial reporting, timely feedback on the achievement of operational or strategic goals, and
compliance with laws and regulations. At the specific transaction level, internal control refers
to the actions taken to achieve a specific objective (e.g., how to ensure the organization’s
payments to third parties are for valid services rendered.)

Internal control procedures reduce process variation, leading to more predictable

outcomes. ‘Internal control has long been recognised as fundamental and indispensable to
modern auditing. The recognition emerged gradually in the early days of the profession as
auditors sought to explain the practical discovery that, for most purposes, an examination of
every transaction was seldom necessary. In recent years, understanding of internal control
and its relationship to auditing has depended, in part as a result of the advances in cybernetics
and in the technology of control made by management scientists and computer specialists.

Montgomery

The scope of internal control, according to this definition, extends beyond accounting
controls and includes all operational controls like quality control, work standards, budgetary
control, periodic reporting, internal checks, internal audit, policy appraisals, quantitative
control etc. Thus, it undoubtedly, consists of many aspects related to control in the
organisation.

‘Internal control is best regarded as the whole system of controls, financial and
otherwise established by the mgt in the conduct of a business including internal check
internal audit and other forms of control’. Spicer and Peglar

According to Water B. Meigs, ‘A system of internal control consists of measures

employed by a business for the purpose of’:
• Safeguarding its resources against waste, fraud and inefficiency,
• Promoting accuracy and reliability in accounting and operating data,
• Encouraging and measuring compliance with company’s policy, and
• Judging the efficiency of operations in all divisions of the business.

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Characteristics of Internal Check

The various principles of internal check system are as follows:

i. Responsibility: Responsibility of each individual must be properly defined and

fixed. The work of the business should be allocated amongst various clerks in
such that their duties and responsibilities are clearly divided.
ii. Completion: The work should be divided in such a way that no single person is
allowed to complete the work solely by himself from the beginning to the end.
However, there should be no duplication of work.
iii. Rotation of employees: A good system of internal check should not allow persons
having custody of assets to have access to the books of accounts. A system of
transfer or rotation of employees from one seat of work to another must be
followed by the business.
iv. Rotation of employees: A good system of internal check should not allow persons
having custody of assets to have access to the books of account. A system of
transfer or rotation of employees from one seat of work to another must be
followed by the business.
v. Automatic check: A good system of internal check must provide for an automatic
checking of the work of one clerk by the other.
vi. Reliance: No clerk of the business should be relied upon too much.
vii. Safeguard: Safeguard should be prescribed to keep un-used cheque books, files
and securities etc.
viii. Supervision. A strict supervision should be exercised to ensure that the prescribed
internal checks and procedures are fully operative.
ix. Formal sanction: No deviation should be allowed from the establishment
procedure till it is formally sanctioned by the top official.
x. Periodical review: The system of internal check should be reviewed from time to
time to introduce improvement.

Objectives of Internal Check

The objects of internal check system are to minimize the chances for the commission of
errors or fraud; to enhance the efficiency of the employees; to avoid any omission of any
transaction from being recorded. The main objectives of internal check are as under:

i. To exercise moral pressure over staff.

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ii. To ensure that the accounting system produces reliable and adequate information.
iii. To provide protection to the resources of the business against fraud, carelessness
and inefficiency.
iv. To distribute the work in such a manner that no business transaction is left
unrecorded.
v. To allocate duties and responsibilities of each clerk in such a way that he may be
held responsible for particular fraud or error.
vi. To minimize the chances of errors, frauds or irregularities in the business.
vii. To increase the efficiency of clerks because the allocation of duties is based on the
Principle of division of labour.
viii. To detect errors and frauds easily if it is committed, because in an efficient
internal check system, there is a provision for independent checking.

Meaning of Internal Audit

It implies the audit of accounts by the staff of the business. The staff may or may not
have professional qualification for audit of accounts. The internal audit staff is permanent in
nature and helps the business in early detection of errors and frauds. The objectives and
functions of internal audit depend on the nature of operations and business. Sometimes the
internal audit may be done by independent persons appointed for the purpose.

‘The Institute of Internal Auditors defines internal audit as, ‘Internal auditing is the
independent appraisal activity within an organisation for the review of the accounting,
financial and other operations as basis for protective and constructive service to the
management. It is a type of control which functions by measuring and evaluating the
effectiveness of other type of control. It deals primarily with accounting and financial matters
but it may also properly deal with the matters of an opening nature’. It is also covered with
the verification and appraisal of the procedures and transactions. The existence of internal
audit is a help to the independent auditor. In certain matters the field of both is common. Both
are interested in knowing whether an effective internal control system exists to prevent errors
and frauds and whether accounting systems and procedures are adequate.

Objectives of Internal Audit

The objectives of internal audit are as follows:

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i. To comment on the effectiveness of the internal control system in force and to

suggest ways and means to improve upon the system.
ii. To verify the correctness, accuracy and authenticity of the financial accounting
records presented to the management.
iii. To facilitate the early detection and prevention of frauds.
iv. To ensure that the international accounting standards or the standard accounting
practices are followed by the organization.
v. To take up an investigation at the special request of the management.
vi. To ensure that the assets of the organization are adequately safeguard and properly
accounted for. vii. To ensure that the organization incurs liabilities in respect of its
valid and legitimate activities.
vii. To ensure that the acquisition and disposal of assets are under proper authority.
viii. To ensure as to whether or not each unit of the organization follows the policies
and procedures as lay down by the top management.

Auditor’s duties regarding Internal Check

Internal check is increasingly recognised by the auditors especially when the size of the
business is large. A good system of internal check may relieve an auditor of a large part of
detailed checking and the time thus saves can be given to more important matters. But,
wherever the system is found to be defective, it is the duty of the auditor to check the whole
transaction in detail because ultimate responsibility, in case anything goes wrong in final
accounts, lies on the external auditor. In the case of a good system of internal check, his work
but not the responsibility, is reduced. Statutory auditor cannot be relieved of his liability on
the ground that since the system of internal check was good, he did not perform a particular
function. No doubt, a good and efficient system of internal check is very helpful to the
auditor but, in no way, it relieves him of his contractual responsibilities. So, the extent to
which he should rely upon the system of internal check will depend upon his skill, experience
and training. Operation of an efficient system of internal check helps an auditor to a great
extent in the conduct of his work but it is wrong to think it will reduce his responsibilities as
well. He may be relieved of a good deal of detailed checking which is automatically done in
an effective system of internal check. In case of smaller business, the auditor must undertake
extensive and thorough checking of all of original records, vouchers and postings etc. as far
as possible. He should not rely much upon test-checking otherwise he may have not be able
to trace the irregularities. It is not possible for an auditor to carry on the detailed checking of

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records of innumerable transactions of a big concern. Therefore, he should try to check the
effectiveness of the operation of internal check system and act accordingly, as mentioned
above. He should satisfy himself as to the correctness of the records as far as possible. But if
the system is so faulty that it becomes difficult for him to get satisfaction as to the correctness
of certain part of the records, he should mention it clearly in his report and should openly
decline to share any consequential responsibility.

Auditor’s duties regarding Internal Audit

1. **Risk Assessment:**

- Assess the organization's risk management processes to identify potential risks.

- Evaluate the effectiveness of risk mitigation strategies and controls.

2. **Internal Control Evaluation:**

- Review and assess the adequacy and effectiveness of internal control systems.

- Ensure that internal controls are designed to safeguard assets, maintain accurate
financial records, and comply with laws and regulations.

3. **Compliance Assurance:**

- Verify compliance with applicable laws, regulations, and internal policies.

- Identify any instances of non-compliance and recommend corrective actions.

4. **Audit Planning and Execution:**

- Participate in the planning of internal audits, including defining audit objectives

and scope.

- Execute audit procedures, examining evidence, and documenting findings.

5. **Reporting:**

- Prepare comprehensive audit reports that communicate findings,

recommendations, and management responses.

- Provide feedback to management on areas that need improvement and commend

areas of good practice.

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6. **Follow-up:**

- Monitor the implementation of audit recommendations to ensure corrective actions

are taken.

- Assess the ongoing effectiveness of implemented changes.

7. **Independence and Objectivity:**

- Maintain independence and objectivity in the audit process to ensure unbiased and
fair assessments.

- Avoid conflicts of interest and ensure that audit opinions are not unduly
influenced.

8. **Continuous Improvement:**

- Evaluate the internal audit process itself and recommend improvements.

- Stay informed about industry best practices and evolving risks to enhance the
effectiveness of the internal audit function.

9. **Communication:**

- Foster open communication with management, audit committee, and other relevant
stakeholders.

- Ensure that audit findings are clearly communicated and understood.

10. **Training and Development:**

- Stay updated on relevant auditing standards, techniques, and industry

developments.

- Provide training and guidance to internal audit staff to enhance their skills and
knowledge.

11. **Coordination with External Audit:**

- Coordinate with external auditors to optimize audit efforts and share relevant
information.
- Ensure that internal audit findings are considered in the external audit process.

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Difference between Internal Check, Internal Control and Internal Audit

(B) Investigation

Meaning and definition of Investigation

Investigation involves inquiry into facts behind the books and accounts into the
technical, financial and economic position of the business. Investigation is a critical
examination of the books and accounts with a specific objective.

“The term investigation implies an examination of the accounts of a business for some
special purpose.” - Spicer and Pegler

“An investigation is an examination of accounting records undertaken for a special

purpose; in fact, it is an audit of which the scope the scope is limited or extended in
accordance with requirements of the particular purpose. Its object is usually to discover and

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display the facts in such a manner as will enable the parties for whom it is undertaken to draw
conclusions and make their decisions accordingly.”

Objectives of investigation
1. It is critical examination and is based on Suspicion on the state of affairs to be
investigated.
2. It may even extend to the examining of individuals like Directors, Auditors and other
officers of the company
3. It does not confine itself only with the financial aspects but technical, political,
economic and managerial aspect are also accounted for.
4. The investigation is normally conducted with certain specific objectives.
5. With the predefined objectives, the scope and the nature of investigation may be
limited or extended.
6. The investigator submits his report of investigation only to his client, who appoints
him.
7. In the investigation report, the factual information is given in an analytical and
descriptive manner.
8. No specific rules and provisions are framed for the investigation. Investigation is
voluntary and contractual in nature, except in companies.
9. It suggests the outlines for the future course of action on a particular problem.

Difference between Auditing and Investigation

Investigation means an inquiry into the accounts of a business for a special purpose. It
is an examination of the books of accounts of a business to know its actual financial position
or earning capacity, etc. Taylor and Perry have defined it as “Investigation involves inquiry
into facts behind the books and accounts, into the technical, financial and the economic
position of the business or organization”. It is a kind of special audit with a limited or
extended scope according to the purpose for which it is conducted. Investigation is neither
accountancy nor auditing.

Thus investigation is a kind of special audit with a limited or extended scope

according to the purpose for which it is conducted. Investigation is neither accountancy nor
auditing. The main points of difference between audit and investigation are outlined as
under:-

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Points of Auditing Investigation

difference
1. Objects The object is to find out whether It is undertaken to know the
balance sheet and profit and loss essential facts about a matter under
account exhibit a true and fair inquiry. It is done with some
view of business. special purpose of view.
2 Period It usually covers one accounting It may cover more than one
year. accounting year.
3 Conducted It is conducted for proprietors It is carried out on behalf of any
only. party interested in the matter.
4 Scope It is restricted to balance sheet and
It is wider in scope. It may be
profit and loss account. carried out beyond balance sheet.
5. Compulsion Audit is legally compulsory for It is voluntary. It is required under
companies. certain circumstances.
6 Time It may be conducted at the end of It may be conducted at any time in
the year. case of suspicion about any
transaction.
7. Report Form of report is prescribed. It is Form of report is not prescribed. It
presented to the shareholders. is presented to the client.
8. Appointment Owners appoint the auditors. Even third party can appoint an
investigator.
9. Qualifications The statutory auditors must Even an employee preferably a
possess proper qualifications. chartered accountant may be
appointed as investigator.
10. Rework Re - audit is not generally Re - investigation may be
undertaken. undertaken.

Points to be considered while conducting Investigation

Investigation on behalf of purchaser of business and on institution for

granting a loan

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