Case study
Lajod company has an internal audit department consisting of a manager and three staff auditors. The manger of internal audit, in turn, reports to the corporate controller. Copies of audit reports are routinely sent to the audit committee of the board of directors as well as the corporate controller and the individual responsible for the area or activity being audited.
The manager of internal audits is aware that the external auditors have been relied on the internal audit function to a substantial degree in the past. However, in recent months, the external auditors have suggested there may be problem related to the objectivity of the internal audit function. This objectivity problem may result in more extensive testing and analysis by external auditors.
The external auditors are concerned about the amount of non-audit work performed by the internal audit department. The percentage of non-audit work performed by the internal auditors in recent years has increased to about 25% of their total hours worked. A sample of five recent no-audit activities are as follows:
1. one of the internal auditors assisted in the preparation of policy statements on internal control. These statements included such things as policies regarding sensitive payments and standard of control for internal controls.
2. The bank statements of the corporation are reconciled each month as a regular assignment for one of the internal auditors. The corporate controller believes this strengthens internal controls because the internal auditor is not involved in the receipt and disbursement of cash.
3. The internal auditors are asked to review the budget data in every area each year for relevance and reasonableness before the budget is approved. In addition, an internal auditor examines the variances each month, along with the associated explanations. These variance analyses are prepared by the corporate controller's staff after consultation with the individuals involved.
4. One of the internal auditors has recently been involve in the design, installation, and initial operation of a new computer system. The auditor was primarily concerned with the design and implementation of internal accounting controls and the computer application controls for the new system. The auditor also conducted the testing of the controls during the test runs.
5. The internal auditors are often asked to make accounting entries foe complex transactions before the transactions are recorded. The employees in the accounting department are not adequately trained to handle such transactions. In addition, this serves as a means of maintaining internal control over complex transactions. The manger of internal audits has always made an effort to remain independent of the corporate controller's office and believes that the internal auditors are objective and independent in their audit and non-audit activities.
Required
. Define objectivity as it relates to the internal audit function.
. For each of the five situations outlined, explain the objectivity of Lajod Company's internal audit department has been materially impaired. Consider each situation independently.
. The manger of audits reports to the corporate controller.
i. Does this reporting relationship result in a problem of objectivity? Explain your answer.
ii. Would your answer to any of the five situations in the requirement B have changed if the manger of internal audits reported to the audit committee of the board of directors? Explain your answer.