What Are Audit Procedures for Internal Controls?

Audit procedures are the processes and methods auditors use to obtain sufficient, appropriate audit evidence to give their professional judgment about the effectiveness of an organization’s internal controls.

Internal controls are the mechanisms and standards businesses use to protect their sensitive data and IT systems or to provide accountability on financial statements and accounting records.

Understanding the Audit Process

In the case of an audit on internal controls, the auditor must assess the client’s risk of ineffective internal controls. That means the auditor must learn as much as possible about the client’s mechanisms for internal control, however good or bad those mechanisms might be.

During the fieldwork phase, the American Institute of Certified Public Accountants (AICPA) requires auditors to assess a client’s internal controls using a variety of audit procedures. This involves understanding the client’s information systems, including the communication and business processes relevant to the client’s financial reporting.

What are the Major Limitations of Auditing?

Unfortunately, auditing comes with several limitations. Let’s take a look at them now.

Audits Are Limited to Relevant Controls Only

In the event of an internal control audit, the audit objectives are strictly limited to internal controls. Therefore, the auditor must refrain from commenting on potential inefficiencies or offering ways to improve organizational performance.

Audits Are Limited to a Sample of Transactions

Another limitation is that, generally speaking, the auditor can’t review the entire set of transactions (say, all accounts payable transactions) in a large organization. So, the auditor must use a representative sample that suggests how well internal controls do or don’t work. That sample might strongly correlate to the untested whole – but perhaps not; it’s only a sample.

Auditors Must Rely on Other Experts

Auditors depend on subject matter experts such as lawyers or engineers to evaluate fixed assets and other relevant information on potential liabilities.

Additional Financial Burden

Lastly, an internal control audit can be a significant financial burden for an organization, and that’s on top of the burden of implementing the internal controls, testing controls, further internal audits, and improving any that may need improvement.

Internal vs external audit

When evaluating an organization’s processes and controls, two distinct types of audits—internal and external—play pivotal roles. Understanding their variances is essential for comprehending their impacts on an organization’s operations and compliance.

Scope and Objectives

Internal audits are conducted by internal teams or designated departments within the organization. They review and assess internal controls, risk management, and operational efficiencies. These audits frequently involve creating an audit program and plan to guide the evaluation process.

In contrast, external audits are performed by independent external auditors. They primarily review an organization’s financial statements to ascertain their accuracy and compliance with accounting standards. The primary objectives of the audit in external auditing are to provide an unbiased audit report on the fairness and accuracy of financial statements to external stakeholders.

Parties Involved and Reporting

Internal audits are typically conducted by employees or an internal audit team reporting directly to the management or audit committee. They generate audit findings, observations, and recommendations to enhance internal processes. On the other hand, external audits involve third-party auditors who provide their findings in a final audit report to shareholders, regulatory bodies, and interested external parties.

Frequency and Follow-Up

Internal audits can occur periodically or as needed, allowing for continuous monitoring and follow-up on previously identified issues. They involve creating an action or corrective action plan to address identified deficiencies.

External audits, usually conducted annually, focus on a snapshot of the organization’s financial status for that specific period. However, their reports might trigger management responses, leading to further corrective action or improvements.

Understanding the distinctions between internal and external audits is crucial for organizations to effectively manage risks, maintain compliance, and continually improve their operations.

What Are Audit Control Procedures?

There is no universal approach to understanding internal controls, business processes, and the effectiveness of a control. Instead, the requirements differ for each audit.

An auditor must also understand each component of the client’s financial reporting controls, including the overall control environment, the risk assessment process, information systems, control activities related to the audit, and how the client monitors internal controls.

What Are the Two Types of Audit Procedures?

While it varies from case to case, two audit procedures are typically used: substantive and analytical.

Substantive Procedures

Substantive procedures are classified as auditors’ processes, steps, and physical examinations. These procedures provide evidence of the correctness, completeness, disclosure, rights, and valuations in statements related to the company’s financial position.

When performing audit procedures, the auditor is expected to gather sufficient evidence to corroborate their audit opinion. This should enable another auditor to apply the same conclusion about the operating effectiveness of controls.

Analytical Procedures

Analytical procedures are the processes, steps, and evaluations to determine plausible relationships between financial and non-financial data. Analytical auditing procedures can differ depending on which financial information is being audited.

What Is the Audit Process Step-by-Step?

Every fiscal year-end, the auditor is supposed to evaluate the design of the financial reporting controls relevant to the audit and determine whether the client has implemented them correctly.

Control activities relevant to any particular audit may vary depending on the client’s size, complexity, and the nature of its operations. The AICPA recommends that auditors consider issues such as risk, other components of the internal controls, and legal and regulatory requirements.

In addition to talking to company employees, the auditor must use additional procedures, such as inspections, observations, or tracing transactions through the information system, to understand the company’s internal controls. An auditor should use professional judgment to identify the appropriate audit procedures.

Let’s take a look at these steps individually.

1. Inspection: In this phase, the auditor checks the accounts payable or receivable transactions for potential misstatements and other relevant reporting standards.
2. Observation: Then, the auditor may observe employees to ensure they perform their tasks according to the appropriate regulations and expectations.
3. Confirmation: In this phase, the auditor will confirm that any financial reporting and account balances match the internal financial statements to check for risks of material misstatement. Examples include control activities relevant to the risk of fraud or control activities over journal entries, such as unusual transactions, allocation of funds, or adjustments.
4. Recalculation: Then, the auditor will cross-check the information presented by the business for mathematical accuracy.
5. Reperformance:  Last, the auditor will re-perform the process to ensure the results are valid and limit audit risk. For existing clients, an auditor may use information obtained from any previous experience with the company to ascertain any changes affecting the control environment.

Audit process best practices

Optimizing audit processes is fundamental for organizational growth and compliance. Embracing best practices ensures precision in evaluations, actionable insights, and seamless improvements. Here are some key best practices:

Thorough Planning and Scope Clarification

Begin by defining the scope of the audit and setting a clear time frame. Establish a detailed audit plan outlining steps for practical fieldwork and evaluation of internal controls.

Precise Methodology and Execution

Utilize a robust audit program and ensure meticulous work aligned with the established methodology. This process demands diligence in conducting internal audits, ensuring accuracy and reliability.

Insightful Observations and Recommendations

Gather comprehensive audit observations to form the basis for valuable audit recommendations during the audit. These insights are crucial for the auditee to implement necessary corrective action plans.

Effective Communication and Reporting

Engage in both entrance and exit meetings for clarity and alignment. An exit conference provides a platform to discuss findings before presenting the draft audit report. This paves the way for a comprehensive audit report highlighting key audit results.

Continuous Improvement and Follow-Up

Following the report, initiate a follow-up process to track the implementation of suggested improvements. Engage with audit clients and the office of internal audit to ensure continuous enhancement of practices.

How Automating Audit Preparation Can Help

Financial audit management requires a lot of planning and documentation.

Auditing software like ZenGRC can streamline the process by empowering you to gather and organize all the information needed and fulfill your requirements in one central location.

ZenGRC simplifies your audit plan with framework templates and a reporting dashboard that shows you what you have and what documentation still needs to be ready for your audit. The ZenGRC’s risk assessment modules can provide valuable insight into where your reporting is lacking so you can take quick action to compile the documentation you need.

Worry-free financial audits are the ‘Zen’ way. Contact our team today to get your free ZenGRC consultation and demo.