Definitions of Operational Auditing

The term “operational auditing” conjures up different images for internal auditors.
It may be used to mean any of the following:
 The audit of operating units such as manufacturing plants, depots,
subsidiaries, overseas operating units, and so on. While the audit scope may
cover only accounting, financial and administrative controls it may be
broadened in scope to cover the administrative and operational controls, risk
management and governance processes of the operating unit under review.
 The audit is how the functional areas of a business (such as sales, marketing,
production, distribution, HR, etc.) account for their activities and exercise
financial control over them.

SCOPE
A key issue for a business and its internal audit function to decide upon is whether
the scope of internal audit work in an operational area of the business should be
restricted to a review of the appropriateness of, and extent of compliance with, key
internal controls or should be a more comprehensive review of the operation
generally.

Internal control is broadly defined as a process, effected by the entity’s board of

directors, management and other personnel, designed to provide reasonable
assurance regarding the achievement of objectives in the following categories:
• Effectiveness and efficiency of operations.
• Reliability of financial reporting.
• Compliance with applicable laws and regulations.

5 Components of Internal Control (CRIME)

1. Control Activities
2. Risk Assessment
3. Information and Communication
4. Monitoring
5. Control Environment

So COSO’s broad view of internal control is that internal control (i.e. management
control) is everything that management does in order that there is reasonable
assurance the business will achieve all of its objectives. A narrower view of
internal control is that it is only one of a number of facets of management—among
others being planning, organising, staffing and leading. It is true that these facets
overlap and an internal audit which intends to focus more narrowly on key internal
controls is likely to need to address planning, organising, staffing and/or leadership
issues to some extent, since deficiencies in these may weaken control. But there
will be many aspects of planning, organising, staffing and leading which are
neutral in their effect on the functioning of key controls but which contribute to
providing reasonable assurance of the achievement of efficient and effective
operations.

The audit function, however, in operational auditing will have to define those
aspects of the organisation which are to be subject to review. In practice, of course,
this will vary considerably between organisations, and will be related directly to
the nature of the business and the way the organisation is structured. Example
• management and administration
• financial and accounting
• personnel and human relations
• procurement
• stock and materials handling
• production/manufacturing
• marketing and sales
• after sales support
• research and development
• information technology
• contracting.

The activities covered in financial institution and health sector-specific sets are
Sector: Financial institutions
• branch security
• branch operations
• management
• treasury dealing
• investments—new accounts
• investments—account maintenance
• investments—account statements
• secured personal loans
• unsecured loans
• commercial lending—new business
• commercial lending—account maintenance
• cheque accounts
• ATM services
• credit and debit cards
• new mortgage business
• mortgage account maintenance
• mortgage arrears
• mortgage possessions and sales
• mortgage mandates
• mortgage annual statements
• treasury environment
• staff accounts
• securities.

Sector: Health
• purchaser contracting
• provider contracting
• general practitioner fund holding
• charitable funds
• use of health centres
• private patients
• welfare foods
• residential accommodation
• joint finance
• residents’ monies
• cashiers
• family health service authority
• road traffic accidents
• nursing homes
• trading agencies
• insurance products
• pharmacy stores
• risk management
• cash collection—car parks
• cash collection—telephones
• cash collection—prescriptions
• cash collection—shops/restaurants
• cash collection—staff meals
• cash collection—vending machines
• income generation
• staff expenses
• losses and compensations.

AUDIT APPROACH TO OPERATIONAL AUDITS

Auditors of operations should keep firmly in their mind the objectives of
management for the operations being audited. At an early stage in planning the
audit engagement, the audit team need to establish what are management’s
objectives.

Note: No time should be expended during the audit engagement on issues which
are immaterial to the achievement of management’s objectives. Nothing should
appear in the audit report of the engagement which is immaterial to the
achievement of business objectives by management.

Note: The audit findings will be addressed to the level of management (higher
level of management) that needs to know and that is capable of ensuring
appropriate action on audit findings is taken.

Steps:
1. What are your objectives?
2. What information do you need to be receiving so that you know whether
these objectives are being achieved?
3. Can you show us the information or evidence?
4. Established Audit Objectives (Focus of auditors)
5. Draw up audit program (list of detailed audit procedures)
a. confirming the reliability of the management information
b. undertaking audit fieldwork so as to develop audit recommendations
on issues they are already aware of with respect to incompleteness,
lack of clarity, inconsistency and untimeliness;
c. determining whether other significant events are occurring which
should be reported to the oversight function.
Auditing for the Three and Six Es
• Economy – means “doing them cheap” – with, for instance, unit costs for labour,
materials, etc. being under control. Economy is the ratio between planned inputs
and actual inputs in terms of unit costs of given quality. (Actual cost < budgeted
cost?)
• Efficiency – means “doing things well” – smoothly, for instance with good
systems which avoid waste and rework. Efficiency is the ratio of actual inputs to
actual outputs. Every organisation, whether a service organisation or a
manufacturing business, has such a conversion process.
• Effectiveness – means “doing the right things” – i.e. achieving objectives.
Effectiveness is the ratio of actual outputs to planned outputs (i.e. planned
objectives) Budgeted output = Actual output?
• Equity—avoidance of discrimination and unfairness; acceptance and promotion
of diversity.
• Environment—acting in an environmentally responsible way.
• Ethics—legal and moral conduct by management and staff.

PRODUCTIVITY AND PERFORMANCE MEASUREMENT SYSTEMS

Organisations are likely to have in place a number of key performance measures,
so as to, among other things, assess the achievement of their objectives and
goals, assess their progress, and compare relative performance (for example,
over time).

Example Performance Measures

Workload/Demand Performance Measures - Indicate the volume of output,
whether services, products or other, and when linked to measures of input of
resources, give useful information on quality or quantity matters.
Examples:
• Number of users
• Number of units produced
• Number of books in a library
• Percentage of first class degrees in a university.

Economy Performance Measures - These may highlight waste in the provision of

resources indicating that the same resources may be provided more cheaply or that
more enterprise may be conducted at the same cost.
Examples:
• Cost of actual input in comparison with planned input
• Cleaning costs per hour worked
• Maintenance costs per unit area
• Cost of the finance function per 100 staff
• Cost of the chief executive’s department per 1000 clients.

Efficiency Performance Measures - These may highlight potential opportunities

to convert given resources to end product with less waste. Many performance
measures will point to either uneconomic or inefficient practices, or both. It is
often not possible to distinguish between one and the other.
Examples:
• Ratio of actual input to actual output
• Breakdown per production day
• Accidents at work per 1000 personnel
• Degree success in comparison to school examination grades.

Effectiveness Performance Measures These performance measures focus on how

objectives are being achieved— regardless of economy, efficiency or equity
(except where the objectives relate specifically to economy, efficiency and equity).
Examples:
• Actual output in comparison to planned output
• Degree success (in a college or university)
• Research output per 100 research staff
• Ratio of customer complaints to sales.

Equity Performance Measures These performance measures draw attention to

unfairness or potential social irresponsibility in terms of corporate policy and
practice.
Examples:
• Departmental grant per member of staff
• Number of library books per category of user
• Proportion of female employees
• Proportion of disabled employees.

Value for Money Auditing

Value for money auditing is sometimes used in a different context to refer to a
style of operational auditing which makes extensive use of key performance
indicators to explore the cost of achieving standards of efficiency and effectiveness
and whether these costs represent good value.

Value for money auditing takes account of the three Es. It frequently makes
extensive use of performance indicators in the form of ratios and other statistics to
give an indication of value for money—especially when trends are explored in
these performance indicators over time, or variations in performance are identified
and explained between different operating units

BENCHMARKING
Benchmarking can be defined simply as a comparison of one’s own performance
in a specific area with that applied by others in compatible circumstances. As a
technique it is founded on the premise that there may be viable alternative ways of
performing a process and fulfilling a requirement. The principal objectives of
benchmarking are likely to include:
• maintaining a competitive advantage in the appropriate market;
• establishing current methods, best practice and related trends;
• ensuring the future survival of the organisation;
• maintaining an awareness of customer expectations (and being able to address
them);
• ensuring that the organisation has the appropriate approach to quality issues.