PILGRIM CHRISTIAN COLLEGE

United Church of Christ in the Philippines

Capistrano – Akut Sts., Cagayan de Oro City

ACCTG EI. IA - OPERATIONS AUDITING

2nd Semester AY 2022-2023

Lesson 1, Week 1: OPERATIONAL AUDITING CONCEPTS

Topics Differentiate efficiency, effectiveness, economy, and

other components of seven E's of audit.
Understand the risk-based audit model.
Appreciate the nature and the value of audits other than
external financial audits.
Describe the benefits challenges of operations audit.
Learn the categories of and who performs operational
auditing.
Appreciate the internal audit function.
Understand and start developing the soft skills and the
qualities expected from an internal auditor.

OVERVIEW

 Institute of Internal Auditors (IAA), defines Internal auditing as:

o an independent, objective assurance and consulting activity designed to add
value and improve an organization's operations. It helps an
organization accomplish its objectives by bringing a systematic,
disciplined approach to evaluate and improve the effectiveness of risk
management, control, and governance processes

 Endorsed by classic management writers, Koonts, O’Doneell and Wehrich

 “An effective tool of managerial control is the Internal audit, or, as it is now
coming to be called, the operational audit
  often limited to the auditing of accounts, in its most useful aspect
operational auditing involves appraisal of operations generally

 operational auditors, in addition to assuring themselves that accounts

properly reflect the facts, also appraise policies, procedures, use of authority,
quality of management, effectiveness of methods, special problems, and
other phases of operations
Deals with efficiency and effectiveness of an organization
Other terms: operational auditing, management auditing and performance
auditing

 institute of Internal Auditors (IAA)

1. "a systematic process of evaluating an organization's effectiveness, efficiency

and economy of operations under management's control and reporting to
appropriate persons the results of the evaluation along with recommendations
for improvement.”

2. more comprehensive and go beyond financial data (although that type of

reporting is often included).

3. The primary information sources are policies and achievements related to the
objectives of the organization.

 future-oriented, independent, systematic, and business-focused evaluation of

management, and the organization's activities controlled by management and
third parties.

 The purpose of operational auditing is to improve organizational profitability and

the attainment of organizational objectives.

 Evaluating management’s performance, since they have a fiduciary responsibility

toward the organization’s owners and another relevant stakeholder

1. fiduciary responsibility - a commitment to act in the best interests of

another person or entity

Verifies a variety of qualitative aspects of the organization and its activities

Also concerned with the structure of the organization

May require an analysis of multiple time periods (not the traditional fiscal-year
scope.

“Operational auditing is designed to evaluate the effectiveness and efficiency of

business
activities processes, programs, functions and units.”

SCOPE OF OPERATIONAL AUDITING

Compliance with regulatory requirements

Regulatory agency

O Bureau of Internal Revenue (BIC), Local Government Unit (LGU),

Securities and Exchange Commission (SEC), Department of
Trade and
Industry (DTI), Bangko Sentral ng Pilipinas (BSP),
Department of Labor

and Employment (DOLE), Department if Internal and Local

Government (DILG), Commission of Audit (COA), FDA

Business leaders and managers witnessed business failures caused by poor

management decisions and practices.

Environmental health and Engineering

safety
Production Customer service

Receiving/purchasing Research and development

Human resources Office services

Information technology Advertising

Corporate social Data processing

responsibility
7 E’S OF OPERATIONAL AUDITING

1. EFFECTIVENESS
Doing the right things
Meeting objectives, such as producing products without defects

2. EFFICIENCY
Doing things well
Determining the resources used to achieve those objectives, such as
determining whether parts are produced at minimum costs
Outputs based,

 more outputs with less inputs utilized

3. ECONOMY
Doing them cheap
Price paid for organizational resources
Historically, to asses the economy, the main criterion was the price
Better approach in assessing the economy is to consider the entire
value of the item
o This includes warranties, replacements/repair guarantees,
speed & reliability of delivery, expected useful life etc.

4. EXCELLENCE
Performance of all work with high quality
5. ETHICS
Individual’s viewpoint regarding what is right and wrong will drive
most aspects of decision-making and corporate behavior

6. EQUITY
Treatment of others with dignity and respect
Fairness, reciprocity, impartiality

7. ECOLOGY
Expects organizations to act responsibly toward the environment
 An internal auditor will certainly get management's attention when savings
are
identified, or recommendations are made to accelerate a business process.
Furthermore, by quantifying environmental benefits and linking these to increased
revenue, lower waste, better public relations, and so on, internal auditors will
demonstrate a strategic mind-set that supersedes the tactical approach of traditional
auditors.

RISK-BASED AUDIT

IAA defined Risk Based Internal Auditing (RBIA) as,

oMethodology that links internal auditing to an organization’s overall
risk management framework

risk management framework – Ex. COSO framework

oAllows internal audit to provide assurance to the board that risk

management processes are managing risk effectively, in relation to
the risk appetite

OPERATIONAL RISK

Opposed to effectiveness
Risk of loss resulting from inadequate internal processes , people and
systems or
from external events

oPeople – performs the operation. Deviation from operating guideline

and or inadequacy in operating guideline increases the risk of
shortcoming

oProcesses and systems – business activities consist of processes.

When
there’s discrepancies in an existing procedure or procedure not
defined, could result in losses (lowers effectiveness)
  Watch out for these two, the processes that is supposed to carry out
and the
people whop carries out the processes

Danger of people or processes not living up to the standards

Summarizes the uncertainties and hazards a company faces when it

attempts to
do its day-to-day business activities

Can result from breakdown in internal procedures, people and systems

Classifies as a variety of unsystematic risk, which is unique to a specific

company or industry

DIFFERENCES BETWEEN OPERATIONAL AND FINANCIAL AUDIT

Operational Audit Financial Audit

Purpose • Emphasizes effectiveness • Emphasizes whether
and efficiency historical information was
• Focuses on improving correctly recorded
future performance • Oriented to the past

Distribution of • Intended primarily for • Typically distributed to

the Reports management external users of FS
• Limited distribution • Widespread distribution
• Vary considerably from • Requires well-defined
audit to audit structure and wording
Inclusion of • Cover any aspects of • Limited to matters that
Nonfinancial efficiency and effectiveness directly affects the fairness
Areas in an organization of FS presentation
• To see if financial records • Look into the correctness of
have been properly financial data and records
Effectiveness designed and maintained to along with correctness of
furnish the management the accounting procedures
with timely info followed
Efficiency, • To see that the internal • To see that the internal
Effectiveness control system has been control system working
 designed to achieve better properly
efficiency and functioning
effectively
• Study whether some • To see that all payments
expenditure of sizeable have proper authorizations
magnitude could have been and approval
avoided and reduced

• Study the credit control • To see that the credit

system for suggesting better control has been strictly
measures followed
• Examine whether the • To see that the FS followed
operational functions are in GAAP and displays true and
tune with the management fair view of the transactions
objectives and to carry out and also potions of the
the cost benefit analysis for concern as on particular
decision making date

CATEGORIES OF OPERATIONAL AUDIT

1. FUNCTIONAL AUDIT

Functions – means of categorizing the activities of a business

oMay be categorized and subdivided many ways
oThese categories are interrelated to each other

Deals with one or more functions in an organization

Has advantage of permitting specialization by auditors
Ex – financial audit
Cycles – revenue cycle, cash disbursement cycle

2. ORGANIZATIONAL AUDITS

Deals with an entire organizational unit

oOrganizational unit – emphasizes how efficiently and
effectively functions interact
Plan of organization and the methods to coordinate activities are important
Start with the organizational chart

Reporting to controller, is a bad practice (violates independency and

objectivity)

3. SPECIAL ASSIGNMENTS

Arise at the request of management for a wide variety of audits, such

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 as determining the cause of an ineffective IT system, investigating the
possibility of fraud in a division and making recommendations for
reducing the cost of a manufactured product

WHO PERFORMS OPERATIONAL AUDITING

1. INTERNAL AUDITORS

Report to the board of directors or president

Also, must have access to and ongoing communications with the audit
committee of board of directors
This organizational structure helps internal auditors remain independent
Professionalized and internationalized by IAA

2. GOVERNMENT AUDITORS

Government standards are set for performance audits

Performance audits include the following:
oEconomy and efficiency audits

1. Whether the entity is acquiring, protecting and using resources economically

and efficiently (operational)
2. Causes of inefficiencies or uneconomical practices (operational)
3. Whether the entity has complied with laws and regulations (compliance)

oProgram audits

1. Extent to which the desired results or benefits established are being achieved
(operational)
2. Effectiveness of the organization, programs, activities or functions
(operational)
3. Entity has compiled with the laws and regulations applicable to the program
(compliance)

THE VALUE THE AUDITORS PROVIDE

 Recognition of duties that all employees have to the principals is central to the
proper discharge of their responsibilities as employees, who should always act
in the interests of the main stakeholders

Internal auditors serve the public and the common interest by making sure that
the owners receive the return on their investments that they are entitled to,
and that means of generating those profits are within the confines of the law.

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 Conducting a stakeholder analysis is an important aspect of modern internal
auditing because it gives the auditor an appreciation for various parties
interested in the outputs and outcomes of the organization, its programs, and
its related processes.

INTERNAL AUDIT FUNCTION

 The staff of Internal Audit Office reports to the Chief Audit Executive (CAE)
who reports to Audit Committee or the board directly

Chief Audit Executive (CAE)

oHave full and free access to the audit committee or the board