A financial audit is a process in which an experienced professional assesses a company’s financial statements. This process aims to identify any material misstatements that may exist in those statements. Similarly, financial audits seek to ensure that the financial statements present a true and fair view of a company’s financial matters.
Financial audits or the auditing field has advanced significantly from the past. In the past, companies only conducted external audits after specific periods. However, the use of internal audits has become prevalent among companies. In some jurisdictions, it is mandatory for companies to have an internal audit function. Internal audits play a significant role in a company’s internal control systems.
Despite its many benefits, some people are skeptical of internal audits. This skepticism stems from the limitations of the internal audit function. Before understanding what these limitations are, it is crucial to understand what internal audit is.
What Is Internal Audit?
Internal audit is a process through which companies assess their internal controls. Unlike external audits, it does not focus on analyzing the financial statements for material misstatements. Instead, it aims to provide independent assurance that a company’s governance, internal control, and risk management processes operate effectively.
Internal auditors have many tasks in any company. While there are some standards that dictate how they perform their work, their work scope may differ from one company to another. Usually, a company’s management defines the roles of internal auditors. It implies that the extent of their work comes from each company’s requirements.
Usually, however, most internal audit functions share the same objectives. The primary goal for any internal audit function is monitoring a company’s internal control systems. As mentioned above, however, there are several other tasks that internal auditors perform. In most of these tasks, internal auditors only act as advisories. They don’t take part in the execution of any activities. Instead, they make recommendations to the company’s management.
While internal auditing has existed for a long time, it became more relevant due to the Sarbanes-Oxley Act of 2002. In most jurisdictions, publicly-listed companies are required to have an internal audit function. While the same does not apply to private companies, they may still employ internal auditors voluntarily.
What Are the Limitations of Internal Audit Function?
Despite its popularity and wide acceptability, internal audit functions may not be effective. There are several reasons that limit internal audit functions. These reasons may stem from the function itself or how a company uses it. Some of the limitations of internal audit functions are as below.
Independence
Like external auditors, internal auditors also need to be independent of a company’s management. Given their relationship, however, it may not be possible to achieve that. If internal auditors cannot establish their independence from the executives, their work will not provide benefits. It is one of the limitations of the internal audit function arising from the employee-employer relationship between internal auditors and management.
Cost
Most companies avoid using the internal audit function due to the high costs associated with it. For most companies, this function entails an additional cost that they can eliminate by removing it. On top of that, a company’s shareholders may not welcome an internal audit function. It is because it reduces profits while they understand how it helps the company.
Incompetency
A strong internal audit function depends on the internal auditors within it. If these auditors are cannot do their work properly and are incompetent, they can severely limit the benefits from this function. The responsibility for choosing competent and professional internal auditors lies with the management. If they fail to do so, the internal audit function will not provide any benefits.
Reactive Approach
Internal auditors can only detect deficiencies in a company’s internal control after it has occurred. On top of that, internal auditors need information from other departments to analyze to identify any anomalies. In both cases, internal auditors take a reactive approach. It is also a contributing factor to the expectations gap that most people have from an internal audit function.
Dependency on Management
One of the limitations of an internal audit function is that its effectiveness depends on the company’s management. Internal auditors play an advisory role in any company. Their job is to identify anomalies and report them to the relevant authority. However, they cannot take any due actions. Instead, they have to rely on the management to employ the necessary countermeasures.
Scope of Work
While internal auditors have some standards that they can follow to perform their work suitably, they don’t have a clear scope of work. Instead, the company and its management make decisions on how the internal audit function should run. If a company’s management fails to provide clear instructions or segregation of duties, the internal audit function may not operate as expected.
Conclusion
Internal audit is a process that companies use for several reasons, such as internal controls, risk management, analyzing financial reports, etc. Despite its prevalence, there are some limitations of internal audit functions. These include the function’s independence, incompetency, reactive approach, dependency on management, and scope of work.
