Types of Internal Audits

Instructor: Dr. Douglas Hawks

Douglas has two master's degrees (MPA & MBA) and a PhD in Higher Education Administration.

Internal audits are conducted for different reasons and with varying objectives. In this lesson, we will discuss four of the most common types of internal audits and provide examples for each.

Types of Internal Audit

Internal audits have the fundamental purpose of optimizing the risk exposure of an organization. Risk exposure is the degree of risk an organization may experience, based on the probability and likelihood of any risk event. There are different types of risk which require different types of internal audits.

Some audits are required by regulation or policy, while others are requested by management to help improve processes or identify internal control weaknesses. Audits also include much more than just financials - essentially any aspect of an organization that can hurt or help the company is auditable. The four most common types of internal audits are compliance, management, environmental, and social audits.

Compliance Audits

Compliance audits are those that are done because of a policy or statutory requirement. This doesn't mean the objective of the audit is just to check a box and complete the audit, but the timing and primary driver of the audit are based on some requirement. A good example of a statutory compliance audit is an annual executive compensation audit done at publicly-traded companies.

Section 301 of the Sarbanes-Oxley Act requires the Board of Directors of a publicly-traded company to review executive compensation. This is done through an internal audit that has the objectives of ensuring proper approvals are in place for executive compensation and processes are in place to control the disbursement and/or transfer of compensation. While the audit is done for regulatory reasons, the objectives are still to ensure adequate control over an important internal process.

Management Audits

Management audits, also called performance audits, are internal consulting projects. Because an internal audit is an activity independent of management, it is often an excellent resource to provide independent and objective insight on the efficiency of business processes. Management can request internal auditors to review a business process, organization, or strategy; and the auditors do not have to worry about backlash from management. This is a big advantage for management since there is no reason for auditors to ''tell the boss what they want to hear.''

Examples of management audits may include a review of inventory management processes, such as how inventory is forecasted, stored, and moved. Another common management audit is a review of organizational structure, such as having an internal audit look at how administrative work is divided among divisions and if there are opportunities to be more efficient.

A management audit does not need to be strictly consultative and not have any assurance work included. In fact, the best audits often have elements of both. For example, if management requests a review of inventory management, an internal audit could also include testing of inventory controls. In this way, they are able to provide helpful feedback to management and also increase assurance over a key asset category - inventory.

Social Audits

Social audits are perhaps the most ambiguous of internal audits. Social audits have the objective of assessing social processes such as corporate culture, ethics, and communication. Those areas are often very difficult to measure and assess, but an internal audit - as an independent and objective activity - is well-positioned to do those reviews.

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