INTERNAL CONTROLS & CORPORATE GOVERNANCE : FNSACC506A - Week 6B-7.
Chapter 10 – Leeson, Di Sisto, Flanders : The Purpose & Practise of Performance Auditing.
Auditing Standards definitions :
ASAE 3500, defines a performance audit engagement or a performance review audit as :
Performance audit or performance review of all or a part of the activities of an entity 9or entities) to assess economy, efficiency or effectiveness. It includes a ‘performance audit engagement’ or a ‘performance review audit’ directed to assess:
- The adequacy of an internal control structure or specific internal controls, in particular those intended to safeguard assets, ensure due regard to economy, efficiency & effectiveness.
- The extent to which resources have been managed economically & efficiently; and
- The extent to which activities have been effective.
As seen from this definition, performance auditing provides for the same type of investigation & evaluation of an entity as that referred to as management auditing.
The terms performance audit & performance review are predominately applied in the public sector. In private sector they are commonly referred to as – operational audits & operational reviews.
Economy, Efficiency & Effectiveness :
· ASAE defines economy as : the acquisition of the appropriate quality & quantity of resources of the appropriate quality & quantity of resources at the appropriate times & at the lowest cost.
For efficient operation of an entity it is important for sufficient resources to be available at the appropriate/needed time. (not before and not too late). There are many factors of supply & timing that need to be considered on their merits.
· Efficiency : means the use of resources such that output is optimised for any given set of resource inputs; or that input is minimised for any given quantity or quality of output.
Efficient use of resources of all types enable the costs of resources to be minimised per unit of production.
· Effectiveness : is defined as ‘te achievement of the objectives or other intended effects of activities at a program or entity level’.
Criteria must be established against which the organisation can be measured. These may be industry averages, levels of efficiency gained by competitors, or drawn from similar operations elsewhere.
Efficiencies may be gained through :
- Better purchasing practises……central purchasing may – buy materials more competitively by bulk ordering; have better awareness of prices across suppliers; call tenders to obtain lower prices.
- Eliminating poor work practises.
- Improving production planning – better scheduling can reduce costs by maintaining even output rather than working overtime for some periods, then having idle periods.
If effectiveness is the objective of the performance audit – then appropriate criteria must be established. This requires careful consideration of the purpose of the organisation to ensure that the criteria relate to the primary purpose, rather than some secondary matter.
ASAE 3500 advises that suitable criteria have the following characterictics :
· Relevance – relevant criteria contribute to conclusions that assist decision-making by the intended users.
· Completeness – criteria are sufficiently complete when relevant factors that could affect the conclusions in the context of the performance engagement circumstances are not omitted. Complete criteria include, benchmarks for presentation & disclosure (where relevant).
· Reliability – reliable criteria allow reasonably consistent evaluation or measurement of the activity, including when used in similar circumstances by similarly qualified assurance practitioners.
· Neutrality – neutral criteria contribute to conclusions that are free from bias.
· Understandability – understandable criteria contribute to conclusions that are clear, comprehensive & not subject to significantly different interpretations.
Types of Performance Audits :
ASAE 3500 – deals with two types of performance engagements :
- Performance audit engagements, that provide reasonable assurance.
- Performance review engagements, that provide limited assurance.
Reasonable assurance – provides a high, but not absolute, level of assurance. While a limited assurance – provides a reduced level of assurance engagement risk, that is acceptable in the circumstances of the assurance engagement; but where risk is greater than for a reasonable assurance engagement.
More generally – functional, organisational & special assignment engagements have also been identified.
Functional -
Is an audit that examines a particular operation within an organisation such as the procedures followed for the cash payments made by the accounting department. It may also extend to the procedures followed for the approval of the introduction of a new product or process.
The audit examines whether the function is performed economically, efficiently & effectively. It is important to include interrelated functions, because to omit them may result in misleading results.
Organisational -
Is an audit that reviews the organisational structure of the entity, department or division or subsidiary. Emphasis is to examine how efficiently & effectively the organisation operates especially when considering the interaction of different functions. Flowcharts of info & org. plans are of particular interest in this type of audit.
Special assignments -
Management may commission audits for a wide variety of special reasons – including the investigation of possible fraud or poor procedures, that could allow misappropriation of company property.
Comparing Financial Auditing & Performance Auditing :
Performance audits involve much more than a review of financial data – may require knowledge of production techniques or other matters.
The differences between financial & performance audits – stem essentially from 2 fundamental differences :
- Performance audits are forward looking while financial ones are reporting the past.
- Performance audits may be concerned with matters beyond the essentially financial focus of a financial audit.
Flowing from these major differences, are a number of others :
Purpose – performance audits aim to evaluate management methods & systems to enable improvement in performance in the future. Financial express an opinion as to whether the fin. reports are true & fair view.
Scope – financial review the fin. Records of the whole organisation. Performance may restrict its scope to a particular section or aspect of an organisation.
Necessity – financial audit is required by Law on an annual basis. Performance audits are entirely at the discretion of management of the organisation.
Focus – financial is focused on the actual fin. Records of the past. Performance audit may be focused on financial, organisational, physical, technological or any other matters as they effect the future potential of the entity.
Reporting – Corp Act requires an audit report of a financial audit in a particular form, that expresses the opinion, and must be attached to the fin. Reports. Performance audit is a comprehensive report that refers to the matters in the original contract of engagement or instructions; and deals with objectives, scope, approach, findings & recommendations.
Audit team – external auditing must be done by registered company auditors, employed by a public accounting firm – interested only in financial reporting. Performance audit team, may include members from a variety of disciplines.
Audit report for a financial audit is widely circulated to shareholders, government & the public.
Performance audit report is available to management only.
Comparison between Financial & Performance auditing – table 10.1…p.278 – text.
Benefits of Performance Auditing :
Seen to offer a number of benefits to management & to the organisation.
1. Provides management with timely & relevant info for decision-making. Info provided will be in response to requests of management.
2. Provides management with an independent view. Can result in issues not apparent to management being raised & dealt with.
3. May identify potential problems at an early stage, giving management time to deal with the problem, before it gets worse.
4. It may identify wastage inherent in the current arrangements that may otherwise be covered up, thus leading to reduced wastage ( result of no vested interest with auditors).
5. In evaluating the effectiveness it may query accepted objectives & goals, leading to a tighter, more focused organisation.
6. Assists management to evaluate management systems including reports, records & procedures.
7. Discovers whether managerial policies & practises are implemented & whether governmental requirements are complied with.
8. Provides top management with a tool to evaluate the performance of decentralised management, or specialised staff in large, complex organisation.
9. Provides a useful management training activity enabling the management team to gain an insight into the various activities & interrelationships within the organisation.
Planning Performance Audits :
As with any audit the standard requires the audit to be properly planned to enable proper attention to be given to important areas of the audit, the potential problems & for expeditious completion of the work. It ensures proper co-ordination of the work.
STEP 1 – Understand the terms of the audit engagement.
Important to understand no matter who has commissioned the audit, the auditor will be guided by and understand the requirement, the degree of discretion, the scope & objectives of the audit.
STEP 2 – Understand the activity.
Auditor needs an understanding of the activity they are to audit, to enable the auditor to identify & assess the performance engagement risks of the activity sufficiently – to be economic, efficient & effective.
STEP 3 – Assess the appropriateness of the activity.
1. Being identifiable – capable of consistent assessment.
2. Ensuring the info is capable of being subjected to procedures; & evidence is appropriate.
STEP 4 – The assurance practitioner shall assess the suitability of the criteria.
To evaluate or measure the performance of the activity, suitable criteria needs to be derived.
STEP 5 – The assurance practitioner shall consider materially & performance engagement risk.
1. Consider quantitive & qualitative factors when assessing matters of materiality & risk.
2. Assess the auditability of the matters included in the scope of the engagement.
STEP 6 – Assess whether the audit staff have the necessary skills, competence & knowledge.
STEP 7 – Identify the probable nature, sources & availability of the evidence required.
Also factors such as availability & cost of the evidence. The practitioner uses professional judgement & exercises professional scepticism in evaluating the quantity & quality of the evidence.
STEP 8 – Establish the engagement plan & the engagement program.
The practitioner will plan a performance engagement so that it will be conducted effectively & achieves the objectives communicated or agreed. Planning involves developing an overall strategy for the scope, emphasis, timing & conduct of the audit.
Adequate planning :
- Helps to devote appropriate attention to important areas of the engagement, identify potential problems & properly organise & manage the engagement – for it to be conducted in an efficient & effective manner.
- Assists the practitioner to properly assign work to the engagement team; and facilitates their direction & supervision.
- Assists the co-ordination of work done by other practitioners & experts.
The assurance report :
When reporting the assurance practitioner must determine whether sufficient evidence has been collected to support the conclusions expressed in the report. The report should also make clear whether matters are dealt with as performance audits or as performance reviews.
The assurance report shall be in writing & shall contain expression of the assurance practitioner's conclusion against the objectives communicated or agreed in the terms of the performance engagement.
ASAE 3500 – paragraph 84 – makes it clear the basic elements of an assurance report.
Paragraph 84 – enables the practitioner to provide one of the following conclusions, when they are unable to express an unqualified conclusion :
1. A qualified conclusion. 2. An adverse conclusion. 3. A disclaimer of conclusion.
Attest Audit :
Requires the auditor to provide a written report expressing a conmclusion supporting a written assertion, or set of assertions made by management or another person responsible for matters that are subject of the assertions made.
This means that the auditor is being asked to support the assertions or claims being made by management; who have the responsibility for the entity’s operations & procedures.
EG. When a chemical company claims to have significantly reduced emissions to very low levels & provides an independent audit finding to support those assertions.
Direct Reporting Audit :
Is where management of an entity requests an examination of an operation or activity, without having made any assertions about that operation or activity.
The practitioner will seek out relevant & reliable info, with the assistance of management, & provide a report that includes the info collected, consideration of the info; & conclusion or set of conclusions.
Generally it is conducted in an atmosphere where the practitioner is able to exercise judgement regarding the necessary scope of the audit; so they can gather the necessary info to form an opinion.
It is most important that the client & audit practitioner both have a clear understanding as to what the scope of the audit is, prior to the engagement. This is so the client will receive a report that is appropriate to their needs.
Performance auditing – in many cases, is a task of internal auditors reporting directly to management.
Role of Performance Auditing in Public & Private Enterprises :
Performance auditing has a strategic role to play in maintaining & developing the competitive position of any business organisation.
As Australia seeks to become more internationally competitive – issues of efficiency, effectiveness & economy (areas dealt with by performance audits), become more central to the approach of management.
Performance auditing in practise : p.283-85 text….read this section.
NB :
- It is important to measure appropriate aspects of a program.
- Performance audits are carried out to evaluate efficiency, effectivenss & economy – it is clear management of all types (public & private), need to regularly review their area of authority, to ensure that the resources available to the organisation, are used to greatest effect – even though their may be objection to change.
- Another value of performance audits to managers – is to communicate value at the end of the year. This is particularly important in the public sector.