ACCT 1163 – Professional Elective (Operations Audit)

2nd Semester Academic Year 2020-2021

Lesson 1, Week 1: Understanding Operational Auditing

Topics: a. Definition of Operations Audit

b. Scope of Operations Audit
c. Audit Approaches to Operational Audits
d. Resourcing the Internal Audit of Technical Activities
e. Productivity and Performance Measure System
f. Value for Money Auditing
g. Benchmarking

Learning Outcomes: At the end of this module, you are expected to:
1. Define operations audit
2. Know the scope and applicability of Operations audit
3. Know the audit approaches and techniques on how to audit the
Operations of an Entity
4. Know the 6 Es of Operation Audit

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Lesson Proper:

OPERATIONAL AUDITING
Business processes often step across the frontiers between sections within a business, requiring high
standards of coordination between different organisational parts. Control is often weaker where coordination is
required between sections that are organizationally separate.
The term “operational auditing” conjures up different images for internal auditors. It may be used to
mean any of the following:
1. The audit of operating units such as manufacturing plants, depots, subsidiaries, overseas operating
units, and so on
2. 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.
3. The audit of any part of the business (operating unit, functional area, section, department or even
business process, etc.) where the audit objective is to review the effectiveness, efficiency and economy with
which management is achieving its own objectives.

SCOPE
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

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 Internal auditing is 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.
Although the focus of operational auditing is likely to be on those activities which are most strongly
associated with the main commercial markets of the organisation (for example, production, sales, after sales
support, service provision, etc.), it is likely that the supporting or infrastructure operations will also need to be
reviewed on the basis that they too contribute to the well-being of the organisation as a whole. At the top level,
one possible categorisation of all these areas could be as follows (although this classification will not fit every
business or service-provision scenario):
• 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.

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.
“Audit objectives” are not synonymous with “management’s objectives” as the audit objectives specify
the particular focus that the auditors will have during the audit engagement.

Auditing for the Three and Six Es

Operational auditors are auditing for the “three Es”—effectiveness, efficiency and economy.

ACTUAL ---------------- [Efficiency]------------------- ACTUAL

INPUTS OUTPUTS

[Economy] [Effectiveness]

PLANNED PLANNED
INPUTS OUTPUTS
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• 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.

• 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.
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 • Effectiveness – means “doing the right things” – i.e. achieving objectives.
Effectiveness is the ratio of actual outputs to planned outputs (i.e. planned
objectives).

Internal auditors have now added a further “three Es” to their portfolio of matters of audit interest, particularly as
a consequence of their role in the audit of governance processes as set out in Standards 2110 to 2110.C1 of
The Institute of Internal Auditors:
• 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.

RESOURCING THE INTERNAL AUDIT OF TECHNICAL ACTIVITIES

The Institute of Internal Auditors on “Proficiency” reads:
“Internal auditors must possess the knowledge, skills, and other competencies needed to perform their
individual responsibilities. The internal audit activity collectively must possess or obtain the knowledge, skills,
and other competencies needed to perform its responsibilities.”

and

“1210.A1—The chief audit executive must obtain competent advice and assistance if the internal auditors lack
the knowledge, skills, or other competencies needed to perform all or part of the engagement. . . .

“1210.C1—The chief audit executive must decline the consulting engagement or obtain competent advice and
assistance if the internal auditors lack the knowledge, skills, or other competencies needed to perform all or part
of the engagement.”

The chief audit executive is responsible for all internal audit engagements, whether performed by or for the
internal audit activity, and all significant professional judgements made throughout the engagement. The CAE
also adopts suitable means to ensure this responsibility is met. Suitable means include policies and
procedures designed to:

• minimize the risk that internal auditors or others performing work for the internal audit activity make
professional judgements or take other actions that are inconsistent with the CAE’s professional judgement
such that the engagement is impacted adversely.

• Resolve differences in professional judgement between the CAE and internal audit staff over significant
issues relating to the engagement. Such means may include discussion of pertinent facts, further inquiry or
research, and documentation and disposition of the differing viewpoints in engagement working papers. In
instances of a difference in professional judgement over an ethical issue, suitable means may include referral
of the issue to those individuals in the organization having responsibility over ethical matters.

PRODUCTIVITY AND PERFORMANCE MEASUREMENT SYSTEMS

Example Performance Measures:
1. Workload/Demand Performance Measures
2. Economy Performance Measures
3. Efficiency Performance Measures
4. Effectiveness Performance Measures
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5. Equity Performance Measures

VALUE FOR MONEY (VFM) AUDITING

Value is provided by improving opportunities to achieve organizational objectives, identifying
operational improvement, and/or reducing risk exposure through both assurance and consulting services.
The internal audit activity adds value when the organisation and its stakeholders benefit from the
results of internal audit work. Benefit arises when the internal audit activity provides objective and relevant
assurance, and contributes to the effectiveness and efficiency of governance, risk management and control
processes.

A better definition of ‘add value’ would be:

1. 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.
2. Value for money auditing takes account of the three Es.
3. Value for money auditing will involve the assessment of an appropriate range of performance
measurement criteria.

In both the management and audit assessment of matters of value for money, the usual approach is to
make comparisons with a range of options or possible solutions to the principal problem. In order to avoid any
potential problems at the conclusion of their assessment, auditors should consider discussing their proposed
assessment and measurement criteria with management at the outset, and furthermore to obtain the
agreement of management on the applied methodology. In certain sectors and industries, recognised criteria
may already exist and so it may not be necessary for auditors to develop their own process.

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. For a benchmarking exercise to be meaningful, it is
necessary to understand fully the existing processes, systems and activities as a firm basis for subsequent
comparison with external points of reference (such as industry or professional standards). This process of
realisation often incorporates the establishment of critical success factors for an operation (or part thereof).
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.

Internal audit departments can often benefit from participating in benchmark comparisons with other
audit functions; such involvement can contribute to their understanding of:
• the internal auditing trends and practices as applied by the companies surveyed;
• the implications and potential of the findings for the participant’s own organisation;
• the validity of the participant’s own stance on internal auditing in relation to that apparent from the survey
data.
Benchmarking is not an end in itself, but rather one platform used to identify and subsequently launch
the required or necessary processes of change within a department, function, activity, process or organization.

REFERENCES

1. Romney, M. and Steinbart, P. (2018). Accounting Information System. Times LT Pro by Cenveo
Publisher Services, Italy.
2. Chambers, A. and Rand, G. (2010). The Operational Auditing Handbook Auditing Business and IT
Processes John Wiley and Sons, Ltd., Publication, UK.
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