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What is Internal Auditing in Accounting?

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The Institute of Internal Auditors (IIA) defines internal auditing as "an independent, objective assurance and consulting activity designed to add value and improve an organization's operations." In a broad sense, internal auditing helps a business to achieve its goals by continuously evaluating and honing the processes of risk management, control, and governance.

With regards to accounting, internal auditing is used to deter and investigate fraud, safeguard assets, and make certain that financial reporting is timely and accurate. Internal auditing also ensures that a company's accounting policies and procedures are in compliance with laws and regulations.

In 2002, the Sarbanes-Oxley Act (SOX) was implemented in response to a number of major corporate and accounting scandals. These scandals ultimately cost investors billions of dollars, shook the public's confidence in the nation's security markets, and led to an outcry for accounting standards among publicly-traded companies. Faced with a sudden need to become compliant, many companies turned to internal auditing to help them meet the requirements of the law.

As the name implies, internal auditing is performed by auditors within a company, rather than by a third party. Although the auditors are part of the company and are paid by the company, they must still be organizationally independent from management to perform their role effectively. Typically, a company's board of directors will set up a separate oversight committee, with a chairperson to oversee the chief audit executives.

Although internal auditing is an ongoing process, the financial audit is usually an annual event scheduled to overlap the year-end. Typically, an audit goes through four stages.

Planning and Risk Assessment

Prior to the year-end, the internal auditors acquaint (or reacquaint) themselves with the company's accounting policies, procedures, and internal controls. They study the company's financial performance, and try to uncover any objectives or strategies that might lead to the misstatement of financial statements.

Finally, they perform a risk assessment on their own internal auditing process, looking for potential weaknesses and major risks where the auditor might overlook vital information or issue an incorrect finding. When developing a plan for the internal audit, the auditors will increase the rigor of their procedures on what they perceive to be potential problem areas.

Internal Controls Testing

A company typically institutes a number of internal controls, such as segregation of duties, authorization of transactions, or reconciliation of accounts, to safeguard its assets and reduce the chances of fraud or error. The internal auditors must assess the effectiveness of these internal controls. This stage of the internal audit typically extends through year-end to allow all internal controls to be fully scrutinized.

Substantive Procedures

During this stage of the internal audit, the auditors collect evidence to verify that the figures and disclosures in the company's year-end financial statements are accurate and in compliance with the law. If the testing of internal controls uncovered no serious weaknesses, then the auditors are usually content to simply compare sets of financial information to ensure that the numbers make sense and that any unexpected results can be explained.

However, if the auditors determine that the internal controls are weak or ineffectual, then they must dig deeper to validate the financial reports. This usually entails selecting a sample of items from the major account balances, and then finding independent collaboration (such as bank statements or invoices) for those items.


At the end of the internal audit, the auditors compile a report for management detailing any important matters that came to their attention. During this stage, the auditors evaluate and review the evidence that they obtained to ensure that it is sufficient to back up their findings. The internal auditing ends with the auditors reporting their critical findings to management.

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