Internal Audit: Role in Corporate Governance and Finance

This report delves into the pivotal role of internal audit within the framework of financial governance. Initially focused on preventing financial fraud and reducing external audit costs, internal audit has evolved to encompass a broader scope, including operational audits. The report highlights the significance of internal audit in supporting the Board of Directors by ensuring compliance with laws and regulations, the reliability of financial statements, and the effectiveness of risk management systems. It emphasizes the critical support internal audit provides to the Audit Committee in overseeing risk management, internal controls, and the accuracy of financial reporting, including accounting estimates and related party transactions. The report also underscores the importance of internal audit in providing assurance on the reliability of data used for strategic decision-making and the adequacy of feedback mechanisms for tactical decisions, thereby contributing to effective corporate governance and financial integrity. The report emphasizes the evolution of internal audit from focusing on financial transactions to providing assurance to the board and audit committee on various matters related to governance and risk.

Aldi Brian Pratama
12030117190228
AI-X-IA11-G6
Long back internal audit objective was to prevent and detect financial frauds in locations
away from the central operating location of the firm. Subsequently, internal audit was used to
achieve another objective, which was to reduce the cost of mandatory financial audit by an external
auditor. In order to achieve both those objectives, the internal audit’s focus was on internal check
and internal controls relating to financial transactions. It used to apply the same audit procedures
and techniques that are used by the external financial auditor.
Even today, as a service to the management, internal audit pursues the above two
objectives. The external financial auditor designs his audit strategy and formulates audit plan and
programme only after evaluating the adequacy and effectiveness of the internal audit. Much later,
the concept of operational audit emerged. Now, almost every firm includes operational audit in the
scope of internal audit. However, internal audit continues to allocate major part of its resources in
financial audit. Therefore, till recently, in most firms, the Chief Internal Auditor (CIA) used to report
to the CFO. Contemporary internal audit is ‘eyes and ears’ of the Board, which is responsible for
governing the firm. Whenever there is governance failure, the Board is held responsible for the
same. The Board sets the ‘tone at the top’. It provides strategic direction to the management. It is
responsible for ensuring that the firm complies with applicable laws and regulations and that
external reporting is correct and not misleading. The Audit Committee of the Board, among other
things, is responsible for:
• Ensuring that the risk management system is adequate and operating effectively;
• Ensuring that internal controls are adequate and operating effectively;
• Ensuring that financial statements provide true and fair view;
• Approving ‘related party transactions’; and
• Evaluating the enterprise performance.
The Board sets the ethical policy and approves the ‘code of conduct’. It depends on the
internal audit for providing an assurance that every employee in the firm has understood the ethical
policy and implements the same. The management owns the strategy of the firm. The Board
approves the same. It critically evaluates proposed strategies when the management presents a new
strategy before it for approval. In some occasions, particularly when the firm is passing through a
crisis, the Board and the management cocreates new strategy.
Board periodically reviews the current strategy. The Board also oversees the strategy
execution, including allocation of resources to different activities. In order to carry out this task
effectively, Board needs deep insights into the business and its internal and external environment
and this requires analysis of internal and external data. The internal audit provides assurance to the
Board that the data and reports presented before it are reliable. The Board expects the internal
audit to provide an assurance that feed back mechanism to help managers to evaluate outcome of
tactical decisions, for example decisions on debt, investment, product portfolio and target markets,
which are based on certain assumptions, is adequate and effective. An effective mechanism helps
managers to take corrective actions, if required, well in time and help them in reviewing
assumptions.
The Audit Committee cannot perform its tasks effectively without the support of the internal
audit. Independent monitoring by the internal audit is necessary for the Audit Committee to get an
assurance that the risk management systems and internal controls are adequate and effective. The
internal audit provides the assurance that all decision-makers understand the risk-appetite and risk
management is embedded in the decision model. The Audit Committee depends on the internal
audit to get an assurance that accounting estimates, particularly, judgement-based estimates are

Aldi Brian Pratama
12030117190228
AI-X-IA11-G6
reliable and that financial statements provide a true and fair view. It depends on internal audit for
initial evaluation of related party transactions. It also relies on internal audit for the integrity of data
that it uses to evaluate the performance of the firm and the CEO.