Auditing In The Public Sector Accounting Essay

Chapter 2

2.1 Introduction

The aim of this chapter is to research current international idea and patterns on the capable country by placing and reexamining relevant local and foreign literature. This will put the footing for set uping a theoretical apprehension on the function of authorities auditing, both external and internal auditing, with peculiar accent on issues refering the relationship between them. Figure 2.1 gives an lineation of this chapter.

Figure 2.1: Outline of Chapter 2


“ In virtually all legal powers, the populace sector plays a major function in society, and effectual administration in the public sector can promote the efficient usage of resources, strengthen answerability for the stewardship of those resources, better direction and service bringing and thereby lend to bettering people ‘s lives. ” ( IFAC, 2001, par.004 )

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Government auditing is a basis of good public sector administration ( IIA, 2006a ) . Hearers play a important function by helping authorities entities achieve, amongst other of import aims, answerability and unity by supplying indifferent sentiments on the usage of public resources.[ 1 ]

The populace sector represents a principal-agent relationship as shown in Figure 2.2 below, with the functionaries moving as the principal ‘s agents that must give history to their principal of the extent to which the populace ‘s aims have been achieved. An effectual audit activity is deemed of import in order to cut down the hazards inherited in such a relationship.

Figure 2.2: 3-Party Relationship ( IIA, 2006a )

Given that public sector entities are complex and diverse, no individual administration theoretical account can function all of such entities ( IIA, 2006a ) . Thus, based on the demands and fortunes, many constructions rely on a combination of audit activities including both external and internal auditing.

2.2.1 External Auditing

The range of external audit in the public sector should travel beyond giving an adept sentiment on the truth and equity of the fiscal statements to integrate appraisals on facets of corporate administration and the usage of resources, normally referred to as ‘value for money ‘ ( Bourn, et. Al, 2002 ) . Furthermore, INTOSAI GOV 9150 asserted that “ compared to the IA, the Supreme Audit Institution ( SAI ) has the extra undertaking of analyzing the effectivity of the IA. ”

Furthermore, in transporting out their work EAs are non to be hindered during the public presentation of the audit but “ aˆ¦shall have the right of entree at all times to the company ‘s accounting recordsaˆ¦ ” ( Companies Act, 1995 ) . In this respect NAO ( 2009 ) specified that the Auditor General ‘s work is “ facilitated by statute law which stipulates that any circumstance inhibiting such entree to information is to be reported to Parliament. ”

It is utile to separate between the cardinal elements of public sector audits. NAO ( 2009 ) sort its audits under the undermentioned classs:[ 2 ]

fiscal and conformity audits ;

public presentation audits ;

particular audits and probes ;

IT audits.

2.2.2 Internal Auditing

INTOSAI GOV 9140 highlighted that the function of internal auditing has “ evolved from an administrative process with a focal point on conformity ” to an indispensable constituent of administration in the populace sector. Indeed internal audit activities are seen as supplying confidence on the effectivity of public sector entities ‘ internal control environment by placing chances for public presentation betterment.

Asare ( 2008 ) identified three chief elements, sometimes referred to as the ‘three pillars ‘ to explicate the function of internal auditing in the populace sector. As shown in Figure 2.3 below, these include the “ rating and betterment of hazard direction, control and administration procedures. ” This suggests that internal audit has continued to travel off from fiscal and conformity audits to a broader value-adding function, encompassing both consultancy and confidence activities, thereby moving as the executive arm of authorities.

Figure 2.3: The Three Pillars of Internal Auditing ( Asare, 2008 )

A brief description on each of these three pillars is summarised in Table 2.1 below:



This relates to the agencies by which ends are established and accomplished. IA ‘s functions are identified to be twofold: 1 ) supplying independent and nonsubjective appraisals that the entity ‘s administration constructions and procedures are decently designed and 2 ) playing as accelerators for alteration by reding on possible betterments for a better administration construction. ( IIA, 2006b )


This includes all the policies and processs put in topographic point that are aimed at bettering the entity ‘s operations and control constructions. Internal Audit Activity has become indispensable for monitoring and measuring managerial activities prior to external rating by external hearers. ( Baltaci & A ; Yilmaz, 2006 )

Hazard Management

Hazard Assessment is cardinal to internal auditing and the INTOSAI ‘s Guideline ( 2004 ) for internal control criterions proposes a four-phase hazard appraisal theoretical account: 1 ) place the hazards, 2 ) measure the hazards, 3 ) buttocks the hazard appetency and 4 ) develop responses.


Diplock ( 2005 ) argued that the challenge for the audit profession is to regularly reassess whether criterions are being followed and to show its independency. Over the old ages, INTOSAI members agreed that robust and dependable auditing criterions were required, underscoring that public sector scrutinizing must be underpinned by international criterions as good. As a consequence of alone cooperation between public and private sector scrutinizing at that place has been the development of International Standards of Supreme Audit Institutions ( ISSAIs )[ 3 ].

With regard to the Maltese scenario, the NAO uses the ISSAIs as guidelines of patterns that are followed when carry oning its fiscal and conformity audits. The Office besides uses International Standards on Auditing ( ISA ) of the IFAC when transporting out the audit of fiscal statements of certain public sector entities ( NAO, 2009 ) . The methodological analysis used by the IAID is based on International Standards for the Professional Practice of Internal Auditing that ( include Diagram ) is issued by the IIA ( IAID, 2010d ) .

The independency of hearers, both EAs and IAs, is critical in guaranting that “ public organic structures are accountable for their public presentation in footings of both stewardship of public money and the bringing of high quality services ” ( Bourn, et. Al, 2002 ) . Indeed Bourn, et. Al ( 2002 ) advocate that such independency ensures that they can ‘speak as they find ‘ and ‘without fright or favor ‘ in an nonsubjective manner. This has become progressively of import following the recent fiscal dirts that have brought with them the loss in credibleness in the auditing profession. Furthermore, INTOSAI GOV 9150 stated that, “ IA ‘s independency is cardinal to SAIs in the issue of utilizing IA ‘s work aˆ¦ to be able to organize and collaborate with an IA. ”


“ If internal audit is judged to be effectual, attempts shall be made aˆ¦ to accomplish the most appropriate division or assignment of undertakings and cooperation between the SAI and Internal Audit. ” ( Lima Declaration, ISSAI 1, subdivision 3, par.3 )

Coordination and cooperation between SAIs and IAs is enhanced as both parties can harvest benefits in their uninterrupted thrust to accomplish efficiency and effectivity in public services. For this ground, such a relationship should be seen as an chance to beef up public sector auditing.

The IIA and INTOSAI recognise the importance of such a relationship by being ‘natural spouses ‘ . They portion a common linguistic communication such as criterions ; understand several functions, duties and outlooks ( Moser, 2008 ) .

2.4.1 Opportunities for Cooperation in Practice

Although comparatively small research has examined the countries of coordination and cooperation between I & A ; EAs in the populace sector, the following five facets of cardinal scrutinizing pattern characteristic most conspicuously in the literature:

Audit planning ;

Internal Controls ;

Fraud and Irregularities ;

Coverage ;


Audited account Planning: INTOSAI GOV 9150 identified five chief phases during an audit procedure where SAIs may utilize the work of IAs amongst which there is the planning phase.[ 4 ]This phase is deemed to be an of import portion of the procedure for pull offing an audit map where the EA should execute a preliminary appraisal of the internal audit map. Such an appraisal will act upon the nature, timing and extent of external audit processs, depending on the SAIs judgement of the relevance of the internal audit.

Audit Commission ( 2010 ) sets out the importance for the EA to place what work it will be seeking to put trust upon during the planning phase as this, “ ensures that the proposed work meets the timetable and demands to enable external audit to put trust upon it. ” Spencer Pickett ( 2010 ) explained that there are several degrees to which audit planning may be interfaced as shown in Figure 2.4.

As can be seen in the below figure, at the extreme, it can ensue in one planning papers being prepared which, harmonizing to Spencer Pickett ( 2010 ) , is more relevant in the populace sector given that EAs tend to presume a function in procuring value for money.

Figure 2.4: Interfaced Audit Planning

Internal Controls: Following the passage of the Sarbanes-Oxley Act of 2002, internal control duties for both I & A ; EAs increased. Harmonizing to Engle and Joseph ( 2008 ) , this “ represents an country where enormous value can be achieved through proper coordination. ”

The primary intent of internal audit is to measure and better the effectivity of the system of internal control.[ 5 ]On the other manus EAs are required to obtain an apprehension of the control environment prior to the readying of the fiscal statements in order to be after the audit and develop an effectual audit attack.

In her survey, Colbert ( 1993 ) concluded that the IAs ‘ work can help the EA in understanding the design of the control construction by, for case, supplying system and papers flow charts of the accounting system and finding if the set system has been really put in topographic point.

Fraud and Irregularities: This has been identified by HM Treasury and NAO ( 2000 ) as another possible country where information can be exchanged, given that both hearers are interested in the bar and sensing of fraud. Internal audit work in relation to fraud can be relevant to EAs when measuring the hazards of stuff misstatements found in the fiscal statements.

Since IAs have greater cognition about the entity ‘s operations than EAs, fraud hazard appraisal warrant important trust on internal audit work. Such a statement is supported by surveies done by KPMG, which indicate that IAs are more likely to detect fraud than EAs ( KPMG, 2009 ) . This is illustrated in Figure 2.5 where 47 % of frauds were discovered by internal audit, legal or conformity forces compared to the 9 % of frauds detected by EAs.

Coverage: One of the basic types of cooperation between hearers includes the exchange of audit certification. Audit Commission ( 2010 ) recognises that sharing of audit studies and other audit information will “ heighten understanding and effectiveness ” .

Moeller ( 2005 ) argued that internal audit studies should be circulated to EAs as they constitute an of import agencies of maintaining the EA informed of the internal audit findings and other activities. In set abouting the work necessary to underpin an sentiment on the audited entity ‘s fiscal statements, the EA may seek to trust on the work of the IA.

Audit Commission ( 2010 ) indicated that the IAs can supply the EAs with:

An audit program ;

Entree to scrutinize studies and associated working paper files ;

Detailss of any important alterations to the audit program.

Spencer Pickett ( 2010 ) further highlighted that the internal audit activity ‘s concluding communications, direction ‘s responses to such communications, together with any subsequent follow-up reappraisals can help EAs in finding and seting the range and timing of their work.

Some EAs, on the other manus, may hold concerns about turning over their work documents to IAs due to their professional duties refering confidentiality and independency as highlighted by Moeller ( 2005 ) . Nonetheless their work can be “ used as input to IAs in be aftering the countries to underscore in future internal audit work ” Spencer Pickett ( 2010 ) .

Consultancy: HM Treasury and NAO ( 2000 ) indicated that audience is cardinal to construct an effectual cooperation channel. The same position is shared by Spencer Pickett ( 2010 ) who affirmed that regular audience is indispensable in order “ to utilize similar techniques, methods and nomenclature ” to transport out the work. The two parties may confer with with each other even when they are non working together in a peculiar country such as confer withing on specific audit findings.

Committedness, communicating and assurance were identified as three indispensable constituents that need to be present to guarantee effectual audience, as indicated in Table 2.2 below.

Table 2.2: Building EFFECTIVE COOPERATION ( HM Treasury and NAO, 2000 )


Both parties must be willing and committed to develop co-ordinated and effectual audit services. They should take an active function in promoting cooperation and be willing to set about alterations. Committedness is seen as an “ attitude of head. ”


Communication must be a bipartisan procedure where there will be regular and unfastened communicating between SAIs and IAs. This may include the exchange of audit studies and direction letters and in some cases, allowing entree to each other ‘s audit plans and certification, by ever supplying for the necessary confidentiality.


Common assurance is deemed indispensable between the two hearers which is based on the acknowledgment that both audits are conducted within relevant professional criterions. Assurance is besides needed to guarantee that information exchanged is treated professionally and with unity.

INTOSAI GOV 9150 acknowledges that coordination and cooperation can be done either officially, where there will be formal understandings or protocols or in an informal manner based on good will such as in the instance of audiences.

Other possible countries of coordination and cooperation between SAIs and IAs were identified by HM Treasury and NAO ( 2000 ) and a brief drumhead is provided below:

Conformity with Laws and Regulations

Since IAs continuously assess the controls over conformity with Torahs and ordinances that are internal to the Government such as Parliamentary blessing for outgo, SAIs can put trust on their work. This is of import given that most SAIs ‘ mission statement underscore the significance of the consideration of properness[ 6 ]and hence internal audit activity is utile to find whether “ activities and concern have been conducted in conformity with Parliament ‘s outlooks ” ( HM Treasury and NAO, 2000 ) .

Audited account of spread administrations

Although non peculiarly applicable to Malta, this has been recognised as another country of cooperation when the audited entity is dispersed geographically. HM Treasury and NAO ( 2000 ) argued that when the two parties are allowed to work in joint squads or one of them undertakes work on behalf of the other, more economical usage of audit resources is made.

Reliance on the Internal Audit ‘s Work

ISSAI 200 pointed out that,

“ When the SAI uses the work of another hearer ( s ) , it must use equal processs to supply confidence that the other hearer ( s ) has exercised due attention and complied with relevant auditing criterions, and may reexamine the work of the other hearer ( s ) to fulfill itself as to the quality of that work. ” ( Section 2, par.2.45 )

Reliance by EAs on internal audit ‘s work is governed by ISSAI 1610 that farther highlighted two chief points that SAIs must see after set uping that the internal audit map is relevant to the audit. These include[ 7 ]:

Whether and to what extent, to utilize the specific work of the IAs ;

If so, whether such work is equal for the intents of the audit.

Such standard requires EAs to reexamine IAs work, which normally involves remaking specific trials every bit good as executing a more general reappraisal.

The Sharman[ 8 ]Report ( 2001 ) found that the relationship between cardinal authorities internal hearers and NAO “ has non been every bit near as might hold been expected ” , in portion because the focal point of internal audit has tended towards non-financial countries, doing its work of less value to those scrutinizing fiscal statements. Three major standards were identified as a common component in the surveies that examined the relationship between I & A ; EAs. These elements influence the EAs ‘ trust on IAs as shown in Figure 2.6 below.

Figure 2.6: Model of Judgement of EAs ‘ trust on IAs ( Haron H. et Al )

2.4.2 Potential Risks of Cooperation

A figure of benefits were identified from the coordination and cooperation between SAIs and IAs including amongst others, more efficient and effectual audits based on a clearer apprehension of the several audit functions and demands ( HM Treasury and NAO,2000 ) .

However, INTOSAI GOV 9150 highlighted some possible hazards that could have in their relationship and that should be managed consequently in order to accomplish the full scope of benefits. The outstanding points include:

Possible struggles of involvement ;

Any via media of independency and objectiveness, blockading the ability to transport out an audit with an indifferent sentiment ;

Premature revelation of audit findings to an external party, possible taking to a breach of confidentiality ;

No consideration of restraints or limitations placed on the other hearer when finding the extent of coordination and cooperation ;

Developing wrong decisions when utilizing the work of IAs ;

Possible difference of decisions or sentiments which could take to a possible hazard of credibleness of either party.

To accomplish a healthy relationship both parties need to be efficient and effectual as otherwise a possible menace might be if inefficient operations are in topographic point, particularly if there is trust on each other ‘s work.

With mention to the Maltese scenario, the NAO conducted a survey on the ‘Internal Audit Function within Government Ministries ‘ ( NAO Report, 2000 ) .[ 9 ]This survey dates back to 1999 and no farther survey has been carried out since so.

It was observed that, although the map did take to some stray benefits, it fell abruptly of the needed degree of effectivity. This was largely due to:

Inadequate cardinal coordination ;

Restrictions in the map ‘s independency within Ministries ;

Lack of direction support ;

Lacks in enlisting and preparation patterns ;

Restrictions and deficiency of resources ;

Other factors act uponing the effectivity of the map including the relationship between the NAO and IAs.

2.5 challenges and barriers to effectual coordination

Golen ( 2008 ) highlighted that “ in any on the job relationship, one has to be wholly aware of the human dealingss constituent that can originate, and the internal and external audit relationship is no exclusion. ” In fact the first relevant survey sing the relationship between I & A ; EAs, realised by Mautz ( 1984 ) , as cited by Haron et Al ( 2004 ) , showed that from internal audit ‘s point of position the relationship with external audit was merely ‘ostensibly ‘ a good one.

Since a working squad relationship is a cardinal constituent for an effectual and efficient independent audit, communicating jobs have a direct impact on the result of an audit. Indeed the undermentioned communicating barriers were recognised by Golen ( 2008 ) , given that, one time identified and addressed, communicating between I & A ; EAs would better.

Distortion or Omission of Information

This occurs when an component of pride influences the information exchanged negatively, as each party perceives his work as critically of import for the decision of an audit. Both parties may non lend in adequate item with regard to the information required from each other. Golen ( 2008 ) highlighted that such a barrier could be managed by “ supplying an environment that encourages unfastened lines of communicating ” in order to run into the aim of the audit.

Lack of Credibility

This is particularly of import from the point of view of the EA because if the latter perceives that the IAs deficiency credibleness, he will be unwilling to put trust on the IA ‘s work. In fact, Golen ( 2008 ) argued that “ some IAs see their interactions with EAs as non one of their favorite parts of the occupation because of the EAs ‘ limited usage of their work. ” Such a state of affairs may ensue in tenseness and struggle. The relationship could be improved if IAs possess the cognition, accomplishments and other competences to show their value, in order for EAs to accept their work as dependable.

Inclination non to listen

Harmonizing to Golen ( 2008 ) , the first measure to heighten communicating is through effectual hearing as negative attitudes towards each other can be damaging to the relationship. He argued that both parties need to be open-minded by set uping a footing of seeking to derive proper information from each other without developing any premature opinions.

Resistance to Change

Another common barrier highlighted is the EAs ‘ opposition to alter to new constructs and processs as these may be seen as a menace. When this happens IAs may develop a feeling of bitterness that could farther decline an “ already delicate relationship ” Golen ( 2008 ) . Both I & A ; EAs must be willing to give adequate clip to each other to turn out the benefits that could be gained by leting for alteration.

2.6 Decision

In visible radiation of the above, one can reason that although there are some possible hazards ensuing from cooperation, working together as a squad instead than two independent groups can merely better the efficiency and effectivity of the independent audit and finally taking to a better service to the populace. Yet, such cooperation can merely boom in an environment where there is common assurance, connoting that both I & A ; EAs should follow an active function in seeking chances to organize work, where possible, in the involvements of maximizing the benefit of their work and understating duplicate of attempt.

( 3160 words )


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