How Internal audit functions in an organization - guidelines and procedure

Internal audit is one of the internal control procedures that are to be followed by the various departments and employees of the organization. The objectives and scope of internal audit cover the following:

-Verification of compliance with established policies.
-Verification of the effective operation of established systems and other controls.
-Verification of both fixed and current assets of the organization.
-Based on the above findings, suggest improvements in the system controls in order to plug the loopholes.


An internal audit manual indicating the scope of verification of each functional area within the organization is necessary so that the responsibility entrusted to the internal audit department is clear to the functional departments and external auditors also. Whether the controls as aforesaid are operating normally without breakdown of any system is to be observed by internal auditor. In judging the adequacy or otherwise of the internal audit functions, the following aspects need to be taken into consideration:


- Qualifications and experience of the internal audit staff.
- The level of the head of the department in relation to other departmental heads.
- The scope of internal audit is incorporated in the internal audit manual and its adequacy to the needs of the organization.
- Adequacy and competency of staff employed in the internal audit department.
- The frequency of reports issued to the departments and the following up till final recommendations are sent to the Chief Executive or Audit Committee.
- The coverage of internal audit in all areas as mentioned in the internal audit manual.
- Objectivity of the reports issued and the promptness with which the action taken by the company on such reports.


The cost auditor should go through the financial auditor’s observations before finalizing this item. Where there is no internal audit system in the company the cost auditor should advise for instituting internal audit considering the size, etc, of the organization. Thus in order to comment on the scope and performance of internal audit the statutory cost auditor should review the work of the internal auditor with special references to his competence, objectivity and work performance. The following questionnaire will enable the cost auditor to evaluate the work of the internal auditor as well as the internal audit department:


- What is the organizational step-up of the departments?
- Is the staff employed in the department adequate?
- Are the qualifications of staffs adequate?
- Is the staff competent?
- Is the staff independent?
- To whom do they report frequently and with what effect?
- Is there any internal audit manual?
- Is a program of internal audit drawn up before the commencement of the financial year?
- Does the program cover the audit of all the important transactions and records of the company including statutory cost accounting records?
- Is the scope of the internal audit wide enough to extend to areas such as management audit, operational audit and the system analysis?
- What is the system of reporting irregularities noticed during internal audit?
- Is prompt corrective action taken by the management on the basis of internal audit reports?
- Is there much duplication of work between the statutory audit and internal audit?

The cost auditor has to study and comment on the capacity utilization. While ascertaining such capacity it may be observed that due to bottleneck in some of the departments the production is suffering. The cost auditor should point out the matter to the company and obtain explanations from the management. He then will be in a position to suggest for improvement by rectification of general imbalance in production facilities. In a particular industry it may be observed that packing is the bottleneck. If more labour or improved machinery is available in the packing department the production can be increased to a great extent to cope with the demand.


Productivity is an index of efficiency showing the effectiveness of individual or combined factors used in producing goods or services. Men, machines, capital, power and services all contribute to productivity and the extent to which each does so may be ascertained by the ratio of output to input of each individual factor. Thus the factoral productivities such as labour productivity, material productivity, etc.. should be ascertained by the cost auditor. He should then evaluate the performance of men, machines or other services and compare the present productivity with the productivity of previous year. He will be in a position to suggest for improvement in performance by concentrating on areas offering scope for increased productivity.


The cost auditor should discuss with the management of the company to ascertain the key or limiting factors which may be one or more of the following:

- Absence of demand.
- Stiff competition or availability of cheaper substitutes.
- Non-availability of materials, skilled labour, machines, power etcc.
- Non-availability of transport facilities or infrastructures.

He after discussing with the management might suggest for profit maximization with the optimum use of such scarce resources with the help of linear programming, simulation, etc.. He should study the present inventory policy of the organization. He should examine whether the perpetual inventory system is in operation with due classification of materials by value. He should also see whether maximum, minimum and reorder levels are being fixed by the company and such levels are reviewed from time to time. He would compute stock turnover ration wherever possible. He would also see whether purchases are made following economic ordering quantity policy. He should discuss with the management if there are shortcoming in the inventory policy. This may help him to make suggestions for improvements in performance by improved inventory policies.


The cost auditor may give a qualified report where:

- He has not received any information or explanation, or
- A record has not been maintained as per cost accounting records, rules, or
- The record does not give the information in the manner required by law, or
- A true and fair view of the cost of production etc. is not reflected.

He should write to the company for furnishing information etc.. Where he is submitting a qualified report he should mention under this item the various points of qualifications and reasons therefore in addition to indicating these qualifications in the main certificate of the cost audit report. Where records relating to power generation are not maintained by the company the qualified report may be “Proper record required under the pertaining section of the companies act…” As per rules the cost records should be reconciled periodically, say monthly, quarterly or half yearly but at the end of the accounting year with the financial books of accounts so as to ensure accuracy of the data.

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