Leading the Way is a column written by PricewaterhouseCoopers professional staff. It appears in the Business section of the Bangkok Post twice each month. The column provides specialised advice to corporate decision-makers in Thailand on global and local business trends.
This article appeared in the April 4, 2006 issue of the Bangkok Post.
By Marius Kunneke
Recent changes in corporate governance have raised the role of the internal audit function to one of a business imperative. This development is increasing the demands placed on internal audit and is revealing the stark evolving requirements of the audit committee.
Internal audit has yet to gain the professional trust and reliance of audit committees. Perhaps influenced by the "lowly" role internal audit is perceived to have - a role propagated by low salaries and little inter-organisational influence - audit committee chairmen don't have a lot of positive things to say about the effectiveness of their internal audit functions.
In January 2006, PricewaterhouseCoopers (PwC) conducted a series of detailed interviews with audit committee chairmen representing 49 companies, predominantly from the FTSE in London. Among the key survey findings, more than one-third (37%) of chairmen indicated that internal audit delivered less than "very good" results.
But meeting the demands of the audit committee means understanding and being clear about what those expectations comprise. The survey showed that, in fact, in very few cases can audit committee chairmen claim that they have made their expectations of internal audit clear.
PwC was surprised to note that 38% of audit committee chairmen placed only low to moderate reliance on the internal audit function. Many reported that they looked far more to external audit, to their business sense, and to the track record of the executive. Here they reported feeling vulnerable, as they depended heavily on the quality of information that they received. They were very aware that operational management may not always be inclined to share bad news with them as quickly as they would like.
Audit committee chairmen felt that internal audit did not have the full picture, nor the right skills and, in some cases, the right remit to provide better assurance to them. We also found that the amount of reliance placed on internal audit was highly correlated to the clarity of expectations of the audit committee chairman.
On the premise that reliance will be related to trust and familiarity with the function, we asked about the regularity of meetings. Approximately half of those surveyed meet with the internal audit head six or fewer times per year. Many of them said that this was insufficient.
In addition to the meetings that take place, reporting is a key part of the interaction between the audit committee and internal audit. Many (72%) chairmen reported that the quality and relevance of the reporting received was high or very high. However, 50% indicated that they received too much information. Many of these would prefer to see shorter and more focused papers.
When probed further on the completeness of the reporting - specifically, "How do you know the reporting is complete?" - almost one-third responded that they did not know. One quarter said they relied on their relationship with the head of internal audit to give them comfort over completeness, whereas 19% relied on external auditors or executive management and 7% relied on their intuition.
In summary, audit committee chairmen highlighted that there are some major challenges to obtaining an effective internal audit:
- The audit committee members are not fully clear about their own expectations and as a result are not clearly driving the assurance agenda.
- They question the skills that their internal audit functions have to fulfil expanding expectations.
- They question the independence of functions that either report directly to, or are substantially controlled by, the finance director.
- They believe that the role of internal audit is being shaped by its capabilities and not by the business's need.
- There are a number of ways of breaking this impasse, all involving the active participation of the audit committee chairman:
- They should be constantly challenging their internal audit head to increase the relevance of the work that internal audit does to critical issues on the audit committee's agenda.
- They should periodically ensure that the annual obligatory review of the effectiveness of internal audit is independent, and that its coverage is appropriate.
- When the head of internal audit changes, committee members must be actively engaged in recruiting the replacement.
Many audit committee chairmen want to see more operational and commercial experience in the internal audit role. But finding suitable candidates may prove tough. One executive search agency has indicated that up to 20% of the FTSE 100 companies are currently searching for new internal audit heads.
An alternative to external candidates would be to bring top-quality internal candidates through the function as part of their career development. It was noted that a number of organisations do this. Many, however, questioned whether their firms had an appetite for this.
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