A performance audit of investment activities must ascertain whether commonsense controls (not explicitly discussed in this chapter) have been established.

The director of the internal audit department of a midsize city received a memo from a member of the city council that included the following:

I am certain that you have followed recent press reports of the losses incurred by city and state governments on their investment portfolios. Many of these losses can be attributed to pressures to boost investment returns. These pressures encouraged the investment officers to acquire derivatives and other highrisk securities, which are clearly inappropriate for governments. I am extremely concerned that our city might also be vulnerable to major losses.

The city currently has investments (including those of our retirement funds, bond reserves, and endowments) totaling more than $800 million. These are managed by our Office of Investments (a subunit of the Treasury Department). The mission of the office as set forth in the enabling legislation is to invest prudently the available resources of the city so as to maximize the return to the city.

I note that whereas our independent CPAs have reviewed the city's investment portfolio as part of their annual financial audit, your department has never conducted a performance audit of the office. I urge, therefore, that you do so as soon as feasible. I think it is especially important that you report on the extent to which the office has in place the administrative controls, policies, and practices necessary to ensure that it is accomplishing its mission.

1. In light of widely accepted criteria for selecting audit targets, do you find it surprising that the internal audit department has never conducted a performance audit of the Office of Investments? Explain, citing relevant criteria.
2. Suppose you are placed in charge of the engagement. Draft a memo to the head of the internal audit department in which you outline the approach you would take in carrying it out. Be as specific as possible, providing examples of the types of administrative controls that you would expect to find in place. Indicate how you would assess whether the Office of Investments is maximizing the return to the city.