Accounting: Public Sector Auditing

Judge Learned Hand, in discussing "degree of care" in connection with the standard by which a prudent person is to be held, said this: "The degree of care demanded of a person by an occasion is the result of three factors: the likelihood that his conduct will injure others, taken with the seriousness of the injury if it happens, and balanced against the interest which he must sacrifice to avoid the risk." Discuss how Judge Hand's statement might be applied to the responsibilities of management in establishing an internal control system and to the role of a performance auditor in assessing the control system. Please answer in own words. (See paragraphs below to get an idea) Note: Internal control system is based on five components: control environment, risk assessment, control activities, information and communication, and monitoring.

The Control Environment

The control environment is the foundation for all the other components of internal control. It provides the underlying managerial discipline and structure for the other components to function effectively. It is the collective impact of the following broad underlying factors on the effectiveness of all other policies and procedures developed to achieve the entity's objectives:the integrity and ethical values of the managers; the operating style and attitude of the managers; the organizational structure and methods of assigning authority and responsibility; the way in which managers exercise control; the competence and reliability of the people in the organization; the influence of legislative bodies and audit committees; and the influence of external entities, such as higher level governments and credit-rating agencies.

In its Standards for Internal Control in the Federal Government, the Government Accountability Office says: "Policy makers and program managers are continually seeking ways to improve accountability in achieving an entity's mission. A key factor in improving accountability in achieving an entity's mission is to implement an effective internal control system." Internal control starts with the highest-ranking executive and extends through every managerial level. The governor, the mayor, the department heads, the division chiefs, and other managers create or sustain the control environment in an organization. They set the tone regarding the importance of internal controls. Managers who establish a good control environment send the message that internal controls are not only an integral part of operations, but also that they apply to everyone in the organization.

A performance auditor, therefore, should see whether goals and objectives have been established, and whether they are in accord with related laws and requirements set forth by higher level funding agencies.

As a performance auditor, you need to assess such factors as: whether the entity attempted to measure performance; whether the performance indicators appeared to be appropriate to the entity; whether the reporting system provided accurate and timely results, and whether management responded effectively and in a timely manner to the performance results.

As a performance auditor, you need to determine whether the policies, procedures and strategies adopted by management meet these criteria. To do the task, you need to review the laws, regulations and literature pertaining to the program you are auditing. You also need to see how management has assessed the risks and what procedures they have used to become aware of "best practices."

As a performance auditor, you need to determine the nature of the quantitative and qualitative work standards established by management. You also need to find out how the standards were established, and whether they are revised to take advantage of changing technology and experience.

When you do the performance audit, you are a part of the monitoring process done through separate evaluations. When an auditor evaluates internal controls as part of attesting to an entity's financial statements, that auditor is also part of the monitoring process.

Role of the performance auditor: Where does the separate evaluation - the performance audit - fit into this picture? The performance auditor will assess such matters as: (a) whether the unit supervisors are doing what they are supposed to do (that is, reviewing the completed check lists, making spot visits, and sending out complaint reports in a timely manner); (b) whether managers get periodic reports showing numbers of completed inspections relative to plan and whether they act promptly in the event of lagging inspection performance; and (c) whether there are a sufficient number of supervisors to do the job.

Performance auditors also have a responsibility to report major problems promptly to the appropriate levels of management. As discussed in Chapter 5, performance auditors need to establish a line of continuous communication with top management at the opening audit conference. Formal procedures should also be established for reporting on actions taken by management to resolve the conditions noted in performance audit reports.

Auditors sometimes tend to over-emphasize the wrong control components under the premise that control activities (i.e., policies and procedures) are the most critical elements of an organization's success. Policies and procedures are certainly important. An effective performance auditor, however, ensures not only that they exist, but also that they exist within the appropriate control environment and that they are followed by staff and not over-ridden by management.