Matalas Co sells cars, car parts and petrol from 25 different locations in one country. Each branch has up to 20 staff working there, although most of the accounting systems are designed and implemented from the company’s head office. All accounting systems, apart from petty cash, are computerised, with the internal audit department frequently advising and implementing controls within those systems.
Matalas has an internal audit department of six staff, all of whom have been employed at Matalas for a minimum of five years and some for as long as 15 years. In the past, the chief internal auditor appoints staff within the internal audit department, although the chief executive officer (CEO) is responsible for appointing the chief internal auditor. The chief internal auditor reports directly to the finance director. The finance director also assists the chief internal auditor in deciding on the scope of work of the internal audit department. You are an audit manager in the internal audit department of Matalas. You are currently auditing the petty cash systems at the different branches. Your initial systems notes on petty cash contain the following information:
1. The average petty cash balance at each branch is $5,000.
2. Average monthly expenditure is $1,538, with amounts ranging from $1 to $500.
3. Petty cash is kept in a lockable box on a bookcase in the accounts office.
4. Vouchers for expenditure are signed by the person incurring that expenditure to confirm they have received re-imbursement from petty cash.
5. Vouchers are recorded in the petty cash book by the accounts clerk; each voucher records the date,reason forthe expenditure, amount of expenditure and person incurring that expenditure.
6. Petty cash is counted every month by the accounts clerk, who is in charge of the cash. The petty cash balance is then reimbursed using the ‘imprest’ system and the journal entry produced to record expenditure in the general ledger.
7. The cheque to reimburse petty cash is signed by the accountant at the branch at the same time as the journal entry to the general ledger is reviewed.
Explain the issues which limit the independence of the internal audit department in Matalas Co.
Factors limiting independence of internal audit
The chief internal auditor reports to the finance director. This limits the effectiveness of the internal audit reports as the finance director will also be responsible for some of the financial systems that the internal auditor is reporting on. Similarly, the chief internal auditor may soften or limit criticism in reports to avoid confrontation with the finance director. To ensure independence, the internal auditor should report to an audit committee.
Scope of work
The scope of work of internal audit is decided by the finance director in discussion with the chief internal auditor. This means that the finance director may try and influence the chief internal auditor regarding the areas that the internal audit department is auditing, possibly directing attention away from any contentious areas that the director does not want auditing. To ensure independence, the scope of work of the internal audit department should be decided by the chief internal auditor, perhaps with the assistance of an audit committee.
The chief internal auditor appears to be auditing the controls which were proposed by that department. This limits
independence as the auditor is effectively auditing his own work, and may not therefore identify any mistakes.
To ensure independence, the chief internal auditor should not establish control systems in Matalas. However, where controls have already been established, another member of the internal audit should carry out the audit of petty cash to provide some limited independence.
Length of service of internal audit staff
All internal audit staff at Matalas have been employed for at least five years. This may limit their effectiveness as they will be very familiar with the systems being reviewed and therefore may not be sufficiently objective to identify errors in those systems.
To ensure independence, the existing staff should be rotated into different areas of internal audit work and the chief internal auditor independently review the work carried out.
Appointment of chief internal auditor
The chief internal auditor is appointed by the chief executive officer (CEO) of Matalas. Given that the CEO is responsible for the running of the company, it is possible that there will be bias in the appointment of the chief internal auditor; the CEO may appoint someone who he knows will not criticise his work or the company.
To ensure independence, the chief internal auditor should be appointed by an audit committee or at least the appointment agreed by the whole board.