In order to evaluate a company’s financial statements, an experienced professional is hired to perform the financial audit. The goal of this approach is to find any major inaccuracies in such assertions. Financial audits aim to guarantee that financial statements offer a fair and true picture of a company’s financial situation. Financial auditing, sometimes known as auditing, has come a long way since its inception. Before, companies used to perform external audits only after a definite period. In the current era, internal audits have grown increasingly common in businesses.
Companies are required to have an internal audit department in various jurisdictions. Internal audit is a critical component of a company’s internal control systems. Despite its many advantages, some people are wary of internal audits. This uncertainty arises due to the limitations that come with it. It is critical to understand what internal audit is before knowing about its limitations.
The internal audit function is a method used to evaluate a business’s internal controls. Unlike external audits, it does not focus on looking for major misstatements in the financial statements. Rather, it seeks to provide a self-regulating assertion that a corporation’s internal control, governance, and risk management mechanisms are in the right functioning direction. However, despite their popularity and widespread acceptance, may not be effective.
Being limited for a variety of reasons, these factors could be related to the function itself or how a corporation employs it. In this regard, the following are some of the limitations:
- Independence: Internal auditors, like external auditors, must possess some freedom from the company’s management. However, given their relationship, it is unlikely that they will be able to do so. Internal auditors’ work will be rendered of no use if they are unable to demonstrate their independence from executives. Internal auditors and management have an employee-employer relationship, which is one of the internal audit function’s restrictions.
- Staff shortage: An internal audit’s limitation is that audit employees may be incompetent. It does not contribute towards the management by any means. Internal audit staff could be deficient in experience and training. An audit’s work necessitates years of education and practice. An untrained auditor has the potential to do more loss than good. As a result, finding enough skilled staff members for the internal audit process is frequently a challenge for the organization. The scarcity of Internal Audit staff is hence a limitation. There may be a need for realistic audit professionals to analyze the records; yet, due to a staff scarcity, obtaining the benefits of internal audit is challenging.
- Time Lag: Another limitation revolves around the time lag among recording and checking records. Both, accounting as well as internal auditing must run concurrently with a minimum of time lag. However, they will always have some time lag separating them. Internal auditing cannot start until the accounting is finished. Moreover, they cannot be done at the same time either. So, if the accounting procedure takes longer than expected, internal audit will be delayed as well.
- Incompetence: It is not a prerequisite for internal auditors to be professionally experienced, thus, their technical expertise and knowledge may be limited. Internal auditors are essential to a strong internal audit function. If these auditors are unable to do their duties correctly or are inept, the benefits of this duty will be relentlessly limited. The management is responsible for selecting knowledgeable and professional internal auditors. In case they fail to do so, the internal audit function will be rendered useless.
- Inaccuracies/ Errors: One downside of internal audit is the possibility of bookkeeping inaccuracies. It is reliant on on the internal audit staff’s competencies. When the audit staff is knowledgeable, there are fewer chances of errors. Likewise, there is never a surety of audited accounts being completely error-free in case of the auditing personnel lacking sufficient knowledge.
- Reactive Strategy: Internal auditors can only uncover flaws in a company’s internal control after they have already happened. Furthermore, internal auditors require data from other departments in order to identify any abnormalities. Internal auditors take a reactive strategy in both circumstances. It is also a factor in the expectation gap between what most people expect from an internal audit function.
- Executive Function: An internal audit’s limitation is that the audit staff may be associated with the executive function. In such case, he is neither capable of checking the accounting books and other data nor will he be able to point out his own flaws and where he lacks.
- Responsibility and Duty: An internal audit’s drawback is that management may not take it as their responsibility to fulfil the audit requirements. The team may make suggestions to improve the business’s efficiency. Upper-level management can disregard such recommendations. In such a case, the work and efforts by audit will go of no use to the corporation. Furthermore, there may not be an appropriate separation of responsibilities. In this scenario, the internal auditor is incapable of assigning responsibility for the failure to achieve the set targets or standards.
Internal audits, like external audits, contain constraints that are relevant to the companies conducting the audit. From the perspective of the auditors, these are the following limitations:
- Cost: The installation and operation of internal audit require additional funds that many small businesses cannot afford. Internal auditing is, in fact, limited to larger corporations. Because of the substantial costs associated with internal auditing, most organizations avoid employing it. Most businesses incur additional costs because of this service, which they can avoid by eliminating it. Furthermore, a company’s shareholders may not welcome an internal audit function. It is because it lowers profits while they see how it benefits the company.
- Management Dependency: A company’s management determines the success of the internal audit function. The division of tasks are expected to be understood well by the management. Auditing task may expose the flaws of firm staffs; otherwise, the entire arrangement may go waste. Any company’s internal auditors serve as advisors. Their role is to spot irregularities and report them to the appropriate authorities. They are, however, unable to take the necessary steps. Instead, they must rely on management to take the appropriate actions.
- Scope of Work: Internal audits are hired by the corporations, which may decline their objectivity and independence, along with their capability to reveal fraud/error to the senior board, because of apparent pressure to their persistent employment within the corporation to guarantee transparency. As per best run through, internal audit should be regularly accountable to both management and those in charge of governance. They have some rules to follow in order to conduct their job properly, but they lack a clear scope of work. Instead, the company’s management and board of directors decide how the internal audit function should operate. It may not function as planned if a company’s management fails to provide clear instructions or division of roles.
Therefore, an internal audit is a procedure that businesses use for a variety of objectives, including internal controls, risk management, financial reporting analysis, and so on. Internal audit functions, despite their widespread use, have several limitations. The function’s independence, incompetence, reactive attitude, management dependency, and scope of work are among them.
To conclude, while internal audit improves a business’s performance and is a systematic approach for the firm to bring about needed change, it may also prove to be an unnecessary process that the company must go through and may not reap any rewards if not done correctly.