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The latest rash of high-profile accounting scandals is adding fuel to the debate over reporting relationships in the finance department. No longer satisfied with financial audits controlled exclusively by senior corporate executives and accounting firms, regulators and institutional investors are now insisting that publicly traded companies reorder some of those reporting relationships.

Reporting Relationships of Internal Auditors

The latest rash of high-profile accounting scandals is adding fuel to the debate over reporting relationships in the finance department. No longer satisfied with financial audits controlled exclusively by senior corporate executives and accounting firms, regulators and institutional investors are now insisting that publicly traded companies reorder some of those reporting relationships.

Internal auditors, who until recently have typically slaved away in anonymity, focusing mostly on broad corporate controls and risk-management programs, are also being asked to take on added responsibility. But internal auditors at some large companies have begun playing key roles in setting audit-committee agendas. At some companies internal auditors have been asked to pore over financial statements, assuring the soundness of the numbers – or ferreting out mistakes.

Some finance chiefs see internal audits as something of a sniff test for overly sophisticated accounting schemes. If a company is engaging in activities beyond the understanding of the internal audit department, that's a warning sign. If there's that kind of a disconnect, it really weakens the control function.

To beef up the function, international reform advocates say internal auditors must have direct links to audit committees. That way, they can report concerns without fear of reprisal from their bosses. Of course, some companies have always allowed the head of internal audit a private audience with the audit committee. Internal auditors should meet separately with the audit committee at least every quarter.

At most large public companies, however, the issue isn't whether there is an internal auditor, but who the auditor's boss should be. It's one thing for regulators and investors to say the internal audit department should get its general marching orders from the board audit committee, but internal auditors usually report to the Head of Finance. The most popular solution, according to the Institute of Internal Auditors – USA, is to provide auditing executives with two masters: the audit committee for policy-making and a senior corporate executive – usually the CEO – for more routine work.

Some reformers believe internal auditors should report to the board more often. They argue that otherwise finance heads and controllers can exert pressure on internal auditors to rubber-stamp finance-department numbers. Some internal auditing chiefs like reporting to finance heads, as long as they have complete, private access to the audit committee. For one thing, finance chiefs tend to be more accessible than CEOs. For another, they are generally more savvy about auditing minutiae.

Beyond a change in the reporting lines for chief internal auditors, observers say a move to more-intense checking of company financials would be a substantial shift in duties for many audit teams. For years, those teams have focused just on keeping information systems and operations running smoothly.

After all, some internal auditors aren't Chartered Accountants. Before the current accounting scandals, internal auditors largely steered clear of such complicated financial maneuverings as off-balance-sheet accounting, third-party investment vehicles, and derivatives accounting. Some internal auditing executives still feel they shouldn't get involved in auditing those processes. Internal audit teams at a number of big companies are now working much more closely with their independent audit firms.

Most chief audit executives get their policy direction from audit committees. But they tend to be managed and evaluated by finance heads. Such a setup, however, can cause an internal auditor to become too beholden to finance or operations.

Rahim Panjwani completed his articleship from KPMG Taseer Hadi Khalid & Co. and qualified for ACA in 2000. In addition to being an ACA, Rahim is a qualified APA from PIPFA (1998) and CIA from the IIA (2001). He has also successfully completed a training course on Management Auditing from London School of Economics. His past work experience includes working with Hongkong Shanghai Bank and Serena Hotels. Presently, Rahim is engaged with The Aga Khan University – Funds Management & Corporate Affairs Department. He is a regular contributor of articles in Dawn, Business Recorder and News. He can be contacted at anoosha@akunet.org

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