The internal audit department’s efficiency [in general] can be difficult to measure; What kind of measurements a controller or CFO possibly performed? What to measure? How to measure to get at least a rough picture of internal audit efficiency? Read on…
The internal audit staff provides a number of crucial functions, such as preventing or “detecting fraud“, “passing judgment on the controls used for new accounting systems“, and “recommending changes that will result in lower costs“. As mentioned in the beginning that measuring the internal audit department’s efficiency can be not an easy task, since a significant finding, such as a fraud situation, may require much more staff time than was originally planned.
Nonetheless, like other service functions, proper planning of audit requirements should result in a steady flow of completed audits on a continual timeline that can be measured. If additional work is required, such as may be caused by a fraud investigation, then it can be scheduled as a new project and included in an orderly manner into the work schedule of the department. Consequently, with proper planning, it is possible to use the internal audit efficiency measurement to gain a general understanding of the operating efficiency of the department.
Of these activities, there are [by far] only two ways to measure Internal Auditor’s efficiency:
- Internal Audit Savings To Cost Percentage
- Internal Audit Efficiency
Let’s go to the details.
Internal Audit Savings To Cost Percentage
The first measurement is somewhat easy. It could be performed by comparing “the sum total of all recommended cost savings by an internal audit group” to its “operating cost in order to arrive at a proportion of savings to costs“.
So what is the formula?
Divide the total amount of savings recommended by the internal audit staff by the total internal audit expense, which should include all departmental costs, such as salaries, payroll taxes, travel and entertainment, and support costs.
The measurement is:
Internal audit recommended savings
Internal audit expense
Example: The audit committee of the Lie Dharma Putra Manufacturer is concerned about the total cost of the internal audit department. Its staff of six costs $300,000 per year, while its travel and support costs are $120,000 per year. The Controller explains that the department does not just search for fraud and review internal controls.
On the contrary, it recommended the following three changes in the past year:
- Eliminate half of the accounts payable staff by installing a new automated three-way matching system for payable transactions, saving $200,000.
- Improving Bill Of Material accuracy implemented in the Production Department that save company for $250,000 a year alone.
- Outsource the payroll function, eliminating one 2 in-house position, saving $20,000.
All of the suggestions were implemented.
The proportion of internal audit savings to costs was calculated as:
Internal audit recommended savings
Internal audit expense
$200,000 + $250,000 + $20,000
$300,000 + $120,000
= 111.90% Proportion of internal audits savings to costs
It is a high efficiency record mark for the internal audit department. The measurement can also be subdivided and used to track the savings from individual audit teams.
Can this be the only measurement of key performance indicator for the internal audit staffs? If yes, then they will insist on conducting reviews that focus exclusively on potential cost savings, rather than also conducting control reviews that could potentially save a company much more money over the long run by preventing fraud. Instead, It should be used as a lesser measure to which performance bonuses or evaluations are not tied.
Moreover, the recommended savings listed in the numerator can be wildly inflated or impractical, since they are strictly recommendations, and may never be tested for their validity.
Let’s see what next way can be implemented to measure the internal audit’s efficiency. Read on…
Internal Audit Efficiency
One among performance measurement that commonly performed is the most basic way; by dividing the number of internal audits completed by the total number of internal audits planned.
Can we get a formula? Yes, here is the basic formula:
Number of internal audits completed
Number of internal audits planned
Example: The Lie Dharma Putra, a white sugar producer has a large internal audit department that performs over a hundred audits per year. The Controller wants to determine the efficiency of the group in completing its assigned audits.
He scheduled 115 audits at the beginning of the year. At the end of the year 90 audits has been closed-out (completed), while 25 is still open. Out of the 25 open jobs, 15 jobs at the beginning of the year had 230 scheduled hours of work finished out of an initial budget of 620 hours, and 7 jobs had 142 hours accumulation of work out of 320 scheduled hours.
Back to the above formulation, it should be an easy calculation:
90 jobs finished [divided by] 119 jobs planned = 75.63%, isn’t it?
Then the internal audit staffs will question, “where the jobs in process [15 jobs and 7 jobs] that has been completed in some percent gone?”. Yea! where? Of course that is not fair for the internal audit staffs.
So, instead, a better calculation approach should be:
+ Beginning equivalent audits completed = (230/620 hours) x 15 open jobs
+ Ending equivalent audits completed = (142/320 hours) x 7 open jobs
+ Audits completed = 90 audits completed
Number of equivalent audits completed = 98.67
So, the final calculation will become:
98 Internal audits completed
115 Internal audits planned
= 85.22% Internal audit efficiency
Note: If there are partially completed audits at the beginning and end of the measurement period, then these can be included in the measurement by using the percentage of completion method.
Things that must be taken into a serious consideration; this measurement focuses solely on the ability of the internal audit staff to complete their audit jobs, not on their ability to discern any systemic problems arising out of those audits. So again, this measurement needs a qualitative review of the results of all completed audits as an important supplement.