Focus on These Four Internal Audit Areas
As my firm reflected on directors’ expectations that have emerged while working with boards, four areas of emphasis that internal auditors should address rise above the rest. We refer to these as the four Cs: culture, competitiveness, compliance, and cybersecurity. These four areas offer suggestions to directors regarding what they should expect from a risk-focused audit plan.
Here’s a closer look.
A breakdown in risk management, internal control, or compliance is almost always due to a dysfunctional culture. The risks spawned by cultural dysfunction often require a lengthy incubation period before noticeable symptoms appear—and lead to consequences that could result in a reputation-damaging event. Examples include an environment that isolates senior leaders from business realities, allows cost and schedule concerns to override legitimate public safety priorities, empowers falsification of emission reports, or drives unacceptable risk-taking through inappropriate performance incentives. Once a culture of dysfunction inculcates a flawed business environment, it may take a long time for the consequences to emerge—and emerge they will if the dysfunction is left unaddressed.
Given that an organization’s culture is the mix of shared values, attitudes, and patterns of behavior that comprise its particular character, how does a board get its arms around it? An opportunity we see is for directors to look to the chief audit executive as the independent “eyes and ears” of the organization’s culture. Specifically, internal audit can be asked to perform the following functions:
- understand the overall working environment;
- identify the unwritten norms and rules governing employee interactions and workplace practices;
- highlight possible barriers to an effective internal environment and communication flow;
- report unacceptable behaviors, decisions and attitudes toward taking and managing risk; and
- make recommendations to address identified problems.
Internal audit can also post warning signs to directors that further investigation into cultural concerns is warranted, and can assist in assessing whether the tone in the middle and at the bottom match the leaders’ perception of the tone at the top. This contrast can be quite revealing. It can serve as a powerful reality check to a management team that really wants to listen.
Competitiveness is a priority of every business and poses a significant opportunity for the internal audit function. If, for instance, the company’s practices are inferior relative to best-of-class performers due to underperforming business processes, the internal audit function can improve operating efficiency. In essence, the board should expect internal audit to look beyond traditional compliance areas and financial reporting to help the organization to continuously improve its operations.
Most organizations use some form of a balanced scorecard when monitoring whether they are successfully establishing and sustaining competitive advantage in the marketplace. Key performance indicators address critical areas such as quality, time, cost, and innovation performance. They often include indicators of customer and employee satisfaction. Internal audit can assist with assessing the reliability of these metrics for decision-making. In addition, internal audit can benchmark selected metrics against competitors and best-in-class performers to identify performance gaps that must be corrected in a timely manner.
Traditionally, the internal audit plan ensures that the organization’s compliance with laws, regulations, and internal policies are under control. As the third line of defense in the compliance chain of command, internal audit should ascertain whether:
- Front-line operators and functional leaders whose activities have significant compliance implications own the responsibility for identifying and managing compliance risk. These front-line operators are responsible for having effective controls in place to reduce the risk of noncompliance to an acceptable level.
- The scope of the independent compliance function, or the second line of defense, is commensurate with the significance of the company’s compliance issues and results in reliable and timely insights to management and primary risk owners.
Internal audit should determine whether a cost-effective monitoring process is in place to address the top compliance risks, and that can assess the overall implementation of the compliance program in light of changes in applicable laws and regulations.
In a recent survey, cybersecurity was cited as the third most critical uncertainty companies are facing as they look forward into 2017. What can internal audit do to alleviate this concern?
- Assess whether the company’s processes give adequate attention to high-value information and information systems. Rather than costly, system-wise protection measures resulting in lack of attention to the most important assets, internal audit can assess whether the information technology organization and business leaders agree on what constitutes the company’s crown jewels.
- Assist the board and senior management with understanding the threat landscape. The organization’s cybersecurity risks should be assessed based on the company’s crown jewels, the nature of its industry and operations, and its visibility as a potential target. For example: Who are the likely adversaries, and how might they attack? Where are our biggest vulnerabilities? How effective are our current internal controls? Do we conduct penetration testing? If so, what are the results?
- Review the organization’s response readiness to a cyber incident. Effective incident response processes are critical to a company’s preparedness to reduce an attack’s impact and proliferation.
By focusing more broadly on the implications of audit findings and thinking beyond the expressed or implied boundaries set by the audit plan, internal audit is better positioned to deliver stronger, more practical and harder-hitting recommendations aligned with what directors are seeking.
Jim DeLoach is managing director of Protiviti.