Internal Audit History and Background

INTERNAL AUDITING HISTORY AND BACKGROUND
It is normal for any activity—including a control activity such as internal auditing—
to come into being as a result of emerging needs. The business organization
of 1942, when modern internal auditing was just getting started, was very different
from our twenty-first century organization of today. For example, aside from
some electromechanical devices and activities in research laboratories, computer
systems did not exist. Organizations had no need for computer programmers
until these machines started to become useful for various record keeping and
other computational functions. Similarly, organizations had very rudimentary
telephone connections where switchboard operators routed all incoming calls to
a limited number of desktop telephones. Today, we are all connected through a
vast, automated worldwide web of telecommunications and the Internet. The
increasing complexity of modern business and other organizations has created
the need for a similar specialist in various business controls: the internal auditor.
We can better understand the nature of internal auditing today if we know something
about the changing conditions in the past and the different needs these
1.2 INTERNAL AUDITING HISTORY AND BACKGROUND
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changes created. What is the simplest or most primitive form of internal auditing
and how did it come into existence? How has internal auditing responded to
changing needs?
At its most primitive level, a self-assessment or internal auditing function can
exist when any single person sits back and surveys something that he or she has
done. At that point, the individual asks him- or herself how well a particular task
has been accomplished and, perhaps, how it might be done better if it were to be
done again. If a second person is involved in this activity, the assessment function
would be expanded to include an evaluation of the second person’s participation in
the endeavor. In a small business, the owner or manager will be doing this review
to some extent for all enterprise employees. In all of these situations, the assessment
or internal audit function is being carried out directly as a part of a basic management
role. However, as the operations of an organization become more
voluminous and complex, it is no longer practicable for the owner or top manager
to have enough contact with every aspect of operations to satisfactorily review
their effectiveness. These operations review responsibilities need to be delegated.
Although this hypothetical senior manager could build a supervisory system
to try to provide a personal overview of operations, that same manager will
find it increasingly difficult to know whether all of the interests of the organization
are being properly served as it grows larger and more complex. Are established
procedures being complied with? Are assets being properly safeguarded?
Are the various employees functioning efficiently? Are the current approaches
still effective in the light of changing conditions?
The ultimate response to these questions is that the manager must obtain
further help by assigning one or more individuals to be directly responsible for
reviewing activities and reporting on the previously mentioned types of questions.
It is here that the internal auditing activity comes into being in a formal
and explicit sense. The first internal auditing assignments usually originated to
satisfy very basic and sharply defined operational needs. The earliest special
concern of management was whether the assets of the organization were being
properly protected, whether company procedures and policies were being complied
with, and whether financial records were being accurately maintained.
There was also considerable emphasis on maintenance of the status quo. To a
great extent, this internal auditing effort was initially viewed as a closely related
extension of the work of external auditors.
The result of all of these factors was that these early internal auditors were
viewed as playing a relatively narrow role in their organizations, with limited
responsibility in the total managerial spectrum. An early internal auditor often
was viewed as a financially oriented checker of records and more of a police
officer than a coworker. In some organizations, internal auditors had major
responsibilities for reconciling canceled payroll checks with bank statements or
checking their mathematics in regular business documents. In retail organizations,
internal auditors often were responsible for reconciling daily cash sales to
recorded sales receipts.
Understanding the history of internal auditing is important because this old
image still persists, to some extent, for today’s modern internal auditors. This is so
even though the character of the internal auditing function is now very different.
FOUNDATIONS OF INTERNAL AUDITING
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Over time, the operations of various organizations increased in volume and complexity,
creating managerial problems and new pressures on senior management. In
response to these pressures, management recognized the possibilities for better utilization
of their internal auditors. Here were individuals already set up in an audit
function, and there seemed to be every good reason for getting greater value from
these individuals with relatively little increase in cost.
At the same time, internal auditors perceived these opportunities and initiated
new types of services themselves. Thus, internal auditors gradually took on
broader and more management-oriented responsibilities in their work efforts.
Because internal auditing was initially largely accounting-oriented, this upward
trend was felt first in the accounting and financial-control areas. Rather than just
report the same accounting-related exceptions—such as some documentation lacking
a supervisor’s initials—internal auditors began to question the overall control
processes they were reviewing. Subsequently, internal audit valuation work began
to be extended to include many nonfinancial areas in the organization.
In 1942, the Institute of Internal Auditors (IIA) was launched. Its first membership
chapter was started in New York City, with Chicago soon to follow. The
IIA was formed by people who had been given the title internal auditor by their
organizations and who wanted to both share experiences and gain knowledge
with others in this new professional field. A profession was born that has undergone
many changes over subsequent years and has resulted in the type of modern
internal auditor discussed in this book.