If you're a typical finance department, discussions about Internal Controls are probably not part of your daily work day. In our experience, accounting teams start thinking and discussing Internal Control when they have:
- found an alarming incidence of error in their business processes
- are subjected to a performance audit (if they are a local government)
- heard of another organization falling victim to fraud
Outside of these scenarios, the strength of internal controls systems doesn't often get a lot of finance's attention while they take care of payroll, budgeting, management reporting, financial reporting and so much more.
There is a large, but often overlooked reason to focus on your internal controls system, an opportunity to reduce audit fees.
Audit Fees Increase with Poor Internal Controls
Poor internal controls and/or poor documentation of existing controls directly lead to increased audit fees. Why?Auditors must increase the amount of testing performed (sample size) when they determine that internal controls can not be relied upon (International Standard on Auditing - 530 Audit Sampling) to reduce audit risk to an acceptable level (International Standard on Auditing - 330 Auditor Responses to Assessed Risk). Specifically:
"Deficiencies in the control environment, however, have the opposite effect; for example, the auditor may respond to an ineffective control environment by:
• Conducting more audit procedures as of the period end rather than at an interim date.
• Obtaining more extensive audit evidence from substantive procedures.
• Increasing the number of locations to be included in the audit scope.
The evidence of this direct relationship between audit fees and internal controls abounds. In December 2016, the Financial Executives Research Foundation (FERF) survey of more than 6,000 organizations found that reviews of internal controls continue to be one of the three major driving factors behind rising audit fees:
- More than 20% of the respondents that had audit fee increases cited a “review of manual controls from [Public Company Accounting Oversight Board] inspections.”
- Companies that cited ineffective internal controls as adding to audit fees experienced a 5.1% median increase, almost two percentage points higher than the median increase for all other filers.
3 Recommendations to Reduce Audit Fees
In their followup article "Mitigating Increases in Audit Fees" the FERF interviewed preparers and auditors to understand causes and develop recommendations. Several recommendations focused specifically on Internal Controls improvements that drive lower audit fees including:
- Align key controls with key risks: Ensuring the organization has strong controls to address the most significant risks will give management and auditors increased confidence.
- Document internal controls: If an organization has very light or poorly organized documentation, or hasn’t thought through all the branches in a process, attestation becomes difficult for the auditor — and more costly for you.
- Evaluate the latest technology: External and internal auditors are both using data analytics and continuous controls monitoring technology to increase audit quality, work smarter and potentially reduce costs.
There are many great reasons to focus on improving your organizations' internal controls. Lower Audit fees is another good one.