Table of Contents
Globalization of business activities, technological innovations, difficulties in accountability and allegations of misappropriation of resources, and incorrect financial reporting have resulted in an increasing need to ensure internal controls and internal auditing. This function of internal auditing is observable in its definition as independent, focused on assurance, and consulting processes oriented towards bringing value and enhancing its activities. It is useful in assisting organizations with accomplishing its purposes by ensuring that a systematic, focused approach is used to determine the value and improve its risk management process, as well as control and governance activities. These challenges are mainly faced by small businesses in the United States. Thus, this paper tries to find a recommendation on the usefulness of internal auditing to assist small businesses in facing an ever-increasing need to ensure quality production of its processes and activities.
Based on the functions of internal auditing mentioned above, it is observed that its functions can be used in managing considerable challenges and problems that are related to strengths, risks assessment, and management of uncertainties. A number of businesses have been observed to have difficulties in such a sector as hospitality that is regarded the fastest growing sector in the world. The US hotel industry is considered an area of research in this study, since it is regarded as a significant sector in economic expansion of the U.S, thus contributing immensely to the overall balance of exterior transactions. The hotel industry is considered a leading industry in the United States along with other industries such as transport and communication, as well as information and communication industries. The growth of the American hotel industry is considered to constitute about 19 percent of the country’s Gross Domestic Product (GDP), in which annual arrivals were estimated to account for 56 million in the year 2011.
In spite of the characteristics mentioned in this paper regarding the function of auditing in accomplishing business objectives and the growing popularity of the hotel industry in the US, no study exists which would recommends way in which internal auditing can be improved in the hotel industry. Since there are a limited number of studies concerning hospitality as a service sector, this research becomes more significant in this sector. In this case, this paper is focused on highlighting the relationship between components of internal audit and its effects on the American hotel industry in particular. To ensure the goals of this study are achieved, survey information from 52 hotel businesses which are considered the best in the United States of America is provided. Based on predictions of the initial research, it is observed that internal audit is attributed to five internal factors of control. They include control environment, assessment of risks, control processes, monitoring of information, and communication.
Other parts of this paper are organized as follows. The literature review section provides a guide for the study by investigating the required research design of internal audit and its efficiency. Another section is the research methodology that assists in obtaining data for the analysis. This is followed by the research design section which provides data on the sample, the process of development of the survey process, and the procedure for data analysis. The methodology section provides data that are used to arrive at the conclusion of the study. It also assists in testing the hypotheses that are formulated for the study. This is followed by the summary section which gives a summary of the entire paper, provides the results of the study, as well as proposes recommendations for future research. Then it gives a conclusion on the significance of internal audit for operations of small businesses in the United States. In the final section of the paper, limitations of the study are identified and future research processes are proposed to enhance the study of auditing in small business activities.
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There have been high profile corporate failures in recent years in areas of management of corporate funds. Penalties related to fraudulent financial reporting are on the rise due to the development of the culture of fraud. Some executives have faced serious court actions as a result of orchestration of financial fraud. Fraud is defined as an intentional act committed by an individual among management when a person is charged with governance in order to achieve an illegal advantage while assigned a task to perform.
A number of misstatements are observed during auditing. One of these involves a misstatement that results from misappropriation of assets. There are a large number of researches that have been done to examine the relationship between corporate governance and financial statement fraud.
Fraud has been associated with the existence of inconsistent results in relation to the audit process during financial accountability. The role of audit committees has been useful in assisting likelihood of sanctions against companies for fraudulent financial accountability. Also, it has been observed that there is a positive relationship between allowing insiders to conduct the auditing process and the possibility of occurrence of financial frauds. In Australia, it has been found that there is a negative relationship between the proportion of independent directors and investors in an institution and the possibility of fraud, while a positive relationship has been found between duality of positions and the likelihood of fraud, such as when a single person is the chair of the board as well as the chief executive officer.
Misappropriation of assets is also considered another form of fraud by employees. This type of fraud has received little attention in comparison to financial fraud. While this type of fraud has been described as the process of perpetrating small amounts of misappropriations, it is considered to have great financial impacts. In the year 2002, it was estimated that 6 percent of the U.S revenue had been lost as a result of fraud caused by employees.
Generally, there is enough previous research that has been done to identify and report fraud. On the other hand, externally reported fraud is more likely to result in serious consequences in controls or governance conditions. A large number of frauds committed were related to financial statement frauds, while there was the possibility of complicit in activities of senior management (Papastathis, 2003). Consequently, this study also tries to show that there is a relationship between poor corporate governance and this type of fraud. This paper provides a research into areas where frauds associated with misappropriation of assets can be identified by an organization and whether it is related to dependency on attribute of good corporate governance such as an internal audit unit.
b. Internal Audit
The effectiveness of corporate governance in an organization is dependent on the level of internal audit within the organization. Corporate governance includes all activities performed by the board of directors as well as audit professionals to be assured of the validity of financial reports. The major monitoring mechanisms that have been used in many organizations include internal audits, external audits, and directorships.
In recent years, high corporate collapse has been related to poor corporate governance and internal auditing processes. The main objective of internal audit is to support and strengthen the organizational governance structure by evaluating and ensuring improvement of risk management and control.The significance of internal audit has also been supported by the decision of the New York Stock Exchange (NYSE) by requiring all listed companies to have audit committees that liaise with internal auditors, external auditors, as well as management and ensuring independence in the auditing process.
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Internal audit has also been emphasized by the Securities and Exchange Commission (SEC), and registrants to the commission have been required to engage internal auditors. In Australia, there have been changes in the Corporations Act and the Australian Stock Exchange (ASX). The rules for listing require that an organization must have good corporate governance. Such changes are likely to result in the enhancement of the roles and significance of internal audit in the Australian environment.
Despite the increasing importance of internal audit, little research has been done to determine the significance of this function. A number of studies have focused on the agency cost framework as a method of illustrating the value of internal auditing. While variables such as size, debt, and agency are not considered to have any association with the presence of internal audit in Australian owned families, internal and external audit are used as methods of evaluating activities of the organizations.
A study in which the relationship between the size of internal audit and budgets was examined found that there was a positive relationship to the size of a firm, leverage, financial, service, inventory, flow of operations, and an audit committee review of budgets. The results of the study showed that there was a negative relationship to the percentage of internal audit that was outsourced. It was generally concluded that companies that faced higher risks in their operations tended to improve their organizational monitoring through internal audit. This led to the conclusion that internal audit is significant in operations of an organization.
A number of studies have been done in which the abilities of internal auditors to perform fraud-related work were investigated. There was greater agreement that external auditors were more efficient in estimating financial fraud with the suggestion that internal auditors were as aware as external auditors of the sources of such frauds.
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The nature of the internal audit variable is also regarded significant in determining the potential effects on an organization. Organizations may use their own staffs or external staffs or a combination of the two. Outsourcing the internal audit function is considered to have a significant effect on the user’s perception regarding independence of the auditor or reliability of the financial statement. However, companies that tend to outsource their auditors claim that the use of external auditors results in arriving at more competent conclusions for the analysis. On the other hand, the limitation of these initial studies is that they were conducted by measuring perception without considering actual performance. Due to the fact that many companies make decisions regarding whether to use internal source of auditing or an external one, the quality of performance of such functions is considered an issue that requires more examination rather than “perceptions”.
Project Approach and Methodology
This project was designed to identify the significance of internal audit in small businesses in the United States of America. It was designed to find ways in which internal audit can be more beneficial to any small business operators in the US. The project includes an introduction in which the two major types of audit are discussed. These are internal audit and external audit. With reference to internal audit, case studies are provided and a comparison is made regarding their differences and efficiencies in the auditing process. The literature review section of the paper provides ways in which internal audit will result in the efficiency of operations of a small scale business. It also includes the study of various components of internal audit and their effects on performance of the auditing process. These components include monitoring, risk assessment, information and communication, and control services.
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The literature review section also involves case studies of organizations that have implemented the use of internal audit to the advantage of their operations. The case studies include PwC and HW Fisher & Company. It is observed that these companies have faced serious management problems which were not identified because of lack of auditing. However, after incorporation of the auditing team, there were improvements in the quality of their services and a corresponding increase in their profitability. The literature review section also includes methods that can be used to improve the internal audit process. It involves an investigation of studies that have been conducted to assess the effectiveness of the internal audit process. An example includes investigation of factors that contribute to the effectiveness of internal audit in an organization.
The methodology section includes a sampling process in which a number of organizations are selected for the study. These organizations are mainly hotels in the United States of America. The survey process includes data collection through administration of questionnaires to respective managers in these institutions. These managers are also interviewed to determine their stand regarding the assessment of the effectiveness of internal audit in these companies.
The data analysis process includes reliability analysis by the use of Cronbach’s Alpha to determine the relationship between the variables used in the study. Descriptive statistics include computation of mean, median, range, and standard deviation between variables used in the analysis of data collected in the primary research. This is followed by discussion of the findings of the research process and explanation of limitations for the study. Finally, the paper provides a conclusion which is a summary of the paper and recommendations for future studies.
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Research Questions and Hypotheses
Internal audit is considered an important factor in adding value to an organization and minimizing errors by external auditors. The main objective of internal audit is to ensure improvement of risk management and governance of a business. It is regarded as an important tool for the protection of corporations from internal criminal activities. In addition, it is argued that internal audit is an important tool for the prevention or detecting fraud when employees try to misappropriate assets.
As a result, it is expected that the ability to detect fraud is enhanced in organizations that have internal audit in comparison to those that do not have one. Some of the hypotheses that were formulated include the following:
H1: It is possible to detect and report fraud in an organization that has internal audit as compared to organizations that do not.
This study also addresses the issue of relative importance of insourcing compared to outsourcing internal audit activities. Initial studies have been focused on investigation of perceptions regarding the two approaches, and it has been found that outsourcing internal audit functions results in achievements of higher quality. Furthermore, there have not been any studies conducted to determine the distinction between the two different techniques, and this study is focused on examination of these differences. It is suggested that despite the nature of internal audit, when the service has been outsourced, it is assumed to be of high quality, but it does not imply that there will be a corresponding effectiveness of operations in an organization. The results of perception of high quality of outsourcing internal audit services can be explained by the fact that it is associated with high reputation. Such a reputation may be in the form of independence of the auditing process. In addition, there is a need to allocate enough time for the study, and as a result companies prefer to use insourced internal auditors in comparison to outsourced internal auditors.
One function of the internal audit process is to ensure there is control in fraud detection and availing of reports concerning frauds to the management. It is expected that since there is a greater amount of time available to insourced internal auditors, greater effectiveness of internal audit can be achieved and reported. One of the research questions that were used to conduct the study of the effectiveness of internal audit is stated as follows:
RQ 1: Do organizations that completely use insourced internal audit functions detect and report fraud better than organizations that completely rely on outsourced audit functions?
Implications of Research
While the normal function of internal auditors is to assist organizations in creating systems of internal audit, which results in control of financial statements, there exists a wide range of opportunities and functions, and there is emergence of potential use in the following business project. Internal audit is focused on assisting Internal Auditor Representatives with exploring techniques for providing the required level of assurance that are required and recommended by stakeholders in the business mentioned. Findings from internal audit are significant in many businesses in the project of business management. Results from the auditing team are important in the task of the auditing committee in ensuring increased efficiency.
The process of auditing involves a number of tasks. These include following the requirements of the company and following every aspect of internal control. It also includes abiding by rules and regulations, laws and expectations, as well as the estimation of risks and opportunities. Auditing assists in the assessment of burdens associated with auditing such as developments experienced by an organization. It also involves queries regarding the growth of people and confirmation of activities that have been performed by the organization.
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As a result, the role of internal auditors is considered an integral part of successful business operations. It is also significant in bigger organizations, since reports from internal audit can be used by the Board of Directors to assess where their resources are implemented effectively in the organization.
Furthermore, effective communication is considered a requirement for effective governance of activities in small businesses, while it is also a key factor in strengthening the relationship between organizational auditors and external auditors, as well as the auditing committee.Thus, the role of auditing should be assigned to the auditing committee and should be kept away from management, since it is regarded as the customer of internal audit.
The main goal of internal audit is to assess the performance of the Audit Committee, while the organization finds the results of internal audit a good source of information. Internal auditors and the Auditing Committee can develop a unique relationship by sharing such aspects as ‘reporting lines’ and ‘protection autonomy’. This does not imply that the role of an internal auditor is to work in isolation from other members of the administration system. For an internal auditor to add value to the organization there is a need to establish fruitful cooperation with the management, as this can be explained by providing the right results regarding conditions in an organization. The data from this analysis are significant in determining where changes need to be made, as well as preferences of stakeholders with respect to the allocation of resources.
This research results in significant findings that can be used by any organization which needs to implement the use of internal audit in its operations. This can be achieved by the proper implementation of the proposed recommendations. There are certain guidelines that must be followed by any organizations that need to implement the findings from this research. This is focused on ensuring that actions and auditing involve certain actions which are targeted towards the attainment of the goals of the study. Businesses that are most likely to benefit from the findings of this research are small hotel businesses in the United States. This is because the data used for the analysis of the research process were obtained from hotel industries in the US.
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One of the recommended approaches to the implementation of the findings of the research is to determine the area of operation which needs to be audited. This assists in selecting the right method of auditing activities in the section. For instance, if it is an area that involves the assessment of risks, procedures that need to be followed during the assessment of risks need to be followed in auditing such an activity. The same applies to other components of auditing, such as information and communication as well as monitoring. For the case of monitoring, managers need to know activities that can be audited by monitoring. This ensures that the right monitoring procedures are followed during the auditing process. After the identification of the right component of auditing to be followed, the management needs to ensure that the right personnel are assigned the task of carrying out auditing work. This can be an external auditor if they have the reputation of conducting effective audit work or an internal auditor if they have the competence to do the work. This is followed by ensuring that records of the audit process are made so that a report of the auditing process can be written. The report should include the actions and events which took place, mentioning irregularities and proposing changes to be made in the process. The report is then forwarded to the management for implementation.
When the management receives the report together with the recommendations, it will be offered for the implementation by a worker in an organization. For instance, if the report shows that there is inconsistency in balancing transactions in the records of a cashier at a hotel, the manager will inform the cashier about this condition. In addition, the manager will propose that the cashier should make their records more accurate in subsequent operations. The management can then observe the subsequent actions of the employee who was audited and commend them for improvement or take further steps in case of lack of improvement. A comparison is then made between the current profitability and initial profitability to assess the effectiveness of the implementation of audit work.
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