The current study delivers a comprehensive image of the internal audit purpose. This necessarily views the conceptual evolution of theory of internal audit, and illustrates the necessity for the same, descriptions of the term, and the way it is inevitable to different entities’ internal audit function operates within. In essence, this runs deeply into the prior studies that are necessarily directly associated to the topic under consideration and delivers their findings. This can aid the process of ascertainment of beginning point of the current study. The present study intends to illustrate and design a conceptual framework and evaluate overall nature and exercise of the internal audit function within companies in Libya.
Notions of internal audit within a corporation
Conceptual approaches concerning internal auditing
Griffiths (2016) indicates that there is a comprehensive image of the internal audit function. The study views the conceptual transformation of the internal audit function and illustrates the requirement for the same, descriptions of the terms and the way it is necessary to different entities. The activities of internal auditing emerged as well as designed owing to value to specific recipients and owing to potential of fulfilling specific requirements of different users. Eulerich et al. (2015) assert that the activity of internal auditing is of great importance and the article recommends specifying significance of the association between specifically section of accounting as well as assessment. Internal auditing can be considered to be of strategic significance, as managers, along with the Board of Directors of the reporting unit, can understand that till there is an appropriate internal structure of control, a few error as well as failures can be examined and eradicated in a well timed method.
The Board of Directors of the company necessarily give the impression auditing that is internal in nature as an act for enhancing the action, in addition to an act of searching for as well as detecting faults as well as wrongdoing. Therefore, amplification of auditing concept that is internal in nature, and over and above than that, elucidation of the role that internal auditing essentially plays today, is crucial. As suggested by Salvioni and Astori (2015), there are several scholars from the specific ground have analysed the advancement of internal auditing at the global level as well as nationwide level. A more strong utilization of the expression audit is discovered during period of economic crisis from the period 1929, given that then role as well as requirement of internal auditing endlessly augmented, a fact that directed to the corporation along with standardisation of exercises of internal auditing by way of institution in the year 1941 in Orlando, USA, of principally the Institute of Internal Auditors (abbreviated as IIA), to which, at the instant, in excess of 120 nations are associated.
As recommended by Alzeban and Gwilliam (2014), internal audit necessarily had a significant role within corporate governance ever since the period 1940. It certainly became more imperative with passage of time. Ever since the period of 1940, several transformations have taken place as regards internal auditing that was regulated by means of diverse norms as well as corporate governance codes. McAlister and Ferrell (2016) takes into account the fact that there are diverse basic actions of internal auditing are registered include analysis of risk, making certain organization within the entity as well as ensuring conformity.
During the year 1942, Lenz and Hahn (2015) asserts that the first president of the entity International Institute of Internal Auditors, announced an surprising forecast that majority of excellent standpoint of internal auditing shall be the “managerial backing”. During the year 1991, Joseph J. Mossis that is the president of the “Institute of Internal Auditors” of Britain, started again the same comment, however in a more a precise manner. In essence, it is quite clear for the ones that operate within “Internal Auditing function” that this necessarily plays an important role, assisting overall management to support the reins of internal control (Yee et al. 2017).
Figure: Evolution of Internal Audit Function
(Source: Yee et al. 2017)
Beginning from the period 1950, IIA declared own internal auditin norms that was entirely different from the ones of external auditting. However, with passage of time these norms were necessarily generalised and from the period 1970 these essentially became standards of internal auditing that are primarily subject to alterations owing to different entities that are continuously struggling with dealing with new difficulties and challenges.
As correctly put forward by Mihret and Grant (2017), initial illustration of internal system of audit was delivered by director of IIA that is the Research institution established during the period 1958. Yasser et al. (2015) suggests that Internal auditing that emerges as a particular section of the wide ground of accounting, using the fundamental mechanisms as well as ways of accounting. Mat Zain et al. (2015) mentioned that the public accountant as well as internal assessor utilizes many similar mechanisms that again direct towards an erroneous supposition that there subsists minute inconsistency in firm’s operation. Essentially, firm’s internal assessor, similar to any evaluator, is worried regarding evaluation of legitimacy of depiction. However, as regards the current case under consideration, the illustration with which particular evaluator is disturbed takes into account fairly broader choice. Also, there is requirement to accomplish different themes in which the association to particular accounting items is frequently to some extent isolated. Also, the internal assessor is relatively more intensely concerned in assisting to carrying out the operations profitably (Christopher 2015).
As recommended by El-Kassar et al. (2014), internal auditing can be referred to as Professional rules declared by the “Institute of Audit and Internal Control”. This rule refers to a specific purpose along with independent activities that confer to a business concern an cover concerning the stage of specific controls regarding different functions. This shows the way to the business concern and helps in enhancement of business functions that in turn can add plus value. In addition to this, this has the requirement to be state that internal audit also assists the business concern to attain its aims since the same evaluates the administrative process, controls in addition to processes of governance. However, there exists a risk to which the business concern is exposed. In addition to this, internal audit presents explanations and solutions for enhancement of effectiveness of these procedures, or else to mask drawbacks (Ruud 2013).
As mentioned by Alzeban (2015), internal auditing action appreciates and directs the corporate governance procedure, in a bid to achieve particular aims associated to ethics, accountability as well as effectiveness in management. Fundamentally, in this regard, it can be said that for the purpose of tracking and making certain compliance to the pertinent code of corporate governance. Essentially, it is crucial to illustrate the notion of corporate governance. In particular, corporate governance as per OECD, reflects different procedures according to which a corporation is directed and at the same time controlled (Drogalas et al. 2016). There are different aspects of corporate governance attained distribution of powers as well as obligations between mainly the Board of Director, firm’s managers, different shareholders as well as stakeholders, in order to make certain coordination of diverse actions and attainment of objectives of the business concern.
The report published by Preda reveals the fact that companies registered at different stock exchange believes that corporate governance is essentially the outcome of specific norms, varied traditions along with behavioural themes designed by each and every system of legislative (Jiang et al. 2017). As published by IIA during the period of July in the year 2006 in their guide on Organisational Governance directed for Internal Auditors of the firm, the association between internal auditing as well as its advisory service role can be essentially strengthened in definite aspects of principally corporate governance.
As suggested by Jiang et al. (2017), internal auditing primarily has a more significant part since the declaration of the law that is the Sarbanes Oxley Law on apparition. Although the directives stipulated under this Sarbanes Oxley Law do not necessarily attend to the definite role of the internal auditing mainly within corporate governance of businesses, but there are different obligations of corporate governance for mainly the audit committees as well as external auditors and there are also recommendations as regards the significance of internal auditing. Nickell and Roberts (2014) assert that progression of internal audit indicates towards orientation towards enhancement of the effectiveness of management of risk, escalating satisfaction level of stakeholders, improvement of the capabilities that different internal assessors need to have, mounting concern in enumerating and analysing overall performance of internal audit. These studies also talk about enhancement of the level of progression of technology in the studies of internal audit (Lenz et al. 2014). In recent times, internal evaluators have also participated more and more in different works of functional auditing, management of risk, several internal controls, and specific requirements of governance as well as IT notions. As such, it is extremely crucial to monitor the direction in which function of internal auditing shall head towards in the upcoming period.
Theoretical Perspective of internal audit function and corporate governance
Nickell and Roberts (2014) suggested that corporate governance can be considered as oversight of policies, processes as well as exercises. This oversight aids to make certain that the business concern is exercised in the best interests of the firm as well as its shareholders. The procedures of handling corporate governance are normally handled by a board of directors. In addition to this, business concern might employ different staff of assessors to examine and scrutinize internal controls.
Ackermann and Marx (2016) mentioned that the ultimate accountability for corporate governance in majority of business concerns lies directly with the board of directors. In essence, internal assessors are mainly charged with making certain that corporate procedures along with related controls are functioning as intended.
Agency Theory as a theory of Corporate Governance
Baharud-din et al. (2014) advocates that agency theory indicates towards issues of directors that control firms and shareholders own the business concern. Agency theory considers this specific subject matter into account for preventing the same. As per Tsai et al. (2015), the main notion of agency notion is that a specific agent gets recruited by primarily the principle to keeping on the task and the agency is the association between mainly agent as well as the principle. In addition to this, agency costs are mainly provided by the principle for the purpose of controlling overall behaviour of the agency owing of deficiency of trust in the conviction of the agents. Al-Matari et al. (2014) suggests that it is important to assume the assignment on behalf of different agents and in this case agent becomes liable to that specific principle. Fundamentally, there is three different segregations of ownership as well as control; namely principal (referring to shareholders of a firm), agents (indicating to the directors of a firm) and task under consideration (indicating towards management of the corporation) (Lee 2017).
In essence, the agency theory aids business enterprises to develop the corporate governance and this necessarily starts off with the business enterprises owned as well as managed by the same individuals. However, in the following phase, it necessarily expands the entire business by means of contributions of requisite financiers. As such, these individuals can be essentially the shareholders having restricted liability. Thereafter, in the subsequent stage, it delegates the responsibility of continuing the operations of the business to principally managers of the firm (referring to the agents). Further, in the following stage, the business undertakes separation of business goals. Martin (2015) mention that separation/ division of business ownership can show the way to probable notions between firm’s directors, firm’s shareholders along with relationship with principal-agent that can be handled with different codes of corporate governance.
Ali and Ahmad (2017) suggested that agency theory comparative to corporate governance supposes a two-tier sketch of firm control and this includes managers as well as owners. Again, agency theory supports the view that there might be some sort of friction as well as doubt between these two different groups. As such, the fundamental framework of the business concern, thus, is the netting of contractual associations among diverse interest groups having a stake in the business concern.
On the whole, there are essentially three different clusters of interest groups within the business concern namely, Managers, shareholders as well as creditors (primarily the banks). Setiawan and Djajadikerta (2017) asserts that shareholders often have disagreements with both banks as well as managers, because their common priorities are unlike. Managers hunt for quick profits that amplify their own riches, power and status, whilst shareholders are further fascinated in unhurried and stable growth over period. The rationale of agency theory is to recognize points of disagreement among corporate clusters of interest groups. As such, Banks intend to lessen risk whilst shareholders wish for to reasonably maximization of profits. Managers are relatively more risky in the area of profit maximization, as their careers are founded on the capability to generate proceeds and present the results to the board. In essence, this fact that contemporary corporations are founded on these associations that generates costs and each and every group has the intent to control the other (Ravjee and Marx 2015).
Costs of agency model on corporate governance
One of the most important insights of essentially agency theory is the notion of costs of keeping up with the labour division among various credit holders, varied shareholders as well as managers. In essence, managers necessarily have the benefit of information, as they understand close up of the firm. Also, they can necessarily utilize this for enhancement of their own status at the cost of shareholders. Restricting overall control of different managers itself involves costs (namely decreased profits), whilst profit seeking in various risky ventures might possibly alienate different banks along with other financial institutions (Al-Matari et al. 2017). Keeping track and restricting managers itself also involves now and then considerable amounts of costs to the business concern.
Significance of agency model on corporate governance
As suggested by Ruud (2013), agency model on corporate governance upholds the view that that business enterprises are principally units of disagreement in place of unitary, profit-seeking equipment. This disagreement is not unusual but embedded within the framework of contemporary business enterprises.
Effects of agency model on corporate governance
Drogalas et al. (2016) asserts that it is quite possible that in case if one accepts the notion of agency theory, that business enterprises are in point of fact groups of associated fiefs. Alzeban (2015) states that each one of the fief has own specific interest as well as culture and opinions regarding the purpose of the firm in a different way. In evaluating the purpose of a corporation, one can suppose that managers shall behave in a manner to make best use of their own profit as well as reputation, even at the costs of firm’s shareholders. Also, one might perhaps even comprehend the role of managers as one of institutionalized deceitfulness, in which the irregularity of knowledge allows managers to function operate with more or less total sovereignty.
3.2 Stewardship Theory of Corporate Governance
As suggested by Stewardship theory is regarding the manager who can operate as accountable stewards of specific principle as well as assets that they manage (Jiang et al. 2017). Furthermore, stewardship theory can be considered as the alternative opinion of the agency theory in which the managers are considered to act in their own eagerness. It can be hereby mentioned that specified that stewardship is a definite mechanism to lessen loss of agency. This strategy incorporated the compensation, retention policy of executives of the firm, ascertaining different benefits as well as incentives of the managers of the corporation by means of financial rewards and delivering shares by the process of maintenance of alignment. In essence, this offers pecuniary interest to the members of the staffs and this can inspire employees to perform better. Lenz et al. (2014) suggests that the steward can be considered to be one who pays attention and looks after the requirements of others as well as executives of the business enterprise intends to look after interest of firm’s shareholders and they necessarily arrive at a decision regarding the business enterprise.
Whilst profit drives any sort of business, certain businesses might perhaps take into account fraction of something greater. In essence, stewardship theory supports that ownership doesn’t in reality own a business; it is only just holding it in a specific trust. As such, this reflects the manner in which business. Nickell and Roberts (2014) suggests that the processes might prove to be a medium for a advanced calling or else are devised to honour a initial vision of a founder, therefore generating a profit that essentially takes a back seat to satisfying a social standards of a company.
Ackermann and Marx (2016) put forward the view that stewardship models might perhaps involve different environmental issues, in which a business thinks that it should function with as slight influence as possible on the entire world. Again, other business concerns might perhaps champion specific human else wise animal rights, abstaining from utilizing products that necessarily are completed in sweatshops or else are examined on various live subjects. However, there are still others who might honour religious beliefs of the owners and represent themselves as servant leadership. In essence, these models have the tendency to be prejudiced, with administration ascertaining boundary between socially accountable or irresponsible behaviour (Baharud-din et al. 2014).
A business concern that is committed to a greater purpose shall attract clients who share the same idea. Nevertheless, in case if the holders indicate towards stewardship else wise social accountability in the area of corporate governance, company’s customers cautiously weigh this alongside the manner in which the business concern actually function. Inconsistency between words and action estrange base of the client (Tsai et al. 2015).
Impacts of Stewardship Theory of Corporate Governance on Employees
Baharud-din et al. (2014) advocates that there are workers who might have greater anticipations than they would in case if a company functions under an untainted profit intention. Nevertheless, workforces who support similar vision have the inclination to adhere to and work diligently to achieve goals of the company even at the time when compensation is not as per industry standard. A concrete sense of stewardship enhances morale of the company when the workforces feel that they are an important part of the business concern (Lee 2017).
Particular Influence of Stewardship Theory of Corporate Governance on Clients
Customers also feel good and like to think that they are also an important part of something related to the firm, and might perhaps stay with a specific stewardship-driven firm even when its price for specifically goods or else services is greater. Nevertheless, stance of the company on stewardship might possibly rub certain prospective clientele the wrong manner, principally in case if their cause is essentially unpopular else administration becomes strident regarding their own beliefs (Martin 2015).
General consequence of Stewardship Theory of Corporate Governance
Tsai et al. (2015) refer to the fact that stewardship-based firms commonly consider themselves to be under scanner or in other words a microscope. In case, if clientele or else workers sense the advanced mission is merely talk, then the business concern shall lose confidence or else reliability. In essence, a business concern might cite social accountability as validation for elevated prices or else inferior products. However, even though a business concerns remain true to all their mission, then in that case it might perhaps miss out on certain profits for the for achievement of higher purpose (Ackermann and Marx 2016). Again, with maturity of business concern, stewardship might come by the wayside in case if founders remain no longer around to set the specific tone. Conversely, employees as well as workers might acquire advantage of stewardship attitude for attainment of their specific purposes.
Developing and implementing well-aligned internal audit strategy
Nickell and Roberts (2014) asserted that internal audit function necessarily a yearly budget plan and corporate governance requires internal auditors to acquire a particular strategic scheme. In essence, internal audit stratagem needs to be approximately three to around five years scheme and roadmap of the business concern need to be founded on the strategy on the whole and expectation of the stakeholders from the business concern. In particular, an appropriately formulated stratagem necessarily has four different steps to generate an internal-audit specific strategic scheme.
Again, in different African nations and in different huge business concerns; framing formal internal audit policy has the need of planning since the corruption is already there. Initially, the business concern has the requirement to develop or else refine strategic vision of internal audit along with roles as well as accountabilities of the stakeholders need to be elaborated properly. In essence, the visions of internal assessors have the need to be mandated plainly. In essence, the business concerns need to achieve the same in long-term. Martin (2015) asserts that in the consequent stage of the well-designed scheme; the business concern has the requirement to identify and prioritise different key strategic proposal. This is important to authorize strategic vision of internal audit and initiatives need to be undertaken to minimize business risks of the business concern. Furthermore, in the subsequent stage, the business concern can formulate the suitable key performance indicators (referred to as KPI) for diverse stakeholders. In addition to this, the shareholders else wise board of directors of the firm can ascertain overall success of principally internal audit by means of KPI set against prioritised scheme. The business concern can monitor the value-driven dimension along with the productivity (Setiawan and Djajadikerta 2017).
In addition to this, the business concern has the requirement to formulate operating stratagem by means of monitoring the actions to acquire strategic initiatives. Furthermore, the internal auditors can necessarily ascertain important milestones by means of communicating the same to numerous external stakeholders. As rightly indicated by Ravjee and Marx (2015), the article “Internal Audits and its role in Corporate Governance”, mentioned the fact that corporate governance has two different indispensable actions, one crystallises overall risk control and other audit assurance as regards regulatory control. Furthermore, supervisor controls ensure the efficiency of different submission reports along with standards of internal audit that confirm the efficiency level of corporate governance. In particular, the authors also mentioned the assessment that different internal evaluators have the requirement to be entirely prepared in a bid to audit overall operations of the business concerns and be in charge of accounting system, strategic operations as well as administrative procedures (Al-Matari, Y.A et al. 2017).
Role of internal audit function in development of corporate governance code
As mentioned by Lee (2017), corporate governance can be considered as an important system by means of which the business concerns are controlled as well as directed. Again, the correct corporate governance framework has mentioned overall distributions of accountabilities along with rights among different stakeholders along with departments within the business concern. As stated by Nickell and Roberts (2014), the business concern primarily has a multi-layered mechanism by means of which it necessarily controls the entire system of organizations. Principally, initial layer of corporate governance of the business concern lie within segment where the procedures of working makes sure the controls that target errors of misbehaviour. In essence, The Chive Executive Officer of the business concern acquires internal assurance from system of internal audit along with board of directors. This uses system of internal audit to make certain that different stakeholders along with departments within the business concern need to be trustworthy and at the same time precise. Also, shareholders can ensure whether their area of interests along with their money is well-guarded. The entire systems within the business concerns are operating and sufficient in the way it operates within the corporation (Ruud 2013). Thus, external assessors analyse the system to deliver recommendations to the holders. In particular, board of directors of the business concern have the requirement to institute the transparent actions and formal management to implement the risk management, reporting of task as well as principles of internal control that in turn can maintain an association with assessors of the business concern.
The article titled “Internal Audit and its Role in Improving the Corporate Governance Systems”, penned by Tabara and Ungureanu, mentioned the fact that corporate governance indicates towards the cycle that can present monitoring role to steering of diverse operational as well as administrative actions. In essence, the authors also mentioned the fact that there are aims of corporate governance to maintain a balance between diverse actors to execute power control mechanism and concerned parties in entity (Alzeban 2015).
Also, internal auditors also mention the fact that there are different systematic as well as disciplines that work towards attainment of improvement and analyse overall effectiveness of the organisational system and governance procedure (Lenz et al. 2014). The positive role of internal audit goes beyond the safeguarding and controlling of the corporate assets, enforcing corporate liabilities and regulatory compliance; the role of the internal auditor is to create the value and suggesting the development of the organisational corporate governance. On the other hand, as contradicted by Ackermann and Marx (2016), internal assessors make sure the effectual internal control and adequacy of control system which ensures responsible governance. According to Baharud-din et al. (2014), internal audit aids the board and stakeholders in protecting the reputation, resources and sustainability of the company. The accountability of the internal audit is just not to expand the financial control but also to preserve non-financial performance as well.
Role of internal auditing functions as a mechanism of corporate governance mechanism
Internal audit is described by the Institute of Internal Auditors as a specific objective action certification as well as consultation that calls for streamlining overall operations of a business concern. However, there are also procedures of management of risk, control as well as governance. In itself, internal auditors can be considered to be important parts of corporate governance and their know-how in control has an important contribution in the process of making certain integrity as well as reliability of financial assertions (Al-Matari et al. 2014).
In due course, role of internal auditors was stretched to analyse and enhance management actions. In essence, a specialist or professional has the need to continually scrutinize the procedures of financial reporting and to locate those indicators known as red flags that indicate prospect of illegal actions. As such, internal auditors’ actions can be aptly categorized in the following way. The role includes analysis of varied functional performance, making certain adequacy along with effectiveness of the system of internal control, assessing procedures of financial reporting to make certain quality along with integrity in the generation of trustworthy as well as dependable financial information, pertinent, useful along with transparent manner of arriving at appropriate decision. Also, the role includes making certain a system of governance that involves prevention, identification along with rectification of fraud, mainly in the financial assertions, that in turn in the subsequent period might perhaps threaten overall integrity along with reporting quality (Al-Matari et al. 2017).
In essence, the procedure of governance is concentrated on chiefly development and preservation of effectual internal audit to defend resources from loss or theft. However, in this regard, it can be hereby said that corporate governance can be observed as a specific mechanism to observe the activities, policies along with decisions framed by management to attain objectives of the business. As per the theory organization, it can be said that corporate control asks for primarily disputes regarding power and the procedures by which the same is considered by the key shareholders of the corporation.. In majority of the nations, firm’s board of directors possesses the power to lead the business concern, although this kind of situation is necessarily subject of definite limitations within governance instruments. Furthermore, there are several structures that rule out shareholders initiatives asking directors to undertake certain dimensions, if not they are an effective advisory suggestions (Ruud 2013). Again, tensions that exist between the ones who want to be supported and the ones who talk about collaborative advances to governance are ever-increasing. As such, the debates are mainly on different topics namely, the capability of individuals operating outside the purview of corporation or else holders of information internal to rule the entire board of the firm, in case if executives need to be tracked or authorized to operate freely and the way the board need to permit market discipline or else surplus of power else wise to shield the managers of diverse market abuse. However, by way of implementing agency theory, it is possible to understand conflicting issues, essentially complementary. Founded on economics as well as finance theory, it can be hereby be deciphered that a specific control approach aims to lessen opportunistic behaviours of different managers with a probable negative influence on main property owners (Alzeban 2015). In essence, internal audit has transformed from an operations that targets different financial as well as accounting issues to a specific function that concentrates on a broad range of operating actions and becomes an important part of governance framework. In essence, its role has the need to aid different individuals along with diverse other functions within the business concern to satisfy commitments, providing requisite suggestions, analysis as well as information (Nickell and Roberts 2014).
Figure: Role of Internal Audit
(Source: Nickell and Roberts 2014)
There is important role of audit committees in directing an enterprise. There is an internal audit service as well as an audit committee that is chaired by a specified non-executive members, have the function to recommend the directors of the corporation. Audit committees also need to have the best orientation in overseeing entire design of yearly accounts, election assessing accounting strategies as well as practices, reviewing systems of internal control and operating structure of both internal as well as external assessors. Also, audit committees are also needed purposely to review accounting decisions and decide on the projected modification as well as restatements after an assessment (Ackermann and Marx 2016). However, in response to definite errors in accounting, disagreements else wise omission with the accounting strategies associated managers; assessors might perhaps propose alterations before pecuniary disclosure or else rewording of previous period outcomes. Operations of an audit committee need to make certain overall quality of accounting as well as control system (Tsai et al. 2015). Also, agency theory anticipates the generation of audit committees as a way to mitigate costs of agency and enhance internal control. This is regarded as an effectual monitoring apparatus for augmenting overall communication. The incidence of independent directors of firms does not necessarily have an effect on revenues and does not engage management earnings diminution.
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