Six Signs You May Be the “Internal Guard-it” Department

Traditionally, internal audit was seen as a value protection element in the organization’s system of risk management and controls. It helped organizations protect value through a heavy emphasis on assurance on the effectiveness of financial, compliance and operational risks. However, over the past 30 years, internal audit has undergone a number of transformational changes. The late 1990’s brought greater emphasis on consulting and advice in addition to traditional assurance engagements. In the early 2000’s, The IIA Standards were revised to emphasize risk-based auditing to require internal audit undertake a risk assessment at least annually as part of its audit planning process. The past decade has witnessed the profession expanding the portfolio of risks it addresses to include organizational culture, the environment, sustainability, governance and more.

As the profession has demonstrated its versatility, a widespread shift in expectations has occurred. No longer is internal audit seen as simply a protector of value in many organizations. The IIA’s 2030 vision is one in which “internal audit professionals will be universally recognized as indispensable to protecting and enhancing organizational value.” And, further, in the most recent update to the International Professional Practices Framework (IPPF), The IIA added a mission statement for internal audit that reads, “to enhance and protect organizational value by providing risk-base and objective assurance, advice, and insight.” The task force working on this at the time, purposely placed emphasis on the word “enhance”, placing it before “protect”, due to the importance of this concept.

Some internal audit departments are already there, and others are on a journey to get there. Unfortunately, far too many internal audit departments are content with the role of value protectors. I have begun to refer light-heartedly to these internal audit departments as internal guard-it departments.

Don’t get me wrong. Internal guard-it departments do add value to their organizations. For, organizations cannot grow, prosper and add value for their stakeholders/shareholders if the assets and resources of the organization are unprotected. Without assurance that risks are effectively managed and that controls have been designed and effectively implemented, organizations face greater risks and challenges in achieving their objectives. However, internal guard-it departments are not realizing their full potential, and their focus on hindsight and even insight often fails to help their organizations avoid the hazards that lie ahead. This “protect value” work is viewed by some as baseline work.

Obviously, there is no formal definition for an internal guard-it department. However, I have identified 5 signs that your department might be one:

• More than 20% of your annual internal audit plan is focused on compliance risks. Every organization faces statutory and regulatory compliance risks. Obviously, such risks are more significant in highly regulated industries such as financial services and healthcare, so the amount of time that internal audit departments will dedicate to compliance risk assurance will certainly vary. Over the past two years, The IIA’s annual Pulse survey has revealed the average time dedicated to compliance-regulatory risks is about 15% in North America. There is no magic threshold that signals a lack of focus on value enhancement, but every percent of your audit plan dedicated to compliance risks is one less percent being dedicated to foresight and value enhancement.

• Internal audit is responsible for SOX compliance. The passage of the Sarbanes-Oxley (SOX) Act of 2002 was jokingly referred to at the time as the “full employment act for internal auditors.” Many internal audit functions were created to help their companies address the Act’s focus on financial reporting controls, and many more saw their budgets and staffing increase substantially in the face of SOX requirements. Over the last 20-years the overall percentage of internal time dedicated to internal control over financial reporting (IFCR) has stabilized in the United States, but it still remains substantially higher than other regions of the world. Over the past two years, The IIA’s annual Pulse survey revealed about 16% of internal audit resources are dedicated to ICFR. From my experience, the average is heavily influenced by the fact that in some publicly traded companies, internal audit is solely, or predominately, responsible for ICFR testing.

• You take a cyclical approach to some of all of your audit coverage. When I first joined the internal audit profession more than four decades ago, the annual plan for my internal audit department was cyclically-based. It was an approach that ensured coverage of each area of operations every three years for our organization. There was little relationship between audit coverage and the risk the areas presented to the organization (other than, possibly, the frequency with which things were reviewed). In 2002, The IIA standards were revised to mandate that the audit plan be based on a risk assessment undertaken at least annually. Unfortunately, even today cyclical audit coverage persists in the plans of some internal audit departments – particularly in the financial services industry (where some regulators are not quite as progressive when it comes to risk-based audit coverage). Cyclical audit coverage is well suited for “guarding,” but doesn’t do much for “enhancing” value. And, further, cyclical work doesn’t lend itself to being anticipatory of new risks on the horizon.

• Your risk assessment is only focused one year ahead. Most internal audit departments today do undertake an annual risk assessment at least annually as part of their audit planning process. However, given the dynamic velocity of 21^st century risks, annual assessments are no longer adequate. As I have commented in previous blogs, a continuous approach to risk assessment should be employed that looks to and beyond the horizon to identify emerging risks. There is no silver bullet for identifying emerging risks. Like all risk assessment, there is a degree of art in addition to science. However, if internal audit isn’t looking in the right direction, there is a greater likelihood of missing emerging risks. But just as storms in the Northern Hemisphere often emerge from the West, there are directions from which potential risks facing your company are likely to emerge. If you are only guarding against risks 12-months ahead, you will likely be surprised along the way.

• The department is totally focused on assurance, and rarely offers advice to management on the effectiveness of risk management or controls. Finally, internal guard-it departments tend to heavily emphasize assurance as their primary means of communication. Assurance will always be an important means of serving the organization, but assurance primarily focuses on the past or present – rarely on the future. I believe internal audit doesn’t reach its full potential if it never offers foresight about risks and opportunities that lie ahead.

• Internal Audit rarely has a “seat at the table” when strategic matters, and/or major change initiatives, are being discussed. The enhanced stature of internal audit has brought about significant changes in many organizations. One of those changes is the inclusion of the chief audit executives in executive or c-suite discussions on business or strategic discussions – having a seat at the table. Earning and sustaining a seat at the table doesn’t just happen. It is the product of strong relationship acumen and deep technical expertise. Others at the table gain the most value when the chief audit executive shares perspectives that will benefit the organization in the future – not when discussions focus on the past.

I recognize that a blog such as this one will elicit a variety of responses in the profession. The objective of my message is not to make anyone feel bad or defensive about their internal audit department. In the end, we must all answer to our stakeholders, and many of them are very comfortable with a more traditional approach to internal audit coverage. However, we should never be content to simply guard our organizations. We should tout our potential to stakeholders as an instrument not only to protect organizational value but to enhance it as well, and encourage CEOs and Audit Committees to tap that opportunity.

In my book Agents of Change: Internal Auditors in an Era of Disruption, I observed:

“Internal auditors used to be derisively referred to as “bean counters.” The classic assurance providers in the profession still count the beans. Trusted advisors, on the other hand, know how to grow, harvest, and take the beans to market. But it is the change agents in the profession who are bold and confident enough to advocate changing the crops from growing beans to growing corn.”