logo-newlogo-newlogo-newlogo-new
  • Home
  • Blog
  • Audit Trail Academy
  • Advisory Services
  • Books
✕
  • Home
  • Chambers on Internal Audit
  • Uncategorized
  • It Is Time We Move Out From Under the CFO Shadow

It Is Time We Move Out From Under the CFO Shadow

A Dead End Job? I Hardly Think So!
November 6, 2012
Good News: More Jobs, Better Budgets, Higher Salaries Ahead for Internal Audit
December 5, 2012
November 26, 2012

I learned important lessons early in my career about internal audit independence and the impairments that can come from reporting relationships. I began my career as a civilian internal auditor for the U.S. Army. At the time, we had more than 1,900 internal review (audit) auditors in more than 300 Army installations and commands around the world. Virtually every one of them worked directly for the comptroller — essentially the equivalent of a corporate chief financial officer (CFO).

Recognizing the importance of auditor independence throughout government, the U.S. comptroller general soon strengthened the independence standards for government auditors and issued new standards that required internal auditors to report to the “head or deputy head” of government agencies. There was an awkward recognition throughout the Army that we were no longer in compliance because we reported to the comptroller; yet the comptrollers were by and large adamant that these reporting relationships not be dissolved. 

In the early 1980s, the head of the Army’s internal review organization at the Pentagon conducted an extensive assessment of the independence of internal review in the Army and issued a chilling report on the actual and perceived impairment of our independence by comptrollers. The report documented actual cases of internal audit plans being altered or draft internal audit reports being changed by comptrollers or senior members of their staff. As the result of this report, the Army soon changed its regulations and mandated that internal review departments report to either the chief of staff or the commander (the head or deputy head of most Army installations/commands).

So, what does all of this have to do with anything in corporate America almost 30 years later? I would submit that there were important lessons learned in a short period of time in a venerable institution like the U.S. Army that are being learned/recognized far too slowly in 21st century corporate America. The fact is that in the corporate sector today, it is estimated that more than 50 percent of chief audit executives (CAEs) report administratively to their companies’ CFO. While safeguards such as functional reporting relationships to audit committees of the board may mitigate the risk of the type of interference with internal audit that the Army witnessed at one time, reporting to the CFO is still fraught with risks and challenges for internal audit. I believe it is a sub-optimal relationship.

On the bright side, the past decade has seen marked changes in internal audit reporting relationships — in particular with respect to our functional reporting relationships. The vast majority of CAEs now report functionally to an audit committee, and all the experts seem to agree that this enhances our independence. But several recent internal audit failures have left me wondering: Are internal audit executives really as independent as we like to think we are? And if we are truly independent of management, why do we occasionally see headlines that imply CAE complicity in a financial statement fraud? Could our administrative reporting lines (particularly to CFOs) be an issue?

I am confident that the vast majority of CFOs recognize the important role that internal audit plays in their companies’ systems of risk management and internal controls; however, I fear that the temptation to direct internal audit resources in ways that best serve the CFO’s interests still prove too much for CFOs to overcome. For example, a 2007 report from PricewaterhouseCoopers found that internal audit functions that reported functionally to the CFO were 50 percent more likely to be dedicating resources to the CFO’s priorities (such as SOX compliance) than those functions that reported administratively to the CEO or another C-level executive within the company. It begged the question as to who really does set internal audit’s priorities.

Even if the CAE and CFO are committed to fostering the independence of the internal audit function, the appearance to third parties is often still problematic. The latest statistics would indicate that more than 25 percent of internal audit’s annual audit plan is still directed at providing assurance over the effectiveness of financial controls or other financial-related operations. A third party such as the CEO or audit committee should ponder whether the assurance over the effectiveness of the CFO’s operations is in any way influenced by the reporting relationship. The risks grow even more when the individual serving as the CAE is assigned from the CFO organization into the role for a designated period of time. If the CAE knows that he or she will be dependent on the CFO for his or her next career assignment, how objective can they really be (or appear to be) in assessing the CFO’s areas of responsibility?

Some regulators have begun to speak out much more vocally on internal audit reporting relationships. For example, The Interagency Policy Statement on the Internal Audit Function and its Outsourcing (issued jointly by the Federal Reserve, FDIC, OCC, and OTS in 2003) prescribes that “the internal audit function should be positioned so that the board (of directors) has confidence that the internal audit function will perform its duties with impartiality and not be unduly influenced by managers of day-to-day operations.” The guidance goes on to say that when internal audit reports functionally to a member of management, “the board should consider the potential for diminished objectivity on the part of the internal audit manager (CAE) with respect to audits concerning the executive to whom he or she reports.” Finally, the guidance says, “the chief financial officer, controller, or other similar officer should ideally be excluded from overseeing the internal audit activities even in a dual role (with the CAE reporting functionally to the audit committee).”

There are times when the perception of CFO-controlled internal audit functions takes on even more ominous tones in the minds of third parties. For example, while conducting an external quality assessment of a corporate internal audit function several years ago, the company’s general counsel put it to me like this during a one-on-one interview: “You do realize that the internal audit function is under the complete control of the CFO don’t you? The rest of us (in the C-suite) perceive them as the CFO’s tool to keep us in line.”  

The IIA’s International Standards for the Professional Practice of Internal Auditing do not preclude the CFO reporting relationship as does the U.S. Government Auditing Standards (Yellow Book); however, The IIA has gone on record in Practice Advisory 1110-2, stating that “the CAE should report directly to the chief executive officer of the organization.” While not mandatory, IIA Practice Advisories do reflect strongly recommended guidance to which regulators in certain industries are paying increasing attention (as evidenced from the financial services regulations cited above).

So what is the solution to the CFO reporting relationship dilemma? I personally have come to believe it is time for the remainder of internal audit functions to move out from under the CFO. We need strong working relationships with our CFOs, but we also need independence and flexibility to evaluate financial information and to establish audit plans without undue influence (or even the perception of influence). Most CAEs could probably establish a strong working relationship with any member of their executive management team, but the danger of undue influence is greater when internal audit answers to the finance function, either functionally or administratively.  

So where should internal audit report administratively? I believe The IIA’s practice advisory has it right. Internal audit should report functionally to the audit committee of the board of directors and administratively to the CEO. I am well aware of the argument that CEOs are too busy to supervise the CAE. However, I heard the same arguments put forth in the Army almost 30 years ago (“commanders and chiefs of staff are too busy to supervise internal review”). Then as now, that is a fallacious argument. Corporate CEOs will embrace the responsibility just as I saw senior military officials do. In fact, once they had the opportunity to directly oversee such a critical component of their system of internal controls, most would not hear of any other reporting relationships. Even today, the CEOs of many of the world’s largest companies who administratively oversee internal audit would not have it any other way.

I’m sure my own experiences involving reporting relationships have colored my perspectives, and many of you have spent more time than I have in non-government audit roles. I would like to take this opportunity to ask for your opinion. What do you consider to be the ideal reporting relationships for CAEs — not only at your own organization, but for all internal audit groups? How would you like to see our reporting relationships evolve over the coming decade? Do you believe The IIA should provide more specific advice for reporting relationships or take any other action to strengthen our reporting relationships?

If we share our opinions on this, I believe we will be fulfilling The Institute’s motto — Progress Through Sharing. Please let us know your thoughts.

Share

Related posts

March 13, 2023

New IIA Report Is a Timely Benchmarking Resource for Internal Auditors


Read more
May 16, 2022

THE STAGGERING TOLL OF COVID RELIEF FRAUD: WHERE WERE THE THREE LINES?


Read more
February 3, 2022

To Live a Life in Color, You May Have to Change Channels


Read more

Leave a Reply Cancel reply

Your email address will not be published. Required fields are marked *

What’s Trending

03-20-23

New Report Reveals Surprising Insights from Internal Audit Executives


03-13-23

New IIA Report Is a Timely Benchmarking Resource for Internal Auditors


03-02-23

6 Things Audit Committee Members Often Won’t Say to Internal Audit


Read More

Archive

  • March 2023
  • February 2023
  • January 2023
  • December 2022
  • November 2022
  • October 2022
  • September 2022
  • August 2022
  • July 2022
  • June 2022
  • May 2022
  • April 2022
  • March 2022
  • February 2022
  • January 2022
  • December 2021
  • November 2021
  • October 2021
  • September 2021
  • August 2021
  • July 2021
  • June 2021
  • May 2021
  • April 2021
  • March 2021
  • February 2021
  • January 2021
  • December 2020
  • November 2020
  • October 2020
  • September 2020
  • August 2020
  • July 2020
  • June 2020
  • May 2020
  • April 2020
  • March 2020
  • February 2020
  • January 2020
  • December 2019
  • November 2019
  • October 2019
  • September 2019
  • August 2019
  • July 2019
  • June 2019
  • May 2019
  • April 2019
  • March 2019
  • February 2019
  • January 2019
  • December 2018
  • November 2018
  • October 2018
  • September 2018
  • August 2018
  • July 2018
  • June 2018
  • May 2018
  • April 2018
  • March 2018
  • February 2018
  • January 2018
  • December 2017
  • November 2017
  • October 2017
  • September 2017
  • August 2017
  • July 2017
  • June 2017
  • May 2017
  • April 2017
  • March 2017
  • February 2017
  • January 2017
  • December 2016
  • November 2016
  • October 2016
  • September 2016
  • August 2016
  • July 2016
  • June 2016
  • May 2016
  • April 2016
  • March 2016
  • February 2016
  • January 2016
  • December 2015
  • November 2015
  • October 2015
  • September 2015
  • August 2015
  • July 2015
  • June 2015
  • May 2015
  • April 2015
  • March 2015
  • February 2015
  • January 2015
  • December 2014
  • November 2014
  • October 2014
  • September 2014
  • August 2014
  • July 2014
  • June 2014
  • May 2014
  • April 2014
  • March 2014
  • February 2014
  • January 2014
  • December 2013
  • November 2013
  • October 2013
  • September 2013
  • August 2013
  • July 2013
  • June 2013
  • May 2013
  • April 2013
  • March 2013
  • February 2013
  • January 2013
  • December 2012
  • November 2012
  • October 2012
  • September 2012
  • August 2012
  • July 2012
  • June 2012
  • May 2012
  • April 2012
  • March 2012
  • February 2012
  • January 2012
  • December 2011
  • November 2011
  • October 2011
  • September 2011
  • August 2011
  • July 2011
  • June 2011
  • May 2011
  • April 2011
  • March 2011
  • February 2011
  • January 2011
  • December 2010
  • October 2010
  • September 2010
  • August 2010
  • July 2010
  • June 2010
  • May 2010
  • April 2010
  • March 2010
  • February 2010
  • January 2010
  • December 2009
  • November 2009
  • October 2009
  • September 2009
  • August 2009
  • July 2009
  • June 2009
  • May 2009
  • April 2009
  • March 2009
  • February 2009

Contact Us

PO Box 1441
New Smyrna Beach, FL 32170

+1-407-463-9389
rchambers@richardchambers.com

About AuditBeacon.com

AuditBeacon.com is a resource center for internal auditors and risk professionals from around the world. In addition to more than 500 blogs authored by Richard Chambers, the site includes links to news and insights on internal audit and other information that illuminates the value of this important profession. AuditBeacon.com is provided as a service by Richard F. Chambers and Associates, LLC.

Copyright © 2023 Richard F. Chambers & Associates. All Rights Reserved.
  • Home
  • Blog
  • Audit Trail Academy
  • Advisory Services
  • Books