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Home > Auditing Best Practice > Incorporating Operational and Performance Auditing into Compliance and Financial Auditing

Auditing Best Practice

Incorporating Operational and Performance Auditing into Compliance and Financial Auditing

by Andrew Cox

Executive Summary

  • Almost every audit can also be an operational or performance audit.

  • With a bit of creativity, it is not too difficult to include a value-adding element to a compliance or financial audit.

  • Operational and performance auditing can provide added value to your organization.

  • Including an operational or performance auditing element in your audits can enhance the image of auditing for those being audited and also for management.

  • Auditors can increase their job satisfaction through operational and performance auditing.

  • The 3Es of economy, efficiency, and effectiveness should be integral components of the internal auditor’s work.

Introduction

“The truth is, “audit gets no respect.” Quite frankly, if the audit department in question is using yesterday’s approach in today’s company, has not manoeuvred top management and the board into focusing on the company’s top five or ten risks, has not caused management to quantify these risks, and has not succeeded in developing authorized bounds of risk tolerance, then it doesn’t deserve any respect.” Larry Small, President, Fannie Mae, 2000.

This is a great quote, but what a pity it was not applied in recent times when this company got into serious financial difficulty. Perhaps a greater focus on operational and performance auditing might have helped.

What are the big risks for management? Are they likely to be immaterial accounting mistakes, a missing signature on a form, an immaterial asset that cannot be located, people not following a procedure exactly, or perhaps petty cash missing?

Or maybe management is more concerned with making sure the organization is running properly, which means focusing on economy, efficiency, and effectiveness—better known as the 3Es.

Operational and Performance Auditing

What is the difference between operational and performance auditing?

  • Operational audit. Sometimes called program or performance audits, these examine the use of resources to evaluate whether those resources are being used in the most efficient and effective ways to fulfill an organization’s objectives. An operational audit may include elements of a compliance audit, a financial audit, and an information systems audit. This term is mainly used in the private sector.

  • Performance audit. This is an independent and systematic examination of the management of an organization, program, or function to identify whether the management is being carried out in an efficient and effective manner and whether management practices promote improvement. This term is mainly used in the public sector and may be the same as or similar to an operational audit.

While there may be purists who will argue there is a difference, the reality is that they seek to achieve the same objective. Although operational and performance auditing are generally applied to public sector auditing, and operational auditing is usually applied to private sector auditing, both seek to achieve organizational improvement of the 3Es.

The Audit Continuum

The audit continuum is shown in Figure 1. As we move from basic compliance auditing to more complex forms of auditing such as operational and performance auditing, the complexity of the audit and the difficulty in getting agreement to the audit objectives from the audit customer increases.

The Differences

The differences between operational and performance auditing, and compliance and financial auditing, are shown in Table 1. The real difference is that operational and performance auditing will genuinely add value and seek to improve the bottom line of an organization. Compliance and financial auditing cannot make this assertion, since their focus is generally on whether things are being done in accordance with legislation, regulations, policies, and procedures. Important though this aspect may be, it is unlikely to have the same improvement objective as operational and performance auditing.

Table 1. Differences between operational and performance auditing, and compliance and financial auditing. (Source: The State Audit of the United Arab Emirates)

Operational and performance auditing Compliance and financial auditing
Purpose Does performance meet the 3Es? Is there compliance?
Focus The organization and its objectives Accounting transactions
Academic base Economics, political science, sociology, etc. Accounting
Methods Methods vary from audit to audit Standardized methods
Assessment criteria Unique for each audit Standardized criteria
Reports Varying format Standardized format

Economy, Efficiency, and Effectiveness

What are we seeking to achieve by using performance and operational auditing? The aim is to find out whether business operations are being managed in an economic, efficient, and effective manner; whether procedures for promoting and monitoring the 3Es are adequate; and, importantly, whether improvements can be made.

Economy is concerned with minimizing the cost of resources used (people, materials, equipment, etc.), having regard to the appropriate quality required: i.e., keeping the cost of inputs low without compromising quality. An example could be where healthcare supplies or services of a specific quality are purchased at the best possible price.

Efficiency is concerned with the relationship between goods and services produced (outputs) and the resources used to produce them (inputs): i.e., getting the most from available resources. An example could be where the cost of providing healthcare has been reduced over time. Efficiency is about “doing things right.”

Effectiveness is concerned with achieving predetermined objectives (specifically planned achievements) and having the actual impact (output achieved) compared with the intended impact (objective): i.e., achieving the predetermined objective. An example could be where disease rates have fallen as a result of the healthcare provided. Effectiveness is about “doing the right things.”

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Further reading

Books:

  • Reding, K. F., P. J. Sobel, U. L. Anderson, M. J. Head, S. Ramamoorti, and M. Salamasick, with C. Riddle. Internal Auditing: Assurance and Consulting Services. Orlando, FL: IIA Research Foundation, 2007.
  • Sawyer, L. B., M. A. Dittenhofer, J. H. Scheiner, and Lawrence B. Sawyer, with A. Graham, and P. Makosz. Sawyer’s Internal Auditing. 5th ed. Orlando, FL: IIA Research Foundation, 2003.

Report:

  • Institute of Internal Auditors (IIA). “International standards for the professional practice of internal auditing.” Orlando, FL: IIA. Available from: www.theiia.org

Websites:

Training Courses and Postgraduate Qualifications:

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