oversight

Management or Operational Auditing

Published by the Government Accountability Office on 1971-09-01.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                                   COMMITTEE 111 (1ST SESSION)




SUMMARY OF SIGNIFICANT ISSUES RAISED
               I N THE
        PAPERS ON SUBJECT 111


                 __
    Supreme AuditInsti tutions"




           PRESENTED BY

        MR. ELMER B . STAATS
        COMPTROLLER GENERAL
      UNITED STATES OF AMERICA
             MANAGEMENT OR OPERATIONAL AUDITING

     I: think it would be well to start with a few comments
about the terminology of the subject we are talking about. It
has been our experience that the terms "management auditing"
and "operational auditing" have no generally accepted meaning.
Viewpoints vary greatly as to what the nature and scope of such
audits embrace. We have another term in the United States which
is also frequently used. That term is "performance auditing.)I
     All of these terms are likely to be used whenever there

appears to be a need to establish a distinction between "finan-
cial
   ...
       auditing" and auditing which goes beyond financial transactlons

and accounting records and examines into the operating,

managerial, or administrative performance of an organization.
     The suggested definition sent to the Supreme-Audit
Institutions as a basis for discussion of this subject at this
Congress reflects this distinction. It defines 'hnagement
audit" as 11a constructive assessment of future alternatives
available to an organization." These alternatives are in turn
further interpreted as being those based on "analysis of stated
objectives, past management activities and current problems."
 .   This definition is quite broad.   In fact, it strikes me
as so broad as not to be really definitive as to what the
objectives of a "management audit" should be.
3




        POP purposes of discussion here, 1 would like to suggest
    that we consider the total audit job as consisting of financial
    auditing, management auditing, and program auditing.
        Financial auditing would be concerned primarily with
            financial transactions, accounts, and financfal
            reports.
        Management (or operational or performance) auditing would
           be concerned primarily with the efficiency and economy
           with which resources are managed and consumed.

         Program auditing would be concerned mainly with inquiring
            into the resugts or benefits being achieved by an
            organization and evaluating whether programs are
           meeting the objectives set by the legislature or other
            authorizing bodies.
        Each of these types of audits would include checking into
    compliance with applicable laws and regulations. A complete
    audit would embrace all three types and could be coisidered
    as a comprehensive audit of an organization's overall per-
    formance.
        Another observation that I would like to introduce early
    in this discussion is one of a cautionary nature.   The office
                              - 3 -

which I head--the United States General Accounting Office--

has accumulated much successful experience in management

auditing.    However, we have learned how to accomplish this

only gradually, and to a considerable extent by trial and

error-some   efforts being more successful than others.
     I believe that management or operational auditing to
be successful must start modestly and expand slowly.        There

must be a gradual development built on experience gained--
the auditor must walk before attempting to m. That grad-
ual development and transition from purely financial or fis-

cal type auditing c a l l s f o r an increased involvement of
staff members who have some acquaintance with such fields

as administration, engineering, economics, etc.       This is
needed for a good understanding of operational. problems.

In examining into management or operational problems, and

the effectiveness of governmental programs, the financial

auditor is no longer on his home ground.      He is in the ter-
ritory of the manager who knows that territory much better
than he does.    Therefore,it behooves the auditor who is
expanding his efforts beyond financial and accounting mat-
ters to develop his competence gradually but surely.
     From a careful reading of the papers distributed by 35
Supreme Audit Institutions before this Congress convened,
                                  - 4 -
    it is quite evident that the extension of auditing practice

    beyond financial matters varies greatly among our members.
         Twenty of the thirty-five papers received on Subject I11
    indicated that they had--I repeat, they did have-legal au-
    thority for such extended auditing practice, Fourteen of
    these twenty countries also reported that they conducted
    management audits as a regular practice and reported on the
    results to their legislative .orparliamentary authorities.
    Thirteen others noted that such auditing was conducted only
    occasionally.    In seven cases, it was reported that no au-
'
    thority has been provided to conduct such audits,
         An   interesting observation made in one paper relates to
    the definition of the scope of management auditing suggested
    as a basis for discussion at this Congress. That paper
    raised the basic question of whether management auditing as
    a constructive assessment of future alternatives available
    to an organization was a logical extension of financial au-
    diting. It argued that this was a responsibility of manage-
    ment itself and not that of the independent auditor. The
    paper stated further that if the auditor finds that the job
    is not being done, he should point that out and suggest that
    it be done but he is neither entitled nor qualified to do

    it himself.
     None of the other papers raised the question quite this
sharply but I believe it is a good question and it suggests that
we might want to recommend changes in the proposed definition.
    Another country stated that it was undecided as to whether
management auditing ’!in the full sense” should be undertaken
and wa8 looking forward to learning the views of other Supreme
Audit Institutions on the question.    This reservation also
suggests a question about the scope of the so-called management
audit as suggested in the definition submitted as a basis for
discussion here.
Management Auditing Concepts
     At this point, I think it would be appropriate to outline
the approach to management auditing we follow in the United
States General Accounting Office.     Basically, our general
approach is’ mot really much different than that we would
follow in an audit confined to financial matters.    The
following broad steps would be performed for almost any type
of audit:

     1. A preliminary survey of the activity being examined
        shuuld be made to obtain necessary backgraund and
        other working information for use in making the audit.
        I would like to add here simply that what this amaunts
        to-is that, to save time in the long run, we can be

        more selective and thus avoid situations where we
                              - 6 -
       would be chasing rabbits when we might be chasing
       elephants    OF   bears.
     2 . The basic charter or assignment of responsibility      ' ,


       for the activity being examined should be studied to
       ascertain the authorized purposes and related au-
       thorities of the activity and any applicable re-
       strictions or limitations. In this respect, we
       need to involve legal staff in questions of legal
       authority. Also, to examine the legislative his-
       tory to determine the full intent of the legisla-
       ture authorizing the expenditure   OF   program we are
       auditing .
     3. The management system should be examined by study-
        ing the policies established to govern the activi-
        ties under examination, testing the effectiveness
        of specific operating and administrative procedures
       and practices followed, and fully exploring any im-
       portant problem areas or weaknesses encountered.
     4. Reports on results of the audit work performed

        should then be prepared and submitted to those re-
        sponsible for receiving or acting on the auditor's
        findings and recommendations.
     In identifying problem areas to examine into, the au-
ditor has several techniques available. Here are some tech-
niques that are employed by auditors in my office:
                            - 7 -

MakinEdsurveys                 By obtaining and studying
                               information on how an activity
                               ‘is supposed to be carried out
                               or how a procedure is supposed
                               to work, key features or pro-
                               cedures can usually be ident-
                               ified that appear difficult
                               to control or to be suscept-
                               ible to abuse.
 Reviewing management           These Can be valuable sources
   reports                      of information on possible
                                problem areas for the auditor
                                to look into.
 Reviewing internal audit       These are invaluable sources
   or inspection reports        of information. Of particular
                                interest to the external auditor
                                are those which bring to light .
                                important findings on which
                                the management has not acted.
 Making physical                These can be very useful ways
   inspections                  to observe possible inefficien-
                                cies or problems that should
                                be analyzed and studied.
                                Examples of such problems would
                                be large accumulations of
                                supplies or materials; idle
                                or little used equipment; idle
                                employees; disposal of apparently
                                good and usable materials; and
                                the like.
 Making test examina-           This is a very useful way to
   tPons of transactions        obtain a practical wokking insight
                                into the efficiency of pro-
                                cedures and their effectiveness
                                in assuring that things are
                                done in the way and with the
                                results intended.
 Holding discussions with       Frank and open discussions with
   agency officials and         such persons can provide the
   employees                    auditor with w c h valuable
                                information. The degree of
..


                                     - 8 -
         Holding discussions with            success in obtaining useful
           agency officials and              information in this way is greatly
           employees (continued)             dependent on the auditor's
                                             reputation for independent and
                                             constructive inquiry. If he
                                             is regarded with fear because
                                             of overly critical reporting
                                             in the past, this source of
                                             information may not be pro-
                                             ductive.
         When the auditor finds a problem area that he believes he
     should examine into, his job becomes one of obtaining all
     pertinent evidence and doing an adequate amount of analytical
     work to:
          1. Identify specifically what the problem is, that is,
                what is deficient, what is defective, what is in
                error, and the like.
          2. Determine whether the condition is isolated or
                widespread.
          3.    Determine the significance of the deficiency in such
                terms as increased   OK   unnecessary costs, loss of
                revenues, l o s s of property, ineffective performance
                of work, or other effects.
          4.    Ascertain the cause or causes for the condition.
          5.    Identify the persons in the organization responsible
                for the deficiency.
          6.    Determine possible lines of corrective or preventive
                action and formulate constructive recommendations.
                                         - 9 -
       The a u d i t o r should review h i s f i n d i n g s w i t h management

o f f i c i a l s responsible f o r t h e operations being examined s o

t h a t he w i l l have t h e opportunity t o o b t a i n as much informa-

t i o n as p o s s i b l e t h a t bears on t h e problems and t o formulate

h i s conclusions i n t h e l i g h t of t h e d e t a i l e d knowledge of t h e

o f f i c i a l s responsible f o r t h e performance being reviewed.

       The a u d i t o r must consider a l l p e r t i n e n t f a c t o r s i n ap-

p r a i s i n g performance.       A l s o , t o be effective and t o be ac-

cepted as a c o n s t r u c t i v e f o r c e , he must be f a i r , o b j e c t i v e ,

and realistic.          For example, he must use a d i f f e r e n t s t a n - '

dard when e v a l u a t i n g a new program from t h a t used t o evaluate

one t h a t has been i n e x i s t e n c e f o r a long t i m e .          Above a l l ,

he must avoid making judgments and conclusions on performance

based s o l e l y on hindsight.

       If these concepts are followed and i f t h e a u d i t o r considers

a l l s i g n i f i c a n t f a c t o r s bearing on a problem, he can make

reasonable judgments concerning the discharge of s p e c i f i c

kinds of management r e s p o n s i b i l i t i e s    e    These judgments can be

of value i n promoting d e s i r a b l e improvements i n management

performance and they can be u s e f u l t o t h i r d p a r t i e s i n connec-

t i o n with t h e i r evaluations of such performance.

       Some of t h e papers submitted raise t h e question as t o

whether it i s appropriate f o r a u d i t o r s t o engage i n management
                           -   10   -

or operational audit, citing the fear that this vpc of

auditing interferes w i t h management's operations. Our
experience has been that when properly conducted, audits of
management performance need not--and certainly should not--
result in interference. They should always be conducted
with a view towards not only identi€ying problems or veak-
nesses, but also with a view towards assisting management
in improving its operations. We have much testimony that

many of our reports have been useful to managers who have
accepted our recommendations with resultant financial sav-
ings and improved operations. Another point to be empha-
sized is that neither the external nor the internal auditor
should participate directly in management decisions.
Relationship Between Interna1
And External Audit

     In commenting on the relationship between internal audit
and the external audit, the papers submitted showed widely
varying views.   In many cases, the work of internal auditors is
given consideration in fixing the scope of the external audit
and effective cooperation exists.       In other cases, the roles
and responsibilities of the two groups are considered to be
quite separate and there is no particular interrelationship         I   .




o r coordination.

     In a few cases, it was noted that government departments
have no internal audit but it was also brought out that there
                             -   11   -

is interest in establishing such systems. I believe this is
a most important point. A strong internal audit system is an
essential part of a good management system. Because of this,
the external auditor should do all he can t o promote the
establishment and development of good internal audit systems.
Such systems not only aid managers in improving their operations
but they make it easier for the external. auditor t o concentrate
his audit efforts on those problem areas most demanding of
attention from the standpoint of efficiency and economy in the
use of scarce public funds.
     This is the view we have embraced in the United States
General Accounting Office and I think it important enough to
dwell on it a little more.       To the fullest extent possible,
the external auditor should utilize available internal audit
work rather than directly performing all of the work himself.
He should also be familiar with the operations and findings of
any other internal review activities, such as inspection,
investigation, appraisal, or management analysis, that may
exist in large organizations.
     Normally, there should be little duplication between
the work of the external and internal auditors. The internal
auditor should be performing his work as part of the manage-
ment's system of operation and control. In contrast, the audits
made by the external auditor are independent appraisals of
(1) the manner in which government agencies discharge their
responsibilities and, (2) the effectiveness of their control
system, including internal audit.
     The external auditor should maintain a close working
relationship with the agency internal auditors. He should
receive copies of internal audit work plans sand the internal
audit reports. In turn, he should inform the internal audit
organization about the areas in which he plans to work.
     It should be the responsibility of the government agency
head to establish and maintain satisfactory accounting systems
and related internal controls pertaining to the custody and
use of public funds and other resources. His internal auditor
should include in his audit program an examination of financial
transactions, including both the receipt and disbursement of
funds, t o the extent necessary to evaluate:
     --The adequacy of the agency's prescribed policies and
       procedures relating to such transactions.
     --The adequacy of internal controls over such transactions.

     --Compliance with prescribed agency policies and
       procedures and applicable laws and regulations.

     In recognition that the basic r e s p o n s i b i l i t y f o r proper
accounting and internal control is that of each government
agency, the external auditor in his examination of financial
                           -   13   -
transactions and accounts should place major emphasis on the
adequacy and effectiveness of the agency's accounting and
internal controls and he should test the adequacy of the
agency's procedures and the work of the internal auditors to
establish the extent to which such work is satisfactorily
performed   e



     T h u s , internal auditors, in addition to their primary

role of serving the managers of their organizations, can have
a very significant impact on the scope and effectiveness of the
work of the external auditors. The more reliable the internal
auditor's work is with respect to financial operations, the
more opportunity the external auditor has to delve into other
problems, including efficiency and economy in the use of funds
and what is accomplished with the use of those funds.     For ex-

ample, as a result of improved internal audits of financial
transactions in our Government, we have been able to reduce
the effort of the General Accounting Office to the point
where its financial auditing now represents less than 10 per-
cent of our audit program.
Training
     Training is another important aspect of the whole question
of extending the auditorssrole in examining into problems of
management performanceo Where and how does the auditor develop
                           -   14   -
his competence t o inquire into such matters in a knowledgeable
manner and with the necessary maturity and judgment to evaluate
performance and make sound recommendations for improvement?
     The answer is intense and continuous training--both formall
training in classrooms and on-the-job training under competent,
experienced supervisors. This need is no different than what
is required for the auditor who concerns himself only with
auditing financial transactions and accounts. But for the
auditor who is extending the scope of his examinations into
management performance, adequate training is even more important.
There are those who will question his qualifications, his
competence, and his ability to effectively analyze and evaluate
such matters.   The only answer to this questioning is demonstrated
competence and that competence comes through conscientious
adherence to the generally accepted auditing standard that
auditors must be adequately trained and properly supervised in
all of their work.
     I realize that training auditing staffs was a major part of
Subject I which was discussed yesterday. However, it is such
a vital part of developing and maintaining a good and acceptable
audit system that some of the key principles can bear repetition.
                                 -       15   -
     The comments in the papers submitted reflect some
variation in views on this subject. Some did not specifically
mention the subject in relation to management aditing on the
basis that it was dealt with in Subject I. Others described
their practices at some length and showed a serious concern
with the importance of the subject.
     I was very much interested in some of the different ways
in which broad training and familiarization with government
operations are carried out in some countries. For example,
one approach is to give staff auditors temporary assignment$
in g.overnment corporations to provide them realistic financial
and operating experience. Another practice is to provide in-
house training in such subjects as civil engineering.    One

country requires considerable advance preparation for its
audit staff such as 2% years of intensive training in its
national school of administration and getting into the school
in the first place requires an advanced degree or 5 years of
public service experience,   .       -



     One auditor general recently established a fiscal control
school in order to train audit staffs in new techniques in
order to achieve broader and more effective audits, particularly
those where operational efficiency is to be evaluated. The
                          -   16   -
school is operated by the auditor general, and the teaching
staff is comprised of officials from his office., university
professors, and other competent officials.     Seminars, con-
ferences, and training courses specializing in auditing and
fiscal control service will be conducted.     In addition,
cultural extension courses are included in order to improve
the overall intellectual and cultural backgrounds of audit
staff
     In the General Accounting Office, we use Parge numbers
.of persons who have concentrated in the study of accounting
and who, through in-house training and on-the-job training,
become quite capable of conducting management and program
audits.   In recent years, we have also added to our
staff large numbers of college graduates     I&O   have concentrated
in such subject areas as economics, business, public administra-
tion, engineering, mathematics and statistics. We also have
added staff members who are expert in systems analysis,
computer science, and actuarial work.   A broadened base of

expertise is essential to the external audit organization that
wishes to broaden its scope of operation into management problems.
                            -   417   -
     Ne matter what their major area of university study may
have been, beginning auditors need close direction, supervision,
and training if they are to develop rapidly into good manage-

ment auditors   @




     Initially, training programs should emphasize the techntcal
aspects of management audits to assist new staff members in
adapting to the work required. More advanced training programs
can then emphasize the development of (1) supervisory and
management skills, such as planning, audit decisionmaking,
communicating, and delegating, and (2) special skills, such
as systems analysis, statistical sampling, and automatic data
processing.
     Formal classroom training programs should be designed to

(1) improve management auditing skills a d technical competence
that can be applied on the j o b , (2) prepare each staff member
for greater responsibility, and (3) inform the staff of new
ideas and practices in management operations.
     All staff members should be encouraged and be given
incentives to continue their professional development throughout
their professional careers. Each staff member must grow through-
out his career if he and the organization are to remain responsive
and useful.
                                     - 18 -
       An e f f e c t i v e s t a f f development program requires an e f f e c t i v e
career planning and evaluation system which dll help each

s t a f f member i d e n t i f y h i s strengths and weaknesses as w e l l as

h i s opportunities f o r growth.        Such a system p e d t s him t o

use h i s existing strengths while developing new strengths

and correcting any weaknesses.             The audit organization should

provide regular performance appraisal and counseling programs

to   assist i t s s t a f f members i n assessing t h e i r strengths and
potentials and i n planning programs which w i l l enable them

t o develop the maximum of t h e i r potential.
Use of Consultants

        I might add another thought here on the point of expanding

the competence of the audit Organization.                Because of the very

wide range of a c t i v i t i e s of modern governments, i t i s doubtful

i f any organization can e f f i c i e n t l y acquire all of t h e

expertise needed t o make management audits.                To supplement
the s t a f f , expert consultants i n various specialized f i e l d s

should a l s o be employed.        I n t h i s way, an audit organization

has available t o i t t h e special knowledge and competence’
needed f o r a p a r t i c u l a r audit a t the t i m e needed without

having t o maintain such s p e c i a l i s t s on the s t a f f all of the
time.
.
                     0
                                -   19   -
         In the General Accounting Office, we have made good use
    of expert consultants in our audits of the programs concerned
    with elimination of poverty, manpower training, control and
    abatement of water pollution, and review of complicated wea-
    pons systems procurement. Our intentions are to increase our
    use of consultants in order to expand our overall capabilities
    to audit government programs.
    The Expanding Role of the Auditor
         I would like to conclude these remarks with a few
    observations about the expanding r o l e of the auditor.
         First, it is my belief that the responsibility of the
    independent, external governmental auditor should embrace
    the following three aspects of management accountability:
         --fiscal accountability, which includes fiscal integrity,
           disclosure, and compliance with applicable laws and
           regulations;
         --managerial accountability, which is concerned with the
           efficient and economical use of personnel and other
           resources; and
         --program accountability, which is designed to assess
           whether programs are achieving their intended objectives
           and whether the best program options have been selected
           to achieve these objectives f r o m the standpoint of
           total cost and outputs.
                             - 20 -
    An accountability system should embrace all three
elements. There must be public confidence as to fiscal
integrity in the spending of public funds; there must be
assurance that waste does not occur through mismanagement;
and, there must be an assessment of whether programs are
accomplishing their intended objectives with the least cost
and maximum results.
     I do not intend to imply that the auditor has an exclusive
responsibility for management and program evaluation. Other
analytical staffs and other systems of review are also available
to government administrators and legislators. Too frequently,
however, such staffs have been primarily concerned with budget
formulation and program planning and not sufficiently with
whether authorized programs are achieving their intended results.
This is the area to which I strongly believe the auditor has
a major and increasingly important contribution to make. He
has a tradition of making and reporting his findings independent
of operating officials. He should be increasingly equipped
with special skills which go far beyond that required for
financial audits alone. And most importantly, he should be
increasingly looked to by legislatures and by the executive
officials for examinations and recommendations on all three
aspects of accountability.