Determining What Rises to the Level of an Internal Audit Observation

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During a recent audit, I encountered a conflict with a senior internal audit team member regarding the finalization of an audit observation. This team member was keen to incorporate insights from a market survey and customer feedback into our report, specifically calling out concerns over the company’s discount policy. While I recognized the insights provided, I had initially overlooked this particular finding, as it did not meet our criteria for an audit observation.

To resolve the disagreement, we conducted a team meeting to review the observation criteria and assess the finding’s relevance, accuracy, and completeness. However, despite our discussions, the team member remained unconvinced and continued to advocate for including the finding in the audit report. Recognizing the intensity of the situation, I decided to bring in the process owner—the marketing personnel responsible for developing and implementing the discount policy—to provide expert insight.

During the meeting with the marketing personnel, it became clear that the finding was incomplete and lacked a holistic analysis, as it did not fully account for the rationale behind the discount policy and pricing strategy. The marketing expert explained the strategic reasoning in detail, addressing both the root cause and expected impact of the policy. This broader context helped the team member see that the issue did not meet our criteria for a formal audit observation, ultimately resolving the conflict.

This experience reinforced the importance of adhering to established criteria and taking a comprehensive approach when evaluating audit observations. By ensuring relevance, accuracy, holistic analysis, and objectivity, internal auditors can provide meaningful, well-founded observations that support effective decision-making.

Criteria and Process for Determining Audit Observations

In internal auditing, distinguishing between general findings and audit observations is crucial. During the fieldwork phase, auditors often encounter numerous findings; however, only those with a significant influence on a process’s control mechanisms and a tangible impact on financial or operational aspects qualify as audit observations. The following four criteria guide us in deciding which findings should be finalized as audit observations:

1. Relevance to Audit Objectives
Before finalizing an audit observation, it is essential to ensure that findings are relevant and align with the audit’s primary objectives. Each observation must deliver actionable insights to stakeholders, providing clarity and guidance for informed decision-making.

2. Accuracy and Data Verification
Audit observations must be factual and based on verified data to ensure accuracy. By relying on reliable data, auditors can prevent misunderstandings or misguided decisions, as accuracy is key to building confidence in the audit process and maintaining the audit’s integrity.

3. Holistic Consideration of Root Cause and Impact
Finalizing an observation involves examining the issue from a broad perspective, considering both its root cause and broader impact. This holistic view helps auditors provide a well-rounded, actionable analysis, giving stakeholders the full context to address issues effectively.

4. Materiality and Objectivity
Observations should only be finalized if they are material and impactful enough to merit management’s attention. Assumptions or personal biases should not influence these decisions; each observation must be assessed on its own merit and potential impact on the organization.

Using these criteria and having an established process can enable internal audit to issue internal audit observations that prevent misunderstandings, are actionable, and ultimately provide value in the organization.  

Shimanto Deb is an experienced audit professional with over five years in internal auditing, specializing in financial data analysis, compliance, and investigative work. He has conducted audits across diverse industries, including pharmaceuticals, hospitality, and nonprofit organizations.