Department of Local Government - Circular to Councils 05 33 - Internal Audit Discussion Paper
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Department of Local Government - Circular to Councils 05 33 - Internal Audit Discussion Paper

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Circular No. 05/33 Contact Paul Terrett Date 15 July 2005 02 4428 4198 Doc ID. A2027 paul.terrett@dlg.nsw.gov.au INTERNAL AUDIT DISCUSSION PAPER The Department of Local Government supports a strengthening of the internal governance framework in NSW councils. To this end, the department considers that internal audit should be given more prominence in NSW local government. The department is working on the development of internal audit guidelines. Prior to doing so, it is appropriate that local government stakeholders be given the opportunity to comment on the appropriate role of internal audit in NSW local government. The department has now prepared a discussion paper to focus discussion on this issue and to provide a framework for comments from interested councils. The discussion paper is attached to this circular. Councils and local government stakeholders are encouraged to make submissions on specific issues that may arise in their particular circumstances. The deadline for submissions is the close of business on 31 August 2005. Details of how to lodge a submission are set out in the discussion paper. Submissions can be made by individual councils or regional organisations or through peak bodies such as the Local Government Association and the Shires Association. After considering submissions, the department will determine the appropriate policy response to promote internal audit in NSW local government. I look forward to ...

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  Circular No. 05/33 Date 15 July 2005 Doc ID. A2027
 
Contact Paul Terrett 02 4428 4198 paul.terrett@dlg.nsw.gov.au 
INTERNAL AUDIT DISCUSSION PAPER  The Department of Local Government supports a strengthening of the internal governance framework in NSW councils.  To this end, the department considers that internal audit should be given more prominence in NSW local government. The department is working on the development of internal audit guidelines. Prior to doing so, it is appropriate that local government stakeholders be given the opportunity to comment on the appropriate role of internal audit in NSW local government.  The department has now prepared a discussion paper to focus discussion on this issue and to provide a framework for comments from interested councils.  The discussion paper is attached to this circular. Councils and local government stakeholders are encouraged to make submissions on specific issues that may arise in their particular circumstances. The deadline for submissions is the close of business on 31 August 2005. Details of how to lodge a submission are set out in the discussion paper.  Submissions can be made by individual councils or regional organisations or through peak bodies such as the Local Government Association and the Shires Association. After considering submissions, the department will determine the appropriate policy response to promote internal audit in NSW local government.  I look forward to your participation in this important process.   
  Garry Payne Director General  
 
Department of Local Government 5 OKeefe Avenue NOWRA NSW 2541 Locked Bag 3015 NOWRA NSW 2541 T 02 4428 4100 F 02 4428 4199 TTY 02 4428 4209 E  dlg@dlg.nsw.gov.au  W  www.dlg.nsw.gov.au  ABN 99 567 863 195  
          
     
Department of Local Government  Discussion Paper   Internal Audit in NSW Local Government
 
Background  In 2001, the Independent Commission Against Corruption (ICAC) found that 80% of general managers considered that internal audit was important. However, the same research found that only about 20% of councils had an audit charter, internal auditor or audit committee. This emphasises the notion that there is a significant difference between theoretical and actual support for internal audit in NSW councils.  The NSW Department of Local Government (the department) considers that internal audit should be given more prominence in NSW local government. To enhance the role of internal audit, the department is working to develop best practice standards to assist councils to put internal audit in place to an appropriate standard.  Promoting internal audit in local government raises the following issues:  
The need to extend councils understanding of risk management beyond traditional areas of public liability and occupational health and safety, into areas such as internal governance, fraud risk and broader regulatory risk. Whether councils should have a uniform approach to assessing and managing risk, regardless of size or location. Whether it is feasible for councils to pool resources with like councils or arrange through regional organisations of councils for internal audit services. Whether small management teams can feasibly conduct audits or internal reviews in the absence of an audit function How councils can properly resource internal audit and internal control programs. In what form guidelines for internal audit in local government in NSW might best be presented.
  Scope of the project This paper has been prepared to assist the department to develop best practice standards for internal audit in the NSW local government context.
 
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 While the department recognises the benefits of internal audit to councils, it is clear that one size does not fit all. The department acknowledges the autonomy of councils to establish policies and procedures that best fit that council. Regardless of this, the department considers that internal audit is an important element in the internal control framework of councils and will continue to encourage councils to develop internal audit programs.  What is internal audit?  Internal audit plays an important role in an organisations governance processes.  According to the International Standards for the Professional Practice of Internal Auditing of the Institute of Internal Auditors, internal audit is:  
An independent, objective assurance and consulting activity designed to add value and improve and organisations operations. It helps an organisation accomplish its objectives by bringing a systematic disciplined approach to evaluate and improve the effectiveness of risk management, control and governance processes.  According to the Australian National Audit Office (ANAO):  Internal Audit is a fundamental element of corporate governance structures and processes within most organisations.  Audits fall into two categories:  
 
Financial audits  focusing on compliance with financial reporting requirements and accounting standards. Operational audits  used to determine compliance with a councils policies and procedures as well as the efficiency and effectiveness of its programs or
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projects. This type of audit establishes more than just that value for money has been achieved and is useful in exposing weaknesses in systems.
 Management has primary day-to-day responsibility for the operation of internal controls within an organisation. Internal audits role is generally separate and, to some extent, independent of management.  Internal audit has no direct involvement in day to day operations, but it has a direct functional relationship with the general manager and the council. An effective internal audit function should, among other things, evaluate and monitor the adequacy and effectiveness of the internal control framework.  Risk management is also an essential part of a councils management and internal control framework. It looks at what may go wrong, what risks the council may face and the best way to address these risks. Assessment and management of risk is central to the direction of an organisations internal audit activities.  The legislation The Local Government Act, Local Government (Financial Management) Regulation (1999)  and the Local Government Code of Accounting Practice and Financial Reporting establish certain requirements for financial audit. The Regulation currently gives the Director General of the department the following powers when confronted with deficiencies in a councils internal controls:  12 Production of accounting records A member of the staff of a council who has control of any of the councils accounting records must:
 
(a) produce those records for inspection and audit in proper order whenever directed or requested to do so by the councils mayor, responsible accounting officer, general manager (if not the councils responsible accounting officer) or auditor or by a Departmental representative, and (b) render all practicable assistance to the mayor, responsible accounting officer, general manager, auditor or Departmental representative with respect to those records.
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 There is less guidance in terms of operational auditing. State Government agencies are bound by section 11 of the Public Finance and Audit Act 1983 requiring the establishment of a system of internal audit where practicable. Section 11 provides as follows: 11  Internal control and audit  (1) The Head of an authority shall ensure that there is an effective system of internal control over the financial and related operations of the authority, including:
 
(a) management policies and requirements made by the provisions of this Act and the prescribed requirements,
(b) sound practices for the efficient, effective and economical management of functions by each organisational branch or section within the authority,
(c) a system of authorisation and recording and procedures adequate to provide accounting control in relation to assets, liabilities, receipts and expenses,
(d) proper segregation of functional responsibilities, and (e) procedures to review the adequacies of and compliance with the system of internal control.
(2) Wherever practicable, the Head of an authority shall establish and maintain an effective internal audit organisation which shall be responsible to the Head of an authority for:
(a) the regular appraisal of the adequacy of and compliance with the system of internal control,
(b) the review of operations or programs to ascertain whether results are consistent with established objectives and goals and whether the operations or programs are being carried out as planned, and
(c) the reporting directly at regular intervals to the Head of the authority as to the result of any appraisal, inspection, investigation, examination or review made by the internal audit organisation.
(3) The Head of an authority shall supervise the preparation and maintenance of an accounting manual for use within the authority.
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(4) To the extent of any inconsistency between the provisions of the regulations or the Treasurers directions and the provisions of an accounting manual, the provisions of the regulations or the Treasurers directions, as the case may require, shall, to the extent of the inconsistency, prevail. The NSW Treasury has also issued a supporting Best Practice Guide ( Statement of Best Practice - Internal Control and Internal Audit, NSW Treasury, June 1995 ).   Internal Audit in Local Government in other jurisdictions  Victoria The Local Government Act 1989 included the requirement for councils to have Audit Committees. Section 139 states:  
(1) A Council must establish an audit committee. (2) An audit committee is an advisory committee. (3) An audit committee must be constituted in the prescribed manner. (4) An audit committee has the functions and responsibilities prescribed for the purposes of this section. (5) The Minister may make guidelines for the purposes of this section. (6) Guidelines made under sub-section (5) must be published in the Government Gazette. (7) A Council may pay a fee to a member of an audit committee who is not a Councillor or member of Council staff.
 To facilitate this legislation, Victoria has introduced Best Practice Guidelines for Local Government Audit Committees and Internal Audit. Councils are required to have Audit Committees comprising at least three members, including two who are not members of the council. The guidelines require council to have and review the Internal Auditors Charter, qualifications and resources, have an approved audit plan and monitor managements response to audit reports.
 
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 Queensland Queensland have recently introduced the following amendment to the Local Government Finance Standard 2005. It states:  
(g) the local government establish an internal audit function, which may be in-house or out-sourced; (h) the local government establish and Audit Committee and the Chairman of the Audit Committee cannot be the Mayor or the CEO. In addition, the Audit Committee has at least one external member with specified qualifications and experience.
 South Australia  The Local Government Act 1993 requires council to have adequate internal controls. Section 125 and 126 states:  Section 125 A council must ensure that appropriate policies, practices and procedures of internal control are implemented and maintained in order to assist the council to carry out its activities in an efficient and orderly manner, to ensure adherence to management policies, to safeguard the council's assets, and to secure (as far as possible) the accuracy and reliability of council records.
 Section 126 Audit committee 1. A council may have an audit committee. 2. The membership of an audit committee will be determined by the council and may include persons who are not members of the council. 3. An employee of the council cannot be a member of an audit committee (but may attend a meeting of the committee (if appropriate)). 4. The functions of an audit committee include (a) reviewing annual financial statements to ensure that they present fairly the state of affairs of the council and (b) liaising with the councils auditor; and
 
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(c) reviewing the adequacy of the accounting, internal control, reporting and other financial management systems and practices of the council on a regular basis.
 There is no compulsory requirement for councils to have audit committees. The legislation recognises the autonomy of councils in establishing appropriate internal controls.  Western Australia The Local Government Act 1995 does not make mention of any requirement for an internal audit committee or internal auditor.  Commonwealth Most Commonwealth authorities are required to have Audit Committees. These provide a forum for communication between directors and senior managers and the internal and external auditors  The ANAO released a Better Practice Guide on Audit Committees in recognition of the Financial Management and Accountability Act 1997 and Commonwealth Authorities and Companies Act 1997. Recently, the ANAO has released a Guide to Audit Committees.  Reporting lines for the internal auditor Agencies establishing an internal audit function must provide appropriate independence for the internal audit function by establishing some degree of separation of the function from management. In private companies, the internal auditor is accountable to the Board through the Chairman of the Audit Committee. This approach cannot be directly reproduced under the provisions of the Local Government Act 1993. Internal audit is an operational matter that falls within the responsibility of the general manager.  Under section 335 (1) of the Local Government Act, the general manager is responsible for the efficient and effective operation of the councils organisation. The
 
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separation of powers between the general manager and the elected council is a key element to the Act and accordingly both need to ensure that they do not interfere with or control the exercise of each of these functions. It is therefore not appropriate for an internal auditor to report directly to a Mayor and/or councillors.  Councils have the power to appoint an external audit firm to be the internal auditor. This does not change the fact that internal audit remains an operational role. Council should not by-pass the general manager by, for example, requiring the internal auditor to report to and or take directions from a council committee or council.  While the internal auditor is employed by management, the internal auditor is also expected to review the conduct of management. Therefore, the internal auditor should be able to report to a person or body with sufficient authority to implement internal audit recommendations.  The internal auditor should report regularly on their performance. Further, it is important for the internal auditor to have direct access to the audit committee (where established) to monitor the scope of the work of internal audit and to review the reports issued. This could be achieved by having the internal auditor attend meetings of the audit committee.  The appointment of an internal auditor does not give council the ability to direct the performance of the audit function. However, councils can use the general managers employment contract to ensure that relevant internal audit work is a requirement of the general managers performance.  
 
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Audit committees The audit committee should monitor and review the effectiveness of the internal audit function and direct the overall strategic direction of internal audit. In particular, it is responsible for ensuring that external reporting and other corporate governance responsibilities are addressed and that the councils internal control and risk management structures are appropriate.  Development and day to day maintenance of internal controls and risk management strategies and practices remains the function of council management.  Charter of the Audit Committee The mandate, structure and methods of the audit committee should be clearly defined in the audit committee charter. All participants should have a clear understanding of the audit committees objectives, role, structure, meeting code, duties and responsibilities. The charter should also provide the audit committee with the resources and authority necessary to meet its objectives. The audit committee can also provide an effective means of formalising and coordinating the working relationship between internal and external auditors.  Composition of Audit Committee The Audit Committee should ideally have the following skills and experience:  Financial skills Audit and review skills Legal and regulatory experience Operational local government experience.  The audit committee can be made up of internal members, external members or, ideally, a combination of both. The members need sufficient skills to perform the duties required.  
 
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