Question

Management and the board of directors are responsible for following up on observations and recommendations made by the external auditors. What role, if any, should the internal audit activity have in this process?

1) the internal audit activity should become involved only if specifically requested by management or the board
2) the internal audit activity should have no role in this process in order to ensure independence
3) the internal audit activity should establish a monitoring process to review the adequacy and effectiveness of management's follow-up actions
4) the internal audit activity should only become involved if the chief audit executive has sufficient evidence that the follow-up is not occurring

Answer 1

The correct answer is option 3, where the internal audit activity should monitor management's follow-up on external auditor recommendations to ensure they are addressed adequately, thus playing a key role in corporate governance.

Step-by-step explanation:

The role of the internal audit activity in the process of following up on observations and recommendations made by external auditors is crucial for ensuring effective corporate governance. While management and the board of directors are responsible for acting on the insights provided by external audits, the internal audit activity plays a supporting role. Option 3 is the correct response, stating that the internal audit activity should establish a monitoring process to review the adequacy and effectiveness of management's follow-up actions. This proactive approach enhances accountability and ensures that the external auditor's observations are not only addressed but also integrated into the company's operational improvements effectively.

In the case of Lehman Brothers, a failure in corporate governance provided misleading financial information to investors. Internal audit involvement could have potentially mitigated the repercussions by identifying and urging for more timely resolutions to the issues found by external audits. Therefore, internal audit oversight is an essential component of a well-functioning corporate governance framework, as it helps bridge the gap between external audit findings and management's response to those findings.