Contributed by SUSAN D. HERMANSON, Cameron Distinguished Professor of Accounting at the University of North Carolina Wilmington. She received her Ph.D. in accounting from Texas A&M University (1994) and her B.B.A. in accounting from the University of Georgia (1988). Susan is coauthor of three accounting textbooks and has published over 60 refereed journal articles. She is the recipient of numerous teaching awards, including the Chancellor’s Teaching Excellence Award.
Over the past year, I have been working with coauthors on research in the area of internal auditing and COVID-19. Our first article, “Downsizing Internal Audit: Saving Costs or Sacrificing Future Performance” was published in the May/June 2020 issue of Internal Auditing and the second article, “The 2020/COVID-19 Environment and Internal Audit” is forthcoming in the July/August issue of Internal Auditing. In this blog, I discuss some of the main points of these articles, but feel free to refer to the original articles for a more detailed discussion of these topics.
During a global pandemic, many companies are trying to cut costs to help mitigate losses in a down economy. While the global pandemic has resulted in some “winners” like Walmart and Home Depot, many companies are struggling. Bankruptcies are on the rise, small businesses are increasingly closing shop, and many companies, such as hotels, restaurants, and airlines, are facing tremendous losses. As the losses mount up and companies struggle to survive, company executives are looking to cut discretionary spending, and one place some companies turn to is the internal audit department. During the banking crisis of 2008 and recession of 2009, slightly over 1/3 of Fortune 500 companies made cuts to their internal audit departments. While on the surface cost cutting in this area may seem appealing, the long-term impacts can be detrimental.
The internal audit function plays a key role in any organization. Internal auditors are not just checking behind the corporate accountants to ensure proper control over and reporting of the financial information, but internal auditors are also key trusted advisors who assist the company on many fronts, both operationally and financially. With expertise in accounting, internal control, and risk management, many internal audit personnel are well equipped to assist companies through tough times by identifying creative ways to manage risks and take advantage of opportunities. In the current COVID-19 economy, there are many risks facing companies that place internal auditors in a prime position to take a leadership role. While the areas discussed below are not intended to be comprehensive, they do provide some insights into the ways that internal audit can be leveraged during these difficult times.
Financial Reporting Risks
In addition to its normal role in financial reporting testing and controls, the internal audit department can help to address additional financial reporting risks that may have arisen due to the new COVID economy. For instance, has management appropriately modified models used in key estimates to reflect changes in the economy? Have forecasts been revised? Do contracts need to be renegotiated? Have assets been appropriately tested for impairment in value and debt covenants checked for potential default? Do the financial statement notes have appropriate disclosures regarding key risks affecting the company? With a struggling economy, all of these questions have become imperative to answer for most companies.
Remote Work/IT Security Risks
In many industries, much of the work force has moved to a remote work environment, often utilizing servers that are much less secure than those provided at work. Even if Virtual Private Networks (VPNs) are available, can they handle the increased traffic, or do expansions need to be made? As expansions are made, are key controls still in place? Are meetings reliable and secure on media such as Zoom? Is data integrity being preserved? The bottom line is that the internal auditors can play a key role in helping to identify and mitigate key risks related to data security of company and customer information.
COVID-19 Related Opportunities
The government has provided various programs to assist companies in the midst of the current economic downturn, such as the Paycheck Protection Program, the Cares Act, debt relief programs and other grants or opportunities. What are the advantages and disadvantages of participation in these programs? Has the company taken advantage of good opportunities, or has it missed any valuable opportunities? Internal auditors can help to ensure available programs have been reviewed and pros and cons have been appropriately addressed.
From an operations standpoint, internal audit can also help the company identify alternative operational models, such as finding additional suppliers to mitigate supply chain risk or leveraging assets in new and unique ways to offset losses. For instance, a minor league franchise in Pensacola FL, known as the Blue Wahoos, refused to fully close its stadium down during COVID. Instead, it decided to use its unoccupied stadium to create the largest open air dining restaurant in the state. Later, they added overnight stays through AirBnB, movies, fireworks, and other perks that fans have enjoyed. With the AirBnB stays at $1500 per night, guests can use locker rooms, the field, and batting cages, all the while staying in a room with nice beds and a view of the ocean. These creative measures helped stem the tide of COVID-related losses and made management more aware of some of the ways the facility might be better utilized moving forward.
Return to Work Risks
As the economy continues to open up, companies must take appropriate measures to protect employees and customers. Internal auditors can help address whether health guidelines are being followed. In addition, is the company appropriately insured? Does the company have a plan for protecting “at risk” workers, and is the company appropriately protecting employee health-related information? How is the company going to prevent infection as employees return to work? What policies will be in place for workers who test positive for COVID-19? What types of PPE (Personal Protection Equipment) will be mandatory, who will provide it, and what is the protocol if employees or customers refuse to wear appropriate PPE? Internal auditors can assist companies in each of these areas.
COSTS ASSOCIATED WITH UNDERFUNDING INTERNAL AUDIT
Not only can internal auditors help companies navigate these tough times, but there also are substantial costs to failing to invest appropriately in the internal function. Ineffective, missing, or limited internal audit functions have been associated with an increased risks of fraud, material weaknesses in internal controls, material misstatements in the financial statements, and elevated external audit fees. Companies with internal control weaknesses related to internal audit are at increased risk of having additional material weaknesses in other areas. As these weaknesses add up, the likelihood of financial statement misstatements and restatements also increases. Restatements are particularly costly, as companies experience a 25% decline in stock price (on average) following a restatement, and some experience significantly higher declines. Further, as controls deteriorate and financial reporting gets messy with misstatements and possibly restatements, external auditing costs also rise, since it hard for external auditors to get comfortable with the numbers as quickly. Therefore, downsizing the internal audit function may lead to costly ramifications.
While internal auditors serve many roles, their role as experts in the area of risk management should not be overlooked during the COVID crisis. The internal audit department should be utilized as a key player during the pandemic, rather than as a discretionary cost subject to budget cuts. A down economy is not the time to cut funding to the internal audit department. Doing so may cause a company to miss out on key opportunities, face more unmitigated risks, and incur additional costs, thereby potentially sacrificing future performance. Internal auditors are often the unsung heroes in an organization, and leveraging the risk management expertise of these individuals during tough times can help a company not only to survive in the downturns but to thrive in the upturns.
Robert T. Burrus, Jr., Ph.D., is the dean of the Cameron School of Business at the University of North Carolina Wilmington, named in June 2015. Burrus joined the UNCW faculty in 1998. Prior to his current position, Burrus was interim dean, associate dean of undergraduate studies and the chair of the department of economics and finance. Burrus earned a Ph.D. and a master’s degree in economics from the University of Virginia and a bachelor’s degree in mathematical economics from Wake Forest University. The Cameron School of Business has approximately 90 full-time faculty members and 30 administrative and staff members. The AACSB-accredited business school currently enrolls approximately 2,600 undergraduate students in three degree programs and 750 graduate students in four degree programs. The school also houses the prestigious Cameron Executive Network, a group of more than 200 retired and practicing executives that provide one-on-one mentoring for Cameron students. To learn more about the Cameron School of Business, please visit http://csb.uncw.edu/. Questions and comments can be sent to [email protected].
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