Managerial Auditing Journal

Developing an internal auditing department balanced scorecard

Douglas E. Ziegenfuss
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 Developing an internal auditing department balanced
scorecard
Keywords
Auditing, Internal Auditing,
Downloaded by UNIVERSITAET OSNABRUCK At 18:44 30 January 2016 (PT)
Audit Quality, Quality Assurance,
Performance Measures,
Benchmarking
Abstract
This article demonstrates the use
of the ``Balanced Scorecard''
methodology developed by Kaplan Auditors' (IIA) professional standards.
and Norton in selecting
performance measures for internal supervision, internal reviews, and external
auditing departments. It then
describes: professional
standards and guidance
concerning the use of performance recognized in recent years as the fourth
measures and benchmarking; the
``Balanced Scorecard''
methodology; and a comprehen-
sive example. Finally, this
article concludes with specific
recommendations concerning the
use of performance measures.
With assistance from
Quality Auditing Services
Institute of Internal
Auditing, Robert A. Ferst,
CIA, Vice President, Global
Services Integration and
Quality Programs, The
Institute of Internal Auditors
and Sridhar Ramamoorti,
CIA, CA, Arthur Andersen
Managerial Auditing Journal
15/1/2 [2000] 12±19
# MCB University Press
[ISSN 0268-6902]
[ 12 ]
Douglas E. Ziegenfuss
Department of Accounting, Old Dominion University, Norfolk, Virginia, USA
Introduction
The Chief Auditing Executive (CAE) is
responsible for establishing and monitoring
a quality assurance program to ensure his or
her department meets its mission and
complies with the Institute of Internal
Alongside such traditional elements as
reviews, monitoring and benchmarking key
performance measures have come to be
element of quality assurance. However,
selecting and monitoring right performance
measures can be difficult given the large
number of available performance measures.
The key issue facing the CAE is to select
performance measures that accurately reflect
his or her department's performance and
more importantly the department's progress
in meeting its mission and objectives. Robert
S. Kaplan and David P. Norton have developed
one methodology for addressing this issue.
Their ``Balanced Scorecard'' methodology ties
departmental and individual performance
measures into an organization's strategic
planning process. CAEs should consider
adopting this methodology for their internal
auditing departments.
Professional standards and
guidance
General guidance concerning quality
assurance is given by the IIA's Standards for
the Professional Practice of Internal Auditing
(SPPIA). SPPIA, Section 560, ``Quality
Assurance'', states, ``The director of internal
auditing should establish and maintain a
quality assurance program to evaluate the
operations of the internal auditing
department (The Institute of Internal
The current issue and full text archive of this journal is available at
http://www.emerald-library.com
Auditors, 1985)''. Section 560 also states that
the quality assurance program exists to
ensure audit work conforms to the SPPIA and
the needs of senior management, external
auditors, the board, and regulatory agencies.
In addition, according to Section 560, the
quality assurance program should include the
following elements: (1) Supervision, (2)
Internal Reviews, and (3) External Reviews.
Section 560 then describes each of these
elements in detail. However, Section 560 does
not mention performance measures and
benchmarking and this appears to be an
important issue that the IIA should address.
During the early 1980s, the IIA stressed the
importance of external reviews as the
principal means of assuring audit quality.
However, by the 1990s, many internal
auditing departments began to adopt a Total
Quality Management (TQM) approach to
quality assurance. A key element of TQM
was the use of performance measures to track
quality and benchmark with other internal
auditing departments. In 1993, the IIA
established its benchmarking service, Global
Auditing Information Network (GAIN). In
1994, the IIA Research Foundation published
its study, Developing Productivity in Quality
Measurement Systems for Internal Auditing
Departments, authored by James C. Lampe
and Steve G. Sutton (The Institute of Internal
Auditors Research Foundation, 1994). The
IIA Research Foundation produced two
additional TQM/benchmarking studies (The
Institute of Internal Auditors Research
Foundation, 1995; 1997). However, these
studies dealt almost exclusively with internal
auditing department as the provider of TQM/
benchmarking services to other departments
within the organization. Finally, the IIA
added performance measures to its latest
edition of its quality assurance manual,
Business-Focused Quality Assurance Review
Manual (The Institute of Internal Auditors,
1996). In addition to the works cited above,
there have been numerous articles dealing
with performance measures/benchmarking.
 Douglas E. Ziegenfuss
Developing an internal
auditing department balanced
scorecard
Managerial Auditing Journal
15/1/2 [2000] 12±19
Downloaded by UNIVERSITAET OSNABRUCK At 18:44 30 January 2016 (PT)
Currently, the use of performance
measures/benchmarking by internal
auditing departments has come to be
viewed by many as the fourth element of
the internal auditing department's quality
assurance system. However there still
remain some issues that need to be
addressed. For instance, which
performance measures are the best? How
can a CAE tie the performance measures to
the internal auditing department's long-
term strategy? Both of these issues are
addressed in the next section of this article
by examining the ``Balanced Scorecard''
methodology.
The balanced scorecard
Kaplan and Norton (1996) presented the
``Balanced Scorecard,'' methodology in a 1996
Harvard Business Review article entitled,
``Using the balanced scorecard as a strategic
management system''. They point out that in
the contemporary business environment,
organizations currently compete based on
information, and that an organization's
ability to exploit intangible assets is
increasingly more important than its ability
to exploit physical assets. The problem
according to Kaplan and Norton is that most
organizations' operational and management
control systems are built around financial
measures and targets that do not measure the
organization's progress in achieving long-
term strategic objectives. A gap exists
between the development of strategy and its
implementation. Their solution is to develop
a ``Balanced Scorecard'' that supplements
traditional financial measures with three
new perspectives ± those of customers,
internal business processes, and learning
and growth. In addition, managers must
introduce four new processes that contribute
to linking long-term strategic objectives with
short-term goals (the performance measures)
± translating the vision, communicating and
linking, business planning, and feedback and
learning.
Figure 1 shows the interaction among the
four ``Balanced Scorecard'' perspectives and
the organization's vision and strategy. Note
that each perspective is defined in terms of a
key question. For instance, the financial
perspective is defined in terms of the
question, ``To succeed financially, how
should we appear to our stakeholders?'' Who
are the internal auditing department's
stakeholders? Ultimately, they are the
organization's owners and constituents as
represented by the Board of Directors or the
Audit Committee and upper management.
Performance measures for this perspective
should relate to the quality of the
relationship between the Audit Committee,
upper management and the internal auditing
department. In addition, the measures for the
financial perspective should relate to the
internal auditing department's use of
resources.
Table I lists some possible performance
measures for the financial perspective. The
performance measures listed were selected
from the many contained in the Institute of
Internal Auditors' (IIA) Global Auditing
Information Network (GAIN) database (The
Institute of Internal Auditors, 1997). Thus,
this article provides a use for the information
maintained by GAIN.
The customer perspective asks the
question, ``To achieve our vision, how should
we appear to our customers?'' Who are the
internal auditing department's customers? I
believe they are managers of the departments
being audited. After all, they are the ones
who gain the most from an audit in terms of
process improvements and reduction in risk.
Consequently, performance measures for
this perspective should relate to auditee
managers' evaluation of audits performed in
their area. Table I lists possible performance
areas.
The learning and growth perspective asks
the question, ``To achieve our vision, how
will we sustain our ability to change and
improve?'' Does the internal auditing
department have the knowledge, skills, and
abilities to constantly reinvent itself in the
constantly changing business environment?
Performance measures for this perspective
should be related to the knowledge, skills,
and abilities of the audit staff. Table I lists
possible performance measures.
The last perspective is internal business
review perspective. It asks the question, ``To
satisfy our stakeholders and customers what
business processes must we excel at?'' What
types of audits should the internal auditing
department perform and what results should
be forthcoming from those audits? Table I
lists possible performance measures.
According to Kaplan and Norton (1996), the
CAE should implement the following four
processes in building a ``Balanced Scorecard''
for his or her department.
1 Translating the vision ± build a consensus
around the internal auditing department's
vision and strategy.
2 Communicating and linking ± allow
interested parties to communicate their
strategy up and down the organization
and link it to departmental and individual
goals.
[ 13 ]
 Douglas E. Ziegenfuss
Developing an internal
auditing department balanced
scorecard
Managerial Auditing Journal
15/1/2 [2000] 12±19
Downloaded by UNIVERSITAET OSNABRUCK At 18:44 30 January 2016 (PT)
[ 14 ]
Figure 1
Balance scorecard four perspectives
3 Business planning ± enable internal
auditing departments to integrate their
business and financial plans.
4 Feedback and learning ± enable the
internal auditing department to evaluate
strategy in terms of recent performance.
Figure 2 illustrates the interaction among
these four processes and the ``Balanced
Scorecard''. Note that these processes are
repeated several times until the ``Balanced
Scorecard'' is fully adopted. Figure 3 shows
the cyclical nature in which the four
processes interact. Ten steps are required to
adopt a ``Balanced Scorecard''. The next
section of this article gives a step-by-step
example of how to implement an internal
auditing balanced scorecard.
A comprehensive example
The first step in developing the ``Balanced
Scorecard'' is for the Chief Auditing
Executive to assemble a strategic planning
team. Key parties outside the internal
auditing department (for example: CEO,
selected managers, and Audit Committee
members) and within the department
(supervisory and staff auditors) should be
included on this team. This is an excellent
opportunity to market the internal auditing
department while also receiving valuable
comments and recommendations. The
strategic planning team should begin by
revising or translating the department's
mission from lofty general language to what
Kaplan and Norton (1996) call ``an integrated
set of objectives and measures, agreed upon
by all that describe the long-term drivers of
success''. The strategic planning team should
state the mission in terms of performance
measures relating to each perspective. This
forces the team to clarify the department
mission to the point that all parties can
understand it. It also allows interested
parties to track the internal auditing
department's progress in fulfilling the
mission.
An example of an internal auditing
department mission in balanced scorecard
format is shown in Table II. Selecting
appropriate performance measures is not
easy. However, the balanced scorecard
methodology gives ample opportunity for
interested parties to reach a consensus on the
appropriate performance measures to use.
The task is made easier because the
measures are tied to the four perspectives.
There appears to be an appropriate number
of perspectives. Fewer perspectives would
not provide the needed breadth and more
would prove administratively difficult to
address. In addition, the total number of
performance measures covering all four
perspectives should not exceed ten, or data
gathering becomes too cumbersome.
The CAE should then discuss the revised
mission or department scorecard with the
internal auditing department's middle
managers (if there are any) or supervisors. In
even smaller internal auditing departments
this discussion may involve the CAE and the
 Douglas E. Ziegenfuss
Developing an internal
auditing department balanced
scorecard
Managerial Auditing Journal
15/1/2 [2000] 12±19
Downloaded by UNIVERSITAET OSNABRUCK At 18:44 30 January 2016 (PT)
Table I
Possible performance measures classified by ``Balanced Scorecard'' perspective
Financial perspective ± ``To succeed financially how should we appear to our stakeholders?''
Possible performance measures:
CAE reporting relationships ± functional
CAE meets privately with audit committee
Role of internal auditing, as viewed by the audit committee
Total costs per auditor ± Travel included
Total costs per auditor ± Travel excluded
Salaries as a percent of total costs
Travel as a percent of total costs
Training as a percent of total costs
Other costs as a percent of total costs
Customer perspective ± ``To achieve our vision, how should we appear to our customers?''
Possible performance measures:
Customer satisfaction survey results
Role of internal auditing, as viewed by the auditee
Management expectations of internal auditing
Number of management requests
Number of complaints about audit
Learning and growth perspective ± ``To achieve our vision, how will we sustain our ability to change and
improve?''
Possible performance measures:
Auditor education levels
Staff turnover rate
Percent of certified staff
Average years of audit experience
Training hours per internal auditor
Internal auditor training by type
Internal training as percent of total training
Internal business review perspective ± ``To satisfy our stakeholders and customers what business processes
must we excel at?''
Possible performance measures:
Types of audit reviews
External quality assurance review
Actual hours versus budgeted hours
Completed versus planned audits
Number of major audit findings/recommendations
Number of process improvements
Number of audit reports issued
Completed audits per auditor
Distribution of audit comments by type
Importance of audit issue
Percent of audit recommendations implemented
Amount of audit savings
Average response time ± Management requests
Cost savings as a percent of total budget
Days from end of field work to report issuance
Target completion dates on management action plans
Source: IIA GAIN database
[ 15 ]
 Douglas E. Ziegenfuss Figure 2
Developing an internal Managing strategy: four processes
auditing department balanced
scorecard
Managerial Auditing Journal
15/1/2 [2000] 12±19
Downloaded by UNIVERSITAET OSNABRUCK At 18:44 30 January 2016 (PT)
audit staff directly. The internal auditing
managers (or staff) should then translate the
department scorecard to smaller units and
ultimately to individual scorecards. Table III
presents an example of an individual
auditor's scorecard.
` ... The strategic planning team should state the mission in terms of
performance measures relating to each perspective. This forces the
team to clarify the department mission to the point that all parties
can understand it. It also allows interested parties to track the
internal auditing department's progress in fulfilling the mission... '
The process of translating the department
scorecard to individual scorecards should
lead to the third step ± identifying the
programs (types of audits) which the internal
auditing department should perform in
meeting its mission. Active programs (types
of audits) that do not contribute to the
department's attainment of its mission
should be eliminated and inactive programs
(types of audits) that would contribute to the
department's attainment of its mission but
are not being done should be implemented.
For example, the department may decide to
adopt control self-assessment or reduce the
number of financial audits.
The CAE and the audit managers (or staff)
should then review the individual scorecards
(step four). This allows the CAE to ensure
that individual scorecards are compatible
[ 16 ]
with the department scorecard and that all
items in the department scorecard are
covered in the individual scorecards. The
results of this step should then be used to
refine the department's mission and
scorecard (step five) by the strategic
planning team. The CAE should then
communicate the refined department and
individual scorecards to all department
personnel (step six). The CAE should then
link the refined scorecards to the
department's long-range plan and budget
(step seven). This involves identifying the
resources required to fulfill the department's
mission for the next five years.
The CAE and other interested parties
should periodically monitor and review the
performance measures (step eight) once
upper management approves the five-year
plan. The timing of this review will vary
according to the department's size ± monthly
for large departments and quarterly for small
departments. These periodic reviews should
focus on the attainment of long-term strategic
goals rather than on short-term issues.
The CAE and the strategic planning
committee should annually review the
department's mission and scorecard (step
nine). This should be an in-depth rethinking
of the department's mission and should begin
the entire process again. Finally, the CAE
should ensure that all internal auditing
personnel are evaluated in terms of their
individual scorecards (step ten).
 Douglas E. Ziegenfuss
Developing an internal
auditing department balanced
scorecard
Managerial Auditing Journal
15/1/2 [2000] 12±19
Downloaded by UNIVERSITAET OSNABRUCK At 18:44 30 January 2016 (PT)
Figure 3
Around the balanced scorecard
Important points concerning
performance measures
This article describes one means of closing
the gap between an internal auditing
department's strategic plans and its short-
term goals. Key lessons from adopting the
Kaplan and Norton ``Balanced Scorecard''
methodology include the following:
. Performance measures should not be
selected and evaluated individually,
rather they should be tied to the internal
auditing department's mission and goals.
. Internal auditing department
performance should be evaluated based on
four perspectives ± financial, customer,
learning and growth, and internal
business process.
. Internal auditing department missions
and goals should be stated as an
integrated set of objectives and measures
that describe long term drivers of success.
. Bridging the gap between long-term goals
and individual performance measures
involves repeating four processes ±
translating the vision, communicating
[ 17 ]
 Douglas E. Ziegenfuss
Developing an internal
auditing department balanced
scorecard
Managerial Auditing Journal
15/1/2 [2000] 12±19
Downloaded by UNIVERSITAET OSNABRUCK At 18:44 30 January 2016 (PT)
[ 18 ]
Table II
Internal auditing department balanced scorecard mission statement
Financial perspective: ``To succeed financially, how should we appear to our stakeholders?''
Measures:
Role of internal auditing viewed by the audit committee ± the number of different types of services will remain
constant or increase
Total costs per auditor ± Travel included ± will remain constant or increase at a rate equal to or less than the
corporate overhead rate increases
Customer perspective: ``To achieve our vision, how should we appear to our customers?''
Measures:
Customer satisfaction survey results ± average score will remain constant or increase from prior year's average
score.
Number of complaints about audit ± will decrease from prior year's number of complaints
Internal business process perspective: ``To satisfy our shareholders and customers, what business processes
must we excel at?''
Measures:
Number of major audit findings/recommendations ± will be greater than the prior year's number of major audit
findings
Days from end of fieldwork to report issuance ± on average will be the same or less than the prior year's average.
Percent of audit recommendations implemented ± for all audits will be the same or greater than the prior year's
percentage
Cost savings as a percent of total budget ± will be the same or greater than the prior year's percentage.
Learning and growth perspective: ``To achieve our vision, how will we sustain our ability to change and
improve?''
Measures:
Training hours per internal auditor ± will be the same or increase from the prior year's amount
Average years of audit experience ± will be the same or increase from the prior year's average years of audit
experience
Table III
Individual internal auditor balanced scorecard
Financial perspective: ``To succeed financially, how should we appear to our stakeholders?''
Measures:
Total costs per auditor ± Travel Included ± for audits performed by internal auditor
Customer Perspective: ``To achieve our vision, how should we appear to our Customers?''
Measures:
Customer satisfaction survey results ± for audits performed by internal auditor
Number of complaints about audit ± for audits performed by internal auditor
Internal business process perspective: ``To satisfy our shareholders and customers, what business processes
must we excel at?''
Measures:
Number of major audit findings/recommendations ± for audits performed by auditor
Days from end of field work to report issuance ± for audits performed by internal auditor
Percent of audit recommendations implemented ± for audits performed by internal auditor
Cost savings as a percent of total budget ± for audits performed by internal auditor
Learning and growth perspective: ``To achieve our vision, how will we sustain our ability to change and
improve?''
Measures:
Training hours per auditor ± completed by internal auditor
Average years of audit experience ± for internal auditor
 Douglas E. Ziegenfuss and linking, business planning, and
Developing an internal feedback and learning.
auditing department balanced
scorecard
. Key parties both outside and inside the
internal auditing department should
Managerial Auditing Journal
15/1/2 [2000] 12±19 participate in the process of selecting
performance measures.
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Professional Standards for the Professional
Practice of Internal Auditing, Section 560,
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Business-Focused Quality Assurance Manual,
Third Edition, The Institute of Internal
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(The) Institute of Internal Auditors (1997), Global
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(The) Institute of Internal Auditors Research
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[ 19 ]
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