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Implementing the Balanced Scorecard to Internal Audit Function

Conference Paper · April 2018

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 Implementing the Balanced Scorecard to Internal Audit Function

Koutoupis G. Andreas1, Filos John2, Pappa Evangelia3, Papanastasiou Pantelis4,

Vousinas Georgios5

Abstract
Over the last decades, a growing attention has been focused on the critical role of
internal audit to firm’s effectiveness. The main purpose of the paper is to analyze the
internal audit function under the contextual perspectives of Balanced Scorecard.
Quantitative data collection method is used including a self-administrative
questionnaire. Internal consistency reliability of scale scores was estimated in terms
of Cronbach’s alpha. The results show that internal audit is a crucial dimension of
firm’s performance. Moreover, internal audit function is a dynamic process that most
influenced from internal business process and specific internal auditor’s
characteristics, such as professional qualifications and lifelong learning. The
contribution of the paper is to enrich the literature by exploring the application of
Balanced Scorecard, as a powerful performance measurement tool, to internal audit
function in Greece.

Keywords: Internal Audit Function, Balanced Scorecard (BSC), Firm Performance,

Effectiveness

1. Introduction
Internal audit is “an independent, objective assurance and consulting activity
designed to add value and improve an organization's operations. It helps an
organization accomplish its objectives by bringing a systematic, disciplined approach
to evaluate and improve the effectiveness of risk management, control and
governance processes” (IIA, 2013). This definition signifies that internal audit is a
catalyst for improving an organization's governance and risk management process
including insight and recommendations (Wood, 2012).

The mission of internal audit articulates what internal audit aspires to accomplish
within an organization. Its place in the new International Professional Practices
Framework (IPPF, 2017) is deliberate, demonstrating how practitioners should

1
Associate Professor (elected), Department of Accounting and Finance, Technological Educational
Institute of Thessaly, 411 10 Larisa, Greece, University of the Aegean and Hellenic Open University,
email: [email protected]
2
Associate Professor, Department of Public Administration, Panteion University of Social and Political
Sciences, Greece, email: [email protected]
3
PostDoctoral Researcher, Department of Public Administration, Panteion University of Social and
Political Sciences, 136, Sygrou Avenue, 17671, Athens, Greece, email: [email protected]
4
MSc Accounting and Auditing, School of Accounting and Finance, Technological Educational Institute
of Crete, 710 04 Heraklion, Crete, Greece, email: [email protected]
5
Doctoral Researcher, School of Mechanical Engineering, Section of Industrial Management &
Operational Research, National Technical University of Athens, Greece, email: [email protected]
leverage the entire framework to facilitate their ability to achieve the Mission: To
enhance and protect organizational value by providing risk-based and objective
assurance, advice, and insight.

More specifically, internal audit’s main role is to provide objective assurance to the
Board on the effectiveness of risk management (IIA, 2009). According to the
framework of corporate governance proposed by the Institute of Internal Auditors
(IIA), an effective IA is one of the four cornerstones of corporate governance, along
with the audit committee of the Board of Directors, executive management, and the
external auditor. From the above, it is obvious that there is an increasing awareness
of the internal audit and the value-added role that internal audit can play in modern
organizations (Al-Twaijry et al., 2003).

Companies and Organizations are the backbones of the economy, and in particular
small and medium-sized enterprises, which today are heavily affected by the ongoing
crisis. At the same time, the volume and complexity of tasks and requirements, as
well as the risk of errors are particularly high. Internal auditing's changing mission,
roles, and strategies have led departments to rethink and refine their strategy and
performance priorities (Frigo, 2002).

The most common means of measuring performance and efficiency in an

organization is the Balanced Scorecard (BSC), which is widely used by policymakers.
The balanced scorecard is an effective tool for fine-tuning and implementing strategy
and also for showcasing the value of an internal audit department (Frigo, 2002).
Internationally, the relationship between Internal Audit and the Balanced Scorecard
has been approached empirically, however, until now, to the best of the authors’
knowledge, no empirical research on the performance measurement of internal audit
through the Balanced Scorecard methodology has been conducted within a Greek
context.

This research gap is covered by this innovative research, which was aimed at
investigating the issue from the perspective of various personnel and executives from
the Internal Audit Department of Greek firms. In this study, we elaborate in detail how
factors such as internal audit, the added value of internal audit and internal auditors
perceive their current role in the Greek context. In the perspective, the present paper
aims at illustrating the interrelationship between internal audit and balanced
scorecard.

This paper is organized into five sections after the introduction. The next one briefly
describes the Balanced Scorecard methodology. Section three discusses the
literature review, while Section four describes the research design. Section five
reports on and discusses the results of the study. The last section presents the
conclusions and implications for future research.

2. The Balanced Scorecard Methodology

Firms around the world, and also in Greece, traditionally measure their operation
efficiency with selected economic indicators, which are depicted graphically. The
2
main focus is put on sales, net profits, gross and net profit margins, liquidity and
working capital. However, it is common for the achievement of the objectives related
to the progress in the above-mentioned sizes to be inadequate with the actual
development of a business over time due to long-term dynamics (e.g. deterioration in
customer service levels due to job cuts). Therefore, these methods are unable to
support management plans in general and strategic plans of the organization in
particular. Nowadays, companies are required to be both strategically and
operationally at appropriate levels in order to be able not only to survive, but also not
to be left behind the future challenges (Rezaei, Moeinadin, and Dehnavi, 2014).

The most common methodology that helps organizations to translate its vision and
strategy into implementation is Balanced Scorecard. It was developed in the early
1990s from Kaplan and Norton in their work entitled "Performance of Scorecards
Measurement. Translating Strategy into Action". Balanced Scorecard includes four
categories of measures, financial, customer, internal business process and learning
and growth. The term "Balanced Scorecard" is interpreted as follows (Lee et al,
2008):
• Balance between long-term and short-term goals
• Balance between internal and external stakeholders
• Balance between financial and non-financial measures
• Balance between prospective and retrospective indicators.

Each of the aforementioned aspects of the balanced scorecard are depicted in Figure
1 and briefly described as follows:

• Financial: is focused on organizational financial performance and the use of

financial resources and after all on the organization’s long-term goals. In the
prospect of assessing performance, financial indicators are not removed, but
they will be examined as an important part of the evaluation measures in the
context of the organization's strategy. On the other hand, the role of these
factors in determining the strategy of the organization is undeniable. Among
important indicators in this area, we can refer to the rate of return on assets
(ROA), return on equity (ROE), economic value added (EVA) etc.

• Customer: this perspective views the organizational performance from the

point of view the customer or other key stakeholders that the organization is
designed to serve. In other words, this perspective is related to product lifetime
and providing high-quality services and products for the satisfaction of
customer (Creamer and Freund, 2010). Customer satisfaction, as one of the
most important issues, plays a substantial role in today's business world and
many fields of business management science. Most indicators such as product
quality, price, waiting time, after sales services etc. are strongly related to this
aspect.

• Internal Business Process: views organizational performance through the

lenses of the quality and efficiency related to our product or services or other
3
 key business processes. What makes a good product or appropriate service is
to design and implement effective processes in an organization. In this regard,
balanced scorecard emphasizes on the evaluation of processes which have a
significant impact on improving the relationship with customers and meeting
financial goals. Among the most important indicators of this prospect, we can
refer to return on sales, circulation period of the asset, price-to-earnings ratio,
etc.

• Learning and Growth: views organizational performance through the lenses of

human capital, infrastructure, technology, culture and other capacities that are
essential to breakthrough performance. This perspective makes the foundation
of BSC, focuses on the prospect of motivation, training, and capacity to
innovate that employees need in order to implement new strategies (Creamer
and Freund, 2010). Staff in an organization is the main human resource and is
considered as the most important beneficiary of an organization. According to
this prospect, survival of many big scientific institutions in the modern world is
dependent on the attention of staff and their continuous improvement.
Accordingly, the balanced scorecard considers employee satisfaction and their
appropriate and continuous training among the main indicators. Objectives of
this prospect include determination of jobs (human capital), systems (investors
information), a kind of organizational climate (organizational capital) required to
support internal processes.

Figure 1: The Balanced Scorecard framework

Source: Adapted from Robert S. Kaplan and David P. Norton, “Using the Balanced
Scorecard as a Strategic Management System,” Harvard Business Review
January-February 1996:76.

The Balanced Scorecard methodology is applied to everyday business practice and

helps organizations effectively implement their strategy, transforming it into

4
measurable goals. The development of measurable goals, based on corporate
strategy, enables the ongoing evaluation and adaptation of a company's strategy so
that all corporate activities, resources, and initiatives are fully aligned with the same
vision in the same direction.

3. Literature Review
Before we proceed with the empirical analysis, a literature review is provided in order
to highlight the related research and the ever growing interest regarding the usage of
the Balanced Scorecard (BSC) model to measure the performance of the Internal
Audit Function.

Bota-Avram, C. et. al., (2011) focused on the methods of measuring the

effectiveness of internal audit activity based on internal audit practices of leading
international companies. The findings concluded that the Balanced Scorecard
instrument is one of the main metrics used by global leading enterprises for
measuring and evaluating the performance of internal audit, while been among the
key trends that will influence the internal audit activity in the future, from the
performance’s point of view.

Feizizadeh (2012) examine through literature review the strengthening audit

effectiveness. The basic question was how an internal audit function does to be most
effective as a key player in corporate governance. He recommends balanced
scorecards, which go well beyond numbers to examine important, broad-based
activities. The four action areas of a BSC give management, audit committees and
internal auditors a high-level framework to assess internal audit effectiveness.

Badara and Saidin (2013) examines internal audit effectiveness in local government
of Nigeria. It contributes to the body of knowledge by extending the existing literature
on the internal audit effectiveness through specific propositions. Namely, effective
internal control system, risk management and audit experience seem to have a
positive relationship with internal audit effectiveness at local government level in
Nigeria. Moreover, cooperation between internal and external auditors seems to have
impact on the internal audit effectiveness at local government level in Nigeria.

Sfetcu, M. (2013) examined the usage of management methods on the internal audit
activity through qualitative and quantitative indicators of performance assurance. The
results showed that Balanced Scorecard is a management method used by the
internal audit, helping to establish the general and specific objectives, but also a tool
used to ensure the performance by analyzing the efficiency, the effectiveness, the
economy and the quality of the audit. Futhermore, BSC is used for planning the audit
resources, analyzing the risks and assessing the internal control, based on specific
audit techniques and tools and contributes to detecting problems, usage of efficiency
and effectiveness.

Zureigat, and Moshaigeh (2014) explore whether Saudi listed companies are using
performance measures to evaluate their internal audit function and, if they are, what
performance measures they use to evaluate internal audit function and the identity of
5
the important measures from the perspective of internal auditors. Based on the data
collected from 134 questionnaires, the descriptive statistics that are presented that
Saudi listed companies are using defined performance measures. The results show
that Saudi listed companies are using both quantitative and quantitative performance
measures to assess the internal audit function performance. They find that internal
auditors rank quantitative measures as important while qualitative measures are
ranked as unimportant. The study also contributes to the existing literature by
identifying key performance measures for the internal audit function in an emerging
market and provides valuable information about how to measure internal auditing
performance.

Baiden, Baiden and Ayariga (2016) critically analyze and assess the value-added
performance of the internal audit function through the use of the balanced scorecard
methodology in the mist of the turbulence and volatile business landscape
confronting the internal audit profession. The study employed the survey method
where a forty questions questionnaire was designed based on the balanced
scorecard approach were sent to 90 employees internal auditors and non-internal
auditors in nine organizations in Sekondi-Takoradi Metropolis in Western Region,
Ghana. The study adopted a descripto-explanatory research; a combination of both
descriptive and explanatory research design. The study revealed that:

➢ Most respondents do not perceive the internal audit function as providing

value-addition services to their organizations based on IIA’s internal audit
performance assessment criteria.
➢ To assess the performance of the internal audit practice using an adaptation
of the balanced scorecard methodology to ascertain whether the function is
providing value-addition or destroying shareholder value.

Park, Lee and Chae (2017) compare the reflective and formative measurement
method with standardized model comparison criteria using BSC. After collecting 217
valid questionnaires from companies in South Korea, the authors applied a structural
equation modeling technique to analyze the data. Their results showed that:

➢ the formative measure provides greater validity for the corporate performance
measurement using BSC.
➢ the indicators’ relative influence on each BSC perspectives using the
formative measure and proved the usefulness of the formative measure
analysis method and suggested its practical use, focusing on the indicators
most useful in developing corporate strategies.
➢ formative indicators could be used in the corporate environment by
overcoming the limitations of conventional studies that were confined to
causal relationships with latent variables.

4. Research Design

4.1 Questionnaire
6
Primary data were collected from a self-structured questionnaire, as a widely
recognized research tool in the Balanced Scorecard literature (Park, et.al. 2017;
Susmanschi and Georgescu, 2014; Cohen, et. al. 2008; Ismail, 2007). Completion of
the questionnaire took no more than 10 minutes. The anonymity and confidentiality
treatment of the data enhance the participation and integrity of responses.

The questionnaire consists of five parts. The first one provides general information
about the socio-demographic profile of participants which comes from four questions.
The other parts depict the four perspectives of Balanced Scorecard into sixteen
questions, as presented in Table 1.

Table 1: Questionnaire structure

Part Two: Value and position of Internal Audit
Perspective

Does the internal audit monitor the achievement of the

Financial

Q01
Company's goals?
Does the Risk-based Audit (RBA) approach affect the function of
Q02
the Internal Audit Department?
Q03 Does the range of internal audit services play a substantial role?
Part Three: Internal Audit Stakeholders
Perspective

Q04 Are the Auditees satisfied about Internal Audit activities?

Customer

Q05 Are the activities of Internal Audit supported by External Auditors?

Q06 Does the company's Management accept the Internal Audit
recommendations?
Q07 Does Internal Audit effectively contribute in cases of Mergers and
Acquisitions?
Part Four: Internal Audit Procedures
Q08 Do internal auditors comply with the International Standards for
Process Perspective
Internal Business

the Professional Practice of Internal Auditing?

Q09 Do Internal Auditors check for deviations among the planned and
actual audit areas?
Q10 Does the weakness of a company's Internal Audit System affect
its business performance?
Q11
Does the use of data analytics improve internal audit efficiency;
Q12 Does the use of IT systems improve the effectiveness of Internal
Audit?
Part Five: Training and Development
Q13 Is the continuing professional education along with certified
Learning and

Perspective

training of Internal Auditors necessary?

Growth

Q14 Is there a specialization of Internal Auditors in different business

sectors?
Q15 Is there a budget planning procedure for further education and
training of Internal Auditors?
Q16 Has the role of the Internal Auditor been upgraded over time?

Respondents were asked to indicate their extent of agreement or disagreement with

each of the 16 questions via a five point Likert scale with the numbers running from
“1” to “5” in the direction from strongly disagree to strongly agree.

7
4.2 Target population and Sample
The survey was conducted between the months of April to July 2016. The target
population was firms that already have internal audit department. Survey participants
were determined through a pre-selection process to ensure high quality of
responses. Contact was made through 120 personalized e-mails. The objective was
to survey all the categories of employees engaged in internal audit activities. In all a
total of 44 responses (36.7%) were gained of which 2 were invalid for data analysis.

A detailed profile of the respondents is contained in Table 2. The typical respondent

is male (78.6%), in the age bracket of 31 to 40 years (52.4%), holds a master’s
degree (85.7%) and his previous experience in internal audit is within 5 to 10 years
(45.2%).

Table 2: Characteristics of respondents (n=42)

Characteristics Variables Frequency %
up to 10 9 21,4
Experience in 5-10 19 45,2
Internal Audit 3-5 2 4,8
0-3 12 28,6
Other 1 2,4
Bachelor 4 9,5
Education
Master 36 85,7
PhD 1 2,4
51-60 2 4,8
41-50 12 28,6
Age
31-40 22 52,4
21-30 6 14,3
Femal 9 21,4
Gender
Male 33 78,6
Source: Field Survey, 2016

5. Results

5.1 Reliability test

The questionnaire was tested for internal consistency reliability with Cronbach's
alpha coefficient. Table 3 presents the value of such measure that is greater than
0.7. Namely, it is above the conventional ‘level of acceptability’ (Spector, 1992;
Nunnally, 1978).

8
 Table 3: Reliability Test
Case Processing Summary
N %
Cases Valid 42 100,0
Excluded(a) 0 ,0
Total 42 100,0
Reliability Statistics
Cronbach's Alpha
Cronbach's Based on
N of Items
Alpha Standardized
Items
,703 ,701 16

5.2 Respondents’ perception on Value and Position of Internal Audit

The first perspective of Balanced Scorecard is “Value and Position of Internal Audit”
that depicted via the questions one to three (Q1-Q3). Regarding the Figure 2, the
results reveal that the largest percentage of respondents (61.9%) agrees with the
statement that internal audit monitors the achievement of the Company's goals.
Concerning the Risk-based Audit (RBA) approach, 76.2% of the respondents agree
that it affects the function of the Internal Audit Department. Lastly, the substantial role
of the range of internal audit services is agreed from the majority of respondents
(64.3%).

Figure 2: Responses on Value and Position of Internal Audit

0,0
Q.3 19,0
64,3
16,7

-2,4
Q.2 7,1
76,2
14,3

-7,1
Q.1 28,6
61,9
2,4

Strongly Agree Agree Neutral Disagree Strongly Disagree

Source: Field Survey, 2016

5.3 Respondents’ perception on Shareholders of Internal Audit Management /

Auditees
The second dimension of Balanced Scorecard is “Shareholders of Internal Audit
(Management and Auditees) that depicted via the questions four to seven (Q4-Q7)
(Figure 3). Regarding the Figure 3, the results reveal that the majority of
respondents (66.7%) agree that Auditees are satisfied about Internal Audit activities.
9
More than 69% of the respondents are neutral with the statement that internal audit
activities are supported by External Auditors. Moreover, neutral is the large
proportion of respondents (64.3%) with the view that the company's Management
accepts the internal audit recommendations. Lastly, 54.8% of the respondents agree
that Internal Audit effectively contributes in cases of Mergers and Acquisitions.

Figure 3: Responses on Shareholders of Internal Audit

-14,3
Q.7 23,8
54,8
7,1

-4,8
Q.6 64,3
31,0
0,0

-11,9
Q.5 69,0
11,9
7,1

0,0
Q.4 26,2
66,7
7,1

Strongly Agree Agree Neutral Disagree Strongly Disagree

Source: Field Survey, 2016

5.4 Respondents’ perception on Internal Audit Procedure

The third dimension of Balanced Scorecard is “Internal Audit Procedure” that
depicted via the questions eight to twelve (Q8-Q12). Regarding the Figure 4, the
results reveal the neutrality of the majority of respondents (52.4% and 50%,
respectively) about internal auditors’ compliance with the International Standards for
the Professional Practice of Internal Auditing, and also the Internal Auditors check
for deviations among the planned and actual audit areas. Furthermore, a great
proportion of respondents (52.4%) agree with the statement that the weakness of a
company’s Internal Audit System affects its business performance. Of the
respondents 85.7% and 78.6 respectively strongly agree that the use of data
analytics improves internal audit efficiency and the improvement of Internal Audit’s
effectiveness via the use of IT systems.

10
 Figure 4: Responses on Internal Audit Procedure

Q.12 2,4
19,0
78,6

Q.11 2,4
11,9
85,7

Q.10 14,3
52,4
33,3
-2,4
-4,8
Q.9 50,0
38,1
4,8
-2,4
Q.8 52,4
33,3
11,9

Strongly Agree Agree Neutral Disagree Strongly Disagree

Source: Field Survey, 2016

5.5 Respondents’ perception on Training and Development

The fourth dimension of Balanced Scorecard is “Training and Development” that
depicted via the questions thirteen to sixteen (Q13-Q16). Regarding the Figure 5,
the results reveal that half of the majority of the respondents (50%) strongly agree
with the necessity of the continuing professional education along with certified
training of Internal Auditors. Additionally, the great part of respondents (76.2%) is
neutral about Internal Auditor’s specialization in different business sectors. A total of
71.4% of the respondents strongly agree with the statement that there is a budget
planning procedure for further education and training of Internal Auditors. Finally,
about the upgraded role of the Internal Auditor over time respondents are neutral
(59.5%).

Figure 5: Responses on Training and Development

-21,4
Q.16 59,5
14,3
4,8
-2,4
-71,4
Q.15 16,7
9,5

-4,8
-4,8
Q.14 76,2
11,9
2,4

Q.13 7,1
42,9
50,0

Strongly Agree Agree Neutral Disagree Strongly Disagree

Source: Field Survey, 2016

11
 6. Summary and Conclusions
Overall, from the results, it is important to mention that internal audit performance is a
dynamic process which is shaped by the interaction among specific dynamic factors:
Value and Position of Internal Audit, Management/Auditees, Internal Audit Procedure
and also Training and Development. Each factor affects in a different way the
efficiency and effectiveness of internal unit function. Namely, internal audit
performance is strongly influenced by internal audit support ensuring the value and
position of internal audit in the organization. Moreover, internal auditor’s skills and
competencies through core training programs may result in high-level audit services.
On the other hand, internal audit functions should be enhanced by internal audit
procedures and techniques which are compliant with International Standards for the
Professional Practice of Internal Auditing, as well as management-auditees
attributes.

Some limitations should be addressed in this study. Firstly, survey results restrict
generalization due to the limited sample size of firms that is not representative.
Secondly, a relatively low response rates must be taken into account. Lastly, there
exists poor information about quantitative indicators for each Balanced Scorecard
perspective.

Despite these limitations, future research is needed to determine the variations in use
of the balanced scorecard which comply with the requirements of internal audit
functions in different organizations of public sector. Last but not least, it is imperative
need to conduct more large scale analysis in the area of performance measurement
systems implementation, conjoining the SWOT analysis with the balanced scorecard.

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