Module 4 - Introduction to Performance Audit_4C

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Case studies are listed above as a potential documentary source but may be used as a research method conducted by the auditor in which a detailed analysis is made of a particular aspect of the subject matter as a way of discovering useful learning points about the subject matter as whole. Measuring Economy, Effectiveness, and Efficiency The auditor must select appropriate measures to support conclusions regarding the economy, effectiveness, and efficiency of the subject matter. Measures may be qualitative and quantitative as well as financial and nonfinancial, and should consider: Inputs (resources applied). o Efficiency (i.e., the degree to which use of resource is minimized) can be measured using input-to-output ratios in terms of costs and volumes or by input-to-input ratios of different categories of inputs (e.g., staffing costs as a percentage of total costs). o Economy (i.e., degree to which resource costs are minimized), including trends over time and variations between locations, teams, and individuals. o Cost of quality, including quality assurance processes and the impact of failures and wastage. Output – work produced or services delivered. o Output quantity. o Output quality. o Output timeliness. o Output costs. Outcomes – results achieved. o Effectiveness of outputs in achieving the intended purpose. 71 Outcomes relate to the effects beyond the entity on people such as service users and civil society as well as broader dimensions like the environment, law and order, the economy, national security, and international relations. These long-term outcomes may be described as impacts. Effectiveness measures the value added (or benefits) created by the subject matter. To measure this the auditor should consider factors such as: Customer satisfaction. Coverage. Financial results. Financial conditions. Readiness. In each case, the auditor will need to determine a suitable unit of measure or proxy and a means of gathering evidence. In their analysis and evaluation, auditors are likely to need to apply a range of operational, financial, and statistical techniques, including net present value (NPV), internal rate of return (IRR), linear programming, regression, and appropriate financial margins and ratios. Common project appraisal models covered in this Module are described below. 71 See Rauum and Morgan, Performance Auditing: A Measurement Approach, The Internal Audit Research Foundation, 2009. 46
Payback The concept of payback is straightforward. The method answers the question: how long will it take for the net cash inflows (i.e., any additional revenues and cost savings) to be equal to the investment needed at the beginning? The payback period can be calculated on the basis of projected or actual results. Once calculated it can be compared with other investment options to help select the projects to be funded. For projects already completed, the result can be compared with planned payback or benchmarks. For example, the following detail relates to a project. Year Additional cash outflows (000,000 LEK) Net cash inflows (from additional revenue and/or saved costs) (000,000 LEK) 0 158 (setup costs) 1 18 2 41 3 65 4 85 5 85 Year 0 is the theoretical point at which investment is made and the project begins. An assumption is usually made that cashflows accrue evenly through the year. The first step is to add a cumulative column for net cash inflows. Year Additional cash outflows (000,000 LEK) Net cash inflows (from additional revenue and/or saved costs) (000,000 LEK) Cumulative net cash inflows (000,000 LEK) 0 158 (setup costs) 1 18 18 2 41 59 3 65 124 4 85 209 5 85 294 You can see in this case that at some point during year 4 the cumulative total passes the initial cost of set up 158. The payback period is somewhere between 3 and 4 years. Year 4 begins with a cumulative total of 124. A further 34,000,000 LEK is needed to reach 158,000,000 LEK. If we assume an even rate of cashflows, it will take 34/85 = 0.4 of a year or 4.8 months. Therefore, Payback period is 3.4 years or 3 years and 4.8 months. The method is simple, easy to understand and easy to calculate. However, it ignores the fact that future cashflows are harder to estimate accurately. It also ignores the time value of money (i.e., that money that will be received in the future is worth less than money that will be received sooner.) Discounted Cashflow (DCF) and Net Present Value (NPV) 47
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Module 4 - Introduction to Performance Audit_4C

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