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Lean Auditing

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Audits have changed their traditional focus from cost control towards a global strategy of risk management, governance, value creation, and organizational culture. Auditing is a representative element of corporate culture because it defines how companies think and act, but manage decisions are the true reflection of how a company thinks and acts. Thus, this area expands its importance thanks to its direct participation in risk management and value creation.

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Lean Auditing

  1. 1. The effectiveness of auditing activities depends more and more on the ability to generate and create value –and not so much on the ability to monitor budgets, processes, and systems. To be more efficient, improve profitability and uniqueness-induced growth, companies have to stop focusing on the costs and hone in generating value and communicatingtheirvision.Nevertheless, Internal Audit Departments are still under the pressure of regulatory contexts that are increasingly more restrictive and of financial constrictions that depend on the market’s particular situation and on the progressive focus on the corporate administration’s mechanisms. Culture is key, also in auditing Culture should be the first concern of any auditor, because here is precisely where most future problems lie and where most of their possible solutions can be found when auditing accounts. The broad experience of Lean Auditing’s specialist consultant author, James C. Paterson, as Head of the Audit Department at multinational pharmaceutical Astra Zeneca, allows him to assure that there is a direct link between risk and control culture in organizations; this subsequently reflects in their accounting reality and financial situation. Audits have changed their traditional focus from cost control towards a global strategy of risk management, governance, value creation, and organizational culture. Auditing is a representative element of corporate culture because it defineshowcompaniesthinkandact,butmanagedecisionsarethetruereflection of how a company thinks and acts. Thus, this area expands its importance thanks to its direct participation in risk management and value creation. Strategy Documents L19/2015 Focusing on value creation for stakeholders: applications of lean processes and systems Reputation Book Summaries This document was developed by Corporate Excellence – Centre for Reputation Leadership and among other sources contains references to the book Lean Auditing written by James C. Paterson, head of Risk & Assurance Insights, Ltd., and published by Wiley in 2015
  2. 2. Book Summaries 2 Focusing on value creation for stakeholders: applications of lean processes and systems The key is that the procedures and decisions that a company makes are coherent with its values and policies. However, most of the time, the values expressed are, in corporate culture, less important than the unconscious assumptions of the people in the organization. Ultimately, those beliefs are used to define more clearly the external expressions of a specific mentality or way of doing things, as the attitudes or behaviours shown and decisions made. The important role of bias We know that, psychologically, we all tend to reinforce our decisions –which apparently are rational but have an emotional origin– with arguments, information, and data that justify them. In other words, we see what we want to see. In this whole process, memory, especially selective one, plays a critical role. According to Paterson, the same thing happens in the cultural sphere of companies (this has been validated by a research conducted in 2010 by British financial firm Lloyd’s): confirmation bias is essential both in the risk acceptation or risk appetite and its rejection. It is also important to include a regulatory role, played by the public authority or government, in order to ensure that certain rules about how the company works are observed, keeping in mind the external perceptions mentioned above. Both the external rule and internal culture directly affect the company’s behaviour and decisions. Even though financial controls are normally the centre of attention when trying to improve work effectiveness, the operative processes and the regulatory compliance often play a more important role. Organizational culture is specially the one with an actual impact on the mid and long term. Cultural barriers for internal audits Some of the usual dilemmas in auditing when talking about organizational culture and regarding a broader function of this role are: • Differences between the stakeholder’s visions about their expectations regarding an internal audit. Some see a higher potential of this role. «Alignment of the risk culture with the corporate culture is a key elements to guarantee the efficiency of value creation» Figure 1: Cognitive dissonance Source: Lloyds - Emerging Risk Report Behaviour MADE A PROFIT (OR WOULD HAVE) MADE A LOSS (OR WOULD HAVE) REJECTED THE RISK ACCEPTED THE RISK Memories are focused here BAD BAD GOOD GOOD
  3. 3. Book Summaries 3 Focusing on value creation for stakeholders: applications of lean processes and systems • A limited understanding of the three lines of defence model. An internal audit is considered a quality control process in management (second line of defence) rather than a process to guarantee that quality (third line). • The perception, based in bad experiences, that guaranteeing quality in management and corporate governance are functions which, rather than enabling organizational performance, hinder it. • An excessive trust in past successes that is projected on the future. This perception entails risks of complacency and a lack of imagination when trying to change the perspective, even when things are not turning out right. • A trend to overreact to real or imaginary risks taking disproportionate decisions. Therefore, an internal audit is important to spot cultural barriers that hinder improvement and effectiveness within the company to help those who are truly interested on it: the stakeholders. Analysis of basic causes (or root causes) A systematic and deep analysis of the reasons that cause a negative scenario in companies is useful to find long-term solutions to reduce the likelihood of risks and their impact in the future. Thus, the best auditors are those that fix a problem but also identify its root, this is to say, the basic reason that caused it in the first place. In comparison with other methodologies, the analysis of root causes generates fewer explanations for a problem but identifies thosewithacommonrootand,henceforth, enables more efficient solutions. Besides, this kind of analysis is particularly interesting when a company experiences the same mistake over and over, when consequences of an activated risk are «An internal audit is important to spot cultural barriers that hinder improvement and effectiveness within the company» Figure 2: Organizational Effectiveness system Source: RiskAl.co.uk External Enviroment Mission & Strategy Organisation Culture Systems (Policies Procedures) Individual Needs & Values Structure Task Requirements & Individual Skills Abilities Leadership Management Practices Work Unit Climate Motivation Individual & Organisational Performances Culture / Behaviour - An outcome Performance / Issues - An outcome
  4. 4. Book Summaries 4 Focusing on value creation for stakeholders: applications of lean processes and systems important, when similar problems happen in different areas or when the performance is consistently low compared to generated expectations. There are different systems and tools that allow companies to know those fundamental reasons, often hidden from the naked eye, that have indeed a great impact on risks: • The 5 Whys: a technique used by Japanese company Toyota consisting on asking five times why a problem was caused until its true nature it is known. • Fishbone Diagram: the reasons of a problem are fit together to offer an integral and full vision and be able to remove information gaps and identify the causes. • Organizational Effectiveness (OE): allows companies to spot root causes and identify key vectors for organizational culture and manager’s behaviours so that they can fit the cultural reasons together with the performance elements and the different issues. Conclusion: audit to create value Lean philosophy significantly improves corporate management because it identifies assumed risks. It is centred in the mid and long-term implications of the decisions made, which are aligned with the risk level previously established by the C-Suite. In the case of an internal audit and its traditional function of financial control, lean mentality contributes to value creation for the stakeholders of a company and guarantees better productivity and a more influential and decisive way of doing business. Thus, the goal in intern auditing is to offer independent and objective counsel to all the stakeholders of a company about its management and performance so that it can provide a true value. To do so, the traditional focus on the cost control and regulatory compliance has to be expanded to also include risk management and other aspects related to corporate governance and organizational culture. To reinforce this approach, we can study examples such as the British financial services company Barclays, which incorporates its corporate culture into any kind of auditing; or 3i, a venture capital company headquartered in London, that considers corporate culture as something attached to the daily work of the auditing; or even the example of BAE Systems, a British multinational defence, security and aerospace company, who defends that most of auditing conclusions are engaged with cultural aspects. At the end, considering all stakeholders, making decisions that are coherent with the corporate values, the commitment of the managers with their company, the application of risk management in all corporate activities and, specially, the alignment of the risk culture (appetite vs. rejection) with the corporate culture, are key elements to guarantee the efficiency of value creation suggested by the lean paradigm in business management.
  5. 5. Leading by reputation ©2015, Corporate Excellence – Centre for Reputation Leadership A foundation established by major companies aiming to excel in the management of intangible assets and facilitate promotion of strong brands with a good reputation and a capacity to compete on the global markets. Our objective is to become the driving force, which would lead and consolidate professional management of strategic assets and resources, which generate value for companies all over the world. Disclaimer This document is a property of Corporate Excellence – Centre for Reputation Leadership developed with an objective to share business knowledge about management of reputation, brand, communication, public affairs and non-financial metrics. Corporate Excellence – Centre for Reputation Leadership is the owner of all rights to the intellectual property related to images, texts, drawings or any other content or elements of this product. Corporate Excellence – Centre for Reputation Leadership is the holder of all necessary permissions for the use of the document and therefore any reproduction, distribution, publishing or modification of the document without its express permission is prohibited.

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