A Comprehensive Analysis: The Impact of Internal Audit Function Elements on Sustainability Audits

Corporate sustainability is based on a company\'s ethical business practices and value system. Previous research specify that companies that are engrossed in sustainability reporting and activities to signal effectiveness, stimulate employees and aid in process control. The importance of this kind of action in corporate sustainability is becoming more widely recognized. Assuring sustainability is still in its infancy even despite of the growing demand for assurance to boost reliability therein and an increase in the studies recording the expansion of sustainability is maintained in order to reduce the possibility of legal ramifications for environmental misconduct and negative public perceptions of unsustainable operations (Corazza, Truant, Scagnelli, & Mio, 2020; Hoffman, 2018).

The scope of internal auditing has included sustainability or reflection on the growing importance of environmental, social and governance (ESG) factors in business operations.

Internal Audit

The concept of internal audit involves an efficient, documented procedure to gather audit evidence and evaluate it objectively to ensure compliance with audit criteria, enhancing the Quality Management System and Organizational Performance. Internal audit serves as a vital tool to verify organizational practices, ensuring that they align with quality objectives and relevant standards, ultimately enhancing product or service quality to meet client needs. It is considered a type of internal economic control with business entities, focusing on efficiency, productivity and cost-effectiveness to improve the accounting system and overall operations of the organization. The effectiveness of internal audit is contingent upon well-organized internal audit systems, auditor\'s activities and audit processes within an enterprise (Kataria & Sharma, 2024).

Beyond the control assurance, internal auditors significantly enhance organizational performance and management decision making. By identifying efficiencies and recommending improvements, they enable managers to make better-informed decisions that can lead to superior organizational outcomes. Internal audit and process improvement initiatives should not be limited to examine only financial aspects. Instead, they should also include other areas such as operational efficiency, regulatory compliance, risk management, technology processes and overall organizational effectiveness. This broader scope can help identify and improve non-financial processes that also contribute to an organization\'s success. This advisory function is a vital aspect of their rule extending the impact of internal auditing from compliance and risk mitigation to being a catalyst for strategic improvements and innovations. The scope of internal auditing has expanded to include sustainability or reflection on the growing importance of environmental, social and governance (ESG) factors in business operations. The extent to which internal auditors are involved in sustainability related issues can be influenced by these several factors. Governance structure that prioritizes sustainability, management\'s commitment to sustainable practices and the extent of sustainability reporting are pivotal in determining the level of involvement by internal auditors in the following areas. These objectives are key to all activities and are critical for improving control and management within organizations. The role of internal audit is expanding to fulfill stakeholders\' expectation and enhance the overall performance of the organization.

• Verification of conformity: Internal audit checks if the company\'s activities match its policies, programs and legal requirements
• Adequacy of information: Internal audit review whether the financial and non-financial information available is sufficient to accurately understand what is happening within the organization.
• Protection and Prevention: Goal is to safeguard the company\'s assets as shown on the balance sheet and to find ways to prevent fraud and losses
• Continuous improvement: Internal audits continuously monitor and critique the auditing process itself to make it better.
• Supporting Development and Change: Internal auditing aids in the company\'s development and helps in achievement of goals and encourages organizational changes.
• Corporate Social Responsibility (CSR): Internal audits can also support CSR initiatives by providing assurance and helping to develop CSR strategies
• Risk Assessment and Management: It is crucial to correctly identify and manage risks and opportunities that could impact the effectiveness of internal audits.

Best Practices for Conducting Effective Internal Audit by Chartered Accountants

• Defining Audit effectiveness: Davies (2009), Carcello, Hermanson, and Raghunandan (2005), and Van Gansberghe (2005) have identified several key indicators and factors that determine the effectiveness of an internal audit. These factors include: (i) concept of ownership (ii) organization of governance framework (iii) improve professional efficiency (iv) law (v) conceptual framework (Gramling, Maletta, Schneider, & Church, 2004). This involves setting clear criteria to measure the success of audits.
• Internal Audit Intelligence: This concept refers to the combination of thorough knowledge and a focus on being skeptical during audits. Auditors need to be well-rounded in their knowledge and always question the information and processes they are reviewing. This helps in making better decisions and following best practices.
• Aiming for Excellence: Striving for excellence in Internal audit can greatly benefit an organization not just in meeting today\'s needs but also in ensuring long-term survival and success. Excellence means continually improving and adapting audit practices to add value.
• Key Factors for Effective Auditing: The skills and competencies of the audit staff along with how well they communicate with the audit committee significantly impact the effectiveness of the audits. Effective communication and skilled auditors are crucial for a successful audit process.
• Quality Assurance Programs: Developing a program to ensure and improve the quality of internal audit is essential. This involves setting standards for the audit process that align with internationally recognized benchmarks and criteria.
• Balancing Standards and Expectations: Internal auditors often face the challenge of meeting both the professional standards set for audits and the expectations of the management. Balancing these can be difficult but is necessary for effective auditing.

Sustainability Audit

A sustainability audit could be referred to as a sustainability assessment or review, a methodical analysis of an organization\'s procedures, practices and guidelines to ascertain how they affect the economy, society and environment. Sustainability audits have a wider focus than traditional financial audits which are mainly concerned with financial performance. They also consider social responsibility, environment stewardship and economic viability. The sustainability audits are comprehensive evaluations that extend across entire supply chains reflecting the broad ESG impacts of an organization and supporting the nature of sustainable business practices. The key areas include energy usage, waste management, water conservation, carbon emissions and resource efficiency. It also evaluates compliance with environmental laws, environmental footprint reduction and supply chain sustainability. Social aspects such as employee welfare, diversity and community engagement are considered as well as ethical sourcing practices. Economic factors like financial viability, cost-effectiveness and long-term sustainability strategies are reviewed. Finally, governance structures, risk management practices and overall corporate social responsibility are also critical components of sustainability audits.

SEBI, the market regulator in India has specified a \"glide path\" for the mandatory \"reasonable assurance\" of Core Business Responsibility and Sustainability Reporting (BRSR Core) which is a novel ESG framework for listed companies. Starting from financial year 2023-24, the top 150 listed companies must comply, with the threshold gradually increasing to the top 1000 listed entities by 2026-27. The BRSR, a framework introduced in India for companies to disclose their sustainability practices to focus on ESG factors. The BRSR core emphasizes 49 parameters for ESG reporting, aiming for standardized disclosures to aid investment decisions. SEBI has updated its BRSR format to incorporate new key performance indicators (KPIs) and directed boards of companies to ensure no conflict of interest with assurance providers. The phased approach will standardize ESG disclosure, promote trust among stakeholders and facilitate informed decision-making in India\'s business landscape.

The industry in which an organization operates also plays a crucial role, as different sectors face unique sustainability challenges and need to comply with different standards. Additionally, the extent and nature of sustainability reporting by a company can affect the depth and scope of sustainability audits. Organizations that publicly report their sustainability practices are likely to undergo more rigorous and detailed audits, driven by the need to substantiate the claims made in these reports.

Is Internal Audit and Sustainability Audit Similar?

Both types of audits support accountability and transparency but internal audits are broader in examining the overall organization while sustainability audits are specifically focused on advancing responsible environmental and social practices. The details of the differences have been reported in the table 1.

Table 1: Difference Between Internal Audit and Sustainability Audit

Source: Authors Study

Impact of Internal Audit Function on Sustainability Audit

There is a positive correlation between the presence of an internal audit function and the robustness of sustainability reporting practices within an organization. This relationship is particularly strong with regard to economic and social sustainability indicators. When internal auditors are engaged in sustainability matters their expertise in verification and control assurance can lead to more comprehensive and reliable sustainability reporting. For instance, internal auditors can verify whether a company\'s carbon emissions or waste reduction claims are accurate by reviewing data, tracking systems and procedures. They also help organizations follow proper controls such as regulatory requirements for environmental or social reporting. By applying their skills in risk management and internal controls, auditors can enhance the reliability and transparency of sustainability reports. This leads to build trust with the stakeholders, ensuring that the company meets its environmental social commitments. This not regulators not stakeholder requirements but also business operation over the long term by aligning audit processes with the business goals and adapting to a changing environment. Internal audit functions play a crucial role in enhancing an organization\'s sustainability and financial robustness through a variety if mechanisms. The impact of internal audit on sustainability audit is influenced by various factors and contribution of them across different dimensions are as follows.

• Management Support and External Reporting: The involvement of internal audits in environmental and social aspects largely depends on the support from management and the level of external reporting of sustainability information. Organizations that emphasize sustainability in their external communications typically see a more pronounced role of internal auditing in these areas. This support enables internal auditors to extend their assurance and consulting services to cover ESG aspects, ensuring that the company\'s sustainability efforts are both effective and transparent.
• Internal audit effect on financial performance: Internal audits contribute to strengthening a company\'s financial performance. This is achieved through various consulting services and assurance activities that help improve reliability in financial reporting and operational efficiencies. By addressing and mitigating risks, internal audits help create a more stable financial environment conducive to growth and sustainability.
• Integrated Audit Management and Business Sustainability: The effectiveness of integrated audit management, which encompasses the audit of both financial and non-financial aspects of a business is influenced by several internal capabilities, including human resources, technology and quality management. Effective integrated audit practices ensure that the organization can sustain its business operation over the long term by aligning audit processes with the business goals and adapting to a changing environment.
• Continuous Audit Environment: In an environment where audits are conducted continuously, statutory auditors tend to place greater reliance on the work performed by internal auditors, especially when existing controls are effective. A continuous audit approach allows for real time monitoring and assessment, enhancing the reliability of financial reporting and operational practice.
• Internal Audit Quality and Control Deficiencies: The quality and skills of internal audit personnel significantly affect the occurrence and severity of deficiencies in internal control. Competent internal auditors are able to identify, assess and suggest improvements for control weaknesses, thereby reducing the risk of errors and fraud.
• Internal Auditors Compliance with Standards and Financial Reporting Quality: Acquiescence with the \"International Standards for the Professional Practice of Internal Auditing (ISPPIA)\" is crucial. Organizations that adhere to these standards generally experience higher quality in financial reporting. This compliance ensures that the internal audits are carried out with a high degree of professionalism and adherence to globally recognized best practices, thereby enhancing the reliability and credibility of financial reports.

Role of Internal Auditors in Sustainability Audits

The present section has been categorized into different dimensions as the role of internal auditors in sustainability audit involves various key duties, challenges and best practices.

I. Key Responsibilities of Internal Auditors in Sustainability Audits

Internal auditors play a crucial role in sustainability audits by ensuring that an organization\'s sustainability efforts are effective and aligned with goals. They assess compliance with environmental regulations, corporate social responsibility standards and sustainability policies. Auditors evaluate the accuracy of sustainability initiatives and identify areas for improvement. Additionally, internal auditors ensure that sustainability practices are integrated into the company\'s overall risk management framework. By providing unbiased assessments, they help organizations improve performance, minimize risks and ensure continuous improvement in sustainability efforts.

II. Contribution of Internal Auditors to Sustainable Business Practices

1. The effectiveness of internal audits along with risk management processes and a focus on sustainability positively impacts sustainability audits. This underscores the importance of internal audits in promoting sustainable practices. For example, A manufacturing company conducts the regular internal audits to assess its energy consumption, waste disposal and environmental impact. Through risk management, auditors can identify areas with high energy consumption and waste production which could lead to regulatory fines or damage to the company\'s reputation. By integrating sustainability goals into their audit processes, the company can create strategies to reduce energy and adopt more sustainable waste management practices. Internal auditor monitors these changes and assesses their effectiveness. Over the time, company reduces costs, complies with environmental regulations and strengthens its commitment to sustainability and shows how audits and risk management processes support sustainable practices and drive positive outcomes.
2. The capabilities of human resources, technology and quality management all play roles in making the internal audit process crucial for integrated audit management and sustainable business outcomes.
3. The effectiveness of audit committee and internal audit functions are closely linked to better sustainability reporting, especially concerning economic and social aspects.
4. The effectiveness of the audit committees and internal audit functions is crucial for ensuring that companies report accurately and transparently under the BRSR guidelines, especially regarding economic and social aspects. The BRSR framework helps companies disclose sustainability practices, focusing on ESG factors. The audit committee and internal audit functions ensure accurate, transparent reporting particularly on economic and social aspects. They oversee compliance, risk management and sustainability policies, ensuring that reports meet BRSR requirements, boosting transparency and trust.

Best Practices for Internal Auditors to Ensure Effective Sustainability Audits

• Internal auditors need to adopt new ways of thinking and acting to play a comprehensive role in governance, supporting sustainability and improving ESG practices. They should move beyond their traditional roles and become drivers of change within their companies, which requires new skills, attitudes and competences. Developing new skills in areas like corporate culture, social responsibility, ethics, cybersecurity and risk management is essential for internal auditors to help their companies achieve their goals and improve sustainability practices.

Table 2: Skills/Training Required for Internal Auditors to handle the Sustainability Audits

Source: Authors Study

By developing these skills and engaging in continuous training, internal auditors can effectively handle sustainability audits and contribute to the accurate and reliable reporting of sustainability initiatives.

Contribution of Sustainability Audit to Internal Audit Effectiveness

The study reveals that the formation of an audit department, acquisition of a permanent internal auditor, providing suitable logistics, training personnel on the value of internal audit and using internal auditing standards and principles enhance sustainability audit effectiveness. The effectiveness of the internal audit function is positively associated with sustainability reporting practices, indicating the role of internal audit in driving sustainability-oriented strategies.

Conclusion

The existing literature supports that the internal audits and sustainability audits are related aspects of organizational governance and risk management even though they have different goals and areas of concentration. The impact of internal audit on sustainability performance is influenced by factors such as management support, external reporting of sustainability information and internal audit function characteristics. Sustainability audit contributes to the effectiveness of internal audit processes by emphasizing the importance of sustainability reporting practices and the role of internal audits in driving sustainability-oriented strategies. The key differences between internal audit and sustainability audit lie in their focus areas and indicators.

Best practices for integrating internal audit and sustainability audit include adopting environmental auditing as a mandatory audit, training internal auditors in environmental auditing and focusing on environmental performance improvement. Organizations can improve their capacity to recognize risks, take advantage of opportunities and accomplish sustainability goals while uploading strict internal controls and compliance standards by utilizing the synergies between the two. The establishment of a culture of accountability, transparency and continuous improvement through collaboration between internal audit and sustainability teams ultimately propels the creation of long-term value for the organization and its stakeholders.