Risk Assessment Principle 6:Objectives & Risk Identification

The organization determines the objectives sufficiently to identify and assess associated risks.

Focus Points:

The following focal points highlight essential aspects of activities, reporting, and compliance objectives.

Activity Purposes

• Reflects Management’s Preferences:

Objectives for activities reflect management’s preferences regarding the organization’s structure, evaluations of the sector in which it operates, and its performance.

Operating objectives reflect management’s preferences in the particular business, industry, and economic environments in which the organization operates. For example, a municipality sets several operational objectives, each supported by initiatives and criteria, including:

• To determine water fees according to the consumption trends of industrial and residential subscribers in the past five years.
• To build 100 km of paved roads in the next two years.

A for-profit organization may set operating objectives that focus on efficiently using resources. For example, a large retailer’s objectives might include:

• To offer its customers a wide range of products at consistently lower prices than its competitors.
• Increasing the inventory turnover rate by up to 12 times per year in the next two quarters.

• Takes Risk Tolerances into Account

Management considers acceptable levels of deviation related to achieving operating objectives.

Risk tolerance for activity purposes can be expressed as acceptable per the purpose. Management also specifies the risk tolerance established during the objective-setting process as part of the operating objectives.

• Includes Operating and Financial Performance Targets:

The organization specifies its desired operating and financial performance levels within the scope of its operating objectives.

Operating objectives include financial performance targets that are relevant to every organization. A for-profit organization may focus on revenue, profitability, liquidity, or other metrics. If it’s a nonprofit or government organization, it may place less emphasis on finances overall.

• Creates a Basis for Allocation of Resources:

Management uses operating objectives to allocate resources necessary to achieve desired activities and financial performance.

A clear set of operating objectives provides a focal point to allocate the organization’s significant resources to achieve desired performance objectives. If an organization’s operating objectives are not transparent or well understood, it can misdirect resources.

Reporting Purposes

Reporting purposes: These are concerned with preparing reports that cover conditions of reliability, timeliness, transparency, or conditions stipulated by the policies of regulatory authorities, standard-setting bodies, or organizations.

1. External Financial Reporting Purposes

External reporting purposes are mainly based on the laws, rules, regulations, and standards issued by governments, regulatory authorities, standard-setting organizations, and accounting institutions. The purposes of financial external reporting are for preparing financial statements for external drives, including published financial opinions, other financial information, and other reports derived from the entity’s financial and management accounting books and records.

• Financial statements for external purposes are prepared in accordance with applicable accounting standards, rules, and regulations. (Example: annual and interim financial statements)
• Other financial statements and reports may be prepared in accordance with other accounting principles and are often prepared in response to requests from tax authorities and government organizations or other requirements established by contracts and agreements. (For example, financial balance sheets prepared for tax returns)
• Other financial reporting derived from an entity’s financial and management accounting books and records, other than financial statements for external purposes (for example, earnings disclosures may include selected financial information shared on an entity’s website and selected amounts reported in regulatory filings).

• Complies with Applicable Accounting Standards.

Financial reporting objectives are appropriate for the organization and consistent with current accounting principles. The accounting principles chosen are appropriate in the present circumstances.

• Financial statements for external purposes are prepared in accordance with applicable accounting standards, rules, and regulations. These tables may be made public, for example, through a regulatory authority, distributed at annual meetings, shared on the organization’s website, or distributed through other electronic media.
• Other financial statements and reports may be prepared in accordance with other accounting principles and are often prepared in response to requests from tax authorities and government organizations or other requirements established by contracts and agreements. (For example, financial balance sheets or balance sheets given to banks)
• Other external financial reporting is derived from an entity’s financial and management accounting books and records. This may include profit disclosures of selected financial information shared on an organization’s website. Such external financial reporting objectives may not arise directly from the standard-setting and regulatory authority. However, stakeholders generally want the objectives to comply with these standards and legislation.

• Considers Materiality

Management evaluates materiality in the presentation of financial statements.

One of the essential characteristics of financial statements is relevance. Inherent in suitability is the concept of “financial statement materiality.” Materiality is the threshold used to determine whether a financial amount is relevant. It is essential if information is missing or misrepresented at a level that could affect decisions made based on financial reporting. Materiality depends on the extent of the item or error for which understatements or misstatements are considered in certain circumstances.

2. Reflects the Activities of the Establishment

External reporting reflects underlying transactions and events to illustrate qualitative characteristics and assertions.

With financial external reporting, materiality reflects the required level of precision and accuracy appropriate to the needs of external users within acceptable constraints. It represents the underlying entity activities, transactions, and events.

External reporting also presents transactions and events within acceptable limits, reflecting the required precision and accuracy appropriate to internal organizational needs and the underlying organizational activities.

2.1. Non-Financial External Reporting Purposes

• Compatible with Externally Determined Standards and Frameworks.

Management sets objectives consistent with laws and regulations or the standards and frameworks of recognized external organizations.

Management may report information outside the organization in accordance with laws, rules and regulations, and non-financial standards and frameworks. For example, when management wants to manage its impact on sustainability, It may prepare and publish a sustainability report containing information about its economic, environmental, and social performance. Another organization may implement chain-of-custody standards for the process by which its products are transferred from forest resources to end-use. The organization reports this information publicly by obtaining an annual certificate showing its responsibilities regarding the production and consumption of forest products.

• Considers the Level of Precision Required

Management reflects the required level of precision and accuracy in its objectives, appropriate to the user’s needs and based on criteria established by third parties for non-financial reporting.

In non-financial reporting, transactions and events are presented with precision and accuracy to suit the user’s needs.

• Reflects the Activities of the Establishment

External reporting reflects the underlying transactions and events within acceptable limits.

Similar to financial reporting, non-financial reporting also includes the following:

• Categorizes and summarizes information reasonably and at an appropriate level of clear and concise detail.
• It reflects the underlying organizational activities.
• It uses criteria determined by third parties and, as the case may be, specified in external standards or frameworks.

2.3. Internal Reporting Purposes

Reliable internal reporting, including scorecards and performance dashboards, provides management with the complete and accurate information needed to manage the organization. It supports management’s decision-making and monitoring of the organization’s activities and performance.

As with other types of reporting, internal reporting:

• It uses criteria determined by third parties and, as appropriate, specified in external standards or frameworks.
• Categories and summarizes information reasonably, sufficiently detailed, and concisely.
• It reflects the main activities of the organization.
• It presents transactions and events with the required level of precision and accuracy to suit the user’s needs.

2.4. Compliance Purposes

Laws and regulations establish minimum standards of conduct that the organization incorporates into its compliance objectives. For example, occupational health and safety legislation may require the organization to define its purpose as “packaging and labeling all chemical substances in accordance with legislation.” Policies and procedures will include communication programs, on-site inspections, and training related to the organization’s compliance objectives.

In this context, many organizations will set goals such as the following:

• To prevent and detect criminal behavior and other unlawful practices.
• Prepare and submit tax returns before submission deadlines and in accordance with regulatory requirements to ensure compliance with tax laws.
• Label nutritional information on food packaging according to applicable guidelines.
• Operating a fleet of vehicles within maximum emission control conditions.

References for Internal Control Articles

• International Internal Auditing Standards, International Institute of Internal Auditors
• Dr. Davut Pehlivanlı, Current Internal Audit Practices, Beta 2010
• Prof. Dr. Nejat Bozkurt, Accounting Audit, Alfa 1998
• Prof.Dr.Nejat Bozkurt, TÜRMOB Independent Audit Training Lecture Notes, 2012
• Dr.Özgür Çatıkkaş, KGK, Marmara University. Corporate Governance Lecture Notes, 2013
• İSMMMO-Practical Information for Internal Audit in SMEs, 2013
• Turkish Internal Audit Institute, www.tide.org.tr
• Alp Buluch, Article, Internal Control, Hurses, 19 March 2013
• Turkish Commercial Code No. 6102
• International Internal Auditing Standards, www.theiia.org
• Treadway Commission Supporting Institutions Committee, Internal Control-Integrated Framework, 2013
• Public Financial Management and Control Law
• Public Internal Control Standards
• Public Internal Control Guide