How to Build an Internal Audit Function from Scratch
Building an internal audit function from the ground up is one of the most demanding — and consequential — things a finance or compliance leader can take on. Done well, it creates a credible, independent assurance capability that protects the organization, supports the audit committee, and adds measurable business value. Done poorly, it becomes a compliance checkbox that satisfies no one. The difference usually comes down to how the function was designed and who drove the build.
This guide covers the core steps to building an internal audit function that is defensible, scalable, and actually useful.
Step 1: Define the Mandate and Reporting Structure
Before any audit work begins, the mandate of the internal audit function must be clearly established. This means defining what internal audit is accountable for, who it reports to, and what authority it has. The audit function should have a formal internal audit charter, approved by the audit committee, that covers scope, independence, authority, and reporting lines.
Independence is foundational. Internal audit must report to the audit committee, not exclusively to the CFO or CEO. Functional reporting to executive management is acceptable for administrative purposes, but the primary reporting line — including the right to communicate findings to the board without management interference — must run through the audit committee.
Step 2: Assess the Risk Landscape
The internal audit plan must be driven by risk. Before building a plan, conduct a risk assessment that identifies the key financial, operational, compliance, and strategic risks facing the organization. This assessment should draw on management interviews, financial data, regulatory requirements, industry benchmarks, and prior audit findings.
The risk assessment should be formally documented and updated at least annually. It forms the basis for prioritizing which areas receive audit coverage and in what depth.
Step 3: Build the Audit Universe and Annual Plan
The audit universe is the comprehensive list of auditable entities — processes, business units, systems, and financial cycles — within the organization’s scope. From this universe, the annual audit plan is developed by prioritizing high-risk areas and allocating coverage based on available resources.
The audit plan should balance financial control coverage (especially if SOX applies), operational audits, compliance reviews, and advisory engagements. It should be presented to and approved by the audit committee before the fiscal year begins, and updated as risks evolve throughout the year.
Step 4: Build the SOX Program (If Applicable)
For public companies or companies preparing for an IPO, building the SOX program is typically the most resource-intensive component of standing up the audit function. This involves identifying the significant accounts and processes subject to SOX scope, selecting a control framework (COSO 2013 is standard), documenting the flow of transactions through key processes, building Risk and Control Matrices (RCMs), testing controls for design and operating effectiveness, and evaluating and remediating deficiencies.
The SOX program must be built with the external auditor’s requirements in mind, particularly if the company is subject to SOX 404(b). Early engagement with the external auditor on scoping, documentation standards, and testing expectations is critical.
Step 5: Establish Methodology and Documentation Standards
A new audit function needs a methodology — a documented, repeatable approach to planning and executing audits. This includes audit program templates, working paper standards, finding documentation requirements, and quality review processes. The methodology does not need to be elaborate, but it must be consistent and defensible.
Documentation should be organized in a way that supports review, both by internal audit leadership and by external auditors if needed. Over-documentation is rarely the problem in new functions; the more common issue is under-documentation that leaves audits exposed to challenge.
Step 6: Determine Resourcing — Staff, Co-Source, or Fractional
Most internal audit functions at companies under $1B in revenue cannot justify a full internal team. The resourcing model should be tailored to the company’s size and risk profile. Options include building a small internal team, co-sourcing specific expertise from external firms (particularly for IT general controls or specialized operational areas), or engaging a fractional CAE to lead the function with external support for execution.
The right model depends on the company’s audit plan complexity, SOX obligations, and budget. Many organizations start with a fractional or co-sourced model and build toward an internal team as the function matures.
Step 7: Report to the Audit Committee
From the first day the function is operational, results must be communicated to the audit committee on a regular cadence — typically quarterly. Reports should cover the status of the audit plan, findings and management responses, open remediation items, and any significant developments in the risk environment.
The audit committee is the primary client of the internal audit function. Audit reports should be written at a level of clarity and conciseness appropriate for a board audience, not a technical working document.
Step 8: Build and Iterate
No internal audit function is built perfectly in its first year. The build should be treated as an ongoing process — refining the risk assessment methodology, improving documentation standards, enhancing reporting, and expanding audit coverage as the function matures.
Annual self-assessments and periodic external quality assessments (required by IIA standards for functions claiming conformance) help identify gaps and drive continuous improvement.
Veridian Advisory LLC specializes in building internal audit functions from scratch for companies across industries and stages of growth. Whether you are preparing for an IPO, navigating your first SOX cycle, or building the foundation for a mature audit program, we can help you design and implement a function that is credible, scalable, and fit for your organization. Contact us to learn more.
