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Performance audits or performance auditing is the public sector version of "Operational Audits" or "Operational Auditing," that are conducted to determine if an entity's operations, programs, or projects are run effectively and efficiently. The Government Accounting Office (GAO) defines a performance audit in its Government Accounting Standards, or Yellow Book, as:

An objective and systematic examination of evidence for the purpose of providing an independent assessment of the performance of a government organization, program, activity, or function in order to provide information to improve public accountability and facilitate decision-making by parties with responsibility to oversee or initiate corrective action.

A performance audit has two parts: (1) an economy and efficiency review, and (2) a program review. The economy and efficiency review determines if resources have been used efficiently. The program review, on the other hand, determines whether the resources were used effectively, that is, for the purpose intended by the grantor of resources. Thus, the two reviews complement each other in providing a complete picture of an agency's performance.

The typical performance audit, like all audits, has three phases: planning, fieldwork, and reporting. The planning phase of a performance audit tends to involve more professional judgment and business commonsense than the planning phase of a financial audit, which is limited to a review of financial statements. In planning an audit, the auditor should first determine specific objectives for the audit. Government Auditing Standards lists the following specific audit objectives, stated as questions, for the economy and efficiency review:

1. Have sound procurement practices been followed?
2. Have the appropriate type, quality, and amount of resources been acquired at an appropriate cost?
3. Have resources been properly protected and maintained?
4. Has duplication of effort by employees and work that served little or no purpose been avoided?
5. Have idleness and overstaffing been avoided?
6. Have efficient operating procedures been used?
7. Have the optimum amount of resources been used in producing or delivering the appropriate quantity and quality of goods or services in a timely manner?
8. Have laws and regulations been complied with that could significantly affect the acquisition, protection, and use of the entity's resources?
9. Has an adequate management control system for measuring, reporting, and monitoring a program's economy and efficiency been installed and maintained?
10. Have measures of economy and efficiency that are valid and reliable been reported?

Specific objectives, as questions, listed in the Government Auditing Standards for the program review include:

1. Have program objectives that are proper, suitable, and relevant been developed?
2. Has the extent to which a program achieves a desired level of program results been determined?
3. Has the effectiveness of the program and/or of individual program components been assessed?
4. Have factors inhibiting satisfactory performance been identified?
5. Has management considered alternatives for carrying out the program that might yield desired results more effectively or at a lower cost?
6. Does the program complement, duplicate, overlap, or conflict with other related programs?
7. Have ways of making programs work better been identified?
8. Has compliance with laws and regulations applicable to the program been ensured?
9. Has the adequacy of the management control system for measuring, reporting, and monitoring a program's effectiveness been assessed?
10. Has management reported measures of program effectiveness that are valid and reliable?

After determining the specific objectives relevant for the audit, the auditor conducts a preliminary survey to obtain information needed to write an audit program and estimate a budget.

The auditor, in completing the preliminary survey, meets with the entity's key employees, reviews relevant documentation such as policy and procedures manuals, and observes the entity's employees as they perform their duties. At the conclusion of the preliminary survey, the auditor is expected to have a thorough understanding of the entity's mission, objectives, goals, operating procedures, and policies. Such knowledge enables the auditor to reach tentative conclusions concerning the audit objectives.

The well-run agency or program will have adopted a well-crafted mission statement, defined a set of goals and objectives that relate to the mission statement, and identified a set of performance measures that accurately reflects entity performance. Thus, the auditor is typically reviewing existing missions, objectives, and goals to determine their reasonableness. Likewise, the entity normally has identified the laws and regulations that its operations or programs must honor. However, an important issue arises if these items are not present or are inadequately prepared. In those cases, the auditor must either stop the performance audit and request that the entity develop the missing items, or the auditor can develop the items and assist the entity in adopting the items recommended by the auditor.

Fieldwork in a performance audit consists of performing the audit tests listed in the audit program. If the preliminary survey was done successfully, then the fieldwork portion of the audit should proceed to confirm the tentative conclusions drawn from the preliminary survey. However, the auditor should fully investigate audit test results that contradict the tentative conclusions and change the audit program accordingly. Once the audit tests are completed, the auditor reaches a final conclusion concerning the entity's performance, which is then presented to interested parties in a draft of the audit report. The draft is then discussed with the entity's management and revised accordingly before it is issued to the appropriate parties. The auditor should return to the entity after giving the entity's management sufficient time to implement any recommendations contained in the audit report. The purpose of this "follow-up" visit is to assess the degree to which management has addressed the findings contained in the audit report.

Management has the responsibility for operating an organization in an effective and efficient manner. In the for-profit sector, this usually means maximizing profit or net income. However, organizations in the not-for-profit sector do not have a measure such as net income or profit to guide the allocation of resources. They adopt alternative performance measure(s) and evaluate them in a manner that fairly reflects performance.

Internal auditors are hired by organizations to assist management in effectively and efficiently operating an organization. Internal auditors do this by reviewing the effectiveness of the organization's internal control process and making suggestions for improving it. In conducting their internal control reviews, the internal auditor should identify the potential risks faced by the organization and then ensure that the most effective and efficient controls are present to address the risks. An internal control review can take many forms, from simply ensuring that controls are present and functioning to an operational audit involving the review of an organization's mission, goals, objectives, and operating procedures.

Up until the 1980s, most internal auditing departments limited the scope of their audits to simply determine whether the organization's policies and procedures were being followed. During the course of these audits, inefficiencies or poor operating procedures were identified and money-savings suggestions generated by the auditors. Concurrently, many organizations have adopted Total Quality Management (TQM) which defines quality in terms of customer satisfaction and measured quality using performance measures that were tracked over time or compared (benchmarked) to other organizations. In addition, organizations faced an increase in legal exposure from laws and regulations enacted beginning in the 1970s and continuing to the present. In the public sector, grantors and constituents demanded accountability in return for the resources provided. Such accountability was to be reported in a document that described efforts and accomplishments. These factors all caused organizations to initially request, and then demand, that their internal auditors downplay compliance with the organization's policies and procedures and emphasize the effective and efficient use of resources and compliance with laws and regulations. This shift in audit scope occurred simultaneously in for-profit and not-for-profit sectors.

The benefits and importance of operational (performance) audits in improving long-term performance is recognized. For example, consider an organization's purchasing function. During the financial audit, an auditor considers only those aspects of the purchasing function that directly affects the financial statements. Thus, the audit would consider whether the terms of purchases are written down in the form of contracts or purchase orders. In addition, the auditor would check to ensure that appropriate officials have been identified who can approve the purchase order. The auditor in a financial audit may go on to check that these two controls were in fact being done, namely that properly approved purchase orders were prepared for all purchases.

The operational auditor, on the other hand, would first identify the purpose of the purchasing function—to get the best terms from vendors for materials and services obtained for the organization. The operational auditor would then obtain the policy and procedures manual for purchasing and review it in the context of the purchasing function's purpose. Additional information may have to be obtained to answer questions raised in the auditor's review. For example, how effective is the bidding process or how much money is actually being saved by obtaining bids? The operational auditor may find that purchasing agents are getting bids for small dollar items, with little return being realized for the effort expended. This type of finding could lead to changes in the policies and procedures followed in the purchasing office with resulting benefits in terms of cost savings accruing to the organization.