This study offers insights into why internal auditing is experiencing a shortage of qualified job candidates and offers a potential solution to the problem. The authors find that external auditors have negative perceptions about internal auditing, and these negative perceptions are associated with a (1) decreased desire to apply for internal auditing positions, (2) lower likelihood of recommending an in-house internal auditing career to high-performing students, and (3) higher likelihood of recommending an in-house internal auditing career to mediocre students. Internal auditors can try solving this problem by improving perceptions about internal auditing via a media campaign that raises awareness about the true internal audit career path.
Bartlett, G.D., J. Kremin, K.K. Saunders, and D.A. Wood. 2016. Attracting Applicants for In-House and Outsourced Internal Audit Positions: Views from External Auditors. Accounting Horizons 30 (1): 143-156.
The results of this study suggest that companies who offer incentive-based compensation to chief internal auditors, especially through equity, are more likely to be perceived as having a higher audit risk by external auditors. Consequently, external auditors may charge a higher fee for their services. This study gives a basis for the benefit/cost analysis of providing incentive-based compensation for chief internal auditors. While it is possible internal auditors will respond positively to an IBC and bring extra value to the organization, there is a risk that an external auditor could raise audit fees cancelling out this added benefit.
Chen, Lucy Huajing, H. H. Chung, G. F. Peters., and J. P. Wynn. (Jeannie).2017. Does Incentive-Based Compensation for Chief Internal Auditors Impact Objectivity? An External Audit Risk Perspective. Auditing, A Journal of Practice and Theory 36 (21): 21-44
These findings provide insight into the decision-making process of external auditors as they make IAF reliance decisions. In particular, the results show how IAF objectivity interacts with external auditor involvement to have an impact on external auditors’ reliance decisions and how subsequent reliance decisions are affected by negative evidence about the quality of the IAF’s work.
Pike, B. J., L. Chui, K. A. Martin, and R. M. Olvera. 2016. External Auditors’ Involvement in the Internal Audit Function’s Work Plan and Subsequent Reliance Before and After a Negative Audit Discovery. Auditing: A Journal of Practice and Theory 35 (4): 159 – 173.
This study develops an empirical measure of internal audit quality, and provides evidence supporting companies’ use and development of an IAF as part of improvements to its overall governance environment. Regulators and other parties interested in corporate governance may find it helpful to more explicitly consider the role of internal auditor in the evaluation of the firm.
Prawitt, D., J. Smith, D. A. Wood 2009. Internal Audit Quality and Earnings Management. The Accounting Review 84 (4): 1255-1280.
This study is the first to establish IAF characteristics as separate, distinct constructs that act jointly in creating IAF quality; therefore, it contributes to the overall understanding of IAF quality and the determinants of the IAF as an effective internally based financial reporting monitor.
Abbott, L. J., B. Daugherty, S. Parker and G. F. Peters. 2016. Internal Audit Quality and Financial Reporting Quality: The Joint Importance of Independence and Competence. Journal of Accounting Research 54 (1): 3-40.
The results of this study are important for audit firms to consider when determining the extent of reliance on internal auditor’s fraud risk assessments. Internal auditor judgments may be influenced by pressures to decrease risk assessments when reporting to the audit committee. Thus, the recent suggested improvements for improving audit practice and risk assessment processes by reporting to the audit committee may have adverse and unexpected consequences. Additionally, internal auditor judgments may be influenced by an over-reliance on attitude cues, even when decomposing fraud risk assessments. Thus, decomposition may amplify the problem that prompted its use.
Norman, C.S., A.M. Rose, and J.M. Rose. 2010. Internal audit reporting lines, fraud risk decomposition, and assessments of fraud risk. Accounting, Organizations and Society 35: 546-557.
The authors note a couple of implications for practitioners resulting from this study. First, given the fact that external auditors assess internal audit quality and rely upon the work similarly for outsourced and cosourced internal audit functions, it may be worthwhile for companies to consider engaging some level of independent outside service provider to work along with their in-house internal auditors for high risk areas.
Second, having the same 3rd party internal audit service provider also provide tax services results in less reliance upon the work performed by internal audit, even though those services are approved by the audit committee and performed by different individuals. Therefore, external audit increases their audit effort, thereby implying that external audit must see this additional service provision to be detrimental to the internal audit service provider’s objectivity.
For more information on this study, please contact Naman K. Desai.
Desai, N. K., G. J. Gerard, and A. Tripathy. 2011. Internal Audit Sourcing Arrangements and Reliance by External Auditors. Auditing: A Journal of Practice & Theory 30 (1):149-171.
The findings illustrate how and when internal auditors can achieve agreement from managers using tactics that can be effective even when the underlying information supporting their position is not particularly strong. The findings should also be informative to external auditors, managers, researchers, and others interested in influencing managers’ judgments and corporate governance. The study can help develop a theory about day-to-day behavioral factors that drive variance in internal auditors’ influence over managers’ judgments.
Fanning, K., & David Piercey, M. 2014. Internal auditors’ use of interpersonal likability, arguments, and accounting information in a corporate governance setting. Accounting, Organizations & Society 39 (8): 575-589.
The results of this study are useful to managers, boards of directors, and audit committees to benchmark their own organizations and determine areas in which they may be able to realize cost savings. Standard setters for external auditors could consider these results in terms of whether external auditors are appropriately relying on specified characteristics of the IAF when making their reliance decisions. Client companies and their auditors might both find it worthwhile to examine whether external auditors could make better use of financial work performed by internal auditors on which the external auditors might later rely. Finally researchers may wish to consider the results of this study when examining the external auditor’s reliance decision or when performing other audit fee analyses, especially considering whether proxies used in this study would be appropriate control variables or experimental variables of interest with respect to the contribution of internal auditing.
For more information on this study, please contact David A. Wood.
Prawitt, D. F., N. Y. Sharp, and D. A. Wood. 2011. Reconciling archival and experimental research: Does internal audit contribution affect the external audit fee. Behavioral Research in Accounting 23 (2): 187-206
The authors conclude that companies should consider the potential costs of using a rotational staffing model in the internal audit function and, if adopting this practice, should ensure the appropriate compensating controls are in place to mitigate such costs. The evidence on the consequences of systematic rotation will also be interesting to investors, boards of directors, audit committees, and management. These stakeholders rely on the IAF to monitor financial reporting, and they can benefit from evidence about how systematic rotation affects financial reporting quality. Furthermore, regulators and standard setters, such as the IIA, would benefit from understanding how these rotational assignments affect financial reporting quality and what organizations can do to address the potential consequences.
Christ, M. H., A. Masli, N. Y. Sharp, and D. A. Wood. 2015. Rotational internal audit programs and financial reporting quality: Do compensating controls help? Accounting, Organizations & Society 44: 37-59.