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  • Jennifer M Mueller-Phillips
    Internal Audit Quality and Financial Reporting Quality: The...
    research summary posted October 12, 2016 by Jennifer M Mueller-Phillips, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 08.11 Reliance on Internal Auditors, 13.0 Governance, 13.07 Internal auditor role and involvement in controls and reporting 
    Title:
    Internal Audit Quality and Financial Reporting Quality: The Joint Importance of Independence and Competence
    Practical Implications:

     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.

    Citation:

     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.

    Purpose of the Study:

     In 2013, the NASDAQ Stock Market LLC (NASDAQ) proposed a rule change that would require all NASDAQ registrants to maintain an internal audit function (IAF). The New York Stock Exchange (NYSE) has required all registrants to maintain an IAF since 2006. The thinking behind these requirements is that an effective IAF provides the audit committee and other financial reporting stakeholders with critical information pertaining to a company’s risks and internal controls. Corporate governance proponents also emphasize the IAF’s role in enhancing financial reporting quality; however, despite having many proponents the IAF’s role in the financial reporting process is not yet fully understood and empirical evidence concerning the impact of IAF quality is minimal. As a result of this lack of evidence, the authors investigate the potential impact of IAF quality as a joint function of the IAF’s competence and independence. They base this view upon theoretical work stating that external audit quality is a function of the external auditor’s ability (competence) to detect accounting misstatements and willingness (independence) to oblige proper accounting treatments.

    Design/Method/ Approach:

    In this paper, the authors develop and test a two-factor model of IAF quality as a function of the IAF’s ability to prevent/detect financial misstatements (competence) and its inclination to report the misstatements to the audit committee and/or external auditor (independence). The study uses survey evidence from 189 Chief Internal Auditors from Fortune 1000 companies during fiscal 2009.

    Findings:
    • The authors’ overall results provide evidence consistent with the hypothesis that the combined presence of both competence and independence is a necessary antecedent to effective IAF financial reporting.
    • The authors find results consistent with independence being enhanced by relatively greater degrees of audit committee oversight of the IAF, as opposed to management oversight.
    • The authors find that enhanced independence interacts with IAF competence as a means of curtailing financial reporting discretion in both income-increasing and income-decreasing environments. A similar set of relationships were documented when the authors interact IAF competence and the relative lack of IAF outsourcing.
    Category:
    Auditing Procedures - Nature - Timing and Extent, Governance
    Sub-category:
    Internal auditor role and involvement in controls and reporting, Reliance on Internal Auditors
  • Jennifer M Mueller-Phillips
    Attracting Applicants for In-House and Outsourced Internal...
    research summary posted April 18, 2016 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.04 Staff Hiring, Turnover and Morale, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.11 Reliance on Internal Auditors, 13.0 Governance, 13.07 Internal auditor role and involvement in controls and reporting 
    Title:
    Attracting Applicants for In-House and Outsourced Internal Audit Positions: Views from External Auditors.
    Practical Implications:

    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.

    Citation:

    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.

    Keywords:
    internal audit, hiring decisions, outsourcing, external auditors
    Purpose of the Study:

    The internal audit function can help organizations strengthen their risk management and corporate governance, yet the demand for qualified candidates to fill internal audit job openings exceeds the supply of interested applicants. Consequently, the internal audit function may find itself short-staffed and/or staffed with lower quality candidates, which may limit its ability to add value to the organization. In order to correct this problem, it is important to fully understand its scope and its root cause(s). Prior research attempting to gain this understanding has focused on investigating how accounting students’ beliefs about internal audit impact their interest to pursue an internal audit career. The authors of this paper extend this research by:

    • Investigating how external auditors’ beliefs about internal audit impact (1) their interest to pursue an internal audit career and (2) their recommendations to students about pursuing an internal audit career,  
    • Investigating differences in external auditor’s perceptions of in-sourced versus out-sourced internal audit, and
    • Asking external auditors to suggest what needs to be done to improve their perceptions of internal audit.
    Design/Method/ Approach:

    The authors use data from three sources. First, the authors performed an experiment using experienced external auditorsmostly seniors or associateswho were asked whether they would apply for a job described as either an accounting, in-house internal audit, or outsourced internal audit position. Second, the authors performed another experiment using experienced external auditorsmostly managers or directorswho were asked whether they would recommend that a high-performing (mediocre performer) student pursue an external audit, in-house internal audit, or outsourced internal audit career. Third, the authors surveyed high-ranking former/current external auditors who never worked in internal audit about what would make internal auditing a more appealing career for them.

    Findings:
    • When the same job opening is labeled as either accounting, in-house internal auditing, or outsourced internal auditing, the accounting label is likely to attract two times as many external auditor applicants as the other two labels.
    • External auditors are equally willing to apply for in-house internal auditing or outsourced internal auditing positions.
    • External auditors have more negative perceptions of in-house internal auditors than outsourced internal auditors.
    • External auditors have negative perceptions of the internal auditing profession. They believe that (1) others have negative stereotypes about the profession, (2) business professionals do not respect internal auditors, and (3) internal auditors do boring work.
    • Those less interested in applying for internal audit jobs have negative perceptions of internal auditing.
    • The average external auditor willing (unwilling) to apply for an internal audit position would want to receive at least 124% (149%) of his current salary before being willing to switch from his current external audit job to an internal audit job.  
    • External auditors will be most likely to recommend that top-performing students work in external audit and mediocre students work in in-house internal audit.
    • External auditors will equally recommend that top-performing students and mediocre students should consider outsourced internal audit as a second best career path.
    • External auditors have more negative perceptions of outsourced internal auditing than external auditing on most dimensions, except in regards to work-life balance. They believe that work-life balance is better for outsourced internal auditors.
    • Current and former external auditors believe that internal auditing could become more appealing if internal auditors do more interesting work, receive more respect, perform value-added tasks, receive better compensation, and have better promotion opportunities. Because internal auditors appear to already be following these suggestions, internal auditors may benefit from giving others a better understanding of internal audit careers.
    Category:
    Audit Team Composition, Auditing Procedures - Nature - Timing and Extent, Governance
    Sub-category:
    Internal auditor role and involvement in controls and reporting, Reliance on Internal Auditors, Staff Hiring - Turnover & Morale
  • Jennifer M Mueller-Phillips
    Rotational internal audit programs and financial reporting...
    research summary posted October 21, 2015 by Jennifer M Mueller-Phillips, tagged 13.0 Governance, 13.07 Internal auditor role and involvement in controls and reporting, 14.0 Corporate Matters, 14.11 Audit Committee Effectiveness 
    Title:
    Rotational internal audit programs and financial reporting quality: Do compensating controls help?
    Practical Implications:

    Results from this study suggest that rotating internal auditors into operational management programs reduces financial reporting quality. Companies that utilize a rotational internal audit program should be aware of these possible unintended consequences. Companies utilizing these programs should consider implementing several compensating controls (listed in the findings section), as the authors have found that these controls can reduce or even eliminate (if used together) the negative consequences of rotational internal audit programs.  

    Citation:

    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 and Society 44: 37-59.

    Keywords:
    internal auditing, financial reporting quality, audit committee oversight, controls
    Purpose of the Study:

    The purpose of this study is to examine unintended consequences of rotational internal audit programs. Specifically, the authors inspect how moving internal auditors out of the internal audit function and into operational management can impact financial reporting quality. In addition, the authors examine how compensating controls can mitigate the unintended consequences.

    Design/Method/ Approach:

    The authors initially utilize semi-structured interviews with audit executives and audit committee chairmen to identify how the rotational internal audit programs impact financial reporting quality. Using the information gathered, the authors test hypotheses utilizing archival data from various firms for the years 2000 to 2005.

    Findings:

    Overall, the authors find that the practice of rotating internal auditors into operational management positions is related to lower financial reporting quality. Specifically, it increases Accounting Risk (that evaluates the risk of misreporting by identifying suspicious patterns in accounting data). However, the authors find that several compensating controls can reduce this negative effect. Specifically, the authors find the effect is reduced when companies only rotate staff internal audit positions, have a more effective audit committee, and when management asks the internal audit function to have a greater role in the financial reporting process. Findings also demonstrate that including all three of these compensating controls can eliminate the unintended consequences.

    Category:
    Corporate Matters, Governance
    Sub-category:
    Audit Committee Effectiveness, Internal auditor role and involvement in controls and reporting
  • Jennifer M Mueller-Phillips
    The Effects of Internal Audit Report Type and Reporting...
    research summary posted October 20, 2015 by Jennifer M Mueller-Phillips, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 08.11 Reliance on Internal Auditors, 13.0 Governance, 13.07 Internal auditor role and involvement in controls and reporting 
    Title:
    The Effects of Internal Audit Report Type and Reporting Relationship on Internal Auditors' Risk Judgments.
    Practical Implications:

    This study’s results are important to regulators thinking about requiring issuance of an internal audit report and practitioners planning how to respond to such proposals. The authors suggest that the assurance internal audit report, which leads to more conservative risk assessment when internal auditors mainly report to the audit committee, may prove rather costly and unpopular among internal auditors. Meanwhile, the descriptive internal audit report, which prior research found to be useful to investors, does not make internal auditors more conservative, but it may prove less costly and more popular among internal auditors. Ultimately, these findings suggest that regulators need to discuss any internal audit report proposals with key stakeholders, including internal auditors, before getting too far into the rule making process. 

    Citation:

    Boyle, D. M., F. T. DeZoort, and D. R. Hermanson. 2015. The Effects of Internal Audit Report Type and Reporting Relationship on Internal Auditors' Risk Judgments. Accounting Horizons 29 (3): 695-718.

    Keywords:
    internal audit, descriptive report, assurance report, reporting relationship, accountability
    Purpose of the Study:

    External stakeholders want information to help them better understand corporate governance at the companies they follow. Although disclosure about many elements of corporate governance is currently available, little is known about the internal audit function. Such information asymmetry may be decreased via the issuance of an internal audit report. In fact, a few organizations have voluntary started issuing internal audit reports to external stakeholders. However, nothing is known about whether and how different forms of these reports impact internal auditors’ judgments. These judgments may also be impacted by whether the internal auditors mainly report to management or the audit committee. The purpose of this study is to discover:

    • How do descriptive internal audit reports (i.e., reports describing the “composition, responsibilities, accountability, activities, and resources” of the internal audit function) impact internal auditors’ fraud risk and control risk assessments?
    • How do assurance internal audit reports (i.e., reports containing the internal auditors’ opinion of the organization’s “internal control effectiveness”) impact internal auditors’ fraud risk and control risk assessments?
    • How do different types of reporting structure (e.g., reporting directly to management vs. the audit committee) impact internal auditors’ fraud risk and control risk assessments?

    The authors hope to find answers to these questions in order to provide regulators with insights that can be used when considering potential regulation of the internal audit function.
     

    Design/Method/ Approach:

    The authors collected their evidence prior to August 2013 via a case emailed to highly experienced IIA members working at public and nonpublic companies. In this case, the authors manipulated the presence of a descriptive internal audit report, presence of an assurance internal audit report, and whether the internal auditor reported to management or the audit committee. Participants were asked to make fraud risk and control risk assessments, as well as explain whether and why they support or do not support the issuance of descriptive and assurance internal audit reports.

    Findings:
    • Compared to their non-reporting peers, internal auditors who provide descriptive internal audit reports do not make more conservative fraud risk or control risk assessments.
    • Compared to their non-reporting peers, internal auditors providing assurance internal audit reports make (do not make) more conservative fraud (control) risk assessments.
    • Internal auditors providing assurance internal audit reports do not make more conservative fraud risk or controls risk assessments than peers providing descriptive internal audit reports.
    • Internal auditors reporting mainly to the audit committee make more conservative fraud risk or control risk assessments than peers reporting mainly to management.
    • Internal auditors providing assurance internal audit reports who report mainly to management (the audit committee) have the least (most) conservative control risk assessments. 
    • Of internal auditors not providing assurance internal audit reports, those reporting mainly to management or mainly to the audit committee make equally conservative control risk assessments.
    • Both public and nonpublic internal auditors show moderate support for descriptive internal audit reports, with support from nonpublic internal auditors marginally higher than from public internal auditors. Participants believe that while descriptive internal audit reports may enhance the prestige of the internal audit function and enhance corporate governance, they not be relevant to external stakeholders and may interfere with internal audits’ true role.
    • Compared to support for descriptive internal audit reports, support for assurance internal audit reports is lower. Participants believe that although assurance internal audit reports may enhance corporate governance, they may open internal audit to scapegoating, interfere with internal audits’ true role, lead to replication of external auditors’ work, and take away the flexibility that lets internal audit focus on important areas that the external auditors consider out of scope.
    • Internal auditors expect descriptive (assurance) internal audit reports to cost about 17.5% (59.3%) of an internal audit department’s current budget.
    Category:
    Auditing Procedures - Nature - Timing and Extent, Governance
    Sub-category:
    Internal auditor role and involvement in controls and reporting, Reliance on Internal Auditors
  • Jennifer M Mueller-Phillips
    External Auditor Evaluations of Outsourced Internal...
    research summary posted October 20, 2015 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.03 Non-Audit Services, 13.0 Governance, 13.07 Internal auditor role and involvement in controls and reporting 
    Title:
    External Auditor Evaluations of Outsourced Internal Auditors.
    Practical Implications:

    These results have implications for both audit research and practice as well as policy makers and firms deciding on whether to outsource the internal audit function. From a research perspective, this study is the first to examine how external auditors view various internal audit outsourcing arrangements. Further, the results indicate a potential cost of internal audit outsourcing that has not been previously considered. That is, if outsourced internal auditors provide other services, the cost of the external audit could increase, which potentially interferes with some of the expected cost savings of AS No. 5.

    Citation:

    Brandon, D. M. 2010. External Auditor Evaluations of Outsourced Internal Auditors. Auditing: A Journal of Practice & Theory 29 (2): 159-173. 

    Keywords:
    auditor independence, external auditing, nonaudit services, outsourced internal auditing
    Purpose of the Study:

    In the last several decades many companies began outsourcing the internal audit function (IAF) to public accounting firms. The prevalence of outsourcing is likely to continue given current exchange requirements to establish and maintain an IAF. Further, lack of an IAF could be considered a significant internal control deficiency or even a material weakness. The primary concern over external auditors providing nonaudit services appears to be the potential negative effects of the fees from those services on the external auditor’s objectivity. This concern was so pervasive that part of the Sarbanes-Oxley Act prohibits external auditors from performing certain nonaudit services for external audit clients. The Panel on Audit Effectiveness acknowledges the role of internal audit in maintaining good corporate governance and encourages the cooperation between internal and external auditors. Public accountants can utilize the client-specific expertise possessed by strong internal audit departments to increase external audit efficiency (resulting in cost savings that could be passed on to the auditee) and also provide a higher level of assurance. These benefits are of particular interest given concerns over the cost of complying with Section 404 of the Sarbanes-Oxley Act (SOX).

    This study investigates some implications of an outsourced internal auditor providing nonaudit services.

    Design/Method/ Approach:

    The 89 participants for the study were experienced practicing auditors. Fifty-six participants were obtained via contact partners at the respective firm. The contact partners were asked to distribute the instruments to auditors who typically evaluate internal auditors. The remaining participants were obtained through an in-house training session. 89 auditors participating, approximately 64 percent were CPAs and had an average of 4.7 years of audit experience. The evidence was gathered prior to September 2007.

    Findings:

    Results indicate that certain external auditor judgments and decisions are negatively affected when an outsourced internal auditor also provides consulting services, while other judgments (long touted by proponents of auditor-provided nonaudit services as benefits) are not. Specifically, inconsistent with proponents of auditor-provided nonaudit services, competence perceptions do not appear to be improved by the provision of consulting services. Consistent with arguments of opponents of auditor-provided nonaudit services, external auditor perceptions of internal auditor objectivity appears to be impacted negatively by the provision of consulting services. Further, consistent with previous research, these results appear to be tempered by the staffing of the team providing the consulting services.

    Other results indicate reduced planned reliance on outsourced internal auditors also providing other services. External auditors appear reluctant to rely on outsourced internal auditors providing additional services, regardless of staffing decisions. Results also indicate differences in audit fee adjustments. Specifically, participants would recommend greater audit fee increases when consulting services are provided, again regardless of the outsourcing arrangement.

    Category:
    Governance, Independence & Ethics
    Sub-category:
    Internal auditor role and involvement in controls and reporting, Non-audit Services
  • Jennifer M Mueller-Phillips
    The effects of disclosure type and audit committee expertise...
    research summary posted October 20, 2015 by Jennifer M Mueller-Phillips, tagged 13.0 Governance, 13.07 Internal auditor role and involvement in controls and reporting, 14.0 Corporate Matters, 14.05 Earnings Targets and Management Behavior, 14.11 Audit Committee Effectiveness 
    Title:
    The effects of disclosure type and audit committee expertise on Chief Audit Executives’ tolerance for financial misstatements.
    Practical Implications:

    The results suggest that internal auditors contribute to decreased reliability of disclosed amounts. It appears that the incentives of external auditors and internal auditors are closely aligned on this issue. In general, both of these parties seem to feel less responsibility for disclosed, relative to recognized amounts. The results indicate that financial reporting location has significant effects on internal auditors’ decisions to correct misstatements. Specifically, internal auditors are more willing to waive disclosed misstatements relative to recognized misstatements. Contrary to expectations, the results do not indicate that increased audit committee expertise and associated increases in audit committee members’ perceived powers cause internal auditors to be less willing to waive misstatements.

    Citation:

    Norman, C. S., J. M. Rose, and I. S. Suh. 2011. The effects of disclosure type and audit committee expertise on Chief Audit Executives’ tolerance for financial misstatements. Accounting, Organizations & Society 36 (2): 102-108.

    Keywords:
    audit committee expertise, misstatements, Chief Audit Executives, audit committee, financial executives
    Purpose of the Study:

    External audit partners are more willing to waive misstatement corrections for disclosed than for recognized amounts. This willingness to allow misstatements may increase management’s incentives to manipulate disclosed amounts and increase the levels of error and bias in disclosed information. While external auditors are more willing to waive disclosed amounts, relative to recognized amounts, internal auditors may require management to adjust misstatements regardless of their reporting locations. If internal auditors do not tolerate misstatements that are disclosed, this will increase the reliability (i.e., decrease the random error and bias) of disclosed amounts and decrease the likelihood of management manipulation of disclosed amounts. As a result, the impact to practice of external auditors’ willingness to waive misstated disclosures could be mitigated or even eliminated by internal audit oversight.

    The authors examine Chief Audit Executives’ and deputy Chief Audit Executives’ decisions to require adjustments of misstatements that are either recognized or disclosed. Chief Audit Executives (CAEs) may require equivalent adjustments for recognized and disclosed amounts, and act to counter the actions of management and external auditors. Understanding the decision processes of CAEs will help to inform regulators and standard setters of the underlying factors that drive financial statement reliability.

    Design/Method/ Approach:

    The participants are 73 Chief Audit Executives (CAEs) and deputy CAEs. CAEs and deputy CAEs are the ultimate decision makers in internal audit. None of these participants are from outsourced internal audit departments. The average number of years of internal audit experience is 13.71. The study was completed on paper and provided to participants in sealed envelopes by one of the study’s authors. All participants completed the materials in their professional offices under controlled conditions in the presence of one of the authors. The evidence was gathered prior to 2011.

    Findings:

    The results of this study indicate that reporting location has a significant effect on internal auditors’ decisions. Specifically, CAEs and their deputies require lesser amounts of misstatement correction of disclosed amounts relative to recognized amounts. While increased audit committee expertise increases audit committee members’ perceived power over management, the authors do not find that CAEs require greater misstatement corrections when the audit committee has more financial expertise, relative to less expertise. It appears that internal auditors may not have enough concern about disclosed misstatements to warrant a decision to exercise the power they derive from audit committee expertise. The results suggest that internal auditors, like external auditors and managers, act to decrease the perceived and actual reliability of disclosed information. Further, increasing the power of the internal audit function does not mitigate this problem. The authors find reason for serious concerns about the accuracy of disclosed amounts, relative to recognized amounts.

    Category:
    Corporate Matters, Governance
    Sub-category:
    Audit Committee Effectiveness, Earnings Targets & Management Behavior, Internal auditor role and involvement in controls and reporting
  • Jennifer M Mueller-Phillips
    Serving Two Masters: The Association between Audit Committee...
    research summary posted October 19, 2015 by Jennifer M Mueller-Phillips, tagged 13.0 Governance, 13.05 Board/Audit Committee Oversight, 13.06 Board/Audit Committee Processes, 13.07 Internal auditor role and involvement in controls and reporting 
    Title:
    Serving Two Masters: The Association between Audit Committee Internal Audit Oversight and Internal Audit Activities.
    Practical Implications:

    The results speak to the need for regulators to consider the incentives of the various stakeholders when determining policy. Should policy makers consider expanding or restricting specific oversight roles, they should consider the concomitant effects on the internal audit function, and the differential incentives faced by the audit committee and executive management. In addition, as audit committees and managers jointly work or oversee the work of internal auditors, the results suggest that these two oversight participants should consider how their respective incentives potentially bias the focus of the internal audit department away from a mix of activities that optimally address the greater business risks of the company. Likewise, as external auditors assess the organizational status of the internal audit department, they may also wish to consider the apparent focus of internal audit as a potential indication of oversight control.

    Citation:

    Abbott, L. J., S. Parker, and G. F. Peters. 2010. Serving Two Masters: The Association between Audit Committee Internal Audit Oversight and Internal Audit Activities. Accounting Horizons 24 (1): 1-24.

    Keywords:
    internal auditing, audit committees, best practices, internal auditors
    Purpose of the Study:

    This study examines the association between the activities performed by the internal audit function (hereafter, IAF) and the extent of audit committee oversight of the IAF. Two primary concerns motivate this study. First, relatively little regulatory or best practices guidance relates to the distribution of IAF activities, and virtually no current research has been done about these activities. The authors believe this topic to be important because current New York Stock Exchange listing rules require registrants to maintain an IAF, increasing the pervasiveness of internal audit. The second motivation concerns the relatively incomplete set of audit-committee related regulations. In particular, the Sarbanes-Oxley Act of 2002 (SOX) requires audit committee oversight of internal controls over financial reporting and also mandates reporting on a registrant’s internal controls. However, SOX is silent on internal audit, a key participant in both the financial reporting process and the internal control structure. Moreover, SOX does not address internal audit’s reporting relationship with the audit committee or the audit committee’s duties concerning internal audit resources.

    Design/Method/ Approach:

    The survey questionnaire was mailed to Fortune 1000 companies, after excluding banks. Consistent with much prior internal audit research, the survey was directed to CIAs. The first survey was sent in July 2006 and resulted in a total of 72 usable responses. A follow-up mailing was conducted in September 2006 and produced an additional 62 usable responses. This lead to the final sample size of 134 observations.

    Findings:

    The authors find that the percentage of the IAF budget devoted to internal-controls-based activities is positively related to the measure of the audit committee’s oversight. In particular, audit committees with greater IAF oversight are associated with larger percentages of IAF hours being allocated toward internal controls activities. Moreover, the results suggest that a significant number of Fortune 1000 companies have audit committees that appear to have little oversight of the IAF. This speaks to the relevance and timeliness of the recommendations of numerous parties concerning audit committee internal audit termination/hiring rights and budgetary controls.

    The authors also document significant differences in the allocation of IAF budgets across different activities, an area with very little prior research. They find that the majority of the IAF budget is devoted to internal controls activities, but the remainder, allocated to non-controls activities, is considerable. The evidence indicates that outsourcing arrangements are quite prevalent, but are also quite specific. In particular, the majority of outsourcing hours were spent on Section 404- related activities, with a lesser portion devoted to assisting the external auditor with the financial statement audit. The results suggest that an audit committee’s demand for better internal controls may lead to greater IAF focus on internal controls. 

    Category:
    Governance
    Sub-category:
    Board/Audit Committee Oversight, Board/Audit Committee Processes, Internal auditor role and involvement in controls and reporting
  • Jennifer M Mueller-Phillips
    Welcome to the day-to-day of internal auditors: How do they...
    research summary posted July 30, 2015 by Jennifer M Mueller-Phillips, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 08.11 Reliance on Internal Auditors, 13.0 Governance, 13.07 Internal auditor role and involvement in controls and reporting 
    Title:
    Welcome to the day-to-day of internal auditors: How do they cope with conflict?
    Practical Implications:

    This study makes an original contribution to the development of new knowledge on internal auditing. It concludes that internal auditors tend to lack independence and audit committee members often exercise disturbingly weak power (on the internal audit function), as compared to the top managers. This points to the difficulty of applying an idealized conception of independence and purist governance principles to practice. That is, it encourages auditors to consider the appropriateness of internal auditing as a meaningful independent assurance device in operating the corporate governance "mosaic."

    Citation:

    Roussy, M. 2015. Welcome to the day-to-day of internal auditors: How do they cope with conflict? Auditing: A Journal of Practice and Theory 34 (2): 237-264.

    Keywords:
    audit committee, conflicts, coping, independence, internal audit
    Purpose of the Study:

    The internal audit function (IAF) was made mandatory in both private and public companies in North America in the early 2000s. This paper proposes a ''micro-level'' analysis of the way in which internal auditors express role conflicts in their day-to-day practice and how they perceive, manage, and resolve them. The study seeks to show that the independence of the internal auditor is often not up to the standards that are expected of the internal audit function (IAF), and therefore unlikely to play an effective governance oversight role compatible with the ideal of the new public management governance reform.

    Design/Method/ Approach:

    A field study was conducted involving semi-structured interviews with 42 internal auditors working in 13 public sector organizations. Interviews were conducted between May and October 2010. Each interviewee had 10-15 years of experience in internal auditing, with 20-25 years of professional experience total. Data was interpreted in the light of a theoretical analysis framework designed especially for this study. Organizational and social context was taken into consideration for each interview.

    Findings:

    Overall, the results indicate that internal auditors have a relative lack of independence (as compared with the Institute of Internal Auditors’ standards.) More specifically:

    • While internal auditors are strategic in managing conflicts, they do not consider the cumulative effect that their coping behavior has on their lack of independence.
    • The audit committee does not greatly influence internal auditors’ coping tactics at any stage in the audit process.
    • Auditors use “pragmatic” behavior because they are embedded in a specific organizational and social context that they are ‘‘forced’’ to take into account.
    • The analysis casts doubt on the audit committee’s ability and commitment to consolidate and ensure internal auditor independence.

    Ultimately, the study concludes that internal auditors behave as if the IAF were a means for managerial control, instead of a governance mechanism.

    Category:
    Auditing Procedures - Nature - Timing and Extent, Governance
    Sub-category:
    Internal auditor role and involvement in controls and reporting, Reliance on Internal Auditors
  • Jennifer M Mueller-Phillips
    Does Internal Audit Function Quality Deter Management...
    research summary posted July 27, 2015 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.04 Management Integrity, 13.0 Governance, 13.07 Internal auditor role and involvement in controls and reporting 
    Title:
    Does Internal Audit Function Quality Deter Management Misconduct?
    Practical Implications:

    These findings suggest that regulators, audit committees, and other stakeholders should consider ways to improve IAF quality, specifically IAF competence, and IAFs improve corporate governance by assisting audit committees in monitoring management. This study provides empirical evidence consistent with the proposition that IAF quality and competence deter management misconduct. IAF quality and, particularly, IAF competence are important in deterring observable instances of management misconduct, both accounting- and nonaccounting-related. These findings are important because in the early 2000s, regulators responded to public outcry over observable management misconduct, yet IAF quality was largely left out of the regulatory debate and reforms that followed.

    Citation:

    Ege, M. S. 2015. Does Internal Audit Function Quality Deter Management Misconduct? Accounting Review 90 (2): 495-527.

    Keywords:
    corporate governance, internal audit function, internal audit quality, management misconduct
    Purpose of the Study:

    This study examines the relation between internal audit function (IAF) quality, as defined by standard-setters, and the likelihood of management misconduct, such as financial reporting fraud, bribery, and misleading disclosure practices. Standard-setters posit that IAFs serve as a key resource to audit committees for monitoring senior management and that high-quality IAFs deter management misconduct. However, U.S. regulators do not enforce IAF quality or require disclosures relating to IAF quality. The U.S. Securities and Exchange Commission (SEC) proposed requirements to increase IAF quality by adding the appointment, compensation, retention, and oversight of the internal auditor to audit committee responsibilities, but these proposed requirements were abandoned. Ten years later, after withdrawing its recent proposal to require high-quality IAFs, NASDAQ is considering how to revise the proposed rules. These proposals demonstrate the need for evidence regarding whether IAF quality results in improved monitoring of management.

    This study informs standard-setters, regulators, audit committees, and shareholders about whether IAF quality deters management misconduct incrementally to other monitors.

    Design/Method/ Approach:

    The author obtained the initial sample from the Institute of Internal Auditors’ proprietary Global Auditing and gathered additional information from COMPUSTAT. The final sample covers 1,398 firm-years representing 617 unique firms from 2000 through 2009. The management misconduct sample comes from four data sources: the Federal Securities Regulation Database, the Stanford Securities Class Action Clearinghouse, SEC’s website and the Department of Justice website.

    Findings:

    The author finds a negative relation between IAF quality and management misconduct, even after controlling for other determinants of misconduct, including board of director, audit committee, and external auditor quality. This effect is economically significant, as a firm with IAF quality one standard deviation above the mean is approximately 2.3 percentage points less likely to have management misconduct than a firm with average IAF quality. This is approximately 29.5 percent of the 7.7 percent unconditional probability of management misconduct. Further analysis reveals that IAF competence, but not objectivity, is negatively related to the likelihood of management misconduct, suggesting that IAF competence is important in deterring management misconduct.

    Misconduct firms have low IAF quality and IAF competence during misconduct years as compared to a matched sample of firms. Then, in post-misconduct years, misconduct firms increase IAF quality through IAF competence. This increase in competence is due to hiring more certified internal auditors and increasing training. However, misconduct firms do not appear to have lower IAF objectivity during or after misconduct years compared to a matched sample. These results are consistent with the proposition from standard-setters that IAFs serve as a key resource for audit committees in monitoring management.

    The findings suggest that high-quality IAFs are effective at deterring both types of management misconduct. Disclosures related to IAF quality would assist stakeholders in predicting accounting-related management misconduct.

    Category:
    Governance, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Internal auditor role and involvement in controls and reporting, Management Integrity
  • Jennifer M Mueller-Phillips
    Correlates of Co-Sourcing/Outsourcing of Internal Audit...
    research summary posted February 20, 2015 by Jennifer M Mueller-Phillips, tagged 13.0 Governance, 13.07 Internal auditor role and involvement in controls and reporting, 14.0 Corporate Matters, 14.11 Audit Committee Effectiveness 
    Title:
    Correlates of Co-Sourcing/Outsourcing of Internal Audit Activities
    Practical Implications:

    The primary result that audit committee involvement is significantly and positively associated with “outsourcing” is an important finding that suggests a need for management to pay close attention to the role that audit committee plays in “outsourcing” internal audit activities. The significance of value-added-activities, missing-skill-set, and audit-staff-vacancies on “outsourcing” also require management attention because collectively these three variables indicate trade-offs between acquiring the expertise in-house or “outsourcing” to external service providers.

    For more information on this study, please contact Mohammad Abdolmohammadi

    Citation:

    Abdolmohammadi, M. 2013. Correlates of Co-Sourcing/Outsourcing of Internal Audit Activities. Auditing: A Journal of Practice and Theory 32(3): 69-85.

    Keywords:
    Outsourcing, internal audit activities, audit committee involvement, missing skill set
    Purpose of the Study:

    I use responses from 1,059 chief audit executives (CAEs) of organizations located in Australia, Canada, New Zealand, South Africa, the U.K./Ireland, and the U.S. to investigate several correlates of co-sourcing/outsourcing (referred to as simply “outsourcing”) of internal audit activities. 

    Design/Method/ Approach:

    In 2010 the Institute of Internal Auditors Research Foundation (IIARF) conducted a survey of IIA’s membership world-wide. The long survey had detailed questions about various issues from CAE attributes, organization characteristics, to practice issues such as “outsourcing.” Called the Common Body of Knowledge in Internal Auditing or CBOK (2010), this database has responses from internal auditors of varying experience and professional rank. I only use CAE responses for my study of “outsourcing” because CAEs are presumed to be highly knowledgeable about various issues of internal audit activities, including “outsourcing.” While CBOK (2010) has over 13,500 responses from members of various professional rank (CAEs, audit managers, etc.) in over 100 countries, I limit the data used in my study to only CAEs from Anglo-culture countries. This is to mitigate the possibility of differences due to various languages and cultural dimensions, such as uncertainty avoidance, levels of femininity/masculinity, etc.  

    Findings:
    • An important finding of the study is that audit committee involvement is positively and significantly associated with “outsourcing” of internal audit activities. Interactions of audit committee involvement with organization size and location generally indicate that medium and large international/multinational organizations with audit committee involvement “outsource” more than medium and large local/national organizations with no audit committee involvement.
    • Other important findings indicate an inverse relationship between “outsourcing” and value-added-activities of the internal audit function, and positive relationships between “outsourcing” and missing skill set and audit staff vacancies.
    • Finally, I find no evidence of relationships between CAE age, college degree (graduate/undergraduate), major (accounting versus others), internal audit certification, and regular meetings with the audit committee and “outsourcing.” Also, country of residence (U.S. versus other Anglo-culture countries) is not significant, but for-profit organizations “outsource” significantly more of their internal audit activities than not-for-profit organizations.
    Category:
    Corporate Matters, Governance
    Sub-category:
    Audit Committee Effectiveness, Internal auditor role and involvement in controls and reporting

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