Auditing Section Research Summaries Space

A Database of Auditing Research - Building Bridges with Practice

This is a public Custom Hive  public

Posts

  • 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
    Does Incentive-Based Compensation for Chief Internal...
    research summary posted June 22, 2017 by Jennifer M Mueller-Phillips, tagged 02.01 Audit Fee Decisions, 02.02 Client Risk Assessment, 04.02 Impact of Fees on Decisions by Auditors & Management, 08.11 Reliance on Internal Auditors 
    Title:
    Does Incentive-Based Compensation for Chief Internal Auditors Impact Objectivity? An External Audit Risk Perspective
    Practical Implications:

    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.   

    Citation:

    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

    Keywords:
    Incentive-based compensation; internal auditor objectivity; audit fees
    Purpose of the Study:

    The internal audit function (IAF) is increasingly seen as a key component of corporate governance. The extent to which external auditors can rely on information from the IAF depends largely on the internal auditor’s objectivity. The researchers question whether receiving incentive-based compensation (IBC) linked to company performance threatens internal audit employees’ objectivity. Subsequently, this threat would lead to a higher assessment of client audit risk and therefore higher audit fees. The authors also consider whether external auditors view stock- and option-based compensation differently from cash incentives. Finally, the authors examine whether the objectivity threat from IBC depends on the company’s financial reporting risks, alignment of IAF compensation with CEO compensation, and presence of any internal audit outsourcing arrangements.

    Design/Method/ Approach:

    The authors surveyed chief internal auditors of NYSE-listed firms in 2007. The participants were asked to rank the performance measures in order of their emphasis and to indicate the form of IBC payment. By asking survey respondents to provide their company names, the authors could match the financial, audit fee, governance, and incentive data from various databases (Compustat, Audit Analytics, proxy statements, etc.). The final sample included 183 companies. Authors used multivariate regression to analyze their research questions.

    Findings:

    The overall finding is that when a company offers incentive-based compensation to a chief internal auditor, external audit fees increase. This finding suggests that external auditors do consider IBC for chief internal auditors as a threat against objectivity.

     

    Additionally, the authors find that:

    • External auditors are more likely to charge higher fees for stock- and option-based compensation compared to cash bonuses. They attribute this result to employees placing more of an emphasis on personal wealth rather than firm value.
    • There is a stronger positive effect of chief internal auditors receiving IBC and external auditor fees increasing when inherent risk is higher in the audit. Specifically, the authors focused on inherent risk related to inventory levels.
    • In situations where the CEO’s equity incentives are aligned with IAF’s equity incentives there is an even greater rise in external auditor fees.
    Category:
    Auditing Procedures - Nature - Timing and Extent, Client Acceptance and Continuance, Independence & Ethics
    Sub-category:
    Client Risk Assessment
  • Jennifer M Mueller-Phillips
    External Auditors’ Involvement in the Internal Audit F...
    research summary posted January 17, 2017 by Jennifer M Mueller-Phillips, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 08.11 Reliance on Internal Auditors 
    Title:
    External Auditors’ Involvement in the Internal Audit Function’s Work Plan and Subsequent Reliance Before and After a Negative Audit Discovery
    Practical Implications:

    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.        

    Citation:

    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.

    Keywords:
    auditor judgment, internal audit function, audit coordination, and belief-adjustment model.
    Purpose of the Study:

    The purpose of this study is to experimentally examine how external auditors’ involvement in the internal audit function’s (IAF’s) work plan influences their decisions to rely on the work of the IAF and how that involvement affects their audit response in terms of re-performance of the IAF’s work and adjustment to budgeted hours. Furthermore, the authors go beyond the focus on external auditors’ initial reliance/re-performance decisions and evaluate how involvement influences their subsequent reliance and re-performance decisions after the discovery of a negative audit finding. 

    Design/Method/ Approach:

    The authors conduct an experiment with senior-level auditors from a large public accounting firm to investigate how involvement in the IAF’s work plan influences external auditors’ reliance on the IAF both before and after a negative audit finding.

    Findings:
    • The authors find that involvement increases the perceived objectivity of the IAF and that both involvement and objectivity influence external auditors’ initial reliance decisions, whereby involved auditors report greater reliance on the work of IAF. This greater reliance translates into re-performing less of the IAF’s work and reducing the audit budget to a greater extent as compared to external auditors with no involvement.
    • The authors find that external auditors in the involvement condition continue to exhibit a greater propensity to rely on the IAF and re-perform less of the IAF’s work when compared to those in the no-involvement condition, even after a negative audit finding. 
    Category:
    Auditing Procedures - Nature - Timing and Extent
    Sub-category:
    Reliance on Internal Auditors
  • The Auditing Section
    Internal Audit Quality and Earnings Management
    research summary posted May 7, 2012 by The Auditing Section, 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 Earnings Management
    Practical Implications:

    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. 

    Citation:

    Prawitt, D., J. Smith, D. A. Wood 2009. Internal Audit Quality and Earnings Management. The Accounting Review 84 (4): 1255-1280.

    Keywords:
    corporate governance; internal audit function; internal audit quality; earnings management; abnormal accruals; analyst forecasts
    Purpose of the Study:

    Standards promulgated by the AICPA and PCAOB recognize the impact that a high-quality internal audit function (IAF) can have on reducing control risk, and by extension, audit risk.  As such, regulators permit and encourage external auditors to rely on the work of others if that work is deemed to be performed by “competent and objective persons” (PCAOB 2007).  Similarly, the Institute of Internal Auditors (IIA) recognizes the IAF as one of the four cornerstones of corporate governance, along with the audit committee, executive management, and the external auditor.  However, while several prior studies establish a negative association between the quality of firm’s corporate governance mechanisms and management’s tendency and ability to manipulate reported financial results, there is little evidence that relies on archival data concerning the impact of a quality IAF on firms’ earnings manipulation activities.

    The purpose of this study is to examine archival data to determine whether differences in the quality of firms’ IAF impact firms’ earnings management activities.

    Design/Method/ Approach:

    The authors rely on the IIA maintained GAIN database (a proprietary database), that is composed of survey responses from chief audit executives associated with IIA member organizations.  Member organizations responding to the survey include publicly traded and private companies, educational and governmental institutions, as well as individual divisions within companies.  The study covers the fiscal years of 2000-2005. 

    The authors create an index based on six factors that SAS No. 65 suggests external auditors should consider when evaluating whether to rely on the work of the internal auditors, and therefore differentiate IAF quality.  Those factors include the IAF’s professional experience, professional certifications, training, objectivity, relevance of their work to the financial reporting function, and the IAF’s relevance to the organization based on how much resources the corporation invests in the IAF group.  To capture management’s earnings management activities, the authors rely on measures of abnormal accruals and whether the firm just misses or beats analysts’ forecasts.

    Findings:
    • Overall, the results suggest that higher quality IAFs reduce management’s ability to manipulate earnings.
    • Specifically, higher quality IAFs appear to be associated with smaller negative abnormal accruals.
    • Companies with higher quality IAFs appear more likely to just miss analysts’ earnings forecasts, a measure of less earnings management.
    Category:
    Auditing Procedures - Nature - Timing and Extent, Governance
    Sub-category:
    Reliance on Internal Auditors, Internal auditor role and involvement in controls and reporting
    Home:
    home button
  • 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
  • The Auditing Section
    Internal Audit Reporting Lines, Fraud Risk Decomposition,...
    research summary posted May 4, 2012 by The Auditing Section, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment, 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 Reporting Lines, Fraud Risk Decomposition, and Assessments of Fraud Risk
    Practical Implications:

    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.

    Citation:

    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.

    Keywords:
    internal audit, fraud risk assessment, audit committee
    Purpose of the Study:

    The internal auditor function is one of the four cornerstones of corporate governance along with senior management, the board, and external auditors.  External auditors frequently rely on the work of internal auditors, including firm risk assessments per AS5, An Audit of Internal Control over Financial Reporting that is Integrated with an Audit of Financial Statements.  Internal auditors may report to management or to the audit committee.  Many investors and regulators have suggested that internal auditors should report directly to the audit committee to minimize the threats to independence and objectivity that may potentially occur when internal auditors report to management.  However, if the audit committee is given power over the internal audit function, this may create potential new threats to internal auditor independence not previously considered.  For example, many audit committees now have the authority to hire or fire the Chief Audit Executive.  This paper addresses the effects of internal audit reporting lines on the fraud risk assessment judgments of internal auditors.  Below are two objectives that the authors address in their study: 

    • Examine the extent that internal auditors may be subconsciously motivated to avoid reporting higher levels of fraud risk to the audit committee, relative to when the risks are reported to management.
    • Examine whether decomposition of fraud risk into the components of the fraud triangle (management attitude, incentives, and opportunities) improves the internal auditor’s sensitivity to opportunity and incentive cues.
    Design/Method/ Approach:

    The authors collected their evidence from highly experienced internal auditors (mean experience of 15.3 years) via survey instruments. The authors then collected additional evidence using an experiment where participants were asked to complete a simulated task. Experiment participants were experienced internal auditors with mean experience of 9.6 years.  Survey participants were asked five questions about risk assessment discussions, reporting lines, and reactions.  In the simulated task participants were asked to assess the level of fraud risk in a hypothetical firm.  Participants were assigned to either a higher or lower level of fraud risk and to a reporting line of either audit committee or management.  The research was conducted in the mid- to late-2000s time period.

    Findings:
    • The authors find that internal auditors perceive greater personal threats when reporting high levels of fraud risk to the audit committee than when reporting to management.  Internal auditors fear overreaction from the audit committee, potentially leading to increased workload and management reprisals.   
    • The perception of greater perceived threats leads internal auditors to reduce assessed levels of fraud risk when reporting to the audit committee relative to reporting to management.  This finding is contrary to expectations and reveals additional unexpected threats created by having internal audit report to the audit committee.
    • Internal auditors increase attention to management attitude when risk assessments are decomposed, without a corresponding increase to incentive or opportunity cues.  Thus, unlike external auditors, fraud decomposition does not appear to mitigate perceived problems associated with insensitivity to incentive and opportunity cues.    
    Category:
    Risk & Risk Management - Including Fraud Risk, Auditing Procedures - Nature - Timing and Extent, Governance
    Sub-category:
    Fraud Risk Assessment, Reliance on Internal Auditors, Internal auditor role and involvement in controls and reporting
    Home:
    home button
  • Jennifer M Mueller-Phillips
    Internal Audit Sourcing Arrangements and Reliance by...
    research summary posted September 26, 2013 by Jennifer M Mueller-Phillips, tagged 07.0 Internal Control, 07.01 Scope of Testing, 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 Sourcing Arrangements and Reliance by External Auditors
    Practical Implications:

    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.
     

    Citation:

    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.

    Keywords:
    cosourcing; external auditor reliance; internal audit; sourcing
    Purpose of the Study:

      The purpose of this study is to investigate potential internal audit (IA) sourcing arrangements (in-house, outsource, and cosource) and to determine how that impacts an external auditor’s evaluation of the IA function’s competency, objectivity, and technical skills. The extent to which the audit team will rely upon work performed by the internal auditors can also be determined this way.  This study also looks at whether tax services provided by the IA service provider impacts the extent of reliance for outsourced or cosourced IA.
    This study is important because the Institute of Internal Auditors makes no preference between any of these sourcing arrangements.  Prior research has shown that outsourcing the IA function results in higher ratings of objectivity and more reliance upon their work when inherent risk is high (but no differences when inherent risk is low).  However, no studies test how cosourcing arrangements are evaluated.  This question is important to answer since a cosourced arrangement is a blend of in-house and outsourced internal auditors, which indicates that results could go either way. 
     

    Design/Method/ Approach:

    The authors conducted an experiment including experienced CPAs from Big 4 and regional firms prior to October 2007.  The design results in only 5 groups – in-house, outsource, or cosource without mention of tax services and outsource or cosource with the service firm also providing tax services.  External auditors were asked to provide ratings related to internal audit’s quality, reliance on internal audit work, audit risk, planned external audit effort, and likelihood that IA would give in to management regarding potential findings.

    Findings:
    • The authors find that in high risk areas, external auditors’ rate outsourced and cosourced internal auditors as having higher levels of quality than in-house internal audit.
    • They similarly find that external audit is more likely to rely upon the internal audit work performed if it is performed by outsourced or cosourced IA.
    • Further, the authors find no differences in quality or reliance ratings between outsourced and cosourced IA. 
    • However, when outsourced or cosourced internal audit service providers also provide tax services (which are performed by individuals other than those who perform the internal audit work) external auditors perceive the quality of the internal audit work to be lower.  As a consequence, they rely less upon the internal auditor’s work and instead increase their own external audit efforts. 
       
    Category:
    Auditing Procedures - Nature - Timing and Extent, Governance, Internal Control
    Sub-category:
    Internal auditor role and involvement in controls and reporting, Reliance on Internal Auditors, Scope of Testing
  • Jennifer M Mueller-Phillips
    Internal auditors’ use of interpersonal likability, a...
    research summary posted July 20, 2015 by Jennifer M Mueller-Phillips, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 08.11 Reliance on Internal Auditors 
    Title:
    Internal auditors’ use of interpersonal likability, arguments, and accounting information in a corporate governance setting.
    Practical Implications:

    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.

    Citation:

    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.

    Keywords:
    internal auditors, interpersonal relations, corporate governance, disclosure of information
    Purpose of the Study:

    In this study, the authors examine how three variables, each fundamental to internal auditors’ interactions with managers, explain internal auditors’ influence on managers’ judgments:

    1. Internal auditors’ interpersonal likability,
       
    2. The underlying information supporting their positions, and
       
    3. Their use of thematically organized arguments to present that information to managers.

    Internal auditors tend to interact with managers frequently, and are “often the party primarily responsible for the day-to-day monitoring of management’s actions, including those related to external financial reporting.” Internal audit lacks the client services incentives of external audit, allowing internal auditors to adopt a “policeman approach,” which places little emphasis on positive interpersonal interactions with managers as clients, compared to external audit. The “police” approach to internal audit can harm the managerinternal auditor relationship. A dysfunctional relationship between managers and internal auditors is a contributing cause, and in some cases, a primary cause of a variety of accounting problems, including material weaknesses, financial restatement, regulatory compliance, and the like. 

    Design/Method/ Approach:

    The experimental case within places participants into the role of a mid-level manager who provides input to a controller about whether the value of inventory should be written down in the financial statements as obsolete. The authors recruited managers, executives, and other professionals in management training programs to participate in the study. The 133 participants averaged 8.5 years of professional business experience and 4.4 years of managerial experience. The evidence was gather prior to 2014.

    Findings:

    The authors found that because people find the thematically structured flow of an argument appealing, and because positive affective states lead to heuristic processing, managers will heuristically agree more with an internal auditor who is both likable and uses an argument structure, beyond the effects of how supportive or unsupportive the internal auditor’s information is of his position.

    • Managers agree more with an auditor who uses more supportive information than one who uses less supportive information.
    • However, beyond that, they also agree more with an internal auditor who is both likable and uses a thematically organized argument structure, regardless of whether the information presented is relatively supportive or unsupportive of the internal auditor’s
      position.
    • The results demonstrate that an internal auditor can achieve (on average) agreement from managers simply because he is likable and uses a flowing argument structure, even when the underlying information is relatively unsupportive and managers otherwise (on average) do not to agree with the internal auditor.

    Overall, the findings suggest that internal auditors can achieve additional agreement from managers on important corporate governance issues, above and beyond how supportive or unsupportive their information is, by using an argument structure and likability jointly, as a fairly straightforward presentation tactic.

    Category:
    Auditing Procedures - Nature - Timing and Extent
    Sub-category:
    Reliance on Internal Auditors
  • Jennifer M Mueller-Phillips
    Reconciling Archival and Experimental Research: Does...
    research summary posted February 16, 2015 by Jennifer M Mueller-Phillips, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 08.11 Reliance on Internal Auditors, 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations 
    Title:
    Reconciling Archival and Experimental Research: Does Internal Audit Contribution Affect the External Audit Fee?
    Practical Implications:

     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.

    Citation:

    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

    Keywords:
    Internal audit function, internal audit costs, internal audit quality, external audit fee, SAS No. 65, AS 5
    Purpose of the Study:

    Experimental and survey research consistently have found evidence of a negative relation between measures of internal audit contribution and external audit fees. By contrast, past archival research typically has documented either no relation or a positive relation.  While it has provided important insights, prior archival research examining the relation between internal auditing and external audit fees has been limited by the unavailability of detailed data about internal audit functions (IAF).  With newly available archival data, this paper examines the internal audit contribution/external audit fee relation using direct measures of the amount of time internal auditors work directly assisting external auditors, and the amount of time internal auditors spend performing tasks upon which the external auditor is likely to rely.

    Understanding the association between the contribution of internal auditing and external audit fees is important because this is an economically important relationship.  External auditing standards allow the external auditor to either use internal auditors as assistants or to rely on work previously performed by the IAF.  This paper also addresses which of the two methods of reliance results in a greater reduction in the external audit fee.

    The conflict mentioned earlier between the results of previous research using surveys and experiments versus those found in archival studies have led a number of researchers to call for additional work in the area.  This paper also suggests an explanation for the divergent findings in the experimental and archival studies in this area.

    Design/Method/ Approach:

    The data set examined in the research is from the IIA’s GAIN database relating to fiscal years 2000 to 2005.  The authors restricted their analysis to these years because of availability of IIA data (they have no data after 2005) and because of availability of external audit fees (audit fee data were not made public before 2000).  

    Findings:
    • The authors find that external audit fees are negatively associated with internal audit contribution.
    • The authors find that the amount of time internal auditors spend performing tasks of a financial nature is not associated with lower external audit fees, but that the time spent working under direct supervision of the external auditor is associated with lower external audit fees.
    • The authors find that proxies used in past archival studies are positively associated with measures of the host companies’ size and complexity, and are negatively associated or are not associated with this study’s relatively direct measures of the contribution of the IAF to the external audit. In other words, proxies used in past archival studies likely did not do a good job of capturing IAF contribution, which explains their contradictory results.
    Category:
    Auditing Procedures - Nature - Timing and Extent, Engagement Management
    Sub-category:
    Audit Fees & Fee Negotiations, Reliance on Internal Auditors
  • Jennifer M Mueller-Phillips
    Rotational internal audit programs and financial reporting...
    research summary posted September 16, 2015 by Jennifer M Mueller-Phillips, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 08.11 Reliance on Internal Auditors 
    Title:
    Rotational internal audit programs and financial reporting quality: Do compensating controls help?
    Practical Implications:

    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.

    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 & Society 44: 37-59.

    Keywords:
    internal auditing, financial statements, internal auditors, financial reporting qualities, internal controls
    Purpose of the Study:

    A report from the Institute of Internal Auditors finds that approximately two-thirds of Fortune 500 companies report that they systematically rotate their internal auditors into management positions outside of internal audit, this practice potentially causes the internal audit function (IAF) to be used or viewed as a training ground for future managers. This practice is somewhat perplexing given evidence from prior research suggesting it diminishes internal auditors’ objectivity.

    The authors extend prior research on the effects of systematically rotating internal auditors into operational management by conducting interviews with chief audit executives and audit committee chairpersons to develop an initial framework of how this practice is thought to impact financial reporting outcomes. The authors then use this initial framework to guide an archival analysis that tests for the presence of key associations between such rotation and financial reporting quality. They posit that specific types of rotational programs have the potential to reduce financial reporting quality. Consistent with prior research, the authors focus on the systematic rotational programs that result in internal auditors later obtaining management positions because these practices are most prevalent and have the potential to impair financial reporting quality. Hereafter, the authors refer to these practices as “systematic rotation.”

    Design/Method/ Approach:

    The authors interviewed heads of internal audit (CAEs) from 11 companies of varying sizes and industries and two audit committee chairpersons who (combined) have worked with 12 unique companies. Interviews lasted an average of 46 min. Six of eleven (55%) interviewees are from Fortune 500 companies. Eight of eleven companies use formal rotation programs, one uses informal rotation, and two do not use rotation. The authors collected this data prior to June 2015.

    Findings:

    The authors find that use of systematic rotation is associated with higher accounting risk. This result suggests that systematic rotation weakens the effectiveness of internal audit’s monitoring of financial reporting within the organization. This result is also consistent with the view from prior research that some rotational IAFs operate primarily as a management training ground, at the expense of the effectiveness of traditional internal audit activities.

    However, consistent with their predictions, other organizations implement compensating controls that mitigate this negative relation. Specifically, organizations that (1) rotate only staff internal audit positions (e.g., not the head of internal audit), (2) have more effective audit committees, or (3) have management who directs internal audit to focus on financial reporting (as opposed to operational or IT audits) are able to reduce the negative financial reporting effects associated with systematic rotation of internal auditors into management positions.

    Further, at least in this data, when all three types of compensating controls are present, the negative association between systematic rotation and financial reporting quality is eliminated. Thus, the results suggest that control-conscious organizations can use compensating controls to prevent systematic rotation from reducing financial reporting quality.

    Category:
    Auditing Procedures - Nature - Timing and Extent
    Sub-category:
    Reliance on Internal Auditors

Filter by Type

Filter by Tag