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  • 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
  • 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
    The Role of Account Subjectivity and Risk of Material...
    research summary posted July 18, 2016 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.05 Assessing Risk of Material Misstatement, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.11 Reliance on Internal Auditors 
    Title:
    The Role of Account Subjectivity and Risk of Material Misstatement on Auditors’ Internal Audit Reliance Judgments
    Practical Implications:

    This paper suggests that the relationship between account subjectivity and usage of internal audit depends on the relative risk of misstatement.  This complex relationship has not been shown in academic literature, nor is it highlighted in audit standards.  More specifically, at lower levels of risk of misstatement, increases in subjectivity have no influence on the reliance of internal audit.  At moderate risk levels the extent of internal audit reliance increases with subjectivity of the account.  At high levels of misstatement internal audit reliance decreases with account subjectivity.  This study provides insight into the decision criteria for internal audit reliance and highlight where internal audit usage maybe more prevalent, as well as were further audit guidance may be beneficial.

    Citation:

    Bhattacharjee, S., M.J. Maletta, K.K. Moreno. 2016. The Role of Account Subjectivity and Risk of Material Misstatement on Auditors’ Internal Audit Reliance Judgments. Accounting Horizons 30 (2): 225-238.

    Keywords:
    Internal audit; account subjectivity; material misstatement risk
    Purpose of the Study:

    Reliance on Internal Audit has become an important element of the external audit.  Use of Internal Audit can play a significant role in reducing audit costs without sacrificing audit quality.  However, the extent of usage of Internal Audit has been shown to be influenced by inherent risk, control risk, and the subjectivity of audit tasks.  This paper looks at the interaction between risk assessment and subjectivity to provide insight into the complexities associated with the usage of internal audit.  The authors aim to dive deeper into the analysis of internal audit usage, expanding on the dichotomous “low or high risk” assessment by investigating moderate risk scenarios.  By analyzing these relationships with a field-based questionnaire, the authors present documentation of how real decisions are based on a complex assessment of the role of internal auditors.

    Design/Method/ Approach:

    The authors conducted a field-based questionnaire using 68 auditors from a Big 4 firm.  These auditors were located in the U.S., but came from different geographic areas.  They have an average experience of 46 months and represented 15 different industry specializations.  The auditors were asked to choose one public company client and respond to questions regarding demographic information, client characteristics, external audit team characteristics, client misstatement risk, account subjectivity, client internal audit structure, and external audit assessment of internal audit usage.

    Findings:
    • The authors find that auditors’ reliance decisions involve an interaction between material misstatement risk and account area subjectivity. 
    • The authors find that incremental increases in account subjectivity have no effect on extent of internal audit reliance when misstatement risk is assessed at lower levels.  At moderate levels of misstatement risk, however, account subjectivity is positively associated with use of internal auditors.  This suggests that moderate misstatement risk creates opportunities for auditors to benefit from increasing internal audit utilization without offsetting impairments to audit effectiveness.  At higher levels of misstatement risk, incremental increases in account subjectivity have a negative association with external audit usage.
    Category:
    Auditing Procedures - Nature - Timing and Extent, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Assessing Risk of Material Misstatement, 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
    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
    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
  • 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
    The Effects of Using the Internal Audit Function as a...
    research summary posted July 27, 2015 by Jennifer M Mueller-Phillips, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 08.11 Reliance on Internal Auditors 
    Title:
    The Effects of Using the Internal Audit Function as a Management Training Ground or as a Consulting Services Provider in Enhancing the Recruitment of Internal Auditors.
    Practical Implications:

    The results suggest that the profession of internal auditing faces a challenge in attracting talent, since college-graduate job applicants with some work experience are deterred from applying to positions labeled as internal audit. These individuals believe that other professionals have negative perceptions of the internal audit profession. Furthermore, the only condition that improved the likelihood that experienced job candidates would apply for an internal audit position is when the job candidates expected to spend little time in internal auditing before moving into positions outside of the IAF and the position performed primarily consulting tasks a deviation from the traditional internal audit role of performing primarily assurance services. If the IAF cannot attract a sufficient number of high-quality applicants, then its ability to serve as an effective cornerstone of high-quality corporate governance will likely be compromised.

    Citation:

    Burton, F. G., Starliper, M. W., Summers, S. L., & Wood, D. A. 2015. The Effects of Using the Internal Audit Function as a Management Training Ground or as a Consulting Services Provider in Enhancing the Recruitment of Internal Auditors. Accounting Horizons 29 (1): 115-140.

    Keywords:
    assurance services, consulting services, hiring decisions, internal audit, management training ground, recruiting
    Purpose of the Study:

    A critical component of high-quality corporate governance is having a high-quality internal audit function (IAF). The purpose of this research is first, to empirically examine the degree to which student job applicants are dissuaded from working in internal auditing positions, and second, to investigate how different job structure factors, namely using the IAF as a management training ground and/or using the IAF to perform consulting versus assurance work, affect the desirability of internal audit positions. Understanding how the type of work the IAF performs impacts job applicants is important for developing a respected and desirable profession.

    In addition to the type of work internal audit performs, a significant number of companies use the IAF as a management training ground (MTG)rotating employees, either new or experienced, into the IAF for a short stint before placing them into management positions outside the IAF. Although popular in practice, prior research shows this staffing model is associated with significant negative outcomes such as higher external audit fees, greater risk of misstated financial statements, and larger internal audit. Given these significant negative consequences, it is important to understand if positive factors exist to explain why so many companies use these rotational staffing arrangements. In this study, the authors specifically examine whether increased interest in internal audit positions is one of these positive factors of using the IAF as a MTG.

    Design/Method/ Approach:

    The authors conduct two experiments to test their hypotheses. All participants in the experiments were senior students or graduate accounting students. Experiment 1 was fully completed by 100 students, and Experiment 2 was fully completed by 169 students. Professors from six different universities emailed their students to encourage participation in the experiment. The sampled universities included both public and private institution across the United States. The evidence was collected prior to January 2014. 

    Findings:

    Responses show that participants are less likely to apply to job positions labeled as “internal audit” as opposed to those that have an “accounting” label. Additional analyses reveal that these results are driven by participants with business experience (regardless of the type and amount of experience). Twenty percent (Experiment 1) and 33 percent (Experiment 2) fewer participants with business experience would apply for a job described as internal auditing than a job described as accounting. For participants with no business experience, there was no difference in willingness to apply for the job based on the internal audit or accounting job labels.

    While participants believe internal auditors are highly respected, have excellent compensation and benefits, perform meaningful and satisfying work, have excellent promotion opportunities, and have excellent work-life balance, experienced participants believe that other business professionals have negative stereotypes of internal auditing. Altering internal audit job descriptions to include both consulting activities and management development only moderately increases applicant interest. Almost twice as many experienced participants are likely to apply to work in internal auditing when the IAF both performs consulting work and is used as a MTG, while inexperienced applicants are indifferent toward the manipulations.

    Category:
    Auditing Procedures - Nature - Timing and Extent
    Sub-category:
    Reliance on Internal Auditors
  • Jennifer M Mueller-Phillips
    The Impact of Internal Audit Function Quality and...
    research summary posted July 24, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.04 Impact of 404, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.11 Reliance on Internal Auditors, 11.0 Audit Quality and Quality Control 
    Title:
    The Impact of Internal Audit Function Quality and Contribution on Audit Delay.
    Practical Implications:

    This research should be of interest to regulators who are concerned with the timeliness of financial reports, practitioners who are responsible for preparing and auditing financial statements, and standard setters who provide auditing guidance. In particular, the findings indicate that firms’ decisions regarding the structure of the IAF and their role in the financial statement audit can significantly affect audit completion times. Reducing audit delay from current levels back to pre- SOX 404 levels could potentially reverse the decline in the reliability of earnings announcements. The results are useful to external auditors in determining whether and how IAF work can be incorporated into the financial statement audit. This study also provides support for recent PCAOB guidance contending that external auditors can improve audit efficiency by making more extensive use of work performed by others.

    Citation:

     Pizzini, M., Lin, S., & Ziegenfuss, D. E. 2015. The Impact of Internal Audit Function Quality and Contribution on Audit Delay. Auditing: A Journal Of Practice & Theory 34 (1): 25-58.

    Keywords:
    audit delay, audit report timeliness, internal audit contribution, internal audit quality
    Purpose of the Study:

    This study investigates the internal audit function’s (IAF’s) role in the financial statement audit by examining whether measures of IAF quality and the IAF’s contribution to the financial statement audit affect audit delay. Audit delay, measured as the number of days between a firm’s fiscal year-end and the audit report date, generally captures the time required to complete fieldwork. Current interest in audit delay stems from recent accelerations in reporting deadlines and the implementation of Section 404 of the Sarbanes-Oxley Act (SOX), which together require preparers and external auditors to do more work in less time. Given the increased attestation requirements created by SOX, it is important to investigate ways in which the IAF can influence audit delay. In this study, the authors argue that the IAF can significantly affect audit completion times by helping management establish and maintain a strong system of internal control over financial reporting (ICFR) and by assisting the external auditor in the financial statement audit. The authors investigate whether IAF quality and the IAF’s contribution to financial statement audits affect audit delay in a sample of 292 firm-year observations drawn from the pre-SOX 404 period. 

    Design/Method/ Approach:

    The authors use firm-level data collected by the IIA through their 2003 and 2004 GAIN surveys. They then collect firm financial data from Compustat and audit fee and restatement data from Audit Analytics. The resulting sample contains 293 firm-year observations from 216 firms with fiscal years ending on or after December 31, 2000 and prior to November 15, 2004.

    Findings:
    • A one standard deviation increase in the comprehensive quality measure corresponds to audit delay reductions of 3.1 to 3.9 days, which are primarily driven by the competence of the internal audit staff and the quality of their fieldwork.
    • Objectivity and investment in the IAF are also associated with reductions in audit delay, but significance levels vary with time period and model specification.
    • Audit delay is significantly shorter (4.1 to 6.6 days) when the IAF contributes to the financial statement audit by independently performing relevant work, but not when the IAF works under the direction of the external auditor.
    • The mean delay is 41.9 days, and earnings are announced an average of 9.8 days prior to the audit report date.
    • High-quality IAFs are more likely to assist the external auditor by independently performing relevant work, while low-quality IAFs are more likely to be used as direct assistants.
    • The authors expect the impact of IAF quality and contribution would be even larger in the current period. The more rigorous attestation requirements of SOX 404 expanded the IAF’s potential to contribute to the financial reporting process and, therefore, should increase the impact of IAF quality and contribution on audit delay.
       
    Category:
    Audit Quality & Quality Control, Auditing Procedures - Nature - Timing and Extent, Standard Setting
    Sub-category:
    Impact of 404, Reliance on Internal Auditors

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