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    Internal Audit Sourcing Arrangement and the External...
    research summary posted May 7, 2012 by The Auditing Section, last edited May 25, 2012, tagged 07.0 Internal Control, 07.01 Scope of Testing, 13.0 Governance, 13.07 Internal auditor role and involvement in controls and reporting 
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    Title:
    Internal Audit Sourcing Arrangement and the External Auditor’s Reliance Decision
    Practical Implications:

    The results of this study suggests that external auditors place more reliance on “outsourced” internal audit work, especially under high inherent risk conditions, than on “in-house” internal audit work due to the external auditors’ assessment of higher objectivity on the part of the “outsourced” internal auditor. The authors suggest this may have implications for external audit teams’ planning and assessment of internal audit work, in that whether or not the work is outsourced might need to be considered in the assessment. Also, audit clients might consider a need to outsource more internal audit work or try to make changes to increase the external auditors’ perception of their “in-house” internal audit team, in terms of objectivity.

    Citation:

    Glover, S. M., Prawitt, D. F., and D. A. Wood. 2008. Internal Audit Sourcing Arrangement and the External Auditor’s Reliance Decision. Contemporary Accounting Research 25 (1) 193-213.

    Keywords:
    assessment of internal audit work; internal audit outsourcing; auditor judgment
    Purpose of the Study:

    Under Section 404 of the Sarbanes-Oxley Act (SOX), client management must evaluate the effectiveness of internal controls over financial reporting (ICOFR). In order to meet new regulations, many firms outsourced internal audit functions to third-parties. Auditing standards state that external auditors are required to evaluate the objectivity, competence, and work performed by internal auditors. Since third-party internal audit teams likely have different incentive and motives, compared to in-house internal audit teams, the external auditor may have different perceptions of each team’s objectivity. This study examines whether external auditors’ reliance on the work of outsourced internal auditors differs from the reliance of “in-house” internal auditors.

    Design/Method/ Approach:

    The authors collected their evidence via experimental cases administered to auditors from one of the Big 4 accounting firms. Approximately 21 percent were staff-level; 59 percent were senior staff, the other 20 percent were manager-level or higher. Data was collected prior to 2007.  Participants were provided background information about the hypothetical company, the internal audit team, and the audit procedures performed by the internal audit team. Participants were asked to evaluate the internal audit team’s competency and objectivity, as well as the amount of reliance to place on the internal audit team’s work.

    Findings:
    • When inherent risk is low, external auditors are just as likely to rely on “outsourced” internal audit work as “in-house” internal audit work. 
    • External auditors perceive “outsourced” internal audit work to be more objective than “in-house” internal audit work. 
    • When inherent risk is high, external auditors are more likely to rely on “outsourced” internal audit work as “in-house” internal audit work. 
    • External auditors are more willing to rely on internal auditors’ work when they perceive the internal auditors to be performing objective tasks, versus subjective tasks. (This is for both “in-house” and “outsourced” internal audit teams.) This difference in reliance between objective and subjective tasks is magnified when inherent risk is high.
    • However, when the task is subjective, the auditor relies less on the internal audit team’s work when inherent risk is high.
    Category:
    Internal Control, Governance
    Sub-category:
    Scope of Testing, Internal auditor role and involvement in controls and reporting
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