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    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 
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    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