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    External Auditor Evaluations of Outsourced Internal...
    research summary posted October 20, 2015 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.03 Non-Audit Services, 13.0 Governance, 13.07 Internal auditor role and involvement in controls and reporting 
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    Title:
    External Auditor Evaluations of Outsourced Internal Auditors.
    Practical Implications:

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

    Citation:

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

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

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

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

    Design/Method/ Approach:

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

    Findings:

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

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

    Category:
    Governance, Independence & Ethics
    Sub-category:
    Internal auditor role and involvement in controls and reporting, Non-audit Services