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    Serving Two Masters: The Association between Audit Committee...
    research summary posted October 19, 2015 by Jennifer M Mueller-Phillips, tagged 13.0 Governance, 13.05 Board/Audit Committee Oversight, 13.06 Board/Audit Committee Processes, 13.07 Internal auditor role and involvement in controls and reporting 
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    Title:
    Serving Two Masters: The Association between Audit Committee Internal Audit Oversight and Internal Audit Activities.
    Practical Implications:

    The results speak to the need for regulators to consider the incentives of the various stakeholders when determining policy. Should policy makers consider expanding or restricting specific oversight roles, they should consider the concomitant effects on the internal audit function, and the differential incentives faced by the audit committee and executive management. In addition, as audit committees and managers jointly work or oversee the work of internal auditors, the results suggest that these two oversight participants should consider how their respective incentives potentially bias the focus of the internal audit department away from a mix of activities that optimally address the greater business risks of the company. Likewise, as external auditors assess the organizational status of the internal audit department, they may also wish to consider the apparent focus of internal audit as a potential indication of oversight control.

    Citation:

    Abbott, L. J., S. Parker, and G. F. Peters. 2010. Serving Two Masters: The Association between Audit Committee Internal Audit Oversight and Internal Audit Activities. Accounting Horizons 24 (1): 1-24.

    Keywords:
    internal auditing, audit committees, best practices, internal auditors
    Purpose of the Study:

    This study examines the association between the activities performed by the internal audit function (hereafter, IAF) and the extent of audit committee oversight of the IAF. Two primary concerns motivate this study. First, relatively little regulatory or best practices guidance relates to the distribution of IAF activities, and virtually no current research has been done about these activities. The authors believe this topic to be important because current New York Stock Exchange listing rules require registrants to maintain an IAF, increasing the pervasiveness of internal audit. The second motivation concerns the relatively incomplete set of audit-committee related regulations. In particular, the Sarbanes-Oxley Act of 2002 (SOX) requires audit committee oversight of internal controls over financial reporting and also mandates reporting on a registrant’s internal controls. However, SOX is silent on internal audit, a key participant in both the financial reporting process and the internal control structure. Moreover, SOX does not address internal audit’s reporting relationship with the audit committee or the audit committee’s duties concerning internal audit resources.

    Design/Method/ Approach:

    The survey questionnaire was mailed to Fortune 1000 companies, after excluding banks. Consistent with much prior internal audit research, the survey was directed to CIAs. The first survey was sent in July 2006 and resulted in a total of 72 usable responses. A follow-up mailing was conducted in September 2006 and produced an additional 62 usable responses. This lead to the final sample size of 134 observations.

    Findings:

    The authors find that the percentage of the IAF budget devoted to internal-controls-based activities is positively related to the measure of the audit committee’s oversight. In particular, audit committees with greater IAF oversight are associated with larger percentages of IAF hours being allocated toward internal controls activities. Moreover, the results suggest that a significant number of Fortune 1000 companies have audit committees that appear to have little oversight of the IAF. This speaks to the relevance and timeliness of the recommendations of numerous parties concerning audit committee internal audit termination/hiring rights and budgetary controls.

    The authors also document significant differences in the allocation of IAF budgets across different activities, an area with very little prior research. They find that the majority of the IAF budget is devoted to internal controls activities, but the remainder, allocated to non-controls activities, is considerable. The evidence indicates that outsourcing arrangements are quite prevalent, but are also quite specific. In particular, the majority of outsourcing hours were spent on Section 404- related activities, with a lesser portion devoted to assisting the external auditor with the financial statement audit. The results suggest that an audit committee’s demand for better internal controls may lead to greater IAF focus on internal controls. 

    Category:
    Governance
    Sub-category:
    Board/Audit Committee Oversight, Board/Audit Committee Processes, Internal auditor role and involvement in controls and reporting