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  • 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 in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    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
    Chief Audit Executives Assessment of Internal Auditors’ P...
    research summary posted February 17, 2015 by Jennifer M Mueller-Phillips, tagged 13.0 Governance, 13.07 Internal auditor role and involvement in controls and reporting, 14.0 Corporate Matters, 14.11 Audit Committee Effectiveness in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Chief Audit Executives Assessment of Internal Auditors’ Performance Attributes by Professional Rank and Cultural Cluster
    Practical Implications:

    These results suggest that a generic profile for internal auditors, regardless of industry, may be in order. However, for a small minority of the attributes for which industry may have effects, industry-specific guidance may be appropriate. This conclusion suggests future studies of industry-specific effects for the purpose of developing industry-specific guidance. The IIA’s (2009) Internal Auditor Competency Framework has no industry-specific guidance, and it has indicated that such information will be added when available.

    An interesting finding in the study is that attributes such as financial analysis, research skills, and statistical sampling that have theoretical appeal to the practice of internal auditing were not selected by the CAEs as most important attributes. This result may be an artifact of limiting the selection of the attributes to the top five from each category of behavioral, technical, and competencies. The differences may also be due to the effects of culture.

    For more information on this study, please contact Mohammad J. Abdolmohammadi

    Citation:

    Abdolmohammadi, M.J. 2012. Chief Audit Executives Assessment of Internal Auditors’ Performance Attributes by Professional Rank and Cultural Cluster. Behavioral Research in Accounting 24(1): 1-23.

    Keywords:
    internal auditor attributes; professional rank; culture
    Purpose of the Study:

    This study explores chief audit executives’ perceptions of the most important performance attributes of internal auditors by professional rank and cultural cluster. Specifically, I investigated the following research questions:

    1. What are the most important performance attributes of internal auditors?
    2. Does the importance of performance attributes differ by internal auditors’ professional rank?
    3. Does the importance of performance attributes of internal auditors differ by cultural cluster?
    Design/Method/ Approach:

    The source of data for this study is the IIA’s CBOK (2006) database. This database contains responses from internal auditors of varying ranks practicing in over 100 countries. The IIARF developed this database in 2006 as a comprehensive study of the current state of the internal auditing profession worldwide. The data collected range from personal attributes of internal auditors (e.g., education), to the characteristics of their organizations (e.g., number of employees), to the internal and external quality assessment of the internal audit function. Included are data on 43 performance attributes of internal auditors.

    I identified 19 countries that could be classified into five distinct cultural clusters for investigation. Specifically, two criteria were used to select countries for the current study. First, the country to be selected had to be clearly identifiable with a specific cultural cluster. Second, to be included, a cultural cluster had to be represented by at least ten observations in the CBOK (2006) database so as to have sufficient data for statistical analysis. The resulting sample used in this study consists of 1,497 responses from CAEs in 19 countries classified into five distinct cultural clusters. The Anglo-Saxon cluster has the largest number of CAE responses with 913 observations, while the East-European cluster has only 58 responses. Within various clusters, Venezuela, with seven responses, has the smallest sample size, and the U.S., with 760 responses, has the largest sample size.

    Findings:

    The results show that while leadership attributes increase in importance by professional rank, technical skills generally decrease in importance by professional rank. The results also indicate that importance of performance attributes differs by cultural cluster. Robustness of the main results were confirmed through various multivariate analyses, where significant interaction effects between cultural cluster and professional rank were found. However, industry-specific analysis indicated no pattern of industry differences for the vast majority of performance attributes.

    Category:
    Corporate Matters, Governance
    Sub-category:
    Audit Committee Effectiveness, Internal auditor role and involvement in controls and reporting
  • Jennifer M Mueller-Phillips
    Chief Audit Executives’ Evaluations of Whistle-Blowing A...
    research summary posted October 24, 2013 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.05 Impact of SOX, 12.0 Accountants’ Reports and Reporting, 12.04 Investigations, 13.0 Governance, 13.07 Internal auditor role and involvement in controls and reporting in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Chief Audit Executives’ Evaluations of Whistle-Blowing Allegations
    Practical Implications:

    The findings of this study should be of interest to boards of directors, audit committees, and senior management who are accountable to investors and other parties for the timely and unbiased examination of whistle-blowing allegations. Prior research has shown that audit committee members can be biased in their evaluations of whistle-blower allegations and in the allocation of resources to investigate those allegations. However, the results of this study show that CAEs do not exhibit the same bias as audit committee members for allocating resources to investigate whistle-blower allegations. The audit committee often relies on the CAE to investigate whistle-blowing reports, and this study suggests that CAEs may be a better choice for managing the evaluation of whistle-blowing allegations relative to members of the audit committee. CAEs’ decisions are not shrouded in secrecy, and CAEs report to both management and the audit committee, creating multiple levels of accountability. They are less able to ignore allegations that pose personal threats than are directors.

    Citation:

    Guthrie, C. P., C. S. Norman, and J. M. Rose. 2012. Chief Audit Executives’ Evaluations of Whistle-Blowing Allegations. Behavioral Research in Accounting 24(2): 87-99.

    Keywords:
    Chief audit executive; internal controls; whistle-blowing.
    Purpose of the Study:

    Section 301(4) of the Sarbanes-Oxley Act of 2002 (SOX) requires that public companies establish procedures for receiving and reviewing complaints regarding accounting and controls, and SOX requires firms to establish a confidential and anonymous channel for reporting such complaints. Prior research has shown that audit committee members evaluate anonymous whistle-blower allegations as less credible than non-anonymous allegations. Additionally, prior research has shown that when whistle-blowing allegations threaten the reputations of corporate directors, the directors justify decisions to limit the investigation of allegations by ascribing low levels of credibility to the allegation. Therefore, the purpose of this study was to evaluate how Chief Audit Executives (CAE) evaluate whistle-blowing allegations and whether CAEs are subject to the same judgment biases that audit committee members exhibit. The authors studied CAE credibility assessments of:

    • Anonymous vs. non-anonymous whistle-blower allegations.
    • Whistle-blower allegations that threaten the reputations of the CAE.

    The authors also evaluated the amount of resources that CAEs planned to allocate to investigate these whistle-blower allegation reports.
     

    Design/Method/ Approach:

    The authors conducted an experiment that took place sometime before March 2012 with CAEs and deputy CAEs from both public and private companies. The participants had an average of 12.76 years of internal audit experience. About 60 percent of the participants were CPAs and about 50 percent of the participants were CIAs. The participants read a case in which they were informed of a whistle-blower allegation that management of the organization had committed fraud, and the participants then assessed the credibility of the allegation and allocated resources to investigate the claim. 

    Findings:
    • The CAEs ascribed a lower level of credibility to anonymous whistle-blowing reports relative to non-anonymous reports.
    • When the allegations threatened their reputations (meaning that the whistle-blowing reports suggested the wrongdoing was perpetrated by the exploitation of weaknesses in previously evaluated internal controls rather than by the circumvention of internal controls) CAEs further lowered their assessed credibility of the allegations.
    • CAE perceptions of lower credibility for allegations that threatened their reputations did not lead the CAEs to make smaller allocations of resources to investigating these allegations. In fact, the CAEs allocated more resources to allegations for which they would be held more responsible.
       
    Category:
    Accountants' Reporting, Governance, Standard Setting
    Sub-category:
    Impact of SOX, Internal auditor role and involvement in controls and reporting, Investigations
  • Jennifer M Mueller-Phillips
    Corporate Managers’ Reliance on Internal Auditor R...
    research summary posted October 15, 2013 by Jennifer M Mueller-Phillips, tagged 13.0 Governance, 13.07 Internal auditor role and involvement in controls and reporting in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Corporate Managers’ Reliance on Internal Auditor Recommendations
    Practical Implications:

    One of the main implications of the study is that the internal audit function does add value to an organization because their recommendations can significantly impact managers’ operational decisions. The study also finds that in-house internal auditors can improve their influence on management by quantifying their recommendations.

    For more information on this study, please contact F. Greg Burton.
     

    Citation:

    Burton, F. G., S. A. Emett, C. A. Simon, and D. A. Wood. 2012. Corporate Managers’ Reliance on Internal Auditor Recommendations. Auditing: A Journal of Practice and Theory 31(2): 151-166.

    Keywords:
    Internal audit; in-house; outsourcing; competence; objectivity
    Purpose of the Study:

    Internal auditors provide both assurance and consulting services to add value and improve the operations of an organization. In order to add value through consulting services, internal auditors must make credible recommendations and effectively communicate those recommendations to management. Therefore, the purpose of the study was to understand the factors that influence managers’ perceptions of and reliance on internal audit consulting recommendations. The factors that the authors studied included:

    • Whether internal auditor recommendations are consistent or not with managers’ initial preferences
    • Whether the internal audit function is performed in-house or outsourced
    • Whether the recommendations are quantified or non-quantified.
       
    Design/Method/ Approach:

    The authors conducted an experiment with business professionals that held either senior or mid-level manager positions in their companies. The participants had an average of 9.12 years of work experience. Participants were given a case study about a plastics company and were given the role of a supervising manager of the company. Managers made an initial operational decision and then were presented with information from internal audit and asked to make their final decision.

    Findings:

    The authors found the following results:

    • Managers change their initial positions more when presented with preference-inconsistent recommendations.
    • There are no differences in managers’ reliance on the non-quantified, preference-inconsistent recommendations of outsourced versus in-house internal auditors.
    • Managers rely more on the quantified recommendations of in-house internal auditors than the non-quantified recommendations of in-house internal auditors. The authors did not find this same effect for outsourced internal auditors.
       
    Category:
    Governance
    Sub-category:
    Internal auditor role and involvement in controls and reporting
  • Jennifer M Mueller-Phillips
    Correlates of Co-Sourcing/Outsourcing of Internal Audit...
    research summary posted February 20, 2015 by Jennifer M Mueller-Phillips, tagged 13.0 Governance, 13.07 Internal auditor role and involvement in controls and reporting, 14.0 Corporate Matters, 14.11 Audit Committee Effectiveness in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Correlates of Co-Sourcing/Outsourcing of Internal Audit Activities
    Practical Implications:

    The primary result that audit committee involvement is significantly and positively associated with “outsourcing” is an important finding that suggests a need for management to pay close attention to the role that audit committee plays in “outsourcing” internal audit activities. The significance of value-added-activities, missing-skill-set, and audit-staff-vacancies on “outsourcing” also require management attention because collectively these three variables indicate trade-offs between acquiring the expertise in-house or “outsourcing” to external service providers.

    For more information on this study, please contact Mohammad Abdolmohammadi

    Citation:

    Abdolmohammadi, M. 2013. Correlates of Co-Sourcing/Outsourcing of Internal Audit Activities. Auditing: A Journal of Practice and Theory 32(3): 69-85.

    Keywords:
    Outsourcing, internal audit activities, audit committee involvement, missing skill set
    Purpose of the Study:

    I use responses from 1,059 chief audit executives (CAEs) of organizations located in Australia, Canada, New Zealand, South Africa, the U.K./Ireland, and the U.S. to investigate several correlates of co-sourcing/outsourcing (referred to as simply “outsourcing”) of internal audit activities. 

    Design/Method/ Approach:

    In 2010 the Institute of Internal Auditors Research Foundation (IIARF) conducted a survey of IIA’s membership world-wide. The long survey had detailed questions about various issues from CAE attributes, organization characteristics, to practice issues such as “outsourcing.” Called the Common Body of Knowledge in Internal Auditing or CBOK (2010), this database has responses from internal auditors of varying experience and professional rank. I only use CAE responses for my study of “outsourcing” because CAEs are presumed to be highly knowledgeable about various issues of internal audit activities, including “outsourcing.” While CBOK (2010) has over 13,500 responses from members of various professional rank (CAEs, audit managers, etc.) in over 100 countries, I limit the data used in my study to only CAEs from Anglo-culture countries. This is to mitigate the possibility of differences due to various languages and cultural dimensions, such as uncertainty avoidance, levels of femininity/masculinity, etc.  

    Findings:
    • An important finding of the study is that audit committee involvement is positively and significantly associated with “outsourcing” of internal audit activities. Interactions of audit committee involvement with organization size and location generally indicate that medium and large international/multinational organizations with audit committee involvement “outsource” more than medium and large local/national organizations with no audit committee involvement.
    • Other important findings indicate an inverse relationship between “outsourcing” and value-added-activities of the internal audit function, and positive relationships between “outsourcing” and missing skill set and audit staff vacancies.
    • Finally, I find no evidence of relationships between CAE age, college degree (graduate/undergraduate), major (accounting versus others), internal audit certification, and regular meetings with the audit committee and “outsourcing.” Also, country of residence (U.S. versus other Anglo-culture countries) is not significant, but for-profit organizations “outsource” significantly more of their internal audit activities than not-for-profit organizations.
    Category:
    Corporate Matters, Governance
    Sub-category:
    Audit Committee Effectiveness, Internal auditor role and involvement in controls and reporting
  • The Auditing Section
    Discussion of “Internal Audit Sourcing Arrangement and the E...
    research summary posted May 7, 2012 by The Auditing Section, tagged 07.0 Internal Control, 07.01 Scope of Testing, 13.0 Governance, 13.07 Internal auditor role and involvement in controls and reporting in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Discussion of “Internal Audit Sourcing Arrangement and the External Auditor’s Reliance Decision”
    Practical Implications:

    The points noted below suggest some limitations in Glover, Prawitt & Wood (2008) article. However, Messier acknowledges that the article provides insight on some factors that might affect the external auditors’ reliance decisions under AS 5.

    Citation:

    Messier, W. F. 2008. Internal Audit Sourcing Arrangement and the External Auditor’s Reliance Decision. Contemporary Accounting Research 25 (1) 215-218.

    Purpose of the Study:

    This is a discussion of the Glover et al. article (2008). The comments are based on Messier’s comments provided during the 2006 Contemporary Accounting Research Conference.

    Findings:
    • Glover, Prawitt, & Wood (2008) used a first-year audit scenario for their experiment. Messier suggests that auditors are more conservative in first-year audits. This conservative nature may have caused the auditors (participants) to assess the internal audit work as relatively low in terms of reliability. 
    • Messier suggests that the evaluation of “task subjectivity” may be confounded with the auditors’ consideration of the type of work performed, in accordance with SAS No. 65. (The “objective task” was control testing; the “subjective task” was inventory valuation.) This may limit the implications for the findings related to task objectivity/subjectivity, noted above.
    Category:
    Internal Control, Governance
    Sub-category:
    Scope of Testing, Internal auditor role and involvement in controls and reporting
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  • Jennifer M Mueller-Phillips
    Does Internal Audit Function Quality Deter Management...
    research summary posted July 27, 2015 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.04 Management Integrity, 13.0 Governance, 13.07 Internal auditor role and involvement in controls and reporting in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Does Internal Audit Function Quality Deter Management Misconduct?
    Practical Implications:

    These findings suggest that regulators, audit committees, and other stakeholders should consider ways to improve IAF quality, specifically IAF competence, and IAFs improve corporate governance by assisting audit committees in monitoring management. This study provides empirical evidence consistent with the proposition that IAF quality and competence deter management misconduct. IAF quality and, particularly, IAF competence are important in deterring observable instances of management misconduct, both accounting- and nonaccounting-related. These findings are important because in the early 2000s, regulators responded to public outcry over observable management misconduct, yet IAF quality was largely left out of the regulatory debate and reforms that followed.

    Citation:

    Ege, M. S. 2015. Does Internal Audit Function Quality Deter Management Misconduct? Accounting Review 90 (2): 495-527.

    Keywords:
    corporate governance, internal audit function, internal audit quality, management misconduct
    Purpose of the Study:

    This study examines the relation between internal audit function (IAF) quality, as defined by standard-setters, and the likelihood of management misconduct, such as financial reporting fraud, bribery, and misleading disclosure practices. Standard-setters posit that IAFs serve as a key resource to audit committees for monitoring senior management and that high-quality IAFs deter management misconduct. However, U.S. regulators do not enforce IAF quality or require disclosures relating to IAF quality. The U.S. Securities and Exchange Commission (SEC) proposed requirements to increase IAF quality by adding the appointment, compensation, retention, and oversight of the internal auditor to audit committee responsibilities, but these proposed requirements were abandoned. Ten years later, after withdrawing its recent proposal to require high-quality IAFs, NASDAQ is considering how to revise the proposed rules. These proposals demonstrate the need for evidence regarding whether IAF quality results in improved monitoring of management.

    This study informs standard-setters, regulators, audit committees, and shareholders about whether IAF quality deters management misconduct incrementally to other monitors.

    Design/Method/ Approach:

    The author obtained the initial sample from the Institute of Internal Auditors’ proprietary Global Auditing and gathered additional information from COMPUSTAT. The final sample covers 1,398 firm-years representing 617 unique firms from 2000 through 2009. The management misconduct sample comes from four data sources: the Federal Securities Regulation Database, the Stanford Securities Class Action Clearinghouse, SEC’s website and the Department of Justice website.

    Findings:

    The author finds a negative relation between IAF quality and management misconduct, even after controlling for other determinants of misconduct, including board of director, audit committee, and external auditor quality. This effect is economically significant, as a firm with IAF quality one standard deviation above the mean is approximately 2.3 percentage points less likely to have management misconduct than a firm with average IAF quality. This is approximately 29.5 percent of the 7.7 percent unconditional probability of management misconduct. Further analysis reveals that IAF competence, but not objectivity, is negatively related to the likelihood of management misconduct, suggesting that IAF competence is important in deterring management misconduct.

    Misconduct firms have low IAF quality and IAF competence during misconduct years as compared to a matched sample of firms. Then, in post-misconduct years, misconduct firms increase IAF quality through IAF competence. This increase in competence is due to hiring more certified internal auditors and increasing training. However, misconduct firms do not appear to have lower IAF objectivity during or after misconduct years compared to a matched sample. These results are consistent with the proposition from standard-setters that IAFs serve as a key resource for audit committees in monitoring management.

    The findings suggest that high-quality IAFs are effective at deterring both types of management misconduct. Disclosures related to IAF quality would assist stakeholders in predicting accounting-related management misconduct.

    Category:
    Governance, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Internal auditor role and involvement in controls and reporting, Management Integrity
  • Jennifer M Mueller-Phillips
    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 in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    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
  • The Auditing Section
    Internal Audit Quality and Earnings Management
    research summary posted May 7, 2012 by The Auditing Section, 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 in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Internal Audit Quality and Earnings Management
    Practical Implications:

    This study develops an empirical measure of internal audit quality, and provides evidence supporting companies’ use and  development of an IAF as part of improvements to its overall governance environment.  Regulators and other parties interested in corporate governance may find it helpful to more explicitly consider the role of internal auditor in the evaluation of the firm. 

    Citation:

    Prawitt, D., J. Smith, D. A. Wood 2009. Internal Audit Quality and Earnings Management. The Accounting Review 84 (4): 1255-1280.

    Keywords:
    corporate governance; internal audit function; internal audit quality; earnings management; abnormal accruals; analyst forecasts
    Purpose of the Study:

    Standards promulgated by the AICPA and PCAOB recognize the impact that a high-quality internal audit function (IAF) can have on reducing control risk, and by extension, audit risk.  As such, regulators permit and encourage external auditors to rely on the work of others if that work is deemed to be performed by “competent and objective persons” (PCAOB 2007).  Similarly, the Institute of Internal Auditors (IIA) recognizes the IAF as one of the four cornerstones of corporate governance, along with the audit committee, executive management, and the external auditor.  However, while several prior studies establish a negative association between the quality of firm’s corporate governance mechanisms and management’s tendency and ability to manipulate reported financial results, there is little evidence that relies on archival data concerning the impact of a quality IAF on firms’ earnings manipulation activities.

    The purpose of this study is to examine archival data to determine whether differences in the quality of firms’ IAF impact firms’ earnings management activities.

    Design/Method/ Approach:

    The authors rely on the IIA maintained GAIN database (a proprietary database), that is composed of survey responses from chief audit executives associated with IIA member organizations.  Member organizations responding to the survey include publicly traded and private companies, educational and governmental institutions, as well as individual divisions within companies.  The study covers the fiscal years of 2000-2005. 

    The authors create an index based on six factors that SAS No. 65 suggests external auditors should consider when evaluating whether to rely on the work of the internal auditors, and therefore differentiate IAF quality.  Those factors include the IAF’s professional experience, professional certifications, training, objectivity, relevance of their work to the financial reporting function, and the IAF’s relevance to the organization based on how much resources the corporation invests in the IAF group.  To capture management’s earnings management activities, the authors rely on measures of abnormal accruals and whether the firm just misses or beats analysts’ forecasts.

    Findings:
    • Overall, the results suggest that higher quality IAFs reduce management’s ability to manipulate earnings.
    • Specifically, higher quality IAFs appear to be associated with smaller negative abnormal accruals.
    • Companies with higher quality IAFs appear more likely to just miss analysts’ earnings forecasts, a measure of less earnings management.
    Category:
    Auditing Procedures - Nature - Timing and Extent, Governance
    Sub-category:
    Reliance on Internal Auditors, Internal auditor role and involvement in controls and reporting
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  • 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 in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    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