The Effect of Frequency and Automation of Internal Control Testing on External Auditor Reliance on the Internal Audit Function

2015 ◽  
Vol 30 (1) ◽  
pp. 21-40 ◽  
Author(s):  
Maia J. Farkas ◽  
Rina M. Hirsch
Keyword(s):  
Internal Control ◽  
Work Performance ◽  
Internal Audit ◽  
Internal Controls ◽  
External Auditors ◽  
Internal Audit Function ◽  
Remediation Strategies ◽  
Low Degree ◽  
External Auditor ◽  
Manual Testing

ABSTRACT Failure of the internal audit function (IAF) to detect a significant deficiency in internal controls is a significant shortcoming in the IAF's work performance. This shortcoming in the IAF's work performance reduces external auditors' willingness to rely on the IAF's work. Using a two-stage experiment, we investigate how the implementation of three different internal control testing remediation strategies (akin to CCM, ACL, and periodic manual testing), which vary in their automation and frequency, affect external auditors' perceptions of IAF strength and planned reliance on the IAF's work. We find that automated remediation strategies fully remediate external auditors' perceptions of poor IAF work performance and low degree of reliance on the IAF, whereas manual remediation strategies result in only partial remediation. Counterintuitively, less frequent remediation strategies are more effective at improving perceptions of poor IAF work performance and low levels of reliance on the IAF, relative to continuous remediation strategies.

External Auditors' Involvement in the Internal Audit Function's Work Plan and Subsequent Reliance Before and After a Negative Audit Discovery

2016 ◽  
Vol 35 (4) ◽  
pp. 159-173 ◽  
Author(s):  
Byron J. Pike ◽  
Lawrence Chui ◽  
Kasey A. Martin ◽  
Renee M. Olvera
Keyword(s):  
Internal Control ◽  
Internal Audit ◽  
Internal Controls ◽  
Professional Standards ◽  
Data Availability ◽  
Internal Auditors ◽  
External Auditors ◽  
Internal Audit Function ◽  
Anchoring Bias ◽  
Before And After

SUMMARY To reduce redundancies and increase efficiency in the evaluation of internal controls (PCAOB 2007, 402–403), professional standards encourage coordination between external auditors and their clients' internal audit function (IAF). Recent surveys of internal auditors find that a component of this coordination is external auditors' involvement in developing the IAF's audit plans. Nevertheless, it is not known how such involvement affects external auditors' reliance on the internal control test work of the IAF, either before or after a negative audit discovery. Based on an experiment with 107 experienced auditors, we find that external auditors involved in the development of the IAF's audit plan perceive the IAF as more objective and that both objectivity and involvement contribute to these auditors' placing more reliance on the IAF as compared to external auditors with no involvement. This initial reliance results in the involved auditors' proposing reductions to the audit budget and re-performing less of the IAF's work. Consistent with an anchoring bias, we find that involvement leads to external auditors' continuing to place greater reliance on the IAF's work, even after they become aware of a negative audit discovery that should not have occurred had the client's controls been effective. Data Availability: Data are available from the authors on request.

scholarly journals Does Internal Audit Function Quality Deter Management Misconduct?

2014 ◽  
Vol 90 (2) ◽  
pp. 495-527 ◽  
Author(s):  
Matthew S. Ege
Keyword(s):  
Internal Control ◽  
Audit Committee ◽  
Internal Audit ◽  
Audit Committees ◽  
Regulatory Requirements ◽  
Difference In Differences ◽  
External Auditors ◽  
Internal Audit Function ◽  
Auditor Quality ◽  
External Auditor

ABSTRACT Standard-setters believe high-quality internal audit functions (IAFs) serve as a key resource to audit committees for monitoring senior management. However, regulators do not enforce IAF quality or require disclosures relating to IAF quality, which is in stark contrast to regulatory requirements placed on boards, audit committees, and external auditors. Using proprietary data, I find that a composite measure of IAF quality is negatively associated with the likelihood of management misconduct even after controlling for board, audit committee, and external auditor quality. This result is robust to a variety of other specifications, including controlling for internal control quality and separate estimation during the pre- and post-SOX time periods. A difference-in-differences analysis indicates that misconduct firms have low IAF quality and competence during misconduct years and improve IAF quality and competence in the post-misconduct years. These findings suggest that regulators, audit committees, and other stakeholders should consider ways to improve IAF quality.

Factors influencing stakeholder’s judgment on internal audit function’s effectiveness and reliance

2021 ◽  
Vol ahead-of-print (ahead-of-print) ◽  
Author(s):  
Khurram Ashfaq ◽  
Shafique Ur Rehman ◽  
Moeez Ul Haq ◽  
Muhammad Usman
Keyword(s):  
Internal Control ◽  
Mixed Method ◽  
Work Performance ◽  
Qualitative Data ◽  
Internal Audit ◽  
Internal Controls ◽  
Significant Relation ◽  
Internal Auditor ◽  
Content Type ◽  
External Auditor

Purpose This study aims to explore the effectiveness and reliability of the performance of internal auditor by the stakeholders for their decision making. The absence of rules and regulations generates the debate that the non-standard reporting of the assessment of the internal controls system’s assessment by internal auditor and reliance by the external auditor. Design/methodology/approach The study used the mixed-method (triangulation) for the analysis quantitative data was used for regression with Smart PLS 3.2.8, and the qualitative data was used to prove and strengthen the results. The data is collected for five IVs (Objectivity of IAF, Work Performance, Competence, Internal Control System’s Assessment and Sourcing of IAF) and their impact on two DVs (Effectiveness and Reliance). This study used five areas as the target audience (Internal Auditor, External Auditor, Professional bodies, Shareholders, SECP and SBP). A total of 150 respondents were approached and received a valid response of 98 respondents. Findings The study explores the positive relationship between Objectivity of IAF, Work Performance, Competence, Sourcing of IAF on Effectiveness and Reliance. Internal Control System’s Assessment having significant relation with Effectiveness and non-significant with reliance because the absence of rules makes it unreliable for stakeholders. Originality/value The study found that the system for reporting the internal control needs rules and regulations advancement on the immediate basis for the betterment and safeguard of stakeholders to avoid the events like WorldCom and ENRON.

scholarly journals An Examination Of Underreporting Of Time And Premature Signoffs By Internal Auditors

2010 ◽  
Vol 14 (4) ◽  
Author(s):  
Qianhua (Q) Ling ◽  
Michael D. Akers
Keyword(s):  
Internal Audit ◽  
Internal Controls ◽  
Professional Skepticism ◽  
Internal Auditors ◽  
External Auditors ◽  
Considerable Research ◽  
Internal Audit Function ◽  
Sarbanes Oxley ◽  
Audit Team ◽  
The Impact

The passage of the Sarbanes-Oxley Act of 2002 (SOX) heightened the importance of internal controls and accordingly, a key control - the internal audit function.  Consequently, management and external auditors have both increased their reliance on internal auditors’ work.  While there has been considerable research regarding the impact of the underreporting of time and premature sign-offs on the external audit, there has only been one study that has examined the impact of these two items on the internal auditors’ work.  Such research is dated (1994) and prior to the passage of SOX.  We surveyed members of the Institute of Internal Auditors (IIA) in the Midwest to examine their behavior and perceptions regarding these two items.  The respondents in our study believe the underreporting of time is unethical and is supported by their reporting of all time worked, even if such time exceeded the budget.  Our findings also show that the respondents feel premature sign-offs are unethical and result primarily from lack of professional skepticism and inadequate training.  Increasing training in audit areas and improving communications within the audit team are possible solutions to reduce premature sign-offs.  Premature sign-offs are more likely to occur in operational audits and to a lesser degree in financial audits and compliance audits. 

scholarly journals The Reliance of External Auditors on Internal Audit's Use of Continuous Audit

2014 ◽  
Vol 29 (1) ◽  
pp. 95-114 ◽  
Author(s):  
Irina Malaescu ◽  
Steve G. Sutton
Keyword(s):  
Internal Control ◽  
Internal Audit ◽  
Economic Consequences ◽  
Automated Control ◽  
Material Weakness ◽  
Internal Auditor ◽  
External Auditors ◽  
Prior Literature ◽  
External Auditor ◽  
The Impact

ABSTRACT As a response to the increased demand for timely and ongoing assurance over the effectiveness of risk management and control systems, companies are moving toward a more automated control environment through the implementation of continuous audit modules. The purpose of this study is to evaluate external auditors' reliance on internal audit's work when advanced audit techniques are introduced by the internal auditor and the impact this reliance has on budgeted audit hours. Prior literature suggests that internal control deficiencies also have an impact on external auditor reliance and the audit budget. The reliance decision of an external auditor has important economic consequences and implications for efficiency and effectiveness of the overall audit. In recent years, the PCAOB has encouraged greater such reliance to improve audit efficiency. An experiment is conducted with 87 experienced external auditors to investigate the theorized effects. Using a 2 × 2 between-subjects factorial design, the frequency of the internal audit (traditional versus continuous audit) and prior year material weakness (absent versus present) are manipulated. Consistent with predictions, we find that auditors are willing to rely more on internal audit work in a continuous audit environment than in a traditional environment, and this effect is magnified when the prior year audit report on the effectiveness of internal controls indicates that controls are working properly. The presence of a material weakness, however, negatively impacts judgments on the budget for the valuation of a complex account. In addition, both material weakness and continuous audit have an impact on the overall audit budget, which is reduced only when the company has no prior year material weakness and a functioning continuous audit module is put in place. The results show that auditors increase budgeted hours for the engagement at a higher rate when the client uses traditional internal audit procedures.

A Summary of Research on External Auditor Reliance on the Internal Audit Function

2012 ◽  
Vol 32 (Supplement 1) ◽  
pp. 251-286 ◽  
Author(s):  
Charles W. Bame-Aldred ◽  
Duane M. Brandon ◽  
William F. Messier ◽  
Larry E. Rittenberg ◽  
Chad M. Stefaniak
Keyword(s):  
Audit Quality ◽  
Internal Audit ◽  
Quality Factors ◽  
Revenue Recognition ◽  
External Auditors ◽  
Internal Audit Function ◽  
Public Company ◽  
Specific Factors ◽  
External Auditor ◽  
Task Environments

SUMMARY Public Company Accounting Oversight Board (PCAOB) Auditing Standard No. 5 (AS5) allows external auditors (EAs) to rely on the internal audit function (IAF) when the internal audit activities meet certain criteria and the EAs would find efficiencies in relying on their work (PCAOB 2007). This paper reviews the extant literature on the EAs' reliance on IAF, identifies gaps in the literature, and proposes a series of research questions aimed at closing these gaps. We focus our review on research pertaining to how environmental factors and IAF-specific factors influence initial EAs' reliance decisions, the nature and extent of EAs' reliance on IAF, and the observable outcomes as a result of EAs' reliance decisions. Our review finds that the environment in which EAs must make a reliance decision is complex—involving several factors that must be considered simultaneously. Moreover, an evolving set of auditing standards introduces several necessary intermediary judgments that the EAs must process before, and during, reliance on the IAF. In addition, our review indicates that we continue to know very little about how, and to what extent, EAs are currently evaluating IAF's quality factors. Similarly, while we find that the nature and extent of EAs' reliance on IAF is influenced by account risk, inherent risk, and IAF sourcing, how the EAs choose task environments (e.g., revenue recognition versus payroll), and the types of tests to be relied upon within these task environments, is not completely understood. Finally, we find that there is a paucity of research concerning the effects of EAs' reliance on IAF in terms of external audit quality.

scholarly journals Outsourcing of internal audit and independence of auditors

2008 ◽  
Vol 4 (2) ◽  
pp. 40-49
Author(s):  
Arumugam Seetharaman ◽  
M. Krishna Moorthy ◽  
A.S. Saravanan
Keyword(s):  
Internal Audit ◽  
Audit Process ◽  
Front Seat ◽  
External Auditors ◽  
Internal Audit Function ◽  
External Auditor ◽  
The Impact

Internal audit which is an integral part of any organization has long been overlooked. In fact, most organizations look at internal audit as a routine function in an organization. However, in the recent years, internal audit has taken a front seat for many organizations. Others are also looking at various options such as outsourcing of the internal audit function of their organizations. However, where outsourcing is concerned, one important issue arises, which is the independence of the external auditor to perform the internal audit function. This paper takes a look at the various aspects of the internal audit process as well as the impact and independence of external auditors who perform internal audit.

Internal Audit Assistance and External Audit Timeliness

2012 ◽  
Vol 31 (4) ◽  
pp. 3-20 ◽  
Author(s):  
Lawrence J. Abbott ◽  
Susan Parker ◽  
Gary F. Peters
Keyword(s):  
Internal Control ◽  
Audit Quality ◽  
Resource Constraints ◽  
Cost Savings ◽  
Internal Audit ◽  
External Audit ◽  
External Auditors ◽  
Audit Fee ◽  
External Auditor ◽  
Regulatory Filing

SUMMARY Professional standards guide external auditors to consider the effect of the client's internal audit work and opportunities to utilize the direct assistance of the internal audit function when planning and conducting audits. We examine the effect of internal audit assistance on external audit timeliness via the extent of external audit delay. We hypothesize and find that internal audit assistance is negatively associated with external audit delay. We also document moderating relationships between internal audit assistance and other internal audit environment characteristics, such as the extent of internal control reliance, coordination with the external auditor, and the investment in internal audit quality. Overall, our findings have implications for firms and external auditors who are evaluating the role and use of internal audit functions. Namely, our findings suggest that internal audit assistance may not only result in audit cost savings, but also in greater audit efficiencies. These findings are particularly germane given the challenges faced by external auditors in the form of greater audit requirements, shorter regulatory filing deadlines, resource constraints, and audit fee pressures.

A Multistage Approach to External Auditors' Evaluation of the Internal Audit Function

2002 ◽  
Vol 21 (1) ◽  
pp. 95-121 ◽  
Author(s):  
Ganesh Krishnamoorthy
Keyword(s):  
Work Performance ◽  
Internal Audit ◽  
Bayesian Probability ◽  
Future Research ◽  
Major Conclusion ◽  
Internal Auditors ◽  
External Auditors ◽  
Internal Audit Function ◽  
Auditing Standards ◽  
Inference Theory

External auditors are continually facing intense pressure to be more efficient in conducting audits without compromising quality and effectiveness. Optimal utilization of internal audit work can improve both the efficiency and the effectiveness of external audits and can enhance the value of internal auditors to the client organization. The objective of this study is to understand how the three factors (objectivity, work performance, and competence of the internal auditors) identified by auditing standards and by prior research interact in determining the strength of the internal audit function. Most prior studies have attempted to understand external auditors' rank ordering of the importance of the three factors, without an explicit attempt to model the interactions among the factors. The results from these studies are mixed and inconclusive. Hence, prior studies have not produced a consensus about how external auditors seem to weight and combine these factors in order to make assessments relating to the strength of the internal audit function. This study employs analytical methods based on Bayesian probability to model external auditors' evaluation of the internal audit function. Specifically, models based on multistage (cascaded) inference theory are developed and analyzed using numerical sensitivity analysis. The modeling contribution is significant in the sense that it is the only study that provides a theoretical model for the decision process. Results reveal that the importance of the three factors varies with the type of evidence (convergent or conflicting) observed and is contingent on the interrelationships among the three factors. A major conclusion of this study is that in the Bayesian context, it is futile to attempt a ranking of the factors since no single factor will dominate under all conditions. The study also provides avenues for future research and for improving the guidance provided by professional auditing standards that relate to the evaluation of internal audit work.

Effects of reporting relationship and type of internal control deficiency on internal auditors’ internal control evaluations

2018 ◽  
Vol 33 (3) ◽  
pp. 318-335 ◽  
Author(s):  
Audrey Gramling ◽  
Arnold Schneider
Keyword(s):  
Internal Control ◽  
Audit Committee ◽  
Internal Audit ◽  
Internal Controls ◽  
Material Weakness ◽  
Content Type ◽  
Internal Auditors ◽  
Tone At The Top ◽  
Internal Audit Function ◽  
Professional Guidance

Purpose This paper aims to explore whether an internal auditor’s evaluation of internal control deficiencies are influenced by the party with primary influence over the internal audit function and by the type of internal control deficiency. Design/methodology/approach A behavioral experiment is conducted with internal auditors as participants in a 2 × 2 between-subjects factorial design. Findings Results indicate that internal auditors are less likely to evaluate a pervasive control deficiency related to “tone at the top” as a material weakness than a process-specific control deficiency. Furthermore, internal auditors are somewhat less likely to evaluate a process-specific internal control deficiency as a material weakness when management has primary influence over the internal audit function than when the audit committee has primary influence. It is also found that the best practice of internal audit oversight (i.e., primary oversight of internal auditors by the audit committee) may lead to potential internal under-reporting of instances where the audit committee represents a material weakness in internal control. Research limitations/implications Limitations of this research include lack of economic consequences (e.g. future pay and job loss) associated with the internal control decisions made by the participants; less concise information provided to the participants than would generally be available to them; and lack of generalizability of the findings beyond the specific company setting and internal control scenario portrayed in the case materials. Practical implications Not evaluating a pervasive control deficiency related to “tone at the top” as a material weakness seems to not fully align with relevant professional guidance and can possibly result in inaccurate internal information about the quality of internal controls. Furthermore, having an internal auditor’s evaluation of a process-specific internal control deficiency influenced by the party with primary influence over the internal audit function would not appear to align with relevant professional guidance. Finally, primary oversight by the audit committee of the internal auditors may lead to potential internal under-reporting of instances where the audit committee represents a material weakness in internal controls and, thus, possible communication of inaccurate internal control information. Originality/value This study is the first to address whether the party with primary influence over the internal audit function influences an internal auditor’s evaluation of internal control deficiencies.

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