Is the objectivity of internal audit compromised when the internal audit function is a management training ground?

We conduct an experiment with 74 internal auditors to examine the effects of using the internal audit function as a training ground for future senior managers. Specifically, we investigate internal auditors' willingness to resist current management's aggressive revenue recognition policies, assuming that internal auditors expect to move into senior management positions in the future. We also examine whether increasing the power of the board of directors can reduce threats to internal auditors' objectivity. This is the first study to empirically examine whether training grounds influence internal auditors objectivity. Results of our study indicate that internal auditors are less objective (i.e. they are more likely to side with management's aggressive revenue recognition policies) when they expect to move into senior management positions, relative to when internal auditing is not used as a training ground. We also find that empowering the audit committee further decreases the objectivity of internal auditors. These results suggest that board power can have unintended consequences on the behaviour of internal auditors and that board empowerment does not guarantee improved governance or improved oversight of financial reporting.     

Evaluating the Work of Internal Audit: A Comparison of Standards and Empirical Evidence

Numerous changes have recently been proposed or made to audit standards providing guidance for external auditors' evaluations of internal audit work. This paper reports the results of a study to compare the UK's Accounting Practices Board Statement of Auditing Standard 500, first, with similar standards promulgated by international, Canadian and US societies, and second, with audit quality factors derived from practising internal auditors. The data for the latter comparison was obtained from a two-phase study that first generated a set of potential quality factors through intensive structured interviews with audit groups from six different and diverse organisations, and then obtained evaluations of these factors from a large sample of internal auditors worldwide. Results first indicate that there are strong similarities between the guidance provided by SAS 500 and that proposed or promulgated by the UK, international, Canadian and US audit groups. Furthermore, the guidance provided by these SASs for items to consider in evaluating the quality of internal audit work are largely in agreement with the factors determined by practising internal auditors. There are, however, several items listed in SAS 500 that are not considered useful by internal auditors and there are other factors considered crucial by internal auditors but not mentioned in the SASs.     

An Empirical Study of the Audit Expectation-Performance Gap

The critical, litigious environment which characterises auditing today can be traced to the audit expectation-performance gap. Defined as the gap between society's expectations of auditors and auditors perceived performance, it is seen to comprise ‘reasonableness’ and ‘performance’ components, the latter being subdivided into ‘deficient standards’ and ‘deficient performance’. Empirical research was conducted in New Zealand in 1989 to investigate the audit expectation-performance gap. The study enables the duties which constitute the reasonableness, deficient standards and deficient performance components of the gap to be identified. It also provides the means to estimate the relative contribution of the duties to their respective components, and of the components to the overall gap between society's expectations of auditors and auditors' perceived performance. The research provides new insights into the structure, composition and extent of the audit expectation-performance gap but, more importantly, it signals a rational, comprehensive approach towards narrowing the gap. If adopted, this should bring society's expectations of auditors and auditors' performance into closer accord and, as a consequence, reduce the criticism and litigation which auditors face today.     

Audit firm's Confucianism and stock price crash risk: Evidence from China

This study examines the association between audit firm's Confucianism and stock price crash risk. We postulate that Confucian moral standards predict a mixed relationship between audit firm's Confucianism and stock price crash risk. Using a large sample of listed firms in China during 2006–2018, we find that audit firm's Confucianism is positively related with client's future stock price crash risk, implying that Confucianism of audit firm aggravates client's bad news hoarding behavior. The effect is more pronounced for client without female auditors and/or with closer personal relationship with auditors. Mechanism analysis shows that audit firm's Confucianism exacerbates crash risk by worsening audit quality and information transparency. Political discipline and external monitoring help to alleviate the negative influence of audit firm's Confucianism on stock price crash risk.     

The influence of judges' attitudes on liability assessments related to failed audits exhibiting significant audit team over-time or significant use of off-shore auditors

This study provides evidence on how audit firms' decisions to use offshore (outsourced) auditors or to assign on-site (local) auditors extensive overtime affect judges' evaluation of auditor legal liability I conduct a behavioral experiment in which actual judges responded to a hypothetical audit lawsuit. The results suggest auditors may be penalized during the litigation process depending on the extent of overtime or off-shoring and judges' attitude toward the public accounting profession. Judges with a positive attitude toward public accounting assessed more liability for an audit firm that used offshore (outsourced) auditors than for the use of extensive overtime for on-site auditors or a control condition. However, judges with a negative attitude toward the auditing profession assessed higher liability for auditors except when on-site auditors bore significant overtime in the final weeks of the audit.     

Factors affecting the internal audit effectiveness: A survey of the Saudi public sector

This study assesses factors influencing internal audit effectiveness (IAE) in Saudi Arabia. Data were obtained from 203 managers and 239 internal auditors from 79 Saudi Arabian public sector organizations. Multiple regression analysis examines the association between IAE and five principal factors. Results suggest that management support for IAE drives perceived effectiveness of the internal audit function from both management's and the internal auditors’ perspective. Management support is linked to hiring trained and experienced staff, providing sufficient resources, enhancing the relationship with external auditors, and having an independent internal audit department. Saudi Arabia is representative of many developed and developing environments, and its recent tradition of governance and audit is mirrored in countries worldwide. Moreover, its specific cultural traditions involving clan and tribal allegiances, and pervasive and core religious beliefs, characterize the GCC countries, the Arab World generally, and indeed, many other developing countries, irrespective of wealth. Thus, links between management support and internal audit effectiveness are likely generalizable beyond the Saudi public sector context.     

Internal audit reporting lines,fraud risk decomposition,and assessments of fraud risk

The main purpose of this research is to examine the effects of internal audit reporting lines on fraud risk assessments made by internal auditors when the level of fraud risk varies. Significant emphasis has been placed on the importance of reporting lines in maintaining the autonomy of internal auditors, but the perceived benefits of requiring internal audit to report directly to the audit committee have not been validated or systematically investigated. Results of an experiment involving 172 experienced internal auditors and additional survey findings indicate that internal auditors perceive more personal threats when they report high levels of risk directly to the audit committee, relative to management. Perceived threats lead internal auditors to reduce assessed levels of fraud risk when reporting to the audit committee relative to when reporting to management. This finding runs counter to the anticipated benefits of requirements that the internal audit function report directly to the audit committee, and it reveals potential conflicts of interest and independence threats created by the audit committee itself. We also investigate the effects of fraud risk decomposition on risk assessments made by internal auditors. We find that fraud risk assessment decomposition does not have the same effects on internal auditors as it has on external auditors, and the effects of decomposition do not align with the expected benefits of decomposition.     

A study of whistleblowing among trainee auditors

Over the last number of years whistleblowers have been gaining prominence. This paper investigates some of the factors that influence the propensity or willingness to blow the whistle among trainee auditors. Three categories of factors are examined: audit firm organisational structures, personal characteristics of whistleblowers and situational variables.A survey of 240 final year students of the Institute of Chartered Accountants in Ireland was undertaken. Trainee auditors (just about to sit their finals) were asked about their confidence in internal and external reporting structures in their firms. Using four scenarios, audit trainees were questioned on their willingness to challenge an audit partner's inappropriate response to concerns raised during the audit. Finally, audit trainees were asked about the influence of legal protection on their likelihood of whistleblowing.Results indicate that where firms have adequate formal structures for reporting wrongdoing, trainee auditors are more likely to report wrongdoing and have greater confidence that this will not adversely affect their careers. Training increases this confidence. Trainee auditors also express a willingness to challenge an audit partner's unsatisfactory response to wrongdoing. Significant differences were found in attitudes depending on whether the reports of wrongdoing were internal or external. The willingness to report wrongdoing externally reduces for older (aged over 25) trainees.     

Towards a conceptual model of whistle-blowing intentions among external auditors

Whistle-blowing has received considerable attention in the ethics literature. However, following the collapse of Arthur Andersen in the Enron debacle, whistle-blowing within audit firms has taken on greater importance. Given the profession's requirements to be confidential, independent and to act in the public interest (e.g. Sarbanes–Oxley Act, 2002), there is a need for a model that is specific to the audit profession (e.g. Louwers, Ponemon, & Radtke, 1997), and in particular, that addresses auditors' whistle-blowing intentions. This paper presents a conceptual model on whistle-blowing intentions among external auditors where an auditor's individual factors (attitudes toward whistle-blowing, perceived behavioural control, independence commitment, personal responsibility for reporting and personal cost of reporting) have a direct influence on his or her intentions to whistle-blow, but are moderated by isomorphic factors (perceived organisational support and team norms) and issue-specific factors (perceived moral intensity). Using justice and institutional theories, the proposed model anticipates that whistle-blowing within an audit firm produces both positive and negative consequences to society, the audit firm and the individual whistle-blower. However, where audit firms have adequate formal supporting mechanisms for reporting wrongdoings to internal and external parties, the negative effects and personal costs of reporting will be minimised.     

The relationship between internal audit and information security: An exploratory investigation

The internal audit and information security functions should work together synergistically: the information security staff designs, implements, and operates various procedures and technologies to protect the organization's information resources, and internal audit provides periodic feedback concerning effectiveness of those activities along with suggestions for improvement. Anecdotal reports in the professional literature, however, suggest that the two functions do not always have a harmonious relationship. This paper presents the first stage of a research program designed to investigate the nature of the relationship between the information security and internal audit functions. It reports the results of a series of semi-structured interviews with both internal auditors and information systems professionals. We develop an exploratory model of the factors that influence the nature of the relationship between the internal audit and information security functions, describe the potential benefits organizations can derive from that relationship, and present propositions to guide future research.     

Does Auditor Industry Specialization Improve Audit Quality?

This study examines whether auditor industry specialization, measured using the auditor's within‐industry market share, improves audit quality and results in a fee premium. After matching clients of specialist and nonspecialist auditors on a number of dimensions, as well as only on industry and size, there is no evidence of differences in commonly used audit‐quality proxies between these two groups of auditors. Moreover, there is no consistent evidence of a specialist fee premium. The matched sample results are confirmed by including client fixed effects in the main models, examining a sample of clients that switched auditors, and using an alternative proxy that aims to capture the auditor's industry knowledge. The combined evidence in this study suggests that the auditor's within‐industry market share is not a reliable indicator of audit quality. Nevertheless, these findings do not imply that industry knowledge is not important for auditors, but that the methodology used in extant archival studies to examine this issue does not fully parse out the effects of auditor industry specialization from client characteristics.     

An Empirical Investigation of the Interface Between Internal and External Auditors

Professional standards place specific responsibilities on auditors for the discovery of material mis-statements in reports of corporate financial performance. Certain factors have been shown to increase the likelihood of fraudulent financial reporting. One warning sign is the potentially pervasive effect of a weak internal control environment consistent with a weak internal audit group. This study investigates the impact of internal audit department quality differences on auditors ‘willingness to place reliance on the work performed by internal auditors. The study also gives consideration to auditors’ recent experiences with material errors and irregularities and examines the influence of two previously untested individual auditor differences on audit judgment decisions: (1) conflict management style and (2) perception of internal/external auditor communication barriers. The results indicate that auditors attend to internal audit department quality differences and that individual auditor differences exhibit significant influence over auditor judgments. Implications for audit practice are considered and directions for future research are suggested.     

The Contribution of Internal Audit as a Determinant of External Audit Fees and Factors Influencing This Contribution

Despite extensive research on the determinants of external audit fees, there is little empirical evidence on the effect of internal audit contribution on the external audit fee. Using a cross-sectional regression model based on prior audit fee research, this study provides evidence that internal audit contribution is a significant determinant of the external audit fee. Further, a second model that provides evidence on the determinants of internal audit contribution is developed and tested. This second model indicates that internal audit contribution is influenced by internal audit quality and, conditional on the level of inherent risk, the availability of internal audit and the extent of coordination between internal and external auditors. These results are based on a unique data-set comprised of publicly available data matched with survey responses from internal and external auditors affiliated with 70 non-financial services Fortune 1000 firms. The sample includes all of the former "Big 6" international accounting firms and clients from twenty-nine different industries.     

External auditors' evaluation of the internal audit function: An empirical investigation

Evaluation of the strength of the client's internal audit function by the external auditor (EA) has taken on increased significance due to stronger regulation around the evaluation of internal controls after SOX (2002). However, research examining how this evaluation occurs in practice is mixed and inconclusive. In this study, we examine empirically whether the Desai et al. (2010) theoretical model is reflective of how auditors make judgments about the strength of their client's internal audit function in practice. Specifically, we present external auditors with evidence about internal auditor work performance, competence and objectivity in a manner consistent with the structure of evidence evaluation implied by the Desai et al. (2010) model. We then compare the auditors' actual strength judgments to the strength levels predicted by the model and evaluate similarities and differences. Results indicate that no one factor dominates the strength judgment in all cases. In addition, EAs do not weigh negative evidence as heavily as does the model. When the evidence about the three factors is conflicting, external auditors have difficulty incorporating them in a consistent way into the calculation of their overall strength judgment. Finally, we find results consistent with prior research indicating auditors tend to be more sensitive to negative than positive evidence. Also, it is harder to move auditors' beliefs away from a negative position with positive evidence than to move those beliefs away from a positive position with negative evidence. Results suggest that additional training and use of a decision aid structured according to the Desai et al. (2010) model would be especially useful when evidence about internal auditors' work performance, competence and objectivity is conflicting.     

Internal auditors’ use of interpersonal likability,arguments, and accounting information in a corporate governance setting

Internal auditors play an important role in influencing managers’ judgments. Yet, the practitioner literature indicates that, because internal audit lacks the client services incentives of external audit, internal auditors often adopt a “policeman approach” that can lead to negative interpersonal relationships with managers. We investigate three variables fundamental to internal auditors’ ability to influence managers: (1) internal auditors’ interpersonal likability, (2) the information used to support their positions, and (3) whether they present that information in a thematically organized argument. We find that managers agree more with an internal auditor who is both likable and uses a thematically organized argument. We find further that this joint effect occurs regardless of whether the internal auditor’s information is relatively supportive or unsupportive of his position. Overall, our theory and findings suggest that an internal auditor can achieve agreement from managers on important corporate governance issues with this fairly straightforward presentation tactic, even when the underlying information is relatively unsupportive and managers otherwise tend not to agree with the internal auditor’s position. Our study contributes to accounting, psychology, and writing and discourse theories with new evidence of the effects of an argument structure (holding the underlying information constant) on users’ judgments, and how those effects depend on the likability of the source of information. Our findings have important implications for internal auditors, managers, external auditors, and others interested in corporate governance.     

Do auditors’ early-life socioeconomic opportunities improve audit quality? Evidence from China

Prior research documents significant variation in audit outcomes based on individual auditors' demographic features, working experience, educational background, and social connections. This study examines whether individual auditors' early-life socioeconomic opportunities also affect audit practices. We expect that auditors from big cities have more access to socioeconomic opportunities and accumulate more human capital in early life, thus are more capable of providing high-quality audits after they start careers. Consistent with this hypothesis, we find that auditors from big cities make more audit adjustments to earnings compared with auditors from small towns. Additional tests suggest that this early-life effect on audit quality is moderated when auditors receive higher education or gain more auditing experience and is more pronounced in downward adjustments than in upward adjustments. We also find a fee premium for auditors from big cities. Overall, this paper provides evidence that auditors’ early-life socioeconomic opportunities have a far-reaching influence on audit quality.     

External auditors’ reliance on internal audit: the impact of sourcing arrangements and consulting activities

This study examines the impact of internal audit outsourcing and involvement in consulting on external auditors’ reliance on the work of internal audit. We test whether these factors influence reliance on internal audit work already undertaken and the use of internal auditors as assistants, distinguishing between control evaluation and substantive testing. Involvement in consulting impacts reliance on work undertaken and the use of internal auditors as assistants for control evaluation. External auditors make greater use of internal auditors as assistants for substantive testing when internal audit is provided in‐house. Overall, external auditors use internal audit more for control evaluation tasks.     

Ethics and internal audit: Moral will and moral skill in a heteronomous field

This paper examines ethics in the field of internal audit. A set of in-depth interviews, the autobiography of ex-Vice President of Internal Audit of World Com, Cynthia Cooper, and the documents of the Institute of Internal Auditors (IIA) are all analyzed to shed light on the ethics—deontic, teleic, and aretaic—that characterize this weakly autonomous field. The paper further employs work in the field of economic sociology and Milan Kundera's literary ideas to highlight how internal auditors actively moralize markets and embrace a moral will that is ambiguous, if not conflicted. The paper further raises questions about the IIA's present offering of ethics-related resources and its ability to effectively develop moral skill in this field. In addition, and in keeping with our phronetic research approach, the paper provides suggestions aimed at improving the Institute's ethics resources.     

AUDITOR'S SKILL,AUDITING STANDARDS,LITIGATION, AND AUDIT QUALITY

This paper introduces a model of the market for audit services in which auditors differ in their levels of skill, which may or may not be observable and capture differences in ability. The model captures the interplay amongst auditing standards, litigation, and auditors’ levels of skill, which determines auditors’ responses to auditing standards. The paper shows that the quality of audit supplied by any auditor is increasing in the auditor's level of skill regardless of whether or not auditors’ levels of skill are observable. An increase in the quality of audit prescribed by auditing standards is shown to induce some auditors endowed with low levels of skill to decrease the quality of their audits so that the average quality of audit and economic welfare may actually decline as auditing standards are raised. Auditors’ choices of audit quality are furthermore shown to be increasing in trial awards. Incentives for trials and out-of-court settlements are shown to depend crucially on whether or not auditors’ levels of skill are observable. Only when auditors’ levels of skill are unobservable do trials obtain with some probability. When auditors’ levels of skill are unobservable, the introduction of either restrictions on costs awarded by the courts or an imperfection in the courts’ technology is shown to lead the most skilled auditors to supply audits of a quality strictly exceeding the quality prescribed by the prevailing auditing standards. When the courts err often enough, the most skilled auditors having exercised due care furthermore make offers to settle when sued.