Quality of Internal Audit

1. Quality of Internal Audit By Neftali C. Adame

2. Introduction • It is the duty of auditors to detect and correct any accounting fraud in the financial statements of a company. • Auditors are divided into internal and external auditors. • A company can utilize both internal and external auditors to evaluate their financial status. • After a surge in accounting fraud, the Sarbanes Oxley Act was passed by congress in 2002 which limited the activities that external auditors performed on client companies and gave a greater reliance on internal auditors.

3. Thesis • While prior research has suggested that there should be a greater reliance in internal auditors to prevent accounting fraud because their quality in auditing is void of corruption, current research has suggested that their quality in auditing is subject to their competence, objectivity, and work performance.

4. Research has suggested that the competence of internal auditors may be a determinate in the quality of their audit. Competence

5. Competence • Urton Anderson’s research finds that there is a relationship between the level of importance of internal auditors and their size in number within a company, however finds that a company with a large number of internal auditors are less experienced and only a few are Certified Internal Auditors (188). • This suggests that while internal auditors are the valued in a company, their experience or certification, which is a sign of their competence, is disregarded and the quality in audit is maintained by their size.

6. Competence • However, Paul Coram’s research concludes that there is a correlation between competence and the quality of audit from internal auditors. • He finds that the depth in knowledge around accounting fraud along with the knowledge of company procedures are internal auditors able to perform at peak level (546). • In contrast to Andersons research, this suggest that when internal auditors have a deeper understanding of their job alongside their company procedures can they perform the best.

7. Another factor that current research suggest to affect the quality of audit from internal auditors is the objectivity they possess from internal control. Objectivity

8. Objectivity • Research by Douglas Prawitt claims that the quality in audit deteriorates when auditors lose sight of their objectives because they are influenced by the “interaction among different parties involved in corporate governance” (1110). • He supports this by concluding from his research that accounting fraud is decreased when “the percentage of work outsourced to the external auditor increases” (1110). • This means that internal auditors are susceptible to the interest of managers from internal control and lose focus on their original objectives.

9. Objectivity • Randal Elders agrees with Prawitts suggestion of objectivity from internal auditors to be compromised by the influence of internal control. • In Elders research, he finds that internal auditors use resignation as a “strategy when they are exposed to a higher level of risk” (570). • This indicates that internal auditors fail to remain objective and commit to their duties because they are subject to managerial influence and therefore resort to resignation.

10. Objectivity • However, Shu Lin’s research disagrees with Prawitt and Elders by suggesting that objectivity from internal auditors remains firm and actually has a positive influence on internal control. • She finds objectivity of internal auditors is unaffected by internal control and when objectivity is clear, the quality of audit increases and eventually “deters managers from taking actions that compromise control” and increases the quality of management (291).

11. Objectivity • While Prawitt and Elders claim that objectivity is lost when internal control becomes involved in auditing activities preformed by internal auditors, Lin suggest that internal auditors remain objective and eventually have a positive affect on management quality.

12. Another factor research suggest to affect the quality in auditing of internal auditors is their work performance. Work Performance

13. Work Performance • Companies also rely on external auditors to review some aspects of their financial profile and according to Vikram Desai, external auditors evaluate the work performance of internal auditors to determine their usefulness in the external performance (537). • Desai’s research finds that while external auditors may find the work performance of internal auditors acceptable, external auditors may still disregard the internal auditors work. • This suggest that the work performance of internal auditors may not be a clear indicator in their quality of audit given that external auditors may still disregard their work despite the work being exceptional.

14. Work Performance • Along side Desai’s research, Steven Glover also studies the external auditors judgment over the work performance of internal auditors as an indication in the quality of audit. • Different from Desai’s conclusion, however, Glover’s research finds that work performance is subject to the area in which the internal auditor is assigned to and whether it was voluntary or assigned (208). • Glover finds that external auditors are more likely to consider the work performance of internal auditors reliable when they are from voluntary tasks and not assigned because of potential internal control interest.

15. Work Performance • Steven Asare takes a different approach from Desai and Glover by analyzing internal auditor’s risk assessment given certain scenarios such as influence from internal control. • According to Asare’s research, internal auditors do change their approach in risk assessment when faced with outside factors, such as interference from internal control, but for the purpose of improving risk assessment since it takes in consideration all relevant factors in accounting fraud (183). • Much like Glover’s conclusion, Asare agrees that work performance is determinate of audit quality, however, Asare concludes that work performance is adjusted to improve the quality of audit.

16. Conclusion • Research is now focusing on the quality of audit from internal auditors since they are now at the center of deterring accounting fraud after the implementation of the Sarbanes-Oxley Act of 2002. • Researchers agree that there are factors that affect the quality of audit given the position of internal auditors such as competence, objectivity, and work performance. • Some researchers would suggest that competence is a determinate in the quality of audit while other researcher would argue that competence is irrelevant when the size of internal auditors is capable to perform sufficiently.

17. Conclusion • For objectivity, some researchers would argue that internal auditors are susceptible to the interest of internal control, while other researchers would disagree and state that objectivity remains the same and it is internal control that is influenced by internal auditors. • Research has also shown that work performance has an affect on the quality of audit. • On one hand, some researcher would argue work performance to be influenced by internal control incentives and therefore deteriorate the quality of audit.

18. Conclusion • On the other hand, some researchers would argue that despite work performance being influence by outside factors the quality of audit remains optimal. • Each research does provide adequate evidence to prove his or her assumption about the correlation between competence, objectivity, and work performance with the quality of audit from internal auditors. • However, there should be more research done on this issue given that the Sarbanes-Oxley Act, which resulted in the focus on internal auditors, is revised regularly and may affect the role of internal auditors in the future.

19. Works Cited • Anderson, Urton L., et al. "A Post-SOX Examination Of Factors Associated With The Size Of Internal Audit Functions." Accounting Horizons 26.2 (2012): 167-191. Business Source Complete. Web. 20 June 2014. • Asare, Stephen Kwaku, et al. "Internal Auditors' Evaluation Of Fraud Factors In Planning An Audit: The Importance Of Audit Committee Quality And Management Incentives." International Journal Of Auditing 12.3 (2008): 181-203. Business Source Complete. Web. 20 June 2014. • Coram, Paul, et al. "Internal Audit, Alternative Internal Audit Structures And The Level Of Misappropriation Of Assets Fraud." Accounting & Finance 48.4 (2008): 543-559. Business Source Complete. Web. 20 June 2014. • Desai, Vikram, et al. "An Analytical Model For External Auditor Evaluation Of The Internal Audit Function Using Belief Functions." Contemporary Accounting Research 27.2 (2010): 537-575. Business Source Complete. Web. 20 June 2014. • Elder, Randal, et al. "Internal Control Weaknesses And Client Risk Management." Journal Of Accounting, Auditing & Finance24.4 (2009): 543-579. Business Source Complete. Web. 20 June 2014. • Glover, Steven M., et al. "Internal Audit Sourcing Arrangement And The External Auditor's Reliance Decision." Contemporary Accounting Research 25.1 (2008): 193-213. Business Source Complete. Web. 20 June 2014. • Shu, Lin, et al. "The Role Of The Internal Audit Function In The Disclosure Of Material Weaknesses." Accounting Review 86.1 (2011): 287-323. Business Source Complete. Web. 20 June 2014. • Prawitt, Douglas F., et al. "Internal Audit Outsourcing And The Risk Of Misleading Or Fraudulent Financial Reporting: Did Sarbanes-Oxley Get It Wrong?."Contemporary Accounting Research 29.4 (2012): 1109-1136. Business Source Complete. Web. 20 June 2014.