Internal audit quality, audit committee independence, growth opportunities and firm performance

This study explores whether the relation between internal audit quality and firm performance is associated with firm characteristics of information asymmetry and uncertainty (growth opportunities) and certain governance controls (audit committee effectiveness). The results from this preliminary study of 60 Malaysian companies show that the association between internal audit quality and firm performance is stronger for firms with high growth opportunities and that this positive association is weakened by increasing audit committee independence. These findings demonstrate the internal auditors conflicting roles and question the governance recommendations that require all members of the audit committee to be non-executive directors.

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

This study examines the impact of internal audit outsourcing and internal audit’s involvement in consulting on external auditors’ reliance on the work of internal audit. We test whether these factors influence (i) reliance on internal audit work already undertaken and (ii) the use of internal auditors as assistants. In each case, we distinguish between control evaluation and substantive testing. We find that 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 than for substantive testing.

Internal audit department characteristics/activities and audit fees : some evidence from Hong Kong firms

This study provides preliminary support for the notion that internal audit function assists in reducing external audit effort and fees. Data on internal audit characteristics and activities are obtained from survey respondents of Hong Kong companies and audit fee model data are acquired from their annual reports. The results of this study suggest that the external auditor of firms in Hong Kong rely on the internal audit function and subsequently charge a lower fee. Lower external audit fees are associated with a larger internal audit department and certain activities carried out by the internal audit. Specifically, lower external audit fees are associated with more internal audit effort spent on activities relating to financial statements, systems development and maintenance, operating efficiency and effectiveness, fraud investigations and unlimited access to internal auditors’ working papers. The results of this study suggest that the contribution of the internal audit may substitute for some substantive external auditing processes and lower monitoring costs.

Internal audit involvement in enterprise risk management

Purpose The paper examines the impact of internal auditors’ involvement in Enterprise Risk Management (ERM) on perceptions of their willingness to report a breakdown in risk procedures and whether a strong relationship with the audit committee affects such willingness to report. The study also investigates the use of ERM and the role of internal audit in ERM in Australian private and public sector entities. Design/methodology/approach The study uses an experimental design, manipulating (i) the internal auditor’s involvement in ERM and (ii) the strength of the relationship between internal audit and the audit committee. Participants are 117 certified internal auditors. The study also gathers descriptive data on the use of ERM. Findings The study indicates that a high involvement in ERM impacts the perceptions of internal auditors’ willingness to report a breakdown in risk procedures to the audit committee. However, a strong relationship with the audit committee does not appear to affect their perceived willingness to report. The study also finds that the majority of organisations have recently adopted ERM. Internal auditors are involved in ERM assurance activities but some also engage in activities that could compromise objectivity.

Informal interactions between audit committees and internal audit functions : exploratory evidence and directions for future research

Purpose – This paper aims to recognise the importance of informal processes within corporate governance and complement existing research in this area by investigating factors associated with the existence of informal interactions between audit committees and internal audit functions and in providing directions for future research. Design/methodology/approach – To examine the existence and drivers of informal interactions between audit committees and internal audit functions, this paper relies on a questionnaire survey of chief audit executives (CAEs) in the UK from listed and non-listed, as well as financial and non-financial, companies. While prior qualitative research suggests that informal interactions do take place, most of the evidence is based on particular organisational setting or on a very small range of interviews. The use of a questionnaire enabled the examination of the existence of internal interactions across a relatively larger number of entities. Findings – The paper finds evidence of audit committees and internal audit functions engaging in informal interactions in addition to formal pre-scheduled regular meetings. Informal interactions complement formal meetings with the audit committee and as such represent additional opportunities for the audit committees to monitor internal audit functions. Audit committees’ informal interactions are significantly and positively associated with audit committee independence, audit chair’s knowledge and experience, and internal audit quality. Originality/value – The results demonstrate the importance of the background of the audit committee chair for the effectiveness of the governance process. This is possibly the first paper to examine the relationship between audit committee quality and internal audit, on the existence and driver of informal interactions. Policy makers should recognize that in addition to formal mechanisms, informal processes, such as communication outside of formal pre-scheduled meetings, play a significant role in corporate governance.

The effect of internal audit function quality and internal audit contribution to external audit on audit fees

Corporate governance mandates and listing rules identify internal audit functions (IAF) as a central internal control mechanism. External audits are expected to assess the quality of IAF before placing reliance on its work. We provide evidence on the effect of IAF quality and IAF contribution to external audit on audit fees. Using data from a matched survey of both external and internal audits, we extend prior research which is based mainly on internal audits' assessment and conducted predominantly in highly developed markets. We find a positive relationship between IAF quality and audit fees as well as a reduction in audit fees as a result of external auditors' reliance on IAF. The interaction between IAF quality and IAF contribution to external audit suggests that high quality IAF induces greater external auditor reliance on internal auditors' work and thus result in lower external audit fees.

The role of internal audit in corporate governance and management

This research report is based on a study undertaken in Australia, and aims to evaluate the role of internal audit in corporate governance and management. It identifies the accountability structures and objectives of internal audit, considers the nature of internal audit functions and the extent of application of The Institute of Internal Auditors Standards of Professional Practice, reviews the relationships of the chief audit executives (CAEs) and assesses the nature of financial report risks and other issues covered by internal auditors. The research findings include a diversity of accountability structures for CAEs and a range of internal audit activities, with the application of the IIA Standards being in need of improvement. In conclusion, the researchers make recommendations for improvements in practice to be considered by The Institute of Internal Auditors and other regulating and governing bodies.

An exploratory study on internal audit independence in Australia

This study draws on agency and institutional theory to examine the issue of internal audit’s independence through its relationship with components of corporate governance.

The internal audit function is actively considered as one of the four components of corporate governance, along with the board, management and external auditors. It serves this purpose by providing a range of services in its capacity of monitoring and consulting which is actively sought by the other components of corporate governance to satisfy their extended accountability requirements. The integrity of these services is, however, only assured if internal audit maintains its independent status. As such there is a “tension” resulting from the pressure to provide these value added services as perceived by the parties involved and maintaining its independence status.

Based on an extended survey with organisations in the Australian corporate sector, this study critically examines the results of the survey against existing literature and best practice guidelines to determine if internal audit functions operating under this tense environment are operating independently.

The results indicate an interesting analysis. While it indicates a somewhat trend in complying with best practice guidelines for maintaining independence, it also indicates that this is not consistently adhered to as organisations are able to operate in an environment that compromises internal audit independence. A main reason for this appears to be a mix of internal audit structural set ups brought about by a lack of statutory backing to provide for consistency in implementation of best practice guidelines for maintaining independence. This is exacerbated by internal audit being viewed as partner by these parties thus widening the “tension” gap between its advisory role and its independent status. A wider question emerges which questions the ability to maintain this independence concept under a partnership management environment. The concept of internal audit being an independent function as promulgated by the Institute of Internal Auditors through its definition of internal audit is seriously questioned under the totality of this environment.

Risk management and ethical environment : effects on internal audit and accounting control procedures

This study examines the impact of the scope of risk management and ethical environment on internal audit activities and the quality of accounting control procedures (ACPQ). The conceptual framework for the study is guided by COSO’s frameworks on internal controls and enterprise risk management and data from a questionnaire survey of 64 Australian firms are analysed using a structural equation model. The results of the study support that (1) internal audit activities have a significant intervening effect on the relationship between the scope of risk management and ACPQ, and (2) a direct and positive relationship exists between ethical environment and ACPQ. Our findings suggest that widening the scope of risk management activities do not directly improve ACPQ, but that it leads to more extensive internal audit activities and in turn such activities promote better ACPQ. Further, the results indicate that fostering a more ethical environment directly leads to higher ACPQ. These results have implications for the design of internal controls, namely with respect to the role of internal audit activities and ethical environment in enhancing ACPQ.

Internal auditors' assessment of their contribution to financial statement audits : the relation with audit committee and internal audit function characteristics

This paper examines the relation between audit committee characteristics, internal audit function characteristics and internal auditors' assessment of their contribution to financial statement audits. Using survey data from chief internal auditors of 76 Malaysian publicly-listed firms, we provide evidence of a positive relationship between internal auditors' assessment of their contribution to financial statement audits and three audit committee characteristics: the proportion of independent audit committee members, their knowledge and experience of accounting and auditing, and the extent of audit committee review of internal audit programmes, budget and coordination proposals. Further, a positive relationship is found between internal auditors' evaluation of their contribution to the financial statement audit and internal audit function characteristics including size, prior experience of staff in auditing, time availability and the closeness of the function's relationship with the external auditor. The results indicate that more effective audit committees and well-resourced internal audit units tend to be positively associated with the internal auditors' assessment of their contribution to the external audit.

Internal audit - an Asia-Pacific profile and the level of compliance with internal auditing standards

Purpose – The purpose of this paper is to provide an overview of the profile of internal audit in five Asia-Pacific countries and investigate the usage and compliance with the Institute of Internal Auditors (IIA) International Standards for the Professional Practices of Internal Auditing (Standards) by organizations' internal audit activities (IAAs). This paper shows the differences between Australia, China, Japan, New Zealand and Taiwan. It also discusses part of the results of the Common Body of Knowledge 2006 global study conducted by the IIA.

Design/methodology/approach – The paper reports the results of a questionnaire survey sent to the global membership of the IIA in September 2006 on various aspects of internal audit practices.

Findings – The profile of internal audit differs amongst the countries with much older organizations exist in Australia, Japan and New Zealand. Respondents in New Zealand, Japan, Chinese Taiwan, China and Australia all report to have a reasonably high level of usage of Standards. However, Australia has the highest number of respondents who report that they are in full compliance of the Standards.

Originality/value – This is the first global study of internal auditors' compliance with the IIA Standards.

A critical analysis of the independence of the internal audit function : evidence from Australia

Purpose – This study aims to critically analyse the independence of the internal audit function through its relationship with management and the audit committee.

Design/methodology/approach – Results are based on a critical comparison of responses from questionnaires sent out to Australian chief audit executives (CAEs) versus existing literature and best practice guidelines.

Findings – With respect to the internal audit function's relationship with management, threats identified include: using the internal audit function as a stepping stone to other positions; having the chief executive officer (CEO) or chief finance officer (CFO) approve the internal audit function's budget and provide input for the internal audit plan; and considering the internal auditor to be a “partner”, especially when combined with other indirect threats. With respect to the relationship with the audit committee, significant threats identified include CAEs not reporting functionally to the audit committee; the audit committee not having sole responsibility for appointing, dismissing and evaluating the CAE; and not having all audit committee members or at least one member qualified in accounting.

Originality/value – This study introduces independence threat scores, thereby generating analysis of the internal audit function's independence taking into account a combination of threats.