Summary Audit fee reductions from Internal audit-provided assistance: The incremental impact of internal audit charateristics

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Summary - Audit fee reductions from Internal audit-provided assistance: The incremental impact of internal audit charateristics

  • 1 Introduction

  • This study investigates how organizational oversight status and commitment to budgetary recources of the internal audit function impact the external auditor's reliance on IAF-provided FS audit assistance. They do this by examine the effect on the external auditors audit fee. 

  • The use of IAF as a means of managing external audit costs remains important issue to companies after SOX. 
  • They hypothesize that for a given level of IAF-provided audit assistance, there is an incrementally greater reduction in audit fees as organizational position increases. 

    They further hypothesize that for a given level of IAF-provided FS audit assistance there is an incrementally greater reduction in audit fee as the IAFRES variable increases - more resources = differences in qualifications, training, tools and experience of personnel.

    Finally the examine whether hours contributed to FS audit assistence by outsourced internal auditors will result in a greater reduction of audit fees than hours contributed by in-house internal auditors. 
  • 1.1 Background

  • Regulation


    SAS No. 65 stipulates the auditor to evaluate objectivity through a review of certain items:
    • Reporting of IAF to an officer of sufficient status to ensure broad audit coverage and action on findings and recommendations.
    • Reporting direct to board
    • Whether BoD, audit committee, or the owner-manager oversees employment decision related to the IAF. 

    And the auditor should evaluate the IAFs competence. 

    Institute of Internal Auditors IIA - recommends oversight by audit committee. Directly and solely reporting to audit committee.
  • PCAOB No. 2 - Evaluating organizational oversight status and commitment to budgetary resources of the IAF.
  • 2 Hypotheses

  • H1: The incremental effect of IAF assistance on reducing audit fees will be greater when the organizational oversight status of the IAF is oriented toward audit committee versus management.

    When the oversight is done by the audit committe instead of the management, the IAF will be able to act more independent of management and be more objective.
  • H2: The incremental effect of IAF assistance on reducing audit fees will be greater when the IAF resources, measured per hour, are greater.

    Simply because there is a positive correlation between levels of the competence-related characteristics and higher per-hour compensation. The higher the compensation the higher the likelihood of professionally certified and engaged in continuing education, likelihood of having large accounting firm experience.
  • H3: Assitance hours provided by outsourced internal auditors wille be associated with greater reduction of audit fees than hours provided by in-house internal auditors.

    Because protection from management will generally increase IAF objectivity. Outsourced auditor are less influenced by management than in-house IAF.
  • 3 Results

  • Model 1 - test variables INHOURS and OUTHOURS are included.

    Both are negative and significant indicating that the more hour the IAF spent on assisting the external auditor the lower his audit fee will be.

    The coefficient is greater for OUTHOURS so outsourced internal auditors cause an even greater reduction in audit fee of the extenal audit.
  • Model 2- INHOURS, OUTHOURS, POSITION, and IAFRES are included.

    All are negative and significant. But here you see that after the adding of the position and iafres variables there is no difference anymore between the in-house IAF and the outsourced IAF. 

    If oversight of the IAF is done by the audit committee instead of management the reduction in audit fee will be even greater. 

    Same with the budgetary resources. When the IAF is more trained, have a higher education and more tools etc they need more money to realize that. The more of this instruments and money the better they operate and the greater the reduction in audit fee is.
  • 3.1 Additional

  • Control for:
    • Additional variable to capture financial performance
    • Variable related to risk of the client, more risk auditor is more sensitive toward the clients objectivity
    • dummy for high cost areas that might explain the higher audit fee
    • additional variable caputering the level of coordination between the IAD and external auditor.


    All are not significant
  • 4 Conclusion

  • In general IAF FS audit assistence lowers the audit fee of the external auditor. The more hours the IAF spent the lower the audit fee will be.

    The effect of the reduction in audit fee is stronger when the IAF has a higher orgazational oversight status, oversight done by audit committee, and the IAF has more budgetary resources, better trained.

    Outsourced IAF result in a greater reduction of audit fee than in-house internal audit functions but only when oversight is done by managment and the resources are low. 
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