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Ee tims International 300 N. Zeeb Road Ann Arbor, M! 48106 8410863 Margheim, Loren L. AN EMPIRICAL STUDY OF EXTERNAL AUDITOR RELIANCE ON INTERNAL AUDITORS Arizona State University D. 1984 University Microfilms International soon.
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Page(s) seem to be missing in numbering only as text follows. 13, Two pages numbered. Curling and wrinkled pages __ 15. Other University Microfilms International AN EMPIRICAL STUDY OF EXTERNAL AUDITOR RELIANCE ON INTERNAL AUDITORS by Loren L.
Margheim A Dissertation Presented in Partial Fulfillment of the Requirements for the Degree. Doctor of Business Administration ARIZONA STATE UNIVERSITY May 1984 © 1984 LOREN L MARGHEIM All Rights Reserved AN EMPIRICAL STUDY OF EXTERNAL AUDITOR RELIANCE ON INTERNAL AUDITORS by Loren L. Margheim has been approved February 1984 APPROVED: Kane Marne bs » Chairperson 2É 222. ⁄4¿t2„- đu Đ¿a Cl Thư Ð 2} Luk: 24 Supervisory Committee ACCEPTED: ⁄ Z S4 Dean of the College CÑ„.+ 4 07 Dean, Graduate College ABSTRACT Generally accepted auditing standards provide external auditors with general guidelines as ta the types and quantities of evidence which should be gathered to support an audit cpinion., However, auditors must still use "professional judgment" to make decisions concerning how much reliance may be placed on various types and quantities of evidence.
This study examined one such type of decision: the evaluation and reliance upon information provided by internal auditors. Specifically, acase study dealing with an audit of accounts receivable was used to examine whether external auditors adjusted the initial audit program based on work already performed by the internal auditors and whether the credibility of the internal auditors affected these judgments. Auditing standards and the related literature were used to construct two dichotomously scaled factors which described internal auditor credibility -- internal auditor competence/work performance and internal auditor objectivity. Both of these factors were tested at a nigh and low level.
The development and use of four cases containing the four different combinations of internal auditor competence/work performance and objectivity resulted in a completely crossed factorial design. In addition, a fifth control case with no internal auditor involvement was used. Five groups of two hundred CPAs were each mailed one of the five cases. Two hundred sixty-seven usable cases were returned.
The degree of reliance on the internal auditors was assessed using Multivariate Analysis of Variance (MANOVA) and Analysis of Variance (ANOVA) testing procedures to examine differences in the audit program plans between the five cases. The results indicated that internal auditor competence/work performance impacted on the external auditors’ judgments. As internal auditor competence/work performance went from a low level to a high level the external auditors reduced the planned amount of audit time. However, internal auditor objectivity and the interaction between the two factors had no effect on the external auditers' audit programs.
The study also indicated that internal auditors had to perform specific, documented work before the external auditors would aiter the amount of planned audit hours. iv ACKNOWLEDGMENTS I wish to express sincere gratitude to Dr. Kurt Pany for his very helpful guidance through the course of this dissertation. I also wish to thank Or.
Hal Reneau, Or. Haried and Dr. Austin Betz for their assistance and advice. In addition, the financial assistance provided by the American Institute of ertified Public Accountants is gratefully acknowledged.
The financial assistance provided by the Departments of Accounting and Quantitative Systems during my tenure at Arizona State University is also gratefully acknowledged. Special thanks to my proofreader, Raymond C. Valli, who contributed greatly to both this manuscript and my knowledge of the English language. Finally, deep appreciation is extended to my parents and the rest of my family for their support during my graduate studies.
CONTENTS age LIST OF TABLES 2. ew ee ew ew we ee ew VIG CHAPTER I - INTRODUCTION e ee eo €¢ © © #© 8 w&» @ _ * s. s - Statement of the Problem. « ws a & & & « @&@ Significance of the Problem.
« ar ee & 8 @ Need for Reliance Research. tha wp 8 © @ Need for Source Credibility Research MON &© 8 © 8 8 Scope of the Study. eee 2 = © ° © Type, Size and Stability of Client A 8» © © © Stage and Program Area of Audit. se 28 = 8 8 Wns Type of Reliance.
6 ew ew eo ._ es e CHAPTER If = LITERATURE REVIEW. * * + Internal Control Evaluations. « vs vo + vo ko VU cá Internal Auditor Relationships. + Internal Auditor Relationship with External Auditors.
se ew ew ew Internal Auditor Relationship with Management. eo 8 ee ew ew Source Credibility Evaluations ee 1 1 1ˆ ŸÝ s. vs 23 CHAPTER ITI - RESEARCH METHOD. 2 1 1 ee ew we ww ew ew 28 Case Development.
6 6 © 6 8 ew we ew wt we et lw 09 Subjects. « « ‹ ee ee ee ew te lw wt ll tl le 3ã Independent Variables” ee ee we ew ww 6 1 ww 9S Dependent Variables. «6 © «© «© © © ww oe oe ts 38 Statistical Techniques. 6 8 0 ww ew ew ew et e 38 Validity Analyses.
«© 26 6 6 © ew ew ew we we ew ew ow 40 Hypothesis Testing Procedures. « « «© «© w « « « 40 CHAPTER IV - RESULTS. 1 0 ee ee ew we x. ew ew AG Response Rate.
k1 rr 2 <) Validity Analyses Results ee ee ew ew ee we. ww AF Manipulation Check. 0 2 we wie ew ew we et ww 48 Subjects’ Backgrounds. 4 + vs ©» ww ee we.
49 vi Nonresponse Bias. * * « Subjective Opinions of Subjects a s * Hypothesis Test Results. “ ® * 2 ° Ancillary Test s » « Summary. CHAPTER V ~ CONCLUSIONS, LIMITATIONS AND POTENTIAL FUTURE RESEARCH.
1 6 ew ew ew ew Limitations .6s » e ° ° s ° REFERENCES e + « « a » ° e ° s * ° e s s * # * e ® Appendix SAMPLE CASE s e e a _* a a a s » e s J s s ° * œ> HIGH COMPETENCE/WORK PERFORMANCE. 109 LOW COMPETENCE/WORK PERFORMANCE. 112 Oo HIGH AND LOW OBJECTIVITY 2. uw ew ew ww ew.
» « 1185 S3 vii LIST OF TABLES Table page 1, Usable Responses by Case. 6 ew ew Q 2, Manipulation Check of Competence, Objectivity and Work Performance. Frequency Table of Subject Experience. Frequency Table of Subject Education.
51 3» Frequency Table of Subject Specialization ÄĂrea. Frequency Table of Subject Position in the Firm. Frequency Table of Case Completion Times. Subjective Opinions of the Subjects.
MANOVAS Comparing the Control Case to the Internal Auditor Cases. «© e «© we we ew ew + - 60 10, ANOVA Table for Total Audit Hours. Mean Total Hours. 6 ee ew we ee we ee ew 63 12.
MANOVA and ANOVAs for Total Compliance and Substantive Hours. 2 6 6 6 © we © ee ew 13. Mean Total Compliance Hours. + và w© + + ew ew + 66 14.
Mean Total Substantive Hours. 1 6 we 2 we tw Ÿ we ew - 67 15. MANOVA on Individual Compliance Test Hours. 68 l6, ANOVAs on Individual Compliance Test Hours.
Mean Individual Compliance Test Hours. MANOVA on Individual Substantive Test Hours. 74 Vii Table ade 19. ANOVAS on Individual Substantive Test Hours.
Mean Individual Substantive Test Hours ,. 7? ix CHAPTER I = INTRODUCTION External auditors must gather and interpret evidential information to support their professional opinion on whether a client's financial statements are prepared in accordance with generally accepted accounting principles. Although generally accepted auditing standards provide general guidelines as to the types and quantities of evidence which should be gathered, auditors still must use "professional judgment" to make many evidence accumulation decisions. When making these decisions auditors attempt to control costs and yet maintain a high quality audit.
Difficult decisions must, therefore, be made as to how much reliance may be placed on various types and quantities of evidence. This study examines one such type of decision: the evaluation and reliance upon information provided by internal auditors. Statement of the Problem External auditors are continually looking for ways to control increasing audit costs. One way external auditors can control such costs is by relying on work performed by other individuals.
Statement on Auditing Standard (SAS) #9 2 (AICPA, 1975), "The Effect of an Internal Audit Function on the Scope of the Independent Auditor's Examination,” has given external auditors significant latitude to rely on internal auditor work. The Standard allows external auditors to adjust the nature and extent of.external audit procedures due to such reliance. Surveys by Ward (1979), Ward and Robertson (1980) and the Institute of Internal Auditors (1975) indicate that external auditors rely on tnternal auditors to a substantial extent.
