This study examines whether internal audit reporting structure and internal audit sourcing arrangement affect financial statement users' perceptions of ability of the internal audit function to prevent financial statement fraud. A survey of lending officers finds that in‐house internal audit departments that report to senior management are perceived as less able to provide protection against fraudulent reporting compared to in‐house departments that report solely to the board of directors' audit committee. This finding is particularly important in light of the SEC's recent consideration of whether the audit committee should be directly responsible for oversight of the internal auditor.

This study does not find a difference in users' perceptions of financial statement fraud prevention between outsourced internal audit teams and in‐house internal audit departments when both report to the audit committee. Results suggest that increases in perceived audit expertise may occur with outsourcing, but such increases may not significantly enhance user confidence in the internal audit function because users perceive outsourced teams to have less in‐depth knowledge of the company than in‐house internal audit departments.

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