Beyond Reliance: Internal Auditors’ Perceptions of Their Relationships with External Auditors Free

Internal auditors perform a variety of functions within an organization, primarily focusing on risk management, corporate governance, operational efficiency, regulatory compliance, and financial statement accuracy (Institute of Internal Auditors (IIA) 2016). These functions require a significant amount of interaction between internal audit and other stakeholders across the entity, including the Board of Directors and/or Audit Committee, management, process owners, and employees. Additionally, internal audit often works with external auditors during the year-end external audit, yet research into the collaboration between the internal and external auditor is generally from the perspective of the external auditor.¹ “[Internal audit quality] research has been dominated by the viewpoint of external auditors,” necessitating additional research into the actual practices of internal audit (Roussy and Perron 2018, 347).

Roussy and Perron (2018) find that there is a significant gap in audit research exploring practice-specific knowledge about internal audit work. Despite this gap in work-specific knowledge, internal audit involvement in the external audit is the focus of 35 percent of internal audit research found in top-tier accounting journals (Behrend and Eulerich 2019). This contradiction is notable, as the internal auditor’s capabilities (i.e., work product) are at the core of the external auditor’s assessment when determining whether the internal auditor’s work can be relied upon for the external audit. Additionally, internal audit practices specific to internal-external auditor interactions could have implications beyond the impact on year-end audit results.

Specifically, Morais and Franco (2019, 275) note, “Internal auditors perceive, more than external auditors, that work performance and coordination can increase both trust and cooperation.” Research has not explored whether external auditors could better use internal auditors as part of the external audit. Furthermore, research has not considered ways the internal-external audit relationship could be improved, potentially increasing the level of reliance placed on the internal audit and possibly improving external reporting and audit quality. Our study addresses this gap in the literature by exploring the relationship between internal and external auditors from the internal auditors’ viewpoint.

To obtain a better understanding of internal auditors’ views of their relationships with external auditors, we conducted a survey with 67 internal auditors. Our results suggest that internal auditors see a lot of room for growth in the internal-external audit relationship and are looking for more opportunities to collaborate with external auditors. Internal auditors appear to feel underutilized, even when external auditors believe they have “maximized” reliance on the internal audit during the external audit. We believe internal auditors’ willingness to work with external audit suggests there could be additional areas where external auditors can benefit from the internal auditors’ assistance. Such collaborative relationships can be beneficial to both external auditors and internal auditors, as well as the internal auditor’s organization.

We surveyed internal auditors using a snowball method whereby individuals were contacted directly through authors’ personal connections with individuals and email distributions by internal auditor societies across the Southeast.² We obtained 67 usable responses for this study. Participants include internal auditors from public companies (34, 50.8 percent), private companies (7, 10.4 percent), governmental entities (15, 22.4 percent), and higher education entities (11, 16.4 percent).³ Our participants have an average of 131.33 months of experience (or 6+ years), and our participant pool consists of 27 male participants (40.3 percent) and 40 female participants (59.7 percent). Demographics are presented in Table 1.

Participants were emailed a link to access an online survey (administered using Qualtrics).⁴ Our survey included five⁵ questions about the participant’s experiences with external auditors, found in  Appendix A. The questions used Likert scales ranging from 1 to 11 for four of the five questions (experience and interaction frequency with the external auditor, confidence in internal audit’s own work, and expected future involvement in the external audit). The third question (percentage of historical contribution to the external audit) used a percentage scale of 0 to 100. Additionally, we included an open-ended question asking participants to describe examples of past experiences with their external auditors. We use quotes from the participant responses to this question to provide additional insight into our findings discussed throughout Sections III and IV.

Our results indicate that internal auditors have overall positive relationships with their external auditors, which are statistically stronger than coexistence (mean of 7.85, significantly different from the coexistence midpoint of 6, p < 0.01; Table 2) but still not at the level of full collaboration (significantly different from the collaboration endpoint of 11, p < 0.01; Table 2). These results suggest that there is still a lot more opportunity for external auditors to collaborate with internal audit (see  Appendix B, Experience).

In general, internal auditors interact with external auditors more often than only during the year-end audit (mean of 7.94, significantly different from the year-end audit interaction midpoint of 6, p < 0.01; Table 2), but there is still a lot more room to interact in a way internal auditors consider “frequent” (mean significantly different from frequent interaction endpoint of 11, p < 0.01; Table 2). In addition, we examine the responses of internal auditors from profit-focused (publicly traded and private) companies and not-profit-focused (governmental and higher education) organizations and find some interesting differences. We find higher internal-external auditor interaction frequency in profit-focused organizations (mean = 8.76) than in not-profit-focused organizations (mean = 6.36, t = 3.96, p < 0.01, two-tailed; Table 3). For example, one of our participants in a publicly traded company suggested, “The key in dealing with external auditors is meeting frequently upfront before the SOX Compliance year begins and getting on the same page with them on many fronts” (IA58).⁶ Alternatively, a participant from the government sector stated, “Our external auditors only request a copy of our internal audit reports that were issued and ask the typical fraud questions. Other than that, we have no other involvement with them” (IA43). Publicly traded companies must perform an annual assessment of internal controls, requiring significant involvement in the testing process by internal auditors, which they may perceive as greater frequency of interaction (Gramling, Maletta, Schneider, and Church 2004). This is also visible in the internal auditors’ responses to the open-ended question related to their interaction with external audit (see  Appendix B, Interaction Frequency).

Our participants also provided the percentage that they believe their own internal audit function has historically contributed to assisting the external auditor’s financial statement audit. Table 2 shows that internal auditors perceive that they contribute approximately 42.46 percent to the year-end audit, which is significantly different from both the scale’s midpoint of 50 percent (p = 0.05; Table 2) and endpoint of 100 percent (p < 0.01; Table 2), suggesting that internal auditors seem to believe they can offer additional contributions to the year-end audit (see  Appendix B, Contribution).⁷ For example, a participant who is a director in a publicly traded company states, “External Auditors have relied less and less on Internal Auditors other than as staff-level resources who can do legwork to save them time” (IA9). In addition, our results support that the percentage of perceived involvement is higher for internal auditors in profit-focused organizations (mean = 48.21 percent) than for not-profit-focused organizations (mean = 28.77 percent, t = 2.84, p < 0.01, two-tailed; Table 3), suggesting that internal auditors in profit-focused companies have more opportunity to be involved with the external auditors in the year-end audit process.

When it comes to the work performed by both internal and external audit, internal auditors indicate that past external audit findings did not have a negative impact on internal auditors’ confidence in their own testing. A possible reason for the lack of impact on confidence is that when external auditors share findings with internal audit, internal auditors might feel challenged and get defensive.⁸ For example a director of a publicly traded company stated, “We are always skeptical of their experience in our business, so we attempt to both educate and train to the extent possible” (IA11). Our findings show that internal audit is relatively confident in its own capabilities and testing. External audit findings do not affect internal auditors’ confidence in their own work (mean = 6.28, not statistically different from the “It had no impact” midpoint of 6, p = 0.21; Table 2), and this confidence is also represented in the open-end question responses presented in  Appendix B, Confidence Impact.

Lastly, we asked how internal auditors perceive that their involvement with the external auditor will change in the future. Our results show internal auditors being slightly optimistic (mean = 6.97, significantly different from the “I don’t see it changing in the future” midpoint of 6, p < 0.01; Table 2). However, internal auditors’ view of future involvement with external audit is still a long way away from the “significantly more involvement” endpoint of 11 (p < 0.01; Table 2).

The results of this study can benefit both audit research and practice. Notably, although many studies have examined the external auditor’s reliance on internal audit (Bame-Aldred, Brandon, Messier, Rittenberg, and Stefaniak 2013), we are not aware of any studies that have considered whether external auditors are truly maximizing the possible reliance on the work of internal audit. From a practical standpoint, our study suggests that internal auditors still perceive that they can contribute more to the external audit despite positive and somewhat frequent internal-external auditor interactions. This issue could be significant for external audit and audit committees, as research has indicated that reliance on internal audit work can reduce audit fees (Abbott, Parker, and Peters 2012; Prawitt, Sharp, and Wood 2011; Felix, Gramling, and Maletta 2001). Below, we discuss a few practical actionable steps to improve the internal-external audit relationship:

1. Communications should occur formally at the various stages of the external audit (planning/risk assessment, risk response, and reporting).

2. Both internal and external auditors should share findings early in the audit process, especially those related to higher-risk areas that might give rise to potentially significant audit issues.

3. External auditors should consider interactions with internal auditors as ways to provide additional recommendations and “value added” services while also gaining a better understanding of the entity.

4. Internal auditors should identify and highlight ways their work could contribute to the external audit process and potentially reduce audit fees.

For the internal auditor, more frequent and substantial communication may allow for increased opportunities to assist in the external audit as well as offer insight about company-specific details that could help external auditors assess and evaluate potential findings. A participant in our study indicated that their team regularly coordinates with the external audit team and “hold formal monthly meetings…to check-in and discuss any issues” (IA61, Director, publicly traded company). We encourage external and internal audit teams to consider implementing some form of regular formal communication to improve the internal-external audit relationship. These communications could allow internal auditors to feel more valued and not just used to source “grunt work,” as one of our participants (IA72) so eloquently states. Such collaborative relationships can be beneficial to external auditors, internal auditors, their companies, and audit committees.

Both external auditors and audit committees should consider the possibilities and/or functions that internal audit can perform to provide value-added benefits to the organization, including their potential impact on the external audit. “IA may often have a better holistic understanding of risk and potential control breakdowns through its examination of a subject” (IA53, Senior, publicly traded company). Further, internal auditors can serve as a good sounding board in discussing potential findings with external audit because internal auditors can understand both the external auditors’ and management’s positions and, perhaps, help improve responses and/or recommendations. “Because internal audit is comprised of auditors who are part of the organization, internal audit can serve a vital role in ‘bridging the gap’ of communication and lingo” (IA6, Director, higher education).

Internal auditors should highlight other functions of their roles that extend beyond just financial statements. External auditors could significantly benefit by receiving more in-depth insights into the specific operations of an organization from the perspective of those who are directly involved in the design and testing of internal controls. Providing the external auditor with an awareness of other internal audit functions (i.e., operational and compliance) could bolster external audit’s confidence in internal audit’s work product. Additionally, this understanding could open the door for other areas where internal audit may be able to assist the external auditor. As some of our participants state, “IAs can also do a LOT of good substantive testing” (IA29, Director, private business), and “there is no need to duplicate work when possible” (IA2, Manager, higher education). This type of collaboration between internal and external auditors could benefit the external audit by encouraging increased reliance on internal audit and potentially reducing audit fees.

Our study has several limitations. First, we must caution the reader that our results might not generalize to all internal auditors’ experiences, even though we sent out our survey to different levels of internal auditors from a variety of organizations. Second, as this study explores personal experiences of internal auditors and their perceived relationship with external auditors, we caution the reader in drawing any causal relationships between variables. Considering these limitations, we encourage future research to further explore the internal-external audit relationship, including ways to increase collaboration. As participant IA45 states, “When testing indicates a concern, our team routinely discusses how the external auditors test and the risks they focus on. We will incorporate any steps considered beneficial especially if it potentially results in more reliance on IA work. Overall, we feel it improves the quality of our work.”

Experience

1. How would you describe your own experience with your company’s external auditor in the past?

Interaction Frequency

2. How frequently do you interact with your company’s external auditor?

Contribution

3. Based on your past experience, what percentage does the internal audit function contribute to assisting with the external auditor’s financial statement audit?

Confidence Impact

4. If you ever had an external auditor identify a problem during their testing of internal controls or substantive testing of account balances, did this finding impact your confidence in your team’s work and in your own assessments?

Future Involvement

5. How do you see your IA department’s involvement with your external auditor changing in the future?

Open-Ended Question

6. If you could share any examples of a past experience with external auditors, we would appreciate your insight!