Abstract

he purpose of this study is to investigate how the level of controls testing coordination with the external auditor affects internal auditors’ effort. The internal auditor’s planned substantive testing audit hours are the measure of effort in this study. Regulators and stakeholder organizations have encouraged more collaboration between external and internal auditors to improve audit efficiency. The effect of external auditor coordination on internal auditors’ planned audit hours has important implications for audit efficiency and effectiveness. An experiment is conducted with 112 internal auditors to examine the hypothesized effect. The study uses a 2  ۲ between-subjects design and manipulates fraud risk and external auditor coordination. Consistent with my prediction, I find that coordination moderates the relationship between fraud risk and planned audit hours. The results illustrate that although high external auditor controls testing coordination decreases internal auditors’ planned substantive testing audit hours, internal auditors are more sensitive to responding to fraud risk when external auditor controls testing coordination is high.

Introduction

The Institute of Internal Auditors (IIA) and the American Institute of Certified Public Accountants’ (AICPA) Auditing Standards Board (ASB) provide guidance regarding the coordination between internal and external auditors. IIA standards state that the chief audit executive should coordinate activities with external providers of assurance (e.g., external auditors) to ensure proper coverage and minimize duplication of effort (Institute of Internal Auditors, 2017). The ASB’s Auditing Standard AU Section 322 (2003, paragraph 0.23) suggests that external auditors and internal auditors coordinate their work by “holding periodic meetings, scheduling audit work, providing access to internal auditors’ working papers, reviewing audit reports, and discussing possible accounting and auditing issues.” AU Section 322 also states that external auditors may request direct assistance from internal auditors with external auditors supervising, reviewing, evaluating and testing the work performed by internal auditors (American Institute of Certified Public Accountants’ Auditing Standards Board (ASB), 2003). While the auditing literature provides evidence about how coordination impacts the work of external auditors (Gramling, Maletta, Schneider, & Church, 2004; Krishnamoorthy & Maletta, 2016; Lin, Pizzini, Vargus, & Bardhan, 2011; Pizzini, Lin, & Ziegenfuss, 2015), little is known about how external auditor coordination impacts the work of internal auditors. Understanding how internal auditors’ behavior is affected by their coordination with external auditors is important because it is an economically important relationship that can be facilitated by a richer understanding of the nuanced interaction between both types of auditors.

Conclusion

This study investigates internal auditors’ sensitivity to fraud risk and the effect of the level of external auditor controls testing coordination on internal auditors’ audit effort as measured by planned substantive testing internal audit hours. The findings indicate that the level of external auditor coordination influences internal auditors’ effort. While increased external auditor CTC results in fewer planned internal audit substantive testing hours, an interaction effect indicates that the effect of fraud risk on internal auditors’ planned audit hours is moderated by the extent of coordination with the external auditor. That is, the effect of fraud risk on internal auditors’ planned substantive testing audit hours depends on external auditor coordination (specifically high external auditor CTC). An interesting finding is that the magnitude of the planned substantive testing hours changes at a different rate when external auditors participate in the controls testing work (under the high external auditor coordination condition) with internal auditors seeming to be less sensitive to high fraud risk under the low external auditor CTC condition. Since DeZoort and Harrison (2008) provide evidence that internal auditors report moderate levels of responsibility for fraud detection, this finding provides insight that more CTC with the external auditor could raise internal auditors’ accountability for responding to fraud risk and detecting fraud.