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MAJ 19,9

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The reliance of external auditors on internal auditors Hasnah Haron

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School of Management, Universiti Sains Malaysia, Penang, Malaysia

Andrew Chambers Management Audit Ltd, Sleaford, UK, and

Rozaldy Ramsi and Ishak Ismail School of Management, Universiti Sains Malaysia, Penang, Malaysia Keywords Internal control, Auditing Abstract External auditors often rely on other professionals for the audit of the financial statements of their clients. Generally, external auditors rely on clients’ internal auditors. Reliance on internal auditors results in cost savings to the client. The objective of this study is to determine which of the criteria as mentioned by AI 610 will be used by the external auditors to evaluate the work of the internal auditors. Respondents of the study consist of those from the big four and non-big four firms located in Kedah and Penang. A one-quarter replicate of 28 Kempthorne’s design was used to determine the experimental task. The findings of the study indicate that technical competence and scope of function are the two most important criteria that external auditors consider in their reliance on internal auditors. Malaysian Institute of Accountants (MIA), being the standard setter of the auditing standards in Malaysia, will have to develop precise and operational criteria for these factors in planning the audits. The study also shows that there was consistency in audit judgement.

Managerial Auditing Journal Vol. 19 No. 9, 2004 pp. 1148-1159 q Emerald Group Publishing Limited 0268-6902 DOI 10.1108/02686900410562795

Introduction Internal auditors usually assist management in ensuring that there is a proper internal control system in place and that the operations of the company are carried out efficiently, economically and effectively. External auditors, on the other hand, are interested in the truth and fairness of the financial statements. In order to achieve this objective, the external auditors will usually evaluate the internal control system of the company to ensure that it is capable of preventing and detecting material mis-statements from occurring. External auditing standards require external auditors to determine whether or not, and if so to what extent, they will rely on their clients’ systems of internal financial control in order to obtain assurance that their clients’ financial statements are reliable. External auditors can rely on the work of internal auditors in many respects in carrying out their external audit duties as both auditors are concerned that proper controls are in place. Internal auditors can assist external auditors to understand the internal control system that has been set up before any compliance or substantive work is being carried out. Other areas where internal auditors can be of assistance to the external auditors are, for instance, in choosing a sample to be tested and sending confirmation letters to the debtors and the banks – though external auditors need to ensure that the objectivity of the external audit process is preserved. External auditors can also review reports of the internal auditors for comments on the control system and for other matters concerning the operations of the company. Reliance on the work of the internal auditors should have the potential to reduce the audit hours that need to be spent on the audit and thus help to reduce the audit fee that needs to be paid – of particular importance in view of the upwards pressure on external audit fees, not least

due to a progressive tightening of the audit requirement in the wake of Enron and other corporate debacles. Internal auditors have grown in importance internationally and locally. New standards for professional practice of internal auditors (2002, comprehensively revised in January 2004) have emphasized the role of internal auditing as a “value added” service rather than a service just performing routine compliance audits. Since 2002, all companies listed in the Kuala Lumpur Stock Exchange have been required to have an internal audit function. In addition, for years ending on or after 31 December 2001, companies have been required to include an internal control statement with their annual reports. Under the new NYSE corporate governance standards (November 2003) internal audit is also mandatory for US-listed companies. Internal audit is not mandatory in the UK but under the new 2003 Combined Code, UK-listed companies must publicly justify any decision not to have an internal audit function. Since the internal auditors’ role is to assist in ensuring that controls are in place, it can be assumed that internal auditors are being called on to assist in preparing this statement. At a minimum, the company is to disclose that there is an ongoing process for identifying, evaluating and managing significant risks faced by the company. As the internal control statement is included in the annual report, it is currently being debated that the external auditors should be auditing the “truth and fairness” of this statement. This has therefore called for an increased reliance on the internal auditors by the external auditors and thus warrants a study to be undertaken to examine this issue. In the UK, the directors’ published statement on internal control and risk management is “reviewed” by the external auditors; but the external auditors’ review is less than an audit – it merely confirms that the directors have conducted a review with appropriate scope. But it does not audit the quality of that review nor the reliability of the conclusions that the directors have drawn from that review. In the USA, the Public Companies Accounting Oversight Board’s (PCAOB’s) auditing standard (March 2004) requires that external auditors undertake a proper attestation (i.e. a proper audit) of the CEO’s and CFO’s review and certification of the effectiveness of internal control over financial reporting which are required by the SEC rule which gives effect to a requirement of the Sarbanes-Oxley Act (2002, Section 404). This is an audit attestation of both the certification itself and also of the effectiveness of internal control over financial reporting. This paper discusses the criteria that the external auditor will use to judge the extent to which he or she may place reliance on internal audit work. The criteria selected are based on Malaysian AI 610(MIA, 2001), Considering the Work of Internal Auditing. The objectives of this study are to determine the judgement model of external auditors and also to determine whether there is “consistency” in external auditors’ judgements. Judgement consistency is consistency from one occasion to another occasion with respect to the conclusions drawn. Literature review Prior research A majority of external auditors rely on internal auditors to some extent and this reliance should increase in the future (Ward and Robinson, 1980). In order to make decisions about the extent of reliance on the work of internal auditors, external auditors should judge and assess internal audit quality. This study is undertaken to address the issue of whether external auditors’ judgements on internal auditors are based on the criteria of the internal audit function as mentioned in the Malaysian Approved Standards on Auditing AI 610 (MIA, 1998), which can be stated as follows:

Reliance on internal auditors

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Organizational status: refers to the specific status of internal auditing in the entity and the effect of this on its ability to be objective. In the ideal situation, internal auditing will report to the highest level of management and be free of any other operating responsibility. Scope of function: refers to the nature and extent of internal auditing assignments performed. The external auditors would also need to consider whether management acts on internal audit recommendations and how this is evidenced. Technical competence: refers to whether internal auditing is performed by persons having adequate technical training and proficiency as internal auditors. This includes the internal auditors’ experience level as well as professional qualifications. Due professional care: refers to whether internal auditing is properly planned, supervised, reviewed and documented. There should be adequate audit manuals, work programs and working papers.

External auditors often rely on other professional evaluations in examining clients’ financial statements (examples include those of attorneys, actuaries, computer specialists, property valuers – and so on). Much of the work of internal auditors may be useful to external auditors in assisting them in determining the nature, timing and extent of their audit work. However, reliance on internal auditors might be less if the internal audit is “in-house” as compared to an “outsourced” internal audit as they are viewed as being less independent. Arens and Loebbecke (1991) defined “competence” as a member who accepts a professional engagement and implies that he has the necessary technical knowledge to complete the engagement. Objectivity is a state of mind, a quality that lends value to a member’s service. It is a distinguishing feature of the profession. The principle of objectivity imposes an obligation to be impartial, intellectually honest and free of conflicts of interest (Carmichael et al., 1996). The standards for the scope of external and internal audit work provide guidance as to what audit work should be performed. Standards for the performance of audit work present guidance for the overall audit structure, including the areas of planning the audit, examining and evaluating information, communicating results, and following up on the engagement. Brown (1983) conducted a study to examine the criteria used by internal auditors that might be considered important by external auditors before the latter can place reliance on the former, and also the degree to which there is consistency of those factors across auditors. A total of 101 auditors of four “big eight” firms dispersed across the USA participated in the study. Each auditor was provided with 48 different scenarios (cases) of internal audit characteristics. About 48 hypothetical audit settings, based on six characteristics of internal audit function, represented the scenarios. The cases consisted of 32 principal cases and 16 repeat ones, arranged in random order. A combination of 32 “yes” and “no” answers to the preselected questions were generated. The auditors were required to evaluate the reliance placed on internal audit on a scale of 1 to 7. Key indicators were obtained from judgement models generated for each auditor using analysis of variance (ANOVA). F-ratios were computed for the six main effects and also 15 two-factor interactions for each auditor. The results indicated independence of the internal audit function (“objectivity category”) and satisfaction

with the internal audit function (“work performed category”) during previous audit external audit judgements about the reliability of the internal audit function. Schneider (1984) conducted a descriptive model study in examining the three factors of internal auditing, that is: (1) objectivity; (2) competence; and (3) work performed. Results of that study showed that external auditors viewed “work performed” by internal auditors as the most important factor followed by “competence” and “objectivity”. Tiessen and Colson (1990) found that internal auditors’ specific work performed accounted for most of the variance in the external auditors’ evaluation of the extent to which they could rely on the internal audit department. Maletta (1993) examined the effect of inherent risk on the extent to which internal auditors’ objectivity, competence and work performed affected external auditors’ decisions to rely on them. It was found that all three factors affected external auditors’ reliance judgment. There were significant interactions between “objectivity” and “competence”, between “objectivity” and “work performed” and three way interactions among those factors. The significant three way interactions suggested that inherent risk does affect external auditors’ reliance decisions. The results also showed that when inherent risk is high, external auditors consider the nature of the previous work performed by internal auditors only when internal auditors’ objectivity is high. When inherent risk is low, work performed has no significant effect on external auditors’ judgment. Also, external auditors appeared to use more complex configural decision processes only when inherent risk is high. Across inherent risk conditions, internal auditors’ “competence” is the most important of the three factors, followed by “objectivity” and “work performed”. Another interesting study by Berry (1984) looked at the coordination efforts between internal and external auditors through the eyes of the internal auditor. A total of 14 large companies were selected and interviewed. The study was able to present ranked criteria for evaluating an internal audit staff’s competence, objectivity and performance, as well as how to establish and introduce a co-ordination programme. Other studies on internal and external auditors which might not be directly relevant to the current study will be discussed below. The studies looked at coordination efforts between internal and external auditors and similarity in judgements between internal and external auditors. Barett and Brink (1980) conducted a survey on 150 business organisations with both types of internal and external audit and then followed up with visits to 20 organisations that have an effective board. The study suggested that the degree of co-ordination between internal and external auditors should be measured by the degree of reliance, that is “much”, “moderate” and “little” co-ordination. Wallace (1984) examined the effect over time of internal audit activities on external audit fees from 1975 to 1981. The study provided clear evidence that internal audit practices had systematically become more formalized and sophisticated over time, concurrent with an increase in the external auditors’ likelihood of reliance on internal audit. Wagonner and Rickette (1989) conducted a study to examine the detection rate of internal and external auditors in the testing of controls of 25 disbursements from an actual international airport company. The internal auditors had an overall detection rate of 63.2


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per cent, and the external auditors of 59 per cent, which was not statistically significant. These results were taken to support the use of internal auditors in the testing of controls by external auditors in the documentation, testing and evaluation of a client’s control system. Haron (1996) studied the ratings of both internal and external auditors on the quality of a payroll internal control system. She found no significant difference between their ratings, which brings us to the conclusion that external auditors can rely on the work or judgement of internal auditors. In summary, previous research has shown that there is not much difference between the judgement of internal and external auditors and has identified three factors, i.e. “competence” “objectivity” and “work performed” as important criteria for external auditors to use in order to assess whether or not to rely on internal auditors in conducting an external audit. In our study the four factors mentioned in AI 610 have been recategorised into three categories. “Organizational status” has been categorized as “objectivity”, “technical competence” has been recategorized as “competence” and “scope of function” and “due professional care” have been recategorised as “work performed”. “Scope of function” and “due professional care” in previous studies is treated as the “work performed” category. The reason for doing this is for the purpose of comparison with previous studies. Judgement Johnson (1971) described three categories of thought processes in an attempt to structure the complexity of thought into identifiable categories: (1) preparation for intellectual activity; (2) productive thought; (3) judgement. The first category, that of “preparation”, includes everything that precedes and influences thought. Johnson’s second classification of thought, that of production, concerns the examining of alternatives on solving a problem. He states that “the thinker halts his productive activity to judge the merit of what he has produced”. In his book, he offers the following definitions of “judgement”: . . . judgement is a conclusive or decisive process, not a productive one that brings a thoughtful episode to an end. In this definition the emphasis is upon choosing between alternatives responses, or placing the object of judgement into one category or another (Johnson, 1971).

It may be argued that external auditors’ overall evaluation of internal auditors fits such a description. In this study, a judgement model of the external auditor has been determined. In short we have used a statistical analysis (ANOVA) to find out which of the eight criteria are used by external auditors to influence their reliance on internal auditors’ decisions. It is difficult to assess the validity of external auditors’ judgement. This is due to the absence of suitable criteria by which to distinguish correct from incorrect judgements. Since strict guidelines do not exist for evaluation, there are no clear cut “right” judgements available with which to compare individual professional judgements in most audit tasks. Einhorn (1974) argues that judgement consistency is important because judgement consistency is considered a necessary condition for expertise. Judgement consistency is agreement of an auditor with “himself” on the evaluation of a particular task, i.e. would an auditor pass the same judgement on a particular audit task, given two cases of the same nature to evaluate. In our study, judgement consistency is measured using two repeat cases with similar “yes and “no” questions/criteria but the questions are placed in sequence.

Theoretical framework Theoretical framework of the study is shown in Figure 1. Measurement of variables Objectivity, competence and work performed A questionnaire comprising eight questions representing the eight criteria was given to the subjects. Questions 1 and 2 measured competence of the internal auditors. Questions 3 and 4 measured the objectivity or independence of the internal auditors. Questions 5, 6, 7 and 8 measured the work performed of the internal auditors. Details are as follows:


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Competence Criterion 1/Question 1. In hiring new internal auditors, has emphasis been placed on having or obtaining professional certification or qualification? (PROFCE) Criterion 2/Question 2. Does the internal audit function have an ongoing training programme that includes thorough coverage of the company’s operations, policies and procedures? (TRAINPR) Objectivity Criterion 3/Question 3. Does the internal audit function report to an organizational level (for example to the audit committee) to assure independence of operations? (ORGLEV) Criterion 4/Question 4. Does the internal audit function communicate to us problematic areas that require more attention? (COMMPRO) Work performed Criterion 5/Question 5. Did we conclude that the work of internal audit function was satisfactory during the previous audit? (WORKSAT) Criterion 6/Question 6. Has the internal audit function performed satisfactory follow-up procedures on deficiencies in company systems, methods, and/or procedures noted in prior audits? (FOLLOWU) Criterion 7/Question 7. Are the staff of the internal audit function closely supervised and their work adequately reviewed by more experienced personnel? (CLOSESP) Criterion 8/Question 8. Does the internal audit function have adequate audit manuals and work programmes? (ADEQMAN) The dependent variable is the ratings that the external auditors placed on a seven point Likert scale from “totally unreliable” to “strongly reliable” after judging the eight criteria presented to them. Hypotheses Judgement model The judgement model was able to indicate the importance that the external auditors attached to each criterion in making their judgement. In this case, the model was able to

Figure 1. Framework of judgment of external auditors’ reliance on internal auditors

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explain whether the external auditors placed more importance on either “competence” or on “the work performed” of the internal auditors in making their judgement as to whether to rely or not on internal auditors. The first hypothesis of the study can be stated as follows: H1. Internal auditors’ objectivity, competence and work performed will affect external auditors’ judgement to rely on internal auditors

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Consistency Auditors are considered as professionals in their field and they have to make consistent judgements. Einhorn (1974) stated that judgement consistency is important because judgement consistency is considered a necessary condition for expertise. Their audit opinions are being relied on by the users of the financial statements. Given the same set of financial statements over time, their audit opinion should not vary. In this study, two similar cases are given to the auditors to test for judgement consistency. The second hypothesis can be stated as follows: H2. There is a significant difference in the variation of judgement (consistency) of the two repeat cases. Research design A one-quarter replicate of 28 based on Kempthorne’s (1952) design was chosen. A “quarter replicate of 28” referred to the number of the respondents sample that should be included in the study. Thus this study requires a sample size of 64 external auditors. In the design, all main effects and the 28, two cue interactions are estimable. Three interactions are not intended to be measured, as a previous study (Brown, 1983) indicated that they account for no, or negligible, interaction. The purpose of using the design was so that the effects of a number of different variables could be investigated simultaneously. The degree of influence of each variable on the final judgment is known as the “main effect”. The interaction effect is the effect of a combination of two or more of the criteria (independent variable) on the external auditors’ judgment whether or not to rely on internal auditors. The dependent variable is the final rating of the auditors on a seven-point Likert scale. Each external auditor was given a set questionnaire consisting of six cases, with one case comprising eight questions/criteria. Out of the six cases, there were two repeat cases, which were always placed as case number 1 and case number 6. The remaining four cases were cases outside the model of a one-quarter replicate of 28 design. The reason for doing this was to avoid making the error of including two or more repeat cases in a questionnaire. In order to camouflage the “repeat” cases, the criteria of the cases were placed in three different orders. The eight criteria were placed in three different orders using a random number table. Please refer to Table I. Using a random number table, cases 1 and 4 were placed in the first order, cases 2 and 5 were placed in the second order and cases 3 and 6 were placed in order 3. The six cases were chosen so that the number of yes’s (presence of internal auditors criteria) increases. The combination of the factor levels of the four cases were then compared with the combination of the factor levels of the model of one-quarter replicate of 28 design. Case number 4 was a case with all the internal auditors criteria present. Please refer to Table II for the combination of the factors level for the four cases. The objective of giving the same case (the repeat cases being case numbers 1 and 6) to the same external auditor was to determine whether there was consistency in auditor judgements. The combination of six cases for the 64 sets were as follows:

. . .

Case 1, which followed Kempthorne’s one-quarter replicate of 28 design; Cases number 2, 3, 4 and 5 consist of similar cases given to the external auditors; and Case number 6 was a repeat of case number 1 but arranged in a different sequence.

Sample The population of our study comprised different auditing firms located in the northern part of Malaysia from Penang and Kedah. Convenience sampling was used. The subjects of this study were limited to auditors who were partners, managers or seniors as they were the persons who are mainly involved in making judgements in particular audit work. A structured questionnaire was used to collect the data. The questionnaires were distributed to audit firms personally or through personal contacts and they were asked to return the questionnaires within four weeks from the date they received the questionnaires. The contact person distributed the questionnaire to fellow colleagues, excluding those holding junior positions. The questionnaire was divided into two sections. Section A consisted of questions relating to the profile of respondents and section B comprised the six cases. External auditors were required to evaluate the degree of reliability that they would place on internal auditors on a seven-point Likert scale ranging from the “totally unreliable” (1) to “strongly reliable”(7). The higher the number, the greater the reliance that external auditors would place on internal auditors.


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Findings Profile of sample The majority of external auditors who participated are in the seniors level, located in Penang and having moderate experience. The ages range from 24 to 58 years old and also a majority of them have professional accounting and auditing qualifications. A total of 57.8 per cent of external auditors who were willing to participate in the study were working in the big four auditing firms. The rest were from the medium-sized firms. Most of the respondents have audited clients that have internal Order 1 Question Question Question Question Question Question Question Question

Order 2 1 2 3 4 5 6 7 8

Question Question Question Question Question Question Question Question

Order 3 2 5 4 7 1 8 6 3

Question Question Question Question Question Question Question Question

5 3 6 4 8 1 7 2

Case

Q1

Q2

Q3

Q4

Q5

Q6

Q7

Q8

2 3 4 5

N Y Y N

Y N Y Y

N Y Y N

N N Y Y

N Y Y N

N N Y Y

Y N Y Y

N N Y N

Table I. Three different orders of the eight “internal auditors criteria”

Table II. Combination of the factor levels of the six cases

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auditing departments. There was a total of 18 external auditors who had never audited clients with internal auditing departments, but they were not excluded because 64 external auditors’ responses were needed to conduct the study (as one-quarter replicate design was used). Please refer to Table III. This tends towards more conservative conclusions based on our statistical analysis.

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Descriptive judgement model of external auditors H1 states that “objectivity”, “competence” and “work performed” by internal auditors will affect external auditors’ judgment about relying on internal auditors. From the analysis done, the two-way interaction effect was not significant at the 5 per cent level of confidence. Thus, it was deleted from the model, leaving behind only the main effects. From the initial analysis as shown in Table IV, it appears that only the internal auditors’ ongoing training program (p ¼ 0:21) and satisfactory follow-up procedure performance (p ¼ 0:04) have an influence on the rating of external auditors. Each criterion represents “technical competence” and “scope of function” respectively (criterion number 2 and 6 of case 1). The model was able to explain about 27.5 per cent of the external auditors’ evaluation. Since only two factors indicated as being of insignificant effect on external auditors’ judgement, it was therefore decided to eliminate one by one the criteria (independent variables) based on the least significant term in order to determine the final model (backward elimination). The final model consists of only terms that are significant to the external auditors’ evaluation. Organizational level was only significant at the 10 per cent level. Therefore for the purpose of the study, it is considered as not significant. The final model for external auditors is shown in Table V. The findings indicate that the “work performed” and “competency” of internal auditors were important criteria for external auditors to judge the reliance of internal audit work. “Objectivity” of internal auditors was not significant in their ratings. This could be due to the fact that the external auditors view internal auditors as employees of the organization and thus their “objectivity” is not seen as an important element affecting the decision that they have made. As for the “work performed” by the internal auditors, the result is consistent with prior studies as indicated in Table VI. However, variations can be seen in terms of the ratings given to competency and objectivity. Under the “competency” criterion, external auditors view only an ongoing training programme that includes a thorough coverage of the company’s operations, policies and procedures to be an important element for them to rely on the internal auditors. Professional certification of internal auditors was not viewed as important – maybe due to the same reasoning as was mentioned with respect to “objectivity” (above). Under the “work performed” criterion, external auditors placed importance on whether the follow-up procedures on deficiencies in the company systems, methods, and/or procedures noted in prior audits were satisfactory. This could be due to the fact that the follow-up procedures could be an indication of the quality of work of the internal auditors whereas the other criteria were merely an “indication” that the internal auditors would perform quality work which might not necessarily materialise. The variables found to be important in this study, that is “competence” and “work performed”, are consistent with previous studies (Maletta, 1993; Tiessen and Colson, 1990; Schneider, 1984). Only Brown’s (1983) study did not find “competence” to be an important element, maybe due to the fact that the respondents were asked to rate about 48

Location Gender Position

Audit firms Number of times external auditors have audited an internal audit department

Source Corrected model Intercept PROFCE TRAINPR ORGLEV COMMPRO WORKSAT FOLLOWU CLOSESP ADEQMAN Error Total Corrected total

Frequencies

Percentage (%)

57 7 64 37 27 64 5 15 44 64 27 37 64 18 28 6 2 7 64

89.00 11.00 100.00 57.8 42.2 100.00 7.8 23.4 68.8 100.00 42.2 57.8 100.00 29.5 45.9 9.8 3.5 11.5 100.00

Penang Kedah Total Male Female Total Partner Manager Senior Total Non-big five Big five Total 0 times 1-3 times 4-6 times 7-9 times More than nine times Total

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Table III. Demographic profile of respondents

Type III sum of squares

df

Mean square

F

Sig.

26.012 945.153 1.427 7.058 3.581 2.403 1.479 5.497 2.859 1.345 68.425 1,040.000 94.437

8 1 1 1 1 1 1 1 1 1 55 64 63

3.252 945.153 1.427 7.058 3.581 2.403 1.479 5.497 2.859 1.345 1.244

2.614 759.711 1.147 5.673 2.879 1.931 1.189 4.419 2.298 1.081

0.017 0.000 0.289 0.021 0.095 0.170 0.280 0.040 0.135 0.303 Table IV. Initial judgement model for external auditors with main effects only

Notes: R-squared = 0.275 (Adjusted R-squared = 0.170); Dependent variable: Case number 1

Source Corrected model Intercept ATRAINPR AFOLLOWU Error Total Corrected total

Type III sum of squares

df

Mean square

F

Sig.

13.222 952.464 7.494 6.972 81.215 1,040.000 94.437

2 1 1 1 61 64 63

6.611 952.464 7.494 6.972 1.331

4.966 715.386 5.629 5.237

0.010 0.000 0.021 0.026

Notes: R-squared = 0.140 (Adjusted R-squared = 0.112); Dependent variable: Case number 1


Table V. Final judgement model of external auditors

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scenario/cases with each scenario comprising six criteria of audit quality. Our study, however, only requires external auditors to evaluate six cases with eight criteria. The fewer cases given to the auditors might have had an influence on their judgement. Judgement consistency H2 states that there is a significant difference in the variation of judgement (consistency) of the repeat cases. Judgement consistency was measured by using Pearson correlation. This analysis focused on relationships between pairs of variables. The result shows that there is a significant relationship between case 1 to case 6. Thus H2 is rejected. The finding is similar to previous studies (Brown, 1983; Haron, 1996). (Refer to Table VII.) Limitations of the study As with other studies, this study has its limitations. The sampling area of the study was limited to the Northern Branch of Malaysia due to time constraints. Maybe future research can expand the geographical areas of study. The sampling was not done at random. It was initially the intention of the researchers to do a random selection of the sample from the list of external auditors obtained from the MIA members’ directory, but due to inevitable factors (for example the auditors were too busy) non-random selection had to be the choice in this study. The 18 respondents with no prior experience auditing clients with an internal auditing department had to be included due to time constraints. There could be other factors that affect the judgement of external auditors in their decisions, such as the length of their auditing experience and the complexity of client transactions, which have not been considered in this study. These variables have been somewhat controlled in this study, such as by limiting the task only to seniors, managers and partner level personnel and also by mentioning in the introductory passage before the external auditors were required to make their ratings regarding the type of company that they would be evaluating. Nevertheless, this could be done in a more structured manner in future. Conclusions Several findings from this study should be highlighted. The two factors judged most important by external auditors are the internal auditors’ training programme (criterion 2, sig 0.021) and satisfactory follow-up procedures performance in prior audits

Table VI. Comparison of results with previous studies

Table VII. Correlation table of judgement consistency

Study

Findings

1. 2. 3. 4. 5.

Independence/objectivity; Work performed Work performed; Competence Work performed; Competence; Objectivity; Objectivity; Competence; Work performed Competence; Work performed

Brown (1983) Schneider (1984) Tiessen and Colson (1990) Maletta (1993) This study (2000)

Case No. 1 Case No. 6

Case No. 1

Case No. 6

1.000 *0.656

*0.656 1.000

(criterion 6, Sig 0.04) – representing “competence” and “work performed” respectively. Furthermore, both “technical competence” and “scope of function” reflect “competence” and “work performed” referred to in previous studies. The importance of “competence” and “work performed” by internal auditors which this study found suggests that company policy makers should emphasize development of precise, operational criteria for these factors when selecting the internal auditors and also when determining the type of work that they perform. If these criteria were in place, it would mean that external auditors would rely more on the internal auditors and, in turn, the external audit would be more cost effective for companies. References Arens, A.A. and Loebbecke, J.K. (1991), Auditing: An Integrated Approach, Prentice-Hall International, Englewood Cliffs, NJ. Barett, M.J. and Brink, Y.Z. (1980), Internal/External Audit Services and Relationships, IIA Inc., Altamonte Springs, FL. Berry, L. (1984), Coordinating Total Audit Coverage: Trends and Practices, IIA Inc., Altamonte Springs, FL. Brown, R.P. (1983), “Independent auditor judgment in the evaluation of internal audit functions”, Journal of Accounting Research, No. 2, pp. 444-55. Carmichael, D.R., Willingham, J.J. and Schaller, C.A. (1996), Auditing Concepts and Methods: A Guide to Current Theory and Practice, McGraw-Hill, New York, NY. Einhorn, H.J. (1974), “Expert judgement: some necessary conditions and an example”, Journal of Applied Psychology, Vol. 59 No. 5, pp. 562-71. Haron, H. (1996), “Internal and external auditors: their judgment and perception on internal control”, PhD thesis, University of Hull, Hull. Johnson, D.M. (1971), The Psychology of Thought and Judgement, Harper & Row, New York, NY. Kempthorne, O. (1952), The Design and Analysis of Experiments, John Wiley & Sons, New York, NY. Malaysian Institute of Accountants (2000), Malaysian Approved Standards on Auditing, Malaysian Institute of Accountants and Malaysian Institute of Certified Public Accountants (MICPA), Kuala Lumpur. Maletta, M. (1993), “An examination of auditors’ decision to use internal auditors as assistants: the effect of inherent risk”, Journal of Contemporary Accounting Research, Vol. 9 No. 2. Schneider, A. (1984), “Modelling external auditors’ evaluations of internal auditing”, Journal of Accounting Research, Vol. 22 No. 2, pp. 657-78. Tiessen, P. and Colson, R.H. (1990), “External auditor reliance on internal audit”, Journal of Internal Auditing, Vol. 5 No. 3, pp. 10-22. Wagonner, J.B. and Rickette, D.E. (1989), “External auditors vs internal auditors in an internal control test”, Internal Auditing (US), Spring, pp. 57-65. Wallace, W. (1984), Time Series Analysis of the Effect of Internal Audit Activities on External Audit Fees, IIA Inc., Altamonte Springs, FL. Ward, D.D. and Robinson, J.C. (1980), “Reliance on internal auditors”, Journal of Accountancy, October, pp. 62-73. Further reading Woolf, E. (1997), Auditing Today, Prentice-Hall Europe, Hemel Hempstead.


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