Academic journal article Academy of Accounting and Financial Studies Journal

Audit Partners' Perceptions of Internal Audit Outsourcing and the SEC's Rule on Auditor Independence: An Investigation of Differences and Similarities

Academic journal article Academy of Accounting and Financial Studies Journal

Audit Partners' Perceptions of Internal Audit Outsourcing and the SEC's Rule on Auditor Independence: An Investigation of Differences and Similarities

Article excerpt

ABSTRACT

Outsourcing of the internal audit function (IAF) to public accounting firms has emerged as an important trend during the last decade. Recently, the SEC has issued a rule that places significant restrictions on audit firms' abilities to perform a significant part of large audit clients' IAF.

This study investigates Big Five audit partners' perceptions concerning internal audit (IA) outsourcing with respect to independence, type of client, IA issue, classification, and knowledge transfers. Similarities and differences between the partners' perceptions and the SEC's rule are identified and implications of these differences considered.

The study finds that audit partners appear to differentiate between audit and non-audit clients in terms of the acceptability of IA engagements, issues of independence, and type of audit issue involved. However, audit partners do not agree on classifying IA outsourcing, and the majority expects that reliance on the IAF will increase, if external auditors also perform the IA.

Audit partners' perceptions are important because actual independence is closely related to the auditors' "mind-set, " and findings from this study may provide insights into whether partners are aware of potential dangers, which may lead them to establish safeguards to protect the integrity of the external audit.

INTRODUCTION

During the past few decades, non-audit services (NAS) have become of increasing economic importance to public accounting firms. Between 1982 and 1988, revenues from NAS increased by an average annual rate of 3.8 percent, reaching 53 percent of total revenues in 1988. (Read & Tomczyk, 1992). At the same time, revenues from audit services have stayed fairly constant in a basically mature market. Currently, audit services represent only about 30 percent of the largest audit firms' total revenues (Levitt, SEC, 2000).

The proliferation of NAS has been enhanced by a continually increasing and broadening demand for such services. Companies are outsourcing many of their traditionally internal functions. For example, overall outsourcing revenues were 100 Billion Dollars in 1996 and are expected to reach 300 billion in the year 2001. (Antonucci et al., 1998). Many of these outsourced services are offered by public accounting firms to their audit and non-audit clients. With each new service offered to audit clients, concern over the auditors' independence deepens. The SEC, and others have repeatedly expressed concern over the performance of NAS by accounting firms for their audit clients. On November 21, 2000, the SEC issued a new auditor independence rule that limits primarily the large accounting firms' abilities to perform certain NAS, including IA services, for their audit clients.

The purpose of this study is to investigate Big Five audit partners' perceptions concerning IA outsourcing with respect to independence, type of client, type of IA issue, classification, and knowledge transfers. Similarities and differences between the partners' perceptions and the SEC's stand are identified and implications of these differences considered in light of the new rule.

Audit partners' perceptions concerning IA outsourcing are important because actual independence is closely related to the auditors "mind-set, " and findings from this study may provide insights into whether partners are aware of potential dangers, which may lead them to establish safeguards to protect the integrity of the external audit. Such safeguards may be necessary, particularly in light of potential measurement problems that may arise in enforcing the SEC restrictions.

This study finds that audit partners are (1) less likely to perceive IA outsourcing engagements involving audit, rather than non-audit clients, as acceptable and (2) more likely to perceive an independence problem associated with audit clients than non-audit clients. Furthermore, the study finds weak indications that the partners perceive engagements involving financial issues less acceptable, than those involving operational issues. …

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