determinants of internal audit function performance by dr. douglas e. ziegenfuss* old dominion...

DETERMINANTS OF INTERNAL AUDIT FUNCTION PERFORMANCE

ByDr. Douglas E. Ziegenfuss*

Old Dominion University

Dr. Patricia M. Myers Brock University

Dr. Wayne K. Talley, Old Dominion University

Dean’s Research Seminar

November 10, 2006

Synopsis

• This study examines the relationship between Internal Audit Function (IAF) and the following independent variables:

• IAF relative size, • IAF resources, • IAF staff quality, • IAF quality assessment review completion, • audit committee effectiveness, • Chief Audit Executive (CAE) reporting relationships, • IAF interaction with external auditors, • reporting year, and • organization demographic variables such as industry and

headquarter country.

Why Is This Research Important?

• Sarbanes-Oxley Act Section 404 requires CEO and CFO to attest to the adequacy of their organization’s internal control system.

• In most cases, Executives are relying on IAFs to fulfill this responsibility.

• Government entities have a similar responsibility under Generally Accepted Government Auditing Standards (Yellow Book).

• The organization’s external auditors must perform an attestation engagement affirming that the organization’s internal control system is adequate.

• The organization’s external auditor cannot assist the Executive because the assistance would violate their independence.

What is Internal Auditing

• Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organization's operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes.

Internal Auditing• Usually located within an organization but may be outsourced.• BIG 4 and other outsourcers are biggest sponsors of the IIA’s

annual conference.• Internal Auditing is considered the fourth leg of an organization’s

four legged governance structure:– Audit Committee of Board of Directors– External Auditor– Internal Auditor– Management

• Internal Auditing has been “Hot” for he past 4 years.• Not only in the US but also globally.• Membership in the IIA has gone from 60,000 in 2000 to 115,000 in

2006.• Careers have taken off spectacularly!

Internal Audit Research

• The Institute of Internal Auditors Research Foundation (IIARF) and Academic Relations Committee (ARC).

• Tries to entice Universities and Colleges to adopt internal auditing into their curriculums

• Promotes academic research into Internal Auditing topics through grants.

• For instance, IIARF will fund Doctoral Dissertations for $10,000 dealing with internal audit.

Research Opportunities in Internal Auditing (ROIA)

• Edited by Andrew Bailey, Audrey Gramling, and Sridhar Ramamorti.

• Leading auditing scholars authored chapters in ROIA dealing with issues affecting IAFs such as corporate governance, IAF management, risk assessment, etc.,

• Each author presented previous literature and then posed questions for future researchers.

• Prawitt (2003) and Lemon and Tatum (2003) wrote chapters especially relevant to this study.

IAF Performance Studies• Lampe and Sutton (1994) developed a method for

IAFs to establish quality measuring systems. • Gupta and Ray (1992) investigated the role that

IAFs could take in their organization’s total quality improvement process. Finally, Frigo (2002) demonstrated how IAFs could implement a balanced scorecard framework to measure their performance.

• Ziegenfuss (1998): – (1) reviewed the Global Internal Auditing Network (GAIN); – (2) identified seventy-two potential performance measures that IAFs could

use; – (3) conducted a survey of CAEs to identify those performance measures

actually used; and – (4) developed an index to measure IAF performance.

• Ziegenfuss (2000a) also proposed an IAF balanced scorecard and (2000b) published the results of the CAE survey.

IAF Performance Studies(Continued)

• Applegate, (1997) described the non-traditional performance measurement process at the Boeing Aircraft Corporation.

• Beeler, (1999) examine the factors associated with internal auditor promotion probabilities.

• Williams (2000) identify the efficiencies associated with value-added auditing.

• Reding (2000) benchmark the Allstate Insurance Company’s IAF against the IIARF’s Competency Framework for Internal Auditing study.

• Brierley (2001) study the factors that prevented the establishment of an IAF in the Sudanese public sector.

• Nash and Flesher (2001) sampled the middle 400 companies from the Fortune 1000 to identify performance measures currently being used by IAFs.

IAF Performance Studies(Continued)

• Felix (2001) research the contribution of internal audit as a determinant of external audit fees and the factors that influenced this contribution.

• Lampe and Garcia (2003) present the current state of professionalism among internal auditors.

• Moeller (2004) describes how to manage an IAF after SOX.

• Carcello (2005a) investigate the factors associated with U.S. public companies’ investment in internal auditing.

• Carcello (2005b) study the changes in IAF during the time of the major U.S. accounting scandals.

• Rittenberg and Anderson (2006) discuss hiring and inspiring a CAE.

What is lacking?

• An exploratory study to determine what factors influence IAF performance.

Research Question

• We propose that IAF-PERFORMANCE varies with • inputs IAF-INPUTS, • organizational governance ACCHARTER and

ACCOUNTABLE, • IAF reporting arrangements with management

ADREPORT AND FUNREPORT, • IAF-Board reporting arrangements QUALCOMM and

FREQUENCY, • IAF relationship with its organization’s external auditor

COORDINATION, • organizational characteristics, such as industry PIC,

headquarters country USA, and GAIN reporting year RYEAR i.e.,

Research Question(Continued)

• IAF-PERFORMANCE = • f (IAF-INPUTS, ACCHARTER, ACCOUNTABLE,

ADREPORT, FUNREPORT, QUALCOMM, FREQUENCY, COORDINATION, PIC, USA, REPORTING YEAR) (1)

Variable Definition and Measurements

Dependent Variables: Measurement (GAIN Question): Mean:Std. Dev:

IAF PERFORMANCE

Report-Time Average days for all audits that it takes IAF to issue final report from the end of field work. 29.43 22.44

Addvalue Respondents’ reply to GAIN question concerning customer satisfaction or whether auditees felt that, “Overall, the audit(s) provided added value.” Respondents answered on a five-point scale with 0=Average, 1=Good, and 2=Excellent. 1.12

Reportqual Respondents’ reply to GAIN question concerning customer satisfaction or whether auditees felt that, “Audit report findings and recommendations were significant, or reliable, or resulted in a beneficial change.” Respondents answered on a five-point scale with 0=Average, 1=Good, and 2=Excellent. 1.12

Independent Variables:

IAF INPUTS

Emp/auditorTotal Employees/Total Audit Positions. 979.45 937.07

AuditcostsTotal Internal Audit Department Costs/Total Annual Revenues. 0.00085 0.00155

Education Total Number of Professional Staff with Master’s Degree/Total Audit Positions. 0.28 0.19

Experience Average Years Experience in Internal Auditing for All Auditors. 7.47 3.9

Training Hours of Training per Auditor. 69.58 33.27

Qar Quality Assurance Review within Last Three Years with 1=yes, 0=no. 0.48

Certifications Total Number of Professional Staff with One or More Certifications/Total Audit Positions 0.56 0.25

ACCHARTER Proxy Report States Committee Fulfills Its Charter?

Accharterd1

1=yes, 0=no or exempt. 0.41

Accharterd2

1=no, 0=yes or exempt. 0.69

Accharterde

1=exempt, 0-yes or no. 0.2

ACCOUNTABLE

Committee is Accountable for Auditor Relations?

Accountabled1

1=yes, 0=no or exempt. 0.63

Accountabled2

1=no, 0=yes or exempt. 0.94

Accountablede

1=exempt, 0-yes or no. 0.39

ADREPORT CAE administratively reporting relationship.

Adreportd1 1=to audit committee,

0.10=not to audit committee.

Adreportd2 1=to Chief Executive Officer,

0.230=not to Chief Executive Officer.

Adreportd3 1=to President,

0.750=not to President.

Adreportd4 1=to Chief Financial Officer,

0.440=not to Chief Financial Officer.

Adreportd5 1=to Controller,

0.360=not to Controller.

Adreportd6 1=to Other

0.120=not to Other.

FUNREPORT

CAE functional reporting relationship.

Funreportd1 1=to audit committee,

0.610=not to audit committee.

Funreportd2 1=to Chief Executive Officer,

0.120=not to Chief Executive Officer.

Funreportd3 1=to President,

0.340=not to President.

Funreportd4 1=to Chief Financial Officer,

0.150=not to Chief Financial Officer.

Funreportd5 1=to Controller,

0.160=not to Controller.

Funreportd6 1=to Other

0.720=not to Other.

QUALCOMM Quality of communications between Audit Committee and CAE.

Qualcommd1 Is a private session with the CAE a regular agenda item of the audit committee? 1=yes, 0=no. 0.65

Qualcommd2 Is a private session with the CAE available by request only? 1=yes, 0=no. 0.11

Qualcommd3 Is a private session with the CAE not available or allowed? 1=yes, 0=no. 0.16

FREQUENCY How Frequently Does the CAE Meet with the Audit Committee?

Frequencyd11=annually, 0=other than annually. 0.63

Frequencyd2 1=semiannually, 0=other than semiannually. 0.53

Frequencyd4 1=quarterly, 0=other than quarterly. 0.48

Frequencyd5 1=more frequently than quarterly, 0=quarterly or less frequently. 0.63

COORDINATION Does internal audit department coordinate audit services with external auditors? 1=yes, 0=no. 0.9

Coordinationd1Loan Staff to Auditor 1=yes,

0=no. 0.28

Coordinationd2 Perform Complete or Partial Audit of Specific Location 1=yes, 0=no. 0.63

Coordinationd3Conduct Joint Annual Planning

Sessions 1=yes, 0=no. 0.7

Coordinationd4Conduct Joint Risk or Control

Sessions 1=yes, 0=no. 0.38

PIC

Industry Codes

Pic1300 1=PIC 1300, 0=PIC other than 1300. 0.23


Pic3900 1=PIC 3900, 0=PIC other than 3900.0.14

Pic4700 1=PIC 4700, 0=PIC other than 4700.0.44








USA Organization headquarters location

Usa 1=USA, 0=other. 0.79

REPORTING YEAR Reporting Year

Ry1999 1=1999, 0=other than 1999. 0.2

Ry2000 1=2000, 0=other than 2000. 0.2

Ry2001 1=2001, 0=other than 2001. 0.2

Ry2002 1=2002, 0=other than 2002. 0.2

Ry2003 1=2003, 0=other than 2003. 0.2

Global Auditing Information Network (GAIN)

• SAMPLE SELECTION• The IIA began GAIN in the mid-1990s as a

benchmarking tool for CAEs. • Initially, few IAFs participated in GAIN due to several

factors: – (1) CAEs were unfamiliar with it, – (2) the paper and pen format of the early years was inconvenient

to complete, and – (3) GAIN’s high annual fee.

• However in 1999, GAIN became internet based and the IIA dramatically reduced the annual fee.

• Participation greatly increased from 438 respondents in 1998 to 747 in 2003.

• We selected 168 IAFs who responded in each of the five years being studied.

TABLE 2: REGRESSION RESULTS (Report-Time as dependent variable) Ordinary Least Squares RegressionModel test: F[ 14, 625] = 9.61, Prob value = .0000 Fit: R-squared = .177, Adjusted R-squared = .159

Variable Coefficient Standard Error b/St. Er.

Constant 35.01427*** 2.997199 11.682

Usa 6.719747*** 2.269843 2.96

Pic2800 -26.2807*** 4.576786 -5.742

Pic3900 -19.627*** 3.352465 -5.855

Pic4700 -16.8014*** 4.661353 -3.604

Pic4800 -7.70466** 3.581486 -2.151

Pic4900 -7.78607** 3.127084 -2.49

Pic5000 -21.9741*** 7.01529 -3.132

Pic6000 -23.2175*** 3.33286 -6.966

Pic6300 -12.1905*** 3.847183 -3.169

Pic8200 -13.9*** 5.301766 -2.622

Pic8900 -6.98672* 3.601033 -1.94

Frequencyd1 6.90457** 3.429834 2.013

Adreportd5 -13.4254*** 4.643124 -2.891

Funreportd1 7.605346*** 1.998113 3.806

* = significant at the .10 level ** = significant at the .05 level *** = significant at the .01 level

TABLE 3: PROBIT ANALYSIS RESULTS (Addvalue as dependent variable) Ordered Probit Model Iterations completed: 13 Log likelihood function: -449.3665 Restricted log likelihood: -472.0351 Chi-squared: 45.33711 Degrees of freedom: 7 Significance level: .0000 Cell frequencies for outcomes:

Y Count Freq Y Count Freq Y Count Freq

0 47 .073 1 469 .732 2 124 .193

Panel B: Ordered Probit Model

Variable Coefficient Standard Error b/St.Er.

Index function of probability

Constant 0.830829*** 0.192596 4.314

Emp/Auditors 0.1076E-03* 0.6049E-04 1.778

Eeperience 0.2898E-01** 0.1303E-01 2.225

Pic5000 1.064905** 0.428006 2.488

Pic6300 -0.627954*** 0.206990 -3.034

Pic8200 0.685338** 0.324858 2.110

Accharterd1 0.244310** 0.108045 2.261

Certifications 0.511089** 0.223167 2.290

Threshold parameters for index

Mu( 1) 2.436108443*** 0.94747E-01 25.712


TABLE 4: PROBIT ANALYSIS RESULTS (ReportQual as dependent variable) Panel A: Ordered Probit Model SatisticsIterations completed: 17 Log likelihood function: -412.9412 Restricted log likelihood: -443.1573 Chi-squared: 60.43224Degrees of freedom: 10 Significance level: .0000 Cell frequencies for outcomes:

Y Count Freq Y Count Freq Y Count Freq

0 39 .060 1 484 .756 2 117 .182

Panel B: Ordered Probit Model

Variable Coefficient Standard Error b/St.Er.

Index function of probability

Constant 0.882432*** 0.187856 4.697

Experience .31287E-01** 0.14410E-01 2.158

Pic5000 0.9317756* 0.568740 1.638

Pic6300 -0.726596*** 0.209258 -3.472

Pic8200 0.476167* 0.290710 1.638

Qualcommd2 -0.272024* 0.139790 -1.946

Adreportd5 0.485296* 0.263133 1.844

Adreportd4 0.280295** 0.11675 2.401

Adreportd3 0.794999*** .255542 3.111

Funreportd3 -0.552509* .30751 -1.795

Certifications 0.755230*** 0.232903 3.243

Threshold parameters for index

Mu( 1) 2.634369071*** .10585268 24.887


TABLE 5: TESTS OF SIGNIFICANCE SUMMARY Regression Analysis

(Report-time as dependent variable)

Probit Analysis(Addvalue as dependent

variable)

Probit Analysis(Reportqaul as

dependent variable)

Independent Variables Significance Significance Significance

USA *** ----- -----

Pic2800 *** ----- -----

Pic3900 *** ----- -----

Pic4700 *** ----- -----

Pic4800 ** ----- -----

Pic4900 ** ----- -----

Pic5000 *** ** *

Pic6000 *** ----- -----

Pic6300 *** *** ***

Pic8200 *** ** *

Pic8900 * ----- -----* = significant at the .10 level ** = significant at the .05 level *** = significant at the .01 level

TABLE 5: TESTS OF SIGNIFICANCE SUMMARY Regression Analysis

(Report-time as dependent variable)

Probit Analysis(Addvalue as dependent

variable)

Probit Analysis(Reportqaul as dependent

variable)

Independent Variables Significance Significance Significance

Frequencyd1 ** ----- -----

Adreportd5 *** ----- *

Adreportd4 ----- ----- **

Adreportd3 ----- ----- ***

Funreportd1 *** ----- -----

Funreportd3 ----- ----- *

Emp/auditors ----- *

Experience ----- ** **

Accharterd1 ----- ** -----

Certifications ----- ** ***

Qualcommd2 ----- ----- ** = significant at the .10 level ** = significant at the .05 level *** = significant at the .01 level

ConclusionsWe draw the following conclusions:1. IAFs appear to be benchmarking their performance

within the industry in which their organizations operate,2. Administrative and to a less extend functional reporting

arrangements appear to influence IAF audit performance, 3. Experience and professional certification seem to affect

IAF performance particularly with respect to auditee ratings,

4. SOX did not have a significant influence on IAF performance,

5. Whether the organization was headquartered in the USA or elsewhere only marginally influenced IAF performance, and as did the employee to auditor ratio, and corporate governance.

determinants of internal audit function performance by dr. douglas e. ziegenfuss* old dominion...

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