Auditing. Desai Et Al. 2011

InternalAudit SourcingArrangements andReliance by ExternalAuditors

Naman K. Desai, Gregory J. Gerard, and Arindam Tripathy

SUMMARY: A companys internal audit IA function can be maintained in-house, out-sourced to an IA service provider, or cosourced a combination of the in-house andoutsourced IA functions. This study explores the effect of these sourcing arrangementson the external auditors assessed quality and reliance on the IA function. We predictthat external auditors consider the cosourced and outsourced IA functions to be equalin terms of assessed quality and reliance. Furthermore, we predict that the externalauditors assessments of objectivity and competence will be greater for cosourced andoutsourced IA functions compared to in-house IA functions; therefore, external auditorswill have greater reliance on the cosourced and outsourced IA functions. Finally, wepredict that when the IA service provider also provides additional tax services to theclient, external auditor reliance is significantly decreased compared to when the serviceprovider does not provide tax services. One hundred and eight CPAs participated in thisstudy and were randomly assigned to one of five treatment conditions: in-house, co-source, outsource, cosource with tax services, and outsource with tax services. Theresults support our predictions and indicate that external auditors place more relianceon cosourced and outsourced IA functions compared to in-house IA functions. Further-more, external auditors reliance on cosourced and outsourced IA functions decreaseswhen tax services are also provided by the IA service provider.

Keywords: cosourcing; external auditor reliance; internal audit; sourcing.

Data Availability: Please contact the authors regarding data availability.

INTRODUCTIONAccording to Statement on Auditing Standards No. 65 SAS No. 65, The Auditors Consid-

eration of the Internal Audit Function in an Audit of Financial Statements, the external auditor is

Naman K. Desai is an Assistant Professor at the University of Central Florida, Gregory J. Gerard is anAssociate Professor at Florida State University, and Arindam Tripathy is an Assistant Professor at TheUniversity of Washington Tacoma.

We appreciate the insightful comments and suggestions of Audrey Gramling Associate Editor, two anonymous reviewers,Tina Carpenter, Bill Hillison, Malcolm McLelland, Jane Reimers, and conference participants at the 2007 AmericanAccounting Association Annual Meeting in Chicago, IL. We also specifically thank Dr. Ann Norris for advice on pathanalysis. We are grateful to The Institute of Internal Auditors Research Foundation IIARF for providing research funding.Although financially supported by the IIARF, the views expressed in this paper are those of the authors and do notnecessarily represent positions or opinions of the IIARF or The Institute of Internal Auditors IIA.

Editors note: Accepted by Audrey A. Gramling, Ad Hoc Associate Editor, under Dan Simunics Editorship.

Auditing: A Journal of Practice & Theory American Accounting AssociationVol. 30, No. 1 DOI: 10.2308/aud.2011.30.1.149February 2011pp. 149171

Submitted: October 2007Accepted: April 2010

Published Online: February 2011

149

able to rely on the internal auditors work if the external auditor is satisfied that standards ofcompetence and objectivity have been met American Institute of Certified Public AccountantsAICPA 1991. Recently, in Auditing Standard No. 5, the Public Company Accounting OversightBoard PCAOB made the decision to retain SAS No. 65 PCAOB 2007, 13. However, since thetime that SAS No. 65 was issued, different IA sourcing arrangements such as outsourcing andcosourcing have evolved Serafini et al. 2003.

The general description of three possible sourcing arrangements is as follows: 1 in-house,where a company maintains its own IA function, 2 outsourced, where an independent IA serviceprovider maintains the IA function, or 3 cosourced, where there is a partnership between anin-house IA function and an independent IA service provider.1 Each sourcing arrangement hasadvantages and disadvantages in terms of control of the IA function, business knowledge, costs,and objectivity.2

Despite the various IA sourcing arrangements, recent guidance from the Institute of InternalAuditors IIA does not recommend any single sourcing arrangement as being preferable to theothers IIA 2009, and to our knowledge there is no empirical research specifically on IAcosourcing.3 However, studies indicate that the sourcing in-house versus outsourced of the IAfunction has a significant effect on external auditors perceptions about the quality of the IAfunction and the planned external audit effort for any particular audit engagement.4 For example,an outsourced IA function is likely to be more objective than an in-house IA function Ahlawatand Lowe 2004. Moreover, external auditors consider an outsourced IA function to be of a higherquality only if the inherent risk associated with the company is high; external auditors are indif-ferent between outsourcing and in-house arrangements when the inherent risk associated with thecompany is low Glover et al. 2008.

Since cosourcing is a combination of in-house and outsourcing, the extent of reliance placedby the external auditor could either be lower due to the in-house personnel than the extent ofreliance on a purely outsourced IA function, or the same as that for a due to the presence of theindependent firm personnel purely outsourced IA function. Therefore, the first purpose of ourresearch is to investigate cosourcing where the high-risk areas are audited by a combination ofin-house internal audit employees and employees of an independent IA service provider as itcompares to in-house and outsourced IA functions, with respect to the external auditors relianceon the IA function.

The second purpose of our research is to investigate the external auditors reliance decision inthe context of nonaudit services such as tax services provided by the IA service provider.Although the Sarbanes-Oxley Act of 2002 SOX; U.S. House of Representatives 2002 prohibitsthe external financial statement auditor from providing internal audit and certain other nonauditservices to an external audit client, there are no such prohibitions placed on IA cosourcing oroutsourcing service providers. Thus, we are interested in whether the external auditors reliancedecision changes when an IA cosourcing or outsourcing provider also provides nonaudit servicessuch as tax services which might potentially compromise objectivity.

1 An independent IA service provider can be a public accounting firm e.g., one of the Big 4 firms or it can be an internalaudit firm e.g., Protiviti.

2 For example, see Del Vecchio and Clinton 2003, Rittenberg et al. 1999, Smith 2002, Aldhizer and Cashell 1997,and Thomas and Parish 1999 for detailed discussions on the various advantages and disadvantages of thesearrangements.

3 A recent position paper IIA 2009 shows that the IIA has taken a neutral position on sourcing alternatives; instead ofadvocating for a certain sourcing arrangement, the IIA has issued guidance on evaluating the optimal sourcing structurefor the IA function also see Schneider 2008; IIA 2001.

4 In this paper, the term internal audit quality refers to competence, objectivity, and technical skills of the IA function.

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One hundred and eight CPAs were randomly assigned to one of five treatments cases as partof a 3 2 incomplete between-subjects factorial design. In three of the cases, the IA function isdescribed as either an in-house, cosourcing, or outsourcing arrangement. In the remaining twocases, the IA function is described as either a cosourcing or outsourcing arrangement where the IAservice provider also provided tax services. The participants responded to questions about reliance,perceptions about the quality of the IA function, planned external audit effort, and overall auditrisk and control risk.

The results indicate that participants assessed the quality and extent of reliance on the out-sourced and cosourced where the IA services for the high-risk areas were provided by a combi-nation of in-house employees and an independent IA service provider IA functions to be signifi-cantly greater than that of an in-house IA function. The assessed external audit effort for thecosourced and outsourced IA functions was significantly lower than the external audit effort forthe in-house IA function. However, there were no significant differences in these measures be-tween the cosourced and outsourced IA functions. The results also indicate that relative to cases inwhich the IA service provider does not supply additional services, when cosourcing or outsourcingservice providers also provide tax services, it 1 reduces the perceived quality of, and the extentof reliance on, the outsourced or cosourced IA functions, and 2 increases the associated externalaudit effort.

Our study contributes to the extant literature in the following ways. First, we extend the workof Glover et al. 2008 and Ahlawat and Lowe 2004 to investigate how cosourcing compares toin-house and outsourced IA functions in relation to external auditors assessment of and relianceon the IA function. Second, we investigate how these external auditor decisions are affected whenan independent IA firm providing IA cosourcing or outsourcing services provides additionalservices such as tax services.

The rest of the paper is organized as follows. In the second section we describe IA sourcingarrangements, review related literature, and present our hypotheses. The third section discussesour research method, and section four presents the results. We conclude the paper with a summaryand discussion.

BACKGROUND AND HYPOTHESESIA Sourcing Arrangements

Typically, the IA function is structured as one of the following arrangements: 1 in-house, inwhich a company maintains its own IA function, 2 outsourced, in which an independent firmconducts the IA, or 3 cosourced, where there is a partnership between the in-house IA functionand an independent firm. There are various advantages and disadvantages in terms of control of IAfunction, business knowledge, costs, independence, etc., related to each of these sourcing arrange-ments for detailed discussion, see Del Vecchio and Clinton 2003; Rittenberg et al. 1999; Smith2002; Thomas and Parish 1999.

For example, some of the advantages of an in-house IA function are: greater control overaudit operations, thereby protecting proprietary information; better understanding of business pro-cesses and associated risks than outsiders and nonemployees; and opportunities to train futuremanagers. Some disadvantages are: limited availability of specialized knowledge; limited geo-graphical coverage of IA function; and higher probability of IA employees giving in to manage-ment pressures Del Vecchio and Clinton 2003.

The outsourcing of the IA function to an external independent firm provides benefits such as:access to specialized knowledge of the independent firm which specializes in providing auditservices; greater geographic coverage of IA activities; greater flexibility in planning of IA activi-ties because the company does not have to hire new employees when a temporary need for expertknowledge arises; and relatively lower probability that outside IA personnel would give in to

Internal Audit Sourcing Arrangements and Reliance by External Auditors 151


management pressures Del Vecchio and Clinton 2003. Some of the drawbacks of this sourcingarrangement are: loss of proprietary information; IA personnel have limited exposure to the com-panys business processes and hence may require more time in understanding the workings of thecompany; and lack of learning opportunities for the companys own employees Del Vecchio andClinton 2003; Rittenberg et al. 1999.

Aldhizer and Cashell 1997 and Aldhizer et al. 2003 discuss cosourcing as a cheaper andmore efficient way of providing the IA function in which in-house auditors can provide theactivities requiring constant attention, and external independent internal auditors can be utilizedfor functions requiring special skills. Additional advantages of cosourcing arrangements are: de-sired level of control over IA services can be maintained by employing an IA management teamthat coordinates IA services with a third party that has the expertise to carry out specific auditfunctions; increased knowledge-sharing between the companys employees and outside firm em-ployees; and if the appropriate IA areas are cosourced, the IA function is perceived to be of a highquality in the opinions of investors, financial institutions, and external auditors Del Vecchio andClinton 2003; Smith 2002; Thomas and Parish 1999. These perceptions, in turn, could reduce theexternal auditors assessed likelihood of the IAs findings being misrepresented or biased in somemanner. We will return to this point below.

Factors Affecting the External Auditors Evaluation of the IA FunctionAccording to SAS No. 65 AICPA 1991, when an external auditor considers whether to rely

on the IA function, the external auditor must obtain a sufficient understanding of the IA function.In this process the external auditor needs to assess the internal auditors competence e.g., educa-tion, experience, certifications, supervision, etc. and objectivity e.g., to whom does the internalauditor report. In the post-Sarbanes-Oxley SOX era, because of the new requirements imposedby SOX Sections 302 and 404, there is a potential for IA to play an increasingly important rolerelated to the controls of an organization Adamec et al. 2005. For example, SOX Section 302requires management to certify the effectiveness of disclosure controls and procedures with re-spect to the firms quarterly and annual reports. In the same vein, SOX Section 404 requires firmmanagement to evaluate and report on the effectiveness of internal controls over financial report-ing. More recently, Auditing Standard No. 5 PCAOB 2007 requires external auditors to conductan integrated audit, which focuses on two things: 1 expressing an opinion on whether thefinancial statements are fairly stated, and 2 expressing an opinion on the effectiveness of thecompanys internal control over financial reporting. These recent changes underscore the impor-tance of the external auditors decision to rely or not rely on the IA function, especially since theIA function is one of the key cornerstones of a companys corporate governance Adamec et al.2005. Furthermore, the increased cost of complying with SOX Levinsohn 2004 also suggeststhat companies are looking for effective ways to control audit costs, and cost savings will beattained when the external auditor can rely on the internal auditors work Felix et al. 2001;Krishnamoorthy 2002; Prawitt et al. 2009a; Gramling et al. 2004.

The evaluation of the IA function helps external auditors make decisions regarding the extentof audit work to be performed during the year-end annual audit engagement, and it also helps inidentifying the specific areas of the business on which to focus the audit effort. Prior researchindicates that the external auditors decision to rely on the IA function is affected by variouscriteria such as objectivity, competence, and work performance Clark et al. 1981; Brown 1983;Schneider 1984, 1985; Brown and Karan 1986; Margheim 1986. Studies have shown that externalauditors are also sensitive to factors like the reporting structure for the director of the IA functionAbdel-khalik et al. 1983 and the source of evidence Hirst 1994.



IA Sourcing and External Auditors Evaluation of the IA FunctionSAS No. 65 does not specifically address the sourcing of IA function as one of the factors to

be evaluated by the external auditors while assessing the quality of the IA function. However, priorresearch indicates that the sourcing specifically, in-house versus outsourcing of the IA functionhas a significant effect on 1 external auditors perceptions about the quality of the IA function,2 the extent of reliance placed on the IA function, and 3 the planned external audit effort forany particular audit engagement. For example, Ahlawat and Lowe 2004 propose that an out-sourced IA function is likely to be more objective than an in-house IA function, and that in-houseinternal auditors are more likely to acquiesce to management pressures than outsourced internalauditors who are independent of company management. Similarly, external auditors considerinternal auditors to be more objective and independent when the internal auditors are not employ-ees of the company Gramling and Vandervelde 2006.

Glover et al. 2008 show that external auditors reliance on the IA function is related to theinteraction between whether the IA function is outsourced and the level of inherent risk. In otherwords, when inherent risk is low, external auditors reliance on the IA function is the sameregardless of whether the IA function is in-house or outsourced; however, when inherent risk ishigh, external auditors reliance on the IA function is greater when the IA function is outsourcedcompared to in-house. Glover et al. 2008 posit attribution theory see, e.g., Jaspars et al. 1983;Eagly and Chaiken 1993 as the reason for this perceived higher reliance on the IA function in thepresence of high inherent risk. Attribution theory suggests that when individuals evaluate asources message, individuals assess a sources incentives to bias the message. Glover et al. 2008argue that in-house internal auditors are usually directly or indirectly accountable to the manage-ment, and their job continuity, promotions, and incentives are decided by that management. On theother hand, the outsourced internal auditor is not directly under managements chain of command,nor is the outsourced internal auditor likely to lose his/her job if a client company fails. Due to theabove factors, there exists a close alignment between an in-house IA function and managementwhich could adversely affect the external auditors perception of objectivity and reliance onin-house IA function compared to outsourced IA function. According to Glover et al. 2008, 197,external auditors will attribute favorable reports by in-house internal auditors to incentives toplease or align with management rather than to work performed by the internal auditors.

Prior research also indicates that the assessed inherent risk of an audit influences the externalauditors decision to rely on the work of the IA function Maletta 1993 and that external auditorswill spend more audit effort when assessed inherent risk is high Maletta and Kida 1993. Gloveret al. 2008 suggest that external auditors attribute the work of internal auditors with incentivesto please or align with management only when the inherent risk associated with a company is highin their study, low/high inherent risk was manipulated via high/low fixed salary for managers,small/large bonuses for managers, and conservative/aggressive accounting positions by managers.They do not find a significant difference in the assessed objectivity of, and reliance on, thein-house and outsourced IA functions when the assessed inherent risk is low. Glover et al. 2008do not specifically mention the accounts or functions of the company that are affected by highinherent risk. It is unlikely that all the accounts or functions of a company will be equally affectedby the high inherent risk. Usually certain key accounts and functions of the company wouldrequire greater attention compared to others. Therefore, insights can be gained through researchthat specifically identifies the accounts and functions that are affected by the high risk and thenmanipulate the sourcing of IA function.

Based on attribution theory, if the external auditors attribute internal auditors reports to theirincentives only in scenarios where risk is relatively high Glover et al. 2008, a company couldcosource IA work related to the relatively high-risk areas a combination of in-house employees



and employees of an independent firm would perform this work and maintain an in-house func-tion to perform the remaining work. Such a cosourcing arrangement could help ensure that theperceptions regarding the quality of the IA function, and extent of reliance placed on the IAfunction, are not compromised. This, in turn, would ensure that the external audit effort and costswould be similarly low for both the outsourced and cosourced IA functions compared to thein-house IA function Felix et al. 2001; Gramling et al. 2004; Prawitt et al. 2009b.5 Based on theabove discussion, we posit the following hypotheses:

H1a: External auditors perceptions about the quality of the IA function will be 1 the samefor a cosourced IA function where the high-risk areas are audited by an independentfirm and a pure outsourced IA function, and 2 significantly lower for an in-house IAfunction compared to an outsourced or cosourced IA function.

H1b: External auditors extent of reliance placed on the IA function will be 1 the same fora cosourced IA function where the high-risk areas are audited by an independent firmand for a pure outsourced IA function, and 2 significantly lower for an in-house IAfunction compared to an outsourced or cosourced IA function.

Prior studies, such as Margheim 1986, Gaumnitz et al. 1982, Schneider 1985, DeZoort etal. 2001, and Prawitt et al. 2009a, have shown that external auditors effort is negativelycorrelated with the overall quality of the IA function. Therefore, if the perceived quality of theoutsourced and cosourced IA functions is equally high in comparison to the in-house IA function,there will be no significant difference in the planned audit effort for the cosourced and outsourcedIA functions. However, the planned audit effort will be significantly higher for the in-house IAfunction.

H1c: External auditors planned effort for the year-end annual audit will be 1 the same fora cosourced IA function where the high-risk areas are audited by an independent firmand for an outsourced IA function, and 2 significantly higher for an in-house IAfunction compared to an outsourced or cosourced IA function.

Sourcing the IA Function and Provision of Additional Services by the IA Service ProviderSOX and related standards mandate that external auditors cannot provide IA or certain con-

sulting services for their financial statement audit clients. A primary motivation underlying SOXwas to enhance objectivity. For example, if an accounting firm provided certain consulting ser-vices and also performed the financial statement audit, the firms external auditors might compro-mise their objectivity. Internal auditors, on the other hand, are under no such restrictions. There-fore, firms which provide cosourced or outsourced IA services could seek to provide additionalservices beyond IA cosourcing and outsourcing provided they are not the external auditor aswell. For example, in a recent KPMG report on the evolution of internal auditing, one of the areasidentified for value creation by the IA function is tax strategy and planning: to create value, IAcan help analyze existing tax structure to help determine the tax strategy the organization maywant to pursue in light of new initiatives and their potential effects. It would consider whether thetax planning strategy aligns with strategic objectives KPMG 2007, 7. Therefore, an independentoutside firm could be hired to do IA cosourcing or outsourcing, as well as other consulting servicessuch as tax.

In an internal audit context, there is very little prior research that examines how external

5 The internal audit function is an important factor affecting external audit costs Felix et al. 2001.



auditors perceive IA functions that also perform consulting work and receive compensation forsuch work. DeZoort et al. 2001 conducted an experiment to investigate how internal auditorcompensation fixed salary versus salary plus incentive compensation, role traditional versusconsulting, and task objective versus subjective relate to external auditor reliance on the IAfunction and related audit effort.6 They found that consulting services provided by the IA functiondo not relate to the external auditors reliance decision. Furthermore, the provision of consultingservices does not increase audit effort i.e., budgeted audit hours unless the internal auditorsreceive incentive compensation. To our knowledge, there is no other research that investigates IAfunctions and provision of consulting services. Therefore, to gain additional insight, we examineresearch related to the context of external auditors and the provision of nonaudit services NAS.

The literature on external auditors and the provision of NAS contains mixed results regardingwhether auditor independence/objectivity is impaired by the provision of NAS. In a comprehen-sive review of the literature on NAS and auditor independence, Schneider et al. 2006, 170conclude a myriad of studies have examined this issue, though the findings are difficult tosummarize due to differences in user groups, time periods, and the specific type of NAS exam-ined. Although the stakeholder groups in the literature classified by Schneider et al. 2006include auditors, financial statement users, and managers, we will focus on findings from theauditor literature. For example, Frankel et al. 2002 suggest that providing NAS affects externalauditor independence because the auditor is more likely to allow discretionary accruals. However,a number of studies either do not find a significant relationship between provision of NAS andimpaired auditor independence e.g., Prawitt et al. 2010; Ashbaugh et al. 2003; DeFond et al.2002; Kinney et al. 2004; Davis et al. 1993. The results of Jenkins and Krawczyk 2003 andLavin 1976 suggest that accountants view only certain types of NAS as leading to independenceimpairment e.g., legal consulting, bookkeeping.

The provisions of SOX are only relevant to external auditors, not internal auditors. Therefore,while SOX prohibits external auditors from providing most tax services as well as internal auditand certain other consulting services to their financial statement audit clients, internal audit firmsare allowed to provide such services. The Institute of Internal Auditors does not restrict theinternal auditor from providing consulting services. It actually defines the IA function as anindependent, objective, assurance and consulting activity designed to add value and improve anorganizations operations Reding et al. 2009. The boards of directors can likely subject toapproval of the audit committee allow an outside firm that provides IA services to a company toalso provide tax services. However, the objectivity concern underlying the SOX requirement toseparate external auditing from other services could extend to the IA functionespecially giventhe possible cosourcing and outsourcing arrangements with independent outside firms providingmultiple services. It is possible that external auditors could perceive these sourcing arrangementsas affecting the IA functions objectivity. Moreover, based on attribution theory Jaspars et al.1983; Eagly and Chaiken 1993, the provision of tax services by the IA service provider shouldincrease the perceived incentive to align with the management. This is because now the IAservices provider has an additional incentive to gain financial benefits arising from providing taxservices. This, in turn, could lower the perceived objectivity of the IA function in the eyes of theexternal auditor.

6 DeZoort et al.s 2001 manipulation of role is different from the one in this study. Here we manipulate whether taxservices are provided by the IA function as opposed to saying that the role of the IA function is traditional versusconsulting. Furthermore, because DeZoort et al. 2001 manipulated compensation as fixed salary versus fixed salaryplus incentive compensation, the IA function was an in-house function the incentive compensation plan would not existfor an outsourced function and likely not for a cosourced function; at any rate, sourcing was not included in theirexperiment.



Although DeZoort et al. 2001 did not find a relationship between the IA functions provisionof consulting services and the external auditors reliance decision, they did find that externalauditors assess the objectivity of the IA function as lower compared to when the IA functionprovided traditional internal auditing. However, that study pre-dates SOX, and it only looked atin-house IA arrangements, so it is unclear whether the reliance result no relationship betweenproviding consulting and external auditor reliance generalizes to the present time or to situationsinvolving cosourcing or outsourcing. Based on the heightened objectivity concerns of regulators inthe post-SOX era, we hypothesize that when IA cosourcing/outsourcing service providers addi-tionally provide tax services, external auditors will view the IA function as less objective andindependent and will rely less on the IA function even if the companys audit committee approvedof the outsourcing arrangement and even if the personnel providing tax and IA services aredifferent. Stated formally:

H2a: The perceived quality of the IA function will be significantly lower when the indepen-dent firm to which the IA function is outsourced or cosourced also provides additionaltax services to the company than when the independent firm to which the IA functionis outsourced or cosourced provides only IA services.

H2b: The extent of reliance placed on the IA function will be significantly lower when theindependent firm to which the IA function is outsourced or cosourced also providesadditional tax services to the company than when the independent firm to which theIA function is outsourced or cosourced provides only IA services.

H2c: The planned external audit effort will be significantly higher when the independent firmto which the IA function is outsourced or cosourced also provides additional taxservices to the company than when the independent firm to which the IA function isoutsourced or cosourced provides only IA services.

RESEARCH METHODParticipants

A total of 108 experienced CPAs from one Big 4 and a number of regional accounting firmsparticipated in the experiment however, three participants failed the manipulation checks andwere removed from the final analysis. The data were collected by one of the researchers on-siteduring firm training sessions. The participants had an average of 6.67 years of auditing experiencewith a standard deviation of 4.06 years. The minimum experience was two years and the maxi-mum was nine years. Out of the 105 usable responses, 76 were current Big 4 auditors, while therest were CPAs employed by regional firms all of the non-Big 4 CPAs had prior Big 4 auditexperience. Our analysis indicates no significant differences in responses between past Big 4 andcurrent Big 4 participants. We also measured other demographic variables such as years of expe-rience in public accounting, and self-assessed experience with evaluating internal audit functions.No statistically significant differences were noted across treatments with respect to any of thesevariables.7

Research DesignThe design was a 3 2 incomplete between-subjects factorial. The factors were sourcing

arrangement in-house, cosourcing, or outsourcing and provision of tax services by cosourcing or

7 We conducted an analysis using the following covariates: Big 4 versus non-Big 4, self-assessed experience in evaluatingclients internal audit functions, and years of experience as an external auditor. These covariates did not significantlyvary with our manipulations, nor did they significantly correlate with our measured variables.



outsourcing service provider tax services provided or not. The in-house group was not exposedto the provision of tax service manipulation; therefore, there were five treatment groups.8 Table 1illustrates the design. All the participants were randomly assigned, within all training sessionsvisited, to one of five treatments.

Experimental Task and ProceduresWe developed three cases designed to manipulate sourcing as in-house, cosourced, or out-

sourced. Additionally, to manipulate provision of tax services by cosourcing or outsourcing serviceprovider, we developed two additional cases by stating that 1 the Big 4 accounting firm to whichthe IA function was outsourced or cosourced also provided tax services to the company, and 2the companys audit committee approved such an arrangement and that the personnel providingtax services were different from the personnel providing IA services to the company. In each of thefive cases, the overall pressures on management associated with the companys operations weredescribed to be moderately high i.e., manager compensation was based on performance, thecompany was in a very competitive industry, and it was involved in complex business operations.We also indicated the specific accounts that would be exposed to high misstatement risk as a resultof these high pressures. This was necessary because in the cosourcing case we indicate that thesecomplex and high-risk areas were audited by a combination of in-house IA department employeesand employees of an independent Big 4 accounting firm, while the in-house internal audit depart-ment audited all the other areas. In all cases involving outsourcing and cosourcing, the participantswere specifically told that the Big 4 firm providing the internal audit services was not the samefirm providing external audit services.

We obtained measures of a number of variables, including level of objectivity, competence,technical skills, control risk, overall audit risk, the extent to which the internal auditors were likelyto acquiesce to management, and the extent of reliance placed on the IA function for the high-riskand low-risk areas please see the Appendix which were used to develop our dependentmeasures.

9 We conducted a factor analysis on these measures to obtain the three constructs orfactors quality, reliance, and effort that were used as dependent measures to test our hypotheses.External audit effort was measured by the extent to which external auditors would adjust theplanned audit hours for the relatively complex and high inherent risk areas and the other relativelylow inherent risk areas. This was measured on a scale of 5 substantially reduce effort to 5substantially increase effort, with 0 being no change in effort. As an additional check, we alsocollected information about the perceived inherent risk associated with the company on a scale of110 low to high. Ideally, the perceived level of inherent risk should not change acrosstreatments.10

RESULTSManipulation and Other Checks

We incorporated the following three manipulation checks in our experiments to ensure theparticipants carefully read the cases and attended to the manipulations. First, participants were

8 Because H1aH1c make predictions about in-house versus cosourcing and outsourcing, and H2aH2c make predictionsabout cosourcing and outsourcing with and without also providing tax services, a complete between-subjects factorialdesign is not used.

9 These scales are similar to the ones used by Glover et al. 2008 and DeZoort et al. 2001.10 Participants also answered specific questions about reliance on low-risk areas, and adjustment to budgeted audit hours

for low-risk areas. For the reliance and budget hours measures in the low-risk areas, there were no significant differencesacross treatment conditions and in comparing reliance on low-risk areas to reliance on high-risk areas, we found theexpected theoretical relationship of more reliance on low-risk areas. Therefore, our primary analysis focuses on thehigh-risk areas.



TABLE 1Experimental Design

(3 2 Incomplete between-Subjects Factorial)Sourcing Arrangement

No Tax ServicesTax Services

In-House Cosourcing Does not provide Tax Services Outsourcing Does not provide Tax ServicesNA see footnote 8 Cosourcing Provides Tax Services Outsourcing Provides Tax Services

This table exhibits the basic research design of this study. The main variables are the sourcing arrangements manipulated across three levels and presence or absence of tax servicesmanipulated across two levels.

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asked to identify the appropriate description of the IA function from a set of choices. Second, theywere asked to list the high-risk areas specifically mentioned in the case. Third, they were asked toidentify if the IA service provider also provided tax services. Three out of the 108 participantsfailed this manipulation test and their responses were removed from the following analysis.

The cases were designed to hold inherent risk constant across treatments; the inherent riskwas described in the cases as relatively high e.g., management compensation consisted of rela-tively low fixed salary and large bonuses based on earnings targets. Statistical tests revealed nosignificant differences across treatments for participants assessments of inherent risk.

Results: IA Sourcing and External Auditors Evaluation of the IA FunctionTable 2 presents means and standard deviations for the five treatments. The first three data

columns of Table 2 are used to test the first hypotheses. The means show a clear pattern of resultsin which the in-house treatment appears to be different from the other two treatments. To obtain anoverview of our multivariate results, we performed a one-way between-subject multivariate analy-sis of variance on eight measures the measures are described above and listed in Table 2associated with external auditors perceptions about the IA function. This analysis revealed asignificant multivariate effect for sourcing arrangement, Wilks lambda 0.08, F 16, 106 16.38; p 0.0001. Table 3 shows Pearson correlations for the dependent variables in theMANOVA. Of the three measures related to the quality of the IA function competence, objectiv-ity, and technical skill, only objectivity is significantly associated with the other measures.

Since we are employing multiple variables to measure perceived IA quality and risk/reliancerelated to the IA function, we used exploratory factor analysis with varimax rotation to determineif the different variables related to quality and risk/reliance load on their respective single factors.The results indicate that two out of the three variables competence and objectivity measuringperceived quality of the IA function load on one factor 0.77 and 0.65, respectively termed IAQuality we do not further analyze the technical skill variable because it did not load on anyfactors; the means and standard deviations for technical skill are reported in Table 2. Furthermore,control risk, overall audit risk, likelihood of acquiescing to management, and reliance on high riskareas load on a second factor factor scores: 0.69, 0.84, 0.86, and 0.85, respectively termedRisk/Reliance. The negative relationship between reliance and the other variables indicates thathigher assessed level of risks translates into lower assessed level of reliance. The CronbachsAlpha was 0.79 and 0.83 for the variables loading on the IA Quality and Risk/Reliance factors,respectively. Also, the variances explained by the variables loading on the IA Quality and Risk/Reliance factors were 1.32 and 2.35, respectively. These two factors, plus the measure of auditeffort adjustment, were analyzed using univariate ANOVA and Tukeys HSD Honestly SignificantDifference test shown below.

H1a predicts that external auditors perceptions about the quality of the IA function will be thesame for a cosourced IA function and a pure outsourced IA function, and significantly lower for anin-house IA function. H1b predicts that external auditors extent of reliance placed on the IAfunction will be the same for a cosourced IA function and a pure outsourced IA function, andsignificantly lower for an in-house IA function. The results of an ANOVA analysis, conducted byusing the factor scores as proxies for IA quality and risk/reliance, indicate that there is a significanteffect of sourcing arrangement on the assessed quality F 2, 60 22.93; p 0.0001 andreliance F 2, 60 142.30; p 0.0001 of the IA functions see Table 4. The results of TukeysHSD tests indicate that there is no significant difference in the IA quality factor for the IAfunctions employing cosourcing and outsourcing. However, the IA quality factor was significantlyhigher for the cosourcing/outsourcing IA functions than for the in-house function. These resultssupport H1a. The same pattern of results hold for the risk/reliance factor: the in-house IA functionis assessed as more risky i.e., there is less reliance; recall the negative factor loading for the



reliance measure compared to the positive loadings for control risk, overall audit risk, likelihoodof acquiescing to management than the cosourcing/outsourcing functions; however, the cosourc-ing and outsourcing functions did not significantly differ. These results support H1a and H1b.

Table 4 also presents results for the factors decomposed into their individual measures, andresults for adjustments to audit hours for high-risk areas. Of note, from the individual measures,the sourcing arrangement is affecting the external auditors assessments of objectivity F 2, 60 52.76; p 0.0001, but not competence. In designing the cases, we attempted to hold competenceconstant across treatments the description of IA personnel across the three treatments had similareducational background, professional qualifications, and experience, so the difference between

TABLE 2Means and Standard Deviations for Measures as a Function of Sourcing Arrangement

Measure

Data for Hypotheses 1a-1c

In-HouseM

(SD)

Data for Hypotheses 2a-2cCosource

M(SD)

OutsourceM

(SD)Cosource/Tax

M(SD)

Outsource/TaxM

(SD)Objectivity 5.67 7.86 7.90 5.10 5.81

0.73 0.73 0.94 0.54 0.75Competence 7.95 8.19 8.33 8.14 8.24

0.67 0.68 0.73 0.73 0.70Technical Skills 8.14 8.43 8.48 8.29 8.43

0.65 0.75 0.68 0.72 0.68RelianceHigh-Risk Areas 5.52 7.52 7.52 4.86 4.90

0.60 0.87 1.08 0.57 0.62Overall Control Risk 4.67 3.48 3.52 5.62 5.52

0.73 1.03 0.81 0.80 0.87Overall Audit Risk 5.95 3.76 3.67 6.38 6.43

0.67 0.83 1.32 0.80 0.81Acquiescence to Management 6.81 3.14 3.05 6.29 5.57

0.68 1.01 0.86 0.72 0.68Adj. Audit Hrs.High-Risk Areas 2.10 0.62 0.52 1.67 1.57

0.54 0.50 0.75 0.73 0.51

This table exhibits mean responses across the five treatments for the eight measures.Sample size equals 21 for each of the five treatments columns.

Variable Definitions:Objectivity perceived objectivity of IAF by external auditors range 010;

Competence perceived competence of IAF by external auditors range 010;Technical Skills perceived technical skills of IAF by external auditors range 010;

RelianceHigh-Risk Areas extent of external auditors reliance on high-risk areas range 010;Overall Inherent Risk overall inherent risk assessed by external auditor range 010;Overall Control Risk overall control risk assessed by external auditor range 010;

Overall Audit Risk overall audit risk assessed by external auditor range 010;Acquiescence to Management the perceived likelihood that internal auditors will acquiesce to management and

not report honestly range 010;Adj. Audit HrsHigh-Risk Areas extent to which external auditors want to increase or decrease audit effort range

5 to 5 for high-risk areas;M mean; and

SD std. dev.



TABLE 3Correlations Coefficients for Measures from In-House, Cosourcing, and Outsourcing Treatments

CompetenceTechnical

SkillsReliance

(High Risk Areas)Overall

Control RiskOverall

Audit RiskAcquiescence to

ManagementAdj. Audit Hrs.

(High Risk Areas)Objectivity 0.18 0.10 0.57*** 0.49*** 0.57*** 0.72*** 0.61***Competence 0.12 0.01 0.18 0.12 0.18 0.19Technical Skills 0.36** 0.13 0..28* 0.17 0.14Reliance (High-Risk Areas) 0.36** 0.67*** 0.67*** 0.53***Overall Control Risk 0.47*** 0.51*** 0.40**Overall Audit Risk 0.59*** 0.56***Acquiescence to Management 0.76***

*, **, *** Indicates p .05, p .01, and p .0001, respectively.n 63.

InternalAuditSourcing

Arrangem

entsand

Reliance

byExternalA

uditors161

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&Theory

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Accounting

Association

objectivity and competence is reasonable. Additionally, there is a significant effect of sourcingarrangement on the adjustment of audit hours for high-risk areas F 2, 60 44.46; p 0.0001.The adjustment to audit effort is higher for the in-house IA function compared to the cosourced/outsourced functions, and not significantly different between cosourced and outsourced functions.These results support H1c.

Results: Sourcing the IA Function and Provision of Additional Services by the IA ServiceProvider

The last four columns of Table 2 show the means and standard deviations for the fourtreatments related to the second set of hypotheses. The means show a pattern of results in whichthe provision of tax services has an effect on most measures. For an overview of our multivariateresults, we performed a 2 cosourcing/outsourcing 2 presence or absence of tax servicesperformed by service provider between-subjects multivariate analysis of variance on nine mea-sures the measures are described above and listed in Table 2 associated with external auditorsperceptions of the IA function. This analysis revealed a significant multivariate main effect for tax;Wilks lambda 0.065, F 8, 73 130.86; p 0.0001. The sourcing by tax multivariateinteraction was not significant Wilks lambda 0.91, F 8, 73 0.91; p 0.53 and neither wasthe sourcing multivariate main effect Wilks lambda 0.86, F 8, 73 1.42; p 0.20. Table5 shows Pearson correlations for the dependent variables in the MANOVA. These results onceagain show that of the three measures related to the quality of the IA function competence,objectivity, and technical skill, only objectivity is significantly associated with the other mea-sures.

We conduct another exploratory factor analysis with varimax rotation, as we did when testingthe first set of hypotheses. The factor analysis results indicate that two out of the three measures

TABLE 4Means for Measures as a Function of Sourcing Arrangement

Measure F-values HSD TestFactor 1: IA Quality 22.93*** I C OFactor 2: Risk/Reliance 142.30*** I C O

Factor 1 Decomposed Into Individual MeasuresObjectivity 52.76*** I C OCompetence 1.62 I C O

Factor 2 Decomposed Into Individual MeasuresReliance (High-Risk Areas) 36.75*** I C OOverall Control Risk 12.68*** I C OOverall Audit Risk 36.68*** I C OAcquiescence to Management 129.51*** I C O

Adj. Audit Hrs. (High-Risk Areas) 44.46*** I C O

*** Indicates p .0001.This table exhibits the F-test 2, 60 df and Tukeys HSD test investigating differences in means across the three treatments:In-House, Cosource, and Outsource.Tukeys HSD test .01; I, C, and O are for in-house, cosource, and outsource.Interpretation of Tukey HSD results: e.g., Factor 1 IA Quality: I In-House is significantly less than C, and C andO are not significantly different.



TABLE 5Correlations Coefficients for Measures from Cosourcing, Cosourcing/Tax, Outsourcing, and Outsourcing/Tax Treatments

CompetenceTechnical

SkillsReliance

(High Risk Areas)Overall

Control RiskOverall

Audit RiskAcquiescence to

ManagementAdj. Audit Hrs.

(High Risk Areas)Objectivity 0.12 0.06 0.71*** 0.65*** 0.71*** 0.73*** 0.56***Competence 0.14 0.01 0.10 0.06 0.01 0.12Technical Skills 0.14 0.05 0.12 0.11 0.06Reliance (High-Risk Areas) 0.62*** 0.74*** 0.73*** 0.54***Overall Control Risk 0.64*** 0.69*** 0.48***Overall Audit Risk 0.62*** 0.52***Acquiescence to Management 0.60***

*** Indicates p 0.0001.n 84.

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Arrangem

entsand

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uditors163

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competence and objectivity load on a single factor 0.52 and 0.88, respectively termed IAQuality, as before. The results also indicate that control risk, overall audit risk, likelihood ofacquiescing with management, and reliance high-risk areas load on a second factor factorscores: 0.85, 0.86, 0.88, and 0.89, respectively termed Risk/Reliance, as before. The CronbachsAlpha was 0.72 and 0.86 for the variables loading on the IA Quality and Risk/Reliance factors,respectively. Also, the variances explained by the variables loading on the IA Quality and Risk/Reliance factors were 1.34 and 2.47, respectively. The negative relationship between reliance andthe other variables indicates that higher assessed level of risks translates into lower assessed levelsof reliance.

H2a and H2b posit that the perceived quality of the IA function and external auditors relianceon the IA function will be relatively lower when the accounting firm to which the IA function isoutsourced or cosourced also provides tax services to the company. H2c posits that the plannedexternal audit effort will be higher when the accounting firm to which the IA function is out-sourced or cosourced also provides tax services. We conducted a two-way ANOVA with twobetween-subjects factors, sourcing cosourcing versus outsourcing and tax presence or absenceof tax services performed by service provider on the two factor scores see Table 6. The resultsindicate that the sourcing arrangement by tax interaction was not statistically significant. Therewas a significant main effect of providing tax services on the perceived quality of the IA functionF 1, 80 767.59; p 0.0001. When the IA service provider also provides tax services, theexternal auditors assessment of IA quality decreases. The sourcing arrangement had a significantmain effect on the perceived quality of the IA function F 1, 80 4.76; p 0.05. Outsourcingwas perceived as higher quality compared to cosourcing.

Analysis of the individual measures not shown in Table 6 indicates that the differences in IAquality factor are due to the objectivity measure and not the competence measure. Furthermore, forthe objectivity measure there is a significant sourcing arrangement by tax interaction F 3, 80

TABLE 6Two-Way ANOVAs for Measures as a Function of Sourcing Arrangement and Tax

Measure and Source MS FFactor 1: IA Quality

Sourcing Arrangement 2.178 4.76*Tax 74.96 767.59***Sourcing Arrangement Tax 0.743 0.21

Factor 2: Risk/RelianceSourcing Arrangement 0.15 1.53Tax 43.49 95.07**Sourcing Arrangement Tax 0.01 0.02

Adjust Audit Hrs. High RiskSourcing Arrangement 0.19 0.48Tax 23.05 57.62***Sourcing Arrangement Tax 0.00 0.00

*, **, *** Indicates p .05, p .01, and p .0001, respectively.df 1, 80This table tabulates results of a two way ANOVA; sourcing arrangement is at two levels cosourcing or outsourcing andtax is at two levels presence or absence of tax services performed by the IA service provider.



4.11; p 0.05. This interaction indicates that the perceived objectivity is adversely affected whenthe IA service provider to whom the IA function is cosourced or outsourced also provides taxservices. However, such an adverse effect is greater for a cosourced IA function than for anoutsourced IA function.

The results indicate a significant main effect of providing tax services on the perceivedrisk/reliance of the IA function F 1, 80 95.07; p 0.0001. The results also indicate that thereis no effect of sourcing arrangement F 1, 80 1.53; p 0.21 on the perceived risk/reliance ofIA function. Overall, these results provide strong evidence in support of H2a and H2b.

There is a significant main effect for tax Table 6, F 1, 80 57.62; p 0.0001 indicatingan increase in the planned external audit effort in the treatments where the internal auditorsprovide tax services compared to the treatments where the internal auditors do not provide taxservices. In the cosource with tax and outsource with tax scenarios, the planned increase inexternal audit effort is 1.67 and 1.57, respectively, while the planned increase in the cosource notax and outsource no tax scenarios is only 0.62 and 0.52 Table 2. These results provideevidence in support of H2c.

Discussion of Results Related to Low-Risk AreasAs we mentioned above, although we had measures of 1 reliance on low-risk areas, and 2

adjustments of audit hours for low-risk areas, the primary analysis focused on the related measuresfor high-risk areas. When we analyzed the measures related to low-risk areas, an interestingpattern was found. Using a one-way ANOVA with IA sourcing arrangement as a between-subjectsfactor with three levels: in-house, cosourcing, or outsourcing we found that there was no effect ofsourcing arrangement on either reliance on low-risk areas or adjustments of audit hours for low-risk areas. However, the results changed significantly when we examined the cosourcing andoutsourcing treatments that included the additional provision of tax services. Using a two-wayANOVA with two between-subjects factors, sourcing cosourcing versus outsourcing and taxpresence or absence of tax services performed by service provider, we found that tax had asignificant main effect the sourcing by tax interaction was not statistically significant for 1reliance on low-risk areas F 1, 80 210.86; p 0.0001, and 2 adjustments of audit hours forlow-risk areas F 1, 80 6.60; p 0.05. The cosourced and outsourced IA functions provisionof tax services resulted in reduced reliance on low-risk areas and increased adjustments to audithours effort. These results suggest that even for the low-risk areas where the sourcing of the IAfunction had no effect on the quality, reliance, and effort, the additional incentive to receivecompensation for tax services is viewed as something that would reduce the objectivity andindependence of the IA function. In turn, this reduces the external auditors assessed quality of,and reliance on, the IA function and results in an increase in external audit effort.

Path AnalysisTo complement our analysis, we investigate whether sourcing arrangement plays a separate

role in the external auditors reliance decision beyond the normative factors mentioned in SAS No.65 objectivity and competence. Therefore, we conduct a path analysis to determine whether theeffect of sourcing is in-house, outsourcing, and cosourcing fully mediated by external auditorsassessments of objectivity and competence or whether the sourcing arrangement has explanatorypower in addition to i.e., not fully mediated by the assessments of objectivity and competence.

Figure 1 presents the path analysis results; overall, the model fits the data well. The goodnessof fit index and adjusted goodness of fit index are 0.81 and 0.79, respectively, and the Chi-squarestatistic is insignificant 2 = 7.90, p-value 0.196. The results of the path analysis suggest thatfor the high-risk areas, sourcing arrangement has a significant effect on the extent of reliance



placed on the IA function.11 This effect is beyond the effect on reliance that is explained by theassessment of objectivity there is no difference in the assessed technical skills and competenceacross the three sourcing arrangements.

For the high-risk areas, the type of sourcing arrangement has a significant effect only on auditrisk and likelihood of acquiescing to management. Similarly, the assessed audit risk and likelihoodof internal auditors acquiescing to management have a significant effect on the extent of relianceplaced on the IA function. There is no effect of the assessed control risk and inherent risk on the

11 Please refer to Norris 2005 and Glover et al. 2008 for a more detailed description of the method used to conduct thepath analysis.

FIGURE 1PathAnalysis Examining SourcingArrangements (In-House, Cosourcing, Outsourcing) and

Related Decisions

-0.269*-0.352*-0.109-0.108

0.424*

Sourcing Arrangement

Competence ObjectivityTechnical Skill

Audit RiskControl Risk

Reliance(High Risk Areas)

Inherent Risk Acquiesce

0.414*0.1670.138

0.121 0.235* 0.245*

0.410*

Auditor Effort

-0.020 -0.013 -0.169* -0.256*

-0.105

Note: *p < .05



extent of reliance placed on the IA function. The results also indicate that sourcing arrangementhas a significant effect on audit effort; however, that effect is fully mediated by the effect ofsourcing arrangement on reliance.

CONCLUSIONPrior research has examined the effects of maintaining an in-house IA function versus out-

sourcing an IA function on external auditors perceptions and reliance decisions. This study con-tributes to the extant literature by examining the effects of a third sourcing arrangement, cosourc-ing relative to in-house or outsourced sourcing arrangements on the external auditorsassessments of quality, reliance, and external audit effort. We find that external auditors assess thequality of outsourced and cosourced where the IA services related to high-risk areas are providedby an outside firm IA functions to be higher than the quality of an in-house IA function. Likewise,external auditors are willing to rely on cosourced and outsourced IA functions to a greater extentthan in-house IA functions. Our findings suggest that there is no significant difference in externalauditors assessments of objectivity, competence, and reliance for the outsourced and cosourced IAfunctions in the high inherent risk areas. We also find that the greater reliance on the cosourcedand outsourced IA functions is correlated with significantly lower external audit effort relative tothe in-house function. However, there is no significant difference in external audit effort for thecosourced and outsourced IA functions. The results also indicate that there were no significantdifferences in external auditors assessments of their willingness to rely on the IA function andratings of related effort for the low-risk areas across the three sourcing arrangements.

The overall results indicate that the quality of the IA function affects external auditorsassessments of reliance on the IA function and related ratings of effort only for the high-risk areas.The results also imply that in a cosourcing arrangement, the presence of independent outside IApersonnel during the audit of high-risk areas despite the presence of in-house IA personnelmitigates the probability of the external auditors attributing the work of the IA function to incen-tives to please or align with management. Hence, it could be beneficial for companies to havesome independent outside firm personnel be part of the IA personnel who provide IA services forhigh inherent risk areas.

With the exception of DeZoort et al. 2001 and now this study, there are no other studies thatexamine an IA function that also performs other NAS. The board of directors can subject toapproval of the audit committee allow an outside internal audit firm to additionally provide taxservices. Therefore, our study evaluates the effect of IA cosourcing and outsourcing when addi-tional services i.e., tax services are provided on external auditors assessments of quality, reli-ance, and audit effort. We find an adverse effect on assessments of IA quality and external auditorreliance on the IA function in cases where the outside IA firm also provides tax services. Thisadverse effect on assessed quality and reliance also translates into a significant increase in externalaudit effort. This result implies that the objectivity concerns that prevent an external auditor fromproviding other NAS are also prevalent in an internal audit context. The sample used for this studyconsisted entirely of external auditors. It is possible that since external auditors are prevented fromproviding other NAS, they would consider the provision of NAS by the internal auditor to have anadverse effect on objectivity. It would be interesting to observe if other stakeholders have the sameperceptions as the external auditors.

Our study finds that external audit effort associated with a cosourcing arrangement wherehigh-risk areas are cosourced to an independent firm are 1 lower than that for an in-house IAfunction, and 2 equal to that for an outsourced IA function. Although we do not specificallyexamine any monetary benefits accruing to the company, prior literature e.g., Felix et al. 2001does suggest that enhanced reliance and lower effort leads to lower external audit costs. Thefindings of this research are limited to the extent that we do not attempt to identify an optimal



cosourcing arrangement from the viewpoint of controlling external audit efforts and costs andfrom the viewpoint of a company. The results indicate that external auditors consider cosourcedi.e., the IA services for high-risk areas are provided by an independent firm and outsourced IAfunctions to be equal in terms of quality and reliance. However, this result could potentiallychange if the design of the cosourcing arrangement differed.

Practitioner literature suggests that there are several benefits of cosourcing Serafini et al.2003; Smith 2002; Thomas and Parish 1999. A detailed field study analysis on a firm-by-firmbasis could be useful in identifying detailed characteristics in terms of which specific activitiesand sub-functions of IA should be outsourced and others which should be handled in-house of anoptimal cosourcing arrangement. Finding such an optimal arrangement could potentially be aninteresting future research opportunity. There are various types of cosourcing arrangements DelVecchio and Clinton 2003, and future research could examine the effects of these various arrange-ments on external auditors judgments related to assessed quality, reliance, and effort. Anotherinteresting research avenue would be to examine the difference in external audit reliance and efforton IA functions in situations where the outsourced and cosourced internal audit service provider isa Big 4 firm versus a non-Big 4 firm, or when the IA service provider is a public accounting firmversus a nonaccounting firm that specializes in providing IA services, or when the IA serviceproviders also provide other ancillary services other than tax to their IA clients.

APPENDIXLIST OF QUESTIONS RELATED TO THE DEPENDENT VARIABLESQuality Related Questions

1. Based on the information given, to what extent do you believe the internal audit departmentis objective when performing compliance testing and financial auditing tasks?

Not at all ExtremelyObjective Objective

_____________________________________________________________| | | | | | | | | | |0 1 2 3 4 5 6 7 8 9 10

2. Based on the information given, to what extent do you believe the internal audit departmentis competent in performing compliance testing and financial auditing tasks?

Not at all ExtremelyCompetent Competent

_____________________________________________________________| | | | | | | | | | |0 1 2 3 4 5 6 7 8 9 10

3. Based on the information given, do you believe the internal audit function has sufficienttechnical skills e.g., education level and professional certification to effectively perform compli-ance testing and financial auditing tasks?

Doesnt have any Has sufficientTechnical Skills Technical Skills

_____________________________________________________________| | | | | | | | | | |0 1 2 3 4 5 6 7 8 9 10



Risk/Reliance Related Questions

1. Based on the information presented in this case, to what extent do you recommend thatyour firm rely on tests of controls already performed by internal auditors on the relatively highinherent risk areas?

No Reliance Moderate Reliance Extensive Reliance_____________________________________________________________| | | | | | | | | | |

0 1 2 3 4 5 6 7 8 9 10

2. Based on the information presented in the case, what is the overall assessed Control Riskassociated with the company?

Low Risk Moderate Risk High Risk_____________________________________________________________| | | | | | | | | | |

0 1 2 3 4 5 6 7 8 9 10

3. Based on the information presented in the case, what is the overall assessed Audit Riskassociated with the company?

Low Risk Moderate Risk High Risk_____________________________________________________________| | | | | | | | | | |

0 1 2 3 4 5 6 7 8 9 10

4. How likely do you believe it is that the internal auditors might give in i.e., acquiesce tothe companys management and fail to issue an appropriate finding in the event of a disagreement?

Not at all ExtremelyLikely Likely

_____________________________________________________________| | | | | | | | | | |0 1 2 3 4 5 6 7 8 9 10

Audit Effort Related Question

1. Based on the information given in this case, how would you suggest adjusting audit hoursfor testing controls over the relatively high-risk areas?

Significantly SignificantlyDecrease Do Not Adjust Increase

_____________________________________________________________| | | | | | | | | | |-5 -4 -3 -2 -1 0 1 2 3 4 5

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