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Abstract:
Despite extensive research on the determinants of external audit fees, there is little empirical evidence on the effect of internal audit contribution on the external audit fee. Using a cross-sectional regression model based on prior audit fee research, this study provides evidence that internal audit contribution is a significant determinant of the external audit fee. Further, a second model that provides evidence on the determinants of internal audit contribution is developed and tested. This second model indicates that internal audit contribution is influenced by internal audit quality and, conditional on the level of inherent risk, the availability of internal audit and the extent of coordination between internal and external auditors. These results are based on a unique data-set comprised of publicly available data matched with survey responses from internal and external auditors affiliated with 70 non-financial services Fortune 1000 firms. The sample includes all of the former "Big 6" international accounting firms and clients from twenty-nine different industries.

Audit fees; Internal audit; SAS No. 65

Abstract:
Despite extensive research on the determinants of external audit fees, there is little empirical evidence on the effect of internal audit contribution on the external audit fee. Using a cross-sectional regression model based on prior audit fee research, this study provides evidence that internal audit contribution is a significant determinant of the external audit fee. Further, a second model that provides evidence on the determinants of internal audit contribution is developed and tested. This second model indicates that internal audit contribution is influenced by internal audit quality and, conditional on the level of inherent risk, the availability of internal audit and the extent of coordination between internal and external auditors. These results are based on a unique data-set comprised of publicly available data matched with survey responses from internal and external auditors affiliated with 70 non-financial services Fortune 1000 firms. The sample includes all of the former "Big 6" international accounting firms and clients from twenty-nine different industries.

Audit fees; Internal audit; SAS No. 65

Abstract:
This paper investigates how external auditor provision of significant non-audit services and client pressure to use the work of internal audit influence external auditors' use of internal auditors' work. More specifically, we study how external audit evidence gathering choices are influenced by non-audit fees and client pressure. Our research is motivated by an observation that the magnitude of non-audit services provided to audit clients introduces the risk that client management may leverage its position with the external auditor and potentially affect the audit process. We address this issue by extending prior research and focusing on the importance of various explanatory variables, including non-audit service revenues, client pressure, internal audit quality, and coordination, to the external auditor's decision to rely on the work of internal audit. We use data primarily obtained through surveys completed by internal and external auditors. The survey responses represent 74 separate audit engagements. Our findings reveal that when significant non-audit services are not provided to a client, internal audit quality and the level of internal/external auditor coordination positively affect auditors' internal audit reliance decisions. However, when the auditor provides significant non-audit services to the client, internal audit quality and the extent of internal/external auditor coordination do not significantly affect auditors' reliance decisions. Furthermore, when significant non-audit services are provided, client pressure significantly increases the extent of internal audit reliance. Thus, external auditors appear to be more affected by client pressure and less concerned about internal audit quality and coordination when making internal audit reliance decisions at clients for whom significant non-audit services are also provided.

Audit evidence, client pressure, internal audit, non-audit service revenues

Abstract:
This paper examines the interaction of a little-studied stakeholder - the venture capitalist (VC) - with the audit function in the initial public offering (IPO) market. While the monitoring role of the external auditor has been studied in the IPO accounting literature, a relatively recent stream of research has begun to provide insight regarding the impact on a firm's reporting and accounting decisions/quality of other potential monitors - e.g., boards of directors, actuaries, etc. Finance and accounting research have both provided evidence consistent with the notion that VCs play a value-added role in their investee firms. This paper contributes to this stream of study by providing first time evidence that in an IPO context a VC provides monitoring value incremental to that of the external auditor. Specifically, our evidence suggests that VCs not only mitigate the demand for information from the external auditor, but that they also weaken the demand for insurance from the external audit function. To our knowledge this result has not been previously documented.

Venture capital, Market for audit services

Abstract:
This study describes and critiques the audit procedures applied to a set of material transactions from the Lincoln Savings and Loan (LSL) audit failure. Auditor deposition testimony and audit working papers produced in the civil litigation against the auditors of LSL provide the basis for this analysis. The public availability of the deposition testimony and audit working papers creates a unique opportunity to study and evaluate audit procedures and decisions from an audit failure. To date, evaluating actual audit procedures from an audit failure has proven nearly impossible for accounting researchers because audit workpapers are owned by the defendant audit firm and are usually sealed in the litigation and/or destroyed when a case is settled. In spite of objections from the audit firms' legal counsel, U.S. District Judge Richard Bilby released to the public deposition transcripts and associated audit working papers from the civil litigation against the former auditors of LSL. We use these documents as the basis for our analysis. To our knowledge, this is the first study to examine audit procedures documented in depositions and working papers from litigation over the adequacy of an auditor's performance.

Our access to LSL's auditor's depositions and work papers enables us to evaluate the audit procedures that were applied by LSL's auditors and the information they used. More importantly, we are able to identify the information that was not used and procedures that were not performed. Other researchers have been unable to study audit procedures associated with audit failures, in spite of the compelling importance of such an inquiry, using traditional research methods. Our ability to study these issues highlights the potential value of a detailed analysis of legal documents from a single case. Moreover, the current approach enables us to generate alternative procedures that may have averted the failure. Our ability to draw such inferences is a unique characteristic of this type of research. This study is one of the first to identify procedures or omissions associated with an audit failure. For this reason, the analyses in this study, although imperfect, provide an important basis upon which future research can build.

The main conclusion of our analysis is that the most significant shortcoming in the LSL audit was the auditor's failure to obtain and use knowledge of LSL's business, the industry in which it operated, and the economic forces that influenced this industry/business. It is our view that had the auditors obtained this understanding and applied it to an evaluation of the substance of LSL's main source of profits during this period, sales of undeveloped Arizona land, the auditors would have reached different revenue recognition conclusions. More specifically, if the auditors had compared LSL's wholesale sales of undeveloped land to trends in Arizona's retail residential real estate market; it would have been apparent that the reported profit margins were "too good to be true." Furthermore, analysis of the substance of these transactions, including consideration of the motivations of LSL and its transacting parties, would have provided additional evidence that immediate revenue recognition on these transactions was inappropriate. Instead, the auditors evaluated the compliance of each material real estate transaction's form with the mechanical aspects of SFAS No. 66 "Accounting for Sales of Real Estate" (e.g. the down payments appeared to meet the requirements of SFAS No. 66). Our evaluation suggests that understanding a client's business is an effective audit procedure that provides reliable audit evidence both in the absence and presence of management fraud.