The Influence of PCAOB Regulatory Actions and Engagement Risk on Auditors’ Internal Audit Reliance Decisions
33 Pages Posted: 21 Sep 2010 Last revised: 10 Sep 2012
Date Written: September 2012
This paper examines how external auditors’ reliance decisions on the internal audit function (IAF) are affected by two Public Company Accounting Oversight Board (PCAOB) regulatory actions (the risk-based audit approach required by auditing standards and a change in the focus of the PCAOB inspection process) and engagement risk. As predicted, we find a significant interaction between these three factors that shows the following. First, when the riskiness of the audit tests is low, the effect of focus of the PCAOB inspection process is not significant on the auditors’ reliance on the IAF when engagement risk is low. However, when engagement risk is high, the auditors placed significantly greater reliance on the IAF when a balanced focus is used for the PCAOB inspection process compared to an effectiveness focus. Second, when the riskiness of the tests to be performed is high, the auditors relied more on the IAF in the balanced focus of the PCAOB inspection process condition regardless of the level of engagement risk. Lastly, we find that under the new regulatory regime external auditors rely more on the IAF to perform tests of controls than substantive procedures.
Keywords: Internal Audit Function, Engagement Risk, PCAOB Inspection Process, Audit Tests
JEL Classification: M40, M42
Suggested Citation: Suggested Citation