Auditor Decision Making on Overall System Reliability: Accuracy, Consensus, and the Usefulness of a Simulation Decision Aid

Abstract

The evaluation of an internal control system involves the joint assessment of piecemeal evidence collected on the various strengths and weaknesses of different control points within the system. For an accounting system, the results of this assessment can be presented in two ways: (a) the probability of the system making an error (Yu and Neter [1973]; Cushing [1974]), and (b) a probability distribution of dollar error the system can produce (Burns and Loebbecke [1975]). Within an external audit context, the probability distribution of dollar error the system can produce is a more useful measure of overall system reliability. It is a necessary input to the auditor's decision on materiality. The auditor must evaluate characteristics of the distribution against a dollar error deemed material and make further decisions on the extent of substantive testing needed or the type of audit opinion to be issued. Thus, the assessment of overall system reliability in terms of the dollar error is a critical audit decision. This paper examines some aspects of external auditors' decision processes in assessing the overall reliability of internal control for a manufacturing company's inventory system. The importance of the inventory audit motivates its selection for study in this research, since