The Effect of Frequency and Automation of Internal Control Testing on External Auditor Reliance on the Internal Audit Function

Abstract

ABSTRACTFailure of the internal audit function (IAF) to detect a significant deficiency in internal controls is a significant shortcoming in the IAF's work performance. This shortcoming in the IAF's work performance reduces external auditors' willingness to rely on the IAF's work. Using a two-stage experiment, we investigate how the implementation of three different internal control testing remediation strategies (akin to CCM, ACL, and periodic manual testing), which vary in their automation and frequency, affect external auditors' perceptions of IAF strength and planned reliance on the IAF's work. We find that automated remediation strategies fully remediate external auditors' perceptions of poor IAF work performance and low degree of reliance on the IAF, whereas manual remediation strategies result in only partial remediation. Counterintuitively, less frequent remediation strategies are more effective at improving perceptions of poor IAF work performance and low levels of reliance on the IAF, relative to continuous remediation strategies.