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Home > Auditing Best Practice > Pros and Cons of Using External Auditors for Internal Auditing and Other Services

Auditing Best Practice

Pros and Cons of Using External Auditors for Internal Auditing and Other Services

by Curtis C. Verschoor

Executive Summary

  • The advantages of engaging an external audit firm for nonaudit services.

  • Regulatory bars to audit firms providing nonaudit services for their clients.

  • Threats to professionalism identified in the code of ethics of the International Federation of Accountants (IFAC).

  • A proposal to enhance the quality of external audit firms in Europe by limiting the services provided.

  • Use of the client’s external audit firm for internal auditing.

  • Advantages and disadvantages of alternative staffing models for internal auditing.

Introduction

For many decades, independent auditing firms have employed the strategy of achieving growth in size and, more importantly, profitability, by expanding the scope and range of services they offered to new and existing clients. In addition to conducting audits of the effectiveness of internal controls over financial reporting as well as financial statements and expressing their opinion thereon, firms in the public accounting industry have offered tax consulting and compliance services and also consulting services that are largely related to information systems and other administrative matters not involving strategic decisions by management. Consulting services were limited to administrative and procedural areas of client operations rather than more strategic areas due to regulatory and professional ethics rules that barred a firm’s participation in the client’s decision-making. Thus, firms tended to provide consulting services that involved issues of technology systems, risk management, and security. Over the years, performance evaluations of the partners in many of the major firms have included an emphasis on the individual’s ability to garner greater fees from existing and new clients. Selling additional services has been viewed as more important to career success in a firm than having an exceptional knowledge of accounting.

The boom in the use of computer systems that began in the 1950s gave rise to a substantial need for expertise in information technology that was required to design and install new systems and maintain existing ones. Public accounting firms participated greatly in providing these services and found the business highly lucrative. In a speech made in December 2003, Douglas R. Carmichael, chief auditor of the Public Company Accounting Oversight Board (PCAOB), commented on the reduced emphasis which auditing was receiving as a result and stated that some firms “sought to capitalize on this position of trust earned as auditors and transfer that stature to other services. At times it seemed the only criteria for these other services was whether they made money” (Carmichael, 2003).

There has always been a huge difference between the growth prospects and profitability of these nonaudit services and those of traditional auditing. Traditional auditing has always been viewed by many as largely a commodity that was required for regulatory purposes, and so fees were subject to downward pressure by management. Consequently, the growth of nonaudit services triggered a number of high-level struggles for power and control of the management of several of the major public accounting firms. The entrenched hierarchy of audit partners who were traditionally in charge of running the firm clashed with the younger nonaudit partners who were newly responsible for bringing high profits to the firm. Most of the nonaudit partners had not completed the legal requirements to perform auditing. As a result, many of the large firms established separate entities based on the consulting division that existed within the firms. These entities were later either sold to existing firms or spun off as independent entities. Some of these businesses have been very successful.

Most notable of the independent entities perhaps is Accenture plc, which began life as the business and technology consulting division of Arthur Andersen LLP. Accenture is listed on the New York Stock Exchange and had fiscal August 2011 revenues of US$25.5 billion. It calls itself a global management consulting, technology services, and outsourcing company, and currently employs more than 223,000 people serving clients in industries in more than 120 countries around the world.

Traditional auditing has always been viewed by many as largely a commodity that was required for regulatory purposes.

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Further reading

Books:

  • Institute of Internal Auditors (IIA). International Professional Practices Framework (IPPF). 2011 edition. Altamonte Springs, FL: IIA Research Foundation, 2011. Online at: tinyurl.com/79nzmne
  • International Federation of Accountants (IFAC). 2010 Handbook of the Code of Ethics for Professional Accountants. 2010 edition. New York: IFAC, 2010. Online at: tinyurl.com/83oh6fb

Articles and Reports:

  • Borowski, David. “2012 outsourcing checklist.” Business Finance (January 17, 2012). Online at: businessfinancemag.com/article/2012-outsourcing-checklist-0117
  • Carmichael, D. R. “Professionalism is primary.” Speech delivered to AICPA National Conference, December 12, 2003. Online at: tinyurl.com/7gw3bjs
  • Center for Audit Quality (CAQ). “Observations on the evolving role of the auditor: A summary of stakeholder discussions.” Washington, DC: CAQ, 2011. Online at: tinyurl.com/8y8ujnr
  • European Commission (EC). “Restoring confidence in financial statements: The European Commission aims at a higher quality, dynamic and open audit market.” Press release, November 30, 2011. Online at: tinyurl.com/6v7u87r
  • Fédération des Experts Comptables Européens (FEE). “FEE initial views on European Commission proposals on audit policy.” Press release, November 30, 2011. Online at: www.fee.be/publications/default.asp?library_ref=4&content_ref=1456
  • Institute of Chartered Accountants of England and Wales (ICAEW). “Key themes being set by governments and regulators.” In “The future of audit,” London: ICAEW, 2011. Online at: tinyurl.com/bngpef8
  • Institute of Internal Auditors (IIA). “IIA position paper: The role of internal auditing in resourcing the internal audit activity.” Altamonte Springs, FL: IIA, January 2009. Online at: tinyurl.com/7mdgpu3
  • International Federation of Accountants (IFAC). “Enhancing the value of auditor reporting: Exploring options for change.” International Auditing and Assurance Standards Board (IAASB) Consultation paper, May 2011. Online at: tinyurl.com/7hy3u5l
  • Public Company Accounting Oversight Board (PCAOB). “PCAOB issues concept release on auditor’s reporting model.” Press release, June 21, 2011. Online at: tinyurl.com/6dcm3zn
  • Public Company Accounting Oversight Board (PCAOB). “Concept release on possible revisions to PCAOB standards related to reports on audited financial statements and related amendments to PCAOB standards.” PCAOB release no. 2011-003, June 21, 2011. Online at: pcaobus.org/Rules/Rulemaking/Docket034/Concept_Release.pdf

Websites:

  • American Institute of Certified Public Accountants (AICPA): www.aicpa.org
  • Fédération des Experts Comptables Européens (FEE): www.fee.be
  • Institute of Chartered Accountants of England and Wales (ICAEW): www.icaew.com
  • Institute of Internal Auditors (IIA): www.theiia.org
  • International Federation of Accountants (IFAC): www.ifac.org
  • Public Company Accounting Oversight Board (PCAOB; US): www.pcaobus.org

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