The Cost of Auditor Independence - - CFO.com

The Cost of Auditor Independence - - CFO.com

The Cost of Auditor Independence
The line Sarbanes-Oxley drew between audit firms and their clients may have been a good idea overall, but it increased accounting risk, a new study indicates.
Sarah Johnson - CFO.com US
February 12, 2009

Excerpts:

The knowledge of a company that an external auditor gained from internal auditing lowered the chances of publishing misleading or fraudulent financial results, according to preliminary findings by professors at Brigham Young and Texas A&M universities.

"This evidence supports the prediction associated with the knowledge spillover hypothesis — the idea that external auditors are more effective when performing both internal and external audit services," concluded a paper written by Douglas Prawitt, accounting professor at Brigham Young University, Nathan Sharp, assistant accounting professor at Texas A&M University, and David Wood, a visiting instructor at Brigham Young.

Until now, there's been lots of talk about how much Sarbox — in particular, its internal-control provision — has cost companies, but little analysis of what benefits the law truly achieved, says Prawitt.

"Of all the services external auditors provided before the SOX prohibition, we believe internal audit outsourcing represents the greatest possibility for creating knowledge spillover effects," the academics said in their paper.

Their conclusion doesn't sit well with IIA president Richard Chambers, who cautions that the researchers' scope was very narrow and doesn't delve into the many responsibilities of internal auditors. "They're also looking at operational risks, compliance risks, business and strategic risks," Chambers says.

While external auditors are independent of a company and primarily focused on reviewing financial statements and attesting to internal controls, internal auditors are — in the views of the IIA — ideally working in-house, as part of the business, and their work in helping management test and document internal controls is just one of their many tasks. Internal auditors have the best understanding of any function in a company to know where a company's risks lie, Chambers contends.

Another outcome the researchers are hoping for is that communication between internal and external auditors will improve, which in turn, as their paper implies, could lead to better financial reporting by knowledge sharing. Chambers says the two groups' anxiety over being open with each other in the beginning of Sarbox has waned. "It's important for both parties to be open and receptive to each other," he says. External auditors can gain from internal auditors' knowledge by talking more regularly and informally than some do now, he adds.

Read Full Article: http://www.cfo.com/article.cfm/13111528/c_2984347
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This posting was made my Jim Jacobs, President & CEO of Jacobs Executive Advisors. Jim also serves as Leader of Jacobs Advisors' Insurance Practice.