The Effect of Prior Consulting Work on Internal Auditors' Evaluations of Internal Controls

Abstract

We analyze internal auditor objectivity by examining whether consulting work performed by internal auditors influences their subsequent judgments. We conduct an experiment with experienced internal auditors. We present them with an internal control scenario representing an at-margin internal control deficiency (i.e., borderline between a significant deficiency and a material weakness) and ask participants how likely they are to conclude that the deficiency is a material weakness. We manipulate the extent of prior involvement with the internal control (consulted on the design of the control or no prior involvement) and the type of the control deficiency (deficiency in design effectiveness or operating effectiveness). Consistent with our predictions, we find some evidence that internal auditors who had prior involvement in consulting on the design of the control are less likely than others to conclude that the deficiency is a material weakness, but only when the deficiency being evaluated relates to the design effectiveness of the control. The results have important practical and regulatory implications. According to professional standards, consulting on the design of internal controls is not presumed to impair internal auditors’ objectivity, yet we find a systematic influence on subsequent evaluations for purposes of reporting on internal control over financial reporting.

Keywords: control deficiencies, internal auditor objectivity, internal control over financial reporting (ICFR), prior involvement