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THE RELATIONSHIP BETWEEN INTERNALAUDITING AND EXTERNALAUDIT FEES:
EVIDENCE FROM KUWAIT
SBE, Vol.20, No.1, 2017
ISSN 1818-1228
©Copyright 2017/College of Business and Economics,
Qatar University
such a positive relationship as a demonstration
of the conception that the IA function is a
complementary tool that enhances the overall
corporate monitoring and control (Singh
et
al
., 2013). Research suggesting a negative
relationship between IA contribution and
audit fees maintains that the IA function can
be viewed as a substitute, at least partially, for
the external audit work. This would happen as
a result of (i) the reduced external audit hours
resulting from internal auditors’ participation
in the actual conduct of the external audit
work, or (ii) the reduced audit risk assessment
resulting from internal auditors’ knowledge
and involvement in internal controls (Singh
et al
., 2013). Research failing to report
a significant relationship between IA
contribution and external audit fees suggests a
number of possible reasons for that
1
. Firstly,
there could be no causal relationship between
IA and audit fees in reality. Secondly, there
could be a positive relationship that is not
observable as the audit firm may decide to
absorb the increased audit costs for client
retention reasons. Thirdly, there could be a
negative relationship between IA contribution
and audit fees that is not evident as the audit
firm may decide not to pass the cost ‘savings’
on to the audit client.
Empirical auditing research has long discussed
the determinants of external audit fees.
Although this research has examined various
factors and their potential influence on audit
fees, auditee’s size, complexity, and risk were
conventionally thought of as the primary
determinants of audit fees. The contribution
of audit clients’ internal auditors to external
auditors’ work was long believed to have the
potential to reduce the costs of performing
the external audit work (and consequently
audit fees). Yet, only few studies have directly
investigated the contribution of IA functions
1 See Singh et al. (2013) for further discussion.
as a determinant of external audit fees. Elliott
and Korpi (1978) paper was among the early
studies that directly investigated the clients’
internal auditors’ participation in the external
auditor work as a determinant of audit fees.
They found that the percentage reduction of
the external audit work due to the participation
of internal audit was significant in predicting
external audit fees. Stein
et al
. (1994) is
another study that explicitly examined the
IA contribution as a determinant of audit
fees. A dichotomous variable, with the level
of IA participation represented as either
“extensive” or “limited”, was used to test
the significance of the contribution variable
in the audit fees model. The results failed to
find such variable significant, probably due to
the use of a dichotomous variable to capture
the contribution of IA. Felix
et al
. (2001)
further examined this issue using a continuous
variable to measure the IA participation in the
external audit work, and found this variable
to be a significant determinant of external
audit fees. As Felix
et al
. (1998) indicated,
the main reason external auditors rely on
clients’ IA work when performing financial
statement audits is to lower external audit
costs. This suggests the presence of an inverse
relationship between IA contribution and the
costs of performing financial statement audits
due to the cost savings external auditors retain
when relying on such IA work.
Goodwin-Stewart and Kent (2006) examined
the relationship between audit fees and IA
using data related to Australian listed firms.
In particular, using data related to a sample of
401 financial statement audits, they predicted
and found evidence of significantly positive
association between external audit fees and the
use of client’s IA. They interpreted their result
as an evidence of the complementary nature of
the relationship between internal and external
audit as corporate monitoring mechanisms.