THE EFFECTS OF RISK, MATERIALITY, AND ASSERTION SUBJECTIVITY ON EXTERNAL AUDITORS RELIANCE ON INTERNAL AUDITORS

This study examines the effects of inherent risk, materiality, and the subjective nature of the assertion under audit on external auditors' reliance on internal auditors. SAS No. 65 emphasizes that these factors should be considered by external auditors when determining the extent of direct internal auditor usage during the audit. A case study experiment was conducted involving judgments by Big-6 audit managers to rely on internal auditors to perform external audit work. A between-subjects design was used where the subjects received a case containing information on a hypothetical company's internal auditors and accounts receivable financial data. Inherent risk and materiality were each manipulated between the cases at low and high levels. The inherent risk manipulation was based on the amount of the allowance for doubtful accounts and the presence of pledged and related party accounts receivable. Materiality was manipulated based on the size of the not accounts receivables in relation to net income and current and total assets. The subjects wore asked to complete an audit time allocation sheet which indicated the amount of audit time to be assigned to the internal and external audit staffs. The allocation sheet required allocations broken down by individual accounts receivable audit assertion. The results indicated that at the low materiality level the managers assigned more tests of control work to the internal auditors. However, inherent risk factors were not found to be significant. Anecdotal evidence relating to the individual accounts receivable assertion work assigned to internal auditors indicates that reliance on internal auditors for substantive work appears to depend on the nature of the individual assertion's evidence.