an empirical study on effectiveness of internal auditing ... ?· an empirical study on...
Post on 20-Aug-2018
Embed Size (px)
An Empirical Study on Effectiveness of Internal Auditing for Listed Firms inTaiwan Jung-Hua Hung National Central University
Hui-Lin Han National Central University
ABSTRACT: The function of internal auditing has become more and more important to thecompanies in Taiwan, because the market environment became more and more competitive,and several business crises happened recently. This study tries to identify the factors thataffect the effectiveness of internal auditing for listed firms in Taiwan. A sample of 210 listedmanufacturing firms was drawn. We mailed a different questionnaire to the management, thehead of audited department 1, and the head of internal auditing department of each company,and the overall response rates were 48%, 64%, and 70%, respectively.
Findings reveal that the factors that affect managements perceiving effectiveness aremanagements attitude, controllers attitude, the probability of internal auditors promotion,the implementation of performance evaluation, the establishment of job description, and thetraining and professional abilities of internal auditor. Secondly, the factors that affect auditeddepartment heads perceiving effectiveness are internal auditor professional abilities, andthe combination of organization formalization and professional abilities. Finally, thefactors that affect the progress of annual auditing plan are managements attitude,controllers attitude, the organization position of internal auditing department in a company,the probability of internal auditors promotion, the implementation of performanceevaluation, the establishment of job description, the training and professional abilities ofinternal auditor, and the combination of organization formalization and the professionalabilities. The implications and limitations of these findings for the practice and theory ofinternal auditing are provided.
Key words: Internal auditing
1Audited department is every department in a company, except auditing department, because all of them must be audited by auditingdepartment.
Owner or management of a business cannot continue to have personal contact with or toknow everything about the business, as the business increases in size. Therefore, it isnecessary to delegate to achieve the objectives of a business effectively. However, it willcause agency problems between management and its subordinates, board of directors andmanagement, and minority investors and board of directors. Fortunately, we can use somecontrolling activities-such as auditing, formal control systems, budget limit,etc.-tomitigate these problems(Jensen and Meckling 1976).
The objectives of this study are: (1) to explore the extent to which listed firms implementtheir internal auditing; (2) to identify the factors that influence the effectiveness of internalauditing; (3) to provide some suggestions, based on the results of this study, to industries andrelevant government departments.
Exploring how the listed firms implement their internal auditing and identifying whatkinds of factors influence the effectiveness of internal auditing are very important , becauserecently, some big companies had financial crises2 and the main reason was their internalauditing did not function well. In 1986, The Ministry of Finance in Taiwan issued TheCritical Points of Establishing Internal Control Systems for Listed and Public Firms, andasked all of the listed and public firms to refer to it when they set up their internal control andinternal auditing systems. Several years have passed since then, but we can still find some bigcompanies getting into trouble because of their bad internal control and internal auditingsystems. Do they face any problems in establishing and implementing internal control andinternal auditing systems? And how can the effectiveness of internal auditing be improved?We really need to address these kinds of questions, and then try to find the solutions for them.
The remainder of this paper is organized as follows. In the next section, a review ofstudies of the internal auditing and research hypotheses is provided. The methods and resultsof an empirical study are then reported. Finally, the implications and limitations of this studyare discussed.
II. LITERATURE REVIEW AND RESEARCH HYPOTHESES
The definition of internal auditing and objectives
According to the Standards for the Professional Practice of Internal Auditing, whichwas issued by The Institute of Internal Auditor, the definition of internal auditing is:Internal auditing is an independent evaluation function in an organization, it examines andevaluates an organization activities, and provides services to the organization. It is a kind ofmanagement control, and works through measuring and evaluating the effectiveness of othercontrols. In other words, internal auditing controls internal control. The objectives ofinternal auditing are: (1) appropriate control; (2) the reliability of information system; (3)assets protection; and (4) efficient use resources(McAvoy 1977). Thus, an internal controlsystem cannot function well without internal auditing.
2For example, a listed firm-Kung Nan company whose checks bounced; a commercial bank-Overseas Chinese Bank-operated derivativesimproperly. Both of them faced financial crises which had very negative impact on the whole society.
The relationships between internal auditors and board of directors
Board of directors represents all stockholders to monitor management. However, most ofthe directors either are very busy or participate in daily operation of the company, therefore,they are not able to control management properly. As a result, nowadays, a lot of Americancompanies set up an audit committee to help board of directors to supervise management.The main responsibility of audit committee is monitoring financial reporting procedures,internal control system, and internal auditing and external auditing(Cook 1993). Most of theaudit committee members are outside directors, which can assure the objectivity of theirsupervising management(Menon and Williams 1994). Internal auditing department is animportant information source for audit committee, The Treadway Commission suggestedthat audit committee members and internal auditor should meet with each other regularly.The direct communication between them shows the independent position of internal auditorsin an organization, allows internal auditor to express their fair, impartial judgment andsuggestions, and increases the possibility of their suggestions being adopted(Verschoor andLiotta 1990).
In Taiwan, there are no audit committees in a company today, however, controller is avery similar position. According to Commercial Code of Taiwan, A controller is electedfrom stockholders, A controller cannot be director, manager or other employee in thesame company, and A controller can investigate a companys operating and financialsituation at any time. In addition, The Critical Points of Establishing Internal ControlSystems for Listed and Public Firms regulates that internal auditing department must handin the auditing report to controller to review. Finally, board of directors must have the right toselect and fire internal auditors, and to establish all kinds of guidelines for internalauditors(Morris 1978). The factors that influence the effectiveness of internal auditing
There are a lot of factors that influence the effectiveness of internal auditing. This studydivides them into environment and inside internal auditing factors, which are as follows.
Firstly, management attitude: managements support is probably the most importantfactor in company environment(Stocks, Albrecht, Howe, and Schueler 1988). Theeffectiveness of internal auditing department mostly depends on management involvementand requirement3. Secondly, the attitude of board of directors: No. 7 of The Statements ofInternal Auditing Standards regulates that the head of internal auditing should communicatedirectly with board of directors regularly, and they should meet with each other withoutmanagement on the scene at least once a year, enhance the independence of internal auditing.Third, organization structure: if management provides internal auditing department with anindependent position inside an organization, it would have a positive influence on controlenvironment(Pushkin 1990).
3Management involvement and requirement means whether or not management uses auditing reports and takes the actions that internalauditor think is necessary.
The degree of autonomy and independence depends on the level internal auditor reports to,and internal auditing department should report both to audit committee and management in
order to assure its autonomy and independence(Schroeder 1977). In addition, internalauditors and the audited activities should be independent of each other , and internal auditorsshould report directly to highest management(DeMarco 1980). Fourth, career planning:promotion opportunity is an important factor to attract excellent internal auditors(Schneider1970). An efficient internal auditing department should be regarded as a good place todevelop employees careers, because internal auditors can understand the whole operation ina company(Stock, Albrecht, Howe, and Schueler 1988).
The factors inside an internal auditing department
Firstly, the human resources policy of internal auditing department. It is related to whetheror not the limited internal auditors are used efficiently, and includes the following. (1)education and training: the education and training internal auditors received is an i