Serving Two Masters: The Association between Audit Committee Internal Audit Oversight and Internal Audit Activities

TLDR

Internal controls and the roles of audit committees and internal audit functions have become increasingly important, yet guidance on how audit committee involvement shapes internal audit activities remains limited. The study examines how audit committee oversight of the internal audit function influences the focus of that function, hypothesizing that greater committee control steers the internal audit toward internal‑controls‑oriented work. To test this, 134 chief internal auditors from Fortune 1000 firms were surveyed about resource allocation in FY 2005, and a composite oversight measure was built from reporting duties, termination rights, and budgetary control. The results show a strong, positive link between audit committee oversight and the proportion of the internal audit budget devoted to internal‑controls‑based activities.

Abstract

SYNOPSIS: In this paper, we investigate the association between the audit committee’s oversight of the internal audit function (IAF) and the nature of IAF activities. The importance of internal controls and of the roles of both the audit committee and the internal audit function in monitoring control activities have grown in recent years. Despite the importance of these topics, relatively little regulatory or best practices guidance addresses the distribution of IAF activities and amount of audit committee involvement with the IAF. We hypothesize that when the balance of oversight over the IAF lies with the audit committee (vis-a`-vis management), the committee will steer the IAF toward a more internal-controls-oriented focus. Our hypothesis is based on the existing practice guidance in this area and the relative incentives of management and the audit committee. To test our hypothesis, we survey 134 chief internal auditors from Fortune 1000 firms regarding the amount of internal audit resources allocated across internal audit activities in fiscal year 2005. We then construct a composite measure of audit committee oversight contingent on the relative control that the audit committee has over IAF vis-a`-vis management. Our composite measure is derived from three key facets of the audit committee/internal audit relationship: reporting duties, termination rights, and budgetary control. Consistent with our hypothesis, we document a strong, positive association between our audit committee oversight variable and the amount of IAF budget allocated to internal-controls-based activities.