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MAJ
19,5 A comparison of internal audit in
the private and public sectors
Jenny Goodwin
640 School of Accountancy, Queensland University of Technology,
Brisbane, Australia
Keywords Internal auditing, Public sector organizations, Private sector organizations
Abstract This paper explores similarities and differences between public sector internal auditing
and its counterpart in the private sector. Features examined include organizational status,
outsourcing, using internal audit as a tour of duty function, activities and relationships with the
external auditor. The study is based on a survey of chief internal auditors in organizations in
Australia and New Zealand. Results suggest that there are differences in status between internal
audit in the two sectors, with public sector internal auditors less likely to report to the chief financial
officer. While a similar amount of work is outsourced, public sector organizations are more likely
than those in the private sector to outsource to the external auditor. There is little difference
between internal audit activities and interactions with external audit in the two sectors. However,
private sector internal audit is perceived to lead to a greater reduction in audit fees compared to
that in the public sector.
The objective of this paper is to compare features of the internal audit function between
organizations in the private sector and those in the public sector. Aspects examined
include organizational status, using internal audit as a tour of duty function,
outsourcing, internal audit activities including involvement in risk management, and
interactions with external auditors. The data were collected by a questionnaire survey
sent to chief internal auditors who were members of the Institute of Internal Auditors
(IIA) in Australia and New Zealand. The study extends that reported in Goodwin
(2003) which focused on the relationship between internal audit and the audit
committee.
The study is motivated by the increasing emphasis on the role of internal audit as a
corporate governance mechanism in both sectors. It has been argued that there are
important differences between public sector internal auditing and its private sector
counterpart in terms of the orientation of the framework in which it operates and the
scope of its activities (Carhill and Kincaid, 1989; Coupland, 1993). However, public
sector reforms have lessened the differences between the two sectors, particularly with
regard to governance (Barrett, 2002a, b). An interesting research question, therefore, is
the current extent to which internal audit in the public sector differs from that in the
private sector with regard to its status, scope and activities.
The results of the study suggest that there are differences in status between internal
audit functions in the two sectors but that internal audit activities and interactions
The author thanks K. Raghunandan for his help in the development of the survey instrument for
Managerial Auditing Journal
Vol. 19 No. 5, 2004 this study. The assistance of the Institute of Internal Auditors Australia and the members who
pp. 640-650 completed the survey is also gratefully acknowledged. The paper has benefited from the helpful
q Emerald Group Publishing Limited
0268-6902
comments of participants in a seminar hosted by the Institute of Internal Auditors Queensland
DOI 10.1108/02686900410537766 Branch.
with external auditors are similar. Reliance on the work of internal audit by the Internal audit
external auditor is perceived to lead to a greater reduction in audit fees in the private
sector compared to the public sector.
The paper is structured as follows. The next section provides the background and
research questions. This is followed in the third section by a description of the research
method used. The fourth section reports the results of the study while in the final
section some conclusions are drawn, the limitations of the study noted and 641
opportunities for further research are discussed.
Research design
The data were collected by means of a questionnaire sent to all chief internal auditors
in Australia and New Zealand who were registered as members of the IIA
Australia[1]. The IIA processed the mailing of questionnaires with responses being
mailed directly to the researcher. A copy of the questions asked is included in the
appendix.
Questionnaires were mailed to 370 heads of audit and 120 responses were received,
generating a response rate of 32 per cent. There were 32 responses from private sector
entities in Australia and 16 from New Zealand, giving a total of 48 private sector
responses. Public sector responses totalled 72, with 53 from Australia and 19 from New
Zealand. There were only two minor differences based on country, and these are noted
in the next section.
To test for a non-response bias, responses were compared between early and late
respondents. There were no significant differences in responses on any of the variables
in the study[2], suggesting that non-response bias is not a problem (Scarbrough et al.,
1998).
Results
Status of internal audit
The IIA stresses the importance of organizational independence of the internal audit
function (IIA, 2001), with the chief internal auditor reporting to a level within the
organization that allows the function to fulfill its responsibilities (IIA 2001, para 1110).
External auditing standards (e.g. AUS 604 (AuASB, 1995) and ISA 610 (IFAC, 1994))
argue that, ideally, internal auditing will report to the highest level of management and
be free of any other operating responsibility. Table I reports the results of a Chi-square
test to determine whether reporting lines differ between private sector entities and
those in the public sector. The table shows that 17 chief internal auditors in the private Internal audit
sector (36 per cent) indicated that they report to the chief financial officer compared to
only five (6.9 per cent) in the public sector. The difference is statistically significant at
p 0.000. This result is of some concern as it suggests that many private sector
internal auditors may not enjoy the day-to-day objectivity required to adequately fulfill
their responsibilities. While Goodwin (2003) reports that most chief internal auditors
appear to have good access to the audit committee, day-to-day reporting lines remain 643
important for internal audit to be recognized as having a high status in the
organization.
A further test of status is whether the internal audit function is staffed by
permanent employees or whether it is considered to be a tour of duty function in the
organization. In the latter case, internal audit is frequently considered to be a training
ground for future managers, with a stint in internal audit providing them with a good
understanding of organizational systems and accounting functions (Goodwin and Yeo,
2001). While this practice can have many advantages for the organization, it can also
have negative implications for internal audit independence, particularly when it
involves senior personnel (Chadwick, 1995). A chief internal auditor who is expecting
to be transferred to a line management position may have little incentive to enhance the
quality of the internal audit function and may also be unwilling to take a strong
position on issues that arise (Goodwin and Yeo, 2001; Chadwick, 1995). Table II reports
responses to questions concerning whether, first, the chief internal audit position is a
tour of duty position and, second, whether internal audit is considered a tour of
Financial
audit/internal Operational/ Special
controls Risk management systems audits projects/other
Mean % SD Mean % SD Mean % SD Mean % SD
Table III.
Public sector 31.31 15.84 15.50 14.60 33.73 15.57 19.03 14.76 Mean percentage
Private sector 30.31 12.69 18.02 13.48 36.75 15.72 15.44 11.86 (standard deviation) of
Total 30.91 14.61 16.51 14.16 34.94 15.63 17.59 13.74 time spent on activities
MAJ Yes No Total
19,5 n % n % n %
The table shows that there is a marginally significant difference between the two
sectors with regards to financial risk management, with 50 per cent of private sector
internal audit functions being involved with this type of risk management compared
to only 33 per cent of public sector internal audit functions ( p 0.068). This no
doubt reflects the lower emphasis placed on financial risk in the public sector. There
are no other statistically significant differences between the two sectors.
Approximately 90 per cent of internal audit functions are actively involved in
operational risk management while 65 per cent are involved in strategic risk
management. Slightly over 30 per cent of functions are engaged in environmental
risk management. Approximately 20 per cent indicated that they are involved in
other areas of risk management. These areas included risk management of special
projects (9), health and safety (8), information technology (7) and fraud (4). Thus, in
spite of spending a relatively small amount of their total time on risk management
activities, it does appear that internal auditors are actively involved in a wide range
of these activities.
Yes No Total
n % n % n %
Reduction in
Reduction in cost more
cost 10 per than 10 per Unsure of
cent or less cent impact Total
n % n % n % n %
Concluding comments
This paper has explored similarities and differences in the status, scope and
activities of internal audit between organizations in the public sector and those in
the private sector. The study is based on a survey of chief internal auditors in
organizations in Australia and New Zealand. Results suggest that, overall, public
sector internal audit functions have a higher status than their private sector
counterparts, where more than a third of chief internal auditors report to the chief
financial officer. Further, the internal audit function is less likely to be used as a
tour of duty function in the public sector. While a similar percentage of entities in
each sector engage in outsourcing some of their internal audit activities, public
sector organizations are more likely to use their external auditor to provide these
services. The time spent on different internal audit activities is similar in both
sectors. Interactions with the external auditor also do not differ significantly
between the two sectors. However, public sector internal auditors are less convinced
than their private sector counterparts that the external auditors reliance on their
work leads to a reduction in audit fees.
There are a number of limitations of the study. The sample size is relatively small,
particularly with regard to the private sector. Generalizability of the results may be
limited as both Australia and New Zealand have had significant reforms in the public
sector, bringing the two sectors closer together with regard to governance and financial
accountability. As with all surveys, a further limitation is that the results rely on the
self-reports of respondents and are therefore open to misinterpretation of the questions
as well as to subjectivity in the responses.
In spite of the limitations, the study makes an interesting contribution to our
understanding of internal audit in both sectors. Additional research could be conducted
in other regulatory frameworks where, for example, internal audit is mandatory or
where there has not been the same level of public sector reforms. Other aspects of
internal audit such as the extent of consulting work compared to assurance activities
could also be explored.
Notes Internal audit
1. The IIA Australia covers members in both Australia and New Zealand.
2. The sample was divided into two, based on surveys postmarked within four weeks of
mailing (82 responses) and those postmarked later (38 responses). Chi-squared tests for
dichotomous responses and t-tests for continuous responses indicated that there were no
statistically significant differences between the two groups. All p values exceeded 0.15.
3. The use of internal audit as a tour of duty function for staff was also more prevalent in 649
New Zealand (29 per cent) than in Australia (10 per cent) ( p 0.025).
4. The mean percentage of time spent on financial audits differed between Australia and New
Zealand, with New Zealand internal audit functions spending 27 per cent of time on this
activity compared to 33 per cent for those in Australia ( p 0.034).
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