Internal audit functions and audit results

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The internal audit division is responsible for overseeing the company’s operations designed to provide added value and improve company operations by evaluating the effectiveness of the risk management process, control and corporate governance. Therefore, it is important to minimize the occurrence of fraudulent financial statements and can provide an independent guarantee for decision making. On the other hand, external auditors provide a significant supervisory role in testing the credibility of financial statements provided by management on behalf of shareholders (Lin & Liu, 2009). Therefore, the relationship between internal auditors and external auditors greatly influences the strength of corporate governance.

Companies with strong governance due to good internal auditors want high audit quality and are willing to pay audit fees high. Thus, a good internal audit function has a positive effect on the amount of external audit fees paid.

Audit quality is described as having correlation with earnings management practices carried out by company management. Moreover, companies audited by Big4 public accounting firms tend to report lower earnings management. Therefore, companies that practice minimum earnings management tend to have high audit quality. Thus, this study assumes adequate internal audit function has a positive effect in the presentation of quality financial statements.

According to Srinidhi and Firth (2014), companies with good internal governance mechanisms tend to choose auditors with big names ( Big4) , to attract investors because they have reasonable confidence in adequate financial statements. So this study predicts that companies that have adequate internal audit mechanisms tend to choose auditors (Big 4) to carry out independent audit tasks.

With the existence of an adequate internal audit function, the oversight mechanism for corporate governance is maximized to increase transparency and effectiveness of management performance. According to (Berglund et al., 2018) the effectiveness of management performance can improve managerial capabilities so that there is no doubt about the company’s ability to maintain its life in the future. Thus this study assumes that internal audit function has a negative effect on modified going concern audit opinion.

The sample in this study consist of all non-financial companies listed on the Indonesia Stock Exchange in the period of 2016 and 2017. The data sources were obtained through company financial reports and OSIRIS database, and 722 observations were obtained as the main sample in this study. This study uses ordinary least square regression. The results showed that companies with adequate internal audit functions tend to improve monitoring by using external auditors and pay higher audit fees to get quality audit results.

In addition, the internal audit function has a significant positive effect on the quality of audits produced, because the internal audit mechanism will increase oversight of corporate governance, which has an impact on decreasing earnings management practices and improving audit quality. Furthermore, adequate internal audit has a significant positive association to the selection of Big4 auditors, this is to increase the value of the company and attract investors because it has adequate financial statement guarantees. Finally, the internal audit function has a significant negative effect on a company’s tendency to accept modified going concern audit opinions. With an adequate internal audit function, the oversight mechanism for corporate governance is maximized thereby increasing the transparency and effectiveness of management performance.

Author: Iman Harymawan, Ph.D.

Details of this research available at:

https://doi.org/10.1080/23311975.2020.1750331

Achmad Dzulfikar Dzikrullah, Iman Harymawan & Melinda Cahyaning Ratri (2020) Internal audit functions and audit outcomes: Evidence from Indonesia, Cogent Business & Management, 7:1, 1750331

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