A Summary of Research on External Auditor Reliance on the Internal Audit Function

Public Company Accounting Oversight Board (PCAOB) Auditing Standard No. 5 (AS5) allows external auditors (EAs) to rely on the internal audit function (IAF) when the internal audit activities meet certain criteria and the EAs would find efficiencies in relying on their work (PCAOB 2007). This paper reviews the extant literature on the EAs' reliance on IAF, identifies gaps in the literature, and proposes a series of research questions aimed at closing these gaps. We focus our review on research pertaining to how environmental factors and IAF-specific factors influence initial EAs' reliance decisions, the nature and extent of EAs' reliance on IAF, and the observable outcomes as a result of EAs' reliance decisions. Our review finds that the environment in which EAs must make a reliance decision is complex—involving several factors that must be considered simultaneously. Moreover, an evolving set of auditing standards introduces several necessary intermediary judgments that the EAs must process before, and during, reliance on the IAF. In addition, our review indicates that we continue to know very little about how, and to what extent, EAs are currently evaluating IAF's quality factors. Similarly, while we find that the nature and extent of EAs' reliance on IAF is influenced by account risk, inherent risk, and IAF sourcing, how the EAs choose task environments (e.g., revenue recognition versus payroll), and the types of tests to be relied upon within these task environments, is not completely understood. Finally, we find that there is a paucity of research concerning the effects of EAs' reliance on IAF in terms of external audit quality.