By: Stephen Kwamena Aikins
Stephen Kwamena Aikins, Ph.D., is an Assistant Professor, Public
Administration Program, Department of Government and International
Affairs, University of South Florida. His research interests include public
financial management and governmental auditing.
ABSTRACT. This research determines the impact of local government's
internal audit process on the audit client management's adoption of audit
recommendations. Publicity of financial and operational problems in
government in recent years has led to concerns about the quality of
government audits, the extent of public managers' adoption of audit
recommendations, as well as citizen demand for accountability in
government. In spite of this, the importance of the government audit process
in ensuring accountability has gained little attention in public management
research. A survey of local government audit executives was conducted to
determine various aspects of the local government internal audit process
and their relationships with audit client management's adoption of audit
recommendations. Results show that client management's adoption of audit
recommendation is a function of auditor professional designation, due
diligence, client relations, documentation and tracking of audit
recommendations, as well as of follow-up audits to verify implementation of
agreed-upon action plans.
INTRODUCTION
The problem of government's operational and financial control
weaknesses has been plaguing many local governments for decades.
Highly publicized financial problems in large city governments in the
mid 1970s brought wide spread attention to the issue of government
accountability. The attention was fueled by the then General
Accounting Office study (GAO 1986), which revealed that 34 percent
of the 120 audits examined were substandard. This finding raised
concern as to the quality of government audits and the extent of
management's implementation of audit recommendations. Although
subsequent studies show improvement iri the quality of government
audits (Lowensohn & Reck, 2004; General Accounting Office, 1989),
there remain concerns about audit processes and their impact on
public managers' implementation of corrective actions to address the
issues identified. For example, recent allegations of misappropriation
of $12 million of funds in the Roslyn, New York district (Hevesi, 2005)
resulted in the New York State comptroller's requesting a substantial
increase in his audit budget as a proactive approach toward
preventing further misappropriations of school funds.
The financial problems in government in recent years have also
motivated citizens to place intense pressure for accountability on
governments, government-owned entities and their elected officials.
Legislative bodies, on behalf of citizens and other stakeholders, act
as principals that impose standards and procedures on managers of
public organizations that act as their agents. Where principals believe
agents may be acting in their own self-interests, the principals may
require monitoring techniques and more credible audit reports as a
means of justifying their actions (Rainey, 1983) and ensuring
accountability. As noted by Sinason (2000), if the cost of such
monitoring is less than the cost of punitive actions taken by principals
when uncertainty exists regarding the validity of t;he agents'
assertions, then agents will select monitoring as a means of
maximizing their overall compensation.
The worthiness of monitoring, such as an internal audit, to the
principals depends not only on the quality of the audit process but
also on the extent to which client management adopts the audit
recommendations to improve the adequacy and effectiveness of
internal controls over governmental operations. Therefore, the
purpose of this research is to determine, from internal auditors'
perspectives, the impact of the local government audit process on
audit client management's adoption of audit recommendations. For
the purpose of this research, the audit process is broadly defined
here to include dimensions of auditor due professional care (e.g.
performing risk assessment of areas audited), independence (e.g.
auditor reporting to a body outside of area audited), quality contro
l(e.g. supervision and review of staff auditor's work) and client
relations (e.g. reporting audit findings to ciient management before
finai decision), internal controls refer to the measures designed and
implemented by the pubiic sector manager to heip accomplish the
entity's goais and objectives, and to mitigate operational and
financial risks. Audit client management refers to the pubiic
management team whose areas or programs are audited (auditee)
and to whom audit recommendations are issued.
BACKGROUND
Research on auditing in the pubiic sector has little noted the audit
process from the perspective of internal audit. Various scholars have
studied comparative accounting and auditing for local governments
([Giroux, Jones, & Pendlebury, 2002), compliance reporting decisions
in municipal audits (Kidwell 1999), the timeliness of school district
audit (Carslaw, Mason, & Mills, 2007), and the emergence of
performance auditing as the activist auditor (Wheat, 1991). Others
have investigated the determinants of audit quality in the public
sector (Deis & Giroux, 1992), ethical implications of independent
quality auditing (Walters & Dangol, 2006), and the determinants of
perceived audit quality and auditee satisfaction in local government
(Samelson, Lowensohn & Johnson, 2006). These studies on audit
quality have concentrated on the work of external auditing firms,
have used proxies to measure audit quality and have considered
quality to be related to attributes such as firm size (Shockey &Holt,
1983), extent of litigation (Palmrose, 1988), premium fees (Copley,
1991), and investment in firm reputation.
In their research of private sector audit quality, Schroeder,
Solomon and Vickrey (1986) surveyed audit committee chairs and
audit partners to determine their perceptions of audit quality.
Carcello, Hermanson and McGrath (1992) also surveyed Big 6
auditors. Fortune 1000 controllers and sophisticated financial
statement users regarding attributes of audit quality. Both studies
found that factors associated with audit teams have greater influence
on perceived audit quality. Behn, Carcello, Hermanson and
Hermanson (1997) examined the effects of audit quality factors on
auditee (audit client) satisfaction in the private sector. More recently,
Samelson, Lowensohn and Johnson (2006) extended these studies
to the external governmental audit by examining audit attributes that
influence government finance officers' perceived audit quality and
auditee satisfaction.
A common thread that runs through the above-mentioned
studies is that perceived audit quality is significantly influenced by
auditor characteristics such as industry expertise, responsiveness to
client needs, exercise of professional due care, conduct of field work,
exercise of professional skepticism (Carcelio, Hermanson & iVIcGrath,
1992; Sameison, Lowensohn & Johnson, 2006). Additionally, auditor
industry expertise, auditor responsiveness to client needs, audit
manager involvement and conduct of fieldwork do significantly
influence auditee satisfaction (Behn, Carcelio, Hermanson &
Hermanson, 1997; Sameison, Lowensohn & Johnson, 2006).
Although these studies make significant contributions to the literature
on perceived audit quality, none of them focuses on the internal audit
regarding the effect of the audit process on auditee adoption of audit
recommendations.
This research seeks to expand existing knowledge on the
influence of perceived audit quality on auditee satisfaction by
focusing on the government's internal audit process, and by
investigating the determinants of auditee adoption of audit
recommendations from internal auditors' perspective. This research
focus is important because an internal audit provides more insightful
information and recommendations about operational efficiency which
could lead to savings and cost-effectiveness. Additionally, unlike in
the private sector, the multiplicity of stakeholders in government
agencies makes accountability an overriding issue. In fact, in a
governmental setting, while perceptions of audit quality and auditee
satisfaction are important, the translation of satisfaction and
perceptions into auditee implementation of audit recommendations
to improve internal controls is more significant given the need for
public managers to be accountable to stakeholders and the general
public.
Given government internal auditors' expertise in audit
methodology, their insight into the internal control structure of the
areas they audit, and their accumulated experience in dealing with
their audit clients, an investigation of their perception of the audit
process and its relation to audit client management behavior will
help provide insight as to whether the internal auditors' perceived
factors that drive client adoption of recommendations are similar to
the determinants of auditees' perceived quality and satisfaction
found by prior researchers. As concluded by Carcello, Hermanson and
McGrath (1992), factors associated with audit teams have greater
influence on perceived audit quality. In the following sections, I dwell
on the literature on principal-agent relationship and the audit
framework provided by Government Auditing Standards, to establish
a theoretical foundation regarding the importance of audit process
variables pertaining to independence, due professional care, quality
control and client relations in influencing management adoption of
audit recommendations.
THEORETICAL FRAMEWORK
Agency theory postulates that an organization consists of a nexus
of contracts between the owners of economic resources (the
principals) and managers (the agents) who are charged with using
and controlling those resources (Jensen & Meckling, 1976, p. 308).
The theory is based on the premise that agents have more
information than principals and that this information asymmetry
adversely results in moral hazard, and affects the principals' ability to
monitor effectively whether their interests are being properly served
by agents. It also assumes that principals and agents act rationally
and that they will use the contracting process to maximize their
wealth. Managers of public resources are agents who are charged
with using and controlling the public resources, and are accountable
to their principals for the resources provided to carry out government
programs and services. These principals are both the citizens and
other government officials, such as elected officials. This principalagent
relationship may significantly impact decisions of local, elected
public officials to have internal audit departments to help monitor
operations, ensure regulatory compliance and minimize misappropriation
risks.
Public administration theory indicates that indirect benefits and
lack of control over investments compel taxpayers to demand more
accountability for their funding, and also directs auditors to require
additional assurance regarding efficiency of operations, regulatory
and procedural compliance, integrity of financial records, safeguarding
of assets and achievement of programmatic objectives.
From agency- theory perspective, the citizens of a governmental
jurisdiction usually find it more difficult than shareholders of private
organizations to monitor and control t he activities of public managers
effectively because citizens are less cohesive and heterogeneous
owners of resources than shareholders. Therefore, to counter the
possibility of loss of confidence that stems from a loose ownershipcontrol
structure in t he public management process, public managers
may be more inclined to employ internal monitoring mechanism such
as internal auditing and to use t he services of an audit committee or
some other monitoring body (Adams, 1994).
A government audit that objectively evaluates evidence could
help minimize moral hazard by public managers, thereby providing
credibility to t he information reported by or obtained from the agent.
In fact, the work of t he government internal auditors in safeguarding
the interest of t he citizens or legislature is strengthened if t he audit
process is based on adherence to applicable standards. The
Government Auditing Standards (1999) place responsibility on
auditors to ensure that (a) audits are conducted by personnel who
collectively have the necessary skills, (b) independence is
maintained, (c) due diligence is maintained by following applicable
standards in planning, conducting and reporting the audit, (d) the
audit entity has an appropriate internal quality control system in
place, and (e) the audit entity undergoes periodic internal quality
control reviews.
Government internal auditors will better be able to prevent public
managers from taking advantage of the incohesive ownership-control
structure of public organizations if those auditors have the requisite
skills to perform their duties. The skills requirements by the auditing
standards (e.g. Government Auditing Standards, 1999 Section 3.3-
3.6) imply that staff assigned to conduct audits should collectively
possess adequate professional proficiency for the tasks required.
Such proficiency includes knowledge obtained through formal
education, professional certification, continuing professional
education and training as well as experience on the job. The
implication here is that possession of requisite qualifications will
enable auditors to be competent. Bonner and Lewis (1990)
differentiated four types of knowledge as germane to auditing tasks:
general domain knowledge, subspecialty knowledge, world knowledge
and general problem solving ability. Ashton (1991) surveyed auditors
with subspecialty knowledge for error frequency in their industries
and found a strong relationship between subspecialty experience and
accuracy. In a review of audit quality assessments made by the
united States Regional Inspectors General, Aldhizer, Miller and
Morgalio (1995) found that industry specialization was associated
with fewer violations of Generally Accepted Government Auditing
(GAGAS ) reporting standards. O'Keefe, King and Gaver (1994) also
found fewer compliance reporting violations among governmental
specialists in audits of Oalifornia school districts.
Meixner and Welker (1988) conducted an experiment to
investigate Which type of experience led to expertise, as measured by
judgment consensus. The researchers found that total audit
experience did not result in higher consensus. In contrast, a
significant consensus was found to be associated with increased
organizational experience. Knowledge about governmental audits,
coupled with formal education and professional training enables the
audit team to better understand the internal control structure, and
perform quality fieldwork by designing and performing appropriate
audit test, and by providing value-added recommendations, thereby
facilitating acceptance and implementation of those
recommendations. This will then help the agent/public manager
demonstrate to the principal that the public resources are being
judiciously utilized. Therefore, I hypothesize that there is a positive
relationship between governmental audit experience, as well as
auditor qualifications such as professional designation and college
degree, and a public manager's acceptance and implementation of
audit recommendations.
Agency theory predicts that an organization with a loose
ownership-control structure may put in place control mechanisms to
prevent agents from adversely influencing monitoring mechanisms to
suit their self-interests (Adams, 1994). For example, a government
legislature may try to prevent public managers from curtailing the
scope of the internal audit function or rejecting internal auditors'
recommendations by ensuring that the role and responsibilities of the
internal audit are mandated in an audit charter, and that the head of
the internal audit maintains independence by reporting directly to the
legislature or audit committee. Auditor independence also includes
the auditors being organizationally located outside of the staff or the
line management function under audit, and refraining from making
management decisions in the areas they audit (Government Auditing
Standards, 1999). Auditors who are independent in all matters
relating to their audit work are more likely to draw objective
conclusions from audit evidence and have their recommendations
adopted by audit client management. Based on this reasoning, a
positive relationship between governmental auditors' independence
attributes, such as reporting structure, and audit client
management's adoption of audit recommendations can be expected.
Agency theory postulates that there is an information asymmetry
problem in the public bureau which hinders principals from effectively
monitoring the opportunistic behavior of agents. Government internal
auditors can minimize the afore-mentioned problem through the
exercise of due professional care in the audit process. This includes
understanding the risks in the client's operations by interviewing
management and personnel, reviewing policies and procedures,
using sound judgment to select the audit methodology, using the
acquired information to analyze the risks inherent in the client's
operations, and developing risk-based audit programs for audit tests.
Deficiencies found during audit tests are brought to the attention of
the audit client manager to ensure the audit team has been provided
with all relevant facts. At the end of the field work, the audit team
reviews audit findings with the audit client manager prior to issuing
the audit report at the exit conference. The above processes
pertaining to due diligence, if followed, minimize the risk of the audit
client rejecting the audit findings and recommendations. Therefore,
one would expect a positive relationship between auditor risk
assessment for each audit project, client relations activities such as
learning of the client management risk perspective, briefing client
management in the course of the audit, discussing findings with
client management prior to issue of the final report, and audit client
management's adoption of audit recommendations.
Quality audits can potentially aid the public manager in fulfilling
his or her obligation through enhanced accountability and the
safeguard of public assets. Government Auditing Standards require
auditors to have appropriate quality control systems in place, and to
undergo external quality control review. The essence of quality control
is that it helps to solidify the due professional care of auditors
through assurance that appropriate policies and procedures are
followed in minimizing opportunistic behavior. Therefore, an internal
quality control system should provide reasonable assurance that the
audit entity has adopted and is following applicable auditing
Standards, and has established and is following adequate internal
audit policies and procedures.
Internal quality control is implemented by ensuring that there is
supervision of audit work through review of work papers, that auditors
are appropriately trained, and that there is periodic independent
review of completed work papers for compliance with standards,
policies and procedures. External quality control is achieved through
periodic external peer review, and correction of any deficiencies
noted by the external reviewer. Properly implemented and enforced,
an audit quality control system helps to minimize audit errors,
enhance impartial conclusions from audit evidence and ensure
issuance of accurate audit reports, thereby facilitating audit client
management adoption of audit recommendations. Therefore, we
should expect a positive relationship between review of audit staff
work for accuracy, external peer review and the audit client
management's adoption of audit recommendations.
METHODOLOGY
This research is in the form of survey research. A survey was sent
to 387 audit department heads of the Association of Local
Government Auditors (ALGA) and 46% of them returned the survey. It
was conducted in the period June 2008 through October 2008. Audit
department heads were chosen as the unit of analysis because by
virtue of their chosen profession, auditors have responsibility for
exercising due professional care, independence and quality audit
work. Additionally, they are in a better position to provide objective
assessment of the risks inherent in their clients' operations and to
understand client management's motivations to accept and
implement audit recommendations. Among those who participated in
the study, 89% were audit directors and managers and the rest had
other titles. Fifty percent had staffing level of up to 5 auditors, 32%
had from 6 to 10 auditors and 18% had more than 10 auditors. Of
the returned surveys, 75% were from municipalities, 23% from
counties and 2% from other local governments. Jurisdictions of all
sizes were represented, with 50% of the cities having population of
less than 100,000 and 80% of the counties having population of
more than 500,000. The survey questionnaires were designed to
measure variables in each of the following broadly defined audit
process categories: auditor qualifications, independence, exercise of
due professionai care, quality control and audit client relations; as
well as the relationships of those variables with audit client
management adoption of audit recommendations. The survey
consisted of several sections which measured several variables in
each of the audit process categories. Table 1 provides a summary of
the variables.
The variable name column shows the variables measured in each
category and the operational definition column contains statements
regarding how each variable was operationalized. For example.
Educational Background was operationalized by the percentage of
audit staff with college degrees. This variable was measured by
asking respondents to select from a list of ranges, the percentage of
their audit staff that possess college degrees. Professional
Designation was measured by asking respondents to choose from a
list of certifications that their auditors possess, and Audit Experience
was measured by asking respondents to select the range of years of
government auditing experience that best matches their audit staff's
experience. Frequency distribution was used to analyze the data in
the auditor qualifications category.
In the independence category. Reporting Structure was measured
by asking respondents to select from a list of oversight bodies to
whom their audit departments report. Consulting Services and auditor
involvement in client management's decisions were measured by
asking respondents to indicate on a seven point scale their
agreement or disagreement with the statements that auditors provide
consulting services to the areas they audit; and auditors make
management decisions in the areas they audit. Frequency distribution
was used to analyze the data in the independence category.
The variables in the due professional care category were
measured by asking respondents to indicate their agreement or
disagreement on a seven-point scale to the operational definition
statements for each variable. The variables in quality control
categories were measured using the same measurement scale and
criteria. Descriptive statistics showing the mean scores were used to
analyze the professional due care and quality control data. In the
audit client relations category. Client Risk Perspective, Audit Olient
Briefings, and Olient Review of Draft Report were measured on a
seven point scale by asking respondents to state their agreements
and disagreements to the operational definition statements
respectively. These variables also reflect the exercise of professional
due care. Descriptive statistics showing the mean scores were used
to analyze the client relations data.
The variables in the mandate category were added as control
variables. They were measured on a seven point scale by asking
respondents to indicate their agreements and disagreements with the
operational definition statements for each variable. Details about the
control variables are provided in data analysis in the audit findings
section. The dependent variable of interest - Audit Olient
Management's Adoption of Audit Recommendations - was
operationalized by management's buy-in for all audit
recommendations, client management documentation of action plans
for all audit findings, and also implementation of the action plans
within deadlines. The variable was measured on a seven-point scale
by asking respondents to indicate their agreement and disagreement
to the operational definition statements. Linear regression was used
to analyze the relationship between the dependent variable and the
independent variables shown in Table 1. The model coefficients,
showing the proportion of the dependent variable explained by each
independent variable, were discerned from the regression results.
RESEARCH FINDINGS
Reliability analysis was performed to determine the extent to
which the variables measured were free from error and therefore
yield internal consistency. Nunnally (1978) and Churchill (1979)
suggest that constructs with a coefficient alpha equal to or greater
than 0.70 have adequate internal consistency. The Cronbach
coefficient for all the variables measured had an alpha coefficient
above 0.768.
Auditor Qualifications
Table 2 shows the percentage of respondents who indicated the
percentage ranges of their audit staff with college degrees. The key
information from this table is that almost all respondents said their
staff members have college degrees. Indeed, 88% of respondents
indicated between 81% and 100% of their staff have college degrees,
and therefore possess basic qualifications for audit work.
The key finding shown in Table 3 is that 97% of respondents
indicated their audit staff members have professional designations,
with 71% saying their staff members have two or more professional
designations. The possession of professional designation in
accountancy and/or auditing demonstrates one's preparedness in
terms of the knowledge, training and skills needed for audit work.
Other analysis performed revealed that on average, the survey
respondents' auditors have 10 to 15 years of audit experience in a
governmental setting. Together with audit experience, professional
designation could enable an auditor to command respect in the eyes
of the audit client, and could facilitate discussions with the client
during the audit process.
Auditor Independence
The reporting structure shown in Table 4 details the oversight
bodies to whom respondents' audit departments report. An important
finding indicated by the table is that almost all the oversight bodies to
whom the respondents' department report are either heads of
governmental entities or the legislature.
According to Table 4, 28% of respondents said their departments
report to the audit committee, 28% report to the city council, 15% to
The county commission and 16% to the city manager/chief
administrative officer. Together, these represent 87% of the audit
departments out of the 178 whose executives responded to the
survey.
The findings mean an overwhelming majority of the audit
departments comply with the independent reporting structure
required by the auditing standards. Additional analysis also revealed
that while the audit executives who responded to the survey
Soniewhat Agreed that their departments provide consulting services
to their audit clients (mean score - 4.66 out of a possible highest
score of 7), they also strongly disagreed that that their auditors make
management decisions in the areas they audit (mean score = 1.81),
suggesting minimal conflict of interest from auditors' perspective.
Due Professional Care and Quality Control
Table 5 details the mean scores of respondents' degree of
agreements to the statements pertaining to due professional care
and quality control on a 7 point scale. For due professional care, the
table shows the survey respondents Strongly Agree that their auditors
perform risk assessments of all areas audited (means score = 6.03)
and consider operational risk in audit program development (mean
score = 6.15). The exercise of audit due diligence is partly dependent
on the quality of audit performed and external peer quality reviews.
Table 5 shows that respondents strongly agree that their staff
auditors' work is reviewed for accuracy and compliance with audit
procedural requirements and applicable standards (mean score =
6.19). Another research finding not indicated in Table 5 revealed that
43% of respondents' audit departments have gone through external
peer quality review within the last five years as of the date of the
survey. Given these results, it can be argued that in general, the local
government auditors who responded to the survey believe the degree
of professional due care and quality control exercised by local
government auditors is strong. However, the findings also suggest
that the auditors are not too keen on maintaining an issue tracker to
enable them to document control weaknesses identified in their
audits (mean score = 4.92) and to follow-up on recommendations.
Furthermore, while they perform follow-up audits to ensure audit
recommendations are being implemented (mean score = 5.83), they
seem indifferent regarding the timeliness of follow-up audits (mean
score = 4.81).
Client Reiations
Table 5 shows the auditors learn of audit client managers' risk
perspectives prior to audit (mean score = 6.17); the auditors
communicate findings to audit clients prior to final decision (mean
score = 6.36); and have their audit client management review draft
reports prior to finalization (mean score - 6.65). These results
suggest that in general, the auditors follow prudent methodology to
understand the clients' operations and the risks inherent in those
operations to determine the appropriate types of audit tests to be
performed. Additionally they ensure the validity of the audit evidence
gathered through communication with client management, thereby
minimizing potential disagreements. However, Table 5 also shows
that despite the auditors' efforts and the apparent good working
relations described above, the degree of enthusiasm with which audit
client management adopts audit recommendations is low. While the
audit executives Agree that their auditors enjoy client management's
buy-in for all audit recommendations issued (mean score = 5.94),
they only Somewhat Agree that their audit clients provide
documented action plans to address audit control weaknesses
communicated in their audit reports (mean score = 5.48), and are
basically Neutral, implying they neither agree nor disagree, as to
whether their audit client management implements ail action plans
within agreed-upon deadlines (mean score = 4.53).
Audit Process and Ciient Management's Adoption of Recommendations
Based on the above findings, the question that comes to mind is
what dimensions of the audit process influence client management's
adoption of audit recommendations issued by the local government's
internal auditors? In order to answer this question, it was appropriate,
to determine through regression analysis, whether there is a
statistically significant relationship between the dependent variable
of interest - Client Management's Adoption of Audit
Recommendations - and the dimensions of due professional care,
independence, quality control and client relations. Given the
possibility of a codified span of the internal audit's authority, audit's
roles and responsibilities, and audit charter to influence the audit
client management's adoption of audit recommendations (Adams
1994), and thus confound the results, these variables (Mandated
Audit Charter, Audit Roles Passed Into Law, Span of Audit Authority)
were included as exogenous, extraneous variables.
Another issue that potentially could explain client management's
implementation of audit recommendations is auditor qualifications.
For example, as noted by Aldhizer, Miller and Morgalio (1995), the
auditors' knowledge of government operations enhances compliance
with GAGAS reporting standards. For this reason, the dimensions of
auditor qualifications were also included as independent extraneous
variables. Kerlinger (1986) noted that a potential extraneous variable
can be controlled by including it as another attribute, an observed
variable, in the study. By considering the extraneous variables in
their own right, I was able to determine how they interact with the
independent variables of interest and the extent to which they
influence Client Management's Adoption of Audit Recommendations,
either individually or in combination with the independent variables of
interest.
Table 6 and Table 7 show the overall significance of the model.
As illustrated in Table 6, the probability of F statistic (P>F) is 0.000
and the R Square is 0.632. This implies that there is a statistically
significant relationship between Client Management's Adoption of
Audit Recommendations and the overall linear combination of the
eighteen independent variables. A closer review of Table 7 reveals
that Client Management's Adoption of Audit Recommendation is a
function of variables such as Professional Designations (P = 0.041),
Project Risk assessment (P = 0.006), Client Risk Perspective (P =
0.011), Issue Tracker (P = 0.001), and Follow-Up Audits (P = 0.031).
These findings support the hypothesis that there is a positive
relationship between the dependent variable and the five
independent variables - auditor professional designations, auditor
assessment of inherent risk in client operations for the areas audited,
auditor understanding and consideration of client management's risk
perspective in the audit process, the maintenance of issue tracker for
documenting audit findings and tracking resolution of
recommendations, and follow-up audits to ensure the control
weaknesses identified have been addressed. Thus the R Square
value of 0.632 indicates that 63% of the variation in client
management adoption of audit recommendations is affected by these
five variables.
DISCUSSION
The research findings reveal that in general, local government
auditors whose executives responded to the survey possess the
necessary skills and knowledge required for their work. An important
finding is that although there are associations between client
management adoption of audit recommendations and audit
experience, college degree, as well as professional designation, only
the association with professional designation translates into a
statistically significant relationship (P = 0.041). This implies that
although audit experience and college degree are important in
facilitating audit client agreement with auditors on recommendations,
client management's adoption of the recommendations is not as
severely constrained or enhanced by audit experience and a college
degree as it is by the possession of professional certification. The
above findings seem to confirm the work of Bonner and Lewis (1990)
that in addition to general domain knowledge, subspecialty
knowledge is germane to audit work. This is because as the research
result implies, total government auditing experience does not
necessarily equate the knowledge gained from auditing specific
operations of government such as accounting or budgeting. The
results also imply that agent/public managers whose areas are
audited appear comfortable accepting and implementing
recommendations to fulfill obligations to their principals if those
recommendations are issued by auditors who are known to have
successfully completed professional training. Perhaps, this is the
case because the agent/public managers are better able to convince
their principals about the value of recommendations to be
implemented in safeguarding public resources if those recommenddations
have the fingerprints of credible and professionally trained
auditors.
The research results also reveal client management's adoption of
audit recommendations is strongly influenced by professional due
diligence such as the auditor's assessment of risks inherent in the
client' operations to determine the areas of appropriate audit tests (p
= 0.006 for Project Risk Assessment), as well as the client relations
activity such as learning and taking into account the client
management's perception of risks in their operations (p = 0.011 for
Client Risk Perspective). These results are not surprising, as the audit
client manager and his or her team who are involved in the daily
operations of the area have more insights of those operations.
Additionally, no meaningful audit could be performed without an
understanding of the area to be audited, and without working with
those manning the operations. These findings also appear consistent
With the results of prior studies (Carcello, Hermanson & McGrath,
1992; Samelson, Lowensohn & Johnson, 2006) that perceived audit
quality is significantly influenced by auditor characteristics such as
due professional care, and responsiveness to client needs. Thus,
government's internal auditors' perceived factors that drive client
adoption of recommendations appear the same as the two
determinants of auditee's perceived quality found by prior research
on external audits. In exercising due professional care through
understanding of the risks inherent in the agent/public manager's
operations, government auditors play a key role in the principal-agent
relationship by not only monitoring opportunistic behavior of the
agent, but also by minimizing information asymmetry between the
two parties through the issuance of reports to the principals.
According to the research results, government auditors'
documentation and tracking of audit findings and recommendations,
as well as follow-up audits performed to ensure agreed-upon action
plans are implemented, are significantly related to client
management's adoption of audit recommendations (p = 0.001 for
Issue Tracker; and p = 0.031 for Follow-Up Audits). The findings
support and extend the arguments of Adams (1994) regarding the
internal audit as a monitoring mechanism in relation to principalagency
theory. As argued by Adams, the heterogeneous ownership of
government resources and information asymmetry make control of
the agent/manager's activities difficult. Therefore, a monitoring
mechanism like an internal audit helps to counter loss of confidence
in the public management process. The research findings suggest the
significance of the internal audit monitoring role lies in the fact that
agent/public managers are more inclined to implement audit
recommendations to address weaknesses identified in the course of
the audit, and enhance public accountability, as long as government
auditors document, track and follow-up to verify management's
actions on those recommendations.
The research findings also reveal that local government auditors
generally maintain independent reporting structure and exercise
quality control over their audit work. These findings are also
consistent with the arguments by Adams (1994) in that although they
do not significantly influence client management's decision to adopt
audit recommendations, they do help minimize the possibility of the
agent/public manager's influence on the internal audit monitoring
activities for individual self-interest.
This study did not include the audit client management's
perception of governmental internal audit quality, as well as the
relationship between the nature of recommendations and audit client
management adoption of audit recommendations. Additionally, it
does not include the influence of the size of the audit function and
audit budget on the quality of the audit performed and the degree of
due diligence maintained in the audit process. Furthermore, the
effect of audit frequency on client management's adoption of audit
recommendations was not included in this study. Further study is
required to determine whether audit size and audit budget impact the
governmental internal audit's quality and due diligence, and whether
audit frequency impacts client management's acceptance and
implementation of audit recommendations. Additionally, a future
review of auditee perception of the quality of government's internal
audit process, as well as the relationship between the nature of
recommendations and client management adoption of
recommendations will be appropriate.
CONCLUSION
Overall, the findings from this research suggest that many of the
government's internal auditors' perceived factors that drive client
adoption of recommendations are the same as the determinants of
auditee perceived quality found by prior research on external audits.
Additionally, the findings suggest that in general, when government
internal auditors take the time to understand the risks in the areas
they audit, use the knowledge of the risk as a guide in their audit
tests, and also communicate with client management to obtain their
perspectives on operational risks, the latter tends to appreciate such
gestures and respond favorably to audit recommendations.
Furthermore, to help fulfill their agency obligations and be
accountable to their principals, audit public managers tend generally
to act on recommendations issued by auditors known to have
recognized professional qualifications, as well as those
recommendations documented, tracked and followed-up by auditors.
The findings from this research have theoretical and practical
implications for public management. From a theoretical perspective,
the findings suggest that through documentation and monitoring of
control weaknesses and related recommendations, and reporting of
audit findings to oversight bodies, government internal auditors could
play a key role in the principal-agent relationship by minimizing
information asymmetry and moral hazard, thereby helping public
managers to fulfill their obligations to citizens and elected officials.
From a practical perspective, client management adoption of audit
recommendations as a result of auditors' tracking and monitoring
those recommendations will help to enhance public accountability in
the public management process. Therefore, local government's
internal auditors should improve the documentation, monitoring and
follow-up of client resolution of audit findings and recommendations
in order to strengthen public accountability.
REFERENCES
Adams, M. B. (1994). "Agency Theory and the Internal Audit."
Managerial Auditing Journal, 9(8): 8-12.
Aldhizer, G. R., Miller, J. R., & Moraglio, J. F. (1995). "Common
Attributes of Quality Audits." Journal of Accountancy, 17(1): 61-
68.
Ashton, A. H. (1991). "Experience and Error Frequency Knowledge as
Potential Determinants of Audit Expertise." The Accounting
Review, 66: 218-239.
Behn, B. K., Carcello, J. V., Hermanson, D. R., & Hermanson, R. H.
(1997). "The Determinants of Audit Client Satisfaction among
Clients of Big 6 Firms." Accounting Horizons, 11(1): 7-24.
Bonner, S. E., & Lewis, B. L. (1990). Determinants of auditor
expertise. Journai of Accounting Research, 28 (Supplement): 1-
20.
Carcello, J. V., Hermanson, R. H., & McGrath, N. T. (1992). "Audit
Quality Attributes: The Perceptions of Audit Partners, Preparers
and Financial Statement Users." Auditing: A Journai of Practice
and Theory, 11(1): 1-15.
Carslaw, C, Mason, R., & Mills, J. R. (2007). "Audit Timeliness of
School District Audits." Journai of Pubiic Budgeting, Accounting
and Financial iVIanagement, 19(3): 290-316.
Churchill, N.C. (1979). Computer-Based Information Systems for
Management. Englewood Cliffs, NJ: Prentice Hall.
Copley, P. A. (1991). "The Association between Municipal Disclosure
Practices and Audit Quality." Journal of Accounting and Public
Policy, 10: 245-266.
Deis, D. R., & Giroux, G. A. (1992). "Determinants of Audit Quality in
the Public Sector." The Accounting Review, 67(3): 462-479.
Giroux, G., Jones, R., & Pendlebury, M. (2002). "Accounting and
Auditing for Local Governments in the U.S. and the U.K." Journal
of Budgeting, Accounting and Financial Management, 14(1): 1-
26.
Government Auditing Standards (1999). Government Accounting
Standrads. [Online]. Available at www.google.com/
search?q=Government+Auditing+Standards&btnG=Search&hl=e
n&rlz=lT4ADBR_enUS268US270&sa=2. (Retrieved, April 3,
2010).
Hevesi, A. (2005). Roslyn Union Free School District Anatomy of a
Scandal: Report of Examination. [Online]. Available at
www.osc.state.ny.us/localgov/audits/2005/schools/roslyn2.htm.
(Retrieved March 17, 2009).
Jensen, M. C, & Meckling, W. H. (1976). "Theory of the Firm;
Management Behavior, Agency Costs and Ownership Structure."
Journal of Financial Economics, 3(3): 305-360.
Kerlinger, F. N. (1986). Foundations of Behavioral Research (3rd ed.).
New York: CBS.
Kidwell, L A. (1999). "Compliance Reporting Decisions in Municipal
Audits: The Impact of Budget Variance and Employment Sector."
Journal of Public Budgeting, Accounting and Financial
Management, 11(3): 325-356.
Lowensohn, S., & Reck, J. (2004). "Longitudinal Analysis of Local
Government Audit Quality." Research in Governmental and
Nonprofit Accounting, 11: 213-228.
Meixner, W., & Welker, R. (1988). Judgment Consensus and Auditor
Experience: An Examination of Organizational Relations." The
Accounting Review, 63: 505-513.
Stephen Kwamena Aikins, Ph.D., is an Assistant Professor, Public
Administration Program, Department of Government and International
Affairs, University of South Florida. His research interests include public
financial management and governmental auditing.
ABSTRACT. This research determines the impact of local government's
internal audit process on the audit client management's adoption of audit
recommendations. Publicity of financial and operational problems in
government in recent years has led to concerns about the quality of
government audits, the extent of public managers' adoption of audit
recommendations, as well as citizen demand for accountability in
government. In spite of this, the importance of the government audit process
in ensuring accountability has gained little attention in public management
research. A survey of local government audit executives was conducted to
determine various aspects of the local government internal audit process
and their relationships with audit client management's adoption of audit
recommendations. Results show that client management's adoption of audit
recommendation is a function of auditor professional designation, due
diligence, client relations, documentation and tracking of audit
recommendations, as well as of follow-up audits to verify implementation of
agreed-upon action plans.
INTRODUCTION
The problem of government's operational and financial control
weaknesses has been plaguing many local governments for decades.
Highly publicized financial problems in large city governments in the
mid 1970s brought wide spread attention to the issue of government
accountability. The attention was fueled by the then General
Accounting Office study (GAO 1986), which revealed that 34 percent
of the 120 audits examined were substandard. This finding raised
concern as to the quality of government audits and the extent of
management's implementation of audit recommendations. Although
subsequent studies show improvement iri the quality of government
audits (Lowensohn & Reck, 2004; General Accounting Office, 1989),
there remain concerns about audit processes and their impact on
public managers' implementation of corrective actions to address the
issues identified. For example, recent allegations of misappropriation
of $12 million of funds in the Roslyn, New York district (Hevesi, 2005)
resulted in the New York State comptroller's requesting a substantial
increase in his audit budget as a proactive approach toward
preventing further misappropriations of school funds.
The financial problems in government in recent years have also
motivated citizens to place intense pressure for accountability on
governments, government-owned entities and their elected officials.
Legislative bodies, on behalf of citizens and other stakeholders, act
as principals that impose standards and procedures on managers of
public organizations that act as their agents. Where principals believe
agents may be acting in their own self-interests, the principals may
require monitoring techniques and more credible audit reports as a
means of justifying their actions (Rainey, 1983) and ensuring
accountability. As noted by Sinason (2000), if the cost of such
monitoring is less than the cost of punitive actions taken by principals
when uncertainty exists regarding the validity of t;he agents'
assertions, then agents will select monitoring as a means of
maximizing their overall compensation.
The worthiness of monitoring, such as an internal audit, to the
principals depends not only on the quality of the audit process but
also on the extent to which client management adopts the audit
recommendations to improve the adequacy and effectiveness of
internal controls over governmental operations. Therefore, the
purpose of this research is to determine, from internal auditors'
perspectives, the impact of the local government audit process on
audit client management's adoption of audit recommendations. For
the purpose of this research, the audit process is broadly defined
here to include dimensions of auditor due professional care (e.g.
performing risk assessment of areas audited), independence (e.g.
auditor reporting to a body outside of area audited), quality contro
l(e.g. supervision and review of staff auditor's work) and client
relations (e.g. reporting audit findings to ciient management before
finai decision), internal controls refer to the measures designed and
implemented by the pubiic sector manager to heip accomplish the
entity's goais and objectives, and to mitigate operational and
financial risks. Audit client management refers to the pubiic
management team whose areas or programs are audited (auditee)
and to whom audit recommendations are issued.
BACKGROUND
Research on auditing in the pubiic sector has little noted the audit
process from the perspective of internal audit. Various scholars have
studied comparative accounting and auditing for local governments
([Giroux, Jones, & Pendlebury, 2002), compliance reporting decisions
in municipal audits (Kidwell 1999), the timeliness of school district
audit (Carslaw, Mason, & Mills, 2007), and the emergence of
performance auditing as the activist auditor (Wheat, 1991). Others
have investigated the determinants of audit quality in the public
sector (Deis & Giroux, 1992), ethical implications of independent
quality auditing (Walters & Dangol, 2006), and the determinants of
perceived audit quality and auditee satisfaction in local government
(Samelson, Lowensohn & Johnson, 2006). These studies on audit
quality have concentrated on the work of external auditing firms,
have used proxies to measure audit quality and have considered
quality to be related to attributes such as firm size (Shockey &Holt,
1983), extent of litigation (Palmrose, 1988), premium fees (Copley,
1991), and investment in firm reputation.
In their research of private sector audit quality, Schroeder,
Solomon and Vickrey (1986) surveyed audit committee chairs and
audit partners to determine their perceptions of audit quality.
Carcello, Hermanson and McGrath (1992) also surveyed Big 6
auditors. Fortune 1000 controllers and sophisticated financial
statement users regarding attributes of audit quality. Both studies
found that factors associated with audit teams have greater influence
on perceived audit quality. Behn, Carcello, Hermanson and
Hermanson (1997) examined the effects of audit quality factors on
auditee (audit client) satisfaction in the private sector. More recently,
Samelson, Lowensohn and Johnson (2006) extended these studies
to the external governmental audit by examining audit attributes that
influence government finance officers' perceived audit quality and
auditee satisfaction.
A common thread that runs through the above-mentioned
studies is that perceived audit quality is significantly influenced by
auditor characteristics such as industry expertise, responsiveness to
client needs, exercise of professional due care, conduct of field work,
exercise of professional skepticism (Carcelio, Hermanson & iVIcGrath,
1992; Sameison, Lowensohn & Johnson, 2006). Additionally, auditor
industry expertise, auditor responsiveness to client needs, audit
manager involvement and conduct of fieldwork do significantly
influence auditee satisfaction (Behn, Carcelio, Hermanson &
Hermanson, 1997; Sameison, Lowensohn & Johnson, 2006).
Although these studies make significant contributions to the literature
on perceived audit quality, none of them focuses on the internal audit
regarding the effect of the audit process on auditee adoption of audit
recommendations.
This research seeks to expand existing knowledge on the
influence of perceived audit quality on auditee satisfaction by
focusing on the government's internal audit process, and by
investigating the determinants of auditee adoption of audit
recommendations from internal auditors' perspective. This research
focus is important because an internal audit provides more insightful
information and recommendations about operational efficiency which
could lead to savings and cost-effectiveness. Additionally, unlike in
the private sector, the multiplicity of stakeholders in government
agencies makes accountability an overriding issue. In fact, in a
governmental setting, while perceptions of audit quality and auditee
satisfaction are important, the translation of satisfaction and
perceptions into auditee implementation of audit recommendations
to improve internal controls is more significant given the need for
public managers to be accountable to stakeholders and the general
public.
Given government internal auditors' expertise in audit
methodology, their insight into the internal control structure of the
areas they audit, and their accumulated experience in dealing with
their audit clients, an investigation of their perception of the audit
process and its relation to audit client management behavior will
help provide insight as to whether the internal auditors' perceived
factors that drive client adoption of recommendations are similar to
the determinants of auditees' perceived quality and satisfaction
found by prior researchers. As concluded by Carcello, Hermanson and
McGrath (1992), factors associated with audit teams have greater
influence on perceived audit quality. In the following sections, I dwell
on the literature on principal-agent relationship and the audit
framework provided by Government Auditing Standards, to establish
a theoretical foundation regarding the importance of audit process
variables pertaining to independence, due professional care, quality
control and client relations in influencing management adoption of
audit recommendations.
THEORETICAL FRAMEWORK
Agency theory postulates that an organization consists of a nexus
of contracts between the owners of economic resources (the
principals) and managers (the agents) who are charged with using
and controlling those resources (Jensen & Meckling, 1976, p. 308).
The theory is based on the premise that agents have more
information than principals and that this information asymmetry
adversely results in moral hazard, and affects the principals' ability to
monitor effectively whether their interests are being properly served
by agents. It also assumes that principals and agents act rationally
and that they will use the contracting process to maximize their
wealth. Managers of public resources are agents who are charged
with using and controlling the public resources, and are accountable
to their principals for the resources provided to carry out government
programs and services. These principals are both the citizens and
other government officials, such as elected officials. This principalagent
relationship may significantly impact decisions of local, elected
public officials to have internal audit departments to help monitor
operations, ensure regulatory compliance and minimize misappropriation
risks.
Public administration theory indicates that indirect benefits and
lack of control over investments compel taxpayers to demand more
accountability for their funding, and also directs auditors to require
additional assurance regarding efficiency of operations, regulatory
and procedural compliance, integrity of financial records, safeguarding
of assets and achievement of programmatic objectives.
From agency- theory perspective, the citizens of a governmental
jurisdiction usually find it more difficult than shareholders of private
organizations to monitor and control t he activities of public managers
effectively because citizens are less cohesive and heterogeneous
owners of resources than shareholders. Therefore, to counter the
possibility of loss of confidence that stems from a loose ownershipcontrol
structure in t he public management process, public managers
may be more inclined to employ internal monitoring mechanism such
as internal auditing and to use t he services of an audit committee or
some other monitoring body (Adams, 1994).
A government audit that objectively evaluates evidence could
help minimize moral hazard by public managers, thereby providing
credibility to t he information reported by or obtained from the agent.
In fact, the work of t he government internal auditors in safeguarding
the interest of t he citizens or legislature is strengthened if t he audit
process is based on adherence to applicable standards. The
Government Auditing Standards (1999) place responsibility on
auditors to ensure that (a) audits are conducted by personnel who
collectively have the necessary skills, (b) independence is
maintained, (c) due diligence is maintained by following applicable
standards in planning, conducting and reporting the audit, (d) the
audit entity has an appropriate internal quality control system in
place, and (e) the audit entity undergoes periodic internal quality
control reviews.
Government internal auditors will better be able to prevent public
managers from taking advantage of the incohesive ownership-control
structure of public organizations if those auditors have the requisite
skills to perform their duties. The skills requirements by the auditing
standards (e.g. Government Auditing Standards, 1999 Section 3.3-
3.6) imply that staff assigned to conduct audits should collectively
possess adequate professional proficiency for the tasks required.
Such proficiency includes knowledge obtained through formal
education, professional certification, continuing professional
education and training as well as experience on the job. The
implication here is that possession of requisite qualifications will
enable auditors to be competent. Bonner and Lewis (1990)
differentiated four types of knowledge as germane to auditing tasks:
general domain knowledge, subspecialty knowledge, world knowledge
and general problem solving ability. Ashton (1991) surveyed auditors
with subspecialty knowledge for error frequency in their industries
and found a strong relationship between subspecialty experience and
accuracy. In a review of audit quality assessments made by the
united States Regional Inspectors General, Aldhizer, Miller and
Morgalio (1995) found that industry specialization was associated
with fewer violations of Generally Accepted Government Auditing
(GAGAS ) reporting standards. O'Keefe, King and Gaver (1994) also
found fewer compliance reporting violations among governmental
specialists in audits of Oalifornia school districts.
Meixner and Welker (1988) conducted an experiment to
investigate Which type of experience led to expertise, as measured by
judgment consensus. The researchers found that total audit
experience did not result in higher consensus. In contrast, a
significant consensus was found to be associated with increased
organizational experience. Knowledge about governmental audits,
coupled with formal education and professional training enables the
audit team to better understand the internal control structure, and
perform quality fieldwork by designing and performing appropriate
audit test, and by providing value-added recommendations, thereby
facilitating acceptance and implementation of those
recommendations. This will then help the agent/public manager
demonstrate to the principal that the public resources are being
judiciously utilized. Therefore, I hypothesize that there is a positive
relationship between governmental audit experience, as well as
auditor qualifications such as professional designation and college
degree, and a public manager's acceptance and implementation of
audit recommendations.
Agency theory predicts that an organization with a loose
ownership-control structure may put in place control mechanisms to
prevent agents from adversely influencing monitoring mechanisms to
suit their self-interests (Adams, 1994). For example, a government
legislature may try to prevent public managers from curtailing the
scope of the internal audit function or rejecting internal auditors'
recommendations by ensuring that the role and responsibilities of the
internal audit are mandated in an audit charter, and that the head of
the internal audit maintains independence by reporting directly to the
legislature or audit committee. Auditor independence also includes
the auditors being organizationally located outside of the staff or the
line management function under audit, and refraining from making
management decisions in the areas they audit (Government Auditing
Standards, 1999). Auditors who are independent in all matters
relating to their audit work are more likely to draw objective
conclusions from audit evidence and have their recommendations
adopted by audit client management. Based on this reasoning, a
positive relationship between governmental auditors' independence
attributes, such as reporting structure, and audit client
management's adoption of audit recommendations can be expected.
Agency theory postulates that there is an information asymmetry
problem in the public bureau which hinders principals from effectively
monitoring the opportunistic behavior of agents. Government internal
auditors can minimize the afore-mentioned problem through the
exercise of due professional care in the audit process. This includes
understanding the risks in the client's operations by interviewing
management and personnel, reviewing policies and procedures,
using sound judgment to select the audit methodology, using the
acquired information to analyze the risks inherent in the client's
operations, and developing risk-based audit programs for audit tests.
Deficiencies found during audit tests are brought to the attention of
the audit client manager to ensure the audit team has been provided
with all relevant facts. At the end of the field work, the audit team
reviews audit findings with the audit client manager prior to issuing
the audit report at the exit conference. The above processes
pertaining to due diligence, if followed, minimize the risk of the audit
client rejecting the audit findings and recommendations. Therefore,
one would expect a positive relationship between auditor risk
assessment for each audit project, client relations activities such as
learning of the client management risk perspective, briefing client
management in the course of the audit, discussing findings with
client management prior to issue of the final report, and audit client
management's adoption of audit recommendations.
Quality audits can potentially aid the public manager in fulfilling
his or her obligation through enhanced accountability and the
safeguard of public assets. Government Auditing Standards require
auditors to have appropriate quality control systems in place, and to
undergo external quality control review. The essence of quality control
is that it helps to solidify the due professional care of auditors
through assurance that appropriate policies and procedures are
followed in minimizing opportunistic behavior. Therefore, an internal
quality control system should provide reasonable assurance that the
audit entity has adopted and is following applicable auditing
Standards, and has established and is following adequate internal
audit policies and procedures.
Internal quality control is implemented by ensuring that there is
supervision of audit work through review of work papers, that auditors
are appropriately trained, and that there is periodic independent
review of completed work papers for compliance with standards,
policies and procedures. External quality control is achieved through
periodic external peer review, and correction of any deficiencies
noted by the external reviewer. Properly implemented and enforced,
an audit quality control system helps to minimize audit errors,
enhance impartial conclusions from audit evidence and ensure
issuance of accurate audit reports, thereby facilitating audit client
management adoption of audit recommendations. Therefore, we
should expect a positive relationship between review of audit staff
work for accuracy, external peer review and the audit client
management's adoption of audit recommendations.
METHODOLOGY
This research is in the form of survey research. A survey was sent
to 387 audit department heads of the Association of Local
Government Auditors (ALGA) and 46% of them returned the survey. It
was conducted in the period June 2008 through October 2008. Audit
department heads were chosen as the unit of analysis because by
virtue of their chosen profession, auditors have responsibility for
exercising due professional care, independence and quality audit
work. Additionally, they are in a better position to provide objective
assessment of the risks inherent in their clients' operations and to
understand client management's motivations to accept and
implement audit recommendations. Among those who participated in
the study, 89% were audit directors and managers and the rest had
other titles. Fifty percent had staffing level of up to 5 auditors, 32%
had from 6 to 10 auditors and 18% had more than 10 auditors. Of
the returned surveys, 75% were from municipalities, 23% from
counties and 2% from other local governments. Jurisdictions of all
sizes were represented, with 50% of the cities having population of
less than 100,000 and 80% of the counties having population of
more than 500,000. The survey questionnaires were designed to
measure variables in each of the following broadly defined audit
process categories: auditor qualifications, independence, exercise of
due professionai care, quality control and audit client relations; as
well as the relationships of those variables with audit client
management adoption of audit recommendations. The survey
consisted of several sections which measured several variables in
each of the audit process categories. Table 1 provides a summary of
the variables.
The variable name column shows the variables measured in each
category and the operational definition column contains statements
regarding how each variable was operationalized. For example.
Educational Background was operationalized by the percentage of
audit staff with college degrees. This variable was measured by
asking respondents to select from a list of ranges, the percentage of
their audit staff that possess college degrees. Professional
Designation was measured by asking respondents to choose from a
list of certifications that their auditors possess, and Audit Experience
was measured by asking respondents to select the range of years of
government auditing experience that best matches their audit staff's
experience. Frequency distribution was used to analyze the data in
the auditor qualifications category.
In the independence category. Reporting Structure was measured
by asking respondents to select from a list of oversight bodies to
whom their audit departments report. Consulting Services and auditor
involvement in client management's decisions were measured by
asking respondents to indicate on a seven point scale their
agreement or disagreement with the statements that auditors provide
consulting services to the areas they audit; and auditors make
management decisions in the areas they audit. Frequency distribution
was used to analyze the data in the independence category.
The variables in the due professional care category were
measured by asking respondents to indicate their agreement or
disagreement on a seven-point scale to the operational definition
statements for each variable. The variables in quality control
categories were measured using the same measurement scale and
criteria. Descriptive statistics showing the mean scores were used to
analyze the professional due care and quality control data. In the
audit client relations category. Client Risk Perspective, Audit Olient
Briefings, and Olient Review of Draft Report were measured on a
seven point scale by asking respondents to state their agreements
and disagreements to the operational definition statements
respectively. These variables also reflect the exercise of professional
due care. Descriptive statistics showing the mean scores were used
to analyze the client relations data.
The variables in the mandate category were added as control
variables. They were measured on a seven point scale by asking
respondents to indicate their agreements and disagreements with the
operational definition statements for each variable. Details about the
control variables are provided in data analysis in the audit findings
section. The dependent variable of interest - Audit Olient
Management's Adoption of Audit Recommendations - was
operationalized by management's buy-in for all audit
recommendations, client management documentation of action plans
for all audit findings, and also implementation of the action plans
within deadlines. The variable was measured on a seven-point scale
by asking respondents to indicate their agreement and disagreement
to the operational definition statements. Linear regression was used
to analyze the relationship between the dependent variable and the
independent variables shown in Table 1. The model coefficients,
showing the proportion of the dependent variable explained by each
independent variable, were discerned from the regression results.
RESEARCH FINDINGS
Reliability analysis was performed to determine the extent to
which the variables measured were free from error and therefore
yield internal consistency. Nunnally (1978) and Churchill (1979)
suggest that constructs with a coefficient alpha equal to or greater
than 0.70 have adequate internal consistency. The Cronbach
coefficient for all the variables measured had an alpha coefficient
above 0.768.
Auditor Qualifications
Table 2 shows the percentage of respondents who indicated the
percentage ranges of their audit staff with college degrees. The key
information from this table is that almost all respondents said their
staff members have college degrees. Indeed, 88% of respondents
indicated between 81% and 100% of their staff have college degrees,
and therefore possess basic qualifications for audit work.
The key finding shown in Table 3 is that 97% of respondents
indicated their audit staff members have professional designations,
with 71% saying their staff members have two or more professional
designations. The possession of professional designation in
accountancy and/or auditing demonstrates one's preparedness in
terms of the knowledge, training and skills needed for audit work.
Other analysis performed revealed that on average, the survey
respondents' auditors have 10 to 15 years of audit experience in a
governmental setting. Together with audit experience, professional
designation could enable an auditor to command respect in the eyes
of the audit client, and could facilitate discussions with the client
during the audit process.
Auditor Independence
The reporting structure shown in Table 4 details the oversight
bodies to whom respondents' audit departments report. An important
finding indicated by the table is that almost all the oversight bodies to
whom the respondents' department report are either heads of
governmental entities or the legislature.
According to Table 4, 28% of respondents said their departments
report to the audit committee, 28% report to the city council, 15% to
The county commission and 16% to the city manager/chief
administrative officer. Together, these represent 87% of the audit
departments out of the 178 whose executives responded to the
survey.
The findings mean an overwhelming majority of the audit
departments comply with the independent reporting structure
required by the auditing standards. Additional analysis also revealed
that while the audit executives who responded to the survey
Soniewhat Agreed that their departments provide consulting services
to their audit clients (mean score - 4.66 out of a possible highest
score of 7), they also strongly disagreed that that their auditors make
management decisions in the areas they audit (mean score = 1.81),
suggesting minimal conflict of interest from auditors' perspective.
Due Professional Care and Quality Control
Table 5 details the mean scores of respondents' degree of
agreements to the statements pertaining to due professional care
and quality control on a 7 point scale. For due professional care, the
table shows the survey respondents Strongly Agree that their auditors
perform risk assessments of all areas audited (means score = 6.03)
and consider operational risk in audit program development (mean
score = 6.15). The exercise of audit due diligence is partly dependent
on the quality of audit performed and external peer quality reviews.
Table 5 shows that respondents strongly agree that their staff
auditors' work is reviewed for accuracy and compliance with audit
procedural requirements and applicable standards (mean score =
6.19). Another research finding not indicated in Table 5 revealed that
43% of respondents' audit departments have gone through external
peer quality review within the last five years as of the date of the
survey. Given these results, it can be argued that in general, the local
government auditors who responded to the survey believe the degree
of professional due care and quality control exercised by local
government auditors is strong. However, the findings also suggest
that the auditors are not too keen on maintaining an issue tracker to
enable them to document control weaknesses identified in their
audits (mean score = 4.92) and to follow-up on recommendations.
Furthermore, while they perform follow-up audits to ensure audit
recommendations are being implemented (mean score = 5.83), they
seem indifferent regarding the timeliness of follow-up audits (mean
score = 4.81).
Client Reiations
Table 5 shows the auditors learn of audit client managers' risk
perspectives prior to audit (mean score = 6.17); the auditors
communicate findings to audit clients prior to final decision (mean
score = 6.36); and have their audit client management review draft
reports prior to finalization (mean score - 6.65). These results
suggest that in general, the auditors follow prudent methodology to
understand the clients' operations and the risks inherent in those
operations to determine the appropriate types of audit tests to be
performed. Additionally they ensure the validity of the audit evidence
gathered through communication with client management, thereby
minimizing potential disagreements. However, Table 5 also shows
that despite the auditors' efforts and the apparent good working
relations described above, the degree of enthusiasm with which audit
client management adopts audit recommendations is low. While the
audit executives Agree that their auditors enjoy client management's
buy-in for all audit recommendations issued (mean score = 5.94),
they only Somewhat Agree that their audit clients provide
documented action plans to address audit control weaknesses
communicated in their audit reports (mean score = 5.48), and are
basically Neutral, implying they neither agree nor disagree, as to
whether their audit client management implements ail action plans
within agreed-upon deadlines (mean score = 4.53).
Audit Process and Ciient Management's Adoption of Recommendations
Based on the above findings, the question that comes to mind is
what dimensions of the audit process influence client management's
adoption of audit recommendations issued by the local government's
internal auditors? In order to answer this question, it was appropriate,
to determine through regression analysis, whether there is a
statistically significant relationship between the dependent variable
of interest - Client Management's Adoption of Audit
Recommendations - and the dimensions of due professional care,
independence, quality control and client relations. Given the
possibility of a codified span of the internal audit's authority, audit's
roles and responsibilities, and audit charter to influence the audit
client management's adoption of audit recommendations (Adams
1994), and thus confound the results, these variables (Mandated
Audit Charter, Audit Roles Passed Into Law, Span of Audit Authority)
were included as exogenous, extraneous variables.
Another issue that potentially could explain client management's
implementation of audit recommendations is auditor qualifications.
For example, as noted by Aldhizer, Miller and Morgalio (1995), the
auditors' knowledge of government operations enhances compliance
with GAGAS reporting standards. For this reason, the dimensions of
auditor qualifications were also included as independent extraneous
variables. Kerlinger (1986) noted that a potential extraneous variable
can be controlled by including it as another attribute, an observed
variable, in the study. By considering the extraneous variables in
their own right, I was able to determine how they interact with the
independent variables of interest and the extent to which they
influence Client Management's Adoption of Audit Recommendations,
either individually or in combination with the independent variables of
interest.
Table 6 and Table 7 show the overall significance of the model.
As illustrated in Table 6, the probability of F statistic (P>F) is 0.000
and the R Square is 0.632. This implies that there is a statistically
significant relationship between Client Management's Adoption of
Audit Recommendations and the overall linear combination of the
eighteen independent variables. A closer review of Table 7 reveals
that Client Management's Adoption of Audit Recommendation is a
function of variables such as Professional Designations (P = 0.041),
Project Risk assessment (P = 0.006), Client Risk Perspective (P =
0.011), Issue Tracker (P = 0.001), and Follow-Up Audits (P = 0.031).
These findings support the hypothesis that there is a positive
relationship between the dependent variable and the five
independent variables - auditor professional designations, auditor
assessment of inherent risk in client operations for the areas audited,
auditor understanding and consideration of client management's risk
perspective in the audit process, the maintenance of issue tracker for
documenting audit findings and tracking resolution of
recommendations, and follow-up audits to ensure the control
weaknesses identified have been addressed. Thus the R Square
value of 0.632 indicates that 63% of the variation in client
management adoption of audit recommendations is affected by these
five variables.
DISCUSSION
The research findings reveal that in general, local government
auditors whose executives responded to the survey possess the
necessary skills and knowledge required for their work. An important
finding is that although there are associations between client
management adoption of audit recommendations and audit
experience, college degree, as well as professional designation, only
the association with professional designation translates into a
statistically significant relationship (P = 0.041). This implies that
although audit experience and college degree are important in
facilitating audit client agreement with auditors on recommendations,
client management's adoption of the recommendations is not as
severely constrained or enhanced by audit experience and a college
degree as it is by the possession of professional certification. The
above findings seem to confirm the work of Bonner and Lewis (1990)
that in addition to general domain knowledge, subspecialty
knowledge is germane to audit work. This is because as the research
result implies, total government auditing experience does not
necessarily equate the knowledge gained from auditing specific
operations of government such as accounting or budgeting. The
results also imply that agent/public managers whose areas are
audited appear comfortable accepting and implementing
recommendations to fulfill obligations to their principals if those
recommendations are issued by auditors who are known to have
successfully completed professional training. Perhaps, this is the
case because the agent/public managers are better able to convince
their principals about the value of recommendations to be
implemented in safeguarding public resources if those recommenddations
have the fingerprints of credible and professionally trained
auditors.
The research results also reveal client management's adoption of
audit recommendations is strongly influenced by professional due
diligence such as the auditor's assessment of risks inherent in the
client' operations to determine the areas of appropriate audit tests (p
= 0.006 for Project Risk Assessment), as well as the client relations
activity such as learning and taking into account the client
management's perception of risks in their operations (p = 0.011 for
Client Risk Perspective). These results are not surprising, as the audit
client manager and his or her team who are involved in the daily
operations of the area have more insights of those operations.
Additionally, no meaningful audit could be performed without an
understanding of the area to be audited, and without working with
those manning the operations. These findings also appear consistent
With the results of prior studies (Carcello, Hermanson & McGrath,
1992; Samelson, Lowensohn & Johnson, 2006) that perceived audit
quality is significantly influenced by auditor characteristics such as
due professional care, and responsiveness to client needs. Thus,
government's internal auditors' perceived factors that drive client
adoption of recommendations appear the same as the two
determinants of auditee's perceived quality found by prior research
on external audits. In exercising due professional care through
understanding of the risks inherent in the agent/public manager's
operations, government auditors play a key role in the principal-agent
relationship by not only monitoring opportunistic behavior of the
agent, but also by minimizing information asymmetry between the
two parties through the issuance of reports to the principals.
According to the research results, government auditors'
documentation and tracking of audit findings and recommendations,
as well as follow-up audits performed to ensure agreed-upon action
plans are implemented, are significantly related to client
management's adoption of audit recommendations (p = 0.001 for
Issue Tracker; and p = 0.031 for Follow-Up Audits). The findings
support and extend the arguments of Adams (1994) regarding the
internal audit as a monitoring mechanism in relation to principalagency
theory. As argued by Adams, the heterogeneous ownership of
government resources and information asymmetry make control of
the agent/manager's activities difficult. Therefore, a monitoring
mechanism like an internal audit helps to counter loss of confidence
in the public management process. The research findings suggest the
significance of the internal audit monitoring role lies in the fact that
agent/public managers are more inclined to implement audit
recommendations to address weaknesses identified in the course of
the audit, and enhance public accountability, as long as government
auditors document, track and follow-up to verify management's
actions on those recommendations.
The research findings also reveal that local government auditors
generally maintain independent reporting structure and exercise
quality control over their audit work. These findings are also
consistent with the arguments by Adams (1994) in that although they
do not significantly influence client management's decision to adopt
audit recommendations, they do help minimize the possibility of the
agent/public manager's influence on the internal audit monitoring
activities for individual self-interest.
This study did not include the audit client management's
perception of governmental internal audit quality, as well as the
relationship between the nature of recommendations and audit client
management adoption of audit recommendations. Additionally, it
does not include the influence of the size of the audit function and
audit budget on the quality of the audit performed and the degree of
due diligence maintained in the audit process. Furthermore, the
effect of audit frequency on client management's adoption of audit
recommendations was not included in this study. Further study is
required to determine whether audit size and audit budget impact the
governmental internal audit's quality and due diligence, and whether
audit frequency impacts client management's acceptance and
implementation of audit recommendations. Additionally, a future
review of auditee perception of the quality of government's internal
audit process, as well as the relationship between the nature of
recommendations and client management adoption of
recommendations will be appropriate.
CONCLUSION
Overall, the findings from this research suggest that many of the
government's internal auditors' perceived factors that drive client
adoption of recommendations are the same as the determinants of
auditee perceived quality found by prior research on external audits.
Additionally, the findings suggest that in general, when government
internal auditors take the time to understand the risks in the areas
they audit, use the knowledge of the risk as a guide in their audit
tests, and also communicate with client management to obtain their
perspectives on operational risks, the latter tends to appreciate such
gestures and respond favorably to audit recommendations.
Furthermore, to help fulfill their agency obligations and be
accountable to their principals, audit public managers tend generally
to act on recommendations issued by auditors known to have
recognized professional qualifications, as well as those
recommendations documented, tracked and followed-up by auditors.
The findings from this research have theoretical and practical
implications for public management. From a theoretical perspective,
the findings suggest that through documentation and monitoring of
control weaknesses and related recommendations, and reporting of
audit findings to oversight bodies, government internal auditors could
play a key role in the principal-agent relationship by minimizing
information asymmetry and moral hazard, thereby helping public
managers to fulfill their obligations to citizens and elected officials.
From a practical perspective, client management adoption of audit
recommendations as a result of auditors' tracking and monitoring
those recommendations will help to enhance public accountability in
the public management process. Therefore, local government's
internal auditors should improve the documentation, monitoring and
follow-up of client resolution of audit findings and recommendations
in order to strengthen public accountability.
REFERENCES
Adams, M. B. (1994). "Agency Theory and the Internal Audit."
Managerial Auditing Journal, 9(8): 8-12.
Aldhizer, G. R., Miller, J. R., & Moraglio, J. F. (1995). "Common
Attributes of Quality Audits." Journal of Accountancy, 17(1): 61-
68.
Ashton, A. H. (1991). "Experience and Error Frequency Knowledge as
Potential Determinants of Audit Expertise." The Accounting
Review, 66: 218-239.
Behn, B. K., Carcello, J. V., Hermanson, D. R., & Hermanson, R. H.
(1997). "The Determinants of Audit Client Satisfaction among
Clients of Big 6 Firms." Accounting Horizons, 11(1): 7-24.
Bonner, S. E., & Lewis, B. L. (1990). Determinants of auditor
expertise. Journai of Accounting Research, 28 (Supplement): 1-
20.
Carcello, J. V., Hermanson, R. H., & McGrath, N. T. (1992). "Audit
Quality Attributes: The Perceptions of Audit Partners, Preparers
and Financial Statement Users." Auditing: A Journai of Practice
and Theory, 11(1): 1-15.
Carslaw, C, Mason, R., & Mills, J. R. (2007). "Audit Timeliness of
School District Audits." Journai of Pubiic Budgeting, Accounting
and Financial iVIanagement, 19(3): 290-316.
Churchill, N.C. (1979). Computer-Based Information Systems for
Management. Englewood Cliffs, NJ: Prentice Hall.
Copley, P. A. (1991). "The Association between Municipal Disclosure
Practices and Audit Quality." Journal of Accounting and Public
Policy, 10: 245-266.
Deis, D. R., & Giroux, G. A. (1992). "Determinants of Audit Quality in
the Public Sector." The Accounting Review, 67(3): 462-479.
Giroux, G., Jones, R., & Pendlebury, M. (2002). "Accounting and
Auditing for Local Governments in the U.S. and the U.K." Journal
of Budgeting, Accounting and Financial Management, 14(1): 1-
26.
Government Auditing Standards (1999). Government Accounting
Standrads. [Online]. Available at www.google.com/
search?q=Government+Auditing+Standards&btnG=Search&hl=e
n&rlz=lT4ADBR_enUS268US270&sa=2. (Retrieved, April 3,
2010).
Hevesi, A. (2005). Roslyn Union Free School District Anatomy of a
Scandal: Report of Examination. [Online]. Available at
www.osc.state.ny.us/localgov/audits/2005/schools/roslyn2.htm.
(Retrieved March 17, 2009).
Jensen, M. C, & Meckling, W. H. (1976). "Theory of the Firm;
Management Behavior, Agency Costs and Ownership Structure."
Journal of Financial Economics, 3(3): 305-360.
Kerlinger, F. N. (1986). Foundations of Behavioral Research (3rd ed.).
New York: CBS.
Kidwell, L A. (1999). "Compliance Reporting Decisions in Municipal
Audits: The Impact of Budget Variance and Employment Sector."
Journal of Public Budgeting, Accounting and Financial
Management, 11(3): 325-356.
Lowensohn, S., & Reck, J. (2004). "Longitudinal Analysis of Local
Government Audit Quality." Research in Governmental and
Nonprofit Accounting, 11: 213-228.
Meixner, W., & Welker, R. (1988). Judgment Consensus and Auditor
Experience: An Examination of Organizational Relations." The
Accounting Review, 63: 505-513.
