The Control Environment & Internal Auditor

127 Pages·2015·2.74 MB·English

The Control Environment & Internal Auditor
From the perspective of the internal auditor: Does the control
environment influence the possibility of internal auditors to
detect fraud?

by
Ha Vu & Silvia Segura
June 2015

Master’s Programme in Management Control and Accounting

Supervisors: Karin Jonnergård & Peter W. Jönsson

Examiner: Amanda Sonnerfeldt
Abstract
Title: The Control Environment and Internal Auditor - Does the control environment influence the
possibility of internal auditors to detect fraud
Seminar date: 2015-06-04
Course: BUSN69 Degree Project - Accounting & Auditing
Authors: Ha Vu & Silvia Segura
Advisors: Karin Jonnergård & Peter W. Jönsson
Five key words: Internal Auditor, COSO, Control Environment, Fraud detection, Fraud Mechanism
Purpose: The purpose of this paper is to provide insight from the internal auditor’s perspective on
whether the control environment has an influence on the possibility of internal auditors to detect fraud.
Methodology: For this paper we use a quantitative research with a deductive method approach.
Theoretical perspective: Main theories in this paper consist of role theory, triangle theory, and agency
theory.
Empirical foundation: The primary data collection consists of information from a web-based
questionnaire sent to members of the Institute of Internal Auditor in the US.
Conclusions: There is no correlation between internal control environment and possibility of internal
auditors in detecting fraud. This research tries to find out if there is any correlation between the years of
experience of internal auditors and the perception of possibility in detecting fraud and if there is any
correlation between the perception of internal auditors in their role and the perception of possibility in
detecting fraud, however, the answers for both these concerns is that there is no correlation.
There is no significant difference in opinion about which factor is important in influencing the possibility
of detecting fraud amongst internal auditors who have different years of experience. Similarly, there is no
significant difference in opinion about which factor is important in influencing the possibility of detecting
fraud amongst internal auditors who have different perception of their role in connection with detecting
fraud having

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Acknowledgement
We would like to express our gratitude to our supervisors Karin Jonnergård and Peter W. Jönsson for
their enthusiastic, helpfulness and their detail guidance. Their feedback enabled us to complete our thesis
and constructive criticism further enhanced its quality. Further, we would like to thank the respondents of
our survey who make this research possible.

As a scholarship holder, I (Ha) would like to express my gratitude to Swedish Institute who granted me
the opportunity to study in Sweden, enable my dream of studying in Sweden become true. I also would
like to heartily thank to many Swedish people in Lund who even do not know me but taught me their
language and introduced me about their culture, which enable my one year studying in Sweden not only
become an academic year but also a memorable cultural adventure.

__________________________ __________________________

Ha Vu Silvia Segura

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Table of Contents
CHAPTER I: INTRODUCTION .................................................................................................... 1
1.1 Background ............................................................................................................................ 1
1.2 Research Problem .................................................................................................................. 1
1.3 Research Objectives ............................................................................................................... 3
1.4 Research Questions ................................................................................................................ 3
1.5 Scope and Limitations ............................................................................................................ 3
1.6 Beneficiaries .......................................................................................................................... 3
1.7 Structure of the thesis ............................................................................................................. 4
CHAPTER 2: LITERATURE REVIEW ....................................................................................... 5
2.1 Introduction ............................................................................................................................ 5
2.2 Definition of fraud ................................................................................................................. 5
2.3 Fraud mechanism ................................................................................................................... 6
2.4 Definition of internal audit and possibility of detecting fraud ............................................... 7
2.5 The role of internal audit ........................................................................................................ 8
2.6 The role of internal auditor in detecting fraud ..................................................................... 10
2.7 Control Environment and best practice ................................................................................ 11
2.8 Previous researches on detecting fraud and factors influencing internal auditor’s
performance .................................................................................................................................. 13
2.9 Literature gap ....................................................................................................................... 17
2.10 Conclusion ........................................................................................................................... 17
CHAPTER 3: THEORY AND THESIS’S HYPOTHESES FORMATION ................................ 18
3.1 Introduction .......................................................................................................................... 18
3.2 Hypotheses formation .......................................................................................................... 18
3.2.1 Connection between control environment and internal auditor’s perception on the
possibility to detect fraud ......................................................................................................... 19
3.2.2 Experience of internal auditors ................................................................................. 25
3.2.3 Role of internal auditors ............................................................................................ 26
3.3 Summary of hypotheses ....................................................................................................... 27
3.4 Conclusion ........................................................................................................................... 28
CHAPTER 4: EMPIRICAL RESEARCH .................................................................................... 29
4.1 Introduction .......................................................................................................................... 29
4.2 Research Approach .............................................................................................................. 29
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4.2.1 Research Design ............................................................................................................. 29
4.2.2 Quantitative Research Strategy ...................................................................................... 30
4.2.3 Primary Data .................................................................................................................. 30
4.3 Deductive Process ................................................................................................................ 30
4.4 Sampling .............................................................................................................................. 31
4.5 Empirical Measurement Method .......................................................................................... 32
4.5.1 The primary data and the questionnaire ......................................................................... 32
4.5.2 Dependent and independent variables ............................................................................ 33
4.6 Reliability and Validity ........................................................................................................ 34
4.6.1 Reliability ....................................................................................................................... 34
4.6.2 Validity ........................................................................................................................... 35
4.7 Selection of statistics tests ................................................................................................... 36
4.8 Conclusion ........................................................................................................................... 38
CHAPTER 5: ANALYSIS & RESULTS ..................................................................................... 39
5.1 Introduction .......................................................................................................................... 39
5.2 Descriptive Statistics on respondent profile ........................................................................ 39
5.3 Statistics tests and analysis of hypothesis 1 ......................................................................... 41
5.3.1 Description of variables ........................................................................................... 41
5.3.2 Internal Reliability .................................................................................................... 45
5.3.3 Correlation ................................................................................................................ 47
5.3.4 Convert data to principal component ....................................................................... 48
5.3.5 Regression test and conclusion for hypothesis 1 ..................................................... 49
5.4 Statistics test results and hypothesis 2 analysis ................................................................... 51
5.4.1 Data description .............................................................................................................. 51
5.4.2 Kruskal Wallis test ......................................................................................................... 57
5.4.3 Hypothesis 2 conclusion ................................................................................................. 59
5.5 Statistics test results and hypothesis 3 analysis ................................................................... 60
5.6 Statistics test results and hypothesis 4 analysis ................................................................... 61
5.6.1 Data description .............................................................................................................. 61
5.6.2 Kruskal Wallis test ......................................................................................................... 64
5.6.3 Hypothesis 4 conclusion: ............................................................................................... 65
5.7 Statistics test results and hypothesis 5 analysis ................................................................... 66
5.8 Conclusion ........................................................................................................................... 67
Chapter 6: DISCUSSION AND CONCLUSION ......................................................................... 68
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6.1 Theoretical Implications ...................................................................................................... 68
6.2 Practical implications ........................................................................................................... 70
6.3 Limitations and Future Research ......................................................................................... 71
REFERENCE ................................................................................................................................ 73
APPENDIX ................................................................................................................................... 79
Appendix 1 – Questionnaire ......................................................................................................... 79
Appendix 2 – Description of data ................................................................................................. 83
Appendix 3 – Cronbach’s alpha .................................................................................................... 99
Appendix 4 – Regression Test .................................................................................................... 105
Appendix 5 – CROSSTAB, Chi-square for hypothesis 2 ........................................................... 106
Appendix 6 – CROSSTAB, Chi-square for hypothesis 4 ........................................................... 112

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List of Tables

Table PAGE
Table 2.1 - Previous Researches & Theories ................................................................................15
Table 4.1 - Summary of Principles & Factors ...............................................................................33
Table 5.1 - Experience of Internal Auditor ....................................................................................40
Table 5.2 - Role of Internal Auditor in Detecting Fraud ...............................................................40
Table 5.3 - Role of Internal Auditor in Detecting Fraud (Percentage) ..........................................40
Table 5.4 - Description of Data for Dependent Variable ...............................................................41
Table 5.5 - Description of Independent Variable 1 ........................................................................42
Table 5.6 - Description of Independent Variable 2 ........................................................................43
Table 5.7 - Description of Independent Variable 3 ........................................................................44
Table 5.8 - Description of Independent Variable 4 ........................................................................44
Table 5.9 - Description of Independent Variable 5 ........................................................................45
Table 5.10 - Cronbach’s Alpha ......................................................................................................46
Table 5.11 - Correlations before PCA ...........................................................................................47
Table 5.12 - PCA Transformation .................................................................................................49
Table 5.13 - Correlation after PCA ................................................................................................50
Table 5.14 - Regression Test .........................................................................................................51
Table 5.15 – Yrs of Experience * Management risk appetite & Control Philosophy
(Crosstabulation) ............................................................................................................................52
Table 5.16 - Yrs of Experience * Code of Ethics (Crosstabulation) .............................................53
Table 5.17 - Yrs of Experience * Human Resource Policy (Crosstabulation) ..............................54
Table 5.18 - Yrs of Experience * Organization Structure (Crosstabulation) .................................55
Table 5.19 - Yrs of Experience * Board of Director’s Oversight (Crosstabulation) .....................56
Table 5.20 - Kruskal Wallis for Years of Experience & Management Control Philosophy and
Risk Appetite .................................................................................................................................57
Table 5.21 - Kruskal Wallis for Years of Experience & Code of Ethics .......................................57
Table 5.22 - Kruskal Wallis for Years of Experience & Human Resources Policy ......................58
Table 5.23 - Kruskal Wallis for Years of Experience & Organization Structure ..........................58
Table 5.24 - Kruskal Wallis for Years of Experience & Board of Director’s Oversight ..............59
Table 5.25 – Pearson’s Test for Hypothesis 3 ...............................................................................60
Table 5.26 – Crosstab for Hypothesis 4 (Management Control and Risk Appetite) .....................62
Table 5.27 - Crosstab for Hypothesis 4 (Code of Ethics) ..............................................................62
Table 5.28 - Crosstab for Hypothesis 4 (Code of Ethics) ..............................................................63
Table 5.29 - Crosstab for Hypothesis 4 (Code of Ethics) ..............................................................64
Table 5.30 - Crosstab for Hypothesis 4 (Code of Ethics) ..............................................................64
Table 5.31 – Kruskal Wallis Test for Hypothesis 4 .......................................................................65
Table 5.32 – Pearson’s Test for Hypothesis 5 ...............................................................................66

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List of Figures

Figures PAGE
Figure 2.1 - Internal Audit Assurance Role ...................................................................................15
Figure 3.1 - Research Process ........................................................................................................18
Figure 3.2 - Summary of First Hypothesis.....................................................................................25
Figure 5.1 - Coordinate System .....................................................................................................48
Figure 5.2 - Bart Chart (Yrs of Experience & Management Philosophy) .....................................52
Figure 5.3 - Bart Chart (Yrs of Experience & Code of Ethics) .....................................................53
Figure 5.3 - Bart Chart (Yrs of Experience & Human Resource Policy) ......................................54
Figure 5.5 - Bart Chart (Yrs of Experience & Organization Structure) .........................................55
Figure 5.6 - Bart Chart (Yrs of Experience & Board of Director’s Oversight) .............................56

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Abbreviations

AICPA American Institute of Certified Public Accountants
COSO Committee of Sponsoring Organizations of the Treadway Commission
HRM Human Resource Management
IFAC International Federation of Accountants
IIA The Institute of Internal Auditors (IIA)
ISA International Standard on Auditing
PCA Principal Component Analysis
SOX The Sarbanes–Oxley Act of 2002

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CHAPTER I: INTRODUCTION
1.1 Background
The concept of auditing has been around for many years. There are traces of some form of auditing
dating back to the Roman Empire times. According to Adelberg, referenced in Gupta and Ray (1992, pp.
3), it was between the sixteenth and eighteenth century in which the detection and prevention of fraud
became the internal auditor’s main objective (Gupta & Ray, 1992). However, Picket (2004) claims that
internal auditors were viewed as a mechanism to double check hundreds of transactions posted to the
accounts on a weekly basis until the 1950’s and 1960’s when the internal auditor role changed to
conducting basic tests of the accounts with the objective of detecting errors and irregularities (Pickett,
2004).
The internal auditor’s role has evolved into being an advisor to management in implementing better
controls and having high-level input in the risk strategies of the company (Pickett, 2004). In agreement
with Pickett (2004), a review, by Gupta and Ray (1992), of several Professional Standard Bulletin issued
by the IIA indicated that internal auditors investigate and detect fraud as well as evaluate internal and
organizational controls. Furthermore, internal auditors provide advice on future actions based on analysis,
have constant communication with the board, and work with the external auditors (Gupta & Ray, 1992).
The internal auditor determines if the plans and activities of the organization are being executed in an
economical, efficient, and effective way; they provide an opinion on whether the objectives of the firm
are being met (Gupta & Ray, 1992). Due to the various corporate fraud scandals in the early 2000’s the
role of the internal auditor saw an increase in responsibilities with the implementation of Section 404 of
the Sarbanes-Oxley Act; one of these responsibilities included internal auditors helping firms comply
with the assessment and reporting of internal controls required under this sections (E&Y, 2011).
SOX increased organizations’ need to use COSO’s framework in order to develop and effectively assess
internal controls (Moeller, 2004). Although using COSO’s framework is not mandatory, most companies
use this framework since according to Moeller (2004) the COSO framework helps firms build a strong
system of internal financial system controls. Despite the fact that SOX was implemented to increase the
responsibility of management and external auditors to detect fraud, this regulation and the COSO
framework has also indirectly influenced the responsibility of the internal auditor when detecting fraud.
1.2 Research Problem
There are people who question the effectiveness of audits. Powers (1999) provides his skepticism on the
auditing function, both internal and external auditing, as he describes auditing as simply ‘rationalized
rituals’ used to create organizational legitimacy. He argues that auditors have increased their focus on
making sure that the controls or auditable as oppose of verifying that they are effective (Power , 1999). In