THE EFFECT OF INTERNAL AUDIT OUTSOURCING ON FINANCIAL ANALYSTS' PERCEPTIONS OF EXTERNAL AUDITOR INDEPENDENCE, FINANCIAL STATEMENT RELIABILITY AND INVESTMENT DESIRABILITY

Auditor independence has long been recognized as the cornerstone of the public accounting profession. Without independence, the opinion of the external auditor is of limited value. At issue is the performance of services that fall outside the realm of traditional external auditing, specifically, providing internal audit services to clients. Because internal auditing is generally thought of as a management function, outsourcing this function to the current external audit firm calls into question the independence of that firm with respect to the audit of its client's financial statements. Further, the increased economic dependence that results when services to clients are thus expanded is thought to reduce independence of the external auditor.; This study examines the perceptions of financial analysts with regard to the independence of the external auditors, the reliability of client financial statements and the desirability of an equity investment in the client company. Findings in phase one of the study (that compares outsourcing to no outsourcing) indicate that providing both external and internal audit services does negatively impact the perceived independence (both in appearance and in fact) of the external audit firm. Results in phase two (that examines extent of outsourcing and staff separation) suggest that providing adequate staff separation by having a separate consulting division perform the internal audit engagement has a positive effect on perceptions of the actual independence of the CPA firm. While outsourcing internal audit had no direct effect upon the perceptions of the reliability of the financial statements or the desirability of the investment in either phase, a path analysis showed an indirect effect via the independence variables. The results in phase two suggest that staff separation does enhance financial statement reliability, however, no differences were found in perceptions relating to partial and full outsourcing engagements, suggesting that outsourcing to the current firm at any level may be problematic. Finally, results in both phases show that more than 65% of respondents believe that external auditors are less independent in fact than they appear to be to the general public.