The Relationship between the Expenditures on Internal Audit Resources and the Expenditures on External Audit Services

There are two readily identifiable areas of a business firm’s operations that require the use of professional auditing services. These areas parallel the organizational forms that the audit services take. In the first area, there is a need for external financial reporting which consists of a set of financial accounting statements certified by an outside agent. Second, there is a need for management information and auditing within the firm beyond the need for an independent financial statement audit. The main goals of this research are identifying fees for external and internal auditing, recognizing the effect of existence of internal auditing on reducing the auditing expenses of the firm, and studying the effectiveness of raising the management levels whom internal auditors report to in the quality of their work. And eventually the usefulness of internal auditors as substitutes for external auditors. Bearing in mind the models used in previous researches including the one done by Simunic (1980), another done by Palmrose (1986) to measuring the costs of auditing services, and experimental relation between the costs of internal and external auditing, we contrived a comprehensive model for auditing expenses of the firm, including two simultaneous equations to test our hypotheses against. The final result of the research indicates that increased amounts of internal audit resources in the firm lower the external audit fee, and internal audit resources which report to the levels in the firm above the controller will exhibit a greater decrease in the external audit fee then internal audit resources which report to the controller, ceteris paribus. Also the rate of usefulness to external auditors of reports provided by internal auditors in the firm in which they report to the board of directors and the managing director is similar to that rate for firms in which the auditing division reports to the director for financial and administrative affairs or lower levels of management.