CHAPTER ONE

INTRODUCTION

1.1       BACKGROUND TO THE STUDY

Auditing standards permit external auditors to rely on the work of internal auditors in performing a financial statement audit (AICPA 1997; PCADB 2004; PCAOB 2007). It stands to reason that cost savings can be realized when external auditors are able to rely on a client’s internal audit function (IAF), and in a competitive audit market a large portion of these cost savings are likely to pass to the client in the form of lower external audit fees. This study investigates the relation between the contribution that internal audit makes to the financial statement audit to the external audit fees. Using a unique and previously unavailable old internal audit data, we improve on the work by creating or introducing quality-related internal audit measures and thereby attempt to better specify the relation between internal auditing and external audit fees. The internal control system of an organization to a large extent determines the audit fees of an external auditor. If the internal control system of an organization is strong the external auditors will have a shorter duration to work and low fees as well will be paid to the external auditors but if the internal control system of an organization or a firm is weak then the external auditor will have much work to do, for a longer duration and a higher audit fees will be paid to the external auditor. Also, the higher the turnover of a company the higher the professional fees charged by the external auditors.

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