Exploring the association between the content of internal audit disclosures and external audit fees: Evidence from Sweden

• Published date: 01 July 2018
• Date: 01 July 2018
• Author: Linus Axén
• DOI: http://doi.org/10.1111/ijau.12120

ORIGINAL ARTICLE

Exploring the association between the content of internal audit

disclosures and external audit fees: Evidence from Sweden

Linus Axén

Division of Business Administration,

Department of Management and Engineering,

Linköping University, Sweden

Correspondence

Linus Axén, Division of Business

Administration, Department of Management

and Engineering, Linköping University, 58183

Linköping, Sweden.

Email: linus.axen@liu.se

The aim of this study is to explore the content of internal audit (IA) disclosures in

annual reports and explain the relationship between IA disclosures and external audit

fees. A content analysis of the IA disclosures made it possible to generate inductive

categories that were used as a basis for statistical analysis. The findings show a large

variation in disclosure practices, and only a small portion of all disclosures contain

firm‐specific information related to IA. Evidence is provided that the use of an IA

function (IAF) is associated with higher external audit fees. However, companies that

disclose firm‐specific information related to IA pay lower audit fees than those not

providing this disclosure. Overall, the results of this study indicate that firm‐specific

IA disclosures most likely represent actual investments in IA and can be used as a

proxy for IAF quality.

KEYWORDS

Audit fees, corporate governance, disclosure, internal audit

1|INTRODUCTION

The aim of this study is to explore the content of internal audit (IA)

disclosures in annual reports and explain the relationship between IA

disclosures and external audit fees. Although the IA function (IAF) is

seen as an important governance mechanism (Gramling, Maletta,

Schneider, & Church, 2004), there are generally no statutory require-

ments to disclose information about the composition and activities

of the IAF (Holt & DeZoort, 2009). Current governance disclosures

focus mainly on management, the audit committee, and external audi-

tors, while little information is disclosed about the nature of the IAF

(Archambeault, DeZoort, & Holt, 2008). According to the Swedish cor-

porate governance code (the Code), the use of an IAF is recommended

and the absence of an IAF needs to be evaluated on an annual basis

and clarified in the corporate governance report (Swedish Corporate

Governance Board, 2010). However, there are no additional reporting

requirements connected to IA. Companies that want to share informa-

tion can do so by voluntary disclosures. Therefore, managers have the

opportunity to voluntarily disclose information that they believe is

relevant and useful to external stakeholders (Meek, Roberts, & Gray,

1995). According to Beekes and Brown (2006), companies with

superior governance quality differentiate themselves from other com-

panies by the use of more informative disclosures in the annual report.

By considering both internal and external auditing as important

elements of corporate governance, previous IA research has

examined whether the existence of an IAF (Goodwin‐Stewart &

Kent, 2006; Hay, Knechel, & Ling, 2008; Singh & Newby, 2010),

IAF quality (Gros, Koch, & Wallek, 2017; Zain, Zaman, & Zulkifflee,

2015), and external auditors' reliance on the IAF (Abbott, Parker, &

Peters, 2012; Felix, Gramling, & Maletta, 2001; Messier, Reynolds,

Simon, & Wood, 2011) are associated with the external audit fees.

Owing to mixed results and different theoretical perspectives, it has

been argued that the IA can act, at least in part, as either a substi-

tute for or a complement to the external audit. This study extends

existing IA research by examining the relationship between IA dis-

closures and external audit fees. Based on previous findings that

more informative disclosures signal actual investments in disclosed

activities (Toms, 2002) and increased governance quality (Beekes

& Brown, 2006), this study posits that companies with more infor-

mative IA disclosures have higher IAF quality, which will likely have

an impact on the external audit fees. Yatim, Kent, and Clarkson

(2006) argue that good corporate governance practice improves

both risk management and internal control processes, which affects

auditors' risk assessments and, in the end, leads to lower external

audit fees. Conversely, investments in IA may also signal that those

charged with governance are willing to pay more for an external

Received: 31 May 2016 Revised: 12 February 2018 Accepted: 26 March 2018

DOI: 10.1111/ijau.12120

Int J Audit. 2018;22:285–297. © 2018 John Wiley & Sons Ltdwileyonlinelibrary.com/journal/ijau 285