Managerial Auditing Journal

The impact of internal audit function characteristics on internal control quality

Ahmed Atef Oussii, Neila Boulila Taktak,
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Ahmed Atef Oussii, Neila Boulila Taktak, (2018) "The impact of internal audit function characteristics
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Internal
The impact of internal audit control quality
function characteristics on
internal control quality
Ahmed Atef Oussii
Department of Accounting, Institut Supérieur d’Adminidtration des Affaires de
Sfax, University of Sfax, Sfax, Tunisia and DEFI Research Unit,
Ecole Superieure des Sciences Economiques et Commerciales
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de Tunis, University of Tunis, Tunis, Tunisia, and

Neila Boulila Taktak
IHEC Carthage, University of Carthage, Tunis, Tunisia and DEFI Research Unit,
Ecole Superieure des Sciences Economiques et Commerciales de Tunis,
University of Tunis, Tunis, Tunisia

Abstract
Purpose – This paper aims to investigate the association between internal audit function (IAF)
characteristics and internal control quality.
Design/methodology/approach – Using data gathered from 59 chief audit executives from Tunisian
listed companies, this paper uses a regression model to examine research hypothesis related to the association
between IAF characteristics and internal control quality.
Findings – The findings of the current study reveal that internal control quality is significantly and
positively associated with IAF competence, internal audit quality control assurance level, follow-up process
and audit committee’s involvement in reviewing the internal audit program and results.
Practical implications – The findings have significant implications for IAF wishing to enhance their
effectiveness, by recognizing the impact of the IAF’s characteristics on internal control quality. The findings
of this study also have significant implications for regulatory bodies who are concerned with the internal
control quality, managers and audit committees who determine IAF investment, oversight IAF activities and
assess internal auditors’ performance.
Originality/value – This study helps fill a gap in the extant literature where existing empirical evidence of
how the IAF characteristics influences the quality of the financial reporting process in emerging markets is scant.
Keywords Audit committee, Internal audit function, Internal control quality
Paper type Research paper

1. Introduction
The past few years have been marked by a succession of high-profile financial scandals which
have drawn attention on the need for effective corporate governance (Endaya and Hanefah,
2016; Sultana et al., 2015; Khlif and Samaha, 2014). Consequently, both regulators and scholars
have increasingly promoted the pivotal role of internal controls in ensuring the reliability of
financial reporting process (Salehi and Bahrami, 2017; Khlif and Samaha, 2016; Lin et al., 2014;
Bedard and Graham, 2011). According to Krishnan (2005, p. 650), an effective internal control
system represents an important factor in achieving good quality financial reporting. Managerial Auditing Journal
Although top management continues to be recognized as the ultimate responsible for © Emerald Publishing Limited
0268-6902
maintaining a firm’s internal control system, “support for management in the discharge of DOI 10.1108/MAJ-06-2017-1579
 MAJ these responsibilities is a legitimate role for internal auditors” (Institute of Internal Auditors
IIA, 2004, p. 3).
Nonetheless, despite the pivotal role played by internal audit function (IAF) in ensuring
the oversight of internal control process, research examining the influence of firm’s IAF
characteristics on internal control quality is scant, with the exception of Fadzil et al. (2005)
and Lin et al. (2011) which provide evidence that internal control weaknesses disclosure is
negatively associated with the IAF activities and practices.
However, Lin’s study is limited in two ways. First, the IAF attributes and activities measures
used do not take into consideration certain aspects in particular those relating to the working
relationship between internal audit and the audit committee. Second, findings from this study are
limited to the USA and do not take into account specific conditions in emerging countries where
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the governance practices may be weak (Klibi, 2015; Khlif and Samaha, 2014). As such, research
into the association between IAF characteristics and internal control quality in an emerging
country, as Tunisia, merit scholarly attention and motivates this study. Tunisia is the
northernmost country in the African continent. Its gross domestic product per capita is $3.6, and
its unemployment rate is about 13 per cent in the first quarter of 2017 (International Monetary
Fund, 2017). Tunisia is also among the first emerging countries that have thought to legislate on
corporate governance (Klibi, 2015). In 2001, a regulatory framework for audit committees was
enacted for the first time. This law stipulates that credit institutions have to establish an internal
control system and an audit committee. However, compared to an international regulatory
framework, the Tunisian regulations remain limited. For example, the Sarbanes-Oxley Act of
2002, (2002) requires that management include in its annual report a formal assessment of the
effectiveness of its internal controls over financial reporting. Nonetheless, the Tunisian
regulations do not give these parties the possibility of closely monitoring the results of IAFs
work. They turn into black boxes where doubts might be raised with regard to their effectiveness.
Based on a sample of 59 Tunisian listed companies, we find that the internal control
quality is significantly and positively associated with IAF competence, internal audit
quality control assurance level, follow-up process and audit committee’s involvement in
reviewing the internal audit program and results. However, our findings failed to support
the predicted positive relation between the IAF objectivity, IAF investment and firm’s
internal control quality.
Overall, results of the current study make various contributions to the extant literature. First,
this study is one of the first to provide empirical evidence that IAF characteristics influence firm’s
internal control quality in an emergent market setting characterized by weak corporate
governance system. Second, this study provides valuable insights by demonstrating the
importance of IAF competence, internal audit quality control assurance level, follow-up process
and intense working relationship between the chief audit executive (CAE) and the audit
committee to IAF quality and effectiveness. Finally, findings raise implications for audit
committees and top management who structure the IAF and external auditors who determine
whether the internal auditors work is adequate for the purposes of the financial statement audit.
The remainder of this study is structured as follows. Section 2 provides background
about internal audit and internal control regulations in Tunisia. Section 3 discusses the
related literature and develops our research hypotheses. Section 4 presents the research
methodology used in this paper. Section 5 contains the main empirical results. Conclusions
and future research directions are discussed in Section 6.

2. Internal audit and internal control regulation in Tunisia

The Tunisian setting on internal audit is fairly new. These rules provide an essential
distinction between listed and non-listed companies (Oussii and Boulila Taktak, 2015, p. 93).
 For example, the article No. 38 of the general regulation of the Tunis Stock Exchange Internal
provides guidance on the establishment of IAF for listed companies. According to this rule, control quality
all listed firms must have an IAF. Additional rules stipulate that credit institutions and
banks have to set up a system of internal control and an audit committee (e.g. Law No. 2001-
65 for credit institutions; Circular concerning credit institutions No. 2006-19).
Since 2005, the Tunisian Government has enacted the Financial Security Act n°2005-96
which aimed to improve corporate transparency, strengthening the policy of disclosure and
reinforcing the role played by audit committee, external and internal auditors as the
cornerstones of corporate governance system (Ahmadi and Bouri, 2016). Specifically, this
Law requires all companies making public offerings and parent companies, where the total
of the balance sheet for the consolidated financial statements exceeds 50 million Tunisian
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dinars (Decree No. 2006-1546, article 6) to have an audit committee.

Additional guidance on the composition of the audit committee is also provided by the
aforementioned Act. Inspired by Sarbanes-Oxley Act of 2002, (2002), the Tunisian Financial
Security Act also requires external auditors to assess the effectiveness of internal control
systems of the audited companies and signal all material weaknesses detected in a special
audit report.

3. Background and hypotheses

3.1 Prior studies on internal audit quality and effectiveness
The IAF effectiveness has become increasingly important in the current governance
environment[1]. However, it still remains an enigma and is largely viewed as an
underexplored “black box” in academic research (Lenz et al., 2014, p. 126).
Several studies on internal audit quality and effectiveness during the past several
decades focused on this topic from “supply-side” (Mihret and Yismaw, 2007; Sarens and De
Beelde, 2006) and “demand-side” perspectives (Roussy and Brivot, 2016; Bame-Aldred et al.,
2013), and considered a number of features as being of particular relevance. The first
internal audit effectiveness research stream involves the analysis of how internal auditors
assess themselves including their role, their skills and their organizational status (Arena and
Azzone, 2009; Mihret and Yismaw, 2007; Sarens and De Beelde, 2006).
The second stream of internal audit quality research included a group of studies which
analyzed how other stakeholders (i.e. the external auditor, the top management and the audit
committee) assess IAF effectiveness (Mat Zain et al., 2015; Soh and Martinov-Bennie, 2011;
Munro and Stewart, 2011; Sarens et al., 2009; Sarens and De Beelde, 2006; Krishnamorthy,
2002; Felix et al., 2001).
For instance, Alzeban and Sawan (2015) measured the IAF effectiveness by the level of
implementation of internal audit recommendations. Soh and Martinov-Bennie (2011) and
Sarens et al. (2009) reported that the reporting lines of IAF to the audit committee are critical
to internal audit effectiveness. Alhajeri (2017), Barua et al. (2010) and Carcello et al. (2005)
measured the effectiveness of IAF by relative investment in internal audit activities. Mat
Zain et al. (2006) used the size of IAF and the percentage of professional staff members with
audit experience to measure IAF effectiveness.
Prawitt et al. (2009, p. 1257) measured IAF quality using a composite measure
comprising six individual components: the experience of internal audit staff, the percentage
of internal auditors that are professionally certified, the amount of time spent training
during the year, the amount of financial work the IAF performs, the reporting relation of the
CAE and the size of the IAF. Lin et al. (2011), Johl et al. (2013) and Pizzini et al. (2015)
developed a composite measure of IAF quality from proxies for IAF competence, IAF
organizational status, IAF size, the use of quality assurance techniques, grading internal
 MAJ audit reports and internal audit financial focus activities. Lenz and Hahn (2015) developed a
model capturing macro and micro factors that influence internal audit effectiveness. The
macro factors suggested can be categorized into four major components: IAF organizational
statue, IAF resources, IAF processes and IAF relationships, whereas the micro factors
considered comprise coercive institutional forces, normative forces and mimetic forces.
Further, substantial archival research has focused on the association between IAF
characteristics and financial reporting quality. For instance, Davidson et al. (2005) find no
significant association between earning management and the presence of an IAF. Prawitt
et al. (2009) observed that IAF quality from proxies for IAF competence, IAF reporting
relation of the CAE and the amount of financial reporting is positively associated with a
lower level of earnings management. Similarly, Johl et al. (2013) reported a negative
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association between IAF quality and abnormal accruals. Lin et al. (2011) found that material
weaknesses disclosures are negatively associated with the IAF competence, the use of
quality assurance techniques into fieldwork and the amount of financial reporting work
performed by the internal auditor.
The present study complements past research referred to above by investigating the
impact of internal audit characteristics on internal control quality. The theoretical
framework underlying the hypotheses development is agency theory which helps explain
the contribution of internal audit characteristics (including, competence, size, organizational
status and the scope of its activities) to internal control quality.
From the agency theory perspective, the IAF is considered as a pivotal monitoring
mechanism within the corporate governance mosaic which aims to reduce information
asymmetry problems between the principals and the agents (Sarens and Abdolmohammadi,
2011; Goodwin-Stewart and Kent, 2006; Fadzil et al., 2005; Adams, 1994).
Agency theory advocates argue that the senior management invests in the IAF to show
to the board of directors, that the internal control system and the risk management process
are functioning adequately. More specifically, agency theory arguments suggest that
specific characteristics of the individuals performing internal audit activities may increase
the IAF’s ability to effectively maintain and evaluate adequate internal control system.
Thus, we expect a positive association between IAF characteristics and internal control
quality.

3.2 Hypotheses development

Effective internal control system represents an adequate assessment of earnings quality and
reliable financial reporting (Costello and Wittenberg-Moerman, 2011; Doyle et al., 2007).
Professional bodies and academics consider that the IAF attributes and activities tend to
enhance the internal control system quality (PCAOB, 2007; American Institute of Certified
Public Accountants AICPA, 1991; Lenz and Hahn, 2015; Soh and Martinov-Bennie, 2011; Lin
et al., 2011). Meanwhile, empirical evidence of this relation is scant.
Based on prior literature (Endaya and Hanefah, 2016; Pizzini et al., 2015; Johl et al., 2013;
Lin et al., 2011; Prawitt et al., 2009) and professional standards (IFAC, 2013; Institute of
Internal Auditors IIA, 2017; PCAOB, 2007), we examine the association between internal
control quality and key IAF attributes found in the past studies to most significantly impact
internal audit quality. The IAF characteristics examined in this study are: IAF
organizational status, working relationship between the internal auditor and the audit
committee, internal audit staff competence, IAF investment, quality assurance program and
the follow-up on internal control deficiencies. Therefore, this section displays the hypotheses
of study and provides a theoretical basis for the association between IAF characteristics and
internal control quality.
 3.2.1 Internal audit function organizational status. Internal audit attribute standard 1100 Internal
suggests that “internal audit activity must be independent, and internal auditors must be control quality
objective in performing their work” (Institute of Internal Auditors IIA, 2017, p. 3). Internal
auditors’ personal objectivity implies that “they must have an impartial, unbiased attitude,
and avoid any conflict of interest” (Institute of Internal Auditors IIA, 2017, Sec. 1120, p. 5).
Prior research shows that IAF organizational status as proxied by the reporting lines of
IAFs, is one of the most significant factors that principally influence external auditors’
reliance decisions on internal controls (Bame-Aldred et al., 2013; Gray and Hunton, 2011;
Desai et al., 2010).
According to Soh and Martinov-Bennie (2011, p. 615), appropriate reporting lines for the
IAF to the audit committee “are perceived to be crucial in contributing to IAF effectiveness
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by ensuring independence and objectivity”. Goodwin and Yeo (2001) reports that audit
committee’s involvement in the appointment or removal of the CAE should encourage
internal auditors to perform their work objectively, leading to greater internal controls
quality.
In Malaysia, Fadzil et al. (2005) investigate the association between the IAF conformance
with internal audit standards and the quality of internal control. Findings show that internal
auditors’ objectivity significantly influences the quality internal control system. The study
also shows that management of IAF, performance of audit work, audit program and audit
reporting significantly influences the risk assessment aspect of the internal control system.
Lin et al. (2011, p. 293) highlighted that “an objective IAF is less likely to be influenced by
management in evaluating controls and reporting internal control problems to the audit
committee”. In a related vein, Bedard and Graham (2011) find that auditor could perform
better at detecting severe internal control weaknesses when he reports directly to the audit
committee rather than to senior management. Pizzini et al. (2015) find that CAE reporting
relationship to the audit committee is associated with reductions in audit report lag by
helping senior management maintain a strong system of internal control over financial
reporting. Thus, we expect that IAF organizational status will positively affect the internal
control quality. Based on these arguments, our hypothesis follows:
H1. There is a positive association between IAF organizational status and internal
control quality.
3.2.2 The working relationship between the chief audit executives and the audit committee.
One of the main missions of the audit committee is to oversee the internal audit program and
processes. Prior research argued that an effective working relationship between the audit
committee and the IAF can contributes toward the enhancement of internal auditors’
objectivity and implication in implementing control improvements (Turley and Zaman,
2004; Goodwin and Yeo, 2001; Raghunandan et al., 2001; Braiotta, 1999). For instance, Arena
and Azzone (2009) suggested that the intensity of the interaction between the internal
auditors and the audit committee may be a key factor of IAF effectiveness.
Abbott et al. (2010) surveyed 134 CAEs from Fortune 1000 companies and found that the
percentage of the IAF budget devoted to internal-controls-based activities is positively
related to the audit committee’s oversight. Lin et al. (2011) suggested that the extent of audit
committee review of the internal audit program and processes is positively associated with
the detection of internal control weaknesses.
Alzeban and Sawan (2015, p. 65) reported that “the amount of oversight by the audit
committee influences opportunities for identifying the IAF program’s strengths and
weaknesses, and for ensuring that internal audit recommendations are properly acted
 MAJ upon”. As discussed above, we expect audit committee’s involvement in reviewing the IAF
program and processes to positively influence the internal control quality.
Thus, the following hypothesis is proposed:
H2. There is a positive association between the audit committee’s involvement in
reviewing the internal audit program and processes and internal control quality.
3.2.3 Internal audit function competence. Internal audit attribute standard 1200 stipulates
that:
Internal auditors must possess the knowledge, skills, and other competencies needed to perform
their individual responsibilities. The internal audit activity collectively must possess or obtain the
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knowledge, skills, and other competencies needed to perform its responsibilities (Institute of
Internal Auditors IIA, 2017, p. 6).
Moreover, International Standard on Auditing ISA 610 states that in determining whether
the work of the IAF is likely to be adequate for purposes of the audit, external auditors shall
consider among other factors the technical competence of the internal auditors.
Consistent with this reasoning, prior academic studies generally considered that effective
internal auditors require competencies and training (Albrecht et al., 1988; Maletta, 1993;
Schneider, 2003; Arena and Azzone, 2009; Rittenberg and Anderson, 2006; Mihret et al.,
2010; Soh and Martinov-Bennie, 2011). For instance, Rittenberg and Anderson (2006)
identify experience and certification as the most important aspects of a qualified internal
auditor. In Malaysia, Fadzil et al. (2005) found that internal auditors’ professional
proficiency significantly affects the monitoring aspect of the internal control system.
Consistent with this finding, Suwaidan and Qasim (2010) reported that external auditors
in Jordan consider the objectivity, competence and work performance of internal auditors as
very important factors which may influence their reliance decisions on IAF work.
Using responses from 782 US CAEs in the CBOK (2006) database, Sarens et al. (2012)
found a positive association between the active role of the IAF in corporate governance and
CAE experience and qualification. Lin et al. (2011) investigated the role of the IAF in the
disclosure of material deficiencies. Findings show that materiel weaknesses disclosures are
negatively associated with the education level of internal auditors.
More recently, Pizzini et al. (2015, p. 54) found that the negative relation between IAF
quality and audit delay is primarily driven by the competence of internal audit staff. We
expect that internal auditors’ higher technical competence will enhance IAF effectiveness
and, therefore, should reduce the likelihood that severe internal control deficiencies exist.
Thus, the following hypothesis tests this assertion:
H3. There is a positive association between IAF competence and internal control
quality.
3.2.4 Internal audit function investment. Several studies contend that IAF effectiveness is
positively related to the resources available to the internal audit staff (Alhajeri, 2017).
Gramling et al. (2013, p. 588) suggested that greater internal audit investment could result in
hiring or training internal auditors to have greater competencies, and thus, the internal
auditors would be more likely to have a positive organizational impact.
Ge and McVay (2005) highlighted that weak internal control quality is generally due to
an insufficient commitment of resources for accounting controls. Mat Zain et al. (2006) found
a positive relationship between internal auditors’ evaluation of their contribution to the
financial statement audit and IAF size.
 Ashbaugh-Skaife et al. (2007) and Doyle et al. (2007) reported that internal control Internal
decencies disclosure and internal audit investment are negatively associated. control quality
According to Bedard and Graham (2011, p. 839):
Companies with an internal audit function might have less severe control flaws prior to Section
404 detection processes, and might also be better able to recognize severity than client personnel
without internal audit experience.
Lin et al. (2011) suggested that firms with greater IAF investment will implement stronger
Section 404 procedures in support of management’s evaluation of internal control over
financial reporting. Johl et al. (2013) found that a well-funded IAF has greater ability to limit
fraud and management opportunism. Pizzini et al. (2015) found that greater IAF investment
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contributes to the reduction of the time taken by the external auditor to issue the annual
audit report. Based on the above studies, the following hypothesis is proposed:
H4. Firms with greater IAF investment are less likely to have severe internal control
weaknesses.
3.2.5 Quality assurance and improvement program. Internal audit attribute standard 1300
suggests that “the CAE must develop and maintain a quality assurance and improvement
program that covers all aspects of the internal audit activity” (Institute of Internal Auditors
IIA, 2017, p. 7). Moreover, the quality assurance program aims to assess the adherence of
internal auditors with the International Standards for the Professional Practice of Internal
Auditing and the Code of Ethics (Institute of Internal Auditors IIA, 2017).
Furthermore, ongoing monitoring of the performance of the internal audit activity (e.g.
auditees satisfaction survey), periodic self-assessment and external independent
assessments are highly recommended under IIA Standard 1300.
Prior empirical studies provide evidence of a positive relationship between the use of
quality assurance techniques and financial reporting quality. Using 214 companies in the
GAIN database, Lin et al. (2011, p. 288) suggest that the extent to which the IAF incorporates
quality assurance techniques into fieldwork helps prevent material deficiencies from
occurring.
In a related vein, Sarens et al. (2012) found that the existence of a quality assurance and
improvement program in place is positively associated with the IAF’s role in corporate
governance. In Malaysia, Johl et al. (2013) reported that the use of quality assurance
techniques reduces opportunistic earnings management. Pizzini et al.’s (2015) findings
suggested that the use of quality assurance practices is significantly associated with
reductions in audit delay.
These arguments suggest that the use of quality assurance practices is positively
associated with internal control quality. Thus, we test the following hypothesis:
H5. There is a positive association between internal audit quality control assurance
level and internal control quality.
3.2.6 Follow-up on internal control deficiencies. Internal audit performance standard 2500
requires the CAE to establish a follow-up process to monitor the previously identified
internal control deficiencies and to ensure that management actions have been effectively
implemented or that top management has accepted the risk of not taking action (Institute of
Internal Auditors IIA, 2017).
According to Mihret and Yismaw (2007), the existence of a follow-up process of the
status of audit findings and recommendations leads to the improvement of IAF
effectiveness. Using data from the 2004 KPMG Fraud Survey, Coram et al.’s (2008) findings
 MAJ suggest “that internal audit adds value through improving the control and monitoring
environment within organizations to detect and self-report fraud” (p. 543).
Lin et al. (2011) used data from 214 US firms and found that firms with IAFs that follow-
up procedure on previously identified control problems reduce the likelihood that a material
weakness exists at year-end. This result suggests that monitoring the remediation of
previously identified control problems prompts management to correct them in a timely
manner. Hence, IAF follow-up procedures can prompt management to remediate identified
weaknesses in a timely manner. Accordingly, we hypothesize that the existence of follow-up
procedures are positively associated with internal control quality:
H6. There is a positive association between the existence of follow-up process and
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internal control quality.

4. Research method
4.1 Sample and data collection
We used a survey method to examine the association between IAF characteristics and
internal control quality. To do so, we contacted all the listed companies on the Tunis Stock
Exchange during the last quarter of 2016 in order to collect data related to firm’s IAF
characteristics’, internal control quality and specific governance and organizational
attributes. Consistent with past research, the survey was sent to CAEs (Oussii and Boulila
Taktak, 2015; Pizzini et al., 2015; Abbott et al., 2010; Prawitt et al., 2009; Mat Zain et al., 2006;
Carcello et al., 2005). Follow-up mailing and phone calls were made with the aim of
increasing the response rate.
In total, 81 questionnaires were distributed. Usable responses were received from 64 of
these 81 companies. Owing to missing necessary internal audit data, we deleted 5 companies
from the study’s sample, resulting in usable responses pertaining to 59 companies,
representing 72.8 per cent of all listed companies on the Tunis Stock Exchange.
This response rate is quite reasonable when compared with rates reported by prior
related studies (Alhajeri, 2017; Alzeban and Sawan, 2015; Zaman and Sarens, 2013; Sarens
and Abdolmohammadi, 2011; Goodwin-Stewart and Kent, 2006). To test for non-response
bias, responses received after the reminder were used as a proxy for non-respondents. We
find no significant differences after a comparison of the interest variables in our model with
respect to early and late participants. Table I shows a breakdown of the sampling design.

4.2 Variable measurement

4.2.1 The dependent variable. Prior empirical research used many indicators to measure
firms internal control quality. For instance, Lin et al. (2014), Barua et al. (2010), Krishnan and
Visvanathan (2007) and Zhang et al. (2007) used the information communicated in annual
reports following the Sarbanes-Oxley Act (section 404). Hu et al. (2017) rely on the
information communicated in the voluntary disclosure of auditors’ reports on internal
control quality. In emerging markets, Khlif and Samaha (2016) apply the survey
methodology to assess the internal control quality in Egypt. In Malaysia, Wan-Hussin and
Bamahrost (2013) used the publicly available data related to IAF investment.
Following prior studies (Bedard and Graham, 2011; Hoitash and Hoitash, 2009;
Hermanson et al., 2009), we use the number of severe internal control weaknesses detected
by internal auditors as a proxy for internal control quality (ICQ). This information is
obtained by the survey sent to CAEs in our sample. Thus, we expect that IAF characteristics
will enhance internal audit quality and, thus, should reduce the existence of internal control
 Panel A. Sample selection
Internal
Number of firms listed on TSE as at December 2016 81 control quality
Exclusions
Firms deleted because of non-responses to the survey (17)
Firms deleted because of missing data (5)
Total number excluded (22)
Final useable sample 59
Panel B. Sample firm break down by industry
Industry No. (%) sample
Consumer staples 12 20.35
Industrials 7 11.8
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Materials 4 6.78
Oil and gas 1 1.7
Health care 4 6.78
Consumers discretionary 8 13.56
Telecommunication services 1 1.7 Table I.
Financial services 22 37.3 Sample selection and
Total 59 100 industry breakdown

severe weaknesses. Conversely, if internal control severe weaknesses do exist, higher IAF
characteristics will be more likely to detect it.
4.2.2 The independent variables. For our tests relating to IAF characteristics, we use six
variables for analysis: IAF organizational status, audit committee involvement in
monitoring IAF’s program and processes, IAF competence, IAF investment, quality
assurance and improvement program and follow-up on internal control deficiencies.
In relation to IAF organizational status, the variable denoted (STAT) is an indicator
variable that takes the value of one if the IAF reports functionally to the audit committee.
This variable is added to test H1 and the regression coefficient of this variable is expected to
have a negative sign.
The (AC_REV) variable is used as a measure of the working relationship between the
internal auditor and the audit committee and is included in the model to test H2. This
variable is measured on a five-point Likert scale ranging from 1 = strongly disagree not at
all to 5 = strongly agree.
To test H3, the variable (COMPET) is added to the model and is proxied by a composite
score that measure the competence of internal audit staff. Following Pizzini et al. (2015,
p. 35), the score is obtained by standardizing four items: experience, education, certification
and training. Experience is the average number of years of audit experience of internal
auditors, while education is the average number of years of higher education. Certification is
the proportion of internal auditors with at least one audit certifications. Finally, training is
the average of annual hours of training per internal auditor. These four items are then
averaged and re-centered to create a continuous positive score.
To test H4, the variable IAF investment (INVEST) is added to the model. Consistent with
Mat Zain et al., 2006), this variable is measured by the natural log of the total number of staff
in the IAF divided by the natural log of total assets.
The variable quality assurance and improvement program (ASSUR) is included in the
model to test H5. Following Johl et al. (2013), ASSUR is a single composite score measuring
the extent to which the IAF incorporates quality assurance techniques into internal audit
activities. The score is an average of three variables, namely, existence of a quality
assurance program (PROG), internal assessment (INTASS) and external assessment
 MAJ (EXTASS). The scoring of each variable is as follows. PROG is a single dichotomous
variable indicating whether there is a formal quality assurance and improvement program.
INTASS is measured as the average of two survey items which are:
(1) the use of internal ongoing monitoring; and
(2) the existence of periodic reviews.

Each of these items ranges between 1 (none at all) and 5 (always).

Three survey items address the external assessment EXTASS: existence of an external
quality assessment (1/0), form of the external assessment: full external assessment versus
self-assessment with independent external validation (1/0) and whether an external
evaluation of the internal audit activities was carried out in the past five years (1/0).
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The score is formed dichotomizing (PROG), (INTASS) and (EXTASS) so that each has a
value of 1 if it is above the sample’s median, and 0 otherwise. Meanwhile, the quality
assurance and improvement program score (ASSUR) is the sum of these three variables.
The variable denoted (FOLLOW) is included in the model to test H6. This variable is
proxied by a dummy variable, taking a value of 1 if the IAF oversight the resolution of
previously identified internal control deficiencies and 0 otherwise.
4.2.3 Control variables. Based on prior studies (Khlif and Samaha, 2016; Bedard and
Graham, 2011; Lin et al., 2011; Bedard et al., 2009; Hoitash and Hoitash, 2009; Zhang et al.,
2007), we include a number of firm and governance characteristics as control variables as
they have been shown to be associated with internal control. The control variables used in
the model are:

the audit committee financial expertise (AC_EXP);

natural logarithm of the entity’s sales controls for firm size (F_SIZE);

the return on assets ratio (ROA) controls for firm’s strength in profitability; and

firm industry (FININD) for companies in the financial services industry.

4.3 Model
To test the empirical validity of our hypotheses formulated above, we estimate a balanced
panel data model and we use the following regression analysis:
ICQ ¼ b 0 þ b 1 STAT þ b 2 AC_REV þ b 3 COMPET þ b 4 INVEST þ b 5 ASSUR
þ b 6 FOLLOW þ b 7 AC_EXP þ b 8 F_SIZE þ b 9 ROA þ b 10 FININD þ «

Variables used in the above model are defined in Table II.

5. Empirical results
5.1 Descriptive statistics and correlations
Table III provides the descriptive statistics for the full sample of 59 companies listed on the
Tunis Stock Exchange. Panel A presents descriptive statistics of continuous variables,
whereas Panel B shows frequencies of categorical variables.
With respect to the dependent variable, the results shown in this table indicate that the
mean number of internal control weaknesses detected by internal auditors of the sampled
firms is approximately 9.
To explore IAF organizational status, the respondents were asked about the level they
report functionally to. Thus, 51 per cent of respondents indicate that they report functionally
 ICQ The number of severe internal control weaknesses detected by internal auditors
Internal
STAT An indicator variable that equals 1 if the CAE reports functionally to the audit committee control quality
and 0 otherwise
AC_REV Audit committee reviews internal audit program and results is measured on a scale from 1 to
5 (1 = strongly disagree to 5 = strongly agree)
COMPET A composite score measuring the competence of the IAF staff. The score is formed by
standardizing Experience, Education, Certification, and Training. These variables are
averaged, and the absolute value of the minimum of this average is added to each
observation to create a continuous, positive variable.
Experience: the average number of years of auditing experience of internal auditors.
Education: the average number of years of undergraduate and graduate education.
Certification: the proportion of internal auditors with one or more audit certifications.
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Training: the average of annual hours of training per internal auditor

INVEST The natural log of the total number of internal auditors employed by the firm
ASSUR A composite score measuring the internal audit quality control assurance level and ranges
between 0 (lowest quality) and 3 (highest quality). This composite score is formed by three
variables: QCPROG, INTASSESS and EXTASSESS, for which each of the measures are
aggregated. A value of 1 is given if the variables value is above median and 0 otherwise.
QCPROG: a dummy variable that equals 1 if the firm’s IAF has a formal quality assurance
program and 0 if otherwise.
INTASSESS: an average of two survey items coded from 0 to 2 (0: Never, 1: Occasionally,
and 2: Regularly) that measures the extent of ongoing monitoring of the performance of the
internal audit activity and periodic of the internal audit practices.
EXTASSESS: an average of three 0-1 survey items that measure the extent of external
quality assessment. The items are the existence of an external quality assessment; a full
external quality assessment was performed; and external assessment is conducted at least
once every five years
FOLLOW An indicator variable that equals 1 if there is a formal follow-up procedure to test the
implementation of corrective action
AC_EXP The proportion of financial experts on the audit committee
F_SIZE The natural logarithm of the entity’s sales
ROA The return on assets measured by net income divided by the total assets of firm i Table II.
FININD An indicator variable that equals one if the firm is defined as being within a financial Definition and
industry sector and zero if otherwise measurement of
« Error term variables

Variable Observation Mean SD Minimum Maximum

Panel A. Descriptive statistics for continuous variables

ICQ 59 9.79661 4.622 4 26
AC_REV 59 3.576271 0.770208 2 5
COMPET 59 1.655085 0.6536512 0.15 3.4
INVEST 59 1.552508 0.6520368 0.7 2.9
ASSUR 59 2.305085 0.7486594 1 3
AC_EXP 59 0.550339 0.1524056 0.33 0.75
ROA 59 0.0644864 0772797 0.85 0.26
F_SIZE 59 18.09517 1.181824 15.42 20.20

Panel B. Descriptive statistics for dummy variables

Variables Minimum Maximum Frequency (%)
STAT 0 1 1 82.098
FOLLOW 0 1 1 43.209 Table III.
FININD 0 1 1 19.135 Descriptive statistics
 MAJ to the audit committee/Board, while 49 per cent indicate that they report functionally to the
senior management.
The variable audit committee’s involvement in reviewing the internal audit program
(measured on a scale from 0 to 5) has an average score of 1.89, a median of 2 and ranges
between 0 and 4. This result refers to a weak level of audit committee’s involvement in
monitoring and reviewing the work of the IAF.
Our IAF competence composite score is formed from the sum of four variables:
Experience, Education, Certification and Training. Following Pizzini et al. (2015) approach,
each variable is standardized and the IAF competence score is then calculated by taking the
average of the four variables mentioned above. We finally add the absolute value of the
minimum of this average to each observation to create a continuous positive variable
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(COMPET). This variable has an average score of 1.65 and ranges between 0.15 and 3.4.
These results suggest that IAF in the sampled firms has adequate qualifications.
In terms of internal audit investment, the mean number of internal audit staff of the
sampled firms is approximately four internal auditors with a minimum of 2 and a maximum
of 16. These numbers of internal audit staff seem to be reasonable with respect to the size of
Tunisian listed companies.
Concerning the extent to which the IAF incorporates quality assurance techniques into
internal audit activities, our ASSUR composite score is the sum of three variables (each
having a score of 1 if above median). The results from Table III (Panel A) also show that the
sample firms have an average score of 2.1 and ranges between 0 and 3 which indicate a
significant level of use of quality assurance techniques in fieldwork.
The results shown in Table III indicate that 83 per cent of internal audit staff of the sampled
companies performed follow-up reviews. As for firm characteristic control variables, Panel B in
Table III shows that the average audit committee in our sample is comprised of approximately
55 per cent financial experts and that all audit committees have at least one financial expert.
The results shown in Panel B also indicate that the mean natural log of our sample firms’ total
revenues is 18.1 (F_SIZE), which is equivalent to about TND 70m indicating that the sample
consists of large companies. Additionally, descriptive statistics reveal that our sample firms
had an average (ROA) of 6.4 per cent. Finally, Panel B in Table III shows that firms in the
finance industry comprise about 40 per cent of the study’s sample.

5.2 Correlations analysis

We examine the Pearson correlation among the study’s variables. Table IV indicates a
number of significant correlation coefficients involving independent and control variables.
For instance, results show that the IAF organizational status is positively and significantly
correlated with committee’s involvement in reviewing the internal audit program and
results. However, all correlation coefficients of the study’s variables are below 0.7 which
indicates that multicollinearity is not of an issue (Kervin, 1992). To further check for the
possibility of multicollinearity between the variables included in our model, we additionally
calculated the variance inflation factors (VIF) for the independent variables. The highest
variance inflation factor of 2.55 is below the threshold of 10. Thus, we find no signs of a
multicollinearity problem.

5.3 Multivariate analysis

Multivariate regression analysis was conducted to investigate the impact of IAF
characteristics on internal control quality for a sample of 59 Tunisian listed companies.
Table V presents the empirical results of our regression model. As indicated in this Table,
the F-statistic of the model is significant (F = 17.55, p < 0.00003 with an R2 of 0.702). The
 Downloaded by UNIVERSITY OF NEW ENGLAND (AUS) At 07:51 01 May 2018 (PT)

Variable STAT AC_REV COMPET INVEST ASSUR FOLLOW AC_EXP ROA FININD F_SIZE VIF 1/VIF

STAT 1.0000 2.32 0.403

AC_REV 0.5727* 1.0000 2.46 0.405
COMPET 0.3736** 0.5727* 1.0000 2.29 0.408
INVEST 0.2943** 0.4735*** 0.4602** 1.0000 2.52 0.392
ASSUR 0.4278** 0.3673** 0.3851** 0.2381 1.0000 2.14 0.466
FOLLOW 0.2849** 0.1817** 0.2590** 0.3629 0.2683** 1.0000 1.42 0.656
AC_EXP 0.4030** 0.3771** 0.5256*** 0.1665 0.4929 ** 0.2329** 1.0000 2.46 0.405
ROA 0.0621 0.0943 0.0917 0.0291 0.2071 0.0989 0.1307 1.0000 1.41 0.660
FININD 0.2421 0.3070** 0.2487*** 0.3716 0.0928 0.2611 0.3294** 0.3577* 1.0000 1.90 0.526
F_SIZE 0.1701* 0.2690** 0.1992** 0.4056 0.0505* 0.1995* 0.0021 0.1413 0.2114 1.0000 1.55 0.645

Notes: Significant at: ***0.01; **0.05; and *0.1 levels; STAT = An indicator variable that equals 1 if the CAE reports functionally to the audit committee and 0
otherwise; AC_REV = audit committee reviews internal audit program and results (1 = strongly disagree to 5 = strongly agree; COMPET = A composite score
measuring the competence of the IAF staff. The score is formed by standardizing experience, education, certification and training. These variables are averaged,
and the absolute value of the minimum of this average is added to each observation to create a continuous, positive variable; INVEST = the natural log of the
total number of internal auditors employed by the firm; ASSUR = Internal audit quality control assurance, is a composite score measuring the internal audit
quality control assurance level and ranges between 0 (lowest quality) and 3 (highest quality). This composite score is formed by three variables: QCPROG,
INTASSESS and EXTASSESS, for which each of the measures are aggregated. A value of 1 is given if the variables value is above median and 0 otherwise;
FOLLOW = an indicator variable that equals 1 if there is a formal follow-up procedure to test the implementation of corrective action; AC_EXP = the proportion
of financial experts on the audit committee; ROA = return on assets measured by net income divided by the total assets of firm i in time period t; FININD =
indicator variable that equals one if the firm is defined as being within a financial industry sector and zero if otherwise; F_SIZE = natural logarithm of the entity’s
sales

Table IV.
control quality
Internal

Pearson correlations
 MAJ value of R2 indicates that about 70 per cent of the variance of internal control quality can be
explained by the independent variables in the regression model.
In terms of IAF characteristics, we find that that the number of severe internal control
weaknesses detected by the IAF is not significantly associated with IAF organizational
status (STAT). Results also show that the coefficient of IAF investment (INVEST) is
statistically insignificant. These findings are contrary to the study’s expectation and do not
provide support to H1 and H4. The lack of a statistically significant relationship between
IAF organizational status, IAF investment and severe internal control weaknesses might
possibly be explained by the greater ability of an independent and bigger IAF to prevent
internal control deficiencies from occurring.
We find support for H2, which predicts associations between the audit committee’s
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involvement in reviewing the internal audit program and results (AC_REV) and our proxy
for internal control quality. The coefficient on (AC_REV) is negative and statistically
significant, with p-values of 0.067.
Consistent with H3, we find that the number of severe internal control weaknesses
detected by the IAF is negatively associated with internal auditors’ skills and competencies
with p-values of 0.049. This result is consistent with the suggestions provided in prior
empirical studies (Lin et al., 2011) that the competence of the internal audit staff is
consistently associated with significant reductions of internal control weaknesses occurrence.
Results also show that, as expected, the regression coefficients of the internal audit quality
control assurance level (QAP) and follow-up process (FOLLOW) have the predicted sign and
are statistically significant, with p-values of 0.001 and 0.047, respectively. These finding are
consistent with are consistent with Lin et al. (2011) who found that materiel weaknesses
disclosures are decreasing in the use of quality assurance techniques during fieldwork and
the extent to which IAF follow-up on extant internal control deficiencies previously detected.
With respect to control variables, the regression results indicate that both audit committee
financial expertise (AC_EXP) and firm’s (ROA) are negatively associated with the number of
severe internal control weaknesses implying that audit committee expertise is associated with
higher quality internal controls (Abernathy et al., 2014; Hoitash and Hoitash, 2009). Our

Variable Estimated coefficient Standard error t-statistic p-value

STAT 0.6817496 0.9144749 0.75 0.460

AC_REV 1.4102251 0.613695 1.68* 0.067
COMPET 1.529867 0.700802 1.90** 0.049
INVEST 0.5381619 0.7205499 0.75 0.459
ASSUR 2.665459 0.5793318 4.50*** 0.001
FOLLOW 1.881973 0.9665505 1.93** 0.047
AC_EXP 1.077584 3.051536 1.57* 0.074
ROA 8.34337 4.717213 2.62 0.012
FININD 0.9544962 0.8300381 1.15 0.256
F_SIZE 0.9605648 0.3121019 2.08** 0.036
Intercept 6.154865 5.632484 1.09 0.280
Model
R2 0.7029
F-statistic 17.55
Significance F <0.002
N 59
Table V.
Regression analyses Notes: Significant at: ***0.01; **0.05; and *0.1 levels. See Table III for variable definitions
 findings are also consistent with Ge and McVay (2005) and Doyle et al. (2007) who documented Internal
that internal control weaknesses disclosure is more likely for less profitable firms more control quality
profitable ones. Results also show that firm’s size is positively related to severe internal control
weaknesses. This implies that larger companies with greater corporate complexity and scope of
operations are more likely to have internal control problems. This finding is consistent with
prior studies such as Khlif and Samaha (2016) and Zhang et al. (2007).
Therefore, our findings reveal that, consistent with expectations, the internal control
quality is significantly and positively associated with audit committee’s involvement in
reviewing the internal audit program and results, IAF competence, internal audit quality
control assurance level, follow-up process and the proportion of financial experts on the
audit committee. The results, however, could not reveal a statistically significant association
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between the IAF organizational status, IAF investment and firm’s internal control quality.

5.4 Sensitivity test

To validate the main results, we perform several sensitivity analyses. In the case of the
dependent variable, we capture internal control quality with the variable ICQ, which is
measured by a dummy variable that equals 1 if the external auditor signals at least one
internal control weakness in his audit report and 0 otherwise. To do so, we perform content
analysis of external auditor’s annual report to assess the firm’s internal control quality.
Consistent with the main results reported in Table V, findings presented in Table VI using the
alternative variable measure continue to show a significant positive association between internal
control quality, audit committee’s involvement in reviewing the internal audit fieldwork, IAF
competence, internal audit quality control assurance level and follow-up process.

6. Conclusion
The main objective of this study is to examine the association between IAF characteristics
are and internal control quality in an emerging market context. Research hypotheses are
developed to analyze whether the internal control quality is influenced by firm’s IAF
characteristics. The empirical findings provide evidence that IAF’s attributes and activities
are positively and significantly related to internal control quality. In particular, the results

Variable Estimated coefficient Standard error t-statistic p-value

STAT 0.0549829 0.1031152 1.55 0.122

AC_REV 0.0740427 0.1081471 1.78** 0.025
COMPET 9.285864 13.9705 1.58** 0.037
INVEST 0.2107601 0.3158428 1.04 0.299
ASSUR 0.0480221 0.0812771 1.79** 0.023
FOLLOW 0.1723615 0.2515084 1.30* 0.058
AC_EXP 0106511 0.0676226 0.72 0.474
ROA 37.9952 391.3045 0.35 0.724
FININD 0.0006122 0.0018602 2.43*** 0.005
F_SIZE 4.406988 4.316879 1.51 0.130
Intercept 0.0027088 0.0365784 0.44 0.662
Logistic regression Number of obs = 59
LR x 2 (10) = 39.20
Prob > x 2 = 0.0000
Log likelihood = 15.826976 Pseudo R2 = 0.5533
Table VI.
Notes: Significant at: ***0.01; **0.05; and *0.1 levels. See Table III for variable definitions Sensitivity analysis
 MAJ show evidence of a significantly positive association between audit committee’s
involvement in reviewing the internal audit fieldwork, IAF competence, internal audit
quality control assurance level, follow-up process and internal control quality as proxied by
the number of severe internal control weaknesses detected by internal auditors. Main results
are found to be robust to alternative measure of internal control quality.
Collectively, our findings shed light on the importance of effective IAF in providing assurance
about internal control quality as well as the financial reporting process. The results of the present
study make a number of key contributions. With respect to researchers, this study adds to the
growing body of literature on the relationships between different corporate governance
mechanisms and provides support for the importance of the IAF characteristics and its ability to
contribute toward financial reporting quality through its improvements to the internal control
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system in an emerging market. With respect to managers and audit committees, our results show
that improving firm’s IAF technical competence and work performance will contribute to
stronger internal controls, and therefore helps managers to improve the quality of financial
reporting by firms. With regard to regulatory bodies, our findings suggest that there may be
benefits in relooking into how to further enhance IAF effectiveness to improve internal control
quality leading to better quality financial reporting outcomes.
Our findings have important implications for regulatory bodies who are concerned with
the internal control quality, managers and audit committees who determine IAF investment,
oversight IAF activities and assess internal auditors’ performance.
Our study is subject to several limitations that should be considered when interpreting
the results. First, the sample size of our study is relatively limited. This small sample size is
however normal for a Tunisian market where the number of listed companies barely
exceeds 80. Second, there may exist other variables influencing internal control quality that
were not included in our model. Hence, future research may thus consider the impact of
other corporate governance variables such as CEO characteristics and audit committee
activity on internal control quality.

Note
1. Prior studies (i.e. Arena and Azzone, 2009; Mihret and Yismaw, 2007) documented that IAF
effectiveness is influenced by internal audit quality (including its organizational status, its size
and the level of expertise of internal audit staff) and senior management support.

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Further reading
Alzeban, A. and Swan, N. (2016), “The relationship between adherence of internal audit with standards
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high: some empirical findings”, Advances in Accounting, Vol. 8 No. 1, pp. 293-311.
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Accounting Research, Vol. 24 No. 1, pp. 194-205.
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function as a management training ground on the external auditor’s reliance decision”, The
Accounting Review, Vol. 86 No. 6, pp. 2131-2154.
Tunisian Financial Security Act (2005), “Law no. 2005-96 of 18 October 2005 concerning enhanced
security measures for financial relations”.

About the authors

Dr Ahmed Atef Oussii is an Assistant Professor of auditing and control at ISAAS School of Business –
University of Sfax. He has published many papers in international journals in the areas of internal
auditing, audit committees, financial reporting quality and accounting education. Ahmed Atef Oussii is
the corresponding author and can be contacted at: ahmed_atef.oussii@yahoo.fr
Professor Neila Boulila Taktak is a full Professor of accounting, IHEC Carthage, University of
Carthage. She is the author of several scientific publications dealing with the North African and
international context. She is a member of the editorial team for Journal of Islamic Accounting and
Business Research and Emerald Insight.

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