Pros and cons of outsourcing internal audit services

¶ … Outsourcing Internal Audit Services by Companies

Internal audit services have changed dramatically, in recent years, with the advancement of technology and its facilitation of outsourcing these services. In addition, due to recent scandals that have plagued corporate America, including: Enron, WorldCom, and others, internal auditing has become evermore important, with management and other organizational stakeholders demanding the absolute best from the internal audit function. With the increased importance of the internal audit and the advancement of technology, many organizations are looking to specialized companies to outsource their internal audit function. This paper will give a brief overview of the trend in outsourcing internal auditing services before then exploring both the pros and the cons of outsourcing internal audit services by organizations.

Outsourcing Internal Audit Services Overview:

Despite the recent attention outsourcing has received, the concept itself is not new, not even for internal auditing. However, due to recent trends in the industry, outsourcing, including outsourcing the internal audit function, has become an increasingly utilized phenomenon.

As Rittenberg, Moore and Covaleski note, outsourcing revenues grew from nearly zero to an estimated $120 billion in 2000. In fact, a report by Corbett noted that 85% of American organizations now purchase services that could be performed in-house (Carey, Subramaniam, Chua, and Ching).

Today, outsourcing of internal auditing services is a common practice in the United States. Carey, Subramaniam, Chua, and Ching state that "although traditionally internal audit has been conducted in-house, the expansion of internal audit outsourcing appears to mirror a wider trend across organizations of outsourcing non-core areas, such as information technology, human resource management and taxation, and legal services." Companies, over the last decade, have worked to streamline their operations by outsourcing these non-core competencies business functions. Trent agrees with Carey, Subramaniam, Chua, and Ching noting that increasingly organizations are seeking to engage experienced third-party outsourcers to perform routine tasks such as managing information technology, administering payroll, collections, and others, such as internal auditing.

There has been an increased interest in corporate governance in recent years. Organizations now more than ever need to effectively manage a varied array of risks, which illustrates the expanding opportunities for the internal audit function. Much of this has been triggered by the recent financial reporting scandals. This has also led to subsequent legislative and professional responses to these scandals. Both results further highlight how important internal audit is, as a critical resource, for organizational management. For this reason, managing both the quality and costs of the internal audit is a key component of management fulfilling its responsibility to providing a sound governance system (Carey, Subramaniam, Chua, and Ching).

Outsourcing of internal audit functions has been facilitated by two primary factors. Increases in information technology has made it easier for both large accounting firms and independent internal audit providers, to offer their services competitively.

This, as well as the previously noted increased importance of the internal audit function, due to recent corporate scandals and a demand from stakeholders for increased internal auditing, has led to an increased usage of specialized internal auditing companies, by organizations.

This trend has sparked a discussion on the pros and cons of outsourcing such an important and sensitive function.

Outsourcing Internal Audit Services Benefits:

As leading internal audit service provider, Deloitte Touche, notes, "Outsourcing the entire internal audit function to an external provider can be an effective business solution to allow management to focus its time and effort on core competencies of the organization." By outsourcing this function, companies can turn over a non-core business function to a provider who specializes in this type of service. These organizations are able to more efficiently and effectively provide internal audit functions than the business can with their staff, due to the provider's specialization (Carey, Subramaniam, Chua, and Ching).

Organizations, especially smaller organizations, simply cannot cost-effectively maintain an in-house internal audit function, with the level of expertise as a company who specializes in this type of service. These organizations are able to provide their services, with the benefit of economies-of-scale, which, as Rittenberg, Moore, and Covaleski put forth, should result in a cost savings for similar services provided in-house, or, in some instances, superior services at a reduced cost to those provided in-house.

In addition, outsourcing these services rather than maintaining an in-house department for internal audit, offer further benefits. The organization no longer has to attract and retain internal audit talent, which can be increasingly difficult, especially in specialized skill areas.

As Carey, Subramaniam, Chua, and Ching note, by outsourcing this function, organizations have access to the most up-to-date internal audit tools and methodologies, when using a company that specializes in internal audit.

Organizations do not have to concern themselves with maintaining relevant training of internal staff ("Internal Audit Services"). Instead, organizations that outsource the internal audit function likely have access to expertise that is not available in-house (Rittenberg, Moore, and Covaleski).

Rittenberg, Moore, and Covaleski surmise that by outsourcing the internal audit function organizations can focus their efforts on their core competencies and the organization's strategic plans. Associated with this, by removing the distraction of the internal audit function, the company can focus on their customers. There is also a greater flexibility in resource allocation, according to these authors, as the organization can take a fixed cost and transform it into primarily a variable cost.

In addition, in today's increasingly globalized world outsourcing internal auditing services offer a unique benefit. Outsourcing to a company with experience in auditing in specific geographic areas strengthens international and cultural coverage. There is also "expanded geographic coverage through trained personnel possessing local knowledge" (Rittenberg, Moore, and Covaleski) for those organizations which choose to outsource.

Outsourcing Internal Auditing Services Disadvantages:

Despite these clear advantages to outsourcing the internal auditing function, there are several disadvantages that opponents to outsourcing are concerned about.

There is a concern that the cost-savings originally experienced will not be sustained. Rittenberg, Moore and Covaleski note that there is a fear that outsourcing providers will increase their pricing as competition decreases, especially as larger providers buy market share.

A greater premium for their services negates one of the primary benefits of outsourcing internal auditing services. In addition, when the a high frequency of internal audit activity is needed, in-house internal audit staff may also be able to capture similar economies-of-scale, reducing this benefit of outsourced auditing services. For this reason, Carey, Subramaniam, Chua, and Ching surmise that these economies-of-scale are only common in smaller firms.

There is also a concern that outsourcing internal auditing does not develop new management. and, that internal auditing is an integral part of corporate governance that simply should not be outsourced (Rittenberg, Moore, and Covaleski). With management removed from the internal auditing function, due to it being outsourced, the training experience that can come from the auditing process is lost. With this educational loss, is a lost opportunity for greater insight on the intricacies of the organization, and thus could result in the loss of valuable strategies that may have come from this greater level of insight.

Although outsourcing the internal audit function allows outsourcing providers to utilize economies-of-scale, to the organizations benefit, as Rittenberg, Moore and Covaleski, as well as Carey, Subramaniam, Chua, and Ching, note that the outsourcer does not know the organization's business as well as an in-house internal auditing team would. Although the outsourcing provider may have the specialized knowledge specific to internal auditing, this benefit is reduced by the lack of specialized knowledge of the company its auditing itself. Internal auditors acquire a tremendous knowledge of the business, that can only be acquired, according to Smith, through years of daily interaction with organizational management and staff.

Outsourced auditors not only don't have this same understanding of the business, but they also don't have the same knowledge regarding the people performing the business transactions. In addition, outsourcing providers may use personnel who are inexperienced to perform audits, further negating this benefit. An organization may have little knowledge or control of this, in contrast to an in-house auditing staff, where they can be assured of an internal auditor's expertise and experience.

There is also a potential for mixed allegiance when an organization outsources their internal auditing services. With in-house internal auditing staff, these employees have an allegiance to the organization. However, when this function is outsourced, the auditors have an allegiance to the outsourcing firm. in-house auditors must live with the results of the accuracy of their audit, while an outsourced auditor does not necessarily (Rittenberg, Moore, and Covaleski).

For this reason, in-house internal auditing staff have a greater commitment to the long-term well-being of the company (Carey, Subramaniam, Chua, and Ching). Outsourced auditors often go from client to client further decreasing their loyalty to the audited organization.

As employees of the organization, in-house internal auditing staff are financially vested in the organization's well-being. "They may have stock options and they may have company stock in their 401(k).

This level of commitment ensures that they will act in the best long-term interests of the company" (Smith).

One of the most significant disadvantages, and potentially dangerous aspects, to outsourcing is the transfer of sensitive data, according to Klosek.

Auditing outsourcers may subcontract their services, unless it is specifically stated in the contract that they cannot do so without the organization's consent. If subcontracting does occur, and is not provided for in the contract, the outsourcer may not be liable for functions that were subcontracted.

However, just as financial scandals such as Enron and WorldCom have highlighted the importance of having the absolute highest quality of internal audit performed, in order to safeguard the interests of stakeholders, these scandals also have provided evidence that outsourcing this critical function may not be the best move, for an organization.