The auditor as consultant: careful planning is required as audit practitioners transition toward a broader orientation and expanded role in the organization - related article: Adapting to the Role of Consultant

Internal Auditor, Dec, 2002 by Sam M. McCall

ENERGIZED IN PART BY THE NEW DEFINITION of internal auditing, many internal auditors currently find themselves performing a much broader spectrum of activities than ever before. In particular, the addition of consultative services to the internal auditor's defined set of competencies has introduced an entirely new dimension to the profession. Audit practitioners who at one time focused largely on measuring, evaluating, and reporting on the effectiveness of internal controls are now expanding their role by working with managements on ways to improve operations and add continuous value to the organization. By providing consulting services, many auditors are helping to ensure that management sees the audit function as essential to achieving organizational goals and objectives.

Although consulting work provides many new opportunities for internal auditors, it can also pose a threat to the audit function if the transition toward consultant auditing is not managed carefully. Specifically, consulting may jeopardize internal auditing's traditional role as the board's trusted, independent, and neutral monitor of management's actions. The board may find that auditing's consulting work with management affects its ability to review management activity objectively and to provide the board with an unbiased appraisal. Failure to effectively serve the board's needs could damage auditing's credibility and, in some organizations, ultimately lead to downsizing--or even outsourcing--of the audit function.

The challenge, then, is for internal auditors to provide consulting services to management without compromising their role as monitor for the board. At the Office of the City Auditor in Tallahassee, Fla., we have found an effective way to achieve this goal that is applicable to almost all audit settings, including those that do not include a board of directors. Our approach, as explained in the context of principal-agent theory, may be helpful to internal auditors seeking to adapt to their new role as consultant while maintaining their commitment to traditional audit services.

THEORY BEHIND THE PRACTICE

Principal-agent theory, in its simplest form, analyzes the dynamics between two parties engaged in business. In a basic principal-agent relationship, one party (the principal) grants another party (the agent) the authority to act on its behalf. The agent, then, is responsible for making decisions that further the interests of the principal.

A potential problem with principal-agent relationships occurs when the interests of the agent and those of the principal conflict. That is, the agent may make decisions that are not in the best interest of the principal, hence calling the reliability of the agent into question. To help resolve this problem, the principal typically establishes some way of monitoring the agent's activity.

The dynamics of principle-agent theory apply to the relationship between internal auditors and their clients. When examined in light of auditing's traditional role, the board can be identified as the principal, management as the agent, and the internal auditor as the board's trusted, independent, and neutral monitor. More specifically, the auditor serves as an extension of the board, representing its interests and reviewing the actions of management in carrying out the board's directions. In addition, the auditor reports to the board--in the form of assurance services--on management's actions.

When viewed in this context, it becomes dear that internal auditors face a potential conflict when requested by management--the agent--to provide consulting services on monitored activities. Principal-agent theory suggests that rendering these additional services for management would violate the auditor's relationship with the board. That is, the monitor's objectivity may be compromised, reducing its effectiveness as a watchdog for the principal.

Furthermore, principal-agent theory, and the conflict it illustrates, can be applied to internal auditors who do not report to a board, but instead report to top-level management or to an organization head in the private or government sector. Auditors in these settings may face similar issues when monitoring for the highest levels of the organization and providing consulting services for those at other levels.

Principal-agent theory, then, helps to illustrate the dilemma faced by auditors who act as consultants: Can auditors serve their "principal" as monitor of the agent's actions when they also concurrently perform consulting services for the agent? Finding an effective way to manage this issue is key to the success, and even survival, of internal auditors looking to provide consulting services to their clients.

MEETING THE CHALLENGE

At the city of Tallahassee, the city auditor serves as monitor for the city commission (the principal), which represents the legislative arm of city government. The city's manager, attorney, and treasurer-clerk function as agents for the commission and represent the executive arm of the government. These three individuals are charged with carrying out city commission policy and implementing services and programs in an economical, efficient, and effective manner. The commission established the position of city auditor to serve as the monitoring link between itself and executive management.