Internal Control Deficiencies in Tax Reporting: A Detailed View

2015 ◽  
Vol 29 (4) ◽  
pp. 917-942 ◽  
Author(s):  
Lynford Graham ◽  
Jean C. Bedard
Keyword(s):  
Financial Reporting ◽  
Internal Control ◽  
Public Information ◽  
Data Availability ◽  
Fiscal Year ◽  
Sarbanes Oxley ◽  
Financial Misstatement ◽  
Internal Control Deficiencies ◽  
Using Data ◽  
Tax Reporting

SYNOPSIS Prior research, using data from Sarbanes-Oxley Act Sections 302/404 (SOX, U.S. House of Representatives 2002) disclosures, finds that material weaknesses (MWs) in internal controls over financial reporting of taxes are more frequent and consequential than other account-specific MWs. Understanding internal control deficiencies (ICDs) in tax reporting is important but public information is limited, as MWs comprise only control flaws remaining unremediated at year-end and few details on their nature are available from SEC filings. We supplement prior studies by providing a detailed look at all Section 404 control deficiencies in tax reporting in a proprietary sample of engagements in 2004–2005 from several large auditing firms. We find that tax ICDs are less likely to be remediated between discovery and fiscal year-end, more likely to be severe, and more likely to have caused a financial misstatement. Remediation failure for tax ICDs is greater when management missed detecting the problem, and more prevalent for poorly designed controls, controls over the tax provision, and monitoring control activities. Auditors' severity classifications imply that ICDs relating to the tax provision and deferred taxes, and those that failed in operation, have higher potential for producing misstatements. Overall, our results underscore the importance of auditor involvement in internal control reporting in the tax area. Data Availability: Data used for this study were provided under confidentiality agreements, and cannot be shared.

SOX Section 404 Material Weakness Disclosures and Audit Fees

2006 ◽  
Vol 25 (1) ◽  
pp. 99-114 ◽  
Author(s):  
K. Raghunandan ◽  
Dasaratha V. Rama
Keyword(s):  
Financial Reporting ◽  
Internal Control ◽  
Audit Fees ◽  
Internal Controls ◽  
Fiscal Year ◽  
Section 404 ◽  
Control Material ◽  
Material Weakness ◽  
Sarbanes Oxley ◽  
The Mean

Section 404 of the Sarbanes-Oxley Act and Auditing Standard No. 2 (PCAOB 2004) require management and the auditor to report on internal controls over financial reporting. Section 404 is arguably the most controversial element of SOX, and much of the debate around the costs of implementing section 404 has focused on auditors' fees (Ernst & Young 2005). In this paper, we examine the association between audit fees and internal control disclosures made pursuant to section 404. Our sample includes 660 manufacturing firms that have a December 31, 2004 fiscal year-end and filed the section 404 report by May 15, 2005. We find that the mean (median) audit fees for the firms in our sample for fiscal 2004 is 86 (128) percent higher than the corresponding fees for fiscal 2003. Audit fees for fiscal 2004 are 43 percent higher for clients with a material weakness disclosure compared to clients without such disclosure; however, audit fees for fiscal 2003 are not associated with an internal control material weakness disclosure (in the 10-K filed following fiscal 2004). We also find that the association between audit fees and the presence of a material weakness disclosure does not vary depending on the type of material weakness (systemic or non-systemic).

The Influence of Auditor and Client Section 404 Processes on Remediation of Internal Control Deficiencies at All Levels of Severity

2013 ◽  
Vol 32 (4) ◽  
pp. 45-69 ◽  
Author(s):  
Lynford Graham ◽  
Jean C. Bedard
Keyword(s):  
Internal Control ◽  
Financial Risk ◽  
Balance Sheet ◽  
Section 404 ◽  
Level Control ◽  
Sarbanes Oxley ◽  
Material Weaknesses ◽  
Financial Misstatements ◽  
Internal Control Deficiencies ◽  
Using Data

SUMMARY This paper examines remediation of Sarbanes-Oxley Section 404 internal control deficiencies (ICDs) at all levels of severity, before the balance sheet date. While a number of studies investigate remediation of publicly disclosed material weaknesses (MWs), the activity we study takes place out of public view and occurs among companies with both clean and adverse Section 404 opinions. Using data provided by multiple auditing firms, we find that about one-fourth of detected ICDs are remediated before year-end, leaving many uncorrected. We model remediation activity with direct measures of company and auditor Section 404 processes not available to prior research. Model results show that companies' effective information technology integration and early start to control testing are positively associated with remediation. In contrast, remediation is negatively associated with discovery by auditors, discovery by substantive tests, and related financial misstatements. Following prior research on MWs, we also observe that ICD remediation is less likely for smaller companies with greater financial risk, and for certain entity-level control problems.

Determinants of the Persistence of Internal Control Weaknesses

2012 ◽  
Vol 26 (2) ◽  
pp. 307-333 ◽  
Author(s):  
Bonnie K. Klamm ◽  
Kevin W. Kobelsky ◽  
Marcia Weidenmier Watson
Keyword(s):  
Financial Reporting ◽  
Internal Control ◽  
Management Training ◽  
Internal Controls ◽  
Senior Management ◽  
Data Availability ◽  
The Public ◽  
Sarbanes Oxley ◽  
Material Weaknesses ◽  
Specific Control

SYNOPSIS This paper analyzes the degree to which material weaknesses (MWs) in internal control reported under the Sarbanes-Oxley Act of 2002 (SOX) affect the future reporting of MWs. Particularly, we examine information technology (IT) and non-IT MWs and their breakdown into specific IT-related entity-level, non-IT-related entity-level, and account-level deficiencies. Analysis reveals that most account-level and entity-level deficiencies occur at a significantly higher rate in SOX 404 reports with at least one IT MW than in MW reports with only non-IT MWs. Further, the presence and count of both types of MWs and all three types of deficiencies are associated with increased future MWs, as are lower profitability, non-Big 6 auditor, and firm complexity. Specific control deficiencies related to senior management, training, and IT control environment have the strongest impact on future MWs. These results indicate that effective corporate governance of both the IT and non-IT domains is pivotal in establishing and maintaining strong internal controls over financial reporting. Data Availability:  Data are available from the public sources identified in the paper.

Former Audit Partners on the Audit Committee and Internal Control Deficiencies

2009 ◽  
Vol 84 (2) ◽  
pp. 559-587 ◽  
Author(s):  
Vic Naiker ◽  
Divesh S. Sharma
Keyword(s):  
Financial Reporting ◽  
Internal Control ◽  
House Of Representatives ◽  
Audit Committee ◽  
Discretionary Accruals ◽  
Negative Association ◽  
Internal Controls ◽  
Sarbanes Oxley ◽  
External Auditor ◽  
Internal Control Deficiencies

ABSTRACT: This study examines the association between internal control deficiencies (ICDs) reported under Section 404 of the Sarbanes-Oxley Act (SOX, U.S. House of Representatives 2002) and the presence of former audit partners on the audit committee who are affiliated (AFAPs) and unaffiliated (UFAPs) with the firm's external auditor. We find a negative association between AFAPs and UFAPs on the audit committee and ICDs. We also find results that suggest the NYSE and NASDAQ three-year “cooling-off” rule applying to AFAPs may be unwarranted and deserves further empirical and regulatory attention. Further tests suggest AFAPs do not allow management to circumvent the disclosure of ICDs when conditions appear to suggest this may be so, and that AFAPs are negatively related to performance-adjusted discretionary accruals. Collectively, we interpret these findings to suggest that AFAPs and UFAPs on the audit committee are associated with more effective monitoring of internal controls and financial reporting.

The Impact of Culture on Internal Control Weaknesses: Evidence from Firms That Cross-List in the U.S.

2017 ◽  
Vol 16 (3) ◽  
pp. 119-145 ◽  
Author(s):  
Maria T. Caban-Garcia ◽  
Carmen B. Ríos Figueroa ◽  
Karin A. Petruska
Keyword(s):  
Financial Reporting ◽  
Internal Control ◽  
Power Distance ◽  
Data Availability ◽  
Country Level ◽  
Sarbanes Oxley ◽  
And Control ◽  
Section 302 ◽  
The Impact

ABSTRACT This study addresses the impact of culture on the likelihood of U.S. foreign issuers reporting material weaknesses in internal control over financial reporting (MWICs). Specifically, we explore whether Hofstede's (1980, 2001) country-level dimensions of power distance, individualism, uncertainty avoidance, masculinity, and long-term orientation explain the likelihood of U.S. foreign issuers reporting internal control deficiencies under Section 302 of the Sarbanes-Oxley Act (SOX). To assess whether home country guidance on internal control reporting influences U.S. foreign issuers detecting and reporting MWICs, we identify and control for the adoption of internal control guidance in foreign jurisdictions. Our results show that firms from countries with a high power distance and long-term orientation are more likely to report MWICs. In addition, we find that firms from countries that implement internal control guidance are less likely to report MWICs, suggesting that the effectiveness of U.S. foreign issuers' internal control over financial reporting is influenced by their home countries' regulation and oversight. These results are generally robust to a number of additional sensitivity tests. JEL Classifications: M14; M16; M48. Data Availability: Data are from publicly available sources.

Behind the Numbers: Insights into Large Audit Firm Sampling Policies

2014 ◽  
Vol 29 (1) ◽  
pp. 61-81 ◽  
Author(s):  
Brant E. Christensen ◽  
Randal J. Elder ◽  
Steven M. Glover
Keyword(s):  
Financial Reporting ◽  
Internal Control ◽  
Data Availability ◽  
Future Research ◽  
Accounting Firms ◽  
Sarbanes Oxley ◽  
Big 4 ◽  
National Office ◽  
Current Sampling ◽  
Audit Sampling

SYNOPSIS Changes in the audit industry after the Sarbanes-Oxley Act, including mandatory audits of internal control over financial reporting and PCAOB oversight and inspection of audit work, have potentially changed the nature and extent of audit sampling in the largest accounting firms. However, little academic evidence exists on these firms' current audit sampling policies (Elder, Akresh, Glover, Higgs, and Liljegren 2013). As such, we administer an extensive, open-ended survey to the national office of the Big 4 and two other international accounting firms regarding their firm's audit sampling policies. We find variation among the largest auditing firms' policies in their use of statistical and nonstatistical sampling methods and in inputs used in the sampling applications that could result in different sample sizes. Sampling experts' internal reviews indicate that projecting and resolving identified misstatements is one of the biggest difficulties that audit engagement teams face when using sampling techniques. Finally, we present evidence that some firms have significantly changed their approach to revenue testing due to PCAOB inspections. This evidence provides important insights into current sampling policies and presents opportunities for future research. Data Availability: Please contact the authors.

Market Response to Audited Internal Control Weakness Disclosures

2020 ◽  
Vol 5 (1) ◽  
pp. 2-20
Author(s):  
Subash Adhikari ◽  
Binod Guragai ◽  
Ananth Seetharaman
Keyword(s):  
Financial Reporting ◽  
Internal Control ◽  
Market Reaction ◽  
Financial Statements ◽  
Data Availability ◽  
Market Response ◽  
Market Participants ◽  
Sarbanes Oxley ◽  
Time Periods ◽  
First Time

ABSTRACT To help guard against weaknesses in internal control over financial reporting (ICFR), the Sarbanes-Oxley Act of 2002 requires certain filers to have their ICFR assertions audited. Beneish et al. (2008) show that market participants fail to react negatively to adverse ICFR audit opinions. This is puzzling because weak ICFR heightens the risk of fraud or materially misstated financial statements. Our study reexamines this issue for the time periods covered by Auditing Standard No. 2 (AS2) and Auditing Standard No. 5 (AS5). We too find no significant negative market reaction to the disclosure of adverse ICFR audits in the AS2 era. However, we show that markets react negatively for first-time disclosures of adverse ICFR audits after the adoption of AS5. Furthermore, in the AS5 regime, markets seem to differentiate between entity-wide versus account-specific ICFR weaknesses. We also show that correcting previous ineffective ICFR results in a positive market reaction. Data Availability: Data are available from sources cited in the text.

The Audit Committee: Management Watchdog or Personal Friend of the CEO?

2013 ◽  
Vol 89 (1) ◽  
pp. 113-145 ◽  
Author(s):  
Liesbeth Bruynseels ◽  
Eddy Cardinaels
Keyword(s):  
Earnings Management ◽  
Financial Reporting ◽  
Internal Control ◽  
Audit Committee ◽  
Social Ties ◽  
Data Availability ◽  
Audit Committees ◽  
Sarbanes Oxley ◽  
Negative Effect

ABSTRACT To ensure that audit committees provide sufficient oversight over the auditing process and quality of financial reporting, legislators have imposed stricter requirements on the independence of audit committee members. Although many audit committees appear to be “fully” independent, anecdotal evidence suggests that CEOs often appoint directors from their social networks. Based on a 2004 to 2008 sample of U.S.-listed companies after the Sarbanes-Oxley Act, we find that these social ties have a negative effect on variables that proxy for oversight quality. In particular, we find that firms whose audit committees have “friendship” ties to the CEO purchase fewer audit services and engage more in earnings management. Auditors are also less likely to issue going-concern opinions or to report internal control weaknesses when friendship ties are present. On the other hand, social ties formed through “advice networks” do not seem to hamper the quality of audit committee oversight. Data Availability: All data are publicly available from sources identified in the text.

The Effectiveness of SOX Regulation: An Interview Study of Corporate Directors

2012 ◽  
Vol 25 (1) ◽  
pp. 61-87 ◽  
Author(s):  
Jeffrey R. Cohen ◽  
Colleen Hayes ◽  
Ganesh Krishnamoorthy ◽  
Gary S. Monroe ◽  
Arnold M. Wright
Keyword(s):  
Financial Reporting ◽  
Internal Control ◽  
Audit Committee ◽  
Policy Decision ◽  
Substantial Improvement ◽  
Data Availability ◽  
Internal Auditors ◽  
Sarbanes Oxley ◽  
Financial Expertise ◽  
Accounting Judgments

ABSTRACT: This study provides insights on the effectiveness of the Sarbanes-Oxley Act (U.S. House of Representatives 2002) in promoting high-quality financial reporting and good corporate governance, based on interviews conducted with 22 experienced directors from U.S. firms. Our analysis indicates that SOX has positively impacted the monitoring role of the audit committee (board), which directors attributed to the financial expertise and internal control requirements and heightened substantive diligence. However, some considered that an emphasis on financial expertise at the expense of legal expertise and financial markets expertise could compromise the quality of financial disclosures due to a lack of business savvy needed to inform accounting judgments and the standardization of reporting. SOX was also perceived as having led to a formalistic approach to accounting policy decision making by the audit committee and external auditor, as a buffer against litigation. While CEO certification was viewed as having led to heightened ownership and diligence on the part of decision agents throughout the financial reporting decision hierarchy, it was also identified as a source of the costly resource-intensive reaction to SOX. Directors also considered that SOX had led boards to take a narrow focus on financial reporting risk at the expense of strategy. Further, management was identified as being actively involved in the more overt process of initiating and administering the process. The directors' responses also demonstrate some variation in the extent and nature of the role played by the audit committee to resolve accounting disputes, reflecting varying interpretations of law. Participants indicate that SOX has also led to a substantial improvement in the scope, responsibility, and status of internal auditors. Data Availability: Contact the authors.

scholarly journals Shades of Gray: Internal Control Reporting by Chinese U.S.-Listed Firms

2018 ◽  
Vol 32 (4) ◽  
pp. 1-30 ◽  
Author(s):  
Raymond Reed Baker ◽  
Gary C. Biddle ◽  
Michelle René Lowry ◽  
Neale G. O'Connor
Keyword(s):  
Initial Public Offerings ◽  
Financial Reporting ◽  
Internal Control ◽  
Reporting Quality ◽  
Data Availability ◽  
Chinese Firms ◽  
Research Attention ◽  
Public Offerings ◽  
Listed Firms ◽  
Sarbanes Oxley

SYNOPSIS Chinese firms listing in the U.S. via reverse mergers (CRMs) have dominated prior media, regulator, and research attention. Yet CRMs have effectively ceased, leaving Chinese firms listing via initial public offerings (CIPOs) as the relevant remaining class of Chinese firms listing on U.S. exchanges. This study documents salient differences between CIPOs, CRMs, and U.S.-domiciled U.S.-listed firms by examining Sarbanes-Oxley Act Section 302 and 404(b) ineffective internal control (IIC) and related disclosures that underlie financial reporting quality, with three main sets of findings. First, both CIPOs and CRMs are more likely to report IICs than U.S.-domiciled counterparts. Second, both CIPOs and CRMs are more likely to under-report IICs than U.S.-domiciled counterparts (CIPO for only 302 disclosures). Third, CIPOs are both less likely to report and less likely to under-report IICs than CRMs. These findings clarify and recast prior characterizations of the internal controls underlying the reporting quality of Chinese U.S.-listed firms. JEL Classifications: G18; G34; G38; M41; M42; M48. Data Availability: All data are available from public sources.

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