Audit Office Experience with SOX 404(b) Filers and SOX 404 Audit Quality

2018 ◽  
Vol 94 (4) ◽  
pp. 1-43 ◽  
Author(s):  
Divya Anantharaman ◽  
Nader Wans
Keyword(s):  
Internal Control ◽  
Audit Quality ◽  
Two Dimensions ◽  
Financial Statement ◽  
Timely Manner ◽  
Material Weaknesses ◽  
History Of ◽  
Timely Fashion ◽  
Internal Control Weaknesses ◽  
Industry Expertise

ABSTRACT We measure two dimensions of SOX 404 audit quality: (1) whether auditors identify and report material weaknesses (MWs) in a timely fashion, and (2) on identifying MWs, whether auditors identify misstatements arising from MWs in a timely fashion. We find that audit practice-offices with a large base of SOX 404(b) clients and those with a long history of conducting control evaluations for that client are more likely (1) to identify and report MWs in a timely manner (i.e., before resulting restatements come to light), and conditional on identifying MWs, (2) to detect MW-related misstatements in a timely manner (i.e., before the misstatements become restatements). Audit office industry expertise also matters, but only to timely MW reporting. Our results inform on the drivers of variation in SOX 404 audit quality, and highlight the key role that auditors play in identifying internal control weaknesses and assessing their impact on financial statement reliability.

The Unintended Consequences of Material Weakness Reporting on Auditors' Acceptance of Aggressive Client Reporting

2019 ◽  
Vol 95 (4) ◽  
pp. 51-72
Author(s):  
Tim D. Bauer ◽  
Anthony C. Bucaro ◽  
Cassandra Estep
Keyword(s):  
Financial Reporting ◽  
Internal Control ◽  
Audit Quality ◽  
Unintended Consequences ◽  
Unintended Consequence ◽  
Financial Statement ◽  
Material Weakness ◽  
Material Weaknesses ◽  
Licensing Effects ◽  
Potential Remedy

ABSTRACT Regulators are concerned that auditors do not sufficiently identify and report material weaknesses in internal control over financial reporting (ICFR). However, psychological licensing theory suggests reporting material weaknesses could have unintended consequences for acceptance of aggressive client financial reporting. In an experiment, we predict and find auditors accept more aggressive client reporting after they report a material weakness in ICFR than after they report no material weakness. We provide evidence licensing underlies this effect. In a second experiment, we investigate the efficacy of an intervention to reduce the identified licensing effects by prompting an audit quality goal. We find this prompt mitigates the unintended consequence when auditors report a material weakness. While regulators are concerned companies are undeservedly receiving clean ICFR audit opinions, our findings indicate adverse ICFR opinions may lead auditors to give companies undeservedly clean financial statement opinions. We provide a potential remedy to this unintended consequence.

Unexpected Fees and the Prediction of Material Weaknesses in Internal Control Over Financial Reporting

2016 ◽  
Vol 33 (4) ◽  
pp. 485-505 ◽  
Author(s):  
Susan M. Albring ◽  
Randal J. Elder ◽  
Xiaolu Xu
Keyword(s):  
Financial Reporting ◽  
Internal Control ◽  
Audit Fees ◽  
Financial Statement ◽  
Section 404 ◽  
Sarbanes Oxley ◽  
Material Weaknesses ◽  
New Material ◽  
Internal Control Weaknesses ◽  
Section 302

We investigate whether prior year unexpected audit fees help predict new material weaknesses in internal control over financial reporting reported under Section 404 of the Sarbanes–Oxley Act (SOX). Predicting material weaknesses may be useful to investors and other financial statement users because these disclosures have adverse economic impacts on disclosing firms. Unexpected fees are significantly associated with material weaknesses reported under Section 404, even after controlling for Section 302 disclosures and other factors associated with internal control weaknesses. Unexpected fees are associated with company-level weaknesses but are not significantly associated with account-specific weaknesses, consistent with differences in the nature and severity of the two types of material weaknesses. Our results are consistent with unexpected audit fees containing information on unobserved audit costs and client control risks, which help predict future internal control weaknesses.

scholarly journals Integration of Internal Control and Financial Statement Audits: Are Two Audits Better than One?

2018 ◽  
Vol 94 (2) ◽  
pp. 53-81 ◽  
Author(s):  
Lori Shefchik Bhaskar ◽  
Joseph H. Schroeder ◽  
Marcy L. Shepardson
Keyword(s):  
Financial Reporting ◽  
Internal Control ◽  
Audit Quality ◽  
Internal Controls ◽  
Data Availability ◽  
Financial Statement ◽  
Auditor Judgment ◽  
Public Company ◽  
Better Than

ABSTRACT The quality of financial statement (FS) audits integrated with audits of internal controls over financial reporting (ICFR) depends upon the quality of ICFR information used in, and its integration into, FS audits. Recent research and PCAOB inspections find auditors underreport existing ICFR weaknesses and perform insufficient testing to address identified risks, suggesting integrated audits—in which substantial ICFR testing is required—may result in lower FS audit quality than FS-only audits. We compare a 2007–2013 sample of small U.S. public company firm-years receiving integrated audits (accelerated filers) to firm-years receiving FS-only audits (non-accelerated filers) and find integrated audits are associated with higher likelihood of material misstatements and discretionary accruals, consistent with lower FS audit quality. We also find evidence of (1) auditor judgment-based integration issues, and (2) low-quality ICFR audits harming FS audit quality. Overall, results suggest an important potential consequence of integrated audits is lower FS audit quality. Data Availability: Data are publicly available from the sources identified in the text.

An Understanding of the Differences between Internal and External Auditors in Obtaining Information about Internal Control Weaknesses

2016 ◽  
Vol 28 (3) ◽  
pp. 83-99 ◽  
Author(s):  
Ian Burt
Keyword(s):  
Internal Control ◽  
Audit Quality ◽  
Audit Fees ◽  
Relevant Information ◽  
Internal Auditor ◽  
Internal Auditors ◽  
External Auditors ◽  
Organizational Silence ◽  
Internal Control Weaknesses ◽  
External Auditor

ABSTRACT The Institute of Internal Auditors (IIA) argues that internal auditors often have a strong “employee” identity within their organization. While external auditors are concerned that this employee identity might negatively impact internal auditors' objectivity, the IIA argues this identity can actually be beneficial as employees may be more willing to share sensitive and audit-relevant information with the internal auditor than they would with the external auditor. Through an experiment relying on the social identity and organizational silence literatures, I test the prediction that non-audit employees will identify more highly with the internal than the external auditor and they will thus, be willing to share more information about internal control weaknesses with the internal than the external auditor. The results from a moderated mediation analysis support this prediction and also show the effect is stronger as the severity of the internal control weakness increases. Overall, this research informs external auditors and regulators about conditions under which the internal auditor may have an advantage over the external auditor in obtaining information that could help improve audit quality. It also informs managers about an important role played by their internal auditors that may result in increased quality of the internal control system while also potentially lowering audit fees.

On Controlling for Misstatement Risk

2021 ◽  
Author(s):  
James R Moon ◽  
Jonathan E Shipman ◽  
Quinn T Swanquist ◽  
Robert L. Whited
Keyword(s):  
Internal Control ◽  
Audit Quality ◽  
Financial Statements ◽  
Audit Fees ◽  
Future Research ◽  
Coefficient Estimates ◽  
Recent Approach ◽  
Material Weaknesses ◽  
Ex Ante ◽  
Alternative Approaches

Ex ante misstatement risk confounds most settings relying on misstatements as a measure of audit quality, but researchers continue to debate how to effectively control for this construct. In this study, we consider a recent approach that involves controlling for prior period misstatements (“Lagged Misstatements”). Using a controlled simulation and a basic archival analysis, we show that a lagged misstatement control can significantly bias coefficient estimates. We demonstrate this bias using audit fees as a variable of interest but also show the same issue manifests for other measures that respond to the restatement of misstated financial statements (i.e., internal control material weaknesses and auditor changes). We conclude by discussing alternative approaches for controlling for ex ante misstatement risk and providing guidance for future research.

Earnings Management of Firms Reporting Material Internal Control Weaknesses under Section 404 of the Sarbanes-Oxley Act

2008 ◽  
Vol 27 (2) ◽  
pp. 161-179 ◽  
Author(s):  
Kam C. Chan ◽  
Barbara Farrell ◽  
Picheng Lee
Keyword(s):  
Earnings Management ◽  
Internal Control ◽  
Internal Controls ◽  
Corporate Disclosure ◽  
Section 404 ◽  
Sarbanes Oxley ◽  
Material Weaknesses ◽  
Potential Benefits ◽  
Internal Control Weaknesses ◽  
Reported Earnings

SUMMARY: The main objectives of the Sarbanes-Oxley Act of 2002 are to improve the accuracy and reliability of corporate disclosure. Under Section 404 of the Sarbanes-Oxley Act, the external auditor has to report an assessment of the firm’s internal controls and attest to management’s assessment of the firm’s internal controls. Material weaknesses in internal controls must be disclosed in the auditor and management reports. The objective of this study is to examine if firms reporting material internal control weaknesses under Section 404 have more earnings management compared to other firms. The results provide mild evidence that there are more positive and absolute discretionary accruals for firms reporting material internal control weaknesses than for other firms. Since the findings of ineffective internal controls by auditors under Section 404 may cause firms to improve their internal controls, Section 404 has the potential benefits of reducing the opportunity of intentional and unintentional accounting errors and of improving the quality of reported earnings.

SOX 404 Reported Internal Control Weaknesses: A Test of COSO Framework Components and Information Technology

2009 ◽  
Vol 23 (2) ◽  
pp. 1-23 ◽  
Author(s):  
Bonnie K. Klamm ◽  
Marcia Weidenmier Watson
Keyword(s):  
Information Technology ◽  
Internal Control ◽  
Negative Impact ◽  
Internal Controls ◽  
First Year ◽  
Section 404 ◽  
Sarbanes Oxley ◽  
Material Weaknesses ◽  
Assessment And Monitoring ◽  
Internal Control Weaknesses

ABSTRACT: This paper examines internal controls, from both an information technology (IT) and non-IT perspective, in relation to the five components of the Committee of Sponsoring Organization's Internal Control-Integrated Framework (COSO 1992), as well as the achievement of one of COSO's three objectives-reporting reliability. Our sample consists of 490 firms with material weaknesses reported under Sarbanes-Oxley Section 404 during the first year of compliance. We classify the weaknesses by COSO component and as IT-related or non-IT-related. Our results support the interrelationships of the COSO Framework. The results also show that the number of misstated accounts is positively related to the number of weak COSO components (i.e., scope) and certain weak COSO components (i.e., existence). Firms with IT-related weak components report more material weaknesses and misstatements than firms without IT-related weak components, providing evidence on the pervasive negative impact of weak IT controls, especially in control environment, risk assessment, and monitoring.

The Persistence in the Association between Section 404 Material Weaknesses and Financial Reporting Quality

2013 ◽  
Vol 33 (1) ◽  
pp. 93-116 ◽  
Author(s):  
Emma-Riikka Myllymäki
Keyword(s):  
Financial Reporting ◽  
Internal Control ◽  
Reporting Quality ◽  
Financial Reporting Quality ◽  
Control Problems ◽  
Section 404 ◽  
Material Weakness ◽  
Sarbanes Oxley ◽  
Material Weaknesses ◽  
History Of

SUMMARY This study examines whether Sarbanes-Oxley (SOX) Section 404 material weakness (MW404) disclosures are predictive of future financial reporting quality. I find evidence that for companies with a history of MW404s, the likelihood of misstatements in financial information continues to be significantly higher for two years after the last MW404 report compared to companies without a history of reported MW404s. The magnitude of the effect decreases non-linearly with decreasing speed. The findings further imply that the reason for the misstatement incidences is the unacknowledged pervasiveness of control problems. In particular, it appears that in many cases, the future misstatements are unrelated to the MW types disclosed in the last MW404 report, suggesting that some MW types are unacknowledged and, hence, control problems are even more pervasive than what was identified. Overall, the findings of this study highlight the importance of discovering and disclosing material weaknesses in internal control over financial reporting.

Daytona Dreams Restaurant: Linking Accounting Systems with Business Valuation

2009 ◽  
Vol 23 (1) ◽  
pp. 119-136 ◽  
Author(s):  
Kevin E. Dow ◽  
Vincent J. Shea ◽  
Bobby E. Waldrup
Keyword(s):  
Internal Control ◽  
Firm Value ◽  
Accounting Information ◽  
Causal Link ◽  
Financial Statement ◽  
Publicly Traded ◽  
Accounting Systems ◽  
Business Valuation ◽  
Accounting Information Systems ◽  
Internal Control Weaknesses

ABSTRACT: A problem encountered in accounting information systems (AIS) education is that students sometimes do not understand how organizational risks affect firm value. This case presents a privately held restaurant that is currently under acquisition consideration by a publicly traded restaurant group that follows internal control guidance as stipulated by the Committee of Sponsoring Organizations (COSO) guidelines. The objective of this case is to present students with a causal link among (1) internal control weaknesses of a restaurant, (2) financial statement assertions, and (3) management decisions that can impact firm value. Students must identify and translate control weaknesses into the case's business valuation decision. The case is appropriate for undergraduate and graduate AIS and audit classes.

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