Accruals Quality and Internal Control over Financial Reporting

2007 ◽  
Vol 82 (5) ◽  
pp. 1141-1170 ◽  
Author(s):  
Jeffrey T. Doyle ◽  
Weili Ge ◽  
Sarah McVay
Keyword(s):  
Financial Reporting ◽  
Internal Control ◽  
Discretionary Accruals ◽  
Cash Flows ◽  
Internal Controls ◽  
Earnings Persistence ◽  
Firm Characteristics ◽  
Material Weakness ◽  
Material Weaknesses ◽  
Accruals Quality

We examine the relation between accruals quality and internal controls using 705 firms that disclosed at least one material weakness from August 2002 to November 2005 and find that weaknesses are generally associated with poorly estimated accruals that are not realized as cash flows. Further, we find that this relation between weak internal controls and lower accruals quality is driven by weakness disclosures that relate to overall company-level controls, which may be more difficult to “audit around.” We find no such relation for more auditable, account-specific weaknesses. We find similar results using four additional measures of accruals quality: discretionary accruals, average accruals quality, historical accounting restatements, and earnings persistence. Our results are robust to the inclusion of firm characteristics that proxy for difficulty in accrual estimation, known determinants of material weaknesses, and corrections for self-selection bias.

Does Audit Quality Influence the Relation between Earnings Management and Internal Control Weakness in the Post –SOX Period

2013 ◽  
Vol 2 (2) ◽  
pp. 70-100
Author(s):  
Judith van Ravenstein ◽  
Georgios Georgakopoulos ◽  
Petros Kalantonis ◽  
Panagiotis Kaldis
Keyword(s):  
Earnings Management ◽  
Internal Control ◽  
Audit Quality ◽  
Discretionary Accruals ◽  
Internal Controls ◽  
Material Weakness ◽  
Material Weaknesses ◽  
Internal Control System ◽  
A Company ◽  
Big Four

Material weaknesses in the internal control system of a company create more opportunities for managers to engage in opportunistic earnings management. In this study the authors investigate the relation between earnings management and disclosed material weaknesses in the internal controls, both under SOX 302 and SOX 404, and examine whether audit quality, measured as being audited by a Big Four auditor, has an effect on that relation. The results suggest that material weakness firms have more absolute discretionary accruals and greater income-decreasing discretionary accruals. So evidence is provided that material weakness firms engage in more earnings management, however not in opportunistic income-increasing earnings management. When audit quality is high, measured as being audited by a Big Four auditor, the disclosed material weaknesses are lower just as total and absolute discretionary accruals are. It is also interesting in our findings that when material weakness firms are audited by a Big Four auditor a positive relationship seems to exist with discretionary accruals, suggesting that when a firm is audited by a Big Four auditor, material weaknesses in the internal controls will lead to opportunistic earnings management.

The Severity of Internal Controls over Financial Reporting Deficiencies: Differences among Types and Industries

2014 ◽  
pp. 55-77
Author(s):  
Tatiana Mazza ◽  
Stefano Azzali
Keyword(s):  
Information Technology ◽  
Financial Reporting ◽  
Internal Control ◽  
Service Industry ◽  
Listed Companies ◽  
Internal Controls ◽  
Service Companies ◽  
Finance Industry ◽  
Material Weaknesses ◽  
Fixed Assets

This study analyzes the severity of Internal Control over Financial Reporting deficiencies (Deficiencies, Significant Deficiencies and Material Weaknesses) in a sample of Italian listed companies, in the period 2007- 2012. Using proprietary data the severity of the deficiencies is tested for account-specific, entity level and information technology controls and for industries (manufacturing and services vs finance industries). The results on ICD severity is compared with one of the most frequent ICD (Acc_Period End/Accounting Policies): for account-specific, ICD in revenues, purchase, fixed assets and intangible, loans and insurance are more severe while ICD in Inventory are less severe. Differences in ICD severity have been found in the characteristic account: ICD in loan and insurance for finance industry and ICD in revenue, purchase for manufacturing and service industry are more severe. Finally, we found that ICD in entity level and information technology controls are less severe than account specific ICD in all industries. However, the results on entity level and information technology deficiencies could also mean that the importance of these types of control are under-evaluated by the manufacturing and service companies.

scholarly journals Material Weaknesses in Tax-Related Internal Controls and Last Chance Earnings Management

2017 ◽  
Vol 39 (1) ◽  
pp. 25-44 ◽  
Author(s):  
Cristi A. Gleason ◽  
Morton Pincus ◽  
Sonja Olhoft Rego
Keyword(s):  
Earnings Management ◽  
Financial Reporting ◽  
Internal Control ◽  
Internal Controls ◽  
Early Years ◽  
Control Material ◽  
Material Weaknesses ◽  
Implementation Period ◽  
Tax Expense

ABSTRACT We investigate the consequences of tax-related internal control material weaknesses (ICMWs) for financial reporting. We hypothesize that the presence of ineffective controls over the tax function makes earnings management through the income tax accrual (both income increasing and income decreasing) easier to implement relative to firms with effective controls. We also predict that the remediation of tax-related ICMWs has the effect of constraining earnings management through the tax accrual. The results provide support for our predictions. We also find that last chance earnings management via tax-related ICMWs is concentrated in the early years of our sample, during the initial SOX implementation period. Our results suggest that tax-related ICMWs were initially associated with greater tax-expense management but that SOX internal control assessments subsequently improved the quality of financial reporting by reducing opportunities for tax-expense management.

Does Ineffective Internal Control over Financial Reporting affect a Firm's Operations? Evidence from Firms' Inventory Management

2014 ◽  
Vol 90 (2) ◽  
pp. 529-557 ◽  
Author(s):  
Mei Feng ◽  
Chan Li ◽  
Sarah E. McVay ◽  
Hollis Skaife
Keyword(s):  
Inventory Management ◽  
Financial Reporting ◽  
Internal Control ◽  
Cash Flows ◽  
Turnover Rates ◽  
General Hypothesis ◽  
Related Material ◽  
Operating Cash Flows ◽  
Material Weaknesses ◽  
Inventory Turnover

ABSTRACT We investigate whether ineffective internal control over financial reporting has implications for firm operations by examining the association between inventory-related material weaknesses in internal control over financial reporting and firms' inventory management. We find that firms with inventory-related material weaknesses have systematically lower inventory turnover ratios and are more likely to report inventory impairments relative to firms with effective internal control over financial reporting. We also find that inventory turnover rates increase for firms that remediate material weaknesses related to inventory tracking. Remediating firms also experience increases in sales, gross profit, and operating cash flows. Finally, we assess the generalizability of our findings by examining all material weaknesses in internal control over financial reporting, regardless of type, and provide evidence that firms' returns on assets are associated with both their existence and remediation. Collectively, our findings support the general hypothesis that internal control over financial reporting has an economically significant effect on firm operations.

The Unintended Consequences of Internal Controls Reporting on Tax Decision Making

2019 ◽  
Vol 42 (1) ◽  
pp. 83-102
Author(s):  
Victoria J. Hansen
Keyword(s):  
Decision Making ◽  
Financial Reporting ◽  
Internal Control ◽  
Unintended Consequences ◽  
Internal Controls ◽  
Corporate Tax ◽  
Material Weakness ◽  
Reporting Requirements ◽  
Internal Control Deficiencies ◽  
The Impact

ABSTRACT This study investigates the impact of the internal controls over financial reporting requirements (ICFR) on the decision making of corporate tax executives. I examine tax executives' decisions to disclose an internal control deficiency by amending a prior year return when the internal control deficiency will be classified as either a significant deficiency or a material weakness. I also examine if tax executives' decisions are impacted by whether amending results in a refund or additional tax due. I find tax executives are less likely to disclose (amend) when the internal control deficiency is classified as a material weakness. When facing a material weakness, 16.7 percent choose not to disclose. Tax executives are also less likely to disclose (amend) when amending results in additional tax due. These results indicate the ICFR requirements may have unintended consequences. If executives do not disclose internal control deficiencies, the reliability of financial reporting is limited.

Are Material Weaknesses in Internal Controls Associated with Poor M&A Decisions? Evidence from Goodwill Impairment

2017 ◽  
Vol 37 (4) ◽  
pp. 49-74 ◽  
Author(s):  
Dennis H. Caplan ◽  
Saurav K. Dutta ◽  
Alfred Zhu Liu
Keyword(s):  
Financial Reporting ◽  
Internal Control ◽  
Internal Controls ◽  
Managerial Performance ◽  
Goodwill Impairment ◽  
Material Weaknesses

SUMMARY This paper examines the effect of the quality of a firm's internal control over financial reporting (ICFR) on the quality of corporate M&A decisions. We use material weaknesses in internal control (ICMWs) from SOX 404 audits as a proxy for the quality of a firm's ICFR and use future goodwill impairment to proxy for the quality of managers' M&A decisions. We find that goodwill recognized from acquisitions in years concurrent with ICMWs has a greater rate of impairment in subsequent years than goodwill recognized from acquisitions in years without ICMWs, thereby establishing a link between ICMW and goodwill impairment. We further show that disclosure and remediation of ICMWs appear to improve valuations of subsequent acquisitions. Our study contributes to the literature on internal controls by documenting unanticipated benefits of SOX 404 audits on managerial performance, and to the goodwill literature by identifying ICMWs as a determinant of goodwill impairment.

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).

Social Capital and Internal Control Material Weaknesses

2021 ◽  
Author(s):  
Jayanthi Krishnan ◽  
Sang Mook Lee ◽  
Myungsoo Son ◽  
Hakjoon Song
Keyword(s):  
Social Capital ◽  
Financial Reporting ◽  
Internal Control ◽  
Reporting Quality ◽  
Internal Controls ◽  
Financial Reporting Quality ◽  
External Monitoring ◽  
Regional Center ◽  
Material Weaknesses ◽  
Specific Material

Using a measure of social capital provided by the Northeast Regional Center for Rural Development, we document that, after controlling for auditor effort, firms headquartered in US counties with higher social capital are less likely to have ineffective internal control over financial reporting than those located in regions with lower social capital. This negative association between local social capital and ineffective internal controls holds when other forms of external monitoring are weak. We also find that the association is driven by ineffective internal control arising from entity-level, but not from account-specific, material weaknesses. Overall, we contribute to the literature that links firms' social environment with financial reporting quality.

Material Weakness in Internal Controls and Stock Price Crash Risk

2017 ◽  
Vol 35 (1) ◽  
pp. 106-138 ◽  
Author(s):  
Gerald Lobo ◽  
Chong Wang ◽  
Xiaoou Yu ◽  
Yuping Zhao
Keyword(s):  
Financial Reporting ◽  
Stock Price ◽  
Positive Association ◽  
Internal Controls ◽  
Crash Risk ◽  
Significant Relation ◽  
Material Weakness ◽  
Sarbanes Oxley ◽  
Material Weaknesses ◽  
Section 302

We investigate the association between material weakness in internal controls (MW) disclosed under Section 302 of the Sarbanes–Oxley Act of 2002 (SOX) and future stock price crash risk. We argue that relative to firms with effective internal controls, firms with MW have lower financial reporting precision. The lower reporting precision (a) increases divergence of investor opinion with regard to firm valuation and (b) facilitates managers’ withholding of negative information, which increases the information asymmetry between managers and outside investors. We hypothesize that both these effects increase the probability of a future stock price crash. We find empirical evidence consistent with our prediction. In additional analyses, we document that the positive association between MW and crash risk is primarily driven by company level rather than by account-specific weaknesses, increases with the number of material weaknesses, and intensifies during the financial crisis. In addition, we find that both the existence and the disclosure of MW incrementally affect crash risk, and that MW facilitates managers’ withholding of bad news. Finally, we fail to find consistent evidence of a significant relation between MW disclosed under Section 404 of SOX and crash risk.

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.

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