Mandatory Internal Control Audits, Audit Adjustments, and Financial Reporting Quality: Evidence from China

2021 ◽  
Author(s):  
Clive Lennox ◽  
Xi Wu
Keyword(s):  
Financial Reporting ◽  
Internal Control ◽  
Reporting Quality ◽  
Financial Statements ◽  
Financial Reporting Quality ◽  
Internal Control Weaknesses ◽  
Quality Evidence

This study examines whether audit adjustments are a mechanism that links the effect of mandatory internal control audits (MICAs) on financial reporting quality. We argue that the requirement for auditors to publicly disclose internal control weaknesses exacerbated auditor-client conflicts and that this resulted in auditors being less likely to detect (and correct) misstatements in their clients’ pre-audit financial statements. Consistent with this argument, we find significant reductions in audit adjustments following the staggered introduction of MICAs in the China setting. We find the reductions in audit adjustments are associated with significant increases in material misstatements following the introduction of MICAs. In contrast, we find that the introduction of MICAs led to a significant reduction in material misstatements among clients that did not experience reductions in audit adjustments. Overall, the two effects offset each other, which explains why financial reporting quality did not improve on average following the introduction of MICAs.

scholarly journals Does Attestation of the effectiveness of Internal Control over Financial Reporting Discourage Earnings Management? Evidence from China

2018 ◽  
Vol 7 (4) ◽  
pp. 1
Author(s):  
Li Dang ◽  
Qiaoling Fang
Keyword(s):  
Earnings Management ◽  
Financial Reporting ◽  
Internal Control ◽  
Reporting Quality ◽  
Financial Statements ◽  
Financial Reporting Quality ◽  
Chinese Government ◽  
Chinese Firms ◽  
Public Firms ◽  
Sarbanes Oxley

To improve financial reporting quality, the Chinese government issued the Basic Standard for Enterprise Internal Control in 2008 and other related guidelines/regulations in the following years (hereafter China SOX). The scope of China SOX is broader but similar to Section 404 of the Sarbanes-Oxley Act (SOX) in the U.S. Formal adoptions of China SOX requires management and external auditor’s report on the effectiveness of internal control over financial reporting (ICFR). A company’s ICFR, if effective, should provide reasonable assurance that the company’s financial statements are reliable and prepared in accordance with the applicable accounting standards. The purpose of this study is to investigate whether China external auditor attestation of ICFR discourage earnings management, an indicator of financial reporting quality. By analyzing a sample of Chinese public firms during 2011 to 2013, we find that: (1) Chinese firms that disclose audited ICFR reports exhibit lower earnings management than firms that do not; (2) Chinese firms that are mandated to disclose audited ICFR reports exhibit lower earnings management than firms that voluntarily disclose audited ICFR reports. Our empirical results seem to suggest that attestation of the effectiveness of ICFR discourages earnings management and therefore improve financial reporting quality. 

scholarly journals Internal Control Weakness and Managerial Myopia: Evidence from SOX Section 404 Disclosures

2019 ◽  
Vol 8 (1) ◽  
pp. 71-83 ◽  
Author(s):  
Amy E. Ji
Keyword(s):  
Financial Reporting ◽  
Internal Control ◽  
Investment Decisions ◽  
Reporting Quality ◽  
Internal Controls ◽  
Financial Reporting Quality ◽  
Section 404 ◽  
Managerial Myopia ◽  
Internal Control Weaknesses ◽  
The Impact

Problem/ Relevance: Managerial myopia is an important issue of interests to academics, practitioners, and regulators as managers have been condemned for their obsession with short-term earnings and myopic investment decisions that sacrifice firms’ long term value for shareholders. This article contributes by examining whether the quality of firms’ internal controls over financial reporting (ICFR) is associated with managerial myopia. Research Objective/ Questions: The purpose of this study is to examine whether managers in firms reporting material internal control weaknesses (ICW) under Section 404 of the Sarbanes-Oxley Act (SOX) of 2002 engage in myopic behaviors more than those in firms without reporting ICW. Methodology: The study uses the logit regression model to investigate a sample obtained from Compustat for the period of 2005-2013. Major Findings: The study finds a positive association between internal control weaknesses reported by auditors under Section 404 of the SOX and managerial short-termism which is measured by the probability of cutting R&D expenses in the current year from the previous year. Implications: Whereas prior studies mostly examine the impact of internal controls on accounting quality, this study demonstrates the implication of internal controls beyond financial reporting quality by showing an association between internal control quality and managerial myopia. Future research may further investigate the association between firms’ financial reporting quality and managerial investment decisions.

scholarly journals Material Internal Control Weaknesses And Earnings Management In The Post-SOX Environment

2012 ◽  
Vol 29 (1) ◽  
pp. 183 ◽  
Author(s):  
Benjamin P. Foster ◽  
Trimbak Shastri
Keyword(s):  
Financial Reporting ◽  
Internal Control ◽  
Reporting Quality ◽  
Financial Statements ◽  
Audit Fees ◽  
Font Size ◽  
Significant Difference ◽  
Internal Control Weaknesses ◽  
Abnormal Accruals ◽  
Audit Opinions

<span style="font-family: Times New Roman; font-size: small;"> </span><p style="margin: 0in 0.5in 0pt; text-align: justify; mso-layout-grid-align: none;" class="MsoNormal"><span style="font-size: 10pt; mso-bidi-font-weight: bold;"><span style="font-family: Times New Roman;">Prior studies found that companies with internal control deficiencies incorporate abnormal accounting accruals into their financial statements.<span style="mso-spacerun: yes;"> </span>However, these studies did not consider the materiality of abnormal accruals. Abnormal accruals should be within materiality when financial statements receive clean audit opinions. When material internal control weaknesses (MICW) exist, to compensate for additional risk, auditors should apply more audit effort to gain the quantity and quality of evidence necessary to obtain a reasonable degree of assurance to support their audit reports. We find evidence of this because audit fees are significantly higher for MICW companies than those for effective internal controls (EIC) companies in our sample. Accordingly, financial statements receiving clean audit opinions should not contain material abnormal accruals irrespective of whether controls are effective EIC or ineffective MICW. To examine this issue, we use post-SOX data to estimate abnormal accruals using a revenue-based accrual model for a matched sample of companies with clean audit opinions on their financial statements: one-half EIC and the other half with MICW. Then, we establish material abnormal revenue accruals (MARA), which is the difference between estimated abnormal revenue accruals and a quantitative materiality based on assets. Finally, we compare MARA between EIC and MICW companies. We find no significant difference in MARA between EIC and MICW companies. We provide a summary of important findings in Table 3, and conclude with suggestions to further improve audit and financial reporting quality.</span></span></p><span style="font-family: Times New Roman; font-size: small;"> </span>

Auditor and FASB Responsibilities for Representing Underlying Economics—What U.S. Standards Actually Say

2018 ◽  
Vol 32 (3) ◽  
pp. 83-90 ◽  
Author(s):  
Zoe-Vonna Palmrose ◽  
William R. Kinney
Keyword(s):  
Financial Reporting ◽  
Audit Quality ◽  
Reporting Quality ◽  
Financial Statements ◽  
Financial Reporting Quality ◽  
Or Practice

SYNOPSIS Does the auditor's responsibility under U.S. authoritative guidance extend to providing assurance of financial reporting quality—specifically whether financial statements “faithfully reflect the firm's underlying economics”—after the auditor has concluded that financial statements are fairly presented in conformity with GAAP, in all material respects? The question arises because DeFond and Zhang (2014) state such a view and cite U.S. authoritative guidance as support. We review SEC, PCAOB, and FASB guidance and other sources and find no authoritative support for DeFond and Zhang's (2014) view. We also find that the PCAOB explicitly recognizes the lack of objective criteria that would be necessary to evaluate financial reporting quality beyond application of GAAP to events and transactions. Further, we find no evidence that practicing auditors do (separately) assess or assure that financial statements faithfully reflect the entire firm's underlying economics. Overall, these findings suggest DeFond and Zhang (2014) express a personal (and impracticable) normative view and not the auditor's actual responsibility or practice under extant U.S. standards. More broadly, results reinforce the importance of defining and measuring audit quality based on the auditor's actual responsibilities and the importance of accurately characterizing authoritative guidance and practice for scholarship regarding complex and multifaceted matters, including audit quality.

Does Auditor Explanatory Language in Unqualified Audit Reports Indicate Increased Financial Misstatement Risk?

2014 ◽  
Vol 89 (6) ◽  
pp. 2115-2149 ◽  
Author(s):  
Keith Czerney ◽  
Jaime J. Schmidt ◽  
Anne M. Thompson
Keyword(s):  
Financial Reporting ◽  
Reporting Quality ◽  
Positive Association ◽  
Financial Statements ◽  
Financial Statement ◽  
Financial Reporting Quality ◽  
Accounting Principles ◽  
Client Relationship ◽  
Financial Misstatement ◽  
Audit Reports

ABSTRACT According to auditing standards, explanatory language added at the auditor's discretion to unqualified audit reports should not indicate increased financial misstatement risk. However, an auditor is unlikely to add language that would strain the auditor-client relationship absent concerns about the client's financial statements. Using a sample of 30,825 financial statements issued with unqualified audit opinions during 2000–2009, we find that financial statements with audit reports containing explanatory language are significantly more likely to be subsequently restated than financial statements without such language. We find that this positive association is driven by language that references the division of responsibility for performance of the audit, adoption of new accounting principles, and previous restatements. In addition, we find that (1) “emphasis of matter” language that discusses mergers, related-party transactions, and management's use of estimates predicts restatements related to these matters, and that (2) the financial statement accounts noted in the explanatory language typically correspond to the accounts subsequently restated. In sum, our results suggest that present-day audit reports communicate some information about financial reporting quality.

Corporate Social Responsibility and Financial Reporting Quality:Evidence from Restatements

2020 ◽  
Author(s):  
Yi-Hung Lin ◽  
Hua-Wei (Solomon) Huang ◽  
Mark E. Riley ◽  
Chih-Chen Lee
Keyword(s):  
Financial Reporting ◽  
Negative Relationship ◽  
Reporting Quality ◽  
Financial Statements ◽  
Financial Statement ◽  
Financial Reporting Quality ◽  
Csr Reporting ◽  
Corporate Social ◽  
Reporting Environment ◽  
The Relationship

We find a negative relationship between aggregate CSR scores and the probability that firms restated financial statements over the period 1991-2012. We then break that period into three sub-periods in order to determine whether the relationship holds for all three sub-periods. During the sub-periods of 1991-2001 and 2002-2005, the negative CSR score - restatement probability relationship holds. The negative relationship disappears in the 2006-2012 sub-period. Additional analyses indicate CSR scores are significantly higher in the 2006-2012 sub-period, suggesting the disappearance of the relationship between aggregate CSR scores and financial statement quality may relate to changes in CSR assessments and the CSR reporting environment. Our findings update the literature linking CSR scores and financial reporting quality and identify the need for further research as to the reasons the link between these constructs disappeared.

scholarly journals A literature review on the impact of IAS/IFRS and regulations on quality of financial reporting

2016 ◽  
Vol 6 (4) ◽  
pp. 102-114 ◽  
Author(s):  
Newman Wadesango ◽  
Edmore Tasa ◽  
Khazamula Milondzo ◽  
Ongayi Vongai Wadesango
Keyword(s):  
Financial Reporting ◽  
Accounting Standards ◽  
Reporting Quality ◽  
Financial Statements ◽  
Conclusive Evidence ◽  
Financial Reporting Quality ◽  
International Accounting Standards ◽  
Ifrs Adoption ◽  
The Impact

The International Accounting Standards Board (IASB) in its objectives and preamble, presume that IFRS adoption and perceived compliance to regulatory framework is associated with increased financial reporting quality. Based on these assumptions, this desktop study reviewed several documents to determine whether the IFRS adoption has led to increased financial reporting quality in Zimbabwe. The researchers reviewed literature on how the IAS/IFRS and regulations affect the financial reporting quality of listed companies. The factors around IFRS adoption were identified (mandatory, voluntary and convergence) and discussed in relation to the financial reporting quality. Evidence from previous studies conducted in line with this same issue shows that there is no conclusive evidence on how IFRS and regulations affect the financial reporting quality. Issues to be addressed in further studies include the importance of financial statements prepared under IFRS framework and the importance of compliance with accounting and auditing requirements.

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