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Article
Publication date: 1 January 1970

Audrey Gramling and Arnold Schneider

This paper aims to explore whether an internal auditor’s evaluation of internal control deficiencies are influenced by the party with primary influence over the internal audit…

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Abstract

Purpose

This paper aims to explore whether an internal auditor’s evaluation of internal control deficiencies are influenced by the party with primary influence over the internal audit function and by the type of internal control deficiency.

Design/methodology/approach

A behavioral experiment is conducted with internal auditors as participants in a 2 × 2 between-subjects factorial design.

Findings

Results indicate that internal auditors are less likely to evaluate a pervasive control deficiency related to “tone at the top” as a material weakness than a process-specific control deficiency. Furthermore, internal auditors are somewhat less likely to evaluate a process-specific internal control deficiency as a material weakness when management has primary influence over the internal audit function than when the audit committee has primary influence. It is also found that the best practice of internal audit oversight (i.e., primary oversight of internal auditors by the audit committee) may lead to potential internal under-reporting of instances where the audit committee represents a material weakness in internal control.

Research limitations/implications

Limitations of this research include lack of economic consequences (e.g. future pay and job loss) associated with the internal control decisions made by the participants; less concise information provided to the participants than would generally be available to them; and lack of generalizability of the findings beyond the specific company setting and internal control scenario portrayed in the case materials.

Practical implications

Not evaluating a pervasive control deficiency related to “tone at the top” as a material weakness seems to not fully align with relevant professional guidance and can possibly result in inaccurate internal information about the quality of internal controls. Furthermore, having an internal auditor’s evaluation of a process-specific internal control deficiency influenced by the party with primary influence over the internal audit function would not appear to align with relevant professional guidance. Finally, primary oversight by the audit committee of the internal auditors may lead to potential internal under-reporting of instances where the audit committee represents a material weakness in internal controls and, thus, possible communication of inaccurate internal control information.

Originality/value

This study is the first to address whether the party with primary influence over the internal audit function influences an internal auditor’s evaluation of internal control deficiencies.

Details

Managerial Auditing Journal, vol. 33 no. 3
Type: Research Article
ISSN: 0268-6902

Keywords

Article
Publication date: 26 October 2012

Matthew J. Keane, Randal J. Elder and Susan M. Albring

The implementation of compliance procedures associated with the Sarbanes‐Oxley Act of 2002 came at a great cost to most publicly‐traded firms, largely due to the internal control

3132

Abstract

Purpose

The implementation of compliance procedures associated with the Sarbanes‐Oxley Act of 2002 came at a great cost to most publicly‐traded firms, largely due to the internal control disclosures required by Section 404 of the Act. The purpose of this paper is to contribute to the inquiry on internal control effectiveness by examining the impact of the type (same or different) and number of internal control weaknesses on audit fees. The paper also examines whether firms that remediate continue to incur higher audit fees compared to firms that never disclosed a weakness.

Design/methodology/approach

The authors evaluate the impact of internal control weaknesses and their remediation on audit fees using ordinary least squares regression for 9,122 firm year observations (3,096 unique firms) over the time period 2004‐2007.

Findings

The authors find: an incremental impact on audit fees of additional material weakness disclosures; firms that report the same material weakness pay higher fees than firms reporting a different material weakness in consecutive years; and audit fees remain high one, two, and three years following remediation compared to a firm that never disclosed an internal control weakness.

Originality/value

In contrast with prior studies, the sample includes firms that remediated weaknesses, firms that failed to remediate weaknesses, and firms that did not have prior weaknesses. The results suggest that the failure to remediate has greater risk implications than new weaknesses and that material weaknesses are associated with higher audit fees several years after remediation.

Details

Review of Accounting and Finance, vol. 11 no. 4
Type: Research Article
ISSN: 1475-7702

Keywords

Article
Publication date: 19 April 2011

Samer Khalil

The purpose of this paper is to test whether firms audited by the same Big 4 audit firm (Big 4 continuing clients) are more/less likely to report material weaknesses (systemic…

1532

Abstract

Purpose

The purpose of this paper is to test whether firms audited by the same Big 4 audit firm (Big 4 continuing clients) are more/less likely to report material weaknesses (systemic material weaknesses) in internal controls over a financial reporting than those audited by the same Non‐Big 4 audit firm (Non‐Big 4 continuing clients) over the period 2005‐2008. It also investigates whether the number of material weaknesses and that of systemic material weaknesses varies among the two groups.

Design/methodology/approach

Logistic regression and count regression analysis for panel data tests the hypotheses using all firms that had SOX 404 filings and that were audited by the same auditor over the period 2005‐2008 (1,668 firms; 6,672 firm‐year observations).

Findings

Findings document that Big 4 continuing clients are less likely to report material weaknesses and systemic material weaknesses than Non‐Big 4 continuing clients, especially during the first two years of investigation. Results also demonstrate that the number of material weaknesses and that of systemic material weaknesses reported by Big 4 continuing clients is significantly lower than that reported by Non‐Big 4 continuing clients, primarily for the years 2005 and 2006.

Originality/value

Findings support the risk avoidance perspective where large audit firms avoid riskier clients due to potential litigation costs and/or due to potential sanctions by the Public Company Accounting Oversight Board (PCAOB). Results also suggest that smaller audit firms did not extensively test the quality of internal controls prior to the year 2004. They highlight that the enactment of SOX 404 and the establishment of the PCAOB heightened audit firms focus on internal controls and raised their sensitivity to audit risk arising from weaknesses in internal controls over financial reporting.

Details

Managerial Auditing Journal, vol. 26 no. 4
Type: Research Article
ISSN: 0268-6902

Keywords

Article
Publication date: 23 March 2010

Kim Ittonen

The purpose of this paper is to examine investor reactions to material internal control weakness disclosures. In particular, the abnormal returns, the change in volatility, and…

3979

Abstract

Purpose

The purpose of this paper is to examine investor reactions to material internal control weakness disclosures. In particular, the abnormal returns, the change in volatility, and the change in systematic risk are analyzed around auditors' material weakness reports.

Design/methodology/approach

The sample consists of 342 firms with initial Sarbanes‐Oxley Act, Section 404 weakness disclosures issued between 2005 and 2007. The paper uses three measures for investor reactions: abnormal returns and the change in volatility and systematic risk. The hypotheses of the paper are investigated using univariate analysis.

Findings

The initial results imply surprisingly that the material weakness disclosure is good news to investors. However, after controlling for the preceding management's internal control disclosure, the results show that the abnormal reaction is positive only when the audit report is consistent with the preceding management report. In addition, the results show a significant change in volatility after the auditor's weakness disclosure.

Research limitations/implications

These results imply that the investor reactions to auditors' material weakness disclosures depend on the content of the preceding report issued by management: there is a positive reaction if management has identified and reported the existing material weaknesses before the auditor, and a negative reaction when management has failed to identify or report the material weaknesses before the auditor.

Originality/value

The findings of this paper emphasize that the value of the information contained in the auditors' material internal control weakness disclosures vary significantly depending on management disclosures.

Details

Managerial Auditing Journal, vol. 25 no. 3
Type: Research Article
ISSN: 0268-6902

Keywords

Article
Publication date: 31 July 2007

Benjamin P. Foster, William Ornstein and Trimbak Shastri

Section 404 of the Sarbanes‐Oxley Act (SOX) of 2002 required companies to report on the effectiveness of their internal controls over financial reporting. Auditors also must…

3000

Abstract

Purpose

Section 404 of the Sarbanes‐Oxley Act (SOX) of 2002 required companies to report on the effectiveness of their internal controls over financial reporting. Auditors also must attest to, and report on, the assessment of the effectiveness of internal control over financial reporting made by the management of the company being audited. The purpose of this paper is to provide analyses of audit fee costs and material weaknesses reported for companies of different sizes after the effective date of Section 404 and suggest approaches to reduce SOX 404 compliance costs.

Design/methodology/approach

Quantitative analysis and deductive reasoning are used to evaluate audit costs associated with Section 404.

Findings

Audit fees have been increased substantially, particularly during the first year a company complied with Section 404, and have not been dropped substantially after the first year of compliance. Companies with sales of less than $1 billion reported significantly more material weaknesses than larger companies.

Originality/value

This paper documents audit costs after the SOX Section 404 effective date, the typical types of material weaknesses reported, the proportion of companies of different sizes reporting material weaknesses, and describes approaches to reduce compliance costs.

Details

Managerial Auditing Journal, vol. 22 no. 7
Type: Research Article
ISSN: 0268-6902

Keywords

Article
Publication date: 17 August 2021

Hyeesoo (Sally) Chung, Sudha Krishnan, John Lauck and Jinyoung Wynn

This paper aims to investigate whether the stock market reacts to presentation options available to auditors under AS 2 (providing separate financial statement audit and internal

Abstract

Purpose

This paper aims to investigate whether the stock market reacts to presentation options available to auditors under AS 2 (providing separate financial statement audit and internal control over financial reporting [ICOFR] audit reports, or presenting a combined report with both audit opinions).

Design/methodology/approach

Drawing on psychology theory, the authors hypothesize that presenting material weaknesses in ICOFR with an unqualified financial statement audit in a combined report effectively dilutes the weight placed on the material weaknesses perceived by investors. The authors further hypothesize the presentation format effect to vary by type of material weaknesses since some material weaknesses are considered more serious than others. The authors examine ICOFR and audit reporting and cumulative abnormal return data from 2007 to 2017 using two-stage least squares regression analysis.

Findings

The results show that a combined report of ineffective ICOFR and unqualified financial statement audit reduces the negative impact of material weakness disclosures on stock price reactions, but only when the weaknesses involve more serious entity-wide controls, as opposed to controls over specific accounts.

Practical implications

The findings help inform preparers, auditors, regulators and investors about the potentially unintended consequences of reporting format choice.

Originality/value

The findings contribute to the literature on internal control disclosures by demonstrating that market reactions to these disclosures depend not only on the types of material weaknesses disclosed but also on their presentation format.

Details

Managerial Auditing Journal, vol. 36 no. 7
Type: Research Article
ISSN: 0268-6902

Keywords

Article
Publication date: 26 June 2009

Joseph Canada, Steve G. Sutton and J. Randel Kuhn

The complexity of computerized information systems increases the complexity of the external auditor's assessment of the reliability of a client's internal control systems. The…

1648

Abstract

Purpose

The complexity of computerized information systems increases the complexity of the external auditor's assessment of the reliability of a client's internal control systems. The purpose of this paper is to investigate the impact of weaknesses in IT related internal controls on the cost of a SOX 404 audit of internal controls over financial reporting.

Design/methodology/approach

The paper considers the impact on audit fees through three dimensions: percentage increase in audit fees; amount of change in audit fees per outstanding common share; and actual dollar amount of audit fees. Examination of first year reports by accelerated filers yields 131 companies with material IT‐control weaknesses. These 131 companies are matched with a similar set of companies with no reported material weaknesses, and for a subset of 54 from the 131 companies in which a good match could be identified, a set of companies having only material non‐IT‐based control weaknesses are compared.

Findings

As expected, substantial fee differentials were identified for companies reporting material IT‐based control weaknesses as compared to both companies without any material weaknesses and those companies with only non‐IT related material weaknesses.

Originality/value

Preliminary evidence in regard to the costs of SOX 404 compliance for stockholders is provided. The cost of SOX 404 compliance has often been cited in criticisms of SOX, yet the focus of SOX is not on corporate wealth, but rather on enhancing corporate governance to protect the interest of stockholders. The cost of SOX compliance across the number of reported outstanding common shares for the companies studied is factored. It is found that the increased cost of audit fees on a per share basis is higher for companies reporting IT material weaknesses.

Details

International Journal of Accounting & Information Management, vol. 17 no. 1
Type: Research Article
ISSN: 1834-7649

Keywords

Article
Publication date: 21 January 2020

Ifeoma Udeh

This paper aims to examine the effectiveness of the Committee of Sponsoring Organization’s 2013 Framework, by investigating how the number of auditor-reported material weaknesses

1143

Abstract

Purpose

This paper aims to examine the effectiveness of the Committee of Sponsoring Organization’s 2013 Framework, by investigating how the number of auditor-reported material weaknesses compares for Early-, Timely- and Late-adopters of the framework, and how the number of auditor-reported material weaknesses changed for Early- and Timely-adopters following their adoption of the framework.

Design/methodology/approach

The paper uses regression analyses based on a sample of US firms subject to Sarbanes-Oxley Act Section 404(b).

Findings

Timely-adopters of the 2013 Framework continued to exhibit fewer instances of auditor-reported material weaknesses than Late-adopters, even though they had a marginal increase in the number of auditor-reported material weaknesses, in the post-2013 Framework period.

Practical implications

The findings suggest that the effectiveness of the 2013 Framework may lie in the iterative nature of the internal control process, and as firms remedy deficiencies they or their auditors identify, they will continuously improve the effectiveness of their internal control systems.

Originality/value

Unlike existing literature, this paper uses data from the pre-2013 Framework, transition and post-2013 Framework periods to examine changes in the number of auditor-reported material weaknesses, thus differentiating between Early-, Timely- and Late-adopters of the 2013 Framework. It also shows the effect of adopting the 2013 Framework on the number of auditor-reported material weaknesses.

Details

Journal of Accounting & Organizational Change, vol. 16 no. 1
Type: Research Article
ISSN: 1832-5912

Keywords

Article
Publication date: 31 January 2020

Kathleen Bakarich and Devon Baranek

This study aims to identify characteristics of firms reporting multiple years of material weaknesses in internal control over financial reporting (MWICFR), labeled “Repeat…

Abstract

Purpose

This study aims to identify characteristics of firms reporting multiple years of material weaknesses in internal control over financial reporting (MWICFR), labeled “Repeat Offenders”, and examine their characteristics and the types of material weaknesses they report using both broad and COSO-based classification schemes. The analysis compares these firms with firms reporting only one year of MWICFR and examines the differences between Repeat Offenders reporting consecutive and non-consecutive weaknesses.

Design/methodology/approach

Univariate and multivariate analyses were conducted on a sample of 1,793 firm-year observations, split into Repeat Offenders and non-Repeat Offenders, and collected from AuditAnalytics and Compustat from 2007 to 2015.

Findings

On average, 40% of adverse opinions in ICFR each year can be attributed to Repeat Offenders. Compared to one-time MWICFR firms, Repeat Offenders are significantly more likely to report general material weaknesses and, within the COSO framework, are significantly more likely to report issues with Segregation of Duties and Processes and Procedures. Repeat Offenders reporting consecutive years of MWICFR are significantly more likely to have general weaknesses than non-consecutive Repeat Offenders and are also significantly more likely to report issues with Segregation of Duties and Personnel.

Research limitations/implications

Prior studies have examined unremediated ICFR issues in the periods immediately following SOX implementation. This study extends this literature with a longer, more current sample period, focusing on both broad and COSO-specific control issues, as well as examining consecutive and non-consecutive MWICFR and firms with more than two years of MWICFR.

Originality/value

This study underpins recent Securities and Exchange Commission and Public Company Accounting Oversight Board concerns regarding pervasive ICFR issues. This study identifies some of the characteristics of firms associated with weaker ICFR and pinpoints more specific areas within internal controls that frequently lead to adverse opinions.

Details

Managerial Auditing Journal, vol. 35 no. 4
Type: Research Article
ISSN: 0268-6902

Keywords

Article
Publication date: 30 October 2009

Santanu Mitra

The purpose of this paper is to examine the association between pervasiveness, severity, and remediation of internal control material weakness (ICMW) reported by the SEC…

1559

Abstract

Purpose

The purpose of this paper is to examine the association between pervasiveness, severity, and remediation of internal control material weakness (ICMW) reported by the SEC registrants pursuant to SOX Section 404 and audit fees.

Design/methodology/approach

The paper employs multivariate regression models for a sample of 854 firms that disclosed ICMW for the first time in 2004, 2005, or 2006, to investigate the empirical relationship of pervasiveness and severity of ICMW and its subsequent remediation with audit fees.

Findings

The analyses demonstrate that audit fees are significantly positively related to the severity (and pervasiveness) of ICMW in the years of ICMW disclosures and are significantly negatively related to the remediation of internal control weaknesses in the years when ICMW remediation took place. The test results further demonstrate that the remediation of systematic control weaknesses has a greater effect on reduction of audit fees compared to the remediation of nonsystematic (transaction/account related) control weaknesses, though the remediation of both systematic and nonsystematic control weaknesses is accompanied by audit fee declines.

Research limitations/implications

The study produces evidence on pricing audit services by incumbent auditors in response to the severity of internal material control weaknesses and their remediation in subsequent fiscal periods. Its results shed light on certain new aspects of audit fee determinants in the post‐SOX period by virtue of their implications that the pervasiveness and severity of internal control problems induce auditors to make an upward fee adjustment while their remediation has a moderating effect on pricing audit services.

Originality/value

The study's finding is a useful addition to the existing fee literature and is relevant for the post‐SOX world which experienced a structural change in financial accounting and auditing environment.

Details

Review of Accounting and Finance, vol. 8 no. 4
Type: Research Article
ISSN: 1475-7702

Keywords

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