The Effect of Internal Control Deficiencies on Audit Fees and Audit Report Lags
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School of Business |
Master's thesis
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Date
2017
Department
Major/Subject
Mcode
Degree programme
Accounting
Language
en
Pages
61
Series
Abstract
An audit can be viewed as a part of an entity’s overall financial reporting system, and as such an audit has its substitutes and complements. As the benefits of a well-functioning financial reporting system, of which both internal controls and auditing are a part of, are in liability avoidance, it follows that internal control is a substitute for auditing, and vice versa. Therefore, a weakness in internal control affects the amount of audit work, which is reflected both in the price of an audit and the length of an audit. The Sarbanes-Oxley Act, implemented in the aftermath of several accounting fraud scandals, aims to enhance financial disclosures and prevent fraudulent accounting. Internal control reporting requirements in Section 404 have been arguably one of the most controversial aspects of SOX as they require the management to document, evaluate, and publicly report the effectiveness of internal controls and the auditor to attest to and report on this assessment. Section 404 internal control disclosures provide more insight into the internal controls of an entity, and open up a new way to research the effects that internal control has on auditing. This thesis investigates how a reported material weakness in internal control influences audit fees and audit report lag. As a weakness in internal control will likely lead to more audit work, the assumption is that a material weakness in internal control affecting financial reporting will increase the price of an audit and prolong the audit report lag. The first hypothesis is that audit fees will be higher for companies that have reported one or more internal control deficiencies under SOX Section 404. The second hypothesis is that the audit report lag will be longer for companies that have reported one or more internal control deficiencies under SOX Section 404. The hypotheses are evaluated using multivariate regression analysis. The analyses will be carried out to model the relationships that audit fees and audit report lags have to their determinants. The data used is taken from Compustat and AuditAnalytics databases and consists of financial information of U.S. companies with fiscal year end dates between 01/01/2005 and 31/12/2015. The results are that a reported material weakness in internal control has a significant positive relationship with audit fees and audit report lags. The percentage effect of an internal control deficiency on audit fees is 20.2 % and 9.4 % on audit report lag. These findings are consistent with previous research, and add to the body of knowledge concerning the effects of reported internal control deficiencies.Description
Thesis advisor
Jarva, HenryKeywords
internal control deficiency, audit fee, audit report lag, Sarbanes-Oxley Act, section 404