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

• In Event: Internal Controls

Abstract

The quality of financial statement (FS) audits integrated with audits of internal controls over financial reporting (ICFR) depends upon both integration of ICFR audit-derived control information into FS audits and ICFR audit quality. Unfortunately, recent research and PCAOB inspections find many auditors underreport existing ICFR weaknesses and do not perform sufficient testing to address identified risks. To test whether the additional ICFR-related effort required for integrated audits affects FS audit quality, we use a 2007 – 2012 sample and compare small, U.S. public company firm-years receiving integrated audits (accelerated filers) to those receiving FS-only audits (non-accelerated filers). We find firm-years with integrated audits have a 99.2% higher likelihood of material misstatement, or lower FS audit quality. Moreover, evidence suggests both integrated auditor over-reliance on ICFR and low-quality ICFR audits yield lower FS audit quality. Overall, results suggest an important cost of integrated audits, as currently implemented, is lower FS audit quality.

Authors

• Lori Shefchik Bhaskar, Indiana University - Bloomington

• Joseph H Schroeder, Indiana University - Bloomington

• Marcy Lynn Shepardson, Indiana University - Bloomington