Unexpected Fees, Section 302 Reporting, and Prediction of Section 404 Material Weaknesses

• In Event: Breakfast and Research Forum
  In Roundtable Session: Table 2: Auditors and Internal Control Weakness

Abstract

Section 302 of the Sarbanes-Oxley Act provides for management disclosure of significant deficiencies in internal control when they certify quarterly or annual financial statements. We investigate whether prior year unexpected audit fees, which precede any Section 302 disclosures, predict Section 404 weaknesses. Unexpected fees are significantly associated with material weaknesses even after controlling for Section 302 disclosures and other factors associated with internal control deficiencies. New Section 302 weaknesses are more likely to result in a Section 404 material weakness if they are reported closer to year-end. Unexpected fees are associated with the more severe company-wide weaknesses, but are not significantly associated with account specific-weaknesses. We further find that the market penalizes firms in the bottom quartile of the unexpected fee distribution that do not report a Section 302 weakness prior to disclosure of a Section 404 weakness. We also find that unexpected fees predict new Section 302 weaknesses.

Authors

• Susan M Albring, Syracuse University

• Randal J Elder, Syracuse University

• Xiaolu Xu, Syracuse University