Internal Control Deficiency Reporting throughout the Auditor-Client Relationship

• In Event: Client Risk and Internal Controls

Abstract

This study examines the detection and reporting of internal control deficiencies over the term of the auditor-client relationship. Auditor assessment of internal control deficiencies has potential implications for planned audit test procedures and auditors’ choices about whether and how to report these deficiencies have the potential to revise the decision-making of their clients’ stakeholders. However, internal control evaluation can be influenced by factors that vary over the auditor-client relationship such as client-specific knowledge, auditor objectivity, and the extent planned audit procedures. We use a sample of audit reports issued for large U.S. not-for-profit organizations between 2001 and 2007, which contain additional information not available in comparable reports issued for SEC registrants. We find a significant increase in material weaknesses, reportable conditions (i.e. significant deficiencies), and audit findings reported in the first year of audit firm tenure. While we find no significant association between audit partner changes and the reporting of internal control deficiencies, we do find that partners are more likely to report audit findings if their tenure exceeds five years. These findings indicate that auditors’ reporting decisions vary over the auditor-client relationship suggest that longer audit partner tenure is associated with higher audit quality.

Authors

• Brian Fitzgerald, Texas A&M University

• Thomas C Omer, Texas A&M University

• Anne Margaret Thompson, University of Illinois at Urbana–Champaign