Do Annual Internal Control Audits and Management Assessments Impact Quarterly Financial Reporting Quality?

• In Event: Internal Controls

Abstract

We address whether U.S. public filer internal control regulations and standards have enhanced internal control system quality, leading to improved quarterly financial reporting quality (QFRQ). Because the intent of the Sarbanes-Oxley Act was “to…[improve] the accuracy and reliability of corporate disclosures”, it is important to understand if control related requirements have enhanced financial reporting quality. We use a quarterly setting because quarterly financial statements are valued and provide a better measure of the pervasive effects of ICFR audits on financial reporting without concurrent annual financial statement audit intervention. We find internal control audits are initially associated with lower abnormal accruals, or better QFRQ, through 2006. However, subsequent to the 2007 change in ICFR auditing standards, material weakness rates decline and abnormal accruals and accrual noise increase. Finally, we find management’s assessment of internal control quality without a concurrent ICFR audit does not enhance QFRQ. It thus appears that while control audits were associated with enhanced QFRQ, the 2007 change in auditing standards may have reduced the identification or disclosure of existing material weaknesses in ICFR and lowered QFRQ.

Authors

• Joseph H Schroeder, Indiana University Bloomington

• Marcy Lynn Shepardson, Indiana University Bloomington