Do Companies Make Voluntary Accounting Changes in Response to a Material Weakness in Internal Control?

• In Event: Responses to Risk Factors

Abstract

This study examines whether companies make voluntary changes in accounting principle in response to a material weakness. The disclosure of voluntary accounting changes enables the examination of whether companies explicitly modify financial reporting in these circumstances. We find that Section 404 material weakness companies are more likely to make voluntary accounting changes, a result driven by entity level material weaknesses. An analysis of manager justifications indicates that companies reporting an entity or process level material weakness in internal control are more likely to disclose voluntary accounting changes to improve accounting and to conform policies across subsidiaries. Material weakness companies with voluntary changes are also associated with a lower absolute value of abnormal accruals than other material weakness companies. These results suggest that material weakness companies evaluate policies to prevent future issues, resulting in voluntary accounting changes that not only improve accounting policies and enable more consistent accounting policies, but also facilitate higher quality accruals. Our study informs both internal control policymakers and accounting standards setters.

Authors

• Marsha Keune, University of Dayton

• Timothy M Keune, University of Dayton