SOX 404(b) Audits: Evidence from Auditing the Financial Close Process

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Abstract

Sarbanes-Oxley Act (SOX) section 404(b) mandates audits of integrated internal control over financial reporting (ICFR) for large issuers. Prior research and PCAOB inspections find that auditors often underreport ICFR weaknesses and over rely on ICFR findings when auditing financial statements. To increase our understanding of integrated audits, this paper explores how external auditors examine an important component of ICFR, the financial close process.

Results suggest that auditors place significant dependence on walk-throughs. Further, some auditors are uncomfortable evaluating financial close related entity-level controls and perform only cursory reviews of these controls. In addition, auditors often fail to test the link between the financial statements and supporting systems, particularly ignoring the access controls that monitor this process. Financial statement only auditors are more likely to re-perform key controls rather than rely on cursory walkthroughs that integrated auditors prefer. This provides evidence that auditors performing integrated audits may over rely on internal control information when conducting financial statement audits. In addition, the PCAOB notes that auditors may not adequately testing internal controls related to the financial close process. Overall, our results suggest that auditors may over rely on ICFR findings and may need to increase the scope of their financial close work.

Authors

• Diane J Janvrin, Iowa State University

• Maureen Francis Mascha, Purdue University Northwest

• Melvin Arnaldo Lamboy Ruiz, Iowa State University