Internal Control Deficiency, Internal Control Audits, and Audit Fees

• In Event: Audit II

Abstract

During 2005-2009, the number of adverse internal control opinions issued by auditors decreased sharply and the SEC raised concerns that the audit firms may fail to adequately test and report internal control weaknesses that are material (SEC, 2009). In 2010, PCOAB reacted to the downward trend in number of adverse internal control opinions by asking its inspectors to assess the sufficiency of evidence collected by audit firms to support their opinions. We examine different types of internal control audit deficiencies reported by the PCAOB for fiscal years 2010 – 2014, and their association with adverse internal control opinion issued by the auditor subsequent to receiving report. We also examine the association between audit fees and internal control audit deficiencies reported by the PCAOB. We find that audit deficiencies reported by the PCAOB that are related to the audit process (roll-forward control testing, information system controls, evaluation of controls over the period-end financial reporting process, risk assessment controls, and nature, timing, extent, and updating of controls) are significantly associated with adverse internal control opinion subsequently issued by an audit firm. We also find that internal control audit deficiencies related to the audit process (communication of identified deficiencies in control, testing of design of controls, information system controls, using the work of other in testing of controls, and nature, timing, extent, and updating of control testing) have significant association with audit fees charged subsequent to receiving the adverse PCAOB inspection report. Overall, our findings show that PCAOB inspection reports identify systematic shortcomings in the audit process of accounting firms and the impact on adverse internal control opinions.

Authors

• Pervaiz Alam, Kent State University

• Amir Moeini, Kent State University