Internal audit quality and earnings management: evidence from the UK

Abstract

Purpose This study aims to examine the association between internal audit quality and the involvement of UK companies in earnings management practices. Design/methodology/approach To measure the internal audit quality, this study uses 115 responses for a postal questionnaire that was addressed to the heads of internal audit departments in a sample of non-financial listed companies in the UK context. The other financial and governance data for the respondent companies were collected from the Datastream and the companies’ annual reports. The present study uses the signed abnormal accruals as a proxy for earnings management and uses both logistic and ordinary least squares regression models to test the research hypothesis. Findings This study finds a negative relationship between the internal audit quality and the abnormal accruals, implying the prominent role of internal audit in reducing the upwards earnings management. The study also finds a significant impact of the internal audit competence on reducing the engagement of UK companies in income-increasing earnings management compared to the internal audit independence. This remarkable result suggests the companies need to focus more on enhancing the internal audit competence to reduce the opportunistic management’s behaviour. Practical implications This study has important implications for the internal audit’s practice, regulation and research. Originality/value This is the first study that investigates the relationship between internal audit quality and earnings management in the UK context. Furthermore, it uses a comprehensive measure for the internal audit function (IAF) quality covering different aspects of IAF quality based on the global Institute of Internal Auditor standards and prior internal audit literature.

A research profile on internal audit quality

“…Kaawaase et al (2021) tried to provide the association among corporate governance roles, IAQ and the quality of financial reports in Uganda's financial entities and found out that either board attributes and IAQ are quite related to better financial reports. Ismael & Kamel (2021) investigated the relationship between IAQ and United Kingdom firms in earnings management procedures and demonstrated the consistent role of IA in diminishing the incidence of atypical accruals, corroborating the negative relation amid IAQ and earnings management. Krichene & Baklouti (2021) tried to figure out the approaches of internal auditors on IAQ and to emphasize their contrasting characteristics considering their impressions of IAQ antecedents and demonstrated that features as the internal auditors' expertise, reporting autonomy, conformity with IPPF, liaison with the external auditors, internal auditors' private affinities, admission to data and area of activity presents a positive relation with IAQ in various levels of significance.…”

“…The internal audit function (IAF) can be considered independent if its practices adhere to standards internationally accepted, as well as its activities are performed autonomously, due both to the adjustment of the level of reporting to senior management and the timely issuance of reports to the Board of Directors (IIA, 2013). The IAF is believed to be a governance branch and, when effective, is widely believed to conduct distinct significant roles during the process of financial reporting (Ismael & Kamel, 2021).…”

“…Alaraji (2020) stands that the use of corporate governance pillars in private sector companies has committed to enhancing and implementing quality in control function and IAF, reinforcing the internal control system and IA, in addition to improving financial statements in terms of neutrality and trustworthiness. Ismael & Kamel (2021) measure IAQ using four distinctive proxies: (i) size; (ii) independence; (iii) methodology; and (iv) management, skills and knowledge.…”

The use of Beneish M-scores to reveal creative accounting: evidence from Slovakia

“…Logistic regression was performed as described by Purba et al (2021). The least-squares method was used by Ismael and Kamel (2021), Bhutta et al (2021), andChakroun et al (2022, pp. 331-362).…”

Besikeičiantis Vidaus Audito Vaidmuo Ir Pridėtinė Vertė

“…Vidaus audito kokybę ir pajamų valdymo ryšį tiriantys mokslininkai (Ismael et al, 2021) teigia, kad įmonės turi daugiau dėmesio skirti vidaus audito kompetencijos stiprinimui, kad sumažintų oportunistinį vadovybės elgesį. Yildiz ir Yilmaz (2020) nuomone, vidaus auditorių profesinė kompetencija, charakteris ir motyvacija yra labai svarbūs, kad vidaus auditas suteiktų pridėtinę vertę organizacijai.…”