The Role of the Internal Audit Function in the Disclosure of Material Weaknesses

Abstract

This study investigates the role that a firm’s internal audit function (IAF) plays in the disclosure of material weaknesses reported under Section 404 of the Sarbanes-Oxley Act of 2002 (U.S. Congress 2002). Using data from 214 firms, we examine the relation between material weakness (MW) disclosures and various IAF attributes and activities. Our results indicate that MW disclosures are negatively associated with the education level of the IAF and the extent to which the IAF incorporates quality assurance techniques into fieldwork, audits activities related to financial reporting, and monitors the remediation of previously identified control problems. The timing of Section 404 work and the nature of follow-up monitoring suggests that these aspects of IAF quality help prevent MWs from occurring. We find that MW disclosures are positively associated with the IAF practice of grading audit engagements and external-internal auditor coordination, suggesting that these activities increase the effectiveness of Section 404 compliance processes.

The Internal Audit Dilemma - The Impact of Executive Directors Versus Audit Committees on Internal Auditing Work

“…There is a growing body of literature showing positive effects of internal auditing, e.g. in the areas of improved financial reporting (Prawitt et al, 2009(Prawitt et al, , 2012Abbott et al, 2012Abbott et al, , 2016, improved corporate governance (Lenz et al, 2014), better fraud risk assessments and detection (Ege, 2015) and better internal controls (Lin et al, 2011).…”

The Impact of Internal Audit Function Quality and Contribution on Audit Delays

“…3 We conduct our tests using data on 216 firms providing detailed responses to the IIA's Global Auditing Information Network (GAIN) survey for the four-year period immediately prior to the implementation of SOX 404. 4 Based on professional standards and following prior research, we use GAIN data to develop multiple measures of IAF quality and the IAF's contribution to the financial statement audit (AICPA 1991;Prawitt et al 2009;IIA 2011;Lin et al 2011). Results indicate that a one-standard deviation increase in our comprehensive quality measure corresponds to a reduction in audit delay of approximately three-to-four days, and that this reduction is primarily driven by the competence of the internal audit staff and the quality of their fieldwork.…”

The Reliance of External Auditors on Internal Audit's Use of Continuous Audit

“…More recent studies highlight a correlation between higher quality internal audit functions and lower likelihoods of material weaknesses (Lin et al 2011), as well as management being less likely to manipulate earnings (Prawitt et al 2009). …”