Article2016

Unexpected Fees and the Prediction of Material Weaknesses in Internal Control Over Financial Reporting

Susan M. Albring · Randal J. Elder · Xiaolu Xu

27 citations0/0 files storedJournal of Accounting Auditing & Finance

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Auditing, Earnings Management, Governance Corporate Finance and Governance Corporate Governance and Financial Management

Abstract

We investigate whether prior year unexpected audit fees help predict new material weaknesses in internal control over financial reporting reported under Section 404 of the Sarbanes–Oxley Act (SOX). Predicting material weaknesses may be useful to investors and other financial statement users because these disclosures have adverse economic impacts on disclosing firms. Unexpected fees are significantly associated with material weaknesses reported under Section 404, even after controlling for Section 302 disclosures and other factors associated with internal control weaknesses. Unexpected fees are associated with company-level weaknesses but are not significantly associated with account-specific weaknesses, consistent with differences in the nature and severity of the two types of material weaknesses. Our results are consistent with unexpected audit fees containing information on unobserved audit costs and client control risks, which help predict future internal control weaknesses.

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References

1968FINANCIAL RATIOS, DISCRIMINANT ANALYSIS AND THE PREDICTION OF CORPORATE BANKRUPTCY 2008Estimating Standard Errors in Finance Panel Data Sets: Comparing Approaches 2011Predicting Material Accounting Misstatements*2007Determinants of weaknesses in internal control over financial reporting 2007Accruals Quality and Internal Control over Financial Reporting 2002Do Non–Audit Service Fees Impair Auditor Independence? Evidence from Going Concern Audit Opinions 2011A Framework for Understanding and Researching Audit Quality 2004Auditor Independence, Non‐Audit Services, and Restatements: Was the U.S. Government Right?*

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