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    Do Small Firms Benefit from Auditor Attestation of Internal...
    research summary posted October 22, 2013 by Jennifer M Mueller-Phillips, last edited October 22, 2013, tagged 01.0 Standard Setting, 01.04 Impact of 404, 12.0 Accountants’ Reports and Reporting, 12.07 Attestation Services 
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    Title:
    Do Small Firms Benefit from Auditor Attestation of Internal Control Effectiveness?
    Practical Implications:

    This study can inform regulators, investors, and others of the potential consequences of exempting non-accelerated filers from Section 404(b) of SOX. The results of this study support the notion that an auditor’s opinion on the effectiveness of internal control over financial reporting adds value beyond certifications provided by management. Additionally, the results of the study support the notion that investors in small public firms regard auditors’ assessment of the effectiveness of internal controls as adding value via higher revenue quality relative to firms that are not required to submit themselves to additional scrutiny by their auditors. Thus, firms contemplating exiting accelerated status may want to consider that such a move may have an adverse effect on firm valuation.

    Citation:

    Krishnan, G. V., and W. Yu. 2012. Do Small Firms Benefit from Auditor Attestation of Internal Control Effectiveness? Auditing: A Journal of Practice and Theory 31(4): 115-137.

    Keywords:
    Dodd-Frank Act; SOX 404; revenue quality; non-accelerated filers; valuation
    Purpose of the Study:

    Several sections of the Sarbanes-Oxley Act of 2002 (SOX) mandate disclosure of information on the effectiveness of internal control over financial reporting (ICFR):

    • Section 302 requires the CEO and CFO to certify 10-K and 10-Q reports, and establish and maintain internal controls.
    • Section 404(a) requires each company’s annual report to include an internal control report containing management’s assessment of the effectiveness of ICFR (management report).
    • Section 404(b) requires companies to have the auditor evaluate the effectiveness of the internal controls.

    Accelerated filers (public companies with a public float of at least $75 million) and non-accelerated filers are both subject to the provisions of Section 302 and 404(a), but the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 permanently exempts non-accelerated filers from the provisions of Section 404(b). Therefore, the purpose of the study was to examine whether the provisions of Section 404(b) add value incremental to those in Sections 302 and 404(a) for small firms. The authors specifically examined whether there was a difference in the revenue quality (which is discretionary or abnormal revenue) between accelerated filers who are subject to auditor attestation of ICFR and non-accelerated filers. They also examines whether there was a difference in the investor valuation of accelerated filers relative to non-accelerated filers.
     

    Design/Method/ Approach:

    The authors used data between the years 2007 and 2009 from publicly-traded companies. The authors identified accelerated and non-accelerated filers that had beginning assets between $25 million and $125 million. The authors fit this data to a model that estimated discretionary revenues for these firms.

    Findings:
    • On average, discretionary (abnormal) revenues were lower by about 1.5 percent of total assets for accelerated filers relative to non-accelerated filers.
    • After excluding observations that had control deficiencies, the authors found that the discretionary revenues were lower by about 1.9 percent for accelerated filers relative to non-accelerated filers.
    • The authors evaluated firms that had changed from being accelerated filers to non-accelerated filers and found that discretionary revenues had increased by about 1 percent of total assets following the change from accelerated filer to non-accelerated filer.
    • The authors matched non-accelerated filers with accelerated filers by the ratio of audit fees over total assets and found that discretionary revenues were smaller for accelerated filers relative to non-accelerated filers.
    • The book value of equity of accelerated filers was valued more by investors relative to the book value of equity of non-accelerated filers.
       
    Category:
    Accountants' Reporting, Standard Setting
    Sub-category:
    Attestation Services, Impact of 404, Impact of SOX