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    The effects of disclosure type and audit committee expertise...
    research summary posted October 20, 2015 by Jennifer M Mueller-Phillips, tagged 13.0 Governance, 13.07 Internal auditor role and involvement in controls and reporting, 14.0 Corporate Matters, 14.05 Earnings Targets and Management Behavior, 14.11 Audit Committee Effectiveness 
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    Title:
    The effects of disclosure type and audit committee expertise on Chief Audit Executives’ tolerance for financial misstatements.
    Practical Implications:

    The results suggest that internal auditors contribute to decreased reliability of disclosed amounts. It appears that the incentives of external auditors and internal auditors are closely aligned on this issue. In general, both of these parties seem to feel less responsibility for disclosed, relative to recognized amounts. The results indicate that financial reporting location has significant effects on internal auditors’ decisions to correct misstatements. Specifically, internal auditors are more willing to waive disclosed misstatements relative to recognized misstatements. Contrary to expectations, the results do not indicate that increased audit committee expertise and associated increases in audit committee members’ perceived powers cause internal auditors to be less willing to waive misstatements.

    Citation:

    Norman, C. S., J. M. Rose, and I. S. Suh. 2011. The effects of disclosure type and audit committee expertise on Chief Audit Executives’ tolerance for financial misstatements. Accounting, Organizations & Society 36 (2): 102-108.

    Keywords:
    audit committee expertise, misstatements, Chief Audit Executives, audit committee, financial executives
    Purpose of the Study:

    External audit partners are more willing to waive misstatement corrections for disclosed than for recognized amounts. This willingness to allow misstatements may increase management’s incentives to manipulate disclosed amounts and increase the levels of error and bias in disclosed information. While external auditors are more willing to waive disclosed amounts, relative to recognized amounts, internal auditors may require management to adjust misstatements regardless of their reporting locations. If internal auditors do not tolerate misstatements that are disclosed, this will increase the reliability (i.e., decrease the random error and bias) of disclosed amounts and decrease the likelihood of management manipulation of disclosed amounts. As a result, the impact to practice of external auditors’ willingness to waive misstated disclosures could be mitigated or even eliminated by internal audit oversight.

    The authors examine Chief Audit Executives’ and deputy Chief Audit Executives’ decisions to require adjustments of misstatements that are either recognized or disclosed. Chief Audit Executives (CAEs) may require equivalent adjustments for recognized and disclosed amounts, and act to counter the actions of management and external auditors. Understanding the decision processes of CAEs will help to inform regulators and standard setters of the underlying factors that drive financial statement reliability.

    Design/Method/ Approach:

    The participants are 73 Chief Audit Executives (CAEs) and deputy CAEs. CAEs and deputy CAEs are the ultimate decision makers in internal audit. None of these participants are from outsourced internal audit departments. The average number of years of internal audit experience is 13.71. The study was completed on paper and provided to participants in sealed envelopes by one of the study’s authors. All participants completed the materials in their professional offices under controlled conditions in the presence of one of the authors. The evidence was gathered prior to 2011.

    Findings:

    The results of this study indicate that reporting location has a significant effect on internal auditors’ decisions. Specifically, CAEs and their deputies require lesser amounts of misstatement correction of disclosed amounts relative to recognized amounts. While increased audit committee expertise increases audit committee members’ perceived power over management, the authors do not find that CAEs require greater misstatement corrections when the audit committee has more financial expertise, relative to less expertise. It appears that internal auditors may not have enough concern about disclosed misstatements to warrant a decision to exercise the power they derive from audit committee expertise. The results suggest that internal auditors, like external auditors and managers, act to decrease the perceived and actual reliability of disclosed information. Further, increasing the power of the internal audit function does not mitigate this problem. The authors find reason for serious concerns about the accuracy of disclosed amounts, relative to recognized amounts.

    Category:
    Corporate Matters, Governance
    Sub-category:
    Audit Committee Effectiveness, Earnings Targets & Management Behavior, Internal auditor role and involvement in controls and reporting