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    Early Warnings of Internal Control Problems: Additional...
    research summary posted May 25, 2014 by Jennifer M Mueller-Phillips, last edited May 25, 2014, tagged 01.0 Standard Setting, 01.04 Impact of 404, 07.0 Internal Control, 07.03 Reporting Material Weaknesses, 12.0 Accountants’ Reports and Reporting, 12.06 Consequences of Adverse 404 Opinions 
    Early Warnings of Internal Control Problems: Additional Evidence
    Practical Implications:

    The results of this study raise many interesting questions. The fact that accelerated filers’ adverse internal control opinions continue to be a surprise over 50 percent of the time suggest that auditors continue to find internal control problems that management had not previously identified or had not evaluated as MWs. The results related to non-accelerated filers provide some interesting data related to the ongoing debate about the efficacy of Section 404(b) testing by auditors. The authors also note that examining the early warnings of non-accelerated filers tells us only about what management of these companies report; it does not give us insight into what auditors would report. The results also raise other interesting issues for future research.


    Munsif, V., K. Raghunandan, and D. V. Rama. 2013. Early Warnings of Internal Control Problems: Additional Evidence. Auditing 32 (2).

    302; 404; internal control; SOX
    Purpose of the Study:

    This study extends the research of Hermanson and Ye (2009; hereafter, HY) that found in the first year of Sarbanes-Oxley Act (SOX) Section 404 reporting, there were many companies with “surprise” adverse internal control reports.  The authors of this study examine a more recent time period (using data from fiscal years 2007 and 2008) and include both accelerated and non-accelerated filers. Motivation for these two extensions of HY comes from the fact that internal control disclosures by public companies and their auditors continue to be of significant interest to legislators and regulators. 

    Design/Method/ Approach:

    Data was obtained from the Audit Analytics and Compustat databases, and from company filings available at the SEC website. This data was used to answer the following two research questions:

    RQ1: What is the proportion of accelerated filers with “surprise” disclosures of material weaknesses in internal control in the fourth and fifth years of Section 404 reporting?

    RQ2: Does the likelihood of “surprise” disclosures of material weaknesses in internal control differ for accelerated and non-accelerated filers?

    To address the research question about characteristics of firms with and without early warning disclosures, following HY, a logistic regression model was used. 

    • The proportions of accelerated filer firms with MW disclosures in their Section 404(b) reports, that had disclosed one or more such MWs in Section 302 certifications in prior quarters of the same fiscal year, are only 40 percent and 39 percent in 2007 and 2008 respectively.
    • In the case of non-accelerated filer firms, the proportions of firms with such early warning disclosures are 20 percent and 56 percent in 2007 and 2008, respectively.
    • A regression model indicates that prior warning disclosures are more likely for firms with (1) more ICWs, (2) a new CFO, (3) more audit committee members, and (4) more frequent audit committee meetings.
    • In 2008, non-accelerated filers were more likely than accelerated filers to have early warning disclosures. 
    Accountants' Reporting, Internal Control, Standard Setting
    Consequences of Adverse 404 Opinions, Impact of 404, Reporting Material Weaknesses

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