Auditing Section Research Summaries Space

A Database of Auditing Research - Building Bridges with Practice

This is a public Custom Hive  public

research summary

    Internal Control Quality: The Role of Auditor-Provided Tax...
    research summary posted September 16, 2015 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.03 Non-Audit Services, 07.0 Internal Control, 07.03 Reporting Material Weaknesses, 13.0 Governance, 13.05 Board/Audit Committee Oversight 
    421 Views
    Title:
    Internal Control Quality: The Role of Auditor-Provided Tax Services.
    Practical Implications:

    The results of this study are important to audit regulators as they make decisions regarding policies, and to corporate governance officials as they make decisions regarding the audit firms they engage to provide tax nonaudit services. The evidence indicates that tax nonaudit services accelerate audit firm awareness of material transactions as these services are associated with a lower likelihood of a material weakness in internal controls. In addition, further evidence supports that this finding is not simply due to impaired auditor independence. Overall, this suggests that tax nonaudit services provided by the audit firm improve internal control quality. As regulators and companies evaluate the consequences of tax nonaudit services, the findings in this paper may impact their conclusions.

    Citation:

    De Simone, L., M.S. Ege, and B. Stomberg. 2015. Internal Control Quality: The Role of Auditor-Provided Tax Services. The Accounting Review. 90(4): 1469-1496.

    Keywords:
    auditor fees, nonaudit services, auditor independence, internal controls, tax, financial reporting quality
    Purpose of the Study:

    Audit regulators and companies’ corporate governance officials are charged with understanding and creating policies for auditor provided nonaudit services. To make informed decisions, it is important for these groups to know the benefits and costs of auditor provided nonaudit services. Previous research has reported a positive association between tax nonaudit services and financial reporting quality and audit quality. This paper investigates the relationship between tax nonaudit services and a specific component of financial reporting quality: internal control quality. Specifically, the authors:

    • Examine the relationship between tax nonaudit services and the probability of a material weakness in internal controls (i.e. internal control quality).
    • Examine whether tax nonaudit services are beneficial to companies experiencing a shock to their internal control environment.
    • Examine how the relationship between tax nonaudit services and internal control quality is affected by audit firm tenure.

    The authors also explain the process through which they propose tax nonaudit services affects non-tax financial reporting quality.

    Design/Method/ Approach:

    The authors collected auditor internal control opinions and data necessary to calculate control variables on publicly-traded companies that are subject to SOX Section 404(b). The information collected on these companies was for years 2004-2012.

    Findings:
    • The authors find that companies that purchase tax nonaudit services are significantly less likely to disclose a material weakness. A one standard-deviation increase in tax nonaudit services is associated with approximately a 13% decrease in the rate of material weaknesses relative to the base rate. Further analysis indicates that impaired auditor independence does not account for this result.
    • The authors find that when companies experience a significant shock to their internal control environment, tax nonaudit services incrementally benefit internal control quality relative to other companies.
    • The authors find that the benefits of tax nonaudit services on internal control quality are greater in the early years of audit firm tenure.
    Category:
    Governance, Independence & Ethics, Internal Control
    Sub-category:
    Board/Audit Committee Oversight, Non-audit Services, Reporting Material Weaknesses