Determinants of weakness in internal control
over financial reporting
Jeffrey Doyle, Weili Ge, Sarah McV ay
Abstract
valintineWe examine determinants of weakness in internal control for 779 firms disclosing material weakness from August 2002 to 2005. We find that the firms tend to be smaller, younger, financially weaker, more complex, growing rapidly, or undergoing restructuring. Firms with more rious entity-wide control problems are smaller, younger and weaker financially, while firms with less vere, account-specific problems are healthy financially but have complex, diversified, and rapidly changing operations. Finally, we find that the determinants also vary bad on the specific reason for the material weakness, consistent with each firm facing their own unique t of internal control challenges.
rapala1. Introduction
In this paper, we examine the determinants of material weakness in internal control over financial reporting. A material weakness in internal control is define d as ‘‘a significant deficiency, or combination
of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected’’ (P CAOB, 2004).1、We u a sample of companies that disclod material weakness in internal control over financial reporting under Sections302 and 404 of the Sarbanes-Oxley Act of 2002 from August 2002 to 2005.2、Under Section 302, SEC registrants’ executives are required to certify that they have evaluated the effectiveness of their internal controls over financial reporting. If management identifies a material weakness in their controls, they are precluded from reporting that the controls are effective and must disclo the identified material weakness (SEC, 2002, 2004). Section 404 requires that each annual report include an asssment by management of the effectiveness of the internal control structure and procedures of the issuer for financial reporting that is attested to by the fir m’s public accountants.Although firms were required to maintain an adequate system of internal control before the enactment of Sarbanes-Oxley, they were only required to publicly disclo deficiencies if there was a change in auditor (SEC, 1988). While prior rearch studies this limited t of disclosures (Krishnan, 2005), there is little evidence regarding internal control quality for firms in general under the new Sarbanes-Oxley regime.We investigate whether material weakness in internal control are associated with(1) firm size, measured by market value of equity; (2) firm age, measured by the number of years the firm has CRSP data; (3) financial health, measured by an aggr
egate loss indicator variable and a proxy for the likelihood of bankruptcy bad on the hazard model developed by Shumway (2001); (4) financial reporting complexity, measured by the number of special purpo entities reported, the number of gments reported, and the existence of a foreign currency translation; (5) rapid growth,
measured by merger and acquisition expenditures and extreme sales growth; (6) restructuring charges; and(7) corporate governance, measured using the governance score developed by Brown and Caylor (2006).
Our sample is comprid of 970 unique firms that reported at least one material weakness from August 2002 to 2005, of which 779 have Compustat data. We identify the firms through a combination of a arch of Compliance Week, a website which tracks internal control disclosures after Sarbanes-Oxley, and a arch of 10-K filings in the EDGAR databa.
For the full sample, we find that material weakness in internal control are more likely for firms that are smaller, younger, financially weaker, more complex, growing rapidly,and/or undergoing restructuring. The firm-specific characteristics em to create challenges for companies in maintaining a strong system of internal controls. Our findings also appear to be economically signific
超人的英文ant in identifying firms with material weakness.For example, the joint marginal effect of our main model (i.e., the change in the predicted probability of a material weakness when altering the independent variables in the predicted direction between the 1st and 3rd quartiles or between zero and one for indicator variables) greatly increas the predicted probability of a material weakness—from 3.75 percent to 26.41 percent.
In this paper, we focus solely on material weakness for two reasons. First, it is the most vere type of internal control deficiency, and thus offers the greatest power for our determinants tests. Second, the disclosure of material weakness is effectively mandatory, while the disclosure of ‘‘significant deficiencies’’ is unambiguously volun tary.3Focusing on the more mandatory disclosures helps avoid lf-lection issues associated with voluntary disclosures. Although disclosures of material weakness are effectively mandatory, it is possible that individual firms or auditors apply different materiality standards in deciding what to disclo. While we do not have a model of the materiality threshold of material weakness (Mayper, 1982; Mayper et al., 1989; Messier et al., 2005),our determinants results are similar to tho documented by Ashbaugh-Skaife et al. (2007)who examine all types of significant deficiencies (i.e., not just tho internal control weakness that meet the threshold to be classified as ‘‘material weakness’’) and find that firms di
womansclosing significant deficiencies typically have more complex operations, recent changes in organization structure, more accounting risk exposure, and fewer resources to invest in internal control. Therefore, it appears that our results extend to a broader sample that does not rely on a potentially subjective judgment of what co nstitutes a ‘‘material weakness,’’ although it is still possible that the broader sample in Ashbaugh-Skaife et al.(2007) suffers from the same concern.4Since Ashbaugh-Skaife et al. (2007) focus on all significant deficiencies, including unambiguously voluntary disclosures, they also include additional variables to model the choice to disclo in their analys. Since our focus is on material weakness disclosures, we do not include the variables in our main analysis. Inuntabulated results, our results are robust to their inclusion, though sales growth weakens considerably in the more restricted sample (with or without the additional variables).
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In addition to our general findings about material weakness firms, discusd above,which complement and corroborate the findings of concurrent studies, we differ from Ashbaugh-Skaife et al. (2007) and others by examining the specific types of material weakness disclod, and how the determinants of internal control problems differ bad on the types. We find that the type of internal control problem is an important factor when examining determinants, and thus should be considered by future rearch on internal control. Specifically, while we focus on material weaknes
s, the most vere internal control problems, the weakness vary widely with respect to verity and underlying reason. For example, consider the two following material weakness disclosures:
As part of the annual audit process, a material weakness was identified in our controls related to the application of generally accepted accounting principles, specifically related to the classification of the Company's short-term investments, resulting in the Company reclassifying approximately $34 million of cash and cash equivalents to short-term investments… (I-Flow Corporation, 12/31/04 10-K). The material weakness identified by the independent registered accounting firm include the following weakness in certain divisions of the Company: (1) Failure to reconcile certain general ledger accounts on a timely and regular basis and lack of management review of certain reconciliations. (2) Inconsistent application of accounting policies, including capitalization policies and procedures for determining unrecorded liabilities. (3) Failure of financial management in certain operating gments to properly supervi personnel, enforce and follow policies and procedures, and perform their assigned duties. (4) Lack of adequately staffed accounting departments (Evergreen Holdings, Inc., 2/29/2004 10-K/A).
so sorryWhile I-Flow's disclosure relates to an account-specific balance sheet classification error, Evergreen's disclosure speaks of larger, more pervasive problems in the company. This distinction is
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幼儿学英语视频deemed to be important by Moody's, the bond rating company. Moody's posits that while account-specific weakness are auditable, company-level weakness are more difficult to audit around and call into question not only management's ability to prepare accurate financial reports but also its ability to control the business (Doss and Jonas, 2004). We investigate whether the determinants of the two types of weakness differ.
We find that firms that report account-specific weakness tend to be larger, older, and financially healthier than firms that report company-level weakness. They also have more complex and diversified business operations and are growing more rapidly. The complexity of their operating environment, along with the rapid change evidenced by merger and acquisition activity and high sales growth, ems to hinder the firms in maintaining adequate account-specific internal controls. In contrast, firms with company-wide problems em to lack the resources or experience to maintain comprehensive control systems.
We also examine whether the determinants differ bad on whether the firm attributes its material weakness to staffing issues (e.g., gregation of duties), complexity issues (e.g., trouble in calculating the deferred tax provision) or more general issues (e.g., lack of supporting
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documentation). Not surprisingly, firms disclosing staffing problems are more likely to be smaller and younger than other firms disclosing material weakness. The firms also tend to be the weakest financially, with the highest incidence of loss and the highest bankruptcy risk. Resource constraints likely hinder the ability of such firms to adequately staff their operations with competent personnel.
Firms disclosing material weakness related to complexity are the largest and oldest companies of the three groups and have the most sophisticated and diversified operations. In addition, when compared to the average Compustat firm, the firms continue to have more diversified and complex operations, and also tend to be weaker financially and have higher restructuring charges. Thus, complex operations, combined with relatively poor financial health and a quickly changing environment, appear to yield difficult financial reporting issues for the firms.
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When examining firms providing more general material weakness disclosures, we find that each of the constructs examined tends to be associated with the firm disclosures, consistent with this subgroup containing many differing weakness (e.g., inadequate reconciliation procedures, revenue recognition problems, or a complete lack of policies and procedures in place). As a final analysis, we examine only tho firms with material weakness related to revenue recognition probl
ems and find that the disclosures are negatively associated with our proxy for good corporate governance.
财务报告中内部控制缺陷的影响因素
Jeffrey Doyle, Weili Ge, Sarah McV ay
摘要：我们检查从2002年8月至2005年披露重大内部控制缺陷的的779家公司的资料，分析其内部控制缺陷影响因素，我们发现，这些企业往往是较小的，更年轻，财务状况不佳的，业务复杂的，快速增长的，或者正在进行重组的。控制权问题较严重公司的均规模较小, 更为年轻，财务状况更弱，而具有不太严重、特定账户问题的公司在虽然财务上是健康的，但具有复杂、多样、快速变化的经营业务。最后，我们发现影响因素还随导致的内部控制缺陷的不同的特定原因而改变，与每个面对自己的特定的内部控制的挑战的公司一致。
关键词：内部控制；重大缺陷；萨班斯—奥克斯利法案
1、引言
在本文中，我们将研究财务报告中内部控制重大缺陷的决定因素。在内部控制重大缺陷被定义为“指存在合理的可能性导致年度或财务报表的重大错报无法及时被阻止或发现的重大错报产生”（PCAOB，2
004）。1、我们以自2002年8月至2005年按照萨班斯—奥克斯利法案第302号和第404号文件规定披露了与财务报告相关的内部控制缺陷的企业作为样本，根据第302条，美国证券交易委员会注册人行政人员须以证明他们已经评价其内部控制对财务报告的有效性。如果管理层在他们的内控中确认了一项重大缺陷，那么他们将被阻止对外报告说其控制是有效的，且必须披露被确认的重大缺陷（美国证券交易会,2002,2004）。塞班斯404条款规定，企业的首席执行官和财务总监必须对呈报给美国证券交易委员会（SEC）的财务报告予以保证，以确保其完全符合证券交易法，在所有重大方面公允地反映财务状况和经营成果。它还规定，上市公司的财务报告必须包括一份内控报告，并明确规定公司管理层对建立和维护财务报告的内部控制体系及相应控制流程负有完全责任；此外，财务报告中必须附有其内控体系和相应流程有效性的年度评估。在“萨班斯-奥克斯利法案”颁布之前，虽然公司必须保持适当的内部控制制度。只有更换审计师的情况下，他们只才要公开披露内部控制缺陷（SEC，1988）。虽然以前的文章研究过这种有限的披露（克里希南，2005），但很少有关于对于一般企业在新的萨班斯-奥克斯利法案体系的内部控制质量的证据。
我们调查以下因素是否与内部控制重大缺陷有关联：（1）企业规模，通过股权的市场价值来衡量；（2）公司的年龄，通过该公司资料在证券价格研究中心保存的年数来衡量；（3）财务状况，由一个总损失的指标变量和一个代表破产可能性的数值的沙姆韦（2001）开发的风险模型来衡量；（4）财务报告的复杂性，由特殊目的的实体的数量，部门报告的数量，是否存在外币折算来测量；（5）快
速的增长，由兼并和收购的费用和急速的销售增长来衡量；（6）重组费用；（7）企业管治，用布朗和凯勒开发的管理评分方法来衡量。
