Direct and Indirect Effects of Internal Control Weaknesses on Accrual Quality: Evidence from a Unique Canadian Regulatory Setting

• Published in: Contemporary accounting research Vol. 28; no. 2; pp. 675 - 707
• Main Authors: Lu, Hai, Richardson, Gordon, Salterio, Steven
• Format: Journal Article
• Language: English
• Published: Oxford, UK Blackwell Publishing Ltd 01.06.2011; CAAA; Canadian Academic Accounting Association
• Subjects: Auditing; Canada; Control theory; Cost-benefit analysis; Disclosure; Internal control; Internal controls; Internes Kontrollsystem; Investors; Kanada; Least squares method; Management techniques; Rechnungsabgrenzung; Regression analysis; Studies; U.S.A; Canada; United States > US
• ISSN: 0823-9150; 1911-3846
• DOI: 10.1111/j.1911-3846.2010.01058.x

Public disclosure about effectiveness of internal control systems is subject to much controversy in Canada, resulting in Canadian disclosures being made in Management Discussion and Analysis These disclosures are provided to investors without a definition of the weaknesses to be reported, without implementation effectiveness testing, with no direct management certification, and with no external audit of such disclosures. The authors use ordinary least squares regression and path analysis embedded in a structural model to examine the association between the strength of internal control and accrual quality in order to infer whether these disclosures are credible. The modest substitution effect implies that auditors cannot fully compensate for poor internal control by increased substantive work, which is per se evidence justifying some form of internal control disclosures for investors. Overall, their results suggest that lower cost SOX North disclosures are credible. This informs the cost-benefit debate facing regulators around the globe seeking alternatives to the costly US model of internal control reporting.