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INTERNAL AUDIT CHARACTERISTICS,
FINANCIAL REPORTING QUALITY: TUNISIAN
CASE
Eya N.A. NOUBBIGH
Assistant professor, IHEC, Carthage
DEFI-ESSEC research Unity
Pr Chokri MAMOGHLI
Full professor, IHEC, Carthage
DEFI-ESSEC research Unity
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INTERNAL AUDIT CHARACTERISTICS,
FINANCIAL REPORTING QUALITY: TUNISIAN
CASE
Abstract
This study evaluates whether internal audit function characteristics have an impact on
financial reporting quality. We examine different determinants of internal audit
quality in Tunisian firm. Internal audit function characteristic was apprehended
through internal auditor competence, internal controls weaknesses and different
procedures put on to improve internal audit quality. The financial reporting quality is
estimated by earnings management. Finally, we find that contractual audit fees, the
presence of an annual audit program, the presence of a internal audit manual of
procedures the membership of IIA Tunisian chapter and the relative experience of
internal auditors have an impact on earnings management and thus on the quality of
financial reporting.
Key words:
Internal audit quality - financial reporting quality – earnings management
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1. Introduction
In this recent period, the business world faces many financial scandals and crises. All
this scandals focuses in the role played by governance mechanism to protect investor
and fulfill their goals. Many laws and rules were established. One of the mechanisms
that it keeps the interest of many authors is internal audit and more specifically his
quality. The quality of internal auditor is usually measured by the competence of
internal auditor, the quality of work and the independence of internal auditor. The
main objective of this paper is to study the impact of internal audit quality on
financial reporting. The originality of this study becomes from the specificities of
Tunisian enterprises involved in this study. In fact, our sample concern 90 enterprises
that hold an internal audit department. As we know internal audit has never been
studied before in Tunisian context. Besides, this work provides some light on the
impact of some internal audit quality proxies on the financial reporting for Tunisian
enterprises. The innovation of this work is inherent to the use of new proxies which
are linked with Tunisian's enterprise specificities.
Recent studies have examined the impact of different governance mechanisms on the
transparency and quality of financial reporting. However, few studies have
investigated the relationship between internal audit and financial reporting quality
(Al-Shetwi et al, 2011).
Abdel-Khalik et al. (1983) found in their study that the internal audit function
supports the financial statement audit performed by external audit. This implies
improving audit quality and therefore the quality of financial reporting. Schneider and
Wilner (1990) estimate that the internal audit functions detect irregularities. Thus, the
study of Gordon and Smith (1992) concluded that the internal audit function plays a
key role in improving the control environment. It avoids irregularities in the financial
statements, which involves improving the quality of financial reporting.
Church et al. (2001) studied the perception of internal auditors and the most important
criteria in the evaluation of fraudulent financial reporting. They were able to detect
that internal auditors are concerned, in the most by, fraud and various manipulations.
The study of Arens et al. (2006) also highlights the fact, that the failure of internal
control increases the weakness of the internal audit function, which increases the risk
of the company and affects the quality of financial reporting. Rusak and Johnson
(2007) examined the role of governance mechanisms to deal with the collapse of
companies. They believe it is necessary to implement a robust and effective system of
governance. In this context, internal audit plays an important role in improving the
quality of financial reporting.
We should not forget that the most important and most innovative aspects of
Sarbannes-Oxcley Act is related to the impact of internal control failures in the
quality of financial reporting (Zhang et al., 2007). This law established the premises
for the benefit of various researchers on this aspect. We can't deny the presence of
studies previous of SOX, but we attended a special enthusiasm after the enactment of
this law. Section 302 of the Act established the disclosure of internal control
deficiencies impair the financial statements of the company by the management of the
firm. This commitment highlighted the participation of the company and therefore the
importance of the internal audit function in the disclosure of internal control
weaknesses.
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Felo (2012) discusses the impact of various governance mechanisms on the
transparency of financial reporting. He argues that the mainly voluntary financial
reporting increases transparency and thus the quality of financial reporting.
Specifically, he argues that information about the effectiveness of the internal audit
function within the company increases the transparency of governance due to the
voluntary disclosure, but also the quality of financial reporting.
Other authors have focused on the contribution of the audit report in improving the
quality of financial reporting. De Zoort and Holt (2009) used in the experimental
study to investigate the impact of the disclosure of internal audit report on the
perceived reliability of financial reporting. The authors believe that the internal audit
function promotes investor confidence in the quality and reliability of financial
information, due to better monitoring and control of the company. Their results show
that confidence is growing, especially when these investors have access to the reports
prepared by the internal auditors.
Prawitt et al. (2009) considers that the presence of an internal audit function
discourages the management of a company to use earnings management. This
decrease in accounting manipulations, result in the reduction of earnings management
and consequently discretionary accruals. This is would improve the quality of
financial reporting. It should be noted that these authors are among the few who
studied the impact of the internal audit function on earnings management. Thus, the
earning management considered as such and not as a measure or proxy of another
factor.
This paper contributes to the internal auditing literature in the following ways. First,
the study studies internal audit in Tunisian firm, for first time. Second, it provides
evidence that internal auditing characteristics/activities affect financial reporting
quality in Tunisian firms. Third, our contribution consists on the choice of unlike
prior proxies on the evaluation of the impact of internal audit characteristics on the
quality of financial reporting. We collected the internal audit inherent information by
surveying all non-financial companies with internal audit units, member of IAA
Tunisian Chapter. In this way we provide a stronger research setting.
The remaining part of the paper is organized as follows. In the next section, we
present a legal framework of internal audit in Tunisia. This is followed by a literature
review on the relation between internal audit and financial reporting quality as a basis
for our hypotheses development. After that we describe our methodology, dataset, and
variables. The next section presents the results and discussion. Finally, the final
section concludes our paper.
2. Literature review and development of hypotheses
2.1.The external auditors assessment of the internal control's
O'Leary et al. (2006) estimate that in the audit process, the external auditor is
required to assess the quality of internal control. It formulates its view of the
importance and the number of internal control deficiencies. The presence of
weaknesses decreases their relying on internal auditor work. The opinion of
the external auditor will have an impact on the growth of validation tests in
order to build a suitable and reliable judgment, given that the financial
statements and the accounting figures may be damaged by the failure of
internal control.
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Goh et al. (2012) demonstrated through their study that the opinion of the
internal auditor on internal control greatly affects his judgment made about the
financial statements of the operation of the business continuity and its
financial reporting quality. Thus, according to the authors the probability of
formulating a negative opinion on internal control in companies in financial
difficulties promotes all things being equal, the issue of going concern opinion
and the quality of its financial statement. Indeed, the adverse opinion on
internal control indicates the deterioration of the reliability on financial
statements that make it difficult to express in a clear and unequivocal opinion.
Finally, no study has been able to link the quality of financial reporting and
the opinion of the external auditor on internal controls effectiveness. This does
not prevent us to pose the following hypothesis:
H1. There is a positive association between the quality of financial
reporting and the opinion of the auditor on internal control
2.2.The number of internal control weaknesses
The study by Zhang et al. (2007) examined the relationship between the
characteristics of the audit committee and the detection of the internal control
weaknesses. But even if it was not their main goal, the authors were able to
demonstrate that the detection of material misstatements by the members of
the audit committee reduces the number of internal control deficiencies that
supports the quality of financial reporting.
Several authors have studied the relationship between the quality of financial
reporting and the quality of internal audit. In some studies, financial reporting
was apprehended through accounting adjustments (Asare et al., 2009). Thus,
companies have an internal audit function; have less accounting restatements,
less earnings management, fewer weaknesses in internal controls than
companies that don't have internal audit (Krishnan 2005). Prawitt et al. (2009)
argue, besides, that companies with an internal audit function detect more
fraud.
Coram et al. (2008) explain, based on the results of their study, that companies
have an internal audit function are more likely to detect and prevent all types
of fraud or anomalies can affect the quality of financial reporting. Thus, the
internal control procedures put in place and controlled by the internal audit
function improve significantly the quality of financial reporting.
Uemura (2012) believes that the quality of internal control procedures affect
the quality of financial reporting. Thus, the presence of internal control
deficiencies promotes errors and problems in the financial statements. The
results of this study, conducted in the Japanese context, have demonstrated the
reliability and credibility of the financial statements are inherent in the quality
of control procedures. If the procedures are effective and limit failures of
internal control, this is reflected positively on the quality of accounting
information published. Especially, it is more interesting for the company to
discover her own deficiencies and correct them better that they will be
discovered by the external auditor.
H2. There is a negative association between the quality of financial
reporting and the number of internal controls weaknesses
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2.3.The time spent by internal auditor on reviewing internal controls efficiency
and effectiveness
The mission of Internal Auditors doesn't stop today on assurance missions it
involves, also, consulting services, according to Mermod and Sungun (2013).
As we recall, the internal audit function doesn't stop to the protection of assets.
Its field becomes wide, since it is linked to the overall business strategy and
the added value of internal audit function. It includes the operational audit, IT
audit, risk management and governance. Thus, evaluation of internal controls
isn't the only part of the work performed by the internal auditor.
Ho's and Hutchinson's study (2010) had among its objectives to study the
relationship between the quality of work of the internal audit function and the
main activities and tasks performed by this function. These authors found that
the majority of respondents spend 29% of their working time in the evaluation
of the efficiency and effectiveness of internal controls. We don't find any
research that study the relation between this time spent on audit controls
assessment and financial reporting quality.
H3. There is a positive association between the quality of financial
reporting and the time spent by internal auditor on reviewing
internal controls efficiency
2.4.The non-audit fees related to internal controls mission
The study of Prawitt et al. (2012) examined the role of the internal audit
function in improving the quality of financial reporting. It focused on a
particular case that the outsourcing of the internal audit functions. Similarly,
the quality of financial reporting in this study is the risk that the financial
statements of a company that is fraudulent or contains irregularities that can
mislead investors. The accounting risk is apprehended through a score that is
"audit integrity". These authors were able to demonstrate through their
regression results that the company has an internal audit function of high
quality improves the quality of financial reporting regardless of whether this
function is internal or external. This does not exclude the improvement of the
quality of financial reporting when the external auditor carries out internal
audit work.Kinney et al. (2004) did not find a significant relationship between
this variable and the quality of financial reporting.
H4. There is a positive association between the quality of financial
reporting and the non-audit fees related to internal controls mission
2.5.The manual of internal audit procedures
The manual of procedures is a document that meets the description of all the
tasks and operations to be performed. This is an internal document to the
company. It is written to define the nature and content of each transaction, to
formalize and define the scope of each employee within a company. It is
intimately connected with the recommendations of the IAA on the
effectiveness of internal audit and denotes the successful organization of a
company. The study of Gumb and Noel (2009) helped to see that the leaders
of the French companies give much importance to the manual of procedures as
an important component in improving the quality of internal audit. In fact,
80% of respondents frequently cited procedures manuals as an important
benchmark in assessing the quality of internal control. Thus, we didn't find
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any studies linking the presence of procedure manual and the quality of
financial reporting and earnings management. This does not prevent us to
formulate our next hypothesis.
H5. There is a positive association between the quality of financial
reporting and the existence of the manual of procedures
2.6.The annual audit program
According to the norms and standards of internal audit, the internal audit
function is required to establish an audit program in the long term, medium
term and short term. The long term is a strategic plan, the medium term is a
more detailed plan and short-term corresponds to an operational plan. The
short term is an annual plan where the internal audit function will program its
various interventions. The annual audit program denotes the good organization
and efficient management within the internal audit function where each
intervention is programmed.
This mission plan specifies the objectives, the scope of intervention, the date
and duration of the mission, the approaches to be followed, as well as
resources (PA-2200-11).
Diard and Trebucq (2007) have demonstrated through a study of audit
departments on the assessment of the level of compliance between the reality
of the procedures and requirements of the standards of IAA-IFACI that
traditional aspects of the audit as the establishment of an annual audit plan are
generally respected in the French context. That is why we pose this following
hypothesis:
H6. There is a positive association between the quality of financial
reporting and the existence of annual program
2.7.salary internal auditors
The internal control procedures will be weak, if the company doesn't have all
the tools to make this function work properly; we inevitably end up with a
poor quality of internal audit. The internal audit function couldn't
appropriately do its job. This is likely to increase the risk of fraud,
manipulation, errors and anomalies. As a result, the quality of financial
reporting and the quality of the published information will be altered.
Authors, as Solomon and Peecher (2004) questioned whether the costs
invested in improving the quality of internal audit and the implementation of
the recommendations of SOX, will protect the interests of investors on the one
hand and improving the reliability of financial informational materials. Some
authors such as Ho and Hutchinson (2010) assessed the cost invested in the
internal audit through the number of internal auditors and therefore the size of
the internal audit function, others have assessed through the percentage that
the internal audit reports by the total number of staff. For our study we will
remember as Ziegenfuss et al. (2006), the percentage of the salaries of internal
auditors divided by the total wage costs. This denotes the importance attached
to the internal audit function within a business.
1 2200-Engagement Planning, guide de l'IPPF
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H7. There is a positive association between the quality of financial
reporting and the proportion of internal auditor's salaries
2.8.internal auditors member of IIA Tunisian Chapter
Continuing education, various training and seminars have been identified as
factors favoring the jurisdiction of the internal auditor (Brown, 1983). The
importance of training and attendance at seminars, have been used by a
number of authors such as Al Tawerejri et al. (2004) or Gramling et al. (2013)
in assessing the competence of internal auditors, which is directly related to
the effectiveness of the internal audit function.
The study of Mermod and Sungun (2013) on the establishment and
development of the internal audit function within the Turkish companies,
focused on key criteria that should be enjoyed internal audit function as
recommended by the IIA. These characteristics include the training and
membership in the IIA. Indeed, membership in the IIA requires compliance
with a competency framework developed to meet the requirements of the job
for the right training and compliance with standards and practices developed
by the IIA. Continuing education and membership in the IAA allows the
internal auditor to carry out their work properly and allows the company to
produce reliable accounting information and financial statements of good
quality .
H8. There is a positive association between the quality of financial
reporting and the proportion of internal auditor's member of IIA
Tunisian chapter
2.9.professional certification
Professional certification is a guarantee of competence and knowledge of the
internal auditor (Brown, 1983). Professional certification was included in the
study Ziegenfuss et al. (2006), the author was able to demonstrate the positive
relationship between the certification of internal auditors and the perceived
quality of the audit report. Certification of internal auditors was apprehended
through the certified percentage of the total number of listeners. However, the
authors have failed to demonstrate the presence of a significant relationship
between certification and the value of the internal audit function. Thus, this
measure of the competence of the internal auditor has been integrated into the
study of Ho and Hutchinson (2010) as features for assessing the quality of the
internal audit function. This variable was also considered by Gramling et al.
(2013).
H9. There is a positive association between the quality of financial
reporting and the proportion of certified internal auditors
2.10. Experience in internal audit
The internal audit profession requires as a minimum experience for the
internal auditor can properly do its job (Gramling et al. 2013). The choice of
three years is not arbitrary. It also follows from the study of Messier and
Schneider (1988). It has been applied also in comparison with the minimum
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number of years of experience required to become CPA in Tunisia. This same
requirement of three years is required by CIMA2.
This measure was also used by Ziegenfuss et al. (2006). These relate the
quality of the audit report, the value of internal audit and the quality of
financial reporting function with the average experience of all internal auditors
of companies. They were able to demonstrate the positive impact of the
experience on the value of the internal audit function and the quality of the
audit report.
H10. There is a positive association between the quality of financial
reporting and the proportion of experienced internal auditors
3. Research design and methodology
3.1.Sample
To assess the impact of internal audit characteristics on financial reporting quality, we
opted for survey because the most important number of this enterprise is not listed in
Tunisia stock exchange. A survey questionnaire was developed and pilot-tested with
internal auditors, external auditors and academic professor to ensure that the questions
were appropriate. After incorporating changes, the final questionnaire was sent by
mail for all internal auditors adherent to IIA, working in 106 non –finance sector
companies to collect information on their internal audit department characteristics and
activities for the fiscal years ended 2009 and 2010. Unfortunately, none respond was
received. To obtain all information that we need, we were compelled to make door to
door, and dispending a semi-directive questionnaire.
A total of 96 companies, among 106 enterprises, accept to respond to this survey,
which represents a response rate of 90 percent. After excluding 6 companies which
gave significantly incomplete responses, there were a total of 90 usable responses,
representing an85 percent usable response rate.
3.2.Measurement of variables
The literature review allowed us to list a panel of variables to measure the quality of
internal audit. This large number of proxies can be explained by the different
approaches and theories that the internal audit was apprehended. For this research, we
selected the closest variables to the Tunisian context. The relationship between the
characteristics of the internal audit and financial reporting quality will be understood
through the following model:
QuaReptFin = f(Opncac, somdef, tempallou, lnhonaudCo, ManelProcd,
Prgannuel, salaire, Atai, Certifi, Exp3ans, lneffectif, lnfiliale, lnchfin)
The variables are defined as follows:
QuaReptFin: dependent variable is the quality of financial reporting proxy measured
by discretionary accruals estimated through Kothari et al. (2005). It should be noted
that there is a negative relationship between the quality of financial reporting and the
presence of discretionary accruals.
2 Chartered Institute of Management Accountants
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Opncac: This is a dichotomous variable that takes the value 1 when the external
auditors assessment of the internal control's is favorable and 0 for a negative opinion
and therefore inefficient procedures.
somdef: independent variable that measures the number of internal control
weaknesses detected by the external auditor and reported at the engagement letter or
audit report.
tempallou: independent variable that estimates the proportion of internal audit time
spent on reviewing operating efficiency and effectiveness including internal controls.
lnhonaudCo: independent variable that corresponds to natural logarithm of the audit
fees paid for due diligence mission related to internal controls and procedures.
ManelProcd: independent dichotomous variable equal to 1 if the firm has a
procedures manual, 0 otherwise .
Prgannuel: independent dichotomous variable that takes the value 1 if the internal
audit function has an annual audit program, 0 otherwise.
Salaire: the proportion of salary internal auditors of the company in relation to the
total payroll continuous variable load independent for determining the importance of
the internal audit function within the company.
Atai: the proportion of internal auditors’ member of IIA Tunisian Chapter
Certifi: the proportion of internal audit staff having professional certification (CIA,
CPA, CISA) within the internal audit function.
Exp3ans: the proportion of internal auditor with more than three years of experience
in internal audit within the internal audit function.
lneffectif: natural logarithm of the number of internal audit staff divided by total
number of employees
lnchfin: natural logarithm of long term debts
lnfiliale: natural logarithm of the number of subsidiaries
4. Empirical results
4.1.Descriptive statistics
Table I presents summary statistics for the variables used in the study. We can see that
respectively 85 percent, 66 percent and 72 percent of firms have a favorable opinion
concerning her internal controls, have manual of procedures and have annual
program. The mean value of weaknesses and time allowed to internal controls is
respectively 40 percent and 37 percent. Besides, we find that on average 80 of internal
auditors of firms have as minimum 3 years of experience, 18 percent of internal
auditors of firms have professional certification and 40 percent of internal auditors of
firms are affiliated to Tunisian IAA Chapter.
The correlation matrix in Table II shows that variables are not highly correlated.
Indeed, as advocated by Kervin (1992), we can say we are on a serious collinearity
problem only from a correlation coefficient equal to 0.7 between the independent
variables to be included in the model. For this case of study, the majority of
correlations do not exceed the threshold of 0.4, except for the case of the correlation
between company size and the number of internal control failure. This result is
understandable. It can be explained by the fact that large firms are more complex and
more difficult to control. So in this type of firm, the risk of errors, frauds,
manipulations and weaknesses, may be multiplied.
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Table I: descriptive Statistics
within .0752252 5.297162 6.042495 T = 2 between 1.413347 2.851891 9.190488 n = 90lneffe~f overall 5.669829 1.411399 2.70805 9.194211 N = 180 within .0893293 -.1360761 1.250218 T = 2 between .922355 0 3.401197 n = 90lnfili~e overall .5570711 .9241027 0 3.401197 N = 180 within 1.276943 -2.757536 14.72461 T = 2 between 3.472106 -.020411 17.35636 n = 90lnchfin overall 5.983536 3.69036 -.9162908 17.55107 N = 180 within .1000465 -.0951683 .9048317 T = 2 between .4421367 0 1 n = 90atai overall .4048317 .4521085 0 1 N = 180 within .0521921 -.0714481 .4285519 T = 2 between .2917268 0 1 n = 90certifi overall .1785519 .2955556 0 1 N = 180 within .0901592 .3042593 1.304259 T = 2 between .3466651 0 1.5 n = 90exp3ans overall .8042593 .3572591 0 2 N = 180 within .008728 -.0382016 .0838417 T = 2 between .0579713 -.0017639 .3780028 n = 90salaire overall .0228201 .0584643 -.0020745 .4390244 N = 180 within .1057033 .2222222 1.222222 T = 2 between .4377619 0 1 n = 90prgann~l overall .7222222 .4491526 0 1 N = 180 within .0915417 .1611111 1.161111 T = 2 between .4670477 0 1 n = 90manlpr~d overall .6611111 .4746523 0 1 N = 180 within .0795571 -.1286111 .8713889 T = 2 between .256182 0 1 n = 90tempsa~u overall .3713889 .2675667 0 1 N = 180 within .0055423 1.672236 1.752278 T = 2 between 3.731568 0 11.08214 n = 90lnhona~o overall 1.712257 3.721134 0 11.08214 N = 180 within 5.866056 7.294444 74.29444 T = 2 between 53.84893 0 270.5 n = 90somdef overall 40.79444 54.01776 0 290 N = 180 within .0915417 .35 1.35 T = 2 between .3471392 0 1 n = 90opncac overall .85 .3580674 0 1 N = 180 within .3712002 -1.882384 .9515571 T = 2 between .7912935 -3.867539 .7613255 n = 90adklw overall -.4654135 .8720304 -3.938273 1.874775 N = 180 Variable Mean Std. Dev. Min Max Observations
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Table II: correlation matrix
4.2.Results of the regression analysis
In this section, we discuss results of the regression. We have opted for the panel
regression. In light of the results of the Hausman Test, we will opt for the
interpretation of variables and results obtained by the fixed effect model. In fact, the
probability is equal to 0, less than 5%. This means that the random model estimators
are biased. In addition, Fisher's exact has a p-value equal to 0 therefore less than 5%.
This is in confirmation of the hypothesis of the prevalence of fixed effect. The results
are exposed in the table III follow.
(1) (2) (3) (4) (5)
VARIABLES adklw adklw adklw adklw adklw
opncac -0.0217 -0.0354 -0.0267 -0.000607
(0.203) (0.214) (0.246) (0.202)
somdef -0.00228 -0.00228 -0.00231 -0.00242
(0.00454) (0.00454) (0.00450) (0.00459)
lnhonaudco -27.69*** -27.69*** -27.40*** -24.65*** -24.97***
(6.339) (6.339) (6.409) (4.884) (4.789)
tempsallou -0.0415 -0.0415 -0.0454 -0.0256 -0.0302
(0.101) (0.101) (0.102) (0.0911) (0.103)
manlprocd 2.423*** 2.423*** 2.436*** 2.306*** 2.306***
(0.371) (0.371) (0.374) (0.321) (0.325)
prgannuel -0.906** -0.906** -0.897** -0.909** -0.900**
(0.441) (0.441) (0.431) (0.413) (0.418)
lneffectif -0.0991 -0.0294 0.2989 0.0178 1.0000 lnfiliale 0.0242 0.0276 0.1453 1.0000 lnchfin -0.1424 -0.0880 1.0000 atai -0.0277 1.0000 certifi 1.0000 certifi atai lnchfin lnfili~e lneffe~f
lneffectif -0.1220 -0.0714 0.4722 0.0704 0.1792 0.0754 0.0402 -0.3533 -0.1456 0.2276 lnfiliale 0.0048 -0.0866 -0.1040 0.0048 -0.0341 0.0180 0.0171 -0.1217 -0.0544 -0.1467 lnchfin 0.0283 -0.0568 -0.0031 0.0502 -0.0330 -0.0269 0.1441 -0.2224 -0.0071 -0.0527 atai 0.0101 0.0551 0.0979 0.0331 -0.0219 -0.1373 0.0879 0.2019 0.1330 0.0576 certifi 0.1021 0.1012 -0.1657 -0.0093 -0.0101 0.2316 0.0388 0.3425 0.0469 0.0565 exp3ans -0.0180 0.0545 0.1485 0.0805 0.2124 0.0459 0.0818 0.0180 -0.0143 1.0000 personnel -0.0753 0.0600 -0.1095 -0.0458 -0.1667 -0.1736 -0.1834 0.6076 1.0000 salaire -0.0035 0.1017 -0.1719 -0.0376 -0.0425 -0.1722 -0.2207 1.0000 prgannuel -0.0823 -0.0521 -0.0178 0.0069 0.2194 0.3421 1.0000 manlprocd 0.0202 -0.0049 -0.0533 -0.0297 0.2048 1.0000 tempsallou -0.0309 -0.0054 0.1969 -0.0839 1.0000 lnhonaudco -0.0136 -0.2130 -0.1009 1.0000 somdef -0.0948 -0.1703 1.0000 opncac 0.2498 1.0000 adklw 1.0000 adklw opncac somdef lnhona~o tempsa~u manlpr~d prgann~l salaire person~l exp3ans
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salaire -4.813 -4.813 -4.972
(4.723) (4.723) (4.792)
exp3ans -1.626*** -1.626*** -1.625*** -1.388** -1.483*
(0.515) (0.515) (0.510) (0.527) (0.828)
certifi 1.094 1.094 1.165 0.728 0.929
(1.141) (1.141) (1.049) (1.188) (1.734)
atai 0.974* 0.974* 1.063** 0.966* 0.976*
(0.541) (0.541) (0.467) (0.545) (0.540)
lnchfin -0.0214 -0.0214 -0.0234 -0.0133 -0.0132
(0.0205) (0.0205) (0.0218) (0.0182) (0.0184)
lnfiliale 0.685* 0.685* 0.732* 0.678* 0.700*
(0.392) (0.392) (0.389) (0.380) (0.378)
lneffectif -1.302* -1.302* -1.382* -1.150 -1.183
(0.770) (0.770) (0.766) (0.777) (1.088)
inefficace 0.0217
(0.203)
lnsomdefimp 0.0218
(0.0852)
lnsomdefnimp -0.171
(0.123)
logsalmoy -0.147
(0.542)
personnel -1.880
(49.29)
Constant 54.08*** 54.06*** 54.25*** 49.23*** 48.60***
(12.24) (12.18) (12.42) (9.555) (12.62)
Observations 180 180 180 180 180
R-squared 0.896 0.896 0.898 0.894 0.894
The results of the panel data regression (regression 1, Table III), allow us to see the
extent to which contractual audit fees (LnhonaudCo), directly related to the internal
control procedures. We find that this variable measures the internal audit quality is
significant at 1%. It has a Student's t of the order of (- 4.37). This variable has, in
addition, a regression coefficient with a negative sign. So, as expected, the contractual
audit fees decreased earnings management. They have a negative impact on the
accounting manipulations and discretionary accruals. This leads us to the fact that the
contractual audit fees, improves the quality of financial reporting. This result is
particularly important as previous studies such as Kinney et al. (2004) did not find a
significant relationship between this variable and the quality of financial reporting.
We also find that the presence of a manual of procedures (ManelProcdl) has an impact
on the quality of internal audit. This variable is significant at 1%. It has a t-statistic of
the order of (6.52). This variable also has a positive sign contrary to expectations. She
seems to have a positive impact on discretionary accruals. It should face earnings
management and accounting manipulations. Normally manual of procedures is used
to delimit the scope of work for each salary in the company. They should also clarify
the procedures in place and the role of each one to reduce errors and frauds. However,
the presence of a manual of procedures does not necessarily mean it is effectively
used and the procedures listed in this manual and are really respected and applied
14
We also note that the presence of a clear internal audit program (Prgannuel) is the
sign of an effective and efficient internal audit function. The organization of work and
its distribution in time throughout one year is a positive sign for the quality of work
performed within the internal audit function. Indeed, this is confirmed by the results
highlight the importance of this variable significant at the 5% with a t-statistic equal
to (-2.06). This variable has also a negative sign consistent with our expectations.
Indeed, this internal audit program denotes the organization, transparency and
professionalism of the internal audit function. Programming this audit plan also even
allows internal auditors to monitor themselves and follow their action points so they
can see if they have touched all procedures, all functions and there are still services or
departments not yet covered and whose procedures were not valued and appreciated.
So, this audit program clearly improves the quality of internal audit. This will has a
positive effect on the quality of financial reporting because of the negative impact of
this variable on the discretionary accruals measuring the extent of the accounting
manipulations.
The membership of IIA Tunisian chapter (Atai) is a significant variable that proved to
be as significant. But the result of this study is unexpected since this variable is
significant at the 10% level with a t-statistic of about (1.80), but a positive sign. This
can be explained by the fact that not all internal auditors who are members of IIA
Tunisian chapter. In addition, we have no real guarantee on the participation of all
members in training. Besides, the audience participation in the various seminars and
courses does not mean that they beneficiated from the contributions of these courses
and they really appreciated and invested to improve their skills.
We note that (Exp3ans) variable that measures the percentage of internal auditors with
experience in internal audit more than 3 years is significant at the 1% level, with a t-
statistic of about (-3.16) and has a sign negative, as expected. Authors such as
Schneider (1970) and Hung and Han (1995) suggest that the internal audit department
should be made by a suitable proportion of experienced internal auditors and non-
experienced internal auditors. However, these authors have not defined what the
appropriate proportion is. In their evaluation of the effectiveness and quality of the
internal audit, interest has focused solely on mutual learning and the ability to
accomplish all missions. Thus, notwithstanding the significant result we have not
been able to consolidate our results with previous studies, but we confirm,
nevertheless, the positive impact of the experience of internal auditors on the quality
of financial reporting.
An unexpected result holds our attention. We note, in this study, several variables are
insignificant. First, the variable the auditor's assessment on the quality of internal
control procedures (Opncac) is an important variable. These procedures are expected
to reduce earnings management and therefore improve the quality of financial
reporting. However, in the case of this study this variable is non-significant. This
result is already due to the estimation method used. Hausman Test and Fisher Test did
lead to choose for fixed effect. Thus, given the limited variability of this measure over
the two years of study (between estimator is 0.091), it is quite understandable that this
variable is not significant. Probably the wrong specification of this variable due to its
dichotomous is the origin of this non-significance. Indeed, this dichotomous value
may not adequately reflect the opinion of the external auditor is much more subtle and
can't be summarized in a favorable or unfavorable opinion. We repeated the
regression (1) by replacing this opinion by only the negative opinion expressed by the
external auditor, this variable is still insignificant.
15
The number of internal control weaknesses (somdef) is a variable that is supposed to
be important to the quality of financial reporting, as measure of earnings management.
However, this result was not significant. The mis-specification of this variable could
be the cause of this unexpected result. Moreover, this result has been extracted from
reports prepared by the auditors. This non-significance may be due to differences in
assessments and interpretation of different auditor. Some auditors hold all the details
and make any remarks and highlight any deficiencies. While others are less
demanding. They will retain and state in their reports only the most significant
weaknesses. To face this non-significant result, we used instead of the sum of the
internal control failures, the natural log of these failures by distinguishing between
failures considered important and others less important. Notwithstanding the results
are still insignificant.
The variable (tempallou) time that internal auditor spend on internal control activities,
is non-significant. This result can be explained by the luck of time allocated to
internal control procedures. The majority of internal auditors felt they don't conduct
only missions related to internal audit activities. In the Tunisian context, most internal
auditors believe they rather carry out inspection tasks. In addition, they even required
to prepare the financial statements of companies and to reinforce the financial and
accounting department. This result is consistent with Al Tawarejri et al. (2003) which
state that internal auditors are generally used to fill absences or lack of staff in
different departments. Finally, we weren't able to identify other proxies to the
importance of time allocated to internal control activities.
The proportion of the internal audit salaries (salary) is a measure rarely used in the
academic literature. The low percentage salary internal auditors relative to the overall
wage costs could explain the non-significance of this result. In addition, this variable
is intended to measure the importance given to the internal audit function considering
as a proxy of Budget allocated to internal audit function. From this same perspective,
we used the proportion of the number of employees divided to the total workforce,
and the result is still not significant (regression 5), since the internal auditors represent
only 2% of employees. Besides, we integrated the natural log of the average wage of
internal auditors in regression 4, and this variable is always non-significant. This
result indicates the lack of importance given to the internal audit function within the
Tunisian firms in this sample.
We expected that the certification (Certified) is an important element in improving the
quality of financial reporting. This diploma is a guarantee of the skills and quality of
work of internal auditors. However, the low number of certified internal auditors
could explain the non-significance of this variable. This leads us to the fact that the
sample firms do not invest in certification of their employees within the internal audit
function. We have seen through different studies in the international context that
professional certification is a key element of recruitment within the internal audit
department. Nevertheless, in some Tunisian firms in the sample, people who have no
knowledge or training in business or accounting are directors of this department. The
non-expansion of this profession is due to a significant lack of understanding of the
internal audit and his standards in Tunisia and the monopolizing of these missions by
the external auditors. What we have suggested is confirmed by Gramling et al., 2013,
which consider the internal audit profession is relatively "young" in emerging
countries.
Two variables among the three control variables are significant, the size of the
company and its complexity.
16
The majority of studies have demonstrated that the size of the company (Size)
encourages earnings management and thus affect the quality of financial reporting. In
this study, we found a significant variable with the threshold of 10%. But the sign
obtained is contrary to expectations. Normally, we expect that the size of the company
boosts earnings management, given the large number of operations which makes it
impossible to complete verification. We expect that the financial statements of these
companies will have anomalies and weaknesses. But these companies owing to their
size are well organized and have the means and resources to recruit competent
internal auditor to establish effective and efficient procedures (Wallace and
Kreutzfeldt, 1991). Finally, we can conclude that this result is not absurd, it was found
by authors such as Davidson et al. (2005), Klein (2002) and (Xie et al (2003).
Varying complexity measured by the number of subsidiaries is significant at 10%
with a t-statistic of the order of (1.75). It has only a positive sign. This sign means that
the complexity of the company encourages earnings management and reduces the
quality of financial reporting. This is quite logical since a complex firms are difficult
to control, which increases the failures of internal control and limit the quality of
financial states.
The variable debt, (lnchfin) is not significant. This result can be explained by the low
corporate debt sample rate.
5. Alternative variable measurement
We have also conducted robustness tests to confirm and corroborate the results,
already obtained. As robustness tests, we started in the first instance, by varying the
proxies already significant variables to confirm their impact and importance in the
improvement or reduction in the quality of financial reporting (regressions 6 and 7).
Subsequently we took the previous regression by calculating discretionary accruals
according to the modified Jones model, suggested by Dechow et al. (1994) in
regression (8). The results are reported in the table below.
Table IV:
(1) (6) (7) (8)
VARIABLES adklw adklw adklw addcw
opncac -0.0217 0.0604 0.00717 0.283
(0.203) (0.158) (0.186) (0.324)
somdef -0.00228 -0.00279 -0.00345 -0.00910
(0.00454) (0.00465) (0.00472) (0.0107)
lnhonaudco -27.69*** -26.04*** -19.77**
(6.339) (6.257) (9.480)
tempsallou -0.0415 -0.0899 -0.0740 0.0856
(0.101) (0.109) (0.0996) (0.164)
manlprocd 2.423*** 2.830*** 2.674*** 3.656***
(0.371) (0.628) (0.328) (0.629)
prgannuel -0.906** -1.284** -0.930** -2.009**
(0.441) (0.599) (0.411) (0.794)
salaire -4.813 -3.494 -5.161 -5.383
(4.723) (5.923) (4.230) (3.895)
exp3ans -1.626*** -1.147** -1.397** -1.717**
(0.515) (0.495) (0.559) (0.839)
17
certifi 1.094 0.579 0.122 1.261
(1.141) (1.244) (1.004) (1.887)
atai 0.974* 0.938* 1.721*
(0.541) (0.545) (0.971)
lnchfin -0.0214 -0.0422 -0.0378* -0.0955**
(0.0205) (0.0275) (0.0194) (0.0421)
lnfiliale 0.685* 0.593 0.661* 0.807
(0.392) (0.395) (0.353) (0.676)
lneffectif -1.302* -1.251 -1.042 -1.910*
(0.770) (0.801) (0.748) (1.126)
honraiaudcont -0.00129**
(0.000492)
nbreatai 0.322***
(0.103)
Constant 54.08*** 11.92** 49.74*** 44.04**
(12.24) (5.393) (11.94) (18.96)
Observations 180 180 180 180
R-squared 0.896 0.891 0.895 0.687
We have integrated new proxy variables as the absolute number of internal auditors
affiliated with IAA Tunisian chapter and not the relative number in percentage terms;
this variable is still significant (regression 7).Besides, the amount of fees contractual
audit instead of natural Log of this amount. We also obtained a still significant
variable (regression 6).
For the last regression (8), we can see that we get almost the same results,
notwithstanding the change in the measurement of the independent variable. And with
discretionary accruals according to the model of Dechow et al. (1996), we get exactly
the same results, except for a slight change in the control variables. This indicates the
robustness of the results. Thus, we always get the contractual audit fees
(LnhonaudCo) are always significant. Only, their significance changes from the 1%
than 5%. The variable presence of a procedures manual (ManelProcdl) and the
presence of an annual audit program (Prgannuel) are always significant to the
respective levels of 1% and 5%. The experience of the internal auditor is still
significant but passes from the level of 1% to 5%. The percentage of internal auditors
affiliated with IATA (Atai) within an internal audit department, are still significant at
10%. For the control variables, the size of the company (Lneffectif) is still significant
at 10%. However, the debt (lnchfin) was not significant became the threshold of 5%,
while the complexity of the company is no longer.
On assumptions, we can confirm the light of the results presented above and that
some of these hypotheses were tested. Indeed, about the assumptions relating to
internal control weaknesses, contractual audit fees one of the measures related to this
hypothesis is significant and reduces earnings management and thus improves the
quality of financial reporting. The hypotheses relating to the procedures put in place,
has two significant measures: the presence of an annual audit program and the
presence of a manual procedure. But this last hypothesis has a positive sign contrary
to expectations. For the hypotheses inherent in the competence of the internal auditor,
two measures are also significant, relative to the membership of IIA and the relative
18
experience of internal auditors. However, contrary to expectations, membership of a
professional body seems to encourage management outcomes and reduce the quality
of financial reporting.
Subsequently, we find that companies rely on the audit contract to improve the quality
of financial reporting. These companies are willing to pay an additional amount to
provide reliable information and improve its internal control procedures and reduce
information asymmetry. In addition, we found some mimetic isomorphism in certain
areas. Indeed, companies copy the same activity behaviors and decisions. We see
principally in the Tunisian context, for the telecom sector. Thus, some companies
have gone even, to appeal to the same audit firm to undertake a contractual audit of
the quality of internal control procedures. This confirms the neo-institutional theory.
Similarly, the presence of a manual procedure reduces conflicts of interest in a
company, defines the fields of action and prevents anyone from interfering in a field
that does not interest him. A clear and comprehensive internal audit program reduces
the cost of internal audits. Thus, each department is organized so as to distribute its
work properly, so it is not delayed by the arrival of the internal auditors. This is
consistent with the theory of transaction costs. Similarly, internal audit regulations
encourage companies to prepare annual audit programs where the normative
obligation refers to the neo-institutional theory. Membership in IIA Tunisian Chapter
also responds to the institutional theory in mimetic and normative point of view.
Indeed, companies tend to adopt effective practices of leaders companies in the same
industry or business. Moreover, membership in a professional organization allows the
internal auditor to have a group membership, on the hand and an institutional
framework on the other hand. Our findings in this case confirm those of Christopher
et al. (2009) who believe that under the pressures of guides to good practice, internal
auditors are compelled to prepare annual programs, procedures manuals, join
professional organizations and follow different training.
Conclusion
We through this study presented the main research concerning our problem. We
focused on the research that has addressed the impact of the internal audit of the
quality of financial reporting. We found that the literature on this aspect remains weak
and needs to be expanded.
This study is part of this aspect of contribution to the existing literature. We believe
that this study is a contribution in terms of literature, adaptation measures to the
Tunisian context and empirical results for this context. This is the first study in
Tunisia, as we know that process and assess the quality of internal audit, taking into
account various measures, considering the quality of internal audit. In addition, in the
Tunisian context, no study has addressed the relationship between internal audit and
financial reporting quality.
The results are consistent with previous findings of other studies. We believe,
moreover, that these results are more relevant than those presented by Gramling et al.
(2013), in the Turkish context. These authors used measures relating to the quality of
internal audit, based on perceptions that may be biased as they declare. However, this
study is based on more objective measures that better describe the quality of the
internal audit function. These measures provide a comprehensive presentation of the
19
reality of Tunisian companies affiliated to IIA Tunisian chapter, which leave no
possibility for subjective.
The results of this study also support the institutional theory, specifically the
normative and mimetic isomorphism. Indeed, membership in IIA Tunisian chapter,
the association that organizes the internal audit profession and the significance of this
variable indicates the important role played by pressure groups. Moreover,
considering the sample, we find a certain mimetic isomorphism; some companies are
even competing in the establishment and development of the internal audit function
and procedures.
We have also wanted to include other variables that we consider useful in measuring
the quality of internal audit. Thus, we have incorporated in this survey questions
concerning the use of internal audit software and programs and the adoption of an
international audit standards, such as IFACI or COSO 1 and 2. But as we have noted
through responses, there are rare companies (only 4) that have internal audit software.
In addition, among the four companies there two that don't use it. Concerning the
international standard, most companies don't follow a well-defined framework, they
use a hybrid framework which depends on their needs and suitable mainly to their
limited budget and resources allocated to internal audit function.
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