Why Do Auditors Fail to Report Material Weaknesses in Internal Controls? Evidence from the PCAOB Data

65 Pages Posted: 18 Sep 2016 Last revised: 15 Nov 2019

Date Written: October 2019

Abstract

This paper investigates why material weaknesses in internal controls are often not reported in audited financial statements issued before restatements. To address this question, we analyze Public Company Accounting Oversight Board (PCAOB) proprietary data on audit clients’ internal control deficiencies (both material weaknesses and less-severe deficiencies) and PCAOB-inspector-documented deficiencies in the audits of internal controls. We find that the auditor’s failure to identify the relevant internal controls to evaluate is a significant, yet overlooked explanation. Exploratory analyses suggest that factors linked to auditor incentives and competence explain undetected internal control weaknesses. Collectively, our results suggest that academics, as well as regulators and practitioners, should consider auditor failures to detect internal control deficiencies as an important reason why restatements are not preceded by disclosures of material weaknesses in internal controls.

Keywords: Internal Controls, Auditing, Material Weakness, Restatements, Audit Deficiencies

JEL Classification: M40, M41, M42, M48, M12

Suggested Citation

Aobdia, Daniel and Choudhary, Preeti and Sadka, Gil, Why Do Auditors Fail to Report Material Weaknesses in Internal Controls? Evidence from the PCAOB Data (October 2019). Available at SSRN: https://ssrn.com/abstract=2838896 or http://dx.doi.org/10.2139/ssrn.2838896

Daniel Aobdia

Northwestern University - Kellogg School of Management ( email )

2211 Campus Drive
Evanston, IL 60208
United States

Preeti Choudhary (Contact Author)

University of Arizona, Eller College of Management ( email )

School of Accountancy
Tucson, AZ 85721
United States

Gil Sadka

University of Texas at Dallas ( email )

2601 North Floyd Road
Richardson, TX 75083
United States

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