The Effect of Audit Firm Internal Inspections on Auditor Effort and Financial Reporting Quality

The Accounting Review, Forthcoming

56 Pages Posted: 15 Jul 2019 Last revised: 29 Aug 2023

See all articles by Daniel Aobdia

Daniel Aobdia

Pennsylvania State University - Smeal College of Business

Reining Petacchi

Georgetown University - Department of Accounting and Business Law

Date Written: October 31, 2022

Abstract

We examine the effect of large audit firms’ internal inspection programs, an important monitoring mechanism, on auditor effort and financial reporting quality. Internal inspections are often predictable, and engagement teams concentrate their effort on audits ultimately selected for inspections. The extra-effort increases the likelihood of a favorable inspection rating. We find some evidence of improvement in financial reporting quality in the inspection year, suggesting that internal inspections are effective in deterring auditor shirking. Upon receiving a favorable rating, the engagement team reverts audit effort back to the pre-inspection level. However, if the rating is unfavorable, the team increases effort on future engagements of the client. This higher effort improves the client’s financial reporting quality if the internal inspection program is not deemed deficient by the PCAOB. Collectively, the results highlight the importance of an effective internal inspection program in improving financial reporting quality.

Suggested Citation

Aobdia, Daniel and Petacchi, Reining, The Effect of Audit Firm Internal Inspections on Auditor Effort and Financial Reporting Quality (October 31, 2022). The Accounting Review, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3419484 or http://dx.doi.org/10.2139/ssrn.3419484

Daniel Aobdia (Contact Author)

Pennsylvania State University - Smeal College of Business ( email )

University Park, PA 16802
United States

Reining Petacchi

Georgetown University - Department of Accounting and Business Law ( email )

McDonough School of Business
Washington, DC 20057
United States

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