Internal Audit Quality and Earnings Management

Prawitt, Douglas F.; Smith, Jason L.; Wood, David A.

Internal Audit Quality and Earnings Management

The Accounting Review, Vol. 84, No. 4, pp. 1255-1280, 2009

42 Pages Posted: 17 Jul 2006 Last revised: 11 May 2010

See all articles by Douglas F. Prawitt

David A. Wood

Brigham Young University - School of Accountancy

Date Written: September 11, 2008

Abstract

Internal auditors often perform work that is relevant to their host entities' financial reporting processes, yet little research attention has focused on the effects of internal auditing on companies' external financial reporting. Using a unique and previously unavailable data set, we investigate the relation between internal audit function (IAF) quality and earnings management. We measure IAF quality using a composite measure comprising six individual components of IAF quality based on SAS No. 65, which guides external auditors in assessing the quality of an IAF with respect to its role in financial reporting. Earnings management is measured using two separate proxies, (1) abnormal accruals and (2) the propensity to meet or barely beat analysts' earnings forecasts. We find evidence that IAF quality is associated with a moderation in the level of earnings management as measured by both proxies.

Keywords: Corporate Governance, Internal Audit Function, Internal Audit Quality, Earnings Management, Abnormal Accruals

JEL Classification: M41, M43, M49, M55, G34, G38

Suggested Citation: Suggested Citation

Prawitt, Douglas F. and Smith, Jason L. and Wood, David A., Internal Audit Quality and Earnings Management (September 11, 2008). The Accounting Review, Vol. 84, No. 4, pp. 1255-1280, 2009. Available at SSRN: https://ssrn.com/abstract=916081