Audit Partners’ Judgments and Challenges in the Audit of Internal Control over Financial Reporting

Abstract

Internal control over financial reporting (ICFR) audits have been the subject of intensive examination by the Public Company Accounting Oversight Board (PCAOB) and researchers, and the SEC has signaled ongoing interest in the monitoring of ICFR. However, the process through which auditors make ICFR judgments and decisions has remained largely a “black box”, that has been relatively unexplored. To better understand how auditors make ICFR judgments, we conducted in-depth, semi-structured interviews with twenty highly experienced audit partners. Common themes in our interviews suggest that the subjectivity inherent in the ICFR evaluation task contributes to resistance against ICFR audit findings and counterarguments from management. In addition, auditors perceive that their judgments are being second-guessed by PCAOB inspectors. Auditors perceive that managers have difficulty accepting that a material weakness can exist without a detected error, management’s reflexive reaction is to deny/avoid a material weakness finding, and that managers routinely claim that management review controls (MRCs) would have caught the detected control deficiency. Consistent with the PCAOB’s practice alert to auditors on the importance of evaluating MRCs, the partners stressed the importance of evaluating the design and operating effectiveness of their client’s MRCs. Auditors cope with management’s defenses by consulting with national office and leveraging support from strong audit committees. Implications for research, practice, and public policy are discussed.