Abstract
The paper investigates the effects of materiality assessment on Internal Controls over Financial Reporting (ICFR) Maturity. Based on private data collected from Italian listed companies, the paper aims to provide a unique score for assessing ICFR Maturity of a company and to assess the effect of quantitative and qualitative factors used to evaluate materiality. Specifically, it examines the processes used to identify significant entities, significant accounts and associating accounts with process. A Partial Least Squares (PLS) Path Modeling approach is used. Among quantitative factors, total assets, sales and earnings before taxation are the best accounting measures used by companies to select entities, while income statement value is more useful than the balance sheet in selecting significant accounts. This last activity is relatively more relevant that the others. Scoping results show: 1) the importance of identification of entities at group level; 2) multiple association accounts – processes is better than single association. Finally results show different effects on ICFR Maturity for the manufacturing and services industry and for the financial industry.
Highlights
After the financial scandals of the 2000s, evaluation of Internal Control over Financial Reporting (ICFR) was made mandatory in most parts of the world and findings of the evaluation today have to be published for use on the market
We contribute to the literature using private data on internal control collected by questionnaires and by proposing a Partial Least Squares (PLS) Path Models (Esposito Vinzi et al, 2010) which allows us to compute a global score for assessing the ICFR Maturity of a company
Each of the three dimensions of ICFR Maturity (i.e. capability in identifying significant Subsidiaries (ID_S), capability in identifying significant accounts (ID_A) and capability in associating accounts with process (ASS)) is approximated by a first-order score obtained as a linear combination of the associated indicators
Summary
After the financial scandals of the 2000s, evaluation of Internal Control over Financial Reporting (ICFR) was made mandatory in most parts of the world and findings of the evaluation today have to be published for use on the market. In the USA, the Statement of Auditing Standard (SAS) 107 and AS11 deal with audit Materiality Both ISA 320 and SAS 107 view the assessment of what is material as a matter of professional judgment and contain no quantitative guidelines for handling Materiality. Two example thresholds are provided in the application of ISA 320 Both standards require that Materiality be defined at both the overall financial statement level (entity) and in relation to particular account balances, classes of transactions and disclosures (account-specific). These two standards recommend that a percentage of a chosen benchmark be used as a starting point for determining the Materiality threshold (quantitative), thereby underscoring the importance of an auditor’s professional judgment (qualitative)
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