Ineffective Internal Controls Research Articles

Coso-Based Control With The Belief in Karmaphala In The Business Sustainability of People's Credit Institutions (LPD)

Objectives: Village Credit Institutions (LPD) are unique financial institutions that exist only in Bali. In 2021, two LPDs in Denpasar, the provincial capital of Bali, experienced significant problems due to ineffective internal controls, resulting in the embezzlement of funds. This research focuses on internal control based on the Committee of Sponsoring Organization of The Treadway Commission (COSO) framework within LPDs, incorporating aspects of Balinese beliefs, specifically Karmaphala, to evaluate their influence on the sustainability of LPD businesses. Methods: The research methodology follows several stages: identifying the issue, collecting relevant theories and hypotheses, observing the population and sample, collecting data, conducting tests, analyzing the data, and reporting the results. The study aims to test the interaction between COSO-based internal control and the business continuity of LPDs, particularly through the lens of karmaphala beliefs held by LPD supervisors. Results: The testing phase indicates that the interaction of COSO-based internal control positively and significantly influences LPD business continuity. The belief in karmaphala among LPD supervisors strengthens the relationship between COSO-based internal control and the sustainability of LPD businesses, suggesting that supervisors who adhere to the law of karma contribute effectively to maintaining robust internal controls and ensuring business sustainability. Conclusion: The study concludes that effective internal control based on the COSO framework, combined with the Balinese belief in karmaphala, significantly enhances the sustainability of LPD businesses. Supervisors who incorporate these beliefs into their oversight practices provide a stronger, more positive impact on the continuity and stability of LPD operations.

Board Interlocks and Company Outcomes: A Managerial Accounting Case

Board interlocks are formed between two company boards when these companies share at least one common director, resulting in a reciprocal relationship from which both partners expect to benefit. Such conditions imply that directors in these interlocks will be less likely to provide strict monitoring oversight (Beckman, Haunschild, Phillips, 2004). This case examines the ethical and governance issues arising from board interlocks. The analysis examines further how board interlocks are less likely to provide strict monitoring functions on firm operations and financial reporting. Participants noted that since board interlocks imply that companies co-share members on their boards in a reciprocal relationship from which both partners expect to benefit, such conditions lead to less rigorous monitoring oversight. Participants also noted that board interlocks may create openings for operational practices with adverse firm outcomes, such as ineffective internal controls over financial reporting.

Do Internal Control Weaknesses Affect Firms’ Demand for Accounting Skills? Evidence from U.S. Job Postings

ABSTRACT In this study, we examine whether firms respond to internal control weaknesses (ICWs) by requiring accounting-specific skills when hiring rank-and-file employees. Using unique data containing an extensive collection of job postings, we document significant increases in firms’ job postings that list accounting skills after the disclosure of an ICW. This effect is more pronounced for firms with better financial resources and when ICWs are more severe or personnel-related. In addition, our results extend to employees that are not specifically designated as accountants, suggesting a broader role for rank-and-file employees in influencing internal control quality. Finally, we find that increases in job postings with accounting skill requirements are associated with improvements in internal controls and a higher likelihood of ICW remediation. Overall, our findings shed new light on how firms respond to ineffective internal controls by increasing their emphasis on accounting skills in their workforce. Data Availability: Data are publicly available from the sources identified in the text. JEL Classifications: G30; J23; M41; M42.

Procurement and contract management deficiencies: analysis of state audit reports

State governments obligate trillions of dollars on contracts for needed products and services. These contracts must be in compliance with statutory requirements focused on achieving public policy objectives. However, these objectives are not always achieved and the government risks not receiving the best value for funds expended. State agencies continue to identify deficiencies and monitor their contracts to ensure they meet mission and public policy objectives. The purpose of this research is to analyse contracting deficiencies identified in state auditor reports to determine how they align with type of product and service, contract life cycle phase, and auditability theory component. Based on an analysis of 165 deficiencies, the findings indicate that the majority of deficiencies were aligned with the procurement of professional services and occurred during the acquisition planning, source selection, and contract administration contracting phases. We also found that the contracting deficiencies were aligned with lack of capable processes and in-effective internal controls.

Social Capital and Internal Control Material Weaknesses

SYNOPSIS Using a measure of social capital provided by the Northeast Regional Center for Rural Development, we document that, after controlling for auditor effort, firms headquartered in U.S. counties with higher social capital are less likely to have ineffective internal control over financial reporting than those located in regions with lower social capital. This negative association between local social capital and ineffective internal controls holds when other forms of external monitoring are weak. We also find that the association is driven by ineffective internal control arising from entity-level, but not from account-specific, material weaknesses. Overall, we contribute to the literature that links firms' social environment with financial reporting quality. Data Availability: Data are available from public sources identified in the paper.

Internal control effectiveness, textual risk disclosure, and their usefulness: U.S. evidence

This paper investigates the impact of internal control effectiveness (ICE) on the level of textual risk disclosure (TRD; including aggregate risk disclosure and its tone of good news and bad news about risk). Our findings suggest that firms with an ineffective internal control system exhibit significantly lower levels of TRD than firms with effective internal controls. Besides, we show a significant change in TRD behavior provided by managers of firms with recurrent ineffective internal controls. Pursuant to agency theory, this behavior change is prompted to reduce the expected public uncertainty and agency problems. We also investigate the usefulness of ICE reporting and TRD to the market. Results suggest that firms reporting ineffective internal controls are likely to have higher investor-perceived risk than firms reporting effective internal controls. Furthermore, TRD improves firms' market liquidity, and such improvement is principally driven by good news rather than bad news about risk. Collectively, our results fill an apparent gap in the literature on the importance of ICE, as well as the usefulness of the external auditor's attestation on a firm's internal controls and management TRD.

Do Negative Corporate Social Responsibility Events Signal Financial Misreporting? — Empirical Finding from Taiwan

This study examines whether negative corporate social responsibility events (NCSRs) signal potential firm misreporting and pending financial reporting restatements. Without formal opinions on the effectiveness of internal controls over financial reporting in Taiwan, we hypothesize NCSRs can represent and/or signal a firm’s internal control weakness, which may in turn result in poor financial reporting. Note that the concern with controlling owners expropriating wealth through ineffective internal controls is given important weight by investors and regulators. We further examine whether the signaling function of NCSRs is more pronounced in contexts with a serious agency problem, such as is found in the high divergence of control and cash flow rights case (denoted as high excess control rights) in Taiwan. Empirical results indicate that, as conjectured, incidence of NCSRs is positively associated with the likelihood of reporting restatements. Further evidence reveals that this result is particularly pronounced in the high divergence of control and cash-flow rights subsample test. We demonstrate several diagnostic tests and show the results are robust in various specifications.

Implementation of Fraud Risk Assessment To Mitigate The Fraud Risk in Tax Audit Process

<p><em>The emergence of a variety of fraud schemes, ineffective internal controls, and the number of fraud cases that occur in the taxation sector, encourage researches related to fraud risk assessment, especially in tax audit activi</em><em>ties</em><em>. This study aimed to identify potential fraud schemes risks, evaluate risk controls and discuss anti-fraud strategies using a case study at the Directorate General of Taxes in Indonesia. With a sequential mix method approach through a combination of quantitative and qualitative research, and by using rational choice theory, this research extends the literature of previous studies by providing evidence that fraud can be prevented by increasing the probability to detect fraud scheme. This study fills out the gaps related to fraud risk assessment research in </em><em>the </em><em>tax audit </em><em>process</em><em> which have been rarely performed in the literatures.</em></p><em>The results concluded that of the 20 fraud scenarios identified, there were 7 fraud scenarios categorized as high level of residual fraud risk, 9 fraud scenarios at the medium level, and the rest at low levels. This study discussed appropriate controls to mitigate the residual fraud risk to be maintained at the level of organizational risk appetite. In addition, this study also discussed anti fraud strategies that are relevant to the organization, through evaluating anti-fraud strategies that have been previously implemented and anti-fraud strategies that have never been implemented</em>

Internal Control Weaknesses and the Demand for Financial Skills: Evidence from U.S. Job Postings

Ineffective internal controls over financial reporting often relates to a lack of qualified personnel with sufficient accounting and technical expertise. In this study, we examine whether firms respond to internal control failures by increasing their demand for specific accounting and finance skills. Using unique data containing an extensive collection of job postings, we document significant increases in firms’ demand for employees with financial skills following the disclosure of an internal control weakness. This demand effect is more pronounced among jobs requiring accounting skills or accounting software knowledge, but also extends to non-accounting personnel that interface with accounting functions, suggesting an important role for all firm personnel in remediating internal control failures. We also find that increased financial skill demand is associated with a higher likelihood of internal control remediation, especially for firms with restatements. We also provide additional evidence consistent with increased financial skill demand relating to the disclosure of a material weaknesses rather than a proactive firm response to internal control issues. Overall, our findings shed new light on how firms internally respond to ineffective internal controls by increasing their demand for financial skills in their workforce.

Interim Effective Tax Rate Estimates and Internal Control Quality

ABSTRACTThis study examines whether the volatility of interim estimates of the annual effective tax rate (ETR) provides ex ante information about the quality of firms' internal control environments. Recent research suggests that some firms selectively disclose internal control weaknesses (ICWs). Given the negative consequences associated with ICWs, it is important for capital market participants to be able to identify firms with ineffective internal controls in a timely manner. We find that firms with more volatile annual ETR estimates are more likely to report both tax‐ and nontax‐related ICWs in the current year. Our results also indicate that the volatility of annual ETR estimates declines following the remediation of tax‐related ICWs, but not following the remediation of nontax‐related ICWs. In addition, we find that ETR volatility in the current year is associated with the likelihood that a firm will report an ICW in the following year. Finally, we provide evidence that the volatility of annual ETR estimates is associated with the likelihood that a firm has an undisclosed ICW. In combination, our results suggest that the volatility of interim estimates of the annual ETR provides an ex ante signal of the likelihood that a firm's internal controls are ineffective.

The impact of high insider ownership on SOX 404 internal controls

PurposeThis study aims to investigate the effect of high insider ownership on firms’ internal controls over financial reporting. In particular, it examines how high insider ownership affects the likelihood of an adverse Sarbanes–Oxley Act Section (SOX Section 404) opinion and its subsequent remediation.Design/methodology/approachTests of hypotheses use ineffective controls and remediation models. The initial tests in this study use ineffective internal controls over financial reporting probit regression models to investigate how high insider ownership affects the ex-post likelihood of an adverse 404 opinion. Two remediation models – a multinominal probit regression and probit regression model – are used to investigate the effect of high insider ownership on the likelihood of successfully remediating an adverse 404 opinion.FindingsResults show that while the ex-ante likelihood of an adverse SOX Section 404 auditor’s internal control opinion increases with high insider ownership, high insider ownership firms are more likely to remediate ineffective 404 controls. This study rationalizes these diverse findings by asserting that prior to an adverse 404 opinion, entrenched managers avoid internal control financial reporting oversight and monitoring. After an adverse opinion, however, and within the context of an imminent and explicit value reducing 404 opinion, powerful high insider owner managers are motivated to remedy ineffective controls.Originality/valueThis research synthesizes existing streams of literature on insider ownership and the effectiveness of internal control over financial reporting quality to provide new information on the effects of high insider ownership on firms’ internal controls.

Process Mining of Event Logs: A Case Study Evaluating Internal Control Effectiveness

SYNOPSIS This paper aims at adopting process mining to evaluate the effectiveness of internal control using a real-life event log. Specifically, the evaluation is based on the full population of an event log and it contains four analyses: (1) variant analysis that identifies standard and non-standard variants, (2) segregation of duties analysis that examines whether employees violate segregation of duties controls, (3) personnel analysis that investigates whether employees are involved in multiple potential control violations, and (4) timestamp analysis that detects time-related issues including weekend activities and lengthy process duration. Results from the case study indicate that process mining could assist auditors in identifying audit-relevant issues such as non-standard variants, weekend activities, and personnel who are involved in multiple violations. Process mining enables auditors to detect potential risks, ineffective internal controls, and inefficient processes. Therefore, process mining generates a new type of audit evidence and could revolutionize the current audit procedure.

Acquirer Internal Control Weaknesses in the Market for Corporate Control

AbstractThis paper examines how disclosures regarding internal controls, required by sections 302 and 404 of the Sarbanes‐Oxley Act of 2002 (SOX), affect the market for corporate control. We hypothesize that acquirers with internal control weaknesses (ICWs) make suboptimal acquisition decisions based on poor‐quality information generated by their ineffective controls over financial reporting. We expect that such acquirers will be more likely to misestimate the value of their targets or the potential synergies from mergers, thereby overpaying for completed deals. Using a treatment sample of acquisitions made by acquirers that have disclosed ICWs and two matched control samples without ICW disclosures, we document that ICW acquirers experience a substantially more negative market response to acquisition announcements and have lower future performance than the two matched control samples without ICW disclosures. Overall, our results suggest that ineffective internal controls hinder decision making related to mergers and acquisitions (M&A).

Stakeholder Conflicts and Cash Flow Shocks: Evidence from Changes in ERISA Pension Funding Rules

ABSTRACTIn 2012, Congress passed Moving Ahead for Progress in the 21st Century (MAP-21), which changed the ERISA pension funding rules such that mandatory pension contributions decreased. Advocates for the bill argued that reducing mandatory contributions would increase firms' investment. In contrast, I do not find an average increase in investment among the firms benefiting from MAP-21. Rather, I find that firms either hold pension funding relief on their balance sheets as liquid assets or pay out pension funding relief to shareholders. To the extent that managers increase investment in response to MAP-21, it is concentrated in firms with weak governance or ineffective internal controls.

Benefits and costs of Sarbanes-Oxley Section 404(b) exemption: Evidence from small firms’ internal control disclosures

We quantify measurable benefits and costs of exempting firms from auditor oversight of internal control effectiveness disclosures. We measure the benefit of exemption as an aggregate $388 million in audit fee savings from 2007–2014. The costs stem from internal control misreporting: an aggregate $719 million of lower operating performance due to non-remediation and a $935 million delay in aggregate market value decline due to the failure to disclose ineffective internal controls. The audit fee savings benefit shareholders of all exempt firms, whereas the costs are borne by shareholders of only a fraction of exempt firms (the internal control misreporters).

Process Mining of Event Logs: A Case Study Evaluating Internal Control Effectiveness

Unlike traditional audit techniques, process mining of event logs provides a new aspect for auditing by tracking and capturing every single routing in the dataset. This paper aims at adopting process mining to evaluate the effectiveness of internal control using a real-life event log from a large European bank. Specifically, the evaluation is based on the full population of event logs and contains four analyses: (1) variant analysis that identifies acceptable and notable variants, (2) segregation of duty analysis that examines process instances and employees that violate segregation of duty controls, (3) personnel analysis that investigates employees who are involved in multiple potential control violations, and (4) timestamp analysis that detects time related issues such as the ones performed during the weekends and process instances that have lengthy process duration. The results from the case study indicate that process mining could assist auditors in identifying audit-relevant issues such as notable variants, activities performed during the weekends and personnel violating segregation of duty controls or involved in multiple violations..., etc. By examining the entire population of event logs, process mining enables auditors to detect potential risks, ineffective internal controls, and inefficient processes. Therefore, process mining of event logs generates a new type of audit evidence and could potentially revolutionize the traditional audit procedure.

Acquirer Internal Control Weaknesses in the Market for Corporate Control

This paper examines how disclosures about internal controls, required by Sections 302 and 404 of the Sarbanes-Oxley Act of 2002 (SOX), affect the market for corporate control. We hypothesize that acquirers with internal control weaknesses (ICWs) make suboptimal acquisition decisions based on poor quality information generated by their ineffective controls over financial reporting. They likely overestimate the value of their targets or the potential synergies from mergers. Using a treatment sample of acquisitions made by acquirers that have disclosed ICWs and two-matched control samples without ICW disclosures, we document that ICW acquirers pay larger premiums and earn smaller cumulative abnormal returns around the announcement dates. We estimate that an ICW acquirer on average pays $46.6 million, or 6 percent more, in premium than a non-ICW acquirer. The future performance of ICW acquirers is also lower than that of non-ICW acquirers. Overall, our results suggest that ineffective internal controls hinder decision-making related to M&A and that investors appear to understand this effect.

Effect of internal controls on credit risk among listed Spanish banks

Purpose: The paper examines the effectiveness of internal control systems, explores the exposure of Spanish banks to the dangers of default as a result of internal control systems and establishes a relationship between internal controls and credit risk. Design/Methodology/Approach: Quantitative research approach is used to test hypotheses on the relationship between internal controls and credit risk among listed banks in Spain. Data from Bankscope and company websites from 2004-2013 were used. Generalized Least Squares (random effect) econometric estimation technique was used for the model. Findings: We find that internal control systems are in place but their effectiveness cannot be guaranteed. This exposes Spanish listed banks to serious default situations. There is significant effect of internal controls on credit risk especially the control environment, risk management, control activities and monitoring. The non-disclosure of material internal control weakness is a contributory factor to the ineffective internal control systems. There is however a perceived board ineffectiveness which does not augur well for effective internal control systems. Board characteristics for Spanish banks confirm the agency theory. Research Limitations and Implications: Data unavailability for certain years, variables and many inactive banks did not permit a larger sample size than expected. The use of quantitative variables lacks flexibility. Practical Implications: Bank management will find the work useful to ensure strict enforcement of internal control mechanisms and see it as both credit risk and operational risk issues. Central bank should hurry to compel banks to disclose material internal control weakness as provided in the reviewed COSO framework. Social Implications: Ineffective internal controls lead to credit risks, bank closure and loss of investments. Society suffers a lot from such losses and contagion. Disclosure of material internal control weakness is a social responsibility of banks. Originality/Value: The authors are yet to come across the use of purely quantitative variables to model the effect of elements of internal controls on credit risk. This study opens and adds a new dimension of internal controls not only to be seen as operational risk issue but also credit risk.

The nexus of corporate governance developments and corporate failures

Since 1992 there has been an increase in the development of corporate governance principles after the wide spread corporate failures in the UK and US in the late 1980s. In response to these failures, various good corporate governance principles and regulations have been developed by different institutions to address the factors that lead to the failures. The basis of the study is to find out whether the developments in corporate governance have led to a decrease in the incidence of corporate failures. In doing so, I used data from UK newspapers, journals, magazines and other publications relating to the period under review. The years were divided into groups made up of four years each and ranked according to corporate governance developments and failures. After which, the Spearman's Rank Correlation Coefficient formula was used to determine the level of correlation. My findings indicated that, there is a fairly strong positive correlation between developments in corporate governance and corporate failures meaning that as the number of codes and principles increased the number of corporate failures also increased. The study also identified some of the reasons for the continuous corporate governance failures as board incompetence, poor risk management by companies, ineffective internal controls, and the failure of external auditors to remain neutral. The researcher is, however, convinced that if the principles and codes that have been developed are effectively assimilated by boards of directors, there could be a significant reduction in corporate failures in the near future.

CORPORATE GOVERNANCE IN THE UNITED KINGDOM (1992 – 2008): DEVELOPMENTS, FAILURES & LESSONS

Since 1992 there has been an increase in the development of corporate governance principles after the wide spread corporate failures in the UK and US in the late 1980s. In response to these failures, various good corporate governance principles and regulations have been developed by different institutions to address the factors that lead to the failures.The basis of the study is to find out whether the developments in corporate governance have led to a decrease in the incidence of corporate failures. In doing so, I used data from UK newspapers, journals, magazines and other publications relating to the period under review. The years were divided into groups made up of four years each and ranked according corporate governance developments and failures. After which, the Spearman’s Rank Correlation Coefficient formular was used to determine the level of correlation. My findings indicated that, there is a fairly strong positive correlation between developments in corporate governance and corporate failures meaning that as the number of codes and principles increase, the number of corporate failures were also increasing. The study also identified some of the reasons for the continuous corporate governance failures as board incompetence, poor risk management by companies, ineffective internal controls, and the failure of external auditors to remain neutral.The researcher is, however, convinced that if the principles and codes that have been developed are effectively assimilated by boards of directors, there could be a significant reduction in corporate failures in the near future. Keywords: Corporate Governance, Spearman’s Rank Correlation, Coefficient formular.