Working Paper: Do Audit Firms' Internal Inspection Programs Have Teeth? Evidence from the U.S. Operations of the Largest Audit Firms

Paper Authors:  Daniel Aobdia and Reining Petacchi

Abstract: We provide the first large sample evidence on the audit firms’ internal inspection programs, an integral part of the quality control mechanisms within an audit firm. We find that internal inspections are highly predictable. Engagement partners can predict not only when they will be inspected, but also which of their engagements will be inspected. Engagement teams take advantage of this predictability and concentrate their effort on the audit that ultimately is selected for an inspection. We further find that engagement teams change their audit effort in response to the inspection outcome. If the inspection outcome is favorable, the team reverts audit effort back to the pre-inspection level. However, if the outcome is unfavorable, the team increases effort on the engagement. We do not find that the change in audit effort around internal inspections is associated with any change in audit fees or financial reporting quality, which suggests that the increased effort may merely reflect lower audit efficiency.

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