Paper Author: Daniel Aobdia, Preeti Choudhary, and Gil Sadka
Abstract: This paper investigates why material weaknesses in internal controls are often not reported in audited financial statements issued before restatements. To address this question, we analyze Public Company Accounting Oversight Board (PCAOB) proprietary data on audit clients’ internal control deficiencies (both material weaknesses and less-severe deficiencies) and PCAOB-inspector-documented deficiencies in the audits of internal controls. We find that the auditor’s failure to identify the relevant internal controls to evaluate is a significant, yet overlooked explanation. Exploratory analyses suggest that factors linked to auditor incentives and competence explain undetected internal control weaknesses. Collectively, our results suggest that academics, as well as regulators and practitioners, should consider auditor failures to detect internal control deficiencies as an important reason why restatements are not preceded by disclosures of material weaknesses in internal controls.
The economic research fellows and staff economists generate high-quality working papers that inform the oversight activities of the PCAOB and are disseminated to stimulate discussion and critical comment to the benefit of the public. Working papers are preliminary materials that have not been approved by the Board and reflect only the views of the author(s).
The research topics of economic research fellows, including a description of any nonpublic data sets required for research, are presented to the Board for approval and research papers are reviewed to confirm that the topic of the paper is consistent with the researcher's proposal. That review does not, however, encompass an evaluation of the conclusions reached by researchers.