Speaker：Dr Xin Ming LIU

Site:B131

Time：9：30-11:00 Monday Nov.13 2017

Abstract:China’s 2012 Rule mandates that listed firms should disclose their internal control (IC) audit fees in the annual reports. Using abnormal audit fees to proxy for over- or under-investment in audit effort, China's new rule provides a natural experiment in which we can distinguish auditor's effort allocation in an integrated audit. This study examines whether IC over-reliance exists and whether this over-reliance leads to lower quality of financial reporting. An IC over-reliance exists if auditors' extra effort in IC audits cannot actually detect IC weaknesses (ICW). Because the auditors mistakenly believe over-invest in IC audits can help detect more ICW, they will under-estimate firms' control risk, resulting in reduced substantive testing and lower financial reporting quality. Based on a sample of 4,411 firm-year observations from the A-share companies listed on China’s stock exchanges during 2012-2016, we show that IC over-reliance exists and harms financial reporting quality when auditors charge positive abnormal IC audit fees and negative abnormal financial statement audit fees. These results are robust to controlling for endogeneity, alternative measures of financial reporting quality, and group-wise comparisons among different effort allocation combinations. However, this negative effect of IC over-reliance on financial reporting quality is mitigated when the auditors are industry experts. Our empirical results bear important implications to recent regulations and standards.