Internal Control Quality Analysis

The determinant of internal control quality according to Li (2015) are firm’s specific features, auditing quality and corporate governance.

Management’s assessment disclose on internal control quality will lead to repercussion that benefit the increase of shareholders value. While, the Internal control quality (ICQ) is one of key firm and industry characteristics and plays an important role on the accrual quality (Doyle, et al., 2007 a; Ashbaugh et al., 2008). Another outcome on internal control is cost of capital. Higher internal control weaknesses (hereafter ICWs) mean lower internal control quality are associated with higher cost of capital such as bank loan (Kim et al., 2011). Also ICWs lead to higher cost of equity (Ogneva et al., 2007).

First, internal control quality is driven by firm’s specific features. Internal control quality has associated with the firm size, firm age and firm’s resources in supporting of internal controls; Furthermore, internal control quality is affected by the complexity of business operations. Firms which involved with many business segments have higher probability in disclosure of internal control weaknesses. Foreign exchange transactions among firms easily lead to internal control deficiencies and worsen internal control quality; In addition, internal control quality is determined by the firm’s financial reporting risks which could be arisen due to the complicated financial reporting procedures, restructuring the firm’s organization, severe financial condition and weak corporate governance. Internal control quality also has related with firms outside factors, such as higher quality of auditing, more auditor resignations, and more financial reports restatements. The corporate governance can also influence the internal control quality as well. (Tian et al., 2010; Li,

When deficiencies in the design or operation of a control are found, management needs to evaluate further how serious the impact may be on the integrity of the com-pany’s financial reporting processes. More serious deficiencies are classified as either significant deficiencies or as material weaknesses.

A material weakness in internal control is defined as “a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected’’ (PCAOB, 2004).

Material weaknesses in internal control are associated with firm size, measured by market value of equity; and firm age, measured by the number of years the firm has CRSP data (Han Li, 2015). Therefore, for the variable control I choose the firm size and firm age.

Also, it is important to understand that a material weakness in ICFR does not nec¬essarily mean that the company’s financial statements are misstated; rather, it means that there is a reasonable possibility that the company’s controls would not have prevented or detected a material misstatement on a timely