Investigating the Impact of Audit Committee Characteristics and Internal Control Reporting on Earning Quality

Document Type : Research Paper

Authors

1 Associate Professor of Accounting, Faculty of Management, University of Tehran, Tehran, Iran

2 Master of Accounting, Faculty of Management, University of Tehran, Tehran, Iran

3 PhD Candidate of Accounting, Faculty of Management, University of Tehran, Tehran, Iran

Abstract

Journal of Accounting Advances, (2020) 12(1): 299-322
DOI: 10.22099/JAA.2020.30579.1745
  Journal of Accounting Advances (JAA)
Journal homepage: www.jaa.shirazu.ac.ir/?lang=en
Investigating the Impact of Audit Committee Characteristics and Internal Control Reporting on Earning Quality

ARTICLE INF
ABSTRACT
Received: 2019-5-2
Accepted: 2020-7-21
  Corporate governance has a significant role in today`s accountancy and auditing environment. The role of the audit committee and internal controls as corporate governance mechanisms, has become more prominent in recent years. In the present study, the effect of the features of the aforementioned mechanisms on the quality of profits has been examined. Data of 159 companies are analyzed for the period of 2011-2017 under statistical test with multivariant regression with OLS approach. According to the results, there is a significant and positive relationship between independence and technical expertise of the members of the audit committee, and internal control reporting and earning quality, which indicates that with increasing independence and expertise of members, as well as the presentation of internal control reports, the quality of earning increases. But there is no significant relationship between the number of members of the audit committee and the earning quality.
  
1- Introduction
       Corporate governance has a significant role in today`s accountancy and auditing environment. The role of the audit committee and internal controls has become more prominent in recent years, after the failure of large, international companies. Corporate governance is an interconnected set of internal and external control mechanisms that enables shareholders to monitor the company in order to ensure that company value increases. Hence, corporate governance mechanisms that include the audit committee and internal controls play an important role in reducing the agency cost and can protect the interests of the owners. The results of studies in related litrature indicate that the existence of the audit committee and internal control over financial reporting are effective and provide better and more reliable financial reporting and higher earnings quality.
       Also, in line with the literature on internal control reporting, it encourages management to improve internal control and enhance the regulatory process of audit committees, and provide additional information to users.
 
2- Hypothesis and Questions
Research hypotheses and research questions are developed as follows:
Q1. Is there any significant relationship (positive or negative) between audit committee’s size and earning quality?
P1. There is a positive and significant relationship between audit committee’s expert (financial and technical expert) and earning quality.
Q2. Is there any significant relationship (positive or negative) between audit committee’s independence and earning quality?
P2. Internal control reporting is a determinant in internal control effectiveness, thus there is a positive and significant relationship between internal control reporting and earning quality.
 
3-Methods 
       In this research, data of 159 companies are analyzed for the period of 2011-2017. The related data was collected through observation of Iranian database of Tehran Stock Exchange annual data files and the accompanying notes as found on Codal.ir. For statistical analysis and to test hypotheses, descriptive and inferential statistics (i.e., correlation-test and enter multiple linear regression) are used. The collected data was calculated using the Excel software and was analyzed using Eviews. To measure earning quality, Francis et al’s (2005) model has been used.
 
4-Results 
       The results of this research show that, there is a significant positive relationship between audit committee’s expertise and independence, internal control reporting, and earning quality. But, there is no significant relationship between number of audit committee members and earning quality. In addition, the results of research concerning control variables show that there is a negative relationship between firm’s leverage and earning quality, but there is a positive relationship between firm’s size and earning quality. Also, results showed no significant relationship between audit firm size and dependent variable.
 
5- Conclusion
       Based on the 1st research question there is no significant relationship between the number of members of the audit committee and the earning quality. Instead, according to the results of the 2nd and 3rd hypotheses, the independence and technical expertise of the members of the audit committee are significant, making the audit committee ultimately better able to be more reliable and financially profitable. Audit committees, in addition to financial members, also need specialist members in the relevant industry, thus making the audit committee more effective, because relevant industry professionals have a better understanding of processes and other relevant factors. And the industry's specifics, and their presence in the audit committee will lead to better performance.
       On the other hand, by increasing the independence of the members of the audit committee, they are presented as better representatives of shareholders who do not necessarily have their interests in line with the interests of the company's executives, and can better perform their duties and responsibilities, in which case the costs of the agency and information asymmetry are reduced, and the audit committee acts as a cornerstone of corporate governance, and more reliable financial reporting and higher-quality earnings result.
The result of the second hypothesis is that the presentation of internal control reports is effective on the quality of corporate earning, so that the presentation of this report will increase the attention of managers to the internal control system and identify their weaknesses and strengths. Managers will also seek to mprove the weaknesses because the results of internal controls and how they workshould be reported, then improving internal controls and fixing the weaknesses are followed by better reporting of internal controls and thus improved internal controls. The current research suggests that, for two reasons, internal control reports provide better performance; First, this internal control reporting can increase the management's high awareness of the company's internal control system, which in turn leads to a greater degree of management of the internal control system in general. Second, this internal control report causes improvement in better internal control.
 
Keywords: Audit Committee Characteristics, Internal Control Reporting, Earning Quality.
 
 

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Journal of Accounting Advances
Volume 12, Issue 1 - Serial Number 80
December 2020
Pages 299-322

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History

  • Receive Date: 03 September 2018
  • Revise Date: 07 July 2020
  • Accept Date: 21 July 2020

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