An International Meeting of the American Accounting Association American Accounting Association 2006 Annual Meeting August 6–9, 2006 Washington, D.C.

Douglas F. Prawitt
Brigham Young University

Jason L. Smith
University of Arizona

David A. Wood
Indiana University

Abstract: We investigate the relation between proxies of investment by companies in their internal audit function (IAF) (relative size, reporting level, level of staff experience and certification, focus on financial auditing, and sourcing arrangement) and abnormal accruals, as a proxy for earnings management. We find a significantly negative relation between abnormal accruals and (1) the degree of IAF focus on financial audit work, (2) the average experience level of auditors in the IAF, (3) whether the head of the IAF reports to the audit committee and (4) outsourcing a portion of the IAF to a third party. We also find evidence that outsourcing the IAF to the external auditor (pre-SOX) is associated with lower levels of abnormal accruals relative to in-sourcing; we find no difference between outsourcing to the external auditor or other third-party outsourcers. Overall, our results suggest that IAFs moderate the level of earnings management in their host companies.

Back to Session Listing

AAA Home Page