In the ever-evolving landscape of financial reporting, the role of internal controls has become increasingly pivotal, particularly in the context of audit completeness and the reliability of earnings announcements. A recent study by Michelle A. Draeger and Eric R. Lohwasser, published in Accounting Horizons, sheds light on this intricate relationship. Their research delves into how the effectiveness of internal controls, a key component of the Sarbanes-Oxley Act of 2002 (SOX), influences the audit process and, consequently, the reliability of earnings disclosures.
A primary outcome of SOX was the enhancement of internal controls to improve financial reporting. Draeger and Lohwasser’s study confirms that effective internal controls indeed reduce the likelihood of revisions in earnings announcements, aligning with SOX’s intentions. However, the study uncovers a paradoxical effect. While robust internal controls are meant to bolster earnings reliability, they simultaneously encourage management to release earnings disclosures earlier, often with less comprehensive audits. This premature release, driven by market demands for timely information, inadvertently increases the probability of revisions in these announcements.
This phenomenon indicates a complex interplay between internal controls, audit completeness, and earnings reliability. Effective internal controls, while directly decreasing earnings announcement revisions, also indirectly contribute to less audit completeness. This, in turn, leads to an increased likelihood of revisions, undermining the very purpose of these controls.
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