Internal Control Audit And Audit Fees

At the beginning of this century, American companies, like Enron and WorldCom, encountered financial fraud scandal. As a result, investors suffered heavy losses and lost the confidence in the capital market. In order to change this situation, the U.S. Congress enacted the Sarbanes-Oxley Act in2002, Section404in which required management assess the effectiveness of the internal control and registered public accounting firm issued the audit report of internal control attesting the management assessment and the effectiveness of internal control. SOX have helped to strengthen the management’s responsibility for internal control and improve the accuracy and reliability of financial reporting, which can protect the interests of investors. But it also trigged controversy because it led to high audit fees, especially for the smaller or less complex companies. In2007, PCAOB enacted the Audit Standard No.5to replace the Audit Standard No.2to reduce the company’s audit fees.Compared with foreign countries, the development of internal control audit system in China is later. From "the Basic Standards for Enterprise Internal Control" in2008to "the Enterprise Internal Control Supporting Guidelines" in2010, the management in China also need to issue assessment for the effectiveness of internal control and compulsory internal control audit begins to be executed gradually in Chinese capital market. For instance, in2011the companies listing both at home and abroad and in2012the companies controlled by central and local government need to issue internal control audit report. In this case, the change of audit fees in the compulsory internal control audit era deserves special attention and detailed study.This paper first reviews the achievement of relevant literature, distinguishes the concepts, such as the audit of financial statement VS the internal control audit. And based on the principle-agent theory,"deep pocket" theory and the market supply-demand basic theory, put forward the hypothesis of this paper. Then chooses the main board listed companies in Shanghai and Shenzhen stock market from2010to2012as samples. At the basic of Simunic(1980) audit pricing model, do the following empirical analysis:(1)the relationship between internal control audit and audit fees.(2) the change of audit fees during the internal control audit system transition for companies with different characters. Specifically, the paper study characters like whether the company disclosures internal control weakness or not, company’s business complexity is high or low, whether the company employ the Big4or the Big10to take the internal control audit.From the empirical analysis, the paper receives the following conclusion:(1) Internal control audit will lead to high audit fees.(2) During the internal control audit system transition, the growth of audit fees for the companies which execute internal control audit is bigger than those not.(3) The audit fees of the companies which compulsorily execute the internal control audit are higher than those voluntarily execute the internal control audit.(4) During the internal control audit system transition, the growth of audit fees for the companies which disclosures internal control weakness is smaller than those not.(5) During the internal control audit system transition, the relationship between the growth of audit fees for the companies and business complexity is not significant.(6) During the internal control audit system transition, the growth of audit fees for the companies which employ the Big4is bigger than those employ the non-Big4.(7) During the internal control audit system transition, the relationship between the growth of audit fees for the companies and whether the company employs the Big10is not significant.This study contributes to both academia and practice.First, the research on internal control audit and audit fees is limited, especially in the context of mandatory internal control audit system. This paper studies the relationship between them and the changes in audit fees for the companies with different characters under this situation. It can enrich the existing literatures. Second, the existing domestic papers focus on whether the internal control audit and the internal control weakness affect audit fees. Barely research is trying to study the changes which the mandatory internal control audit system leads to. This paper studies the effect of mandatory internal control audit system and it can provide data support for the reform of internal control audit system.Third, with the gradual implementation of the mandatory internal control audit system, internal control audit will become a general business for auditing firms and companies. Then the pricing for internal control audit will also attract more concern. This paper studies changes in audit fees for companies with different characters like whether they execute internal control audit, disclosure internal control weakness, have high or low business complexity, explore big auditing firm. This can help to set internal control audit price in practice.