A Study On The Relationship Between Internal Control And Conditional Conservatism

In2002, the United States congress issued the Sarbanes-Oxley Act (SOX). Its purpose is to improve the quality of financial reporting and restore the confidence of investors about the conservatism of the financial report. SOX section404requires the CEO and CFO evaluate and report the effect of internal control on financial report. The aim is to improve the company governance by improving the quality of internal control, and ultimately strengthen the company’s fiduciary duty.Our internal control system basically completed experienced the following steps. In June2006and September2006, Shanghai Stock Exchange and Shenzhen Stock Exchange issued Internal control guidelines by themselves; in June2008, the Ministry of Finance, the Securities and Futures Commission, the Audit Commission, the CBRC, CIRC jointly issued the internal control norms, which purpose is to strengthen and standardize the internal control of enterprises in China; In April2010, five ministries jointly issued a supporting guidelines about internal control. The supporting guidelines, together with the basic norms of the internal control, marked the internal control system of norms with Chinese characteristics basically completed, which not only consistent with China’s actual conditions, but also absorb advanced international experience. The produce process of this series of regulations and guidelines, coupled with the occurrence of a series of major financial fraud which is closely related with internal control, indicate that for a long period of time, the study of internal control will be a hot topic. The paper is divided into seven chapters; the overall structure is organized as follows:The first chapter is the introduction. This chapter is the opening of this article, something about the background, research purposes, the significance of the study, and the basic ideas.The second chapter is the Literature Survey. We discussed the concepts of internal control and conditional conservatism, the related concepts involved in the research process. Finally we summarized the previous literature review from domestic and international aspects.The third chapter is the theoretical derivation and hypothesis. This chapter showed us a detailed discussion of the relationship between internal control and accounting conservatism. From the theories we proposed hypothesizes.The fourth chapter is the study design. First of all, we described our basic Basu model, because the later models in this paper are all based on this model. For our research we set two group hypothesizes, set three main research models.The fifth chapter is the sample selection and descriptive statistics. This chapter shows us the process of the sample selection, the descriptive statistics about the data we obtained.The sixth chapter is the regression results. Using the data and model in the previous chapter, we draw the regression results.The seventh chapter is the conclusion and revelation. This chapter summarizes the findings of our empirical analysis, making some suggestions for the future of our internal control system and the development of conditional conservatism. Finally, we discussed the limitations and inadequacies of our paper.Internal control has been argued to provide several governance benefits. The disclosure of internal control information can help manages to find the internal control weaknesses in time, and then improve the internal control system, to improve the quality of accounting information. Accounting conservatism is an important feature of the financial report. The implementation of the principle can affect the implementation of the entire corporate accounting policies and their method of accounting. Accounting conservatism has also played a certain role in improving the corporate governance. From another perspective, because of all kinds of contract, managers tend to choose lower conservatism. The implementation of conservatism will cause financial reports are not neutral, damaging to the conceptual framework of reliability and unbiased of the financial reporting quality, while strong internal control make the financial report are unbiased. Therefore, the main research of my paper is the relationship between the internal control and accounting conservatism.We summarized the previous literature, and then use empirical analysis to prove the hypothesis we raised. Select a appropriate model to study the relationship between internal control and accounting conservatism. We will use three measures to study the asymmetric timeliness of economic loss recognition:(1) Persistence of earnings changes (Basu1997)(2) Accrual-based loss recognition (Ball and Shivakumar2005)(3) Timeliness of earnings to news (Basu1997)The empirical analysis results show that there is an uncertain relationship between internal control and accounting conservatism. From three measure of conservatism, we come to a different and even opposite conclusions. First measure shows that lower internal control quality is associated with greater conservatism. Only the last hypothesis shows that the continuous existence of the internal controls weaknesses is consistence with lower conservatism, which is in accordance with previous research results. Weak internal controls mean that the internal governance mechanisms and structures are not perfect. There is more space to manage earnings, and make the conservatism of the financial reporting reduced. Therefore, this study concluded that the relation between internal control and conservatism will become clearer after2011.We need to learn from the experience of developed countries. China has established internal control system norms to solve our current problems encountered in the disclosure of internal control information. First of all, strengthen the mandatory requirements of disclosure of internal control information. Second, regulate the contents of disclosure of internal control information. Third, strengthen the audit of disclosure of internal control information. Accounting conservatism can also play the same role in management governance.