Earnings Management, Audit Costs And Internal Control Audits

Conforming to the trend of change in the international capital market regulation, the China Government has gradually established a system of internal control. In2008May, the Ministry of Finance issued the "basic norms of internal control",in conjunction with CSRC, the Audit Administration, China Banking Regulatory Commission and the China Insurance Regulatory Commission, which demand for the internal control evaluation of enterprise management level of the listing Corporation. In2010April, the relevant departments issued the pertain enterprise internal control system such as "The Audit Guidelines For Enterprise Internal Control"(hereinafter referred to as the "guidelines"), ever since China Government has established the audit system of internal control of enterprises."Guidelines" provides that the companies, listing at aboard and home, must make the audit of internal control since January1st,2011. Besides that the corporations, listing in the main board of the Shanghai stock exchange as the Shenzhen Stock Exchange should make the audit of IC since January1,2012. On this basis, the same implementation in the small board and GEM Listing Corporation will make at proper time; at the same time, the government encourages the early implementation of non-listed medium-sized enterprises. Thus, the disclosure of the IC information has turn from the voluntary disclosure into mandatory disclosure. Modern internal control system has originated from the modern western economic, but there are actually some differences between China and abroad, then it is worth us to study the effectiveness of the system in China. This paper researches the effectiveness of the audit of internal control from the perspective of the earnings management and audit fees. For the relationship between the audit of internal control effectiveness and earnings management, this paper does an empirical research about the change of earnings management after the audit of IC based on the listed companies on the main board. We find that:(1) the internal control audit can significantly inhibit the growth of accrual-based earnings management and real earnings management activities;(2) in the subsample of manipulating earnings management up, AIC could significantly keep down the growth of the accrual-based earnings management, abnormal production cost and the overall real earnings management activities, in the subsample of manipulating earnings management down, AIC could significantly keep down the growth of abnormal cash flow, discretionary expenses and the overall real earnings management activities. Further studies show that, the implementation of AIC is more effective in private firms than in the state-owned enterprises,which maybe the result of the fact that private enterprises will invest more resources for the audit of internal control to get the favor of investors. This shows that the AIC is effective from the perspective of earnings management in Sample Firms; and For the relationship between the audit of internal control effectiveness and audit fees, this paper this paper does an empirical research about the change of earnings management after the audit of IC based on the listed companies at home and aboard. Study found that there is no significant change of the audit fees after implementation of AIC. The reasons for this may be (1) there actually exist many different forms for audit fee disclosure, which leading to different companies audit fees can not be compared directly;(2) the AIC has different effects on from the perspective of the audit fees at the same time for the different exchanges has different order for the implementation of AIC as well as the differences among the firms about the voluntary AIC;(3)Besides that, the existence of the long-term contracts also may cause the little change of the audit fees. While the AIC is effective from the perspective of the earnings management, the AIC is not effective from the aspect of audit fees. After all, the results implies that the effectiveness of China’s audit of internal control is not clear and need further examination.We make a empirical research of the effectiveness of AIC in China based on the prior researches. Over the past years, the Chinese Government has been making preparation for the improvement and the implementation of AIC, accordingly, our research will provide empirical evidence.