The Effect Of Internal Control Audit On Earnings Management

Financial report is not only the main way for the information disclosure of listedenterprises but also the vital links between stakeholders, listed enterprises andcommunication of management. However, control of earnings has decreased the creditof financial reports, which will mislead the stakeholders and investors and causedamage to the legal benefits them. In order to increase the quality of earnings andrelativity of financial report, the internal control system is now gaining more and moreattention. In2002, SOX bill was carried out in America that requested all the listedenterprises should employ a CPA to audit the internal control system and giving advices.From then on, internal control auditing became one of the external supervisions forlisted enterprises. Internal control auditing is now prospering in the world.In2008, Basic regulations on enterprise internal control were published in Chinaso as to guide the establishment and improvement of listed enterprise internal controlsystem. In2010, relative regulations were carried out by the Five Ministries in China,among which Guidance on enterprise internal control auditing provided much guidanceand the law of internal control auditing became complete gradually. From then oninternal control auditing spread widely in China. In2011, enterprises that go listed bothhome and abroad at the same time were asked to make an internal control auditing anddisclose the auditing report. In2012, the scope is widened to all the state-ownedenterprises that are listed on the main board and part of the non state-owned enterpriseswith big scale.In2014,all the listed enterprises on the main board are requested formaking internal control auditing and disclosing the auditing report. Now it is animportant period for publicizing internal control auditing. The purpose of this thesis isto research on the effects of internal control auditing from the perspective of earningmanagement. Real examples are selected from the listed enterprises that are listed from2009to2013in order to research on the influences on accrual earning management andreal earning management caused by internal control auditing. The influences on the realearning management of listed enterprises of different scales and ownership are alsodiscussed in this thesis so that reasonable suggestions shall be given to the internal control auditing system in China. Earning management is composed of accrual earningmanagement and real earning management. Influence on the two earning managementmethods caused by internal control auditing will be demonstrated in this thesis. Firstly,revised Jones model is used for researching the extent of management in accrual earningmanagement of listed enterprises. Evidence shows that the relationship between extentof accrual earning management and internal control auditing is negative. Listedenterprises that make internal control auditing have a lower level in accrual earningmanagement comparing to those who don’t make internal control auditing, whichindicates that internal control auditing could restrain the accrual earning managementand improve the quality and earnings. Then the relationship between internal controlauditing and real earning management is researched by using the research ofRoychowdhury for reference. Sales control, production control and discretionaryexpenses control are used for measuring the management of real earnings in listedenterprises. Regression models are made to get the analysis that the relationshipbetween real earning management and internal control auditing is negative, whichmeans the enterprises with internal control auditing have a lower level of real earningmanagement comparing to those who don’t make internal control auditing and internalcontrol auditing could control the real earning management of listed enterprises.According to existing research, listed enterprises prefer more real earning managementfacing with stricter supervision. Listed enterprises of big operation scale could makemore real earning management by taking advantage of their own convenience.Considering the benefits, listed enterprises of big operation scale has complete internalcontrol system and more external supervisions. Whether internal control auditing couldrestrain the real earning management or not shall be researched in this thesis. Accordingto the research, in the listed enterprises that have made internal control auditing, realearning management has a negative relationship to the scale. In the listed enterprises ofbig scale, internal control auditing could make good performance in restraining realearning management. Further research is done to research the effect on real earningmanagement caused by internal control auditing in different ownership. In the listedenterprises that have internal control auditing, real earning management has a negative relationship to state holding variables, which means that internal control auditing instate owned listed enterprises has a better performance in controlling real earningmanagement. Examples are used to examine the effects of suggestions on internalcontrol auditing. Results show that in current situation, suggestions on internal controlauditing have no obvious relationship with real earning management, which meanssuggestions on internal control auditing haven’t had the due effects yet.The research in this thesis shows that internal control auditing does restrain theearning management in listed enterprises. And the effect will be more obvious in stateowned listed enterprises and big scale listed enterprises. But the suggestions on internalcontrol auditing haven’t gained the due effect, which provides evidence to relativeresearch on internal control auditing. The necessity and usability of internal controlauditing is confirmed in this thesis. According to the results, suggestions are given inthis thesis, including giving guidance to enterprises on establishing complete andeffective internal control system; accelerating the process of internal control auditingand improvement of relative laws and regulations; the supervision on internal controlauditing shall be strengthened in order to guarantee the effects; the training of CPAshall be strengthened so as to improve the professional standards.