Effort Allocation in Integrated Audits and Implications for Financial Reporting Quality

SUMMARY This study investigates the implications of effort allocation in integrated audits on financial reporting quality. We examine whether increased-reliance on internal controls, defined as auditors allocating greater effort to the audit of internal controls and less effort to the financial statement audit, relative to expected levels of effort, negatively impacts financial reporting quality. Based on a sample of 9,094 firm-year observations from companies listed on China’s stock exchanges during 2012–2019, we find evidence that increased-reliance on internal controls is associated with lower financial reporting quality. However, client importance mitigates this negative effect. Our main findings are robust to controlling for endogeneity, excluding observations whose abnormal audit fees are close to zero, and using a sample with stable total audit fees over time. Overall, our findings suggest that disclosure of fees related to internal control audits and financial statement audits provides information relevant to assessing financial reporting quality. Data Availability: The data used in this paper are available from China Stock Market & Accounting Research, Taiwan Economic Journal, and public filings. JEL Classifications: D81; G38; M42; M48.