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found substantial increases in the disclosure rate of material weakness for small-sized
companies undergoing initial internal control audits. They report the change in disclosure
rate of control weakness of small firms exactly as they appear. However, in our study, we
assess ICFR-disclosure quality further by examining the respective likelihood of Type I or
Type II errors for accelerated filers of all sizes.
Further, Rice and Weber (2012) have found that only a few restatement companies
acknowledged control weaknesses during their misstatement periods. Myllymäki (2014)
has found that compared to companies that never disclose material weaknesses, the
likelihood of misstatements for companies with a history of material weaknesses
continues to be higher for two years after their last material weakness reports. Acito et al.
(2014) have indicated that compared with the AS2 period, auditors in the AS5 period are
less likely to identify material weaknesses, possibly because auditors under AS5 may not
focus their testing on certain risky areas. All of the studies suggest that ICFR reporting
under SOX 404 or AS5 are noticeably prone to Type II errors. Our study differs from
previous studies because we examine not only Type II but also Type I errors in ICFR
reporting. The issue of Type I errors is noteworthy because there are negative wealth
distribution implications for weak control reports issued by companies with effective
internal controls. Additionally, we extend the preceding studies by investigating the
incremental effects of SOX 404 from SOX 302 and the effect of AS5 relative to AS2 on
ICFR-disclosure errors.
Second, prior research regarding AS5 mainly concentrates on its effect on audit fees
(Jiang and Wu, 2009; Doogar, Sivadasan, and Solomon, 2010; Krishnan, Krishnan, and
Song, 2011; Wang and Zhou, 2012). Wang and Zhou (2012) have also examined whether
audit quality has changed following AS5 adoption and found no evidence of a decrease in
audit quality. The main difference between Wang and Zhou (2012) from this study is that
we examine the first-order effect of AS5 (i.e., the effect of AS5 on ICFR-disclosure
quality) and therefore, we can provide direct and clear evidence of the effect of AS5
adoption.
Third, because compliance with the requirements of SOX 404 is costly, whether the
burdensome mandatory internal control audits (Hartman, 2007; Eldridge and Kealey,
2005; Kinney and Shepardson, 2011) can improve the quality of public ICFR disclosures
is a crucial research question that demands further empirical interrogation. Although AS5
prescribes a more flexible, top-down risk-based approach, concerns about auditors’ misuse