internal audit characteristics, financial … audit characteristics, financial reporting quality:...

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INTERNAL AUDIT CHARACTERISTICS,

FINANCIAL REPORTING QUALITY: TUNISIAN

CASE

Eya N.A. NOUBBIGH

Assistant professor, IHEC, Carthage

DEFI-ESSEC research Unity

[email protected]

Pr Chokri MAMOGHLI

Full professor, IHEC, Carthage

DEFI-ESSEC research Unity

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INTERNAL AUDIT CHARACTERISTICS,

FINANCIAL REPORTING QUALITY: TUNISIAN

CASE

Abstract

This study evaluates whether internal audit function characteristics have an impact on

financial reporting quality. We examine different determinants of internal audit

quality in Tunisian firm. Internal audit function characteristic was apprehended

through internal auditor competence, internal controls weaknesses and different

procedures put on to improve internal audit quality. The financial reporting quality is

estimated by earnings management. Finally, we find that contractual audit fees, the

presence of an annual audit program, the presence of a internal audit manual of

procedures the membership of IIA Tunisian chapter and the relative experience of

internal auditors have an impact on earnings management and thus on the quality of

financial reporting.

Key words:

Internal audit quality - financial reporting quality – earnings management

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1. Introduction

In this recent period, the business world faces many financial scandals and crises. All

this scandals focuses in the role played by governance mechanism to protect investor

and fulfill their goals. Many laws and rules were established. One of the mechanisms

that it keeps the interest of many authors is internal audit and more specifically his

quality. The quality of internal auditor is usually measured by the competence of

internal auditor, the quality of work and the independence of internal auditor. The

main objective of this paper is to study the impact of internal audit quality on

financial reporting. The originality of this study becomes from the specificities of

Tunisian enterprises involved in this study. In fact, our sample concern 90 enterprises

that hold an internal audit department. As we know internal audit has never been

studied before in Tunisian context. Besides, this work provides some light on the

impact of some internal audit quality proxies on the financial reporting for Tunisian

enterprises. The innovation of this work is inherent to the use of new proxies which

are linked with Tunisian's enterprise specificities.

Recent studies have examined the impact of different governance mechanisms on the

transparency and quality of financial reporting. However, few studies have

investigated the relationship between internal audit and financial reporting quality

(Al-Shetwi et al, 2011).

Abdel-Khalik et al. (1983) found in their study that the internal audit function

supports the financial statement audit performed by external audit. This implies

improving audit quality and therefore the quality of financial reporting. Schneider and

Wilner (1990) estimate that the internal audit functions detect irregularities. Thus, the

study of Gordon and Smith (1992) concluded that the internal audit function plays a

key role in improving the control environment. It avoids irregularities in the financial

statements, which involves improving the quality of financial reporting.

Church et al. (2001) studied the perception of internal auditors and the most important

criteria in the evaluation of fraudulent financial reporting. They were able to detect

that internal auditors are concerned, in the most by, fraud and various manipulations.

The study of Arens et al. (2006) also highlights the fact, that the failure of internal

control increases the weakness of the internal audit function, which increases the risk

of the company and affects the quality of financial reporting. Rusak and Johnson

(2007) examined the role of governance mechanisms to deal with the collapse of

companies. They believe it is necessary to implement a robust and effective system of

governance. In this context, internal audit plays an important role in improving the

quality of financial reporting.

We should not forget that the most important and most innovative aspects of

Sarbannes-Oxcley Act is related to the impact of internal control failures in the

quality of financial reporting (Zhang et al., 2007). This law established the premises

for the benefit of various researchers on this aspect. We can't deny the presence of

studies previous of SOX, but we attended a special enthusiasm after the enactment of

this law. Section 302 of the Act established the disclosure of internal control

deficiencies impair the financial statements of the company by the management of the

firm. This commitment highlighted the participation of the company and therefore the

importance of the internal audit function in the disclosure of internal control

weaknesses.

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Felo (2012) discusses the impact of various governance mechanisms on the

transparency of financial reporting. He argues that the mainly voluntary financial

reporting increases transparency and thus the quality of financial reporting.

Specifically, he argues that information about the effectiveness of the internal audit

function within the company increases the transparency of governance due to the

voluntary disclosure, but also the quality of financial reporting.

Other authors have focused on the contribution of the audit report in improving the

quality of financial reporting. De Zoort and Holt (2009) used in the experimental

study to investigate the impact of the disclosure of internal audit report on the

perceived reliability of financial reporting. The authors believe that the internal audit

function promotes investor confidence in the quality and reliability of financial

information, due to better monitoring and control of the company. Their results show

that confidence is growing, especially when these investors have access to the reports

prepared by the internal auditors.

Prawitt et al. (2009) considers that the presence of an internal audit function

discourages the management of a company to use earnings management. This

decrease in accounting manipulations, result in the reduction of earnings management

and consequently discretionary accruals. This is would improve the quality of

financial reporting. It should be noted that these authors are among the few who

studied the impact of the internal audit function on earnings management. Thus, the

earning management considered as such and not as a measure or proxy of another

factor.

This paper contributes to the internal auditing literature in the following ways. First,

the study studies internal audit in Tunisian firm, for first time. Second, it provides

evidence that internal auditing characteristics/activities affect financial reporting

quality in Tunisian firms. Third, our contribution consists on the choice of unlike

prior proxies on the evaluation of the impact of internal audit characteristics on the

quality of financial reporting. We collected the internal audit inherent information by

surveying all non-financial companies with internal audit units, member of IAA

Tunisian Chapter. In this way we provide a stronger research setting.

The remaining part of the paper is organized as follows. In the next section, we

present a legal framework of internal audit in Tunisia. This is followed by a literature

review on the relation between internal audit and financial reporting quality as a basis

for our hypotheses development. After that we describe our methodology, dataset, and

variables. The next section presents the results and discussion. Finally, the final

section concludes our paper.

2. Literature review and development of hypotheses

2.1.The external auditors assessment of the internal control's

O'Leary et al. (2006) estimate that in the audit process, the external auditor is

required to assess the quality of internal control. It formulates its view of the

importance and the number of internal control deficiencies. The presence of

weaknesses decreases their relying on internal auditor work. The opinion of

the external auditor will have an impact on the growth of validation tests in

order to build a suitable and reliable judgment, given that the financial

statements and the accounting figures may be damaged by the failure of

internal control.

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Goh et al. (2012) demonstrated through their study that the opinion of the

internal auditor on internal control greatly affects his judgment made about the

financial statements of the operation of the business continuity and its

financial reporting quality. Thus, according to the authors the probability of

formulating a negative opinion on internal control in companies in financial

difficulties promotes all things being equal, the issue of going concern opinion

and the quality of its financial statement. Indeed, the adverse opinion on

internal control indicates the deterioration of the reliability on financial

statements that make it difficult to express in a clear and unequivocal opinion.

Finally, no study has been able to link the quality of financial reporting and

the opinion of the external auditor on internal controls effectiveness. This does

not prevent us to pose the following hypothesis:

H1. There is a positive association between the quality of financial

reporting and the opinion of the auditor on internal control

2.2.The number of internal control weaknesses

The study by Zhang et al. (2007) examined the relationship between the

characteristics of the audit committee and the detection of the internal control

weaknesses. But even if it was not their main goal, the authors were able to

demonstrate that the detection of material misstatements by the members of

the audit committee reduces the number of internal control deficiencies that

supports the quality of financial reporting.

Several authors have studied the relationship between the quality of financial

reporting and the quality of internal audit. In some studies, financial reporting

was apprehended through accounting adjustments (Asare et al., 2009). Thus,

companies have an internal audit function; have less accounting restatements,

less earnings management, fewer weaknesses in internal controls than

companies that don't have internal audit (Krishnan 2005). Prawitt et al. (2009)

argue, besides, that companies with an internal audit function detect more

fraud.

Coram et al. (2008) explain, based on the results of their study, that companies

have an internal audit function are more likely to detect and prevent all types

of fraud or anomalies can affect the quality of financial reporting. Thus, the

internal control procedures put in place and controlled by the internal audit

function improve significantly the quality of financial reporting.

Uemura (2012) believes that the quality of internal control procedures affect

the quality of financial reporting. Thus, the presence of internal control

deficiencies promotes errors and problems in the financial statements. The

results of this study, conducted in the Japanese context, have demonstrated the

reliability and credibility of the financial statements are inherent in the quality

of control procedures. If the procedures are effective and limit failures of

internal control, this is reflected positively on the quality of accounting

information published. Especially, it is more interesting for the company to

discover her own deficiencies and correct them better that they will be

discovered by the external auditor.

H2. There is a negative association between the quality of financial

reporting and the number of internal controls weaknesses

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2.3.The time spent by internal auditor on reviewing internal controls efficiency

and effectiveness

The mission of Internal Auditors doesn't stop today on assurance missions it

involves, also, consulting services, according to Mermod and Sungun (2013).

As we recall, the internal audit function doesn't stop to the protection of assets.

Its field becomes wide, since it is linked to the overall business strategy and

the added value of internal audit function. It includes the operational audit, IT

audit, risk management and governance. Thus, evaluation of internal controls

isn't the only part of the work performed by the internal auditor.

Ho's and Hutchinson's study (2010) had among its objectives to study the

relationship between the quality of work of the internal audit function and the

main activities and tasks performed by this function. These authors found that

the majority of respondents spend 29% of their working time in the evaluation

of the efficiency and effectiveness of internal controls. We don't find any

research that study the relation between this time spent on audit controls

assessment and financial reporting quality.


reporting and the time spent by internal auditor on reviewing

internal controls efficiency

2.4.The non-audit fees related to internal controls mission

The study of Prawitt et al. (2012) examined the role of the internal audit

function in improving the quality of financial reporting. It focused on a

particular case that the outsourcing of the internal audit functions. Similarly,

the quality of financial reporting in this study is the risk that the financial

statements of a company that is fraudulent or contains irregularities that can

mislead investors. The accounting risk is apprehended through a score that is

"audit integrity". These authors were able to demonstrate through their

regression results that the company has an internal audit function of high

quality improves the quality of financial reporting regardless of whether this

function is internal or external. This does not exclude the improvement of the

quality of financial reporting when the external auditor carries out internal

audit work.Kinney et al. (2004) did not find a significant relationship between

this variable and the quality of financial reporting.


reporting and the non-audit fees related to internal controls mission

2.5.The manual of internal audit procedures

The manual of procedures is a document that meets the description of all the

tasks and operations to be performed. This is an internal document to the

company. It is written to define the nature and content of each transaction, to

formalize and define the scope of each employee within a company. It is

intimately connected with the recommendations of the IAA on the

effectiveness of internal audit and denotes the successful organization of a

company. The study of Gumb and Noel (2009) helped to see that the leaders

of the French companies give much importance to the manual of procedures as

an important component in improving the quality of internal audit. In fact,

80% of respondents frequently cited procedures manuals as an important

benchmark in assessing the quality of internal control. Thus, we didn't find

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any studies linking the presence of procedure manual and the quality of

financial reporting and earnings management. This does not prevent us to

formulate our next hypothesis.


reporting and the existence of the manual of procedures

2.6.The annual audit program

According to the norms and standards of internal audit, the internal audit

function is required to establish an audit program in the long term, medium

term and short term. The long term is a strategic plan, the medium term is a

more detailed plan and short-term corresponds to an operational plan. The

short term is an annual plan where the internal audit function will program its

various interventions. The annual audit program denotes the good organization

and efficient management within the internal audit function where each

intervention is programmed.

This mission plan specifies the objectives, the scope of intervention, the date

and duration of the mission, the approaches to be followed, as well as

resources (PA-2200-11).

Diard and Trebucq (2007) have demonstrated through a study of audit

departments on the assessment of the level of compliance between the reality

of the procedures and requirements of the standards of IAA-IFACI that

traditional aspects of the audit as the establishment of an annual audit plan are

generally respected in the French context. That is why we pose this following

hypothesis:


reporting and the existence of annual program

2.7.salary internal auditors

The internal control procedures will be weak, if the company doesn't have all

the tools to make this function work properly; we inevitably end up with a

poor quality of internal audit. The internal audit function couldn't

appropriately do its job. This is likely to increase the risk of fraud,

manipulation, errors and anomalies. As a result, the quality of financial

reporting and the quality of the published information will be altered.

Authors, as Solomon and Peecher (2004) questioned whether the costs

invested in improving the quality of internal audit and the implementation of

the recommendations of SOX, will protect the interests of investors on the one

hand and improving the reliability of financial informational materials. Some

authors such as Ho and Hutchinson (2010) assessed the cost invested in the

internal audit through the number of internal auditors and therefore the size of

the internal audit function, others have assessed through the percentage that

the internal audit reports by the total number of staff. For our study we will

remember as Ziegenfuss et al. (2006), the percentage of the salaries of internal

auditors divided by the total wage costs. This denotes the importance attached

to the internal audit function within a business.

1 2200-Engagement Planning, guide de l'IPPF

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reporting and the proportion of internal auditor's salaries

2.8.internal auditors member of IIA Tunisian Chapter

Continuing education, various training and seminars have been identified as

factors favoring the jurisdiction of the internal auditor (Brown, 1983). The

importance of training and attendance at seminars, have been used by a

number of authors such as Al Tawerejri et al. (2004) or Gramling et al. (2013)

in assessing the competence of internal auditors, which is directly related to

the effectiveness of the internal audit function.

The study of Mermod and Sungun (2013) on the establishment and

development of the internal audit function within the Turkish companies,

focused on key criteria that should be enjoyed internal audit function as

recommended by the IIA. These characteristics include the training and

membership in the IIA. Indeed, membership in the IIA requires compliance

with a competency framework developed to meet the requirements of the job

for the right training and compliance with standards and practices developed

by the IIA. Continuing education and membership in the IAA allows the

internal auditor to carry out their work properly and allows the company to

produce reliable accounting information and financial statements of good

quality .


reporting and the proportion of internal auditor's member of IIA

Tunisian chapter

2.9.professional certification

Professional certification is a guarantee of competence and knowledge of the

internal auditor (Brown, 1983). Professional certification was included in the

study Ziegenfuss et al. (2006), the author was able to demonstrate the positive

relationship between the certification of internal auditors and the perceived

quality of the audit report. Certification of internal auditors was apprehended

through the certified percentage of the total number of listeners. However, the

authors have failed to demonstrate the presence of a significant relationship

between certification and the value of the internal audit function. Thus, this

measure of the competence of the internal auditor has been integrated into the

study of Ho and Hutchinson (2010) as features for assessing the quality of the

internal audit function. This variable was also considered by Gramling et al.

(2013).


reporting and the proportion of certified internal auditors

2.10. Experience in internal audit

The internal audit profession requires as a minimum experience for the

internal auditor can properly do its job (Gramling et al. 2013). The choice of

three years is not arbitrary. It also follows from the study of Messier and

Schneider (1988). It has been applied also in comparison with the minimum

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number of years of experience required to become CPA in Tunisia. This same

requirement of three years is required by CIMA2.

This measure was also used by Ziegenfuss et al. (2006). These relate the

quality of the audit report, the value of internal audit and the quality of

financial reporting function with the average experience of all internal auditors

of companies. They were able to demonstrate the positive impact of the

experience on the value of the internal audit function and the quality of the

audit report.


reporting and the proportion of experienced internal auditors

3. Research design and methodology

3.1.Sample

To assess the impact of internal audit characteristics on financial reporting quality, we

opted for survey because the most important number of this enterprise is not listed in

Tunisia stock exchange. A survey questionnaire was developed and pilot-tested with

internal auditors, external auditors and academic professor to ensure that the questions

were appropriate. After incorporating changes, the final questionnaire was sent by

mail for all internal auditors adherent to IIA, working in 106 non –finance sector

companies to collect information on their internal audit department characteristics and

activities for the fiscal years ended 2009 and 2010. Unfortunately, none respond was

received. To obtain all information that we need, we were compelled to make door to

door, and dispending a semi-directive questionnaire.

A total of 96 companies, among 106 enterprises, accept to respond to this survey,

which represents a response rate of 90 percent. After excluding 6 companies which

gave significantly incomplete responses, there were a total of 90 usable responses,

representing an85 percent usable response rate.

3.2.Measurement of variables

The literature review allowed us to list a panel of variables to measure the quality of

internal audit. This large number of proxies can be explained by the different

approaches and theories that the internal audit was apprehended. For this research, we

selected the closest variables to the Tunisian context. The relationship between the

characteristics of the internal audit and financial reporting quality will be understood

through the following model:

QuaReptFin = f(Opncac, somdef, tempallou, lnhonaudCo, ManelProcd,

Prgannuel, salaire, Atai, Certifi, Exp3ans, lneffectif, lnfiliale, lnchfin)

The variables are defined as follows:

QuaReptFin: dependent variable is the quality of financial reporting proxy measured

by discretionary accruals estimated through Kothari et al. (2005). It should be noted

that there is a negative relationship between the quality of financial reporting and the

presence of discretionary accruals.

2 Chartered Institute of Management Accountants

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Opncac: This is a dichotomous variable that takes the value 1 when the external

auditors assessment of the internal control's is favorable and 0 for a negative opinion

and therefore inefficient procedures.

somdef: independent variable that measures the number of internal control

weaknesses detected by the external auditor and reported at the engagement letter or

audit report.

tempallou: independent variable that estimates the proportion of internal audit time

spent on reviewing operating efficiency and effectiveness including internal controls.

lnhonaudCo: independent variable that corresponds to natural logarithm of the audit

fees paid for due diligence mission related to internal controls and procedures.

ManelProcd: independent dichotomous variable equal to 1 if the firm has a

procedures manual, 0 otherwise .

Prgannuel: independent dichotomous variable that takes the value 1 if the internal

audit function has an annual audit program, 0 otherwise.

Salaire: the proportion of salary internal auditors of the company in relation to the

total payroll continuous variable load independent for determining the importance of

the internal audit function within the company.

Atai: the proportion of internal auditors’ member of IIA Tunisian Chapter

Certifi: the proportion of internal audit staff having professional certification (CIA,

CPA, CISA) within the internal audit function.

Exp3ans: the proportion of internal auditor with more than three years of experience

in internal audit within the internal audit function.

lneffectif: natural logarithm of the number of internal audit staff divided by total

number of employees

lnchfin: natural logarithm of long term debts

lnfiliale: natural logarithm of the number of subsidiaries

4. Empirical results

4.1.Descriptive statistics

Table I presents summary statistics for the variables used in the study. We can see that

respectively 85 percent, 66 percent and 72 percent of firms have a favorable opinion

concerning her internal controls, have manual of procedures and have annual

program. The mean value of weaknesses and time allowed to internal controls is

respectively 40 percent and 37 percent. Besides, we find that on average 80 of internal

auditors of firms have as minimum 3 years of experience, 18 percent of internal

auditors of firms have professional certification and 40 percent of internal auditors of

firms are affiliated to Tunisian IAA Chapter.

The correlation matrix in Table II shows that variables are not highly correlated.

Indeed, as advocated by Kervin (1992), we can say we are on a serious collinearity

problem only from a correlation coefficient equal to 0.7 between the independent

variables to be included in the model. For this case of study, the majority of

correlations do not exceed the threshold of 0.4, except for the case of the correlation

between company size and the number of internal control failure. This result is

understandable. It can be explained by the fact that large firms are more complex and

more difficult to control. So in this type of firm, the risk of errors, frauds,

manipulations and weaknesses, may be multiplied.

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Table I: descriptive Statistics

within .0752252 5.297162 6.042495 T = 2 between 1.413347 2.851891 9.190488 n = 90lneffe~f overall 5.669829 1.411399 2.70805 9.194211 N = 180 within .0893293 -.1360761 1.250218 T = 2 between .922355 0 3.401197 n = 90lnfili~e overall .5570711 .9241027 0 3.401197 N = 180 within 1.276943 -2.757536 14.72461 T = 2 between 3.472106 -.020411 17.35636 n = 90lnchfin overall 5.983536 3.69036 -.9162908 17.55107 N = 180 within .1000465 -.0951683 .9048317 T = 2 between .4421367 0 1 n = 90atai overall .4048317 .4521085 0 1 N = 180 within .0521921 -.0714481 .4285519 T = 2 between .2917268 0 1 n = 90certifi overall .1785519 .2955556 0 1 N = 180 within .0901592 .3042593 1.304259 T = 2 between .3466651 0 1.5 n = 90exp3ans overall .8042593 .3572591 0 2 N = 180 within .008728 -.0382016 .0838417 T = 2 between .0579713 -.0017639 .3780028 n = 90salaire overall .0228201 .0584643 -.0020745 .4390244 N = 180 within .1057033 .2222222 1.222222 T = 2 between .4377619 0 1 n = 90prgann~l overall .7222222 .4491526 0 1 N = 180 within .0915417 .1611111 1.161111 T = 2 between .4670477 0 1 n = 90manlpr~d overall .6611111 .4746523 0 1 N = 180 within .0795571 -.1286111 .8713889 T = 2 between .256182 0 1 n = 90tempsa~u overall .3713889 .2675667 0 1 N = 180 within .0055423 1.672236 1.752278 T = 2 between 3.731568 0 11.08214 n = 90lnhona~o overall 1.712257 3.721134 0 11.08214 N = 180 within 5.866056 7.294444 74.29444 T = 2 between 53.84893 0 270.5 n = 90somdef overall 40.79444 54.01776 0 290 N = 180 within .0915417 .35 1.35 T = 2 between .3471392 0 1 n = 90opncac overall .85 .3580674 0 1 N = 180 within .3712002 -1.882384 .9515571 T = 2 between .7912935 -3.867539 .7613255 n = 90adklw overall -.4654135 .8720304 -3.938273 1.874775 N = 180 Variable Mean Std. Dev. Min Max Observations

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Table II: correlation matrix

4.2.Results of the regression analysis

In this section, we discuss results of the regression. We have opted for the panel

regression. In light of the results of the Hausman Test, we will opt for the

interpretation of variables and results obtained by the fixed effect model. In fact, the

probability is equal to 0, less than 5%. This means that the random model estimators

are biased. In addition, Fisher's exact has a p-value equal to 0 therefore less than 5%.

This is in confirmation of the hypothesis of the prevalence of fixed effect. The results

are exposed in the table III follow.

(1) (2) (3) (4) (5)

VARIABLES adklw adklw adklw adklw adklw

opncac -0.0217 -0.0354 -0.0267 -0.000607

(0.203) (0.214) (0.246) (0.202)

somdef -0.00228 -0.00228 -0.00231 -0.00242

(0.00454) (0.00454) (0.00450) (0.00459)

lnhonaudco -27.69*** -27.69*** -27.40*** -24.65*** -24.97***

(6.339) (6.339) (6.409) (4.884) (4.789)

tempsallou -0.0415 -0.0415 -0.0454 -0.0256 -0.0302

(0.101) (0.101) (0.102) (0.0911) (0.103)

manlprocd 2.423*** 2.423*** 2.436*** 2.306*** 2.306***

(0.371) (0.371) (0.374) (0.321) (0.325)

prgannuel -0.906** -0.906** -0.897** -0.909** -0.900**

(0.441) (0.441) (0.431) (0.413) (0.418)

lneffectif -0.0991 -0.0294 0.2989 0.0178 1.0000 lnfiliale 0.0242 0.0276 0.1453 1.0000 lnchfin -0.1424 -0.0880 1.0000 atai -0.0277 1.0000 certifi 1.0000 certifi atai lnchfin lnfili~e lneffe~f

lneffectif -0.1220 -0.0714 0.4722 0.0704 0.1792 0.0754 0.0402 -0.3533 -0.1456 0.2276 lnfiliale 0.0048 -0.0866 -0.1040 0.0048 -0.0341 0.0180 0.0171 -0.1217 -0.0544 -0.1467 lnchfin 0.0283 -0.0568 -0.0031 0.0502 -0.0330 -0.0269 0.1441 -0.2224 -0.0071 -0.0527 atai 0.0101 0.0551 0.0979 0.0331 -0.0219 -0.1373 0.0879 0.2019 0.1330 0.0576 certifi 0.1021 0.1012 -0.1657 -0.0093 -0.0101 0.2316 0.0388 0.3425 0.0469 0.0565 exp3ans -0.0180 0.0545 0.1485 0.0805 0.2124 0.0459 0.0818 0.0180 -0.0143 1.0000 personnel -0.0753 0.0600 -0.1095 -0.0458 -0.1667 -0.1736 -0.1834 0.6076 1.0000 salaire -0.0035 0.1017 -0.1719 -0.0376 -0.0425 -0.1722 -0.2207 1.0000 prgannuel -0.0823 -0.0521 -0.0178 0.0069 0.2194 0.3421 1.0000 manlprocd 0.0202 -0.0049 -0.0533 -0.0297 0.2048 1.0000 tempsallou -0.0309 -0.0054 0.1969 -0.0839 1.0000 lnhonaudco -0.0136 -0.2130 -0.1009 1.0000 somdef -0.0948 -0.1703 1.0000 opncac 0.2498 1.0000 adklw 1.0000 adklw opncac somdef lnhona~o tempsa~u manlpr~d prgann~l salaire person~l exp3ans

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salaire -4.813 -4.813 -4.972

(4.723) (4.723) (4.792)

exp3ans -1.626*** -1.626*** -1.625*** -1.388** -1.483*

(0.515) (0.515) (0.510) (0.527) (0.828)

certifi 1.094 1.094 1.165 0.728 0.929

(1.141) (1.141) (1.049) (1.188) (1.734)

atai 0.974* 0.974* 1.063** 0.966* 0.976*

(0.541) (0.541) (0.467) (0.545) (0.540)

lnchfin -0.0214 -0.0214 -0.0234 -0.0133 -0.0132

(0.0205) (0.0205) (0.0218) (0.0182) (0.0184)

lnfiliale 0.685* 0.685* 0.732* 0.678* 0.700*

(0.392) (0.392) (0.389) (0.380) (0.378)

lneffectif -1.302* -1.302* -1.382* -1.150 -1.183

(0.770) (0.770) (0.766) (0.777) (1.088)

inefficace 0.0217

(0.203)

lnsomdefimp 0.0218

(0.0852)

lnsomdefnimp -0.171

(0.123)

logsalmoy -0.147

(0.542)

personnel -1.880

(49.29)

Constant 54.08*** 54.06*** 54.25*** 49.23*** 48.60***

(12.24) (12.18) (12.42) (9.555) (12.62)

Observations 180 180 180 180 180

R-squared 0.896 0.896 0.898 0.894 0.894

The results of the panel data regression (regression 1, Table III), allow us to see the

extent to which contractual audit fees (LnhonaudCo), directly related to the internal

control procedures. We find that this variable measures the internal audit quality is

significant at 1%. It has a Student's t of the order of (- 4.37). This variable has, in

addition, a regression coefficient with a negative sign. So, as expected, the contractual

audit fees decreased earnings management. They have a negative impact on the

accounting manipulations and discretionary accruals. This leads us to the fact that the

contractual audit fees, improves the quality of financial reporting. This result is

particularly important as previous studies such as Kinney et al. (2004) did not find a

significant relationship between this variable and the quality of financial reporting.

We also find that the presence of a manual of procedures (ManelProcdl) has an impact

on the quality of internal audit. This variable is significant at 1%. It has a t-statistic of

the order of (6.52). This variable also has a positive sign contrary to expectations. She

seems to have a positive impact on discretionary accruals. It should face earnings

management and accounting manipulations. Normally manual of procedures is used

to delimit the scope of work for each salary in the company. They should also clarify

the procedures in place and the role of each one to reduce errors and frauds. However,

the presence of a manual of procedures does not necessarily mean it is effectively

used and the procedures listed in this manual and are really respected and applied

14

We also note that the presence of a clear internal audit program (Prgannuel) is the

sign of an effective and efficient internal audit function. The organization of work and

its distribution in time throughout one year is a positive sign for the quality of work

performed within the internal audit function. Indeed, this is confirmed by the results

highlight the importance of this variable significant at the 5% with a t-statistic equal

to (-2.06). This variable has also a negative sign consistent with our expectations.

Indeed, this internal audit program denotes the organization, transparency and

professionalism of the internal audit function. Programming this audit plan also even

allows internal auditors to monitor themselves and follow their action points so they

can see if they have touched all procedures, all functions and there are still services or

departments not yet covered and whose procedures were not valued and appreciated.

So, this audit program clearly improves the quality of internal audit. This will has a

positive effect on the quality of financial reporting because of the negative impact of

this variable on the discretionary accruals measuring the extent of the accounting

manipulations.

The membership of IIA Tunisian chapter (Atai) is a significant variable that proved to

be as significant. But the result of this study is unexpected since this variable is

significant at the 10% level with a t-statistic of about (1.80), but a positive sign. This

can be explained by the fact that not all internal auditors who are members of IIA

Tunisian chapter. In addition, we have no real guarantee on the participation of all

members in training. Besides, the audience participation in the various seminars and

courses does not mean that they beneficiated from the contributions of these courses

and they really appreciated and invested to improve their skills.

We note that (Exp3ans) variable that measures the percentage of internal auditors with

experience in internal audit more than 3 years is significant at the 1% level, with a t-

statistic of about (-3.16) and has a sign negative, as expected. Authors such as

Schneider (1970) and Hung and Han (1995) suggest that the internal audit department

should be made by a suitable proportion of experienced internal auditors and non-

experienced internal auditors. However, these authors have not defined what the

appropriate proportion is. In their evaluation of the effectiveness and quality of the

internal audit, interest has focused solely on mutual learning and the ability to

accomplish all missions. Thus, notwithstanding the significant result we have not

been able to consolidate our results with previous studies, but we confirm,

nevertheless, the positive impact of the experience of internal auditors on the quality

of financial reporting.

An unexpected result holds our attention. We note, in this study, several variables are

insignificant. First, the variable the auditor's assessment on the quality of internal

control procedures (Opncac) is an important variable. These procedures are expected

to reduce earnings management and therefore improve the quality of financial

reporting. However, in the case of this study this variable is non-significant. This

result is already due to the estimation method used. Hausman Test and Fisher Test did

lead to choose for fixed effect. Thus, given the limited variability of this measure over

the two years of study (between estimator is 0.091), it is quite understandable that this

variable is not significant. Probably the wrong specification of this variable due to its

dichotomous is the origin of this non-significance. Indeed, this dichotomous value

may not adequately reflect the opinion of the external auditor is much more subtle and

can't be summarized in a favorable or unfavorable opinion. We repeated the

regression (1) by replacing this opinion by only the negative opinion expressed by the

external auditor, this variable is still insignificant.

15

The number of internal control weaknesses (somdef) is a variable that is supposed to

be important to the quality of financial reporting, as measure of earnings management.

However, this result was not significant. The mis-specification of this variable could

be the cause of this unexpected result. Moreover, this result has been extracted from

reports prepared by the auditors. This non-significance may be due to differences in

assessments and interpretation of different auditor. Some auditors hold all the details

and make any remarks and highlight any deficiencies. While others are less

demanding. They will retain and state in their reports only the most significant

weaknesses. To face this non-significant result, we used instead of the sum of the

internal control failures, the natural log of these failures by distinguishing between

failures considered important and others less important. Notwithstanding the results

are still insignificant.

The variable (tempallou) time that internal auditor spend on internal control activities,

is non-significant. This result can be explained by the luck of time allocated to

internal control procedures. The majority of internal auditors felt they don't conduct

only missions related to internal audit activities. In the Tunisian context, most internal

auditors believe they rather carry out inspection tasks. In addition, they even required

to prepare the financial statements of companies and to reinforce the financial and

accounting department. This result is consistent with Al Tawarejri et al. (2003) which

state that internal auditors are generally used to fill absences or lack of staff in

different departments. Finally, we weren't able to identify other proxies to the

importance of time allocated to internal control activities.

The proportion of the internal audit salaries (salary) is a measure rarely used in the

academic literature. The low percentage salary internal auditors relative to the overall

wage costs could explain the non-significance of this result. In addition, this variable

is intended to measure the importance given to the internal audit function considering

as a proxy of Budget allocated to internal audit function. From this same perspective,

we used the proportion of the number of employees divided to the total workforce,

and the result is still not significant (regression 5), since the internal auditors represent

only 2% of employees. Besides, we integrated the natural log of the average wage of

internal auditors in regression 4, and this variable is always non-significant. This

result indicates the lack of importance given to the internal audit function within the

Tunisian firms in this sample.

We expected that the certification (Certified) is an important element in improving the

quality of financial reporting. This diploma is a guarantee of the skills and quality of

work of internal auditors. However, the low number of certified internal auditors

could explain the non-significance of this variable. This leads us to the fact that the

sample firms do not invest in certification of their employees within the internal audit

function. We have seen through different studies in the international context that

professional certification is a key element of recruitment within the internal audit

department. Nevertheless, in some Tunisian firms in the sample, people who have no

knowledge or training in business or accounting are directors of this department. The

non-expansion of this profession is due to a significant lack of understanding of the

internal audit and his standards in Tunisia and the monopolizing of these missions by

the external auditors. What we have suggested is confirmed by Gramling et al., 2013,

which consider the internal audit profession is relatively "young" in emerging

countries.

Two variables among the three control variables are significant, the size of the

company and its complexity.

16

The majority of studies have demonstrated that the size of the company (Size)

encourages earnings management and thus affect the quality of financial reporting. In

this study, we found a significant variable with the threshold of 10%. But the sign

obtained is contrary to expectations. Normally, we expect that the size of the company

boosts earnings management, given the large number of operations which makes it

impossible to complete verification. We expect that the financial statements of these

companies will have anomalies and weaknesses. But these companies owing to their

size are well organized and have the means and resources to recruit competent

internal auditor to establish effective and efficient procedures (Wallace and

Kreutzfeldt, 1991). Finally, we can conclude that this result is not absurd, it was found

by authors such as Davidson et al. (2005), Klein (2002) and (Xie et al (2003).

Varying complexity measured by the number of subsidiaries is significant at 10%

with a t-statistic of the order of (1.75). It has only a positive sign. This sign means that

the complexity of the company encourages earnings management and reduces the

quality of financial reporting. This is quite logical since a complex firms are difficult

to control, which increases the failures of internal control and limit the quality of

financial states.

The variable debt, (lnchfin) is not significant. This result can be explained by the low

corporate debt sample rate.

5. Alternative variable measurement

We have also conducted robustness tests to confirm and corroborate the results,

already obtained. As robustness tests, we started in the first instance, by varying the

proxies already significant variables to confirm their impact and importance in the

improvement or reduction in the quality of financial reporting (regressions 6 and 7).

Subsequently we took the previous regression by calculating discretionary accruals

according to the modified Jones model, suggested by Dechow et al. (1994) in

regression (8). The results are reported in the table below.

Table IV:

(1) (6) (7) (8)

VARIABLES adklw adklw adklw addcw

opncac -0.0217 0.0604 0.00717 0.283

(0.203) (0.158) (0.186) (0.324)

somdef -0.00228 -0.00279 -0.00345 -0.00910

(0.00454) (0.00465) (0.00472) (0.0107)

lnhonaudco -27.69*** -26.04*** -19.77**

(6.339) (6.257) (9.480)

tempsallou -0.0415 -0.0899 -0.0740 0.0856

(0.101) (0.109) (0.0996) (0.164)

manlprocd 2.423*** 2.830*** 2.674*** 3.656***

(0.371) (0.628) (0.328) (0.629)

prgannuel -0.906** -1.284** -0.930** -2.009**

(0.441) (0.599) (0.411) (0.794)

salaire -4.813 -3.494 -5.161 -5.383

(4.723) (5.923) (4.230) (3.895)

exp3ans -1.626*** -1.147** -1.397** -1.717**

(0.515) (0.495) (0.559) (0.839)

17

certifi 1.094 0.579 0.122 1.261

(1.141) (1.244) (1.004) (1.887)

atai 0.974* 0.938* 1.721*

(0.541) (0.545) (0.971)

lnchfin -0.0214 -0.0422 -0.0378* -0.0955**

(0.0205) (0.0275) (0.0194) (0.0421)

lnfiliale 0.685* 0.593 0.661* 0.807

(0.392) (0.395) (0.353) (0.676)

lneffectif -1.302* -1.251 -1.042 -1.910*

(0.770) (0.801) (0.748) (1.126)

honraiaudcont -0.00129**

(0.000492)

nbreatai 0.322***

(0.103)

Constant 54.08*** 11.92** 49.74*** 44.04**

(12.24) (5.393) (11.94) (18.96)

Observations 180 180 180 180

R-squared 0.896 0.891 0.895 0.687

We have integrated new proxy variables as the absolute number of internal auditors

affiliated with IAA Tunisian chapter and not the relative number in percentage terms;

this variable is still significant (regression 7).Besides, the amount of fees contractual

audit instead of natural Log of this amount. We also obtained a still significant

variable (regression 6).

For the last regression (8), we can see that we get almost the same results,

notwithstanding the change in the measurement of the independent variable. And with

discretionary accruals according to the model of Dechow et al. (1996), we get exactly

the same results, except for a slight change in the control variables. This indicates the

robustness of the results. Thus, we always get the contractual audit fees

(LnhonaudCo) are always significant. Only, their significance changes from the 1%

than 5%. The variable presence of a procedures manual (ManelProcdl) and the

presence of an annual audit program (Prgannuel) are always significant to the

respective levels of 1% and 5%. The experience of the internal auditor is still

significant but passes from the level of 1% to 5%. The percentage of internal auditors

affiliated with IATA (Atai) within an internal audit department, are still significant at

10%. For the control variables, the size of the company (Lneffectif) is still significant

at 10%. However, the debt (lnchfin) was not significant became the threshold of 5%,

while the complexity of the company is no longer.

On assumptions, we can confirm the light of the results presented above and that

some of these hypotheses were tested. Indeed, about the assumptions relating to

internal control weaknesses, contractual audit fees one of the measures related to this

hypothesis is significant and reduces earnings management and thus improves the

quality of financial reporting. The hypotheses relating to the procedures put in place,

has two significant measures: the presence of an annual audit program and the

presence of a manual procedure. But this last hypothesis has a positive sign contrary

to expectations. For the hypotheses inherent in the competence of the internal auditor,

two measures are also significant, relative to the membership of IIA and the relative

18

experience of internal auditors. However, contrary to expectations, membership of a

professional body seems to encourage management outcomes and reduce the quality

of financial reporting.

Subsequently, we find that companies rely on the audit contract to improve the quality

of financial reporting. These companies are willing to pay an additional amount to

provide reliable information and improve its internal control procedures and reduce

information asymmetry. In addition, we found some mimetic isomorphism in certain

areas. Indeed, companies copy the same activity behaviors and decisions. We see

principally in the Tunisian context, for the telecom sector. Thus, some companies

have gone even, to appeal to the same audit firm to undertake a contractual audit of

the quality of internal control procedures. This confirms the neo-institutional theory.

Similarly, the presence of a manual procedure reduces conflicts of interest in a

company, defines the fields of action and prevents anyone from interfering in a field

that does not interest him. A clear and comprehensive internal audit program reduces

the cost of internal audits. Thus, each department is organized so as to distribute its

work properly, so it is not delayed by the arrival of the internal auditors. This is

consistent with the theory of transaction costs. Similarly, internal audit regulations

encourage companies to prepare annual audit programs where the normative

obligation refers to the neo-institutional theory. Membership in IIA Tunisian Chapter

also responds to the institutional theory in mimetic and normative point of view.

Indeed, companies tend to adopt effective practices of leaders companies in the same

industry or business. Moreover, membership in a professional organization allows the

internal auditor to have a group membership, on the hand and an institutional

framework on the other hand. Our findings in this case confirm those of Christopher

et al. (2009) who believe that under the pressures of guides to good practice, internal

auditors are compelled to prepare annual programs, procedures manuals, join

professional organizations and follow different training.

Conclusion

We through this study presented the main research concerning our problem. We

focused on the research that has addressed the impact of the internal audit of the

quality of financial reporting. We found that the literature on this aspect remains weak

and needs to be expanded.

This study is part of this aspect of contribution to the existing literature. We believe

that this study is a contribution in terms of literature, adaptation measures to the

Tunisian context and empirical results for this context. This is the first study in

Tunisia, as we know that process and assess the quality of internal audit, taking into

account various measures, considering the quality of internal audit. In addition, in the

Tunisian context, no study has addressed the relationship between internal audit and

financial reporting quality.

The results are consistent with previous findings of other studies. We believe,

moreover, that these results are more relevant than those presented by Gramling et al.

(2013), in the Turkish context. These authors used measures relating to the quality of

internal audit, based on perceptions that may be biased as they declare. However, this

study is based on more objective measures that better describe the quality of the

internal audit function. These measures provide a comprehensive presentation of the

19

reality of Tunisian companies affiliated to IIA Tunisian chapter, which leave no

possibility for subjective.

The results of this study also support the institutional theory, specifically the

normative and mimetic isomorphism. Indeed, membership in IIA Tunisian chapter,

the association that organizes the internal audit profession and the significance of this

variable indicates the important role played by pressure groups. Moreover,

considering the sample, we find a certain mimetic isomorphism; some companies are

even competing in the establishment and development of the internal audit function

and procedures.

We have also wanted to include other variables that we consider useful in measuring

the quality of internal audit. Thus, we have incorporated in this survey questions

concerning the use of internal audit software and programs and the adoption of an

international audit standards, such as IFACI or COSO 1 and 2. But as we have noted

through responses, there are rare companies (only 4) that have internal audit software.

In addition, among the four companies there two that don't use it. Concerning the

international standard, most companies don't follow a well-defined framework, they

use a hybrid framework which depends on their needs and suitable mainly to their

limited budget and resources allocated to internal audit function.

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