The Impacts of Investment in Internal Audit Functions on the Going Concern Opinion for Financially Distressed Firms

We investigate the effects of internal audit investments on financially distressed firms in Malaysia. Specifically, we examine the impacts of internal audit investments on these firms’ going concern opinion. We argue that higher internal audit investments expedite these firms’ recoverability by improving their controls and operations. The assurance and consulting activities provided by internal auditors enable these firms to mitigate the material uncertainty of the going concern opinions issued by external auditors. To examine such relationship, we chose 137 firm-year observations of Malaysian financially distressed firms listed on Bursa Malaysia from 2016 to 2018. We ran a logistic regression analysis and found that internal audit investments are negatively and significantly associated with the going concern opinions reported by an external auditor. This result suggests that high internal audit investments reduce the likelihood for an external auditor to issue a going concern opinion. As stated in ISA 570, if recovery plans have no material uncertainty and are sufficient to mitigate the going concern problem (which is argued to be assisted by the internal audit function of the firm), then an external auditor can issue a clean audit report even for firms that are in financial distress. Evidence from this study contributes to our understanding of the importance of investments in internal audit functions and highlights that the assurance and consultation from internal auditors can ensure a careful monitoring of the strategies and operations of firms. This paper examines the relationship between internal audit investments and going concern problem as reported by external auditors for financially distressed firms in Malaysia with an aim to show how a going concern opinion changes when internal audit investment is added as a variable to our model. By using 137 observations of financially distressed firms listed on Bursa Malaysia from 2016 to 2018, our main results suggest that internal audit investment is negatively and significantly related to the going concern opinion reported by external auditors. In other words, internal audit contributes to the recoverability process of firms by improving their controls and operations, which in turn reduces the probability for external auditors to issue a going concern opinion. To enhance the credibility of our findings, we conduct a robustness test by using alternative measures of financial distress. Our robustness test results are consistent with our main analysis results. Our findings provide important implications for managers and internal auditors. On the one hand, managers must at least maintain their investment in internal audit to reduce their risk of receiving a going concern opinion from external auditors. Reducing such investment may also deteriorate the conditions of their firms, and the controls, effectiveness, and efficiency of their operations need to be in place especially during periods of financial distress. Instead of reducing their internal audit investments, managers should focus on their strategies and recovery plans while allowing internal auditors to focus on their controls, operational efficiency, and effectiveness. These results imply that internal auditors play a crucial role for financially distressed firms by ensuring that the strategies and plans of these firms are carefully executed and closely monitored. study identify firms utilize a panel data research different scores