INTERNAL AUDIT FUNCTION AND MODIFIED AUDIT OPINION: EMPIRICAL EVIDENCE FROM EMERGING MARKET

Abstract

Abstract This study investigates how the internal audit function, particularly its sourcing arrangements and the level of investment allocated to it, influences the likelihood of a firm receiving a modified audit opinion. As a key component of an organization’s internal corporate governance and monitoring framework, the internal audit function plays an important role in supporting the quality and reliability of external financial reporting. The study analyses 132 firm-year observations from companies across seven sectors listed on the Main Market and ACE Market of Bursa Malaysia between 2009 and 2011. A logistic regression model with a matched-pairs sample design is employed to examine the relationship between internal audit characteristics and the probability of receiving a modified audit opinion. The findings suggest that greater investment in the internal audit function strengthens its monitoring effectiveness and reduces the likelihood of a modified audit opinion. These results are consistent with the Bursa Malaysia Corporate Governance Guide (2009) and the Malaysian Code on Corporate Governance (2007), both of which recognize internal auditing as a fundamental pillar of effective corporate governance and reliable financial reporting. By exploring the influence of internal audit sourcing arrangements and investment on modified audit opinions in the context of Malaysia, this study extends the existing literature on audit quality and corporate governance while providing empirical evidence from an emerging Asian economy.