Integrated versus financial statement-only audits in smaller firms

Abstract

Purpose This study examines whether internal control over financial reporting (ICFR) audits improve the perceived reliability of financial statements for economically significant stakeholders—namely, lenders and auditors—in smaller public firms. Design/methodology/approach This study examines how the presence of ICFR audits influences two key aspects: debtholders' risk perception (measured by cost of debt) and auditors' assessment of financial viability (measured by going-concern opinions). The authors compare small accelerated filers, which are subject to integrated audits, with non-accelerated filers, which undergo FS-only audits, to assess the impact of ICFR audits on these outcomes. Findings We find that ICFR audits are associated with lower borrowing costs and more accurate issuance of going-concern opinions for financially distressed firms. These results suggest that ICFR audits play a significant role in shaping debtholders' risk perceptions and in improving auditors' assessments of financial viability. Research limitations/implications This study is subject to several limitations. First, our analysis focuses on smaller US public firms near the accelerated filer threshold, which may limit generalizability to larger firms or non-US settings. Second, while we document associations between ICFR audits, cost of debt, and going-concern opinion accuracy, our design is not causal, and unobservable factors could influence both audit type and stakeholder responses. Third, data constraints limit our examination of other capital market outcomes such as debt covenants, loan terms, or equity issuance success. These limitations highlight opportunities for future research to explore broader economic consequences of ICFR audits. Practical implications Our findings offer important insights for regulators, auditors, and lenders. The evidence that ICFR audits are associated with lower borrowing costs and more accurate going-concern opinions suggests that these audits enhance the perceived reliability of financial reporting and improve stakeholder decision-making. For regulators, the results highlight that exemptions from SOX 404(b) may reduce informational value for capital providers, even as they lower compliance costs. For auditors, the findings underscore the role of ICFR audits in supporting high-quality viability assessments. Lenders may also consider ICFR audit status as a meaningful signal when evaluating credit risk and structuring financing terms. Originality/value While prior studies have investigated the benefits of integrated audits primarily through accrual-based measures and restatement likelihood, this study provides new evidence on how ICFR audits affect external stakeholder decisions (i.e. debt capital providers' lending decisions and external auditors' going concern judgments). Our findings contribute to the broader discussion on the relevance of ICFR audit mandates for smaller firms.