Internal auditor competence and internal control: Improving internal audit quality to prevent fraudulent financial statements

Novatiani, R. Ait; Kusumah, R. Wedi Rusmawan; Yadiati, Winwin; Rachmat, Radhi Abdul Halim; Rachman, Andry Arifian Article Internal auditor competence and internal control: Improving internal audit quality to prevent fraudulent financial statements Cogent Business & Management Provided in Cooperation with: Taylor & Francis Group Suggested Citation: Novatiani, R. Ait; Kusumah, R. Wedi Rusmawan; Yadiati, Winwin; Rachmat, Radhi Abdul Halim; Rachman, Andry Arifian (2024) : Internal auditor competence and internal control: Improving internal audit quality to prevent fraudulent financial statements, Cogent Business & Management, ISSN 2331-1975, Taylor & Francis, Abingdon, Vol. 11, Iss. 1, pp. 1-16, https://doi.org/10.1080/23311975.2024.2409339 This Version is available at: https://hdl.handle.net/10419/326590 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/ Cogent Business & Management ISSN: 2331-1975 (Online) Journal homepage: www.tandfonline.com/journals/oabm20 Internal auditor competence and internal control: Improving internal audit quality to prevent fraudulent financial statements R. Ait Novatiani, R. Wedi Rusmawan Kusumah, Winwin Yadiati, Radhi Abdul Halim Rachmat & Andry Arifian Rachman To cite this article: R. Ait Novatiani, R. Wedi Rusmawan Kusumah, Winwin Yadiati, Radhi Abdul Halim Rachmat & Andry Arifian Rachman (2024) Internal auditor competence and internal control: Improving internal audit quality to prevent fraudulent financial statements, Cogent Business & Management, 11:1, 2409339, DOI: 10.1080/23311975.2024.2409339 To link to this article: https://doi.org/10.1080/23311975.2024.2409339 © 2024 The Author(s). Published by Informa UK Limited, trading as Taylor & Francis Group Published online: 03 Oct 2024. Submit your article to this journal Article views: 4880 View related articles View Crossmark data Full Terms & Conditions of access and use can be found at https://www.tandfonline.com/action/journalInformation?journalCode=oabm20 Accounting, corporAte governAnce & Business ethics | reseArch Article Cogent Business & ManageMent 2024, VoL. 11, no. 1, 2409339 Internal auditor competence and internal control: Improving internal audit quality to prevent fraudulent financial statements r. Ait novatiania , r. Wedi rusmawan Kusumaha , Winwin Yadiatib , radhi Abdul halim rachmata and Andry Arifian rachmana aDepartment of accounting, Widyatama university, Bandung, indonesia; bDepartment of accounting, universitas Padjadjaran, Bandung, indonesia ABSTRACT state-owned enterprises (BuMns) in indonesia are faced with challenges due to the weak prevention of fraudulent financial statements. the prevention of fraudulent financial statements has long been a subject of discussion. therefore, this study aimed to investigate the relationship between internal auditor competence, internal control, and internal audit quality in efforts to prevent fraudulent financial statements. respondents in this research were 475 people from 33 BuMn in indonesia. Data were then collected through online surveys using google Forms and direct visits to several BuMns, and subsequently analysed using seM-pls. the results showed that internal auditor competence had an impact on internal audit quality and the prevention of fraudulent financial statements. internal control influenced both internal audit quality and the prevention of fraudulent financial statements. Moreover, internal audit quality affected the prevention of fraudulent financial statements, while mediating the effects of internal control on preventing fraudulent financial statements. this research provides a practical contribution, which can contribute to BuMn in indonesia in improving the prevention of fraudulent financial statements. Furthermore, it contributes to increasing the confidence of investors and other stakeholders in investing in BuMn in indonesia. Introduction one of the primary responsibilities of management to businesses is the presentation of financial reports that are transparent and devoid of substantial misstatements, whether resulting from fraud or error (nurunnabi et al., 2011; novatiani & rusmawan, 2019; nti et al., 2020; Yang et al., 2022). Audits are necessary to ensure that the financial statements are accurate, as well as to guarantee of management accountability and the validity of financial information (lo et al., 2019; nti et al., 2020; szerwo, 2020). however, the high-quality financial statements can be compromised by various types of fraud, including earnings management, creative accounting, accounting fraud, and earnings smoothing (Di vaio & varriale, 2019; pizzi et al., 2020). Financial statements that are manipulated or contain fraudulent elements present biased and misleading information, reducing investor confidence, affecting financial markets, and impacting the international society at large (law, 2011; Amiram et al., 2018). Financial statement fraud includes planned actions by individuals both inside and outside the company to mislead users of financial data through data manipulation and deliberate misstatements (rahman & Bremer, 2016; Dubey et al., 2018; Muslu et al., 2019; Jaswadi et al., 2022). this phenomenon often occurs in indonesian state-owned enterprises (BuMns), where information is manipulated to inflate © 2024 the author(s). Published by informa uK Limited, trading as taylor & Francis group CONTACT R. ait novatiani ait.nova[email protected] Department of accounting, Widyatama university, Bandung, indonesia this article was originally published with errors, which have now been corrected in the online version. Please see Correction (http://dx.doi.or g/10.1080/23311975.2025.2557654). https://doi.org/10.1080/23311975.2024.2409339 this is an open access article distributed under the terms of the Creative Commons attribution License (http://creativecommons.org/licenses/by/4.0/), which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. the terms on which this article has been published allow the posting of the accepted Manuscript in a repository by the author(s) or with their consent. ARTICLE HISTORY received 26 January 2024 revised 14 september 2024 Accepted 20 september 2024 KEYWORDS internal auditor competence; internal control; internal audit quality; fraudulent financial statement prevention SUBJECTS Financial Accounting; Accounting; Business, Management and Accounting 2 r. A. novAtiAni etAl. profits and obtain bonuses or awards. public accountants often fail to rectify or cover up this fraud. table 1 shows some indonesian BuMns committed to fraud in financial statements. Financial statement fraud cases are shown in table 1 within several indonesian BuMns, attributed to inadequate measures in preventing fraudulent financial statements. the deficiencies in preventing fraud in these entities originate from both opportunities and pressures to engage in fraudulent activities. ineffective prevention measures open avenues for potential fraudulent financial statements (Alqudah et al., 2019). According to Bamahros and Wan-hussin (2015), Demerjian et al. (2017), and tobar et al. (2023), managers play a role in implementing earnings smoothing and deliberate earnings management. this is often done to benefit shareholders and cater to the personal interests of managers in bolstering reputation. Furthermore, executive directors implement investment and earnings management strategies to increase the value of compensation and increase stock prices (chu & song, 2012; sun, 2012; Boudabbous etal., 2021). previous studies have predominantly concentrated on financial statement fraud within the financial services sector, particularly public and private banks (Kedia & philippon, 2009; Beatty et al., 2013; Königstorfer & thalmann, 2020; Al-hashedi & Magalingam, 2021; Asteriou et al., 2021; Di et al., 2021; Flore et al., 2021; Zhao et al., 2022; Arum et al., 2023). previous studies also often ignore fraudulent financial prevention and focus on detecting financial statement fraud (skousen et al., 2009; ravisankar et al., 2011; West & Bhattacharya, 2016). this research specifically focuses on preventing financial statement fraud at BuMn in indonesia. this is because BuMn often causes fraud in the financial statements as presented in table 1, so it is necessary to prevent fraudulent financial statements. in addition, fraudulent financial statement activities in BuMn are caused by the prevalence of accounting information falsification aimed at portraying profitability to secure rewards or incentives. given that fraudulent activities were frequently concealed and rarely disclosed. therefore, BuMn is used as the unit of analysis in this study compared to non-BuMn companies. this study fills the gap from previous research, namely highlighting the weak prevention of financial statement fraud that occurs in BuMn in indonesia. efforts at fraudulent financial statement prevention can be supported by quality internal audits, internal auditors who have the competence and effectiveness of internal control (Donelson et al., 2017; camfferman & Wielhouwer, 2019; chen etal., 2021). Furthermore, internal audit quality can be supported by competent internal auditors and effective internal controls (Afzal, 2023; Kim, 2023). We believe that enhancing internal auditor competence could improve both internal audit quality and the prevention of fraudulent financial statements. internal control could bolster both quality internal audits and prevent financial statement fraud. effective internal audit quality significantly contributed to the prevention of financial statement fraud. therefore, this research is very important to be conducted at BuMns in indonesia. in addition, our results should be of interest to investors and other stakeholders. Based on this explanation, this research contributes to developing theory by providing complete knowledge about the components that help companies improve financial statement fraud prevention. specifically, the purpose of this study is to analyse the competence of internal auditors that affect internal audit quality and financial statement fraud prevention, internal controls that affect internal audit Table 1. Financial statement fraud cases in several BuMns in indonesia. name of BuMns Financial statement fraud cases Pt. garuda indonesia a mistake occurred in presenting the 2018 financial statements of Pt garuda, showing an increased profit. this was due to the recognition of revenue, not in accordance with PsaK 23. Revenue should be recognised when the task is completed, or performance requirements are met. Pt. asuransi Jiwasraya Mr agung, the Chairman of BPK, stated that the 2017 financial statements of Pt asuransi Jiwasraya were falsified. the company recorded a profit of Rp 360.3 billion but received an unfavorable opinion due to a reserve shortfall of Rp 7.7 trillion. the company potentially suffered losses when reserves were appropriately accounted. Pt. Waskita Karya M. Choliq, the new President Director of Pt Waskita Karya, discovered inadequate recordings in the financial statements from 2004 to 2007, amounting to an overstated net profit of 400 billion Rupiah. Pt. Kereta api indonesia (Kai) the 2005 financial statements of Pt Kai showed manipulation. Despite incurring a loss of Rp 600 billion, the company reported earnings of Rp 6.9 billion, falsely presenting a profit instead of the actual loss. Pt Kimia Farma there was an inflation of net earnings in the financial statements of Pt Kimia Farma starting in 2001. the management recorded a net profit of Rp 132.3 billion, while the actual profit was only Rp 99.6 billion, showing an inflated amount of Rp 32.7 billion. cogent Business & MAnAgeMent 3 quality and financial statement fraud prevention. in addition, testing the quality of internal audits that has an influence on the prevention of financial statement fraud. the article is organised into segments: segment two provides a literature review as well as hypotheses, segment three provides an explanation of the research methodology, segment four details the results and discussion, and segment five provides conclusions. Literature and hypothesis Internal auditor competence and internal audit quality the competence of internal auditors facilitates the execution of examinations, contributing to high-quality internal audits (Anggraini, 2020; ta & Doan, 2022; Afzal, 2023). several elements that determine internal audit quality, specifically being independent and competent (roussy & Brivot, 2016; Demeke & Kaur, 2021; samagaio & Felício, 2023). the ability of an internal auditor to conduct audits effectively can lead to effective internal audits (gamayuni, 2018). therefore, the hypothesis stated: h1: internal auditor competence influences internal audit quality Internal control and internal audit quality Adequate and effectively implemented internal control can ensure high audit quality (Kim, 2023; nur Zeina & effendy, 2015). Moreover, internal control has the potential to improve audit quality (Yi-Fang et al., 2015; Barr-pulliam et al., 2022; Diya, 2022). the following hypothesis was proposed based on this rationale: h2: internal control affects internal audit quality. Internal auditor competence and fraudulent financial statement prevention Auditors with optimal abilities can mitigate the occurrence of fraud (Ahmed Abdullah et al., 2022; chen et al., 2021). Moreover, chi et al. (2011) signified the need for competent auditors to prevent fraud in financial reports, such as management of earnings, thereby the financial statements become quality. proficient internal auditors can hinder financial statement fraud through examinations (indriasih, 2016; Budiatmaja & Yanuar, 2022). this premise led to the following hypothesis: h3: internal auditor competence affects fraudulent financial statement prevention. Internal control and fraudulent financial statement prevention Well-implemented internal control measures can prevent fraud (tunggal, 2012), while inadequate implementation may provide opportunities for managers to manipulate financial reporting (Donelson et al., 2017). Awareness of fraud can deter fraudulent actions, necessitating an internal control framework capable of helping in combating financial statement fraud (lyinomen & nkechi, 2016; taufik, 2019; Budiatmaja & Yanuar, 2022; Maulidi & Ansel, 2022). the following hypothesis was proposed based on the discussion above: h4: internal control influences fraudulent financial statement prevention. Internal audit quality and fraudulent financial statement prevention empowered internal audit is a crucial step in mitigating fraud within financial statements (Dbouk & Zaarour, 2017; iwan putra et al., 2022; camfferman & Wielhouwer, 2019). Moreover, fraud in financial statements can be reduced by competent internal audit (Madawaki et al., 2021). the enhancement of 4 r. A. novAtiAni etAl. preventing fraud financial statements, such as reduced opportunities and justifications, is attributed to the presence of quality internal audit, which include competence, independent scope, and examination implementation (Alleyne & howard, 2005). Furthermore, Alsharairi and iqtait (2017), putra et al. (2022), and lonto etal. (2023) stated successful internal auditing is a preventive measure against fraud in financial statements, particularly regarding earnings management. companies conducting internal audits effectively can identify and prevent fraud, resulting in improved financial reporting and enhanced corporate value through environmental controls (ismael & roberts, 2018). the following hypothesis was proposed based on the discussion above: h5: internal audit quality affects fraudulent financial statement prevention. Internal control, internal audit quality, and fraudulent financial statement prevention effective prevention of financial reporting fraud can be achieved with adequate internal control, which is realised through quality internal audits (Mandal & s, 2023). the impetus for committing fraud in financial statements originates from a lack of understanding and is caused by opportunities and pressures. therefore, fraud can be prevented through effective internal control (omar et al., 2016). Weak internal control is a significant factor contributing to fraud occurrences, and improved control is facilitated through audit support (Zakaria et al., 2016; oduro & cromwell, 2018). the following hypothesis was proposed based on the discussion above: h6: internal audit quality mediates the effect of internal control on fraudulent financial statement prevention. Based on the theoretical review of previous research and the relationship between research variables in the framework, a conceptual model can be made as shown in Figure 1. Methodology Study method this study adopted a quantitative method, specifically aimed at testing theories, establishing facts, showing relationships between variables, providing statistical explanations, estimating, and forecasting outcomes (sugiyono, 2018). Figure 1. Conceptual model. cogent Business & MAnAgeMent 5 Population, sample and study design the unit of analysis in this research is BuMn. the population in this study is the holding company of BuMn in indonesia, totalling 33 BuMn. the technique of determining the sample with non-probability sampling namely the census sample technique, where all members of the population are used as sample (sugiyono, 2018). respondents in this study were 475 people from 33 BuMn in indonesia consisting of the gM in charge of financial reporting/Accounting Manager, spi Manager and Audit committee. this is because these staff are related to our research variables and the scope of their work is relevant to the research variables. table 2 explains that researchers initially targeted to reach 495 respondents from 33 BuMn in indonesia, namely each BuMn represented by 15 respondents consisting of a gM in charge of financial reporting/Accounting Manager represented by 5 respondents, spi Manager represented by 5 respondents, and Audit committee represented by 5 respondents. We distributed questionnaires to 495 respondents from 33 BuMn through online platforms and direct visits to the BuMn. From the data obtained, 20 respondents did not complete the questionnaire, so it could not be used for further analysis. Data collection Based on the results of distributing questionnaires, respondents who were willing to fill out the questionnaire were 475 people from 33 BuMn in indonesia. A total of 185 respondents from the gM in charge of financial reporting/Accounting Manager filled out the fraudulent financial statement prevention variable questionnaire, as many as 160 respondents from the spi Manager to fill out the internal auditor competence variable questionnaire and the internal control variable. Furthermore, 130 respondents from the Audit committee filled out the internal audit quality variable questionnaire. the results of the questionnaire return are presented in table 3. Before filling in the questionnaire, respondents need to be sure of the questions they will fill in. We researchers have given instructions at the beginning that the gM in charge of financial reporting/ Accounting Manager only fills in the questionnaire in part d, the spi Manager only fills in part a and part b, and then the Audit committee fills in part c. Questionnaires were distributed through the google Forms platform and direct visits to BuMns willing to participate, chosen for flexibility and wider reach. the items in the questionnaire were rated on a five-point likert scale, with scores ranging from one (strongly disagree) to five (strongly agree). Table 2. target research respondents. no Position total respondents 1gM in charge of financial reporting/accounting manager 5 people 2sPi manager 5 people 3audit Committee 5 people total target respondent for each BuMn 15 people total BuMns in indonesia 33 BuMn total target research respondents 495 people Table 3. Results of questionnaire returns. analysis unit Questionnaire returns results BuMn Position Respondents Filling out the questionnaire BuMn 33 gM in charge of financial reporting/accounting manager 185 Fraudulent financial statement prevention (Part d) sPi manager 160 internal auditor competence and internal control (Part a and Part b) audit Committee 130 internal audit quality (Part c) total questionnaire returns results 33 BuMn 475 People 6 r. A. novAtiAni etAl. subsequently, the data collected was analysed for validity and reliability. hypothesis testing was also conducted structural equation Modeling with partial-least square (seM-pls). this research has passed and has received approval from the research ethics committee of universitas padjadjaran (unpAD) with number: 1017/un6.Kep/ec/2023, dated 8 August 2023. then we distributed the questionnaires to the respondents by following procedures in accordance with the research ethics committee, such as: a. seeking consent from the respondents before asking them to complete the questionnaire b. maintaining the confidentiality of data from respondents c. the participation of the respondents is voluntary and there is no coercion the consent of the respondents was collected in written form. Measurement Measurement of internal auditor competence was adopted from Bailey (2010) and gamayuni (2018), which comprised five dimensions, namely general competence, behavioural skills, technical skills, knowledge, as well as audit tools and techniques. internal control measurement was adopted from coso (2013) and Arens Alvin et al. (2014), consisting of five dimensions, namely control environment, risk assessment, control activities, monitoring, as well as information and communication. internal audit quality is measured by adopting from gamayuni (2018) and singh et al. (2021), comprising two dimensions, namely attribute and performance standards. the measurement of fraudulent financial statement prevention was adopted from Dorminey et al. (2012) and Karyono (2013), consisting of three dimensions, namely reducing pressure, reducing opportunities, and reducing justification. Results and discussions Results Respondent Characteristics table 4 shows that the majority of respondents were male (59%), holding the position of gM responsible for financial statements/accounting manager (39%), aged between 41 and 45 years (23%), with a bachelor’s degree (36%), and having 6–10 years of service (34%). Evaluation of the measurement model (outer Model) this research comprised 18 latent variables with a total of 53 manifest variables. the latent variable of internal auditor competence consisted of 15 manifest variables, with internal control comprising 17, internal audit quality including 10, and fraudulent financial statement prevention consisting of 16. the loading factors contained in Figure 2 showed that all indicators had loading factors greater than 0.4. the results of validity and reliability tests in the first stage for internal auditor competence are shown in table 5, internal control is presented in table 6, internal audit quality is realised using table 7 and fraudulent financial statement prevention is provided in table 8. Furthermore, the validity testing and reliability testing in the second stage are described in table 9. An indicator is considered valid if the Ave is larger than 0.50 and factor loading exceeds 0.4. similarly, an indicator is considered reliable when both its cr and cA values surpass 0.70. the results showed that all parameters met the acceptance criteria. Coefficient of determination the coefficient of determination for internal audit quality was 0.411, signifying that internal auditor competence and internal control could affect internal audit quality by 41.1%. the coefficient of determination for fraudulent financial statement prevention was 0.768, showing that internal auditor competence, internal control, and internal audit quality collectively explained 76.8% of the variance in fraudulent financial cogent Business & MAnAgeMent 7 statement prevention. table 10 provides the coefficient of determination for the causal relationship of exogenous and endogenous variables. Model structural (inner model) structural models are used to predict causal relationships between variables. the significance level used for the degrees of freedom, specifically 471, was 5%, resulting in a t-table value of 1.965. the data obtained from the test results showed that all alternative hypotheses presented in table 11 and Figure 3 could be accepted. Table 4. Respondent characteristics. no Demography amount Percentage 1 gender Men 280 59 % Women 195 41 % 2 Position gM in charge of financial reporting/accounting manager 185 39 % sPi manager 160 34 % audit Committee 130 27 % 3age Less than 35 years 92 19 % 35–40 years 98 21 % 41–45 years 110 23 % 46–50 years 95 20 % above 50 years 80 17 % 4 education D-3 48 10 % s-1 172 36 % s-2 165 35 % s-3 90 19 % 5Length of service Less than 1 year 73 15 % 1–5 years 123 26 % 6–10 year 159 34 % More than 10 years 120 25 % Figure 2. structural model path coefficient values. 14 r. A. novAtiAni etAl. 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