The Moderating Effect of Audit Quality on the Relationship Between Internal Controls and Financial Reporting Quality of Non-Financial Companies Listed at The Nairobi Securities Exchange, Kenya

Abstract

This study examined whether audit quality moderates the relationship between internal control systems and financial reporting quality among non-financial companies listed on the Nairobi Securities Exchange (NSE). Although internal controls are intended to support reliable reporting, their contribution may depend on the strength of external audit scrutiny. Using a positivist, quantitative explanatory longitudinal panel design, the study analysed secondary data from 26 non-financial firms over 2010–2025 (416 firm-year observations). Internal control systems were assessed through an Internal Control Disclosure Index (ICDI) based on the five COSO components. Audit quality was represented by a composite index incorporating auditor size, audit tenure and audit opinion; the use of audit opinion as an outcome-related indicator is a measurement limitation that should be considered when interpreting the index. Financial reporting quality was proxied by signed discretionary accruals estimated using the modified Jones model and reverse-coded so that values closer to zero indicated higher quality. The study used firm fixed-effects regressions with firm-clustered robust standard errors to estimate direct and interaction effects. The interaction between internal control systems and audit quality was positive and statistically significant (? = 1.038, p = .013), providing evidence that the association between internal controls and reporting quality varies with audit quality. The result supports rejection of the null hypothesis of no moderation, although it should be interpreted as an estimated conditional association rather than proof of causation. The study contributes Kenya-specific panel evidence on the complementary roles of internal controls and external audit in financial reporting governance.