Do Internal Control Capacity Improve Reporting Quality? Evidence from Indonesian Local Government

Abstract

This study investigates the determinants of local government reporting quality through the use of discretionary accruals in Indonesian local governments, with emphasis on the moderating role of internal control apparatus (APIP) capacity. Drawing on public choice theory, the analysis examines whether accruals are strategically employed to manage financial outcomes or reflect persistent reporting practices. Using the data from 34 province level and applying regression analysis, the results reveal that surplus-deficit before accruals are consistently and negatively associated with the discretionary accruals, indicating the use of dicretionary accrual to offset financial imbalances and achieve performance benchmarks. In the baseline model, lagged discretionary accruals are positively associated with current accruals, suggesting persistence and strategic continuation of such practices. However, once APIP capacity is incorporated, the persistence effect weakens. APIP capacity itself significantly reduces discretionary accruals, and its interaction with financial balance further constrains accrual-based adjustments, while its interaction with lagged accruals reinforces persistence in reporting practices. These findings highlight a paradox: institutional oversight reduces opportunistic accrual adjustments but simultaneously entrenches established reporting behavior, limiting substantive improvements in financial reporting quality.