Audit quality and classification shifting: evidence from UK and Germany

Abstract

PurposeThe authors examine the impact of audit quality (AQ) on classification shifting (CS) among non-financial firms operating in the UK and Germany.Design/methodology/approachThis paper used various audit committee variables (size, meetings, gender diversity and financial expertise) to measure AQ and its impact on CS. The authors used a total of 2,110 firm-year observations from 2010 to 2019.FindingsThe authors found that the presence of female members on the audit committee and audit committee financial expertise deter the UK and German managers from shifting core expenses and revenue items into special items to inflate core earnings. However, audit committee size is positively related to CS among German firms but has no impact on UK firms. The authors also document evidence that audit committee meetings restrain UK managers from engaging in CS. However, the authors found no impact on CS among German firms. The study results hold even after employing several tests.Research limitations/implicationsOverall, the study findings provide broad support in an international setting for the board to improve its auditing practices and offer essential information to investors to assess how AQ affects the financial reporting process.Originality/valueMost CS studies used market-oriented economies such as the USA and UK and ignored bank-based economies such as Germany, France and Japan. The authors provide a comparison among bank and market-oriented economies on whether the AQ has a similar impact on CS or not among them.