Does Auditor Industry Expertise Improve Audit Quality In Complex Business Environments?

Sansaloni Butar-Butar,Stefani Lily Indarto Lily Indarto

doi:10.9744/jak.20.1.1-12

Sansaloni Butar-Butar, Stefani Lily Indarto Lily Indarto

Open Access

https://doi.org/10.9744/jak.20.1.1-12

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Abstract

This study examines the role of specialist auditors in enhancing the quality of financial statements by taking into account industry complexity. The test of hypotheses are conducted in two steps. The first step is to provide evidence that earnings quality, measured by earnings persistent, of firms operating in the complex and non-complex industry are different. The second step is to compare the absolute abnormal accruals of companies engaged in the complex industry with those from non-complex industry audited by non-specialist and specialists auditors. Results show: 1) earnings persistence of firms in complex industries are lower than those in non-complex industries. 2) absolute abnormal accruals of firms operating in complex industries are higher than those in non-complex industries regardless industry specialization. Overall, the results suggest that auditor industry expertise does not play a significant role in improving the quality of audited earnings in complex business environment.

Highlights

Firm business environment may affect the reliability of financial statements to reflect firm economic reality
The results suggest that the absolute abnormal accruals of firms in complex industries are higher relative to firms operating in less complex industries even though they use non-specialist auditors
The assumption that the auditors who have industry specialization expertise can always improve the quality of financial statements regardless of type of industries they operate are misleading

Summary

Introduction

Firm business environment may affect the reliability of financial statements to reflect firm economic reality. A sophisticated business environment creates uncertainty causing accountants to face difficulties in assessing the impact of events and transactions on company’s resources. The situation may lead to inappropriate accounting policy choices and hinder financial statements users in making effective business decisions. Bushman et al [1] argue that firm complexity due to business and geographic line diversification decreases transparency. Firms operating in a particular industry where rapid environment changes occur very often will have high obstacles in recording business transactions. Francis and Gunn [2] supported the view stating that accounting industry complexity arises from difficulties in mapping economic activities into generally accepted accounting principles (GPPA), and accounting rules as basis for measurement of assets, liabilities, revenues, costs, and owner's equity

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