The Effect of Auditor Rotation on the Relationship between Financial Manipulation and Auditor’s Opinion

Ivica Filipović,Toni Šušak,Andrea Lijić

doi:10.2478/bsrj-2021-0007

Abstract

Abstract Background: Since external auditors possess the expertise necessary for detecting manipulations in financial statements, they should also take into account earnings management that could lead to it. In that context, auditor’s independence, which can be affected by auditor’s rotation, is of utmost importance. Objectives: This paper aims to examine the moderating effect of auditor rotation on the relationship between the extent of financial manipulation and the type of auditor’s opinion for companies listed on the Zagreb Stock Exchange in the Republic of Croatia. Methods/Approach: A panel analysis with logistic regression is conducted to test the research hypothesis. The sample consists of 210 observations during the three years from 2015 to 2017. Results: Results show a significant positive relationship between auditor rotation in a current financial year and auditor’s opinion. Furthermore, there is a negative, but the statistically insignificant moderating effect of auditor rotation in a current financial year on the relationship between financial manipulation and auditor’s opinion, as well as the statistically insignificant moderating effect of auditor rotation frequency over five years on the relationship between financial manipulation and auditor’s opinion. Conclusions: It is not likely that auditors take earnings management into account when generating their opinion on financial statements, and auditor rotation is not proven to be an adequate stimulus in that context.

Highlights

The beginning of the current century was extremely challenging for the corporate sector because of numerous accounting scandals (Bajra et al, 2018) which have drawn attention to earnings management practices worldwide (Idris et al, 2018)
The importance of auditor’s consideration of earnings management activities was emphasized in the International Standard on Auditing 240: The Auditor's Responsibilities Relating to Fraud in an Audit of Financial Statements, which has been effective since 15th December 2009. This standard stipulates that “discussion among the engagement team may include a consideration of circumstances that might be indicative of earnings management and the practices that might be followed by management to manage earnings that could lead to fraudulent financial reporting”
Content analysis was applied to determine the information contained in independent auditors’ reports, such as auditor’s opinion, auditor’s size, and auditor rotation, while financial data was gathered from annual financial statements

Summary

Introduction

The beginning of the current century was extremely challenging for the corporate sector because of numerous accounting scandals (Bajra et al, 2018) which have drawn attention to earnings management practices worldwide (Idris et al, 2018). Objectives: This paper aims to examine the moderating effect of auditor rotation on the relationship between the extent of financial manipulation and the type of auditor’s opinion for companies listed on the Zagreb Stock Exchange in the Republic of Croatia. Results: Results show a significant positive relationship between auditor rotation in a current financial year and auditor’s opinion. Conclusions: It is not likely that auditors take earnings management into account when generating their opinion on financial statements, and auditor rotation is not proven to be an adequate stimulus in that context. (2021), “The Effect of Auditor Rotation on the Relationship between Financial Manipulation and Auditor’s Opinion”, Business Systems Research, Vol 12, No 1, pp.

Objectives

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Discussion

Conclusion