Accrual Estimation Errors Research Articles

Auditors’ Religious Beliefs and Audit Quality: Some Evidence from Taiwan

Synopsis The research problem Adding to the literature in auditing, this study examines whether there is an association between the religious beliefs of audit partners and audit quality in Taiwan. Motivation Previous studies have found that firms headquartered in areas with strong religious social norms are associated with higher audit quality. However, prior studies measured religiosity in terms of whether the audit practice offices were in more religious metropolitan statistical areas. No work had examined whether the religious beliefs of the individual auditors affect auditor decision making. In addition, prior studies using US data were mainly confined to one group who are, in the main, Christians. We examined this issue in Taiwan where the auditors come from three main religious groups: Christian, Buddhist, and Taoist. This setting provides another cultural environment for understanding the links between religiosity and financial reporting issues. The test hypotheses H1: Audit engagement partners with a religious belief are associated with higher audit quality. H2: The positive association between auditors’ religion and audit quality is more pronounced for auditors with industry specialization than auditors without specialization. Target population Various stakeholders include investors, auditors, financial analysts, and users of financial reports. Adopted methodology Ordinary least squares (OLS) regression and logistics regression. Analyses We conducted the study in Taiwan where audit partners are required to sign audit reports. We obtained data on the religious beliefs of auditors by distributing a questionnaire to individual auditors in the Big 4 in Taiwan. We used four measures of audit quality: (a) discretionary accruals, (b) accrual estimation errors, (c) the probability of a client meeting an earnings benchmark, and (d) the propensity to issue modified audit opinions. We tested whether there is a positive association between auditors’ religious beliefs and audit quality. Findings Our study finds that firms with an audit partner who professes a religion are associated with higher audit quality. However, unlike evidence from the United States, we do not find that auditors in an area with strong religious social norms exhibit better audit quality than auditors in less religious areas when the audit partner’s religious belief is controlled in the analysis. The results suggest that auditor quality is more affected by auditor’s personal characteristics than the social norms. We also find that the positive association between auditors with industry specialization and audit quality is stronger when the auditor has religious beliefs. The results suggest that ethics and competence are complements to each other.

A Test of Income Smoothing Using Pseudo Fiscal Years

The purpose of our study is to further understand managerial incentives that affect the volatility of reported earnings. Prior research suggests that the volatility of fourth-quarter earnings may be affected by the integral approach to accounting (i.e., “settling up” of accrual estimation errors in the first three quarters of the fiscal year) or earnings management to meet certain reporting objectives (e.g., analyst forecasts). We suggest that another factor affecting fourth-quarter earnings is managers’ intentional smoothing of fiscal-year earnings. For each firm, we create pseudo-year earnings using four consecutive quarters other than the four quarters of the reported fiscal year. We then compare the earnings volatility of pseudo years to the earnings volatility of the firm’s own reported fiscal year. We find evidence consistent with fourth-quarter accruals reflecting managerial incentives to smooth fiscal-year earnings. This conclusion is validated by several cross-sectional tests, the pattern in quarterly cash flows and accruals, and several robustness tests. Overall, we contribute to the literature exploring alternative explanations for the differential volatility of fiscal-year and fourth-quarter earnings. This paper was accepted by Brian Bushee, accounting.

Managers’ Use of External Information in Their Accrual Estimates: Evidence from the Impact of Stock Liquidity on Accruals Quality

Because stock liquidity should improve managers’ access to external information, we examine whether managers of firms with higher stock liquidity form more accurate accrual estimates. Consistent with our expectations, we find that accrual estimation errors of firms with more liquid stocks are significantly smaller. Moreover, results from a difference-in-differences test around an exogenous shock to stock liquidity (produced by the 2001 decimalization) support the idea that the external information revealed when stocks are more liquid allows managers to reduce their accrual estimation errors. Finally, we find that the negative association between stock liquidity and accrual estimation errors is stronger for firms incurring losses, operating in more volatile environments, or with higher business cyclicality. Collectively, our findings are consistent with the notion that the external information available when stocks are more liquid helps managers to form more accurate accrual estimates.

Does Routine Labor Generate Routine Earnings?

A substantial body of research investigates how skills and attributes of upper management affect firm policies and performance, but the impact of workers outside of upper management has received little attention due to scarcity of data involving lower-level workers. Prior research also suggests that operating uncertainty impedes managers’ ability to understand and predict their own firm’s future earnings performance, leading to accrual estimation errors, and that higher-ability managers are better able to transform economic predictability into smoother accruals and earnings. We predict and find that a firm’s utilization of routine labor (defined as labor at greater risk of future automation) contributes to firms’ and managers’ propensity to report more persistent and predictable accruals and earnings. Results indicate that routine labor generates the most predictable and persistent accruals when managers have higher ability and when firm efficiency is higher, when firms build up inventory and therefore accrue a greater proportion of labor cost, and when the routine labor supply is less impacted by external economic policy (in the form of state minimum wage increases). Taken together, our results suggest the characteristics of lower-level workers interact with those of managers, firms, and the economy to determine the persistence of accruals and earnings.

The Impact of Going Concern on Financial Reporting Quality: Evidence from Vietnam

The investigation was conducted to contribute empirical evidence of the association between going concern and financial reporting quality of listed firms on the Vietnam stock market. Based on data from 279 companies listed on the HNX and HOSE exchanges in Vietnam for the period 2009-2015, the quantitative research. Results found that the relationship between the going concern and financial reporting quality of listed firms. Research results are significant for investors, regulators to the transparency of financial reporting information.
 Keywords
 Going concern, financial reporting quality, listed firms
 References
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BOARD STRUCTURE AND EARNINGS MANAGEMENT: EVIDENCE OF SOUTH EAST ASIA COUNTRIES CATEGORISED BY AGENCY COST LEVEL

Agency theory infers that investors will incur cost to make alignment on principal-agent interest. A critic, however, has pointed out that the conflict of interest between principal and agent is not the only cause for agency cost. Cultural context (Johnson & Droege, 2004) and legal system (La Porta, et al., 2000) are also found as contributing factors. This study is to empirically investigate how board size, board independency, audit committee size and audit committee independency affect the earnings quality in the context of low or high level agency cost country according to Transparency International’s corruption level and Hofstede’s cultural values. 538 firm-year across 6 South East Asian countries (Indonesia, Malaysia, Philippines, Singapore, Thailand, and Vietnam) are observed in this research. Five Different accrual models (Jones, 1991; Dechow, Sloan, & Sweeney, Detecting Earnings Management, 1995; Kasznik, 1999; Dechow, Richardson, & Tuna, Earnings management and costs to investors from firms meeting or slightly exceeding benchmarks, 2002; Dechow & Dichev, The Quality of Accruals and Earnings: The Role of Accrual Estimation Errors, 2002) are used to generate abnormal accruals which will be used as proxy for earnings management while to generate suitable factors from corporate governance variables, principal component analysis (PCA) is employed. Results indicate that (1) earnings management is efficient; (2) size and independency of Board of Director and audit committee are effective in reducing earnings management behaviour; (3) the management of firms operating in higher agency cost context will take advantage from the structure of corporate governance (size and independency of Board of Directors and audit committee) to conduct earnings management. Additionally, it is also found that bigger size (higher leverage) firms perform less (more) accounting discretion compared to their counterparts.

Types of investor uncertainty and the cost of equity capital

AbstractWe jointly test the effects of two types of investor uncertainty, one related to future firm performance and unrelated to accruals (cash flow uncertainty) and one directly related to accrual estimation errors (accounting quality uncertainty). Distinct from prior studies, our uncertainty estimates are based on a matched‐firm design that minimizes the mechanical relationship between the two uncertainty variables. We find a strong negative relationship between cash flow uncertainty and multiple estimates of the cost of equity capital. With respect to accounting quality uncertainty, we find a strong positive association with both expected stock returns and implied costs of equity, but only in settings that control for cash flow uncertainty. Collectively, our results suggest the need to consider different types of investor uncertainty when examining how investor uncertainty affects the cost of equity capital.

A New Measure of Managers' Intentional Income Smoothing

The purpose of our study is to further understand managerial incentives that affect the volatility of reported earnings. Prior research suggests that the volatility of fourth-quarter earnings may be affected by the integral approach to accounting (i.e., “settling up” of accrual estimation errors in the first three quarters of the fiscal year) or earnings management to meet certain reporting objectives (e.g., analyst forecasts). We suggest that another factor affecting fourth-quarter earnings is managers’ intentional smoothing of fiscal-year earnings. For each firm, we create pseudo-year earnings using four consecutive quarters other than the four quarters of the reported fiscal year. We then compare the earnings volatility of pseudo years to the earnings volatility of the firm’s own reported fiscal year. We find evidence consistent with fourth-quarter accruals reflecting managerial incentives to smooth fiscal-year earnings. This conclusion is validated by several cross-sectional tests, the pattern in quarterly cash flows and accruals, and several robustness tests. Overall, we contribute to the literature exploring alternative explanations for the differential volatility of fiscal year and fourth-quarter earnings.

On the Association between Accrual Quality and Persistence

We offer a theoretical framework to help isolate persistence estimates of fundamental earnings innovations from the effects of accounting measurements. We show that a downward bias results when persistence of earnings innovations is estimated using reported earnings. We show that the greater the accrual estimation errors, the greater this downward bias, thus explaining the empirically observed positive association between accrual quality and estimated earnings persistence. However, when we debias reported earnings persistence as guided by our theoretical framework, we fail to detect any such association. We further show that market returns around earnings announcements are associated with the debiased measure of earnings persistence incremental to reported earnings persistence indicating that the market is able to undo the bias in a manner consistent with our theoretical model. Overall, our results help bring clarity to the literature by pointing out that accrual quality per se does not bear any relation to persistence of earnings innovations; rather, improving accrual quality merely improves the precision in estimating the persistence of these innovations.

The role of accrual estimation errors to determine accrual and earnings quality

Purpose Managers, investors and security analysts all pay special attention to the bottom line of income statements and they miss significant information included in accruals about the quality of earnings. A considerable portion of the earnings-quality literature examines the possibility of using the accruals to shift reported income among fiscal periods. One of the main roles of working-capital accruals is to adjust the recognition of cash flows. This paper aims to focus on earnings quality by examining the working-capital accruals quality using the method of Dechow and Dichev (2002). Design/methodology/approach Following the Dechow and Dichev (2002) model, the result of this paper shows that accrual quality is related to the absolute magnitude of accruals negatively. Also, the standard deviation of accruals, cash flows, sales and earnings is positively related to firm size. The result demonstrates and suggests that these observable firm characteristics can be used as instruments for measuring accrual quality. According to this framework, the author expects that the larger the unsigned abnormal accrual measure, the lower the earnings quality. Therefore, firms with low accrual quality have more accruals that are unrelated to cash flow realisations and so have more noise and less persistence in their earnings. Findings After examining earnings and accrual quality, this paper finds that average UK company behaviour was quite similar to the behaviour found earlier in the USA. This paper’s findings show that greater volatility of sales, cash flow, accruals and earnings results in a lower accrual quality. Without a doubt, some of the analysis in this paper, especially that using different equations to calculate working-capital accruals, leads us to a valuable improvement of the earlier studies. Originality/value In this paper, the author follows the method of Dechow and Dichev (2002) and define accrual quality as the extent to which accruals map into cash-flow insights based on the UK data. To find the quality of working-capital accruals, the author uses the standard deviation of the residuals as accrual quality that resulted from the author’s firm-specific OLS regressions of working-capital accruals based on last, current and one-year-ahead operating cash flow. Unlike prior research, to avoid a restriction to working-capital accruals, we use different equations to cover more items of working-capital accruals.

Accrual Quality of Indonesian Firms Before and After Initial Public Offerings

Changing from a private to a public firm will change the financial reporting environment of a company. More stakeholders and regulations demand high-quality financial reports. Using Indonesian quoted non-finance and related industry IPO firms, this study purports to examine the change in reported earnings quality, measured by accrual quality, before and after the IPOs. Based on the discretionary-accrual model, we find that there is no difference of accrual quality before and after IPO. However, as we hypothesized, based on cash-flow model, the result shows that accrual quality increases after IPO due to diminishing of unintentional accrual estimation errors after IPO.

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Does pedigree matter? Earnings quality of U.S. listed domestic firms via reverse mergers

This paper examines earnings quality of U.S. domestic firms that access capital markets via a reverse merger transaction (RM firms) compared to those via the more traditional initial public offering (IPO firms) during the period from 1997 to 2011. In order to mitigate confounding effects of legal regime, law enforcement, and culture, we require both the acquiring and target firms to be incorporated and headquartered in the U.S. to be included in our sample. We also use the Heckman (1976) procedure to control for self-selection bias. To capture earnings quality, we use a battery of measures established in prior literature, including discretionary accruals, discretionary revenues, real activities earnings management, and accrual estimation errors. Our measures have both convergent and discriminant validity and therefore appear to capture earnings quality fairly well. We find consistent evidence that U.S. domestic RM firms have lower earnings quality compared with U.S. IPO firms. Our evidence suggests that investors and other stakeholders should take into account the fact and consequences of the method that firms use to access capital markets in their investment decision making process.

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