Modified Audit Opinions Research Articles

Stock Price Contagion Effects of Low-Quality Audits at the Individual Audit Partner Level

SUMMARYWe use Chinese audit partner data to show that partners associated with financial reporting fraud induce share price declines among non-fraudulent firms audited by the same audit partners. In cross-sectional analyses, we find that share price declines are more pronounced when low-quality partners (LQPs) failed to issue modified audit opinions during the period in question and when the LQPs were from one of the Top 10 audit firms. Additional analyses show that investors impose larger penalties on contagion firms when fraudulent firms are larger and the time lapse between sanction and fraud commitment is shorter. The personal characteristics of LQPs (except gender) do not cause a difference in market reaction to contagion firms. Overall, our results speak to the importance of audit partner identity to stock market valuation.JEL Classifications: M41; M42; M48.

The effect of audit partner gender on modified audit opinions

We examine the effect of audit partner gender on the likelihood of issuing a modified audit opinion (MAO) across conditions in which the issuance of an MAO is warranted and/or that create incentives to report opportunistically at the audit‐partner level. We find that, after an audit partner switch, female audit partners are more likely to issue first‐time MAOs and MAOs generally and that female audit partners are more persistent in issuing MAOs. However, after correcting for self‐selection bias, we do not find an effect on the part of audit partner gender on the likelihood of issuing an MAO in the case of partner‐level opinion shopping, subsequently failing firms, or firms that are economically important at the audit‐partner level. This stands in contrast with the previous evidence regarding the effect of audit partner gender on going‐concern reporting. Overall, our study provides new evidence regarding the conditions that induce female audit partners to report more conservatively compared with male audit partners. The results imply that female audit partners report more conservatively if an MAO was issued in the previous year and if the audit partner has been switched.

Auditing Related Party Transactions: Evidence from Audit Opinions and Restatements

SUMMARY Using data from the Chinese market where related party transactions (RPTs) are particularly prevalent, we examine how the independent auditor responds to the potentially heightened risk of RPTs and the efficacy of the auditor's response. First, we find that the auditor is more likely to issue a modified audit opinion that specifically discusses RPTs (RPTMAO) to firms reporting higher related sales or related lending, but not to firms reporting higher RPTs of other categories (i.e., related purchases, related borrowing, and related assets/equity transactions). These findings suggest that the auditor alerts investors to the possibility of earnings management and/or expropriation risk from related sales or related lending through audit opinions. The positive relation between related sales and RPTMAO is driven by related sales with nonmarket-based or undisclosed pricing policy and related sales above the industry average. Second, RPTMAO has robust predictive power for future RPT-related restatements, and the predictive power is greater than that of modified opinions that do not specifically discuss RPTs, suggesting that the auditor is effective at communicating the risk associated with RPTs through opinion modifications, especially RPTMAOs. JEL Classifications: M49 Data Availability: Data used in this study are available from public sources.

The impact of litigation risk on the association between audit quality and auditor size: Evidence from China

AbstractWe examine whether audit quality varies across different sizes of CPA firms under high or low auditor‐specific litigation risk exposure. We measure audit quality by the issuance of modified audit opinions and the audit fees charged to clients, and we use the organizational form of CPA firms as the proxy for auditors’ litigation risk exposure, where a partnership (limited liability) CPA firm represents a high (low) litigation risk exposure. Built on Choi, Kim, Liu, and Simunic's (2008) theoretical framework, we hypothesize that the litigation risk exposure of CPA firm moderates the association between auditor size and audit quality. Our results show that when the auditor's liability is capped (i.e., registered as a limited liability form of CPA firm), larger size CPA firms are associated with higher audit quality when compared to smaller size CPA firms. However, this positive association between auditor size and audit quality disappears for audit firms that are subject to high litigation risk exposures (i.e., registered as a partnership form of CPA firm). Our research provides new insights on the impact of auditor‐specific litigation risks on the relation between audit quality and auditor size. In particular, we show that only when auditor‐specific litigation risk is limited, do large CPA firms appear to perform higher quality audits than small CPA firms.

Foreign Ownership and the Auditor's Opinion: An Analysis in Private Subsidiaries

In a large sample of private Spanish subsidiaries, we observe a significantly greater incidence of modified audit reports in foreign than in local group subsidiaries. Results are consistent with foreign group subsidiaries having lower incentives to avoid receiving modified audit opinions (MAOs) because of their lower dependence on external financing. Additionally, our tests reveal that, of the two types of MAOs that are potentially avoidable, only opacity related MAOs are significantly more frequent in foreign than in local group subsidiaries. Curiously, despite that the literature documents a higher incidence of earnings management in foreign-owned private subsidiaries, the evidence of higher frequency of GAAP violation related MAOs in foreign group subsidiaries is weak. Our findings indicate that foreign shareholders do not improve financial reporting quality in the private setting, but are associated with more opaque companies where the auditors are prevented from doing their work. Additionally, results suggest that the cost-benefit relation of avoiding MAOs hinges on the underlying reason for modification.

Long-Term Impact of Economic Conditions on Auditors' Judgment

ABSTRACTWe find that economic conditions at the time an auditor enters the labor market have a long-term impact on her judgment and decision making. Specifically, engagement partners who started their career during economic downturns issue audit adjustments more frequently. For the subsample of company-years with no audit adjustments, downturn auditors are more likely to issue a modified audit opinion. In addition, companies audited by downturn auditors are less likely to violate financial reporting and disclosure regulations. Together, our findings suggest that the early career stage is a critical formative period for auditors.JEL Classifications: J24; M42.

Revizija odloženog poreza na dobitak - studija slučaja

Deferred income tax, generated as a result of temporary differences between values in business and tax evidences, represents important category of financial statements of Serbian entities from 2004.Research subject in this paper is deferred income tax audit, which is conducted under regular financial statements audit. Research objective is to overview specific features of deferred income tax audit in relation to audit of other financial statements positions. In the paper has been used a case study method, which showed that deferred income tax irregularities can be a reason for modified audit opinion. In the case study, accuracy in the calculation of deferred income tax is identified as a key management assertion.

Federal Judge Ideology and the Going Concern Reporting Incentives of Big 4 and Non-Big 4 Auditors

We analyze how variation in federal level legal liability associated with judge ideology is associated with the likelihood of firms receiving going-concern modified audit opinions, separately for Big Four and non-Big Four clients. With auditors trading off between Type I and Type II reporting errors, the threshold value (of client bankruptcy probability) above which auditors issue going-concern reports is decreasing and convex in the level of federal litigation risk. Building on literature showing that federal judge ideology affects the likelihood and outcome of lawsuits, we find that Big Four and non-Big Four auditors converge in their going-concern reporting decisions as federal litigation risk increases and that this convergence is caused by the greater effect of judge ideology on non-Big Four than on Big Four auditors. The key results remain with firm-fixed effects and are not driven by the effects of judge ideology on auditor choice or bankruptcy probability.

Hospitality and auditor independence: do gifts blind the eyes?

In the Chinese audit market, some firms provide hospitality to their auditors. There is a well-known saying in China: ‘Gifts blind the eyes and there is no such thing as a free lunch’. The phenomenon provides researchers with a unique setting to examine whether hospitality (proxied by free food and drink) can impair actual auditor independence. Using a sample of Chinese listed firms during the period of 2001–2010, my findings show that hospitality is significantly positively associated with discretionary accruals, and further hospitality is significantly negatively associated with auditors’ propensity to issue modified audit opinions. These findings, taken together, imply that some Chinese listed firms compromise auditor independence and establish bonding relations with their auditors via hospitality. This study validates the impairment of hospitality on actual auditor independence, lending important support to the existing ethical standards about hospitality in the auditing profession.

What can auditors tell us about accounting manipulations?

PurposeThis paper aims to examine the frequency and the nature of International Financial Reporting Standards/International Accounting Standards (IFRS/IAS) violations that resulted in modified audit opinions (MAOs); determinants of MAO decision; and underlying motives, targets and techniques of accounting manipulations.Design/methodology/approachDescriptive statistics and in-depth investigation on archival data collected from the published audit reports are used to analyse the frequency and the nature of IFRS violations that resulted in MAOs, while the logistic regression is applied to identify the possible determinants of MAO decisions. A survey instrument is used to identify the relative importance of different manipulation motives, targets and techniques from the perspective of an external auditor.FindingsResults from the archival research show that MAOs are expressed in 29% of audit reports of listed companies in Croatia. A majority of the qualifications refer to noncompliance with provisions of IAS 39, IAS 16, IAS 1, IAS 2 and IAS 36. The survey results show that manipulations are principally oriented towards creditors, tax authorities and suppliers with the intention to hide bad performance, get better terms of crediting and minimize fiscal and political costs. Results from the field study complement and confirm the archival research results in respect to the accounting areas and techniques used for manipulation purposes.Originality/valueThe analysis provides a rather robust estimation of the extent of accounting manipulations, compared to commonly used earnings management metrics. Application of multi-method research that integrates archival research and field study offers significant contribution to the existing earnings management literature in methodological approach. The results directly address particular provisions of the IFRS that are frequently violated and provide better understanding of the features of accounting manipulations in a specific institutional setting.

Does Severe Air Pollution Affect Audit Judgment?: Evidence From China

This study examines whether and how air pollution affects auditors’ proclivity for modified audit opinion issuance. We argue that air pollution affects auditors’ audit judgment through two separate channels, i.e., the productivity reduction channel and the cognitive bias channel. Our empirical tests confirm that high levels of air pollution make auditors less likely to issue modified audit opinions. Consistent with the adverse effect on audit quality, we further show that air pollution is positively associated with client companies’ discretionary accruals and subsequent restatements. Applying a discontinuity design that focuses on observations with air quality index falling in the narrow range around 100, we again confirm that local air pollution leads to lower audit quality.

KM Theory Applied in Accounting and Statistics Education: Case on the Cost of Debt

This study examines the impact of audit opinions on the cost of debt based on accounting education and knowledge management theory. The empirical results of whole sample regression show that audit opinions are negatively correlated with the cost of debt and financial marketization weakens the effect of audit opinions on debt pricing. The subsample regression results of audit opinions indicate that financial marketization is negatively correlated with the cost of debt only in companies with modified audit opinions. This implies that audit opinions play a more important role in debt pricing compared to the financial marketization of companies’ localities.

Regulatory investigations of audit partners and audit quality improvement

Prior studies of the effect of regulatory monitoring on audit quality focus on regulatory sanctions but ignore regulatory investigations. We hand-collected data on the China Securities Regulatory Commission (CSRC) investigations announced during 2001–2015 to examine the impact of CSRC investigations on the audit quality of the targeted partners. We find that after the audit partners are investigated by the CSRC, their clients exhibit a lower absolute value of discretionary accruals and the partners are more likely to issue modified audit opinions. Our results suggest that CSRC investigations lead to improvement in the audit quality of the partners involved in the investigations. In contrast, CSRC sanctions have a relatively weak effect on the audit quality of the involved partners. Overall, our study provides evidence that CSRC monitoring helps to improve the audit quality of audit partners, and the effect manifests around CSRC investigations.

Audit risk and articulation errors from different cash flow disclosures: evidence from China

We investigate the effects of articulation errors on audit opinions and fees, and moderating effects of the auditor size and different litigation regimes on the relationships between articulation errors on audit opinions and fees in China. We find that auditors are more likely to issue modified audit opinions (MAOs) and charge higher audit fees from their clients with higher absolute articulation errors, especially for big auditors and in high litigation risk regime. We also find that auditors who do not issue MAOs to clients with abnormal articulation errors receive higher fees than auditors who do issue MAOs.

Certification of Audit Committee Effectiveness: Evidence from a One-Time Regulatory Event in China

The China Securities Regulatory Commission (CSRC) launched the Campaign for Strengthening Corporate Governance of Public Companies in 2007. As part of this pilot program, public firms were required to report to CSRC whether their boards had established audit committees and whether these audit committees operated effectively. Using this unique one-time regulatory event in China, we examine whether it is beneficial for firms to certify the effectiveness of their audit committees. Through analyzing hand-collected data from the campaign reports filed with CSRC, we find that firms with certified audit committee effectiveness are associated with less earnings management and lower audit fees, and are less likely to have modified audit opinions and delayed filings. This positive association implies that certification can be an effective way to ensure that audit committees function in substance rather than in appearance, as intended by the Blue Ribbon Committee reports and subsequent audit committee regulations.

Do Social Ties between External Auditors and Audit Committee Members Affect Audit Quality?

ABSTRACT We examine whether social ties between engagement auditors and audit committee members shape audit outcomes. Although these social ties can facilitate information transfer and help auditors alleviate management pressure to waive correction of detected misstatements, close interpersonal relations can undermine auditors' monitoring of the financial reporting process. We measure social ties by alma mater connections, professor-student bonding, and employment affiliation, and audit quality by the propensity to render modified audit opinions, financial reporting irregularities, and firm valuation. Our evidence implies that social ties between engagement auditors and audit committee members impair audit quality. In additional results consistent with expectations, we generally find that this relation is concentrated where social ties are more salient, or firm governance is relatively poor and agency conflicts are more severe. Implying reciprocity stemming from social networks, we also report some suggestive evidence that audit fees are higher in the presence of social ties between an engagement auditor and the audit committee. Collectively, our analysis lends support to the narrative that the negative implications—namely, worse audit quality and higher audit fees—of these social ties may outweigh the benefits.

PENGARUH OPINI AUDIT MODIFIKASI TERHADAP KEPUTUSAN PIN-JAMAN DAN KEPUTUSAN INVESTASI

The objective of this study was to examine whether the effect of the modified audit opinion of loans received by the company's decision and the decision of investment expenditure by the company. Design research is quantitative research with the hypothesis. The sample used in this study are manufacturing companies that listed in Indonesia Stock Exchange with a four year study period from 2011-2014. The independent variable of this study is a modified audit opinion, while the dependent variable is the financial constraints represented by the decision of the loan and investment decisions. The results from this study indicate that in 2011-2014, for overall modified audit opinion does not affect the decision-making loans to companies and corporate investment spending. However, an unqualified audit opinion with an explanation of the going concern paragraph affect tothe loan or investment decision because of corporate business con-tinuity uncertainty.Stable economic conditions and the majority shareholder also can determine the effect of modified audit opinion of loans and investment decisions.

Market Reaction to the Going-Concern Modified Audit Opinions of Public Companies After the IFRS Adoption

The objective of this paper is to analyze the market reaction to the auditors’ going-concern audit opinions after the IFRS adoption in Brazil. The event study methodology was applied for the analysis of three public non-financial companies in the first year in which they received a qualified opinion about uncertainties as to their capacity to continue operating. We observed that there was just one company with a market reaction for stock price and traded volume on the day the auditors’ report was released. The results of this study are relevant because they present new evidence in the Brazilian context, which may be added to the existing literature and can be used as practical examples to understand the complexity and importance of the theme.

Audit Partner Gender Diversity and Audit Quality

This study examines how audit-partner gender-diversity impacts audit quality, using data from China, where two partners are assigned to lead each engagement. Female and male partners bring different resources, in the form of information, expertise, experience, and perspectives that could result in higher professional skepticism and better audit quality. The beneficial effect of gender diversity on audit quality is likely to be stronger when the two partners have similar authority or collaborated before, resulting in effective inter-partner communication, and in complex engagements where different perspectives are more valuable. Using the propensity to issue modified audit opinions as a proxy for audit quality, we provide evidence supporting these propositions. Additional analyses show that dyads of gender-diverse partners are less likely to be sanctioned and can charge higher audit fees. These findings further support the hypothesis that partner gender diversity enhances audit quality.

The Effect of CEO and CFO Resignations on Going Concern Opinions

Anecdotal evidence suggests that the resignation of a top executive increases a firm’s likelihood of failure. When auditors perceive an increased likelihood of failure, a going concern modified audit opinion is issued. This study tests the relationship between top management resignations and the issuance of going concern audit opinions. The study uses financially distressed firms in the United States from 2008-2010 and a logistic regression model to test the relationship. The findings show a positive relationship between CFO resignations and firms receiving a going concern audit opinion even after controlling for other predictors of a going concern audit opinion. However, no significant relationship is found between CEO resignations and receiving a going concern audit opinion. Firm size, cash flow from operations, stock return, and investments all had a significant relationship with going concern opinions.