Academic journal article Academy of Accounting and Financial Studies Journal

Impact of Non-Audit Assurance Level (Compilation versus Review) on Production Management of Private Manufacturing Companies

Academic journal article Academy of Accounting and Financial Studies Journal

Impact of Non-Audit Assurance Level (Compilation versus Review) on Production Management of Private Manufacturing Companies

Article excerpt


The AICPA (2013) recently issued its Financial Reporting Framework for Small- and Medium-Sized Entities (FRF for SMEs). The Framework resulted from concerns that traditional GAAP statements were expensive and perhaps not useful or relevant to relatively small business enterprises. This Framework and the Blue Ribbon Panel Report on Standard Setting for Private Companies from the Financial Accounting Foundation (2011) indicate a heightened interest in financial reporting by relatively small business entities, sometimes called the Big GAAP/Little GAAP debate (Burton and Hillison 1979; Grusd 2006; Thrower 2010; Wright et al. 2012). However, a paucity of research has been conducted on United States companies' non-audited financial statements.

This study focuses on financial reporting for private companies whose financial statements have been provided non-audit-level assurance (reviewed) or no assurance (compiled) by independent accountants. Information obtained from Sageworks Incorporated's privately held company database was used for analyses. The Sageworks database contains many data items for some included private companies. However, many observations from reviewed or compiled data lack information on many items necessary to construct complex earnings management measures used in previous research.

Most private manufacturers in the Sageworks database provide sufficient information to examine one form of earnings management through inventory and production decisions. Only manufacturers can substantially increase or decrease reported income by adjusting work in process and finished goods inventories to time the expensing of fixed manufacturing costs. Consequently, due to data limitations, I focus on use of this real earnings management technique manufacturing industries. Following previous studies (Gunny 2010; Chien et al. 2011; Cohen et al. 2008; Roychowdhury 2006), I use an abnormal production measure to examine whether differences exist in production levels between statements possessing the different assurance levels. I also examine whether the tax status (separately taxed or pass-through entities) of these companies impacts their abnormal production.

SSARS 10, Performance of Review Engagements (AICPA 2004), issued in 2004, provided substantial clarification and guidance for independent accountants' review services. One major change was that this standard required accountants performing review services to make specific fraud related inquiries of management and expanded documentation requirements. My sample comes from financial statements impacted by SSARS 10: 4,883 yearly observations of 2,709 private companies over the period of 2005-2008 from the Sageworks database. (Note: Sageworks made entity-level data available to researchers for a short period of time, but their data is no longer publicly available other than in summary form.)

I find that abnormal production differs between companies whose financial statements were reviewed and those whose statements were compiled. Overall, financial statements that were reviewed tend to exhibit relatively more income-increasing abnormal production than compiled financial statements, while compiled financial statements tend to exhibit relatively more income-decreasing abnormal production than reviewed statements. Overall, abnormal production in reviewed and compiled statements does not appear to be impacted by organizational tax status. I also examine abnormal production of manufacturing companies most likely to have an incentive to engage in earnings management. Reviewed taxable companies just meeting earnings benchmarks exhibit significantly higher abnormal production, but this behavior is not evident for other company groups.

The next section of this article contains a review of related literature and a discussion explaining my hypotheses. The following sections describe the sample, explain statistical methods, and discuss results of empirical analysis. …

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