Academic journal article Academy of Accounting and Financial Studies Journal

Auditor Quality and IFRS Information Comparability

Academic journal article Academy of Accounting and Financial Studies Journal

Auditor Quality and IFRS Information Comparability

Article excerpt

INTRODUCTION

This study examines the difference in audit quality between Big 4 and non-Big 4 auditors. The issue of whether Big 4 firms provide higher quality audit service is important for accounting researchers who often rely on the Big 4 versus non-Big 4 dichotomy as a proxy for audit quality (Beatty, 1989; Gul et al. 2009). The issue also has significant practical ramifications in the selection of auditors by audit committees (CFA Institute Center, 2009; Moizer, 1997) and in loan and underwriting agreements (De Angelo, 1981).

A large body of research has examined the issue of Big 4 versus non-Big 4 audit quality (DeAngelo, 1981; Dopuch & Simunic, 1980; Khurana & Raman, 2004; Behn et al. 2008; Francis & Yu, 2009). Abnormal accruals, benchmark beating, timely loss recognition, analyst forecast accuracy, audit opinions, and litigation against auditors have been used as audit quality proxies in the literature (Becker et al. 1998; Krishnan, 2003; Behn et al. 2008; Lawrence et al. 2011; DeFond & Lennox, 2011). This study extends the research on audit quality by exploring a different audit quality matrix: the comparability of clients' audited financial statements.

Comparable information enables financial statement users to evaluate the merits of alternative investment opportunities for efficient capital allocation (SEC, 2000). Making financial information comparable was cited by the Financial Accounting Standard Board (FASB) as the primary reason for developing accounting standards (FASB 1980, par. 112). Reducing the divergence in accounting standards across countries in order to enhance the cross-country comparability of accounting information was also cited as the primary reason for the creation of International Accounting Standards Committee (IASC), the predecessor of the International Accounting Standards Board (IASB) (Camfferman and Zeff, 2007). While the widespread adoption of International Financial Reporting Standards (IFRS) has undoubtedly reduced the divergence in accounting standards across countries, increased standard comparability alone would not lead to information comparability because information comparability is also affected by institutional environment, management reporting incentives, and audit quality. Particularly, given the numerous accounting choices under IFRS and the significant variations in enforcement infrastructure across countries, auditors play a critical role in the rigorous interpretation and consistent application of IFRS to produce comparable financial information (Ball, 2006). Consequently, for similar economic events, clients of high quality auditors should report more comparable accounting amounts, other things being equal. However, until recently, the literature has not examined the comparability of audited financial statements in audit quality studies (1). This study attempts to bring the audit quality research and comparability studies together by examining audit quality of Big 4 versus non-Big 4 firms based on the cross-country comparability of clients' IFRS-based financial statements. Specifically, we investigate the difference in audit quality between Big 4 and non-Big 4 firms and how such difference is affected by the adoption of IFRS in China. We choose China for our study for two major reasons: (1) there are contradicting predictions and mixed evidence regarding Big 4 versus non-Big 4 audit quality in developing economies with weak institutional environment and low litigation risk, and (2) many of IASB's constituent countries are developing economies with weak institutional environment and low litigation risks.

Litigation risk avoidance and reputation protection are the two primary motivations cited in the audit literature for high quality audit service. Both motivations would yield the same prediction for developed economies with strong investor protection and high litigation risk. However, the two motivations provide very different predictions for developing economies with code law legal origins and low litigation risk. …

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