Do goodwill impairments affect audit opinions? Evidence from China

There has been a steady growth of goodwill impairments in the Chinese stock market since the adoption of the impairment approach in accounting. The influence of goodwill impairments on a firm’s financial position and profitability give reason to doubt its current and future performance. We examine whether auditors, as a crucial external monitor, identify the information risks of goodwill impairments and express their concerns about financial reporting quality in their audit opinions. Using a sample of firms listed on China’s A-share market from 2007 to 2017, we test the association between goodwill impairments and the type of audit opinion received in the same financial period. Our findings are as follows. First, the probability of receiving a modified opinion increases with the amount of goodwill impairments. Second, the positive association between goodwill impairments and modified audit opinions is driven primarily by earnings management risks. Third, this positive association is more salient when auditors are industry experts and there is no auditor–client mismatch. Fourth, auditors are more sensitive to the amount of goodwill impairments than to their mere existence. Overall, we document that auditors perceive goodwill impairments as a signal of information risks and communicate their concerns to investors to avoid litigation.     

Debt Covenant Restriction,Financial Misreporting,and Auditor Monitoring*

Theory suggests that financial report-based debt covenants engender incentives for the manager to relax covenant constraints through accounting choices in order to avoid costly covenant violations. Prior studies directly testing this hypothesis in the context of financial misreporting fail to find consistent evidence. Using a more refined measure of debt covenant restriction, we find that debt covenant restriction is positively associated with the probability of financial statement misstatements. This positive association is driven by performance covenants rather than capital covenants and is more consistent with the manager striving to avoid a “false-positive” violation than to delay the violation. Our results also imply that managers resort to both income-increasing and non–income-increasing misreporting to relieve covenant constraints and rely more on the latter when faced with greater earnings management constraints. Additionally, the auditor charges higher audit fees to firms with more binding covenants even outside the violation state, and audit fees increase with constraints relative to both performance and capital covenants, reflecting greater financial reporting risk and bankruptcy risk, respectively. Within capital covenants, we find some evidence of even higher audit fees for tighter intangible-inclusive versus intangible-exclusive capital covenants. Lastly, our evidence suggests that the positive association between covenant constraints and misreporting is attenuated when the auditor has more experience with debt covenants, has greater bargaining power over the client, or faces greater litigation risk.     

What Drives the Consequences of Intentional Misstatements? Evidence from Rating Analysts’ Reactions

This paper aims to identify the mechanisms through which intentional misstatements adversely affect firms by analyzing rating analysts’ reaction to misstatements. In order to identify the mechanisms through which the misstatement affects firms’ credit ratings, we analyze the content of rating reports. Rating analysts are concerned about seven different mechanisms. They are most concerned about misstatement‐related violations of debt covenants that increase a firm's liquidity risk. We find that, subsequent to an intentional misstatement becoming publicly known, credit ratings of misreporting firms are adversely affected for up to seven years. The adverse impact of an intentional misstatement on a firm's credit rating is most pronounced in cases in which rating analysts mention concerns about misstatement‐related violations of covenants. Our results suggest that these covenant violations are the most severe mechanism through which misstatements adversely affect firms’ creditworthiness.     

Investor Sentiment,Misstatements, and Auditor Behavior*

High investor sentiment has been linked with opportunistic managerial behavior in the face of more optimistic investors and analysts. We extend this line of work by documenting that the likelihood of misstatements is higher when sentiment is high. Although this would suggest elevated audit risk, we posit that a contemporaneous reduction in auditors' litigation cost could drive down audit fees and going concern opinion (GCO) reporting conservatism in order to please clientele. Consistent with this notion, we document that auditors charge lower fees and report GCOs less conservatively when sentiment is high. However, this reduction in reporting conservatism is unwarranted; results reveal that auditors are less likely to issue GCOs to clients which subsequently file for bankruptcy during high sentiment periods. We conduct additional tests to examine whether auditors' litigation costs indeed vary with sentiment and document that auditors are less likely to be sued and the market reacts less negatively to misstatement announcements when sentiment is high. Collectively, our findings suggest that, although misstatement risk is increasing with sentiment, auditors' litigation risk actually declines.     

A re-examination of accruals quality following restatements

Empirical research from the first years following the Sarbanes-Oxley Act (SOX) in the US suggests that firms improve accruals quality following restatements, but the materiality of restatements has declined since then. This decline may affect firms' responses to restatements, and hence we re-examine whether restatements are associated with subsequent improvements in accruals quality in a more recent sample. We compare the changes in accruals quality of firms restating between 2000 and 2014 with that of a control group. We do not find that firms improve accruals quality more than the control group following a restatement, even when we isolate the types of restatements considered to be most material. However, we do find that restatements followed by the most negative stock market reactions are associated with a relative increase in accruals quality, indicating that only restatements deemed very severe by investors lead to subsequent improvements in accruals quality. Our results suggest that firms' responses to restatements have changed concurrently with the trend of fewer and less material restatements in recent years.     

我国注册会计师虚假陈述之原因及立法完善

通过分析注册会计师虚假陈述的原因,指出规范注册会计师独立审计行为的关键是建立健全相关法律制度,并从完善注册会计师虚假陈述的民事责任制度,建立完善的执业准则,营造良好的执业环境,建立相应的激励制度等方面提出了立法建议。     

国际审计准则第320号和450号的新发展及其对我国的启示

本文介绍和分析了经过重新修订和起草的ISA320《计划和实施审计工作时的重要性》和ISA450《对审计过程中已识别错报的评估》的征求意见稿的主要内容,通过与2004年12月发布的征求意见稿的比较,重点介绍其最新发展情况,并总结出对我国审计准则制定的几点启示。     

Changes in audit effort and changes in auditors’ disclosures of risks of material misstatement

This paper investigates whether auditors' year-to-year modification to risks of material misstatements (RMMs) in extended auditors' reports (EARs) are associated with changes in underlying audit effort, as proxied by changes in audit fees. We examine the dynamics of RMMs over time in terms of adding or dropping specific RMMs. Our main results show that, on average, audit fees increase more from the previous year's fees when more RMMs are added to the current year's EAR. This increase is partially offset by dropping RMMs that were disclosed in the previous year, but changes in audit fees are not significantly affected by dropping RMMs without adding new RMMs. Further analysis suggests the effect of added RMMs is attributable to “new” RMMs originating with the auditor and that added RMMs that were previously known, based on related disclosures in the prior year's audit committee report, do not significantly impact on changes in audit fees. Overall, our results suggest that changes in the choice of RMMs included in EARs reflect changes in underlying audit effort.     

Investor reaction to accounting misstatements under IFRS: Australian evidence

We examine the investor reaction to misstatement news for Australian listed firms from 2006 to 2013. We find 4.1 percent of firm-years have a misstatement and 79 percent of misstatements are disclosed initially only in the periodic filings (stealth misstatements). We find no investor reaction for the average misstatement, reactions of between −2.3 percent and −2.8 percent (−1.5 and −1.7 percent) for misstatements that reduce prior-period earnings or equity (affect revenue) and reactions of between −1.3 and −2.7 percent for non-stealth misstatements. Investor reactions are more negative for non-stealth misstatements that reduce prior-period earnings or equity than for stealth misstatements.     

Audit Partners’ Role in Material Misstatement Resolution: Survey and Interview Evidence

Auditors are expected to identify and resolve material misstatements (MMs) in management's financial statements. However, beyond the audit opinion, the audit process is opaque. To address this, we independently survey 462 audit partners and interview 24 audit partners, CFOs, and audit committee members on how partners assess and address MM risk, resolve MMs, and the consequences of MMs. Partners identify MMs in approximately 9% (15%) of public (private) engagements and use qualitative factors to waive apparent MMs. Loan covenant and going-concern issues increase MM risk more than earnings benchmark issues. Partners point to a variety of both auditor and client factors as threats to audit effectiveness. Partners often rely on rapport with management and involve the national office and audit committee in resolving MMs. Partner incentives around restatements are context specific. Our results provide new insights into the auditor's role in financial reporting that are relevant to academics, practitioners, and regulators.