Auditor reporting and earnings management: some additional evidence

Kathleen Herbohn and Vanitha Ragunathan

Accounting and Finance, 2008, vol. 48, issue 4, pages 575-601

Abstract: This paper investigates the reasons that lead to modification of auditors' opinions. We revisit the conclusions of prior US-based research on whether a modification highlights likely earnings management activities. Extending this research, we consider an alternate explanation that managers adjust accruals to report earnings that better predict future firm performance, which has the side-effect of placing them in conflict with their auditors. Our study sample comprises all firms listed on the Australian Stock Exchange over the period 1999-2003. Consistent with prior research, there is no evidence of earnings management leading to an audit opinion modification. However, we do show that firms receiving inherent uncertainty modifications (other than going concern) have greater persistence of earnings (accruals) relative to other firms. This is consistent with the proposition that managers have made policy choices in reporting current earnings, with which their auditors disagree, that will likely result in a greater ability to forecast the firm's future earnings. Copyright (c) 2007 The Authors. Journal compilation (c) 2007 AFAANZ.

Date: 2008

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