The effect of real activities manipulation on going concern audit opinions for financially distressed companies

Hongkang Xu, Mai Dao and Jia Wu

Review of Accounting and Finance, 2018, vol. 17, issue 4, 514-539

Abstract: Purpose - This study aims to examine the effect of real activities manipulation (RAM) on auditors’ decision of issuing going concern (GC) opinions for distressed companies. Design/methodology/approach - This study estimates and examines three types of RAM: reduction of discretionary expenses, sales manipulation and overproduction. It investigates the effect of RAM on auditor reporting conservatism by including the three measures of RAM methods in logistic regressions that explain the issuance of going concern opinions. The authors perform the analysis specifically on distressed firms for 2004-2013 period. Findings - This study finds a significant and positive association between RAM and the likelihood of receiving going concern opinion in the financial distressed firm sample, suggesting that client’s abnormal business activity affects the auditor reporting conservatism. Practical implications - This study provides evidence that auditors make going concern reporting decisions in consideration of the client’s abnormal operating decisions and management’s opportunism. Originality/value - Recent literature argues that auditors have little recourse other than to resign if a client uses RAM to impact earnings or the financial statements, and hence the enhanced audit quality in the post-SOX period is due to the shift from using accruals management to RAM (Cohenet al., 2008;Chiet al., 2011;Kim and Park, 2014). The evidence provided in this study indicates that auditors report more conservatively (rather than simply resign) in response to the aggressive RAM.

Keywords: Going concern opinion; Real activities manipulation; Auditor reporting conservatism (search for similar items in EconPapers)
Date: 2018
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eme:rafpps:raf-09-2016-0135

DOI: 10.1108/RAF-09-2016-0135

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