The impact of audit rotation on the comparability of financial reports

Authors

DOI:

https://doi.org/10.1590/1808-057x202111830

Keywords:

comparability, auditor rotation, consistency

Abstract

This study aims to assess the effect of the rotation and tenure of audit firm and audit partner on the comparability and consistency of financial reports. Several studies have addressed the effect of auditor rotation on the quality of financial reports, but none of them focused specifically on the impact on the comparability and consistency of financial reports. Around the world, the impact of mandatory rotation of audit partner and audit firm is being discussed in academia and

regulatory bodies. The peculiarity of the Brazilian regulatory environment allows us to contribute to the discussions on the effects of implementing mandatory auditor rotation. Our sample included 50 companies for which we analyzed data from 2012 to 2018. To measure comparability, we used the similarity of the accounting function model by DeFranco, Kothari

and Verdi (2011), and to measure consistency we used the adaptations to this model proposed by Ribeiro (2014). For data analysis, we used descriptive statistics and multivariate panel analysis. Our results suggest that the rotation (mandatory and voluntary) of audit firm and audit partner does not affect the comparability and consistency of financial reports. Results also suggest that auditor-client relationships of up to three years contribute to a significant increase in comparability and consistency, indicating that mandatory rotation does not impair investors’ ability to compare the information concerning their investments. In addition, regulators are shown that a possible reduction in the mandatory rotation term (from five to three years, as in Italy) would be in line with market practices and would imply an increase in the comparability and consistency of financial information.

Downloads

Download data is not yet available.

References

Arel, B., Brody, R., & Pany, K. (2006). Findings on the effects of audit firm rotation on the audit process under varying strengths of corporate governance. Advances in Accounting, 22, 1-27.

Bagnoli, M., & Watts, S. G. (2010). Oligopoly, disclosure, and earnings management. The Accounting Review, 85(4), 1191-1214.

Barth, M. E., Landsman, W. R., Lang, M. H., & Williams, C. D. (2013). Effects on comparability and capital market benefits of voluntary adoption of IFRS by US firms: Insights from

voluntary adoption of IFRS by non-US firms. Rock Center for Corporate Governance at Stanford University. Working Papers, (3074).

Bell, T. B., Causholli, M., & Knechel, W. R. (2015). Audit firm tenure, non‐audit services, and internal assessments of audit quality. Journal of Accounting Research, 53(3), 461-509.

Cameron, M., Prencipe, A., & Trombetta, M. (2014). Mandatory audit firm rotation and audit quality. European Accounting Review, 25(1), 35-58.

Casterella, J. R., & Johnston, D. (2013). Can the academic literature contribute to the debate over mandatory audit firm rotation? Research in Accounting Regulation, 25(1), 108-116.

Chen, C. Y., Lin, C. J., & Lin, Y. C. (2008). Audit partner tenure, audit firm tenure, and discretionary accruals: Does long auditor tenure impair earnings quality? Contemporary

Accounting Research, 25(2), 415-445.

Chi, W., Lisic, L. L., & Pevzner, M. (2011). Is enhanced audit quality associated with greater real earnings management? Accounting Horizons, 25(2), 315-335.

Cohen, D. A., & Zarowin, P. (2007). Earnings management over the business cycle. Retrieved

from https://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.1060.381&rep=rep1&type=pdf

Comissão de Valores Mobiliários (CVM). (2008). Deliberação n. 549.

Comissão de Valores Mobiliários (CVM) (1999). Instrução n. 308. Com as alterações introduzidas pelas instruções CVM n. 509/2011, 545/2014 e 591/2017.

Daniels, B. W., & Booker, Q. (2011). The effects of audit firm rotation on perceived auditor independence and audit quality. Research in Accounting Regulation, 23(1), 78-82.

Davis, L. R., Soo, B. S., & Trompeter, G. M. (2009). Auditor tenure and the ability to meet or beat earnings forecasts. Contemporary Accounting Research, 26(2), 517-548.

DeAngelo, L. E. (1981). Auditor size and audit quality. Journal of Accounting and Economics,

(3), 183-199.

DeFond, M. L., & Francis, J. R. (2005). Audit research after sarbanes-oxley. Auditing: A Journal of Practice & Theory, 24(s-1), 5-30.

DeFond, M. L., & Subramanyam, K. R. (1998). Auditor changes and discretionary accruals.

Journal of Accounting and Economics, 25(1), 35-67.

DeFond, M. L., & Zhang, J. (2014). A review of archival auditing research. Journal of Accounting and Economics, 58(2-3), 275-326.

DeFond, M. L., Hu, X., Hung, M., & Li, S. (2011). The impact of mandatory IFRS adoption on foreign mutual fund ownership: The role of comparability. Journal of Accounting and Economics, 51(3), 240-258.

DeFranco, G., Kothari, S. P., & Verdi, R. S. (2011). The benefits of financial statement comparability. Journal of Accounting Research, 49(4), 895-931.

Dopuch, N., King, R. R., & Schwartz, R. (2001). An experimental investigation of retention and rotation requirements. Journal of Accounting Research, 39(1), 93-117.

Doyle, J., Ge, W., & McVay, S. (2007). Determinants of weaknesses in internal control over financial reporting. Journal of Accounting and Economics, 44(1-2), 193-223.

Fang, V. W., Maffett, M., & Zhang, B. (2015). Foreign institutional ownership and the global convergence of financial reporting practices. Journal of Accounting Research, 53(3), 593-631.

Fang, X., Li, Y., Xin, B., & Zhang, W. J. (2012). Accounting comparability and loan contracting.

Working Paper.

Fávero, L. P., & Belfiore, P. (2017). Manual de análise de dados: estatística e modelagem multivariada com Excel®, SPSS® e Stata®. Rio de Janeiro, RJ: Elsevier.

Francis, J. R., Hanna, J. D., & Vincent, L. (1996). Causes and effects of discretionary asset write-offs. Journal of Accounting Research, 34, 117-134.

Francis, J. R., Pinnuck, M. L., & Watanabe, O. (2014). Auditor style and financial statement comparability. The Accounting Review, 89(2), 605-633.

Garcia-Blandon, J., & Argiles-Bosch, J. M. (2017). The interaction effects of firm and partner tenure on audit quality. Accounting and Business Research, 47(7), 810-830.

Ghosh, A., & Moon, D. (2005). Auditor tenure and perceptions of audit quality. The Accounting Review, 80(2), 585-612.

Hadi, A. S. (1992). Identifying multiple outliers in multivariate data. Journal of the Royal Statistical Society. Series B (Methodological), 54(3), 761-771.

Harris, K., & Whisenant, S. (2012). Mandatory audit rotation: an international investigation

(Doctoral Dissertation, University of Houston). Retrieved from https://uh-ir.tdl.org/

bitstream/handle/10657/ETD-UH-2012-05-372/HARRIS-.pdf ?sequence=2&isAllowed=y.

Healy, P. M., & Palepu, K. G. (2001). Information asymmetry, corporate disclosure, and the capital markets: A review of the empirical disclosure literature. Journal of Accounting and

Economics, 31(1-3), 405-440.

International Financial Reporting Standards (IFRS). (2018). Conceptual framework for financial reporting. London: IFRS.

Jenkins, D. S., & Velury, U. (2008). Does auditor tenure influence the reporting of conservative earnings? Journal of Accounting and Public Policy, 27(2), 115-132.

Jennings, M. M., Pany, K. J., & Reckers, P. M. (2006). Strong corporate governance and audit firm rotation: Effects on judges’ independence perceptions and litigation judgments.

Accounting Horizons, 20(3), 253-270.

Johnson, V. E., Khurana, I. K., & Reynolds, J. K. (2002). Audit‐firm tenure and the quality of financial reports. Contemporary Accounting Research, 19(4), 637-660.

Kaplan, S. E., & Mauldin, E. G. (2008). Auditor rotation and the appearance of independence: Evidence from non-professional investors. Journal of Accounting and Public Policy, 27

(2), 177-192.

Kim, H., Lee, H., & Lee, J. E. (2015). Mandatory audit firm rotation and audit quality.

Journal of Applied Business Research, 31(3), 1089.

Kim, S., Kraft, P., & Ryan, S. G. (2013). Financial statement comparability and credit risk.

Review of Accounting Studies, 18(3), 783-823.

Kwon, S. Y., Lim, Y., & Simnett, R. (2014). The effect of mandatory audit firm rotation on audit quality and audit fees: Empirical evidence from the Korean audit market. Auditing: A Journal of

Practice & Theory, 33(4), 167-196.

Lawrence, A., Minutti-Meza, M., & Zhang, P. (2011). Can Big 4 versus non-Big 4 differences in audit-quality proxies be attributed to client characteristics? The Accounting Review, 86

(1), 259-286.

Lee, C. W. J., Li, L. Y., & Yue, H. (2006). Performance, growth and earnings management.

Review of Accounting Studies, 11(2-3), 305-334.

Li, D. (2010). Does auditor tenure affect accounting conservatism? Further evidence.

Journal of Accounting and Public Policy, 29(3), 226-241.

Li, L., Qi, B., & and Zhang, J. (2017). The effect of engagement auditors on financial statement comparability. Retrieved from https://ssrn.com/abstract=3047631. Lowensohn, S., Reck, J., Casterella, J. R., & Lewis, B. (2007). An empirical investigation of auditor rotation requirements.

Retrieved from https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1021789

Lu, T., & Sivaramakrishnan, K. (2009). Mandatory audit firm rotation: Fresh look versus poor knowledge. Journal of Accounting and Public Policy, 28(2), 71-91.

McVay, S., Nagar, V., & Tang, V. W. (2006). Trading incentives to meet the analyst forecast.

Review of Accounting Studies, 11(4), 575-598.

Myers, J. N., Myers, L. A., & Omer, T. C. (2003). Exploring the term of the auditor-client relationship and the quality of earnings: A case for mandatory auditor rotation? The

Accounting Review, 78(3), 779-799.

Nagy, A. L. (2005). Mandatory audit firm turnover, financial reporting quality, and client bargaining power: The case of Arthur Andersen. Accounting Horizons, 19(2), 51-68.

Paulo, E., & Mota, R. H. G. (2019). Ciclos econômicos e estratégias de gerenciamento de resultados contábeis: um estudo nas companhias abertas brasileiras. Revista

Contabilidade & Finanças, 30(80), 216-233.

Raiborn, C., Schorg, C. A., & Massoud, M. (2006). Should auditor rotation be mandatory?

Journal of Corporate Accounting & Finance, 17(4), 37-49.

Ribeiro, A. M. (2014). Poder discricionário do gestor e comparabilidade dos relatórios financeiros: uma análise dos efeitos da convergência do Brasil às IFRS (Tese de Doutorado).

Universidade de São Paulo, São Paulo.

Ribeiro, A. M., do Carmo, C. H. S., Lopes Fávero, L. P., & de Carvalho, L. N. G. (2016a). Comparabilidade X uniformidade dos relatórios financeiros: uma análise empírica durante o

período de transição regulatória da contabilidade brasileira ao padrão internacional. Advances in Scientific & Applied Accounting, 9(3), 262-282.

Ribeiro, A. M., do Carmo, C. H. S., Lopes Fávero, L. P., & de Carvalho, L. N. (2016b). Poder discricionário do gestor e comparabilidade dos relatórios financeiros: uma análise

do processo de transição regulatória da contabilidade brasileira.

Revista Contabilidade & Finanças, 27(70), 12-28.

Securities and Exchange Commission (SEC). (2003). Strengthening the Commission’s requirements regarding auditor independence. Final Rule 68, File No. S7-49-02.

Washington, DC: SEC.

Silvestre, A. O., Costa, C. M., & Kronbauer, C. A. (2018). Audit rotation and earnings quality: An analysis using discretionary accruals. BBR – Brazilian Business Review, 15(5), 410-426.

Simmons, J. K. (1967). A concept of comparability in financial reporting. The Accounting Review,

(4), 680-692.

Sohn, B. C. (2016). The effect of accounting comparability on the accrual-based and real earnings management. Journal of Accounting and Public Policy, 35(5), 513-539.

Verrecchia, R. E., & Weber, J. (2006). Redacted disclosure. Journal of Accounting Research,

(4), 791-814.

Wang, K. J., & Tuttle, B. M. (2009). The impact of auditor rotation on auditor-client negotiation.

Accounting, Organizations and Society, 34(2), 222-243.

Watts, R. L., & Zimmerman, J. L. (1986). Positive accounting theory. Englewood Cliffs, NJ.

Wolf, F. M., Tackett, J. A., & Claypool, G. A. (1999). Audit disaster futures: antidotes for the expectation gap? Managerial Auditing Journal, 14(9), 468-478.

Yip, R. W., & Young, D. (2012). Does mandatory IFRS adoption improve information comparability? The Accounting Review, 87(5), 1767-1789.

Zhang, J. H. (2018). Accounting comparability, audit effort, and audit outcomes. Contemporary Accounting Research, 35(1), 245-276.

Published

2021-12-01

Issue

Section

Original Articles

How to Cite

Sousa, A. M. de, Ribeiro, A. M., & Vicente, E. F. R. (2021). The impact of audit rotation on the comparability of financial reports. Revista Contabilidade & Finanças, 32(87), 413-428. https://doi.org/10.1590/1808-057x202111830