Research On CPA's Audit Care

The audit opinion, as the observable output from an otherwise unobservable process, represents a crucial piece of information for financial statement users. More recently, several studies examine the relation between accounting accruals and the presence of certain modified audit opinions (Zhang and Liu,2002; Xu,2001). In essence, these studies test the hypothesis that earnings management increases the likelihood of receiving a modified audit opinion. The direction of causality is important because if auditor reporting conveys information about earnings management, then a link can be made between audit opinions and earnings quality. In this paper, we re-examine auditor reporting and its association with abnormal accruals, assessing, in particular, the claim that modified opinions are reliable signals of earnings management.Although we expect auditing to limit earnings management, it is not obvious that earnings management will typically lead to a modified audit opinion. Indeed, if an auditor detects earnings management and firm managers refuse to adjust the financial statements, the auditor's reporting options under Accounting Standards for Business Enterprises are to issue an adverse, disclaimed, or qualified opinion, the consequences of which can be severe. Moreover, firms with certain modified opinions have unusual accruals for reasons other than earnings management. Due,for example, to poor firm performance or liquidity-motivated survival tactics, the presence of GC opinions is often contemporaneously associated with large negative accruals. For these reasons, and consistent with the view that most earnings management takes place within the boundaries of Accounting Standards, we argue that the opinion/accruals relation is not due to earnings management.To examine the link between abnormal accruals and auditor opinion type, we begin by providing descriptive information on CSMAR and (www.info.com.cn) auditor/auditor's opinion data item for the 3 years from 2003 to 2005. We find that the reasons provided for these qualified opinions appear unrelated to earnings management and is thus inconsistent with the view that earnings management typically"causes"modified audit opinions.Based on our analysis of the reasons auditors depart from standard unqualified opinions, we identify the types of modified opinions that are associated with large accruals. Then, we detect that the documented relation between modified opinions and abnormal accruals rests with companies that have going-concern opinions. We find that companies with GC opinions drive the opinion/accruals relation because such companies have extremely abnormal accruals that are likely to be encountering financial difficult. Overall, we find no evidence that firms receiving modified audit opinions manage earnings more than those receiving clean audit opinions.Our contribution is two-fold. First, we provide a content analysis of the reasons why companies receive modified opinions. Second, we show that the modified opinions/abnormal accruals relation stems from companies with GC opinions, because they have negative accruals. As such, our findings cast some doubt on the conclusions of previous research that has attributed the opinion/accruals relation to more aggressive earnings management. We find no evidence to support the claim that firms receiving modified audit opinions manage earnings more than those receiving clean audit opinions.Our findings also have implications for research on the relation between audit opinion modifications and earnings management, as well as earnings management in general. In particular, because the auditor's role is not to assess earnings quality, researchers should be cautious when drawing inferences about the relation between auditors'opinions and traditional measures of abnormal accruals as proxies for earnings management.New Accounting Standards and Audit Standards were published in 2006, and carried out in Jan. 1, 2007, so changes in capital market must take place. However, our research is based on the data of 2003-2005 that follow the old standards. In particular, the new audit standards implements"risk-based audit", and differ from before. Auditors'care will switch to the material misstatement risk. Therefore, the relationship between abnormal accruals and audit opinion is likely to change.The remainder of the paper is organized as follows. Section 1 discusses institutional details and theory introduction. Section2 Section 3 details our sampling methodology. Section 4 provides a content analysis for those modified audit opinions that we can find on CSMAR, and then re-examines the opinion/accruals relation. Section 5 summarizes our main findings and offers some implications and suggestions for past and future earnings-management research.