According to auditing standards, explanatory language added at the auditor's discretion to unqualified audit reports should not indicate increased financial misstatement risk. However, an auditor is unlikely to add language that would strain the auditor-client relationship absent concerns about the client's financial statements. Using a sample of 30,825 financial statements issued with unqualified audit opinions during 2000–2009, we find that financial statements with audit reports containing explanatory language are significantly more likely to be subsequently restated than financial statements without such language. We find that this positive association is driven by language that references the division of responsibility for performance of the audit, adoption of new accounting principles, and previous restatements. In addition, we find that (1) “emphasis of matter” language that discusses mergers, related-party transactions, and management's use of estimates predicts restatements related to these matters, and that (2) the financial statement accounts noted in the explanatory language typically correspond to the accounts subsequently restated. In sum, our results suggest that present-day audit reports communicate some information about financial reporting quality.
SUMMARY This research investigates the effect on audit quality of concentrated public company financial statement filing deadlines in audit offices. Audit offices must effectively manage their resources to meet clients' audit service requirements. When an audit office has deadlines that are more concentrated in time, effective resource management is of greater importance to reduce the likelihood of audit failure. Drawing on relevant research from the auditing and management literatures, we hypothesize and find that audit quality is lower when an audit office's clients' financial statement deadlines concentrate in time, which we term client deadline concentration. The significant, negative effect of client deadline concentration on audit quality is incremental to the effects of other resource-based constraints from the prior literature and to controls for unobservable differences in audit offices that explain a significant amount of the variation in audit quality outcomes. JEL Classifications: M40; M41; M42; M48. Data Availability: Data are available from public sources identified in the text.
This article investigates whether investors respond to explanatory language (EL) added to unqualified audit reports. Although prior research finds an association between auditor EL and lower financial reporting quality, surveys suggest that many investors limit their attention to the unqualified nature of the opinion. We use three-day abnormal returns and abnormal trading volume to measure investor response to EL in unqualified audit reports issued from 2000 to 2014. We find little evidence to indicate that investors respond to auditor EL at the audit report release date. In further analyses, we find that the lack of investor response is attributable both to incomplete investor reactions (55 percent of EL occurrences) and previous incorporation of EL (40 percent of EL occurrences). Overall, the results support policymakers' initiatives to improve the usefulness of unqualified audit reports.Les investisseurs réagissent-ils au texte explicatif des rapports d'audit sans réserve ? RÉSUMÉLes auteurs se demandent si les investisseurs réagissent au texte explicatif ajouté dans les rapports d'audit sans réserve. Bien qu'un lien entre le texte explicatif de l'auditeur et la qualité inférieure de l'information financière ait été observé dans de précédentes études, les sondages semblent indiquer que seule l'absence de réserve dans le rapport d'audit retient l'attention de bon nombre d'investisseurs. Les auteurs utilisent les rendements anormaux et les volumes d'échange anormaux notés sur une période de trois jours pour évaluer la réaction des investisseurs au texte explicatif que contiennent les rapports d'audit sans réserve publiés entre 2000 et 2014. Ils relèvent peu d'indications susceptibles de confirmer que les investisseurs réagissent au texte explicatif de l'auditeur à la date de publication du rapport d'audit. En poussant plus loin leurs analyses, les auteurs constatent que l'absence de réaction des investisseurs est attribuable à la fois à l'incomplétude de leur réaction (55 pour cent des occurrences de texte explicatif) et à l'intégration antérieure du texte explicatif (40 pour cent des occurrences de texte explicatif). Dans l'ensemble, les résultats justifient les efforts des normalisateurs pour améliorer l'utilité des rapports d'audit sans réserve.
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