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The impact of audit quality on real earnings management in the UK context

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journal contribution
posted on 08.04.2021, 13:24 by Syed Numan Chowdhury, Yasser EliwaYasser Eliwa
Purpose
The purpose of this paper is to examine whether audit quality influence real earnings management activities using a sample of UK listed firms that have strong incentives to manage earnings upward through meeting past year’s earnings as a benchmark in the post-adoption period of International Financial Reporting Standards (IFRS).

Design/methodology/approach
The authors use a sample of 4,774 firm-year observations of UK listed firms during the period 2005–2018. Univariate and multivariate analyses have been conducted to test the association after controlling for firm characteristics and institutional variables.

Findings
The study reports that the presence of Big 4 auditors is significantly and positively related with greater levels of sales and discretionary expenses manipulation. Though the authors do not find any conclusive evidence on production costs manipulation, the aggregated measure of real earnings management shows a significant positive association with the presence of Big 4 auditors.

Practical implications
The study implies that managers who have incentives to manage earnings upward around the UK firms take advantage of the accounting flexibility in defining policies while reducing information asymmetry among the investors to signal better future performance. The approach to detect earnings manipulation as described in the auditing standards fails to limit the managerial use of real activities due to limited scope and unclear guidance. Thus, due to the significant impact on public policies, the results should, therefore, be of interest to the regulators and standard setters.

Originality/value
To the best of the authors’ knowledge, this is the first study that examines the association between audit quality and real earnings management for the UK all-purpose operational firms in sampled data that just meet past year’s earnings as a benchmark in the post-IFRS period.

History

School

  • Business and Economics

Department

  • Business

Published in

International Journal of Accounting & Information Management

Volume

29

Issue

3

Pages

368-391

Publisher

Emerald

Version

AM (Accepted Manuscript)

Rights holder

© Emerald

Publisher statement

This paper was accepted for publication in the journal International Journal of Accounting & Information Management and the definitive published version is available at https://doi.org/10.1108/ijaim-10-2020-0156

Publication date

2021-03-19

Copyright date

2021

ISSN

1834-7649

eISSN

1758-9037

Language

en

Depositor

Dr Yasser Eliwa. Deposit date: 1 April 2021

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