Audit Firm Size and Going-Concern Reporting Accuracy

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INTERDISCIPLINARY JOURNAL OF CONTEMPORARY RESEARCH IN BUSINESS

JANUARY 2012
VOL 3, NO 9

Audit Firm Size and Going-Concern Reporting Accuracy
Dr. Daruosh Foroghi, PhD
Faculty of Accounting
Department of Accounting, University of Isfahan, Iran

Amir Mirshams Shahshahani
Graduate Student at Department of Accounting, Mobarakeh Branch, Islamic Azad Univeristy, Mobarakeh, Iran
Abstract
This study examines the association between measures of going-concern reporting accuracy and audit firm size of the companies listed in Tehran Stock Exchange. Prior works have examined the association between auditor size and audit quality, using various proxies for audit quality. Recent work has hypothesized that going- concern reporting accuracy can also measure audit quality. Furthermore, Prior research suggests that big audit firms are of higher quality than are smaller firms. However, existing tests for an association between audit firm size and reporting accuracy are indirect and provide different results. Our study extends this line of research by examining whether big audit firms exhibit higher quality reporting by having fewer ‘‘audit-reporting errors’’ in the context of issuing going-concern modified reports. Our analyses examine going-concern reporting errors (unmodified opinions rendered to subsequently bankrupt clients) over an 9 year period. Our findings indicate no association between the size of audit firm and going-concern reporting accuracy.

Keywords: audit quality; audit reporting; going concern; bankruptcy. Data Availability: All data are publicly available from the sources indicated. 1. INTRODUCTION
Effective auditing is essential for efficient capital markets (Watts and Zimmerman,1983), and one of the necessary conditions for effective auditing is auditor independence. The auditing literature generally concludes that the audit quality of Big 4 auditors is superior to that of non-Big 4 auditors. DeAngelo (1981) argues that accounting firm size is a proxy for auditor quality, as no single client is important to larger accounting firms and, hence, larger accounting firms are less likely than smaller accounting firms to compromise their independence. Dopuch and Simunic (1980) propose that larger accounting firms provide higher quality services because they have greater reputations to protect. Furthermore, it could be argued that Big 4 firms provide superior audit quality as their sheer size can support more robust training programs, standardized audit methodologies, and more options for appropriate second partner reviews (Lawrence et al, 2011). Hence, larger audit firms are better able to discern when to modify or not modify their opinion for going-concern difficulties of their clients. This greater accuracy would in turn lead to lower going-concern ‘‘reporting error’’ rate.

However, there are also arguments as to why Big 4 and non-Big 4 firms could provide comparable audit quality. First, Big 4 and non-Big 4 firms are held to the same regulatory and professional standards, and thus both types of audit firms must adhere to a reasonable level of quality. Second, as non-Big 4 auditors have superior knowledge of local markets and better relation with their clients, these factors may enable non-Big 4 firms to better detect irregularities. Of course, the converse argument could be made that closer relationships among non-Big 4 accounting firms and their clients could potentially lead to a compromise of independence; however, the net effect of these counteracting forces is unclear. Third, the inability of nonBig 4 firms to obtain affordable insurance coverage may actually increase the audit effort of non-Big 4

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ijcrb.webs.com

INTERDISCIPLINARY JOURNAL OF CONTEMPORARY RESEARCH IN BUSINESS

JANUARY 2012
VOL 3, NO 9

firms relative to Big 4 firms because smaller audit firms cannot obtain a similar level of backing...
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