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Qualified audit reports and costly contracting

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Abstract

This paper investigates the financial characteristics of the population of listed Singaporean companies receiving first-time qualified audit reports. It develops and tests hypotheses which take into account the costly contracting implications of a qualification for both the auditor and client. A matched pair design is used as a control. Results show that firms receiving qualified reports are significantly less profitable and liquid and have significantly more debt than the control in the year of qualification. Profitability and liquidity are shown to have declined in the four-year period up to the qualification, while debt levels have increased. These results may partially explain why the general (overseas) no-effect result from share market announcement date studies exists; the qualification per se is a dated signal of financial deterioration that has existed for at least the previous four years. Qualification is also significantly associated with auditor type and ownership of the firm, and is also dependent upon whether or not the firm has revalued its assets or changed accounting methods. It is more likely that a qualified report will be issued by a “non Big 8” auditor in Singapore to a firm which has a higher proportion of the equity owned by the management. Qualified firms are more likely to have revalued assets and changed accounting methods to increase income than the control group. The strength of the results is also shown to depend on the nature of the qualification. Companies receiving “severe” qualifications (ie going concern, not true and fair, and unable to form an opinion) have far more significant differences than their pairs compared with those firms receiving “moderate” or “other” qualifications.

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Authors
  1. Yoke-Kai Chan
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  2. Terry S. Walter
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Additional information

The authors are Senior Lecturer, School of Accountancy and Business, Nanyang Technological University and Professor, Department of Accounting, University of Sydney, respectively. All correspondence should be addressed to Yoke-Kai Chan, School of Accountancy and Business, Nayang Technological University, Nanyang Avenue, Singapore 639798.

This paper has benefited from the comments of an anonymous referee, participants at the Australasian Banking and Finance Conference, the 15th Annual Congress of the European Accounting Association, and at workshops at the Australian Graduate School of Management, the Royal Melbourne Institute of Technology, the Nanyang Technological University and the University of Southern Queensland, and in particular those of Greg Whittred, Steve Taylor, Roger Simnett, Kim Sawyer and Don Stokes. Financial support from the National University of Singapore is gratefully acknowledge. The usual caveats apply.

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Chan, YK., Walter, T.S. Qualified audit reports and costly contracting. Asia Pacific J Manage 13, 37–63 (1996). https://doi.org/10.1007/BF01739681

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