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Earnings management and audit quality: stakeholders’ perceptions

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Abstract

This paper examines the perceptions of Libyan Commercial Banks’ (LCBs) stakeholders regarding the role of the external auditor in relation to earnings management (EM). A total of 28 semi-structured interviews were carried out with a range of LCB stakeholders comprising preparers of financial statements, users, regulators and academics. A questionnaire survey of stakeholders which yielded 102 Responses (response rate 53%) was also carried out. A variety of views were held which varied to some extent according to stakeholder group. A widely held perception amongst interviewees was that the auditor has the ability to detect EM practices but may not be able to prevent it. However questionnaire respondents were, in aggregate, more confident of the auditor’s ability to deter EM due to the influence of the audit report. The paper provides insights into stakeholders’ perceptions of the quality of bank audits. The findings are of particular relevance to regulators, and specifically, the Central Bank of Libya. Perceptions of audit quality raise questions about its guidance and regulations especially in connection with audit firm rotation. Perceptions of audit quality, and therefore, of the credibility of financial statements should be of interest to all stakeholders. The importance of the banking sector for society has been amply demonstrated in recent years. A well-functioning audit function is a key component of its regulation. To the best of our knowledge, this paper is the first to examine issues related to banks’ audit quality and audit firm rotation in Libya.

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Notes

  1. Before 1952 when Libya gained its independence, there was no national accounting body nor accounting firms, business firms at that time were served by foreign accounting firms from Italy and UK (Ahmad and Gao 2004).

  2. During the 1950s and 1960s, most of the accounting firms which worked in Libya were either British or American; Libyan accounting firms have existed only since 1970 (Mahmud and Russell 2003).

  3. This situation still remains the case, and it may of course be even worse. As with other Libyan institutions, the LAAA is having to cope with the disruption caused by the Libyan revolution and its aftermath.

  4. The accounting education system was primarily based on UK and US systems; therefore, it is logical that the accounting profession is influenced by both UK and US practices. Practitioners are the products of the education system as emphasised by Ahmad and Gao (2004) who suggest that the educational system is the first stage in the qualifying accountants process.

  5. Article 82 of the law requires the Central Bank of Libya to maintain a register of external auditors who are capable of auditing and inspecting banks’ accounts.

  6. Some scholars, according to Gong (2009), argue that “auditing has strong anticorruption functions” due to the nature of audit work which puts the auditors in a position to uncover and deter potentially illegal or immoral behaviour.

  7. The law has not defined what approved accounting standards are. Financial reporting in Libya is largely influenced by the legal system; in particular the Libyan mercantile law, income tax law, and banking law for commercial banks, are considered to be the most important legal factors that have shaped accounting practices in Libya (Shareia 2014).

  8. See for example, Corbella et al. (2015) employed two different measures of EM to test for audit quality.

  9. Means and standard deviations are, strictly speaking, not appropriate as measures of ordinal data, but their use is widespread and they arguably have reasonable information content subject to assumptions made about the intervals in the ordinal data.

  10. Threatening that he/she may issue a qualified opinion.

  11. According to the CBL’s regulation, an auditor can only be assigned for maximum 2 years for the same bank. However, the appointment may be renewed after a 1 year audit by another auditor.

  12. There are, in Libya, two reports an auditor has to submit to the general assembly; a detailed report which normally consists of auditor’s remarks on the internal control system and any mistaken transactions, the other is the opinion report.

  13. Trust can broadly be defined as “a mechanism that can reduce uncertainty in context of interaction and facilitate the functioning of organizational systems” (Malsch and Gendron 2009, p. 739).

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Author information

Authors and Affiliations

  1. School of Social Science, Heriot-Watt University, Dubai, United Arab Emirates

    Yasser Barghathi

  2. Accounting and Finance Department, University of Dundee, Dundee, UK

    David Collison

  3. ABS Department of Accounting and Finance, The Robert Gordon University, Aberdeen, UK

    Louise Crawford

Authors
  1. Yasser Barghathi
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  2. David Collison
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  3. Louise Crawford
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Correspondence to Yasser Barghathi.

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Barghathi, Y., Collison, D. & Crawford, L. Earnings management and audit quality: stakeholders’ perceptions. J Manag Gov 22, 629–659 (2018). https://doi.org/10.1007/s10997-017-9396-2

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