Conservative accounting: less accurate but better?
In another example of bringing real world insight into areas previously only examined through theory, Professor Zang’s empirical research has also uncovered the impact on audit quality of another controversial change in the accounting world—the move away from conservative accounting.
Under a conservative accounting approach, companies are slower to recognise profits and faster to acknowledge losses in the reported accounts. In recent years, standard setters have steered away from this seemingly prudent approach in favour of real-time accuracy—for example reporting the fair market value is favoured over reporting historical-based assessments.
In theory, auditors prefer conservative accounting so that companies will not hold on to bad news until the last possible moment.
Putting this theory to the test, Professor Zang and his colleagues used audit-related information from the Audit Analytics database for the period of 2000-2010, and merged it with other data to obtain financial and stock return variables.
Their findings, in the article recently published in The Accounting Review “Client Conservatism and Auditor-Client Contracting” with M. L. DeFond and C. Y. Lim, pointed to benefits not previously appreciated with conservative accounting. They found that auditors of more conservative clients charged lower fees, issued fewer going concern opinions, and resigned less frequently.
More opportunities to investigate factors affecting audit quality could come with further changes to financial reporting and auditing rules, says Professor Zang. These include proposals in the US to disclose the name of the individual audit partners in charge of the audit, rather than just the name of the audit firm.
“With more information about an individual’s background, social interactions, and educational background, we could do more interesting research about the impact of networks on audit quality,” he says.
The effect of informal business networks on audit quality might be particularly important to markets with limited pools of directors, like Singapore, says Professor Zang.
“Companies like to find directors with experience in the industry, and this creates many connections across many companies. If we do not pay close attention, independence could be endangered.”
Asian Scientist Magazine is a media partner of the Singapore Management University Office of Research.
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Copyright: SMU Office of Research. Read the original article here; Photo: Cyril Ng.
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