Adoption of international auditing standards leads to better financial reporting

(Press-News.org) Toronto - Despite a very uncertain economic climate, investors can at least feel confident that audited financial reports are more reliable thanks to the spread of international standards.

New research led by a researcher at the University of Toronto’s Rotman School of Management shows that the quality of financial audits increasing in countries which have adopted the International Standards on Auditing, or ISA, issued through the International Federation of Accountants, the accounting profession’s worldwide body.

“We show improvement in audit quality, on average,” said researcher Ole-Kristian Hope, the Deloitte Professor of Accounting at the Rotman School. However, “our findings also show that the effectiveness of the standards also depends in part on the enforcement.”

The ISA are developed out of best practices from around the world, are based on principles versus strict rules and were first issued as standards in 1991.

Since then and in line with the movement towards economic globalization, a growing list of countries and jurisdictions, more than 160, have voluntarily adopted the ISA either partially or fully into their own domestic practices and regulations. Canada has fully adopted the standards while the U.S. has partially integrated them. Nevertheless, there has not been much large-scale research into whether ISA has accomplished the goal of superior audit quality so that investors and anyone else interested in a company’s financial statements have high confidence that they are getting relevant and reliable information.

Prof. Hope and a team of three other researchers painstakingly hand-coded and analyzed data from 41 countries that had integrated ISA into their own auditing standards somewhere between 2001 and 2018. The fact that the countries did not all adopt ISA at the same time helped with comparisons.

ISA adoption had the most pronounced effect among domestic or smaller auditors. That may be because they had the most to gain from international accounting standards, compared to big global auditing companies that tend to have more stringent auditing practices, even sometimes going beyond ISA standards, due to their size, resources and reach.

The ISA also had a bigger impact in countries with stronger enforcement of auditing standards and where ISA had been more fully integrated into domestic practices, such as by making them mandatory.

To measure audit quality, the researchers primarily focused on the value of discretionary accruals, an accounting practice that allows for adjustment of earnings statements. The lower the value of discretionary accruals, the higher the rating of audit quality. While discretionary accruals can be used legitimately, such as to claim estimated earnings that have not yet been paid, they can also be misused and manipulated, making it hard to gauge a company’s financial health. The study found consistent results with alternative proxies for audit quality.

An exploratory machine learning analysis suggested that ISA enhances audit quality because of the standards’ focus on a company’s viability, compliance with legal requirements, fraud risk, its internal controls system, and related-party transaction.

Prof. Hope’s research was co-authored with Cyndia Wang of the University of British Columbia, Yaqian Wu of Nanjing Agricultural University and Min Zhang of Renmin University of China. The study appears in The Accounting Review.

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For more information:

Ken McGuffin

Manager, Media Relations

Rotman School of Management

University of Toronto

E-mail:mcguffin@rotman.utoronto.ca

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