Document Type : Research Paper

Authors

• Hanie Hekmat ¹
• Vahid Heydarzadeh khalife khandi ²
• Razieh Ghorbani ³

¹ Assistant Professor,Department of Accounting, Faculty of Social Science and Econimic,Alzahra University, Tehran, Iran

² PhD Student of Accounting, Faculty of Management and Economics, Shahid Bahonar University of Kerman, Kerman, Iran

³ PhD Student of Accounting, Faculty of Management and Accounting, College of Farabi, University of Tehran, Qom, Iran

Abstract

The purpose of this research is to investigate the moderating role of conservatism in the relationship between audit quality and earnings management. The current research is analytical and correlational. Furthermore, this study is considered quantitative based on the nature and characteristics of the data used to analyze the hypotheses. Data collection involved first using the library method, followed by statistics provided by the Tehran Stock Exchange Organization. The findings obtained from the regression model, based on a sample of 110 companies listed on the Tehran Stock Exchange over an 8-year period from 2015 to 2022, indicate that audit quality has an inverse and significant relationship with earnings management. Additionally, it was found that conservatism influences the relationship between audit quality and earnings management. The results concluded that conservatism reduces earnings management by recognizing losses promptly and delaying the recognition of profits. Since audit quality reduces information asymmetry, it limits profit manipulation through earnings management. In this context, conservatism plays a vital role in restricting managers' opportunistic reporting. Also, conservatism diminishes the company's incentives for earnings management, thereby reducing biases caused by managerial opportunism in accounting. Consequently, conservatism is expected to have a moderating role in the relationship between audit quality and earnings management, and the findings of this research confirm these expectations.
Introduction
The objective of this research is to investigate the moderating role of accounting conservatism in the relationship between audit quality and earnings management. In today's capital markets, earnings management has become a critical concern. It is a tool used by company management to influence earnings so that the numbers reach a predetermined target. This approach is employed for various reasons, one of which is earnings smoothing. As a result, instead of experiencing years of abnormally high or negative earnings, companies aim to maintain relatively stable results by employing innovative accounting tactics (Ismail et al., 2022). The main objective of financial statement auditing is to assure users that the financial statements are prepared in accordance with International Financial Reporting Standards (IFRS). According to IFRS, financial reporting must provide truthful information, ensuring that financial statements accurately present the information they claim to provide. It is therefore logical that audit quality has an inverse relationship with the occurrence of earnings manipulation (Ismail et al., 2022). There is also substantial research suggesting that the level of accounting conservatism may reduce the practice of earnings management (Chen et al., 2007; Ball et al., 2000; Khan & Watts, 2009; Aminu & Hassan, 2018; Li et al., 2018). Chen et al. (2007) argued for the existence of a trade-off in conservative practice. Adopting the principle of conservatism may lead to more noise in accounting reports, potentially reducing the value of the stewardship role. On the other hand, this principle may decrease the practice of earnings management. However, Chen et al., (2007) asserted that under reasonable conditions, the reduction in earnings management is sufficient to compensate for the noise caused by excessive accounting conservatism. Legislators, standard setters, and academics have expressed concern that companies use conservative accounting coverage to manage earnings (AICPA, 1939; Devine, 1963; FASB, 1980; Levitt, 1998; Penman, 2001). A significant number of previous studies link the effects of earnings management to audit quality issues (Chowdhury & Eliwa, 2021). The importance of this research lies in its effort to fill the gap in understanding the moderating role of accounting conservatism in the relationship between audit quality and earnings management.

Methodology

Research Type: Based on its objective, this research falls under the category of applied research. Applied research uses the theories, principles, and techniques developed in basic research to address practical, real-world problems. In terms of methodology and nature, this research is a correlational study. Additionally, it is considered descriptive research, as the researcher does not intervene in the position, state, or role of the variables. The research method is inductive.
Data Collection: Data collection will be conducted in two stages. In the first stage, a literature review will be performed using library resources and specialized Persian and English texts to establish the theoretical and conceptual framework of the research. In the second stage, financial data for the research will be extracted from the financial statements of companies listed on the Tehran Stock Exchange.
Data Analysis: Eviews software will be used to analyze the collected data.
Population and Sample: The population of this study includes all companies listed on the Tehran Stock Exchange between 2015 and 2022 (eight years). After applying the necessary limitations, the sample size for this research will consist of 110 companies listed on the Tehran Stock Exchange, representing 880 company-years. It is important to note that only listed companies are included in the study.

Result

Hypothesis 1: To test the first hypothesis of the study, Model (1) was used. The results of the model estimation show that the coefficient of audit quality (0.3645) is significant at the 5% level, indicating a significant inverse relationship between audit quality and earnings management. Among the control variables, firm size, sales growth, and research and development expenses exhibit a positive and significant relationship with earnings management, while financial leverage shows a negative and significant relationship. Additionally, it was found that book value, operating expenses, and sales volatility do not have a significant relationship with earnings management. The variance inflation factor values confirm the absence of multicollinearity among the explanatory variables. The significance of the F-statistic (3674.6) at the 1% level demonstrates that the model is significant. The Durbin-Watson statistic (2.0803) indicates no autocorrelation problem in the model components. Furthermore, the coefficient of determination shows that the independent variable explains approximately 53% of the variation in total. Based on these results, the first hypothesis of the study is not rejected at the 5% confidence level.
Hypothesis 2: To test the second hypothesis of the study, Model (2) was used. The results show that the coefficient of the audit quality variable (0.6577) is significant at the 5% level, indicating a significant inverse relationship between audit quality and earnings management. The coefficient of the conservatism variable (0.7305), significant at the 10% level, reveals a significant inverse relationship between conservatism and earnings management. Finally, the combined coefficient of determination for audit quality and conservatism (0.5913) is significant at the 5% level, indicating that conservatism moderates the relationship between audit quality and earnings management. The variance inflation factor values confirm the absence of multicollinearity among the explanatory variables. The significance of the F-statistic (1893.6) at the 1% level demonstrates that the model is significant. The Durbin-Watson statistic (2.1972) indicates no autocorrelation problem in the model components. Furthermore, the coefficient of determination shows that the independent variable explains about 51% of the variation in total. Based on these results, the second hypothesis of the study is not rejected at the 5% confidence level.

Conclusion

The results of the test for the first hypothesis indicate a significant inverse relationship between audit quality and corporate earnings management. Low audit quality occurs when audited financial statements contain errors that the auditor has not identified or disclosed in their report. Therefore, audit quality can be associated with the quality of financial reporting, as higher audit quality ensures higher reporting quality. The presence of audit quality reduces in information asymmetry, which in turn decreases earnings manipulation through earnings management. These results are consistent with the research of Hanoun et al. (2010), Alzoubi (2017), Fatahi Nafchi, and Fazel Dehkordi (2018), and Khajavi and Maimand (2015). The results of the test of the second hypothesis show that conservatism has a moderating effect on the relationship between audit quality and earnings management. Audit quality reduces information asymmetry, which subsequently decreases earnings manipulation through earnings management. In this context, conservatism plays an important role in restricting opportunistic reporting by managers. Furthermore, conservatism reduces a company's motivation for earnings management, thereby mitigating the biases caused by opportunism in accounting.
 
 

Keywords

• Audit
• Audit Quality
• Conservatism
• Earnings Management

Main Subjects

• Accounting and various aspects of finance
• Financial audit
• Profit management