Publication Type
Journal Article
Version
acceptedVersion
Publication Date
11-2023
Abstract
Accounting researchers have documented that a discontinuity exists in earnings distribution around zero. However, there is considerable debate among researchers whether the earnings discontinuity around zero is caused by earnings management. We aim to shed light on the earnings discontinuity debate by examining the impact of audit adjustments on the distribution of earnings using a unique dataset from Singapore containing both recorded and waived adjustments. We find that audit adjustments do not reduce the discontinuity of earnings distribution around zero. This affirms that the results of Lennox et. al (2016) based on pre-tax earnings also apply to post-tax earnings and are not restricted to China only. In addition, we also find that the incidence of small profits and losses are not significantly different in the full sample after considering both recorded and waived audit adjustments. Our findings suggest earnings discontinuity around zero is not caused by earnings management in the form of accounting misstatements. Our results provide evidence that researchers should reconsider making assumption that auditing alleviates the tendency of loss avoidance by clients. Overall, our results suggest that the relative incidence of small profits versus small losses is not a good proxy for audit quality. Our research findings are relevant to accounting researchers, regulators, and audit committee members for making policies on audit quality.
Keywords
audit quality, audit adjustments, earnings management, discontinuity in earnings distribution
Discipline
Accounting | Corporate Finance
Research Areas
Corporate Governance, Auditing and Risk Management
Publication
Pacific Accounting Review
Volume
35
Issue
5
First Page
746
Last Page
772
ISSN
0114-0582
Identifier
10.1108/PAR-09-2022-0141
Publisher
Emerald
Citation
LIM, Chu Yeong; SUWARDY, Themin; and ZHANG, Tracey Chunqi.
Audit adjustments and the discontinuity in earnings distribution around zero. (2023). Pacific Accounting Review. 35, (5), 746-772.
Available at: https://ink.library.smu.edu.sg/soa_research/2013
Copyright Owner and License
Authors
Creative Commons License
This work is licensed under a Creative Commons Attribution-NonCommercial-No Derivative Works 4.0 International License.
Additional URL
https://doi.org/10.1108/PAR-09-2022-0141