The Impact of Potential Litigation Risk Motives arising from Material Errors & Misstatement in Clients’ Financial Reporting on Modified Audit Opinion

Subject Areas :

محمد حسنی ¹ ( گروه حسابداری وحسابرسی،دانشکده مدیریت،واحدتهران شمال،دانشگاه آزاداسلامی،تهران ،ایران )

Received: 2022-07-17 Accepted : 2022-09-21 Published : 2022-09-23

Keywords: Key words: Modified Audit Opinion, Litigation Risk, Errors & Misstatement in Financial Reporting,

Abstract :

Abstract Considering the importance of potential litigation risk motives in the risk-based audit process, this paper assessed the impact of annual audit adjustments and earnings management due to material errors & misstatement in clients' financial reporting on the modified audit opinion. Research population includes 131 listed firms in Tehran Securities & Exchange over the period March 2012 till March 2020. Research Hypotheses analyzed using multivariate binary logit regression models based on firm-year observations. Findings showed that more earnings management due to misstatement in clients’ financial reporting lead to increase the likelihood of issuance the modified opinion by auditors. Also, as the prior period adjustments due to errors in clients’financial reporting increase, the likelihood of issuance the modified audit opinion has increased. In addition, the evidence suggested that the higher level of abnormal accruals and abnormal real activities to manage earnings has strengthened the positive relationship between annual adjustments and likelihood of issuance modified audit opinion. In fact, annual adjustments and earnings management as consequences of errors and misstatement in clients' financial reporting expose auditors to litigation risk, which is expected to result in more auditors effort and audit quality in risk-based audit process. In such circumstances, the auditors act conservatively in order to reduce the potential litigation risk and respond by issuance the modified audit opinion.

References:

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