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The effect of real activities manipulation on going concern audit opinions for financially distressed companies

Author

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  • Hongkang Xu
  • Mai Dao
  • Jia Wu

Abstract

Purpose - This study aims to examine the effect of real activities manipulation (RAM) on auditors’ decision of issuing going concern (GC) opinions for distressed companies. Design/methodology/approach - This study estimates and examines three types of RAM: reduction of discretionary expenses, sales manipulation and overproduction. It investigates the effect of RAM on auditor reporting conservatism by including the three measures of RAM methods in logistic regressions that explain the issuance of going concern opinions. The authors perform the analysis specifically on distressed firms for 2004-2013 period. Findings - This study finds a significant and positive association between RAM and the likelihood of receiving going concern opinion in the financial distressed firm sample, suggesting that client’s abnormal business activity affects the auditor reporting conservatism. Practical implications - This study provides evidence that auditors make going concern reporting decisions in consideration of the client’s abnormal operating decisions and management’s opportunism. Originality/value - Recent literature argues that auditors have little recourse other than to resign if a client uses RAM to impact earnings or the financial statements, and hence the enhanced audit quality in the post-SOX period is due to the shift from using accruals management to RAM (Cohenet al., 2008;Chiet al., 2011;Kim and Park, 2014). The evidence provided in this study indicates that auditors report more conservatively (rather than simply resign) in response to the aggressive RAM.

Suggested Citation

  • Hongkang Xu & Mai Dao & Jia Wu, 2018. "The effect of real activities manipulation on going concern audit opinions for financially distressed companies," Review of Accounting and Finance, Emerald Group Publishing Limited, vol. 17(4), pages 514-539, October.
    • Handle: RePEc:eme:rafpps:raf-09-2016-0135
    DOI: 10.1108/RAF-09-2016-0135
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    Citations

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    Cited by:

    1. Mihai CARP & Iuliana Eugenia GEORGESCU, 2019. "The Influence of Audit Opinion on the Degree of Real Earnings Management. The Case of Romanian Listed Companies," The Audit Financiar journal, Chamber of Financial Auditors of Romania, vol. 17(156), pages 666-666.
    2. Ahmed A. Diab & Samir I. Abdelazim & Aref M. Eissa & Eid Mahmoud Abozaid & Mona Mohamed Elshaabany, 2021. "The Impact of Client Size and Financial Performance on Audit Opinion: Evidence from a Developing Market," Academic Journal of Interdisciplinary Studies, Richtmann Publishing Ltd, vol. 10, January.

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