# Master s#thesis# Audit#style#of#a#big#4#audit#firm#and#financial#statement#comparability#

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1 ERASMUSUNIVERSITYROTTERDAM ErasmusSchoolofEconomics Department:Accounting,AuditingandControl Master sthesis W.vanOs Auditstyleofabig4auditfirmandfinancialstatementcomparability AnassessmentastowhetheramoreprincipledLbasedaccountingstandardapproachwouldinfluence theeffectofthebig4auditfirmonfinancialstatementcomparabilityascomparedtoruleslbased accountingstandards.!!! Abstract Althoughstandardsettersaimtomakefinancialstatementsmorecomparablewithuniformaccounting standards, prior literature shows that uniform accounting standards do not automatically lead to comparable financial statements. This study examines as to whether an audit firm influences the financialstatementcomparabilityinauksetting.duetoinlhouseworkingrulesofaspecificauditfirm, the audit firm influences the comparability of financial statements (Francis, Pinnuck and Watanabe, 2014).WhereprinciplesLbasedaccountingstandardsrequiremoreprofessionaljudgment,theprediction isthatanauditfirmhasmoreinfluenceonthefinancialstatementcomparabilityintheukcomparedto intheus.mysetofresultsshowthatthebig4auditfirmhasmoreinfluenceonfinancialstatement comparabilityinauk(principleslbased)settingcomparedtoaus(ruleslbased)setting. Keywords:auditstyle;financialstatementcomparability;principlesLbased;rulesLbased;big4. Date July2015 Student W.vanOs Studentnumber Supervisor Dr.C.D.Knoops CoLreader Drs.R.vanderWalRA 74

2 TableofContents 1.INTRODUCTION! 4! 1.1INTRODUCTIONOFTHETOPIC 4! 1.2RESEARCHQUESTION 5! 1.3RELEVANCE 6! 1.4STRUCTURE 6! 2.LITERATUREREVIEW! 8! 2.1INTRODUCTION 8! 2.2RULESLBASEDVERSUSPRINCIPLESLBASEDSTANDARDS 8! 2.2.1STANDARDSANDTHEIMPACTONCOMPARABILITY! 8! 2.2.2AGGRESSIVEREPORTINGUNDERRULESLBASEDSTANDARDS! 9! 2.2.3SUMMARYRULESLBASEDVERSUSPRINCIPLESLBASEDSTANDARDS! 10! 2.3FINANCIALSTATEMENTCOMPARABILITY 10! 2.3.1EFFECTOFUNIFORMACCOUNTINGSTANDARDSFORINVESTORS! 11! 2.3.2EFFECTOFUNIFORMACCOUNTINGSTANDARDSFORDEBTHOLDERS! 14! 2.3.3UNIFORMACCOUNTINGSTANDARDSANDACCOUNTINGPRACTICES! 14! 2.3.4EFFECTOFCOUNTRYL,LEGALLANDPOLITICALLFACTORSONFINANCIALSTATEMENTCOMPARABILITY! 17! 2.3.5LOCALSTANDARDSANDFINANCIALSTATEMENTCOMPARABILITY! 19! 2.3.6SUMMARYFINANCIALSTATEMENTCOMPARABILITY! 20! 2.4AUDITORCHARACTERISTICS 21! 2.4.1INCENTIVES! 21! 2.4.2EFFECTAUDITFIRMONFINANCIALSTATEMENT! 22! 2.4.3INLHOUSEWORKINGRULESOFAUDITFIRMS! 23! 2.5SUMMARYANDCONCLUSION 25! 3.AUDITREGULATION! 27! 3.1INTRODUCTION 27! 3.2INDEPENDENTOVERSIGHTBODIES 27! 3.3CONCLUSION 30! 4.HYPOTHESESDEVELOPMENT! 31! 5.RESEARCHDESIGN! 33! 5.1INTRODUCTION 33! 5.2MODELS 33! 5.3CONTROLS 38! 5.4METHODOLOGYUS 39! 5.5METHODOLOGYUK 41! 5.6CONCLUSION 42! 6.!RESULTS! 43! 6.1INTRODUCTION 43! 2

3 6.2ASSUMPTIONSOLSREGRESSION 43! 6.3DESCRIPTIVESTATISTICSUS 43! 6.4DESCRIPTIVESTATISTICSUK 44! 6.5FINDINGS 46! 6.6ROBUSTNESS 49! 6.7CONCLUSION 50! 7.!SUMMARY!AND!CONCLUSION! 51! 7.1SUMMARY 51! 7.2LIMITATIONS 52! 7.3FURTHERRESEARCH 52! BIBLIOGRAPHY! 54! APPENDICES! 59! CONTROLVARIABLES 59! INDUSTRIES 60! OLSASSUMPTIONS 61! CHANGEINCALCULATIONOFCONTROLVARIABLES 67! ROBUSTNESS;SAMEINDUSTRIES 69! ROBUSTNESS;OPERATINGCASHFLOWASDEPENDENTVARIABLE 71! ROBUSTNESS;FINANCIALCRISIS 72! PEARSONCORRELATIONMATRIXUK 74! PEARSONCORRELATIONMATRIXUS 75! SUMMARYTABLE 76!! 3

4 1.Introduction 1.1Introductionofthetopic Thisthesiswillexaminetherelationbetween auditstyle andfinancialstatementcomparabilityoffirms in the United Kingdom (UK). The audit style is the set of internal working rules the audit firm uses. PreviousresearchhasexaminedtheimpactofinLhouseworkingrulesofbig4 1 auditfirmsonfinancial statement comparability with US firms (Francis, Pinnuck and Watanabe, 2014). Francis et al. (2014) founddifferencesintheinterpretationoftheaccountingstandardsduetotheinternalworkingrules. They found that firms in the same industry with the same big 4 audit firm have a higher financial statement comparability, based on accrual and earnings structure, compared to companies with a differentbig4auditfirm. Withthecurrentshifttowardsuniformaccountingstandardsandtheintendedconvergencebetween InternationalFinancial Reporting Standards (IFRS) and UnitedStates Generally Accepted Accounting Principles (US GAAP), the question arises: what is the role of the audit firm in the comparability of financialstatements.althoughthegoalofthe,in2002signed,norwalkagreement 2 wastoachievefull convergence,thisnolongerappearsrealisticunderthecurrentsentiment.inaspeechgivenbythechief accountantofthesecindecember2014,severalconcernswereaddressedaboutifrsadoptionthat include legalimpediments,practicalchallengesandanimpactoncomparability (Schnurr,2014).This thesisaimstoexaminewhethertheinlhouseworkingrulesofanauditfirmhaveastrongerinfluenceon thefinancialstatementcomparabilityinauksettingcomparedtoinaussetting.accordingtokothari, Ramanna and Skinner (2010, p. 276), principleslbased standards have a negative effect on the comparabilityofstandardsandan increasedpotentialformanipulation.kotharietal.(2010)assume thatitisnotcosteffectivetoworkwithprinciplesonadailybasis,thereforetheapplicationofstandards byaccountantsandauditorswillbedonewithworkingrules. 1 Big4auditfirmsrefertothelargestfouraccountingandauditfirms:Deloitte,EY,KPMG& PricewaterhouseCoopers 2 TheNorwalkAgreement(2002)isamemorandumofunderstandingsignedbytheInternationalAccounting StandardsBoard(IASB)andtheFinancialAccountingStandardsBoard(FASB).Inthismemorandumof understandingbothstandardboardspledgetousetheirbesteffortstomaketheaccountingstandardsmore comparable. 4

5 1.2Researchquestion WhereasFrancisetal.(2014)foundthattheauditstylehasaninfluenceonthecomparabilityofthe financialstatementsinasettingofusgaapfirms,thisthesiswillexaminewhethertheinlhouseworking ruleshaveagreatereffectonthefinancialstatementcomparabilitywiththeprincipleslbasedstandards intheuk.wherethepreparationoffinancialstatementsunderruleslbasedaccountingrequiresalistof detailed rules that must be followed, the principleslbased standards are based on the professional judgmentintheeffectuationofthestandards.theukgaapareregardedasverysimilartoifrs(bae, TanandWelker,2008).AssumingthattheIFRSisamoreprinciplesLbasedstandardsthantheGAAP,the comparison will be made between the UK and the US. This will be done by answering the following researchquestion: Does% the% audit% style % of% a% Big% 4% audit% firm% have% a% stronger% effect% on% the% financial% statements% comparability%when%the%accounting%standards%are%more%principles<based%instead%of%rules<based?% The answer to this research question is interesting with respect to the current shift towards more comparable standards and financial reports. Considering that the audit firm has an impact on the financial statement comparability, the question arises whether these inlhouse working rules of the auditor have a greater impact when the standards are principleslbased. Where Francis et al. (2014) conducttheirresearchinaussetting,thegoalhereistoexaminewhethertheseinlhouseworkingrules have a greater effect in a UK setting, which in comparison to the US, has a more principleslbased accounting standard. The convergence plan of the IASB and FASB aims to develop high quality, common accounting standards for use in the world s capital markets (IASB, 2008, p. 5). Where full convergence between IFRS and US GAAP might not currently be feasible, the importance of global comparablefinancialinformationisbothrecognizedbytheinternationalaccountingstandardsboard (IASB),FinancialAccountingStandardsBoard(FASB)andtheSecuritiesandExchangeCommission(SEC) (Schnurr,2014).PriorresearchhasalsoinvestigatedtheincreaseincomparabilityunderIFRS(Yipand Young,2012;Horton,SerafeimandSerafeim,2013).TheimplementationofIFRSstillrequiresjudgment in the selection and application of IFRS accounting treatment (EY, 2006). According to a report of EY (2006) these treatments have a negative effect on the consistency and comparability of financial statementsduetothejudgmentofaccountingpolicies. 5

6 1.3Relevance Thesubjectofthisthesisisrelevantwiththecurrentnegativesentimenttowardsandlackoftrustinthe audit profession. This study aims to provide an answer as to whether the audit firm as an economic agent has an impact on the financial statements. An economic agent could be defined as a person, company or organization that has an effect on the economy by producing, buying or selling. It is assumedinthisthesisthattheauditfirmhasaroleintheoutcomeofthefinancialstatements.possible reasonsareuniqueauditapproaches,interpretationsofaccountingandauditstandardsandconsistency inclientlerrordetection.moreover,thisthesisexamineswhethertheinfluenceoftheauditfirmonthe financialstatementcomparabilityincreaseswhentheaccountingstandardsaremoreprincipleslbased. WhethertheinLhouseworkingrulesofanauditoraffectthefinancialstatementcomparability,mightbe usefulforinvestors,firms,auditfirmsandregulators.withtheaimofstandardsetterstomakefinancial reportsmorecomparable,thisresearchgivesaninsightontheimpactofthe auditstyle fortheaudit qualityandtheimpactoftheworkinglrulesofauditfirmswhentheaccountingstandardsareprinciplesl based.furthermorethisthesisprovidesinsightintotheroleofeconomicinstitutions auditors inthe comparability of financial statements. The existing literature of financial statement comparability is mainlyfocusedonthecomparabilityofaccountingstandardsandtheimpactofthesestandardsonthe comparabilityoffinancialstatements.furthermore,thegoalistoevaluatetheroleoftheauditorinthe productionofthefinancialstatements.itisimportanttorecognizewhethertheroleoftheauditoron financialstatementcomparabilityincreaseswhentheaccountingstandardsaremoreprincipleslbased. Theoutcomeisrelevantforstandardsetters. ThefindingsofmyresearchshowtheimpactofprinciplesLbasedorrulesLbasedaccountingstandardson the differences in financial statement comparability between firms with the same audit firm. In summary, this assumes that the audit firm has more influence on financial statement comparability whentheaccountingstandardsaremoreprincipleslbased.wherepriorliteraturemainlyexaminedthe impactofaccountingstandardsonthecomparabilityoffinancialstatements,thisresearchshowsthat big4auditfirmsintheukhaveanimpactonthecomparabilityoffinancialstatements.thisimpactofa big4auditfirmonfinancialstatementcomparabilityislargerintheukcomparedtoaussetting. 1.4Structure Theremainderofthispaperisstructuredasfollows:thesecondchaptercontainsaliteraturestudythat examines prior literature of ruleslbased versus principleslbased standards, financial statement 6

7 comparabilityandthecharacteristicsoftheauditorthatinfluencetheaccountingoutcome.thethird chapter provides an overview of audit regulation in the UK in relation to the US. The fourth chapter contains the development of the hypotheses. After the hypotheses development, the fifth chapter showstheresearchdesignandthemeasurementmethodoffinancialstatementcomparability.thelast chaptershowstheoutcomeoftheresearchandcontainsananalysisofthisoutcome. 7

8 2.LiteratureReview 2.1Introduction Theliteraturereviewwillbebasedonfourstreamsofliterature.Firstly,theliteraturethatprovidesan insightintheruleslbasedandprincipleslbasedstandards.theresearchquestionofthispaperisbased onadifferenceinauditstylewhenthestandardsaremoreprincipleslbased.therefore,thedifferences betweenprincipleslbasedandruleslbasedstandardsarerelevant.secondly,theliteraturerelatedtothe financialstatementcomparabilitywillbeidentifiedandevaluated.thispartshowspriorresearchwhich focusesspecificallyontheimpactofuniformaccountingstandardsonfinancialstatementcomparability. The last part will examine the literature that relates the auditor characteristics to performance and financialstatementmeasures.thismainlyexaminespriorliteraturethatshowstheeffectsoftheaudit firm on the financial statements. This is relevant considering the assumption that firmlspecific characteristicsoftheauditfirmhaveanimpactonthefinancialstatement. 2.2RulesLbasedversusprinciplesLbasedstandards AftersomeaccountingscandalstheFASBcamewiththeSarbanesLOxleyAct(SOx)in2002.Accordingto thefasbtherewasanimpressionthataccountingstandardsweredifficult,complexandcostlytoapply (MacDonald,2002)duringtheperiodoftheimplementationofSOx.Inthisresearchtheassumptionis made that the audit style has more impact on the comparability of financial statements when the accounting standards are principleslbased. Therefore this chapter examines prior research that discussesthebasisoftheaccountingstandards Standardsandtheimpactoncomparability AccordingtoAgoglia,DuopnikandTsakumis(2011)USGAAPisoftendescribedandcriticizedforbeinga ruleslbasedaccountingstandard.thiscanbecontrastedtotheifrsstandards,whicharedescribedas principleslbased.accordingtonelson(2003)animportantdifferenceisthatprincipleslbasedstandards have expressions that are less precise and expressions that are less precise could lead to different interpretations. These different interpretations result in a decrease in comparability of financial statements (Nelson, 2003). Whereas the ruleslbased accounting standards rely on detailed guidance, i.e.,howtoaccount,theprincipleslbasedaccountingstandardsrelyontheprofessionaljudgmentofthe auditor(scott,2014).nobes(2005)assumesthatusgaaparebasedonrules,becausetheunderlying 8

9 principle is poor or because there is a lack of principles. Nobes (2005) research is in line with the researchofnelson(2003),whoconcludesthatruleslbasedstandardsleadtoanincreaseinclarityand comparability. Although Nobes (2005) agrees with Nelson (2003) about the notion that more precise standards results in increased comparability, he argues that less rules could also lead to increased comparability. According to Nobes (2005) principles could be clearer, what leads to increased comparability and less rules. Van Beest and Knoops (2011) provide an overview of literature that examinedtherelationofprincipleslbased/ruleslbasedaccountingstandardsandearningsmanagement. The authors state that according to prior literature it is unclear whether principleslbased accounting standardsleadtoanincreaseordecreaseinearningscomparability. Katherine Schipper (a member of the FASB during 2001L2006) published an article in 2003 about principleslbasedaccountingstandardsafterthepublicationofsox.schipper(2003)observedthatthe US GAAP as a ruleslbased standard was undesirable, and a shift towards more principleslbased standardswasdemandedbyusersoffinancialstatements.schipper(2003)explainsthat,althoughus GAAPisperceivedasarulesLbasedstandard, itwas originally based upon principles. Schipper(2003) elaborates on the impact of treatment exceptions (the accounting treatment for an exception in the standard) and scope exceptions (how to treat items that are excluded) on the rules. Schipper (2003) argues that the treatment and scope exceptions lead to more rules and therefore a ruleslbased accountingstandard.ontheotherhandthesescopeandtreatmentexceptionsareanexplanationfor theapplicationofthestandard.shearguesthatwhenfinancialstatementcomparabilityisdesirable,itis necessary to limit the permissible treatments of events in the financial statements. Schipper (2003) argues that the reason the FASB needs to have ruleslbased reporting standards that are based on principlesistoachievecomparabilityandconsistency AggressivereportingunderrulesLbasedstandards Agoglia et al. (2011) investigated whether CFOs are more likely to report aggressively when the standards are more principleslbased or ruleslbased. Agoglia et al. (2011) found that moreprinciplesl based standards result in less aggressive reporting. The authors conducted the research with an experimentaboutaleaseclassificationcriterion.theyfoundthatmanagershaveahigherlikelihoodto capitalize the lease when the lease classification criterion is less precise. According to Agoglia et al. (2011) the reason managers will report less aggressively is because principleslbased accounting standardshavetheabilityformanagerstoreflecttheunderlyingeconomicreality.theresultsshowthe importance of principleslbased standards and could be used as an argument for standard setters to 9

10 movetowardmoreprincipleslbasedstandards.intheirexperiment,theauthorsalsofoundthatastrong audit committee has an impact on the extent of aggressive reporting when the standards are rulesl based SummaryrulesLbasedversusprinciplesLbasedstandards PriorliteraturehasexaminedtheimpactofprinciplesLbasedorrulesLbasedaccountingstandards,and whether principleslbased or ruleslbased standards are desirable. Before attempting to answer this question,itisnecessarytoexaminewhetherusgaaporifrsareruleslbasedorprincipleslbased.in prior literature US GAAP is defined as a ruleslbased standard and IFRS as a more principleslbased standard. Suggested in prior literature is that a ruleslbased accounting standard increases the comparabilityandclarity.literaturealsoshowsthattheruleslbasedaccountingstandardapproachhas merits and limitations. The ruleslbased accounting standards might be too complex and difficult to apply.anotherviewisthatprincipleslbasedstandardsaremoreappropriateandhavelessaggressive reporting as a result. This view suggests that principleslbased standards will eventually lead to more comparable financial statements. Mentioned conditions to achieve comparability are clear principles andnecessaryexpertisetoapplytheprinciple. 2.3Financialstatementcomparability Asitistheaimofthestandardsboardstomakefinancialreportsmorecomparablethroughauniform set of accounting standards, it is pertinent to ask whether uniform standards will lead to higher comparability.inordertoaddressthequestionitisnecessarytoconsidertheimpactofifrsonfinancial statementcomparability.furthermoreitwillbeusefultoexaminepriorliteraturethatshowstheeffect of comparable financial reports on the capital markets. Additionally this section examines whether politicall, legall and countrylfactors have an impact on the financial statement comparability. Lastly, there will be an analysis on whether the local environment of a country has an influence on the comparabilityoffinancialstatements. In the International Accounting Standards Board (IASB) Framework and the Financial Accounting StandardsBoard(FASB)ConceptsStatements,comparabilityisdefinedasaqualitativecharacteristicof financial information (IFRS, 2005). The definition of comparability given in the exposure draft of the conceptualframeworkforfinancialreportingis(iasb,2015): 10

11 Information about a reporting entity is more useful if it can be compared with similar information aboutotherentitiesandwithsimilarinformationaboutthesameentityforanotherperiodoranother date. Comparability enables users to identify and understand similarities in, and differences among, items. Accordingtothisdefinitiontheassumptioncouldbemadethatfirmsreportsimilaraccountingnumbers in case of similar economic events. ThisisinlinewiththedefinitionofBeuselinck,JoosandVander Meulen (2007) where the definition is based on regulator views (Jenkins, 1999) and prior academic research(landandlang,2002).theydefinecomparabilityas: toaccountsimilarlyforaliketransactionanddifferentlyfordissimilartransaction (Beuselincketal., 2007,p.3) Toachievecomparability,priorliteraturesuggeststhattheaccountingproceduresmustbeconsistent anduniform.consistentproceduresmeansthattheuseofaccountingproceduresisthesameovertime. Uniformityreferstotheuseofthesameproceduresbydifferentfirmsinthesamecircumstances Effectofuniformaccountingstandardsforinvestors WiththesigningoftheNorwalkAgreementtheIASBandFASB pledgedtousetheirbesteffortto(a) maketheirexistingfinancialreportingstandardsfullycompatibleassoon as is practicable and (b) to coordinate their future work programs to ensure that once achieved, compatibility is maintained. EventsthatincreasedthelikelihoodofIFRSadoptionintheUShavehadapositivemarketreaction.This shows that investors expected to have benefits when IFRS reporting is in place (Armstrong, Barth, JagolinzerandRiedl,2010).InlinewithArmstrongetal.(2010),JoosandLeung(2013)investigatedthe effectofeventsthatincreasethelikelihoodofifrsadoptionforusfirms.consistentwithresearchof Amstrongetal.(2010),JoosandLeung(2013)foundapositivemarketreactionwhenthelikelihoodof IFRSadoptionincreases.Moreover,JoosandLeung(2013)showanincreasingpositiveeffectwhenthe convergence benefits of the company are perceived higher and a smaller effect when the firm has a higher litigation risk. According to Joos and Leung (2013) convergence benefits are reduced costs for investors to compare financial reports. Whether or not the market reaction after an increasing likelihood of IFRS adoption is due to a greater financial statement comparability or audit quality is unclear(armstrongetal.,2010). 11

12 One method to determine whether uniform standards lead to an increase in comparability is to determinewhetherthereisachangeintheuseofinsiderinformationbyinvestorsandanincreasein crosslborderinvestments.brochet,jagolinzerandriedl(2013)assumethatifthefinancialstatements aremorecomparable,therearelessopportunitiesforinsiderstobenefitfrominsideinformation.with the adoption of IFRS the authors expect that there is more of, as well as higher quality public information and less private information. The reason is thatthe adoption of IFRS allows users of the financialstatementstobetterdeduceandcomparefinancialinformation.brochetetal.(2013)found thattheabilityforinsiderstouseinsideinformationisreducedbytheadoptionofifrsforcompanies from the UK. According to Brochet et al. (2013) this suggests that the adoption of IFRS improved financialstatementcomparability.beneish,millerandyohn(2015)suggestthatthemandatoryadoption of a global standard such as IFRS increased the crosslborder investment flows for debt and equity investors.beneishetal.(2015,p.24)foundthattheincreaseinforeigndebtinvestmentsafteradoption of IFRS is not associated with the quality of the government, a higher economic development and creditor rights prior to adoption.a rather different outcome is found for the equity investors. The equity investments after the adoption of IFRS are positively associated with the quality of the government,theeconomicdevelopmentandthecreditorrightspriortoadoption. AccordingtoBeneishetal.(2015)animportantremarkisthattheincreaseinforeigninvestmentsafter IFRS adoption is probably due to higher financial reporting quality and not because of an increase in financial statement comparability. The authors examined this alongside the origin of the increase in investments.whentheincreaseininvestmentscomesfromothercountriesthatadoptedifrs,thenthe benefitininvestmentsisrelatedtotheadoption.whentheincreaseininvestmentsoriginatesfromnonl adopting IFRS countries, then this is due to an increase in reporting quality (Beneish et al., 2015). AlthoughthisargumentholdsforthereplacementoflocalGAAPforIFRS,boththeUSGAAPandIFRS areperceivedtobehighqualitystandards(leuzetal.,2003;joosandleung,2013).ifitisassumedthat both US GAAP and IFRS are high quality standards, the outcome of Joos and Leung (2013) and Armstrongetal.(2010)(positivemarketreactionwithahigherlikelihoodofIFRSadoptionintheUS) showthatthemarketreactsonthepotentialconvergencebenefits. WhereBeneishetal.(2015)focusonthemacroeconomiceffectofIFRSadoptionforequityanddebt investments,defrancoetal.(2011)examinedwhetherfinancialstatementcomparabilitychangesthe 12

13 ability for investors to acquire information. They found that an increase in financial statement comparabilitydecreasesthecostsofacquiringinformationandincreasesthequalityofinformationfor analysts (De Franco, Kothari and Verdi, 2011). DeFranco et al. (2011) had different ways to measure comparability.thefirstmethodtheyusedwasmeasuringthecovariationofearningsfordifferentfirms. Thismeasureiscalled earningscomparability bydefrancoetal.(2011).theearningscomparability measureassumesthatahighcomovementofearningsbetweenfirmsinthesameindustrylyearshows anincreaseincomparability.thesecondwayofmeasuringcomparabilityusedbydefrancoetal.(2011) isbasedontheassumptionthatbothfirmshavethesamestockpricereturn. 3 Firstlyallfirmsarepaired based on their industry and fiscallyear. DeFranco et al. (2011, p. 900) assume that firms that experienced the same economic events have more comparable accounting what eventually leads to morecomparablefinancialstatements.wherestockreturnsareusedasaproxyforeconomicevents, theauthorsstatethatusingjustearningsforfinancialstatementcomparabilityisalimitation.therefore DeFrancoetal.(2011)firstusedanequationwhereearningsisthedependentvariableandstockreturn the independent variable. The authors measure comparability with the closeness of the functions betweentwofirms.duetodifferencesineconomiceventsexperiencedbyfirms,theauthorsusethe accountingequationtopredicttheearningsbasedonthesameeconomicevent.withthisapproachthe authorspredictedearnings,assumingthatbothfirmshaveexperiencedthesameeconomicevents.this secondmeasureiscalled accountingcomparability. DeFondetal.(2011)expectedthattheadoptionofIFRSlowerstheacquisitioncostsofinformation,and thereforeresultsinhighercrosslborderinvestments.theseacquisitioncostsarealsomentionedbyyu (2010),whoexaminedwhetheruniformaccountingstandardsresultinlowerinformationasymmetryfor investors.yu(2010)statesthattheseprocessingcosts(similartotheacquisitioncostsofinformation mentionedbydefondetal.,2011)decreasewhenaccountingstandardsaremoreuniform.defondet al. (2011) found that mandatoryifrsadoption leads to a greater increase in foreign investments for companies in countries that have strong implementation credibility and a large increase in the uniformity of the accounting standards used by companies within an industry. The uniformity is measuredwiththechangeinthenumberofcompanieswithinanindustrythatusethesameaccounting standardaftertheadoptionofifrs.moreover,defondetal.(2011,p.256)suggestthatuniformityof accounting standards does not necessarily result in comparability of financial statements. As IFRS is 3 Theauthorsusetheregressionforfirmi:earnings ijt =a i +b i Return i Andforfirmj:earnings ijt =a j +b j Return i. Intheequationoffirmjthereturnremainsthereturnoffirmi 13

14 principleslbased, the differences in implementation are considered to be larger compared to more ruleslbased standards. The effect of credible accounting standards on the crosslborder investments dependsoneconomicinstitutionsandtheincentivesofmanagement(defondetal.,2011). Insummary,theliteraturesuggeststhatthemandatoryadoptionofIFRShadapositiveeffectonforeign investments. Additionally, prior literature provides evidence that higher comparability leads to increasingforeigninvestmentsaftermandatoryifrsadoption.therearealsosomemixedresultsabout the cause of increased crosslborder investments after IFRS adoption. Some authors argue that the increase in investments is due to an increase in financial statement comparability and convergence benefits.otherssuggestthatifrsisperceivedasahigherqualitystandard,whichleadstoanincreaseof crosslborderinvestments Effectofuniformaccountingstandardsfordebtholders TheadoptionofIFRSdidnotonlyhaveapositiveeffectontheinvestmentsintheequitymarket,the increasing effect is even stronger for investments in the debt market of that country (Beneish et al., 2015).ThisresultisinlinewithKim,KraftandRyan(2013),whostatethatmorecomparablefinancial statementsreducetheuncertaintyofdebtmarketparticipants.thereductioninthisuncertaintyresults inalowercostofdebt(kimetal.,2013,p.6).kimetal.(2013)foundthatcomparabilityoffinancial statementshadapositiveeffectonthebidlaskspreadoftradedbonds,reducedtheuncertaintyofdebt marketparticipantsandloweredthecreditriskofthefirm.assumingthattheimplementationofifrs makes financial statements more comparable, Li (2010) shows that the mandatory adoption of IFRS resultsinasignificantdecreaseinthecostofcapital.thissupportsthefindingsofkimetal.(2013)that morecomparablefinancialstatementsduetocomparableaccountingstandardsleadtoalowercostof capital.theseresultsshowtheimportanceofcomparablefinancialstatementsfortheusersoffinancial statements Uniformaccountingstandardsandaccountingpractices Dichev, Graham, Harvey and Rajgopal (2013) interviewed and distributed surveys among CFO s and financialexecutives.withthesurveysandinterviewstheauthorstriedtogaininsightinearningsquality. Firstly the authors examined the definition, characteristics and determinants of earnings quality. Secondlytheresultsshowhowstandardsettingaffects earningsquality.thethirdpartoftheresults showtheprevalence,magnitudeandthedetectionofearningsmanagement.the secondpartofthe 14

15 researchbydichevetal.(2013)isrelevantforthisstudy.theresultsshowthatcfosconsidertheus GAAPstandardsasaconstraintinprovidinghighqualityreports.Moreover,theresultsshowthatCFOs wantlessregulationsbystandardsettersandcontinuationoftheconvergenceprogramofusgaapand IFRS.Insummary,accordingtothesurveyandinterviewsofDichevetal.(2013)itcanbeconcludedthat CFO sconsiderfinancialreportingasmoreofa complianceactivityratherthanasameanstoinnovate todeliverthebestpossibleinformationtostakeholders (p.2).dichevetal.(2013)showthedemand forconvergenceofthestandardsbycfo s.thefindingsofdichevetal.(2013)showthatnotonlythe investors react positively to uniform accounting standards (Joos and Leung, 2013), it also shows that managersareinfavorofifrsadoption.theremainderofthisparagraphwillexaminewhetheruniform accounting standards will result in financial statement comparability, based on chosen accounting policiesandpractices.thesestudiesmainlyinvestigateifuniformaccountingstandardsleadtotheuse ofuniformaccountingpoliciesandpractices. Differencesinfinancialstatementcomparabilitycanariseduetodifferencesintheapplicationofthe GAAP. The effect of accounting standards on consistency in chosen accounting policies has been investigatedbyseveralresearchers.bradshawandmiller(2008)measurethechosenaccountingpolicies withtheaccruallcashflowrelationandmeasuresofconservatism.theapproachofbradshawandmiller (2008) could be classified as a measure that is based on accounting policy choices. They examined whetheracertainaccountingmethodischosenafteradoptionofusgaap,andwhetherthisaccounting methodissimilartoaccountingmethodsthatareusedbyothercompaniesintheindustry.bradshaw and Miller (2008) found that uniform accounting standards result in more comparable accounting numbersinaussetting.theyinvestigatednonluscompaniesthatvoluntarilyadoptedusgaap.the authors determine financial statement comparability as an increase in the use of similar accounting methodsafterusgaapadoption. Based on accounting outputs the authors found that the group of nonluscompaniessubstantiallymovetowardthegroupofusfirmsaftertheadoptionofusgaap. Additionally,BradshawandMiller(2008)foundthatstrongerregulatoryoversightincreasesthedegree ofcompliancewithusgaap.theauthorssupposethatfirmswithacrossllistingintheushaveahigher degreeofregulatoryoversight.whentheregulatoryoversightisstronger,therewillbeahigherlevelof compliance with the accounting standards. Bradshaw and Miller (2008) also show that uniform accountingstandardsleadtoanincreaseinanalysts forecastaccuracy.thisisshownmoreextensively by Bradshaw, Miller and Serafeim (2011). Bradshaw et al. (2011) examine the market effect when 15

16 companies use different accounting methods compared to the widely used methods within their industry. When a company has, compared to the accounting method that is widely used in their industry,an atypical accountingmethod,theauthorsexpectthattheforecastsofthesecompaniesare lessaccurate.consistentwiththeirprediction,bradshawetal.(2011)foundthat atypical accounting methodsleadtomoreforecasterrorsandlargerforecastdispersion. Althoughuniformaccountingstandardsresultinmorecomparableaccountingnumbers,thequestion whetherthisisbeneficialarises.sunder(2010)arguesthatuniformaccountingstandardsdonotleadto an improvement of financial reporting. To achieve higher quality financial reporting Sunder (2010) proposes a balance between written standards and unwritten social norms. Even though the same rulecouldbeappliedinthesamecountryandindustryitwillstilldependontheeconomyofwhichthe firm operates. The same set of rules does not necessarily lead to comparability of financial reports (Sunder, 2010). According to Sunder (2010) financial reports are a result of economic and financial conditionsontheonehand,andeventsandtheapplicablefinancialreportingrulesontheother (p.12). TheprinciplesLbasedaccountingstandardsrequiremoreprofessionaljudgmentandexpertisefromthe preparers and auditors of financial statements. Due to a higher degree of judgment involved in the applicationofthestandard,thereisahigherlikelihoodthatthesameeventsortransactionscouldhave different outcomes in the financial report. According to Sunder (2010) this leads to a lower comparabilityoffinancialstatements. Prior research has mainly focused on the impact on the comparability after the adoption of US GAAP/IFRS,withinitiativesfromstandardsetterstocreateuniformaccountingstandards.Barthetal. (2012)examinedthecomparabilityofaccountingamountsofUSfirmsandnonLUSfirmsthatadoptIFRS. TomeasurecomparabilityBarthetal.(2012)usedaccountingLoutputLbasedmeasuresofcomparability that relate the stock returns to earnings. This approach used by Barth et al. (2012) is based on the accounting comparability measureof DeFranco et al. (2011). The authors found that the adoption of IFRSbynonLUSfirmshasapositiveeffectonthecomparabilityoftheaccountingnumbersofUSfirms that report according to US GAAP. Moreover, Barth et al. (2012) show that three measures of accountingquality(earningssmoothing,accrualsqualityandearningstimeliness)areapotentialsource oftheincreaseincomparabilityofaccountingamountsafterifrsadoption. 16

17 2.3.4EffectofcountryL,legalLandpoliticalLfactorsonfinancialstatementcomparability Cascino and Gassen (2015) investigated the effect of mandatory IFRS adoption on the financial accounting information in a crosslcountry setting. They investigate the crosslcountry effect on comparability after the adoption of IFRS. The difference between other studies that measured the impactofifrsadoptiononfinancialstatementcomparabilityisthedeterminationofcountrylandfirml specificfactors. TheoutcomeoftheresearchshowsthattheeffectofIFRSadoptiononthefinancial statement comparability is very weak. Using Germany and Italy as main sample for countries of IFRS adoption,theauthorsfoundthattherearefactorsthatarefirml,regionlandcountrylspecific(cascino andgassen,2015).thesefirml,regionlandcountrylfactorscausedifferencesinthecomplianceofifrs amongdifferentcountries.intheirmeasureoffirmllevelincentivesofcompliancetheyalsodetermined theimpactofabig4auditfirmonthecomplianceofifrs.theoutcomeshowsthatabig4auditfirm leadstoahighercompliancescoreforthefirmcomparedtoanonlbig4auditfirm. Beuselinck et al. (2007) investigated the accounting comparability in 14 European countries and examinedtheunderlyingdeterminantofearningscomparability.theyfocusedontheaccruals cash flowrelationasanunderlyingdeterminantofcomparability.theauthorsassumethatthebusinesscycle andtheinstitutionalcountryfeaturesarethemostimportantdriversforreportingbehavior.withthe businesscycletheauthorswanttoexaminewhetherthereportingchoicesdifferwhentheeconomic circumstances(recessionorexpansion)change.theextentofthestockmarket,thedomesticbankdebt andthemembershipsoflaborunionsdeterminetheinstitutionalcountryfeatures.theauthorsfound thattheinstitutionalcountryfeaturesalsohaveanimpactonthereportingoutcome.beuselincketal. (2007) suggest that the role of the Big 4 audit firms have to be examined to establish accounting comparability. The authors state that the Big 4 audit firms have the international expertise and the knowledgeofnationaldifferences. JoosandLang(1994)foundthattheaccountingmeasurementpracticeshaveanimpactonthestock market valuation of accounting data and financial ratios. According to Joos and Lang (1994) the measurementpracticesingermanyduringtheirsampleperiodaremoreconservativecomparedtothe UK. Joos and Lang (1994) provide evidence that there are differences in measurement practices for France,GermanyandtheUK.Thiscouldprovidestructuraldifferencesintheapplicationofaccounting standardspercountry.thesecountrylspecificmeasurementpracticeshaveaneffectontheaccountingl basedperformancemeasures.theoutcomeoftheresearchofjoosandlang(1994)isinlinewiththe 17

18 contributionofbeechy(1999),whosuggeststhatnationalcharacteristicscauseaccountingdifferences, even when the accounting standards are similar. According to Beechy (1999) these differences could arise due to economic factors, having a different way of doing business or different objectives and differences in political factors. Kvaal and Nobes (2010) investigated systematic differences in the accounting policies of five countries that adopted IFRS. The authors state that countries tend to continuethenationalpracticewhereifrsallowsthis.kvaalandnobes(2010,p.185)foundthatthere are systematic differences between countries in trivial matters (such as the liquidity order of the balancesheet)andinmorecomplexmatters(suchasthecompositionofcashflowsfromoperationsor thetreatmentofactuariallosses). ItwasstatedinareportofEY(2006)thatfinancialstatementsretainastrongnationalidentity,even after the adoption of IFRS. An example given in the report (EY, 2006) is of a French retailer, whose financial statements look more similar to a French manufacturer than to a Dutch or UK retailer. The effectofthepermissiblechoiceofaccountingpoliciesintheapplicationofifrsisexaminedbystadler andnobes(2014).wherekvaalandnobes(2010)foundthatthecountryfactorshaveaninfluenceon thechosenaccountingpolicy,stadlerandnobes(2014)examinetheimpactofcountry,industryand topic factors on a IFRS policy choice. Moreover, the authors provide a framework that shows managementdecisionlmakingofspecificaccountingpoliciesandexaminetheextenttowhichcountry, industryandtopicfactorshaveaninfluenceontheaccountingpolicymaking.stadlerandnobes(2014) usethe16ifrspolicytopicsthatarealsousedinthepaperofkvaalandnobes(2010).animportant remark for this study is that the authors only use the observable accounting policy choices of management.theauthorsfindthatcountryfactorshaveaneffectontheifrspolicychoicewhenthe choicedoesnothaveaninfluenceonanimportantaccountingnumber.theindustryandtopicfactors haveaninfluenceontheifrspolicychoice,butonlyinspecificcircumstances.however, Stadlerand Nobes(2014)findthatcountryeffectshaveahigherinfluenceontheIFRSpolicychoicecomparedto industryandtopicfactors. The findings of Stadler and Nobes (2014) are in consonance with the findings of Ball, Robin and Wu (2003).Balletal.(2003)statethatsimilaraccountingstandardsarenotenoughtohavesimilarearnings qualityandearningscomparability.theystatethatcomparabilitycanbeachievedwithinternationally uniformmanagerandauditorincentives.thisisinlinewiththeresearchofbeuselincketal.(2007,p. 38),whoshowthattheadoptionofIFRSdoesnot perseresultin higher financialreportingquality. 18

19 2.3.5Localstandardsandfinancialstatementcomparability Another view is that a uniform accounting standard is not beneficial to financial statement comparability, because the standards are not adjusted to the local economic environment of each country.lang,maffettandowens(2010)investigatetheeffectofifrsadoptiononthecrosslcountry financialstatementcomparability.accordingtolangetal.(2010)priorliteraturehasmainlyassumed that a common accounting standard increases the comparability of financial statements without a propermeasureofcomparability.theauthorswanttoassesswhetherthecomparabilitymeasuresof financialstatementcomparabilityofdefrancoetal.(2011)holdinacrosslcountrysetting.langetal. (2010) predict that the earnings comparability measure does not hold in a crosslcountry setting, becauseitdoesnotcapturetheunderlyingdifferencesinlocaleconomics.langetal.(2010)showthat earningscomovementandaccountingcomparabilityaredifferentandcanhavecontradictingresults.to measuretheearningscomovementlangetal.(2010)usetheearningscovarianceofdefrancoetal. (2011) (mentioned as measure of earnings comparability earlier). To measure the accounting comparabilitylangetal.(2010)usethe accountingcomparability measureofdefrancoetal.(2011). Langetal.(2010)arguethatIFRSadoptiondoesnotautomaticallyleadtoanincreaseincomparability betweencountries.firstlythe localincentives,oversightandlegalenvironment (Langetal.,2010,p. 10) have a role in the implementation of the standards. Secondly the authors argue that earnings comovementincreasesafterifrsadoptionwithoutanincreaseincomparabilityofaccountingpractices. Lang et al. (2010) argue that local standards are created in a way which best reflect the economic environmentofacountry.ifrsmightincreasethecomovementoftheearnings,buttheauthorsstate that it is less comparable in the sense of consistently capturing economic reality. This means that adoptionofifrsmightleadtoanincreaseinearningscomovement,butinrealitytheearningsareless comparable in a way that it captures the economic reality. As a reason Lang et al. (2010) state that managersreportearningsthataresimilartocompetitorstomaintaintheirreputation.moreover,the authorsstatethatareasonfortheincreaseinearningscomovementmightbethesimilarapproaches thatcanbeusedbyanauditfirmineachcountry.asmultiplefirmshavethesameaccountingstandard, theauditfirmusesthesameauditapproachtomaintainconsistencyandgainefficiency. The Lang et al. (2010) research contradicts the results found by DeFranco et al. (2011) in a withinl countrysetting.wheredefrancoetal.(2011)foundthatearningscomovementispositivelyrelatedto forecast accuracy in a withinlus setting, the findings of Lang et al. (2010) show that earnings 19

20 comovementisnegativelyassociatedwith forecast accuracy in a crosslcountry setting. Theresultsof Lang et al. (2010) show that the earnings comparability measure used by DeFranco et al. (2011) has otherresultsinacrosslcountrysetting.accordingtolangetal.(2010)theunderlyingeconomicsper country could cause the differences in the financial statements, even though there are similar accountingstandards.additionally,langetal.(2010)foundthataccountingcomparabilityincreasesin thesampleofnonladopters(firmsthatuselocalgaapincountrieswhereifrsisnotmandatory),andis constantforthegroupofmandatoryadoptersforthelevelofcrosslcountrycomparability.insummary, theresultsoflangetal.(2010)showthatinacrosslcountrysettingtheadoptionofifrsleadstoan increase in the comovement of earnings (earnings comparability). This increase in comovement of earningsafterifrsadoptionresultsinanegativeeffectonanalystcoverageandforecastaccuracy.this isatoddswiththeresultsofdefrancoetal.(2011)inawithinlcountrysetting.moreover,theresults showthattheadoptionofifrsdidnothaveaneffectontheaccountingcomparabilityinacrosslcountry setting.however,theaccountingcomparabilitymeasureispositivelyassociatedwithanalystcoverage andforecastaccuracy(whichisinlinewiththeresearchofdefrancoetal.(2011).theresultsoflanget al.(2011)showthatthereisnoevidencethattheadoptionofifrsleadstoanincreaseincomparability inacrosslcountrysetting.moreover,theresultsshowthatifrsadoptiondoesnotimpacttheabilityof analyststocomparefinancialinformationofmultiplecompaniesfromdifferentcountries. Langetal.(2010)showthatanalystsarenotabletohavebetterfinancialstatementcomparabilityof firms from different countries, after the adoption of IFRS. Although the implementation of global accountingstandardssuchasifrshavetheaimtomakethefinancialstatementsinternationallymore comparable, it is not always the case that similar accounting standards make financial statements comparable in a crosslcountry setting. The results of DeFranco et al. (2011) and Lang et al. (2010) suggestthatcomparabilityinawithinlcountrysettingmightincreaseaftertheadoptionofifrs,butthat theadoptionofifrsdoesnothaveapositiveeffectonthecomparabilityinacrosslcountrysetting Summaryfinancialstatementcomparability The question of this chapter is whether uniform accounting standards lead to comparability. Having consideredpriorliteratureshowingtheimpactofcomparablefinancialstatements,itispossibletoset outtheimplicationsofuniformstandardsforstakeholdersandaccountingpractices.firstlythissection showsthatauniformhighqualitystandardisperceivedaspositivebyinvestors.thequestionwhether thisisduetothequalityofthestandardsorcrosslcountrycomparabilityoffinancialstatementsisnot 20

21 entirelyclear.researchshowsthateventhoughtheimplementationofifrshadapositiveeffectonthe comparability in a withinlcountry setting, the effect on a crosslcountry level is marginal. Next to the countrylspecific effects there are also political factors such as regulatory oversight and legal environment that effect the results of comparability. In addition, prior literature shows that industry factors and enforcement of the standards also have an effect on the comparability of financial statements. Overall, this section shows that uniform standards do not automatically lead to comparabilityofthefinancialstatements. 2.4Auditorcharacteristics This section examines the impact of auditor characteristics on the financial statement outcome of a client.itisassumedthattheauditfirmusesworkinglrulestoconducttheaudit.kotharietal.(2010)and Francisetal.(2014)assumethateachbig4auditfirmhasitsownapproachintheimplementationof auditing standards and application of accounting principles. Due to standardized workinglrules and consistency in the detection of clientlerrorsbyeachbig 4 audit firm, the assumptionin this paper is madethatfinancialreportsthatareauditedbythesamebig4auditfirmhavemorefinancialstatement comparabilitycomparedtofinancialstatementsthatareauditedbydifferentauditfirms.thischapter provides prior literature that document the impact of audit firms on the financial statement and whethercharacteristicsoftheauditfirmresultindifferencesinfinancialstatements Incentives AccordingtoBall,RobinandWu(2003)thereportingqualityissubjectedtotheincentivesofmanagers andauditors.balletal.(2003)arguethattheseincentivesdependonmarketandpoliticalforces.the marketforcesconsiderthedemandofthemarketforhighlqualityfinancialreportingandthepolitical forcesdependonthegovernmentalpressureonthedesiredreportingquality.balletal.(2003)argue that these forces provide incentives for managers and auditors to issue lowlquality financial reports whenthemarketandpoliticalforcesarelow.thiscanbecontrastedtocircumstanceswherethemarket andpoliticalforcesarehigh,whichleadtoincentivesformanagersandauditfirmstoissuehighlquality financial reports. The authors show, based on research with data of East Asian countries, that the incentivesofmanagersandauditorsinthepreparationoffinancialstatementshaveanimpactonthe financial reporting policies choices. DeFond et al. (2011) found that incentives of managers have an impact on the financial statement comparability. Additionally, DeFond et al. (2011) state that the credibility of the implementation of the accounting standards by management increases the 21

22 comparability.credibilityisatermusedbydefondetal.(2011)todefinehowfaithfulthestandardsare applied in the financial statements. Additionally, DeFond et al. (2011) show that the institutional environmenthasanimpactonthecredibilityofimplementation. In the survey of Dichev et al. (2013, p. 42) CFOs of US companies are asked about determinants of earningsquality. In their surveyandinterviewsthecfos also examined audit firm behavior and the effect on earnings quality. In the survey and interviews the CFOs mentioned that the FASB overl emphasizes therules.accordingtothecfo overlemphasisonrules doesaffectsthequalityofthe audits.somecfosarguethattheinterpretationoftheaccountingrules in an audit firm comesfrom highabovenowratherthanfromthefield.anotherinterestingstatementprovidedbyacfoinan interviewconductedbydichevetal.(2013)isthatinterpretationsofauditorsaredrivenbylitigationand fear.theyfollowastrictinterpretationoftherulesinordertonothavetroublewiththesecinsteadof doingwhatisrelevantforthebusiness Effectauditfirmonfinancialstatement Priorresearchshowsthatthefinancialstatementsofcompaniesthatareauditedbyalargerauditfirm areofahigherquality.becker,defond,jiambalvoandsubramanyam(1998)examinedtheimpacton accruals when a company is audited by a big 4 audit firm. The authors use a Jones (1991) model of discretionary accruals to measure earnings quality. They found that companies that are audited by a largerauditfirm(bigsix)havehigherearningsquality.theresearchofbeckeretal.(1998)isrelevant becauseitshowsthatanauditfirmhasanimpactonthefinancialstatement.asmentionedearlierlang et al. (2010) find an increase in the comovement of earnings in a crosslcountry setting after the adoptionofifrs.oneexplanationofthesimilarityinearningsamongcountriesprovidedbylangetal. (2010)istheconsistentapproachofauditfirms.Langetal.(2010)arguethatwhenthereareuniform accountingstandards,theauditfirmwillusesimilarauditapproachestomaintainconsistencyandgain efficiency. Johnson,JamalandBerryman(1991)designedafieldstudytoinvestigatewhetherfraudwasdetected earlier by experienced auditors who are specialists in a specific industry. They made a distinction betweennoviceandexperiencedauditorsandwhetherauditorsareindustryspecialists.johnsonetal. (1991) found that industry expertise and experience is related to fraud detection. The impact of a specialistauditorontheauditqualityisalsoinvestigatedbysolomon,shieldsandwhittington(1999). 22

23 Theystatethatauditorswhoarespecializedinanindustryhavemoreknowledge,whichresultsinbetter audit judgments. The improvement in audit judgments results in higher accuracy with regard to the predictionoferrorsinthefinancialstatements.otherresearchthatexaminedtheimpactofindustry expertizeoftheauditfirmalsoshowsthatthefirmsauditedbyanauditfirmthatisspecializedinan industryhavelessdiscretionaryaccruals(balsam,krishnanandyang,2003). Frankel,JohnsonandNelson(2002)investigatedtherelationbetweenauditfeesfornonLauditservices and earnings management. They found that companies that pay auditors more nonlaudit fees have largerdiscretionaryaccruals.moreoverfrankeletal.(2002)provideevidencethatcompaniesthatpay theirauditfirmmorenonlauditfeesaremorelikelytobeatormeettheearningsforecasts.frankeletal. (2002)provideadditionalevidenceshowingthatfeeshaveanimpactonthediscretionaryaccrualsina financialstatement. ThearticlesofBeckeretal.(1998),Johnsonetal.(1991)andFrankeletal.(2002)arerelevantforthis research because they show that characteristics of the audit firm have an influence on the financial statement. In summary, Becker et al. (1998) show that a larger audit firm leads to less discretionary accrualsandahigherearningsquality,johnsonetal.(1991)showthatindustryexpertiseoftheaudit firmleadstothedetectionoffraudandfrankeletal.(2002)showthatmorenonlauditfeesresultin largerdiscretionarylaccruals InLhouseworkingrulesofauditfirms Kothari,RamannaandSkinner(2010)arguethatauditfirmsdevelopworkingrulestostandardizethe accountingpractice.theseworkingrulesareuniqueforeachauditfirmandserveasaframeworkfor guidance and standardization in the application of accounting and auditing standards. Kothari et al. (2010)providefourreasonswhymanagers,accountantsandauditorsuseworkingLrulesforthedayLtoL dayapplicationofprinciples: ItisnotcosteffectivetouseprinciplesinsteadofworkingLrulesonadailybasis. Incaseoflitigation,anauditfirmhasaruleitfollowedinsteadofan abstract principle. ThereputationoftheauditorcouldleadtoworkingLrules. Userswantauditorstoworkefficiently,souserspreferauditreportsthatarepreparedwithspecific workingrulesoftheauditfirm. 23

24 Therearestudiesthatclassifiedauditfirmsbasedontheirsoftwareproductsorinformationtechnology (IT)systems.Janvrin,BierstakerandLowe(2008)arguethatthe deeppockets ofthelargerauditfirms createmorepossibilitiesforthelargerauditfirmstoinvestinitsystemswhichinturnleadstohigher qualityaudits.janvrinetal.(2008)showthatauditorsincreasinglyuseandrelyonitsystems.thisisin linewithpriorresearchshowingthatauditautomationandproceduresleadtoanincreaseintheaudit qualityandproductivity(veralmunoz,hoandchow,2006;dowlingandleech,2014).veralmunozetal. (2006)showthateachbig4auditfirmusetheirownsystemstocaptureandretrievedata,information andknowledge 4.Janvrinetal.(2008)showthatITisoneofthemostimportantdecisiontoolsforaudit firms.thisdecisiontoolcouldinfluencetheauditjudgment. Francisetal.(2014)statethattheseuniquesetofworkingrulesdiffersystematicallyintheirapproachof anaudit.thisisthemainreasonfortheexistenceof auditstyle.francisetal.(2014)foundthatthe accrualsandearningsaremoreconsistentandcomparableforfirmsthathavethesameauditorthan firmsthatdifferfromauditorinthesameindustrylyearinauslsetting.so,the auditstyle ofabig4 auditfirmhasaninfluenceonthefinancialstatementcomparability.theauthorsusedthreeapproaches tomeasurecomparability.thefirstapproachisbasedonaccruals,andwillbeusedinmyresearchas well.thesecondapproachissimilartotheapproachtakenbydefrancoetal.(2011)andearlierinthis chapterexplainedasthe earningscomparability measure.thesemeasuresofcomparabilityareinline withthemethodsusedbydefrancoetal.(2011)andlangetal.(2010).asstatedearlier,accordingto Lang et al. (2010) the earnings comparability measure is not effective when examining crosslcountry differences. Moreover, Francis et al. (2014) found that Big 4 audit firms have a larger effect on accountingcomparabilitythannonlbig4auditfirms.francisetal.(2014)formsthebasisofmyresearch. WhereFrancisetal.(2014)linkedtheinfluenceoftheeachbig4auditfirmtothefinancialstatement comparability,myresearchextentsthequestiontowhethertheinfluenceofthebig4auditfirmislarger whenthestandardsaremoreprincipleslbased.thereforethefindingsandmethodsusedbyfranciset al.(2014)areessentiallyrelevantformystudy. 4 Examplesare:KPMG skworld TM,PricewaterhouseCoopers TeamAsset TM &KnowledgeCurve TM andey s KnowledgeWeb TM (VeraLMunoz,Ho,&Chow,2006,p.139). 24

25 2.5Summaryandconclusion The literature review in this paper is divided in three sections. The first section elaborates on the differences between ruleslbased and principleslbased standards. Important for this research is the classificationofusgaapandifrsasruleslbasedorprincipleslbasedstandards.usgaapisconsidered to be a more ruleslbased accounting standard and IFRS is considered to be a principleslbased accounting standard. Moreover, the link between the accounting standards and financial statement comparabilityisprovided.literatureaboutwhetherruleslbasedorprincipleslbasedstandardsprovide morecomparablefinancialstatementsismixed.someauthorsarguethatstrictlguidelinesintheaudit and accounting standards make financial statements more comparable, while others argue that professionaljudgmentisnecessaryintheapplicationoftheauditandaccountingstandardstoreflect theeconomicrealityandmakefinancialstatementscomparable(nobes,2005). Where standard setters aim to achieve comparable financial statements with uniform accounting standards, prior research shows that uniform accounting standards do not automatically lead to an increase in financial statement comparability. The importance of comparable financial statements is shownbyincreasedcrosslborderinvestmentsanddecreasedthecostofcapital.however,withuniform standardstherearestillfactorsthatinfluencethefinancialstatementcomparabilityamongfirms.those factors relate to country and local factors that influence the degree of comparability of financial statements in particular. Where this research elaborates on the effect of the audit firm on the comparabilityoffinancialstatements,thethirdsectionprovidespriorliteraturethatexaminesauditfirm characteristicstothefinancialstatementcomparability.asitisnotefficientforauditfirmstoworkwith accountingprinciplesonadailybasis,eachauditfirmhastheirownworkinglrules(kotharietal.,2010). DifferencesbetweenauditfirmscouldbetheresultofaspecificITsystemafirmuses,theusedaudit methodtoconductanauditortheincentivesofanauditfirm.theauditproceduresofbig4auditfirms andnonlbig4auditfirmsarenotcomparabletoeachother.itisshownthatanauditfirmhasanimpact onthefinancialstatements(francisetal.,2014).whetherthisimpactincreaseswhentheaccounting standardsaremoreprincipleslbasedisunclear.whenthestandardsaremoreprincipleslbasedthereis moreneedforprofessionaljudgmentintheapplicationoftheaccountingandtheauditingstandards. Presumablythisincreases the degree that financial statements of firms with the same audit firm are morecomparabletoeachother,comparedtoasettingwithruleslbasedstandards.thispredictionwill be investigated in this research. The summary table in the appendix shows relevant articles that 25

26 elaborated on the impact of accounting standards on the financial statement comparability and the effectofauditorcharacteristicsonfinancialstatementcomparability. Thischapterprovidesanoverviewofliteraturethatformsthebasisformyhypothesesdevelopmentin chapter4.boththestandardsettersandtheauditfirmhaveanimpactonthecomparabilityoffinancial statements.whethertheimpactofthe audit firm increases in a UK setting where more professional judgmentisrequiredwillbeinvestigatedbyexaminingthethreehypothesesinchapter4. 26

27 3.Auditregulation 3.1Introduction This chapter elaborates on the audit regulation in the UK and how it relates to the US. In the US accountingscandalssuchasenron,aholdandworldcomleadtotheimplementationofthesoxin2002 and the creation of the Public Company Accounting Oversight Board (PCAOB). Where in the US the PCOAB was created after the scandals, the Financial Reporting Council (FRC) also reacted after the accountingscandalswiththecreationoftheprofessionaloversightboard(pob)in2004.bothboards have the tasks to, independently, oversee the audits of public interest entities. This chapter aims to provideanoverviewoftheauditregulationintheukinrelationtotheus.additionally,thischapter examineswhetherauditregulationimpactstheworkinglrulesofanauditfirm. 3.2Independentoversightbodies TheFRCistheindependentregulatorintheUKandisresponsibleformaintaininghighqualitycorporate governance.asthefrcwantstomaintainindependenceasapublicoversightbody,thefrcstatesin theirarticlesofassociationthatpracticingauditorscannotbeamemberoftheboard. ItisexplainedinthecorporategovernanceandstewardshipcodessetbytheFRCwhatisnecessaryto besureoftrustworthybehaviorandinformation.withthecorporategovernancecodethefrc setsout standards of good practice in relation to board leadership and effectiveness, remuneration, accountability and relations with shareholders (FRC, 2014). In this code the FRC defines the term effective board practice. This includes: accountability, transparency, probity and focus on the sustainable success of an entity over the longer term (Financial Reporting Council, 2014, p. 1). The stewardshipcodethatispublishedbythefrchastheaimtomakeinstitutionalinvestorsmoreengaged with corporate governance. Since the adoption of IFRS in the UK, the IASB sets the accounting standards. Although the IASB sets the accounting standards, the FRC has the responsibility to ensure that published information is compliant with IFRS. Bae et al. (2008) show that the UK GAAP are the closesttotheifrs,comparedtoallothercountriesthatadoptedifrs. TheroleoftheFRCinauditregulationisimportantforthisresearch.TheFRCpublishedtheAuditFirm Governance Code in The Audit Firm Governance Code only applies for the seven biggest audit firms (Baker Tilly, BDO, Deloitte, EY, Grant Thornton, KPMG, PwC) that together audits 95% of the companies that are listed at the main market or London Stock Exchange (LSE). The code is a formal 27

28 benchmark that is divided in six parts namely: leadership, values, independent nonlexecutives, operations,reportinganddialogue.in keyfactsandtrendsintheaccountancyprofession publishedby thefrcinjune2014isshownthat99%ofalltheftse100companiesareauditedbyabig4auditfirm. IntheiryearlyAuditQualityInspectiontheFRCfoundthatthreebig4auditfirmshaveconductedaudits thatneed significantimprovement (ICAEW,2014).IntheirqualityreviewitwasEYthathadtheworst scorewith4outof16auditsthatneeded significantimprovement.moreoverthefrcconducteda surveyamongtheauditstaffofthebig4offices.thefrcfoundthatinthecaseofeyitwasinthatsame yearthatonly50%ofthestaffagreedwiththestatementthattheyhadenoughtimetodeliverahigh quality audit. An important notion of the FRC in their Audit Quality Inspection is that quality is not consistentacrossallauditfirmsandtypesofcompany (FRC,2014).ItisalsomentionedbytheFRCthat auditqualitydiffersperindustry.thefrcconsidersthequalityofbankauditsas disappointing (FRC, 2014;Economia,2014). Thefinancialcrisisin2008showedthatauditquality(especiallyforfinancialservicescompanies)was insufficient(icaew,2010).whereafterthefinancialcrisistheimpressionemergedthatauditregulation intheukwastoomuchselflregulated,theemphasisshiftedtowardsmoreindependentregulation.a development inthisregulationistheauditqualityframeworkdevelopedbythefrcin2008.inthis frameworkthefrcaimed tocodifyauditquality (HolmandZaman,2012).HolmandZaman(2012) analyzedtheauditqualityframeworkofthefrcandexaminedwhethercompaniesandstakeholders findtheauditqualityframeworksufficient.withtheirattempttocodifyauditquality,thefrcwasthe first regulatory body that codified audit quality. Although the Audit Quality Framework of the FRC is seen as a step forward, Holm and Zaman (2008) conclude that accounting bodies, audit firms and investorsconsidertheattemptofthefrcinsufficient. WhenanauditfirmauditsacompanythatispubliclylistedintheUS,theSECrequirestheauditfirmto beregisteredatthepcaob.sincethepcaobstartedtheirinspectionsofauditfirms,theauditqualityof big 4 audit firms improved significantly (Carcello, Hollingsworth and Mastrolia, 2011). Carcello, HollingsworthandMastrolia(2011)foundasignificantdecreaseofdiscretionaryaccrualsintheyears after the PCAOB started with their audit inspections. When the PCOAB reviews an audit it includes (Carcello,HollingsworthandMastrolia,2011,p.86;Gillan,2005): 1. Whetherthefirmiscompliantwithalltheapplicablerules(GAAP,auditingstandards,SECrules andthecontrolguidelines). 2. Howthefirmismanaged. 28

29 3. Reviewingauditengagements. AfterthepublicationofSOxin2002,thePCAOBwascreatedasanonprofitcorporationthatoversees theaudits(pcaob,2015).beforethecreationofthepcaobtheprofessionwasselflregulatedbythe AmericanInstituteofCPAs(AICPA).WheretheAICPAworkedwithapeerreviewauditorprogram,the PCAOBconductsanindependentinspection.ThatthePCAOBinspectionshaveaninfluenceontheway auditfirmsworkisshownbydrake,goldmanandlusch(2014).theauthorsinvestigatewhetherthe deficienciesthatareidentifiedinthepcoabpartiireport 5 resultinchangesinthefinancialstatements ofanauditfirm sclient.wherethefrcpublishedreportsthatarerelatedtothewholeauditprofession ofthebig4auditfirms,thepcaobconductinspectionsforeachauditfirm.drakeetal.(2014)identified weaknesses in the audit of tax accounts in the Part II report of Deloitte. The authors found that the clientsofdeloitteincreasetheuncertaintaxbenefits(utbs)afterthepcaobpartiireport. ThePCAOBpartIIinspectionofEYalsoshowsthatauditregulationhasaninfluenceonthewayaudit firmsperformtheiraudits.thepublicresponseofeyafterthepcoabpartiiinspectionstates(johnson E.,2015).ThisresponseofEYsuggeststhatauditregulationchangesthewayhowanauditfirmconducts anaudit: The Board determined that we did not address certain quality control matters to the Board s satisfactionduringthe12lmonthperiodfollowingtheissuanceoftheinspectionreport.webelievewe took significant remedial actions with respect to all these matters, including making significant enhancementsinourresources,policiesandpractices.ineachoftheareasnoted,wehaveprovidedour auditprofessionalswithnewaudittools,additionaltrainingandexpandedtechnicalguidance.overall, wehaveinvestigatedthousandsofpartnerandstaffhoursontheseissuesandbelieveweapproached eachboardcriticismseriouslyandresponsibly (PCAOB,2010a). The research of Drake et al. (2014) and Johnson (2015) show that audit regulation has animpacton workinglrules of audit firms. That audit regulation affects the audit quality is shown by Church and Shefchik (2012). Church and Shefchik (2012) investigated whether large audit firms have less deficienciesafterthepcaobstartedwiththeirinspectionreports.theyfoundadecreaseintheamount ofdeficienciesduring2004l2009.thefindingsofchurchandshefchik(2012)showthatinspectionsand auditregulationinfluencesthenumberofauditdeficiencies. 5 The$PCOAB$part$II$report$provides$an$assessment$of$the$quality$control$system$of$an$audit$firm.$This$includes$critics$ and$potential$defects$in$the$quality$control$system$of$the$audit$firm$(pcaob,$2010a). 29

30 3.3Conclusion ThischapterelaboratesontheauditregulationintheUKandUS.Theaccountingscandalsthatemerged resultedinmoreregulationinboththeusandtheuk.theuspublishedsoxandcreatedthepcaob, andintheukthepobprovidestheassurancethattheauditfirmsimplementthestandardsintheright way.bothintheusandtheuktheoversightboardconductinspectionsandpublishesreportsaboutthe qualityoftheconductedaudits.theseinspectionshaveeffectonthewaythefirmconductsanaudit, shownbydrakeetal.(2014)andtheresponseofeyonthepcoabpartiiinspection.asshowninthe publicreactionaftertheinspectionreport,eystatedthatitchangedtheiraudittools,trainingsscheme andtechnicalguidance.bothoutcomessuggestthattheauditregulationhasaninfluenceontheaudit approacheachauditfirmhas. 30

31 4.Hypothesesdevelopment Basedonpriorresearchitcanbeassumedthattheaccountingstandardsandtheauditfirmhavean effect on the comparability of financial statements. Mentioned by Kothari et al. (2010) financial statementsbasedonprincipleslbasedaccountingstandardsarenotcomparable.accordingtokothariet al.(2010)thisisbecauseeachauditfirmhasdifferentinterpretationsofthestandards.kotharietal. (2010)arguethateachauditfirmhastheirowninLhouseworkingrulestoconductanaudit.Research that examines the differences between ruleslbased and principleslbased standards and whether financialstatementsaremorecomparableshowmixedshows.kotharietal.(2010)predictthatrulesl based accounting standards lead to more comparable accounting standards due to less influence of professionaljudgment.kotharietal.(2010)andfrancisetal.(2014)bothmentionthatwhenaccounting standardsareprincipleslbased,theauditfirmwilldevelopinlhouseworkingrules.whethertheimpact ofanauditfirmonfinancialstatementcomparabilityishigherwhentheaccountingstandardsaremore principleslbasedisnotmentionedinpriorresearch. Priorliteratureshowsthattheauditfirmcharacteristicsandtheaccountingprincipleshaveaninfluence onthefinancialstatements.moreover,thereportspublishedbyoversightboardsintheusandukshow thatauditregulationeffectsthewayauditfirmsconducttheiraudits.additionally,literatureshowsthat inspections of oversights boards also effect the accounting policies of firms with the same audit firm (Drakeetal.,2014). Thefirsthypothesisexamineswhethertheworkingrulesofabig4auditfirmhaveanimpactonthe comparability of financial statements in the US. Because this study eventually aims to compare the findingsofaruleslbased(us)withaprincipleslbased(uk)setting,theeffectinaruleslbasedsettingis examinedfirst.thepredictedoutcomeisinlinewiththeresearchoffrancisetal.(2014),whofound thatthedifferencesintotalanddiscretionaryaccrualsarelowerwhenfirmshavethesameauditfirm. H1: Financial statements of companies that are audited by the same big 4 audit firm have financial statementsthataremorecomparablethanfinancialstatementsthatareauditedby(two)differentbig4 auditfirms. TheexpectedfindingsareinlinewiththefindingsofFrancisetal.(2014);alowerabsolutedifferenceof total and discretionary accruals when companies have the same big 4 audit firm. This hypothesis is testedinaussettingandauksetting. 31

32 AftertheimpactoftheauditfirmonthefinancialstatementcomparabilityareexaminedinaUSsetting (ruleslbased) and a UK setting (principleslbased) the expectations are that the influence of the audit firmonthefinancialstatementcomparabilityarelargerwhentheaccountingstandardsareprinciplesl based(uk). H2:TheimpactofinLhouseworkingrulesonthefinancialstatementcomparabilityhasagreatereffectin theukcomparedtotheus. Allthehypothesesstatedaboveareinalternativeform. 32

33 5.Researchdesign 5.1Introduction This chapter explains the research design using an elaboration of previous used models to measure financialstatementcomparability.afterwards,themodelthatisusedinthisresearchwillbeexplained, andthecalculationmethodsofcertain variablesare examined. After the models and regressionsare explained, a closer look of the control variables and the methodology is given. This chapter aims to provideanoverviewoftheresearchdesignthatisusedtogathertheresultsthatareshowninthenext chapter. 5.2Models The research design will be based on the assumption that audit style will have an impact on the financial statement comparability. Prior methods show several techniques to measure financial statement comparability. As previously explained the method of accounting comparability and earnings comparability of DeFranco et al. (2011) is widely used in previous research. As previously explained the accounting comparability method measures financial comparability with earnings and stockreturns.defrancoetal.(2011)assumethatfinancialcomparabilityishighwhentheearningsof eachpairoffirmscapturetheunderlyingstockreturninthesameway.asmentionedbyfrancisetal. (2014)auditstylehasanimpactonthefinancialstatementcomparabilityduetotheinLhouserulesofan auditfirm.duetotheseinlhouseworkingrulescompanieswiththesamebig4auditfirmareexpected to have more similar accounting choices and financial statements as companies with different big 4 auditfirms.theaccountingcomparabilitymethodwillnotbeused,becausemyresearchassumesthat theauditfirmhasanimpactontheaccountingchoicesandthefinancialstatements.thiseffectisonthe financialstatement.thisisregardlessthereactionofthemarket. TheearningscomparabilitymeasureofDeFrancoetal.(2011)isalsousedbyFrancisetal.(2014).Inthis methodthecovariationoftheearningsbetweenthepairedfirmswilldeterminewhetherthefinancial statementsarecomparable.themethodusedtopairthecompanieswillbebasedonindustryandfiscal year, and is similar to the method used in this research. Francis et al. (2014) used the earnings comparability method of DeFranco et al. (2011) within a US sample from 1987 to 2014 based on quarterlydata.astheearningscomparabilitymethodcapturesthecovarianceoftwofirmsinthesame industryovertime(intheresearchoffrancisetal.(2014)16quarters),thismethodwillnotbeusedin 33

34 myresearch.thesampleofukfirmsinthisresearchisfrom2005l2014.duetohugeeconomicshocks duringthesampleperiodinthisresearch,itislikelythatthecovariationofearningsbetweenfirmsover this period is caused by economic shocks. As the earnings covariation method is a method that measuresthecomparabilityovertime,thismethodwillnotbeusedinthisresearch. The best method to observe the effect of audit style on the accounting choices and the financial statementisthemethodusedbybradshawandmiller(2008).bradshawandmiller(2008)basetheir method on the chosen accounting policies. Although it is interesting to see whether the audit style affectsthechosenaccountingpolicies,themethodofbradshawandmiller(2008)willnotbeusedinthis researchduetoalackofavailabledata. ConsistentwiththeresearchbyFrancisetal.(2014)thesimilaritiesinauditstylewillbemeasuredwith the crosslsectional similarities in the levels of total and discretionary accruals. This means that this researchassumesthattheauditfirmaffectsthefinancialstatementcomparabilityduetotheaccrual component.thedesignissimilartothedesignusedbyfrancisetal.(2014)basedonthecrosslsectional similaritiesinthelevelsofcontemporaneousmeasuresbyjoosandlang(1994).thetotalaccrualswill becalculatedwiththeearningsbeforeextraordinaryitemsminustheoperatingcashflows.toscalethe totalaccrualsthisoutcomewillbedividedbythelaggedtotalassets.thisleadstothefollowingformula (Jones,1991) 6 :!!!! =!!"$%$&'!!"$%"!!"$%&$'()%$*!!"$%!"$%&'()!!"$!!"$" Where: TA t =Totalaccrualsoverperiodt PriorliteratureshowsthattheJonesmodel(1991)andthemodifiedJonesmodel(Dechow,Sloanand Sweeney,1995)arewidelyusedmodelstomeasurediscretionaryaccruals.Thediscretionaryaccrualsin my research will be calculated based on the modified Jones model (1991) including the contemporaneous performance measure of Kothari et al. (2005). Francis et al. (2014) measure the discretionary accruals with the Jones (1991) model including the contemporaneous performance 6 TotalAccruals=NetIncome(Loss) OperatingActivitiesNetCashFlow ExtraordinaryItemsandDiscontinued Operations(CashFlow),[COMPUSTAT:NI,OANCF,XIDOC] 34

35 measureofkotharietal.(2005).toexaminewhethertherearedifferencesbetweenthemodifiedjones modelandthejones(1991)model(bothcontrolledforcontemporaneousperformance(kotharietal. (2005)),arobustnesstestwillbedonewiththeJones(1991)modelthatFrancisetal.(2014)used.The totalaccrualshaveadiscretionaryandnonldiscretionarycomponent.jones(1991)modelestimatesthe normalaccrualsasafunctionofthechangeinrevenuesandthelevelofproperty,plantandequipment. Dechowetal.(1995)addsaccountsreceivablesasavariabletotheJones(1991)model.Priorresearch bykotharietal.(2005)showsthatthemodifiedjones(1991)modelincludingreturnonassetsbetter controls for contemporaneous performance on discretionary accruals. Kothari et al. (2005) have two approaches to control for performance in the Jones model. The variable return on assets could be includedtotheregressionorthefirmscouldbematchedbasedonreturnonassets.kotharietal.(2005) foundthatthematchingreturnonassetsprovidebetterresultsthanaddingreturnonassets.however, the authors also conclude that including the return on assets as an independent variable in the regressionprovidesbetterresultsthanmerelyajones(1991)model.tocontrolforcontemporaneous performancethereturnonassetswillbeaddedtothemodel. Thisisnotthe performancelmatched approach thatisexplainedbykotharietal.(2005),butthisapproachiscalledthe regressionlbased approach bykotharietal.(2005).thisapproachaddsthereturnonassetstothemodifiedjones(1991) modeltocontrolforcontemporaneousperformance.!!!"!!"!!! =!!!!!"!!"! =!!!! Where:!!!"!! +!!!.!!"!!"!!"!!"!!"!!!+!!!.!!!!"!!"!! +!!.!"!!"!! +!!!"!!!"!! +!!!.!!"!!"!!"!!"!!"!!!+!!!.!!!!"!!"!! +!!.!"!!"!! "!!!"! =!!!!"!!!"!!"!! A itl1 =TotalassetsoffirmiatyeartL1 α 1, β 1, β 2, β 3 =Parametersestimatedbyusingregression DA it =Discretionaryaccrualsoffirmioverperiodt NDA it =NonLdiscretionaryaccrualsoffirmioverperiodt PPE it =Grossproperty,plantandequipmentoffirmiatyeart ΔREC it =Changeinaccountsreceivablesoffirmioverperiodt ΔREV it =Changeinrevenueoffirmioverperiodt 35

36 ROA itl1 =Returnonassets 7 TA it =Totalaccrualsoffirmioverperiodt Thespecificparameters(α 1, β 1, β 2, β 3 )willbecalculatedforeachindustrylyear.thedifferentindustries are divided based on the first two digits of the Standard Industrial Classification (SIC) code. The coefficients that are used in the calculation of total accruals are used for the prediction of the nonl discretionaryaccruals.discretionaryaccrualsarecalculatedasthedifferenceoftotalaccrualsandnonl discretionaryaccruals. To test the financial statement comparability in earnings the firms will be divided based on their industryandyear.eachfirmwillbepairedwitheachindustrypeerinthesamefiscalyear.thismeans thatwithineachindustryandfiscalyearalluniquecombinationsoffirmlpairsareinthepairedsample 8. TobesurethatthethereisonlyonefirmLpaircombination,allpairsthatcontainthesamefirmLpair combinationorarematchedwithitself(ala,bla,cla,clb)aredropped.duetothematchingoffirmsl pairsbasedonhavingthesamefiscalyearandindustry,thedatacouldberegardedasacrosslsectional data. The absolute difference between the total accruals and thediscretionary accruals between the pairoffirmswillbecalculatedwiththefollowingformulas: Where:!"!!" =!!"(!!!"!!!!" )!!!!" =!!"(!!!"!!!!" ) DTA ijt =AbsolutedifferenceoftotalaccrualsofthematchedfirmLpair DDA ijt =Absolutedifferenceofdiscretionaryaccrualsofthematched firmlpair Intheequationabovearefirmi%andfirmj%amatchedfirmLpairwiththesameindustryandfiscalyear. After calculationof theabsolute 9 differencebetweenthetotalanddiscretionary accrualsofthefirml pairsbasedontheirindustryandyear,theregressionanalysiswillexaminewhetherfirmsthathavethe 7 Iscalculatedwith:returnoffirmi%over%yeart%dividedbythelaggedtotalassets(A itl1 ) 8 Forexample:ifbasedonindustryandfiscalyeartherearethreefirms(firmA,firmB&firmC).ThefirmLpairswill bealb,alcandblc. 9 Theabsolutevalueistakentoexaminetheeffectonthedifference.Forexample:whenfirmi%hastotalaccrualsof L0.4andfirmj%hastotalaccrualsof0.2.Thisleadsto(L0.4L0.2=L0.6)0.6difference.Whenfirmi%has0.2total accrualsandfirmj%hasl0.4totalaccruals.thisresultsinadifferenceof(0.2ll0.4=0.6)

37 samebig4auditfirmaremorelikelytohavethesametotalanddiscretionaryaccruals.theordinary least square regression will examine whether two firms with the same big 4 audit firm have more comparablefinancialstatements.thisregressionisalsousedbyfrancisetal.(2014)intheirresearch.!"!!" =!!! +!!!!"$%&!" +!!!!"$%"&' +!!!!!!!" =!!! +!!!!"$%&'( +!!!!"$%"&' +!!!! ThevariableSameBig4isadummyvariablethatis1whenafirmLpairhasthesamebig4auditfirmand is0whenapairoffirmshavedifferentbig4auditfirms. TheLibbyboxesareoriginallycalledthePredictiveValidityFramework(Libby,1981;Libby,Bloomfield andnelson,2002,pp.793l805).thelibbyboxesshowtheconceptualindependentanddependent variables.tobeabletomeasurethevariablestheseconceptualvariablesareoperationalized.so,the Libbyboxesshowhowthesevariablesareoperationalized.Tobesurethatthetestedcausaleffectisnot effectedbyastructuralerrorterm,thestatedcontrolvariablesareaddedtotheregression. 37

38 Libbyboxes(Libby,1981;Libbyetal.,2002) IndependentVariable Pairoffirmshasthesame big4auditfirm DummyVariable 1ifpairoffirmshavethe samebig4auditfirmand0 whenthepairoffirmshave differentbig4auditfirms DependentVariable Differenceintotalaccruals/ Differenceindiscretionaryaccruals Differenceoftotalaccruals= earningsbeforeextraordinaryitems Loperatingcashflow Differenceofdiscretionaryaccruals calculatedwithperformance controlledmodifiedjonesmodel Controlvariables: Minimumoftotalaccruals,size,leverage,MarketLtoLBook,operatingcashLflow,SDsales,SD operatingcfandsdsalesgrowth Differenceofsize,leverage,MarketLtoLBook,operatingcashLflow,SDsales,SDoperatingCF andsdsalesgrowth 5.3Controls The model assumes that firms that are in the same industry and year are subjected to the same economic shocks. By matching firms based on their industry and year, the assumption is made that thosefirmshavethesameeconomiccircumstances.thesetofcontrolvariablesisbasedonthesetof controlvariables by Francisetal.(2014)namely;size,leverage,marketLtoLbook,operatingcashflow, lossprobability,standarddeviationofsales,standarddeviationofquarterlysales,operatingcashflow and sales growth. This increases the comparability of the results with the research of Francis et al. (2014). The control variables size and marketltolbook are widely used control variables. Lang et al. (2010)alsousethesetwovariablestocontrolforfirmLspecificcharacteristics.Theresearchexpectsthat firms with similar size and marketltolbook ratio are more comparable with each other. Francis et al. 38

39 (2014)extendtheamountofcontrolvariablesthatareusedintheresearchofLangetal.(2010)inthe measurementofcomparability.thecontrolvariablesarebasedoneconomicfundamentalsthatcause comparabilitybetweenfirms.forexample,afirmlpairinthesameindustrylyearwithsimilarsize,might havemoresimilarfinancialstatements.asbothstatedbyfrancisetal.(2014)andlangetal.(2010) thereisnopriorliteraturethatprovidesevidenceforappropriatecontrolvariablesforaregressionthat capturesfinancialstatementcomparability. Bartov,GulandTsui(2000)showthatmarketLtoLbookratioandfinancialleverageareimportantcontrol variables for earnings management. When companies have similar earnings performance, marketltol bookratioorfinancialleverageratio,thereisapossibilitythatfirmshavesimilaraccrualsduetoahigher likelihoodofearningsmanagement. ThepredictedsignsofthecontrolvariablesareallnegativefortheminimumvaluesofeachfirmLpair. TheminimumvalueisthelowestvalueineachfirmLpair 10.Theexpectedsignforvariablesthatshow differencesispositive.theexpectationisthatiffirmlpairshaveamoresimilarsize,leverage,marketltol book,operatingcashflow,lossprobability,standarddeviationofsales,standarddeviationofcashflow and standard deviation of sales growth they have more comparable financial statements and comparabilityintheearningsofthefirm.firmsaremoresimilarwhentheminimumvalueofthefirml pairinthegivenvariablesishigherorwhentheabsolutedifferenceislower 11.Theabsolutedifferencein total and discretionary accruals will be lower (more comparable earnings) when firms have more comparablecharacteristics.thepredictionsinmyresearcharebasedonthenotionthatfirmswiththe same economic fundamentals have more similar accruals. However, as Francis et al. (2014, p. 614) mentionthereisnounderlyingtheorywhichhelpstopredictthesignsofeachcoefficient. 5.4MethodologyUS In line with the first hypothesis my research examines the effect of audit style on the total and discretionary accruals in a US setting. I start with 342,849 firmlyear observations obtained from the COMPUSTATNorthAmericadatabase.Itakeonlytheobservationssincefiscalyear2000,duetoaudit firmmergersofthebig4auditfirmsearlier.auditfirmarthurandersonisexcludedfromthesample, 10 Forexample:thecalculationofMinSize.ThisvariableincludesallthelowestvaluesofsizeforeachfirmLpair. WhenfirmAinafirmLpairhasasizeof20andfirmBasizeof18.TheMinSizeforthatspecificfirmLyear observationis WhentheminimumvalueintheequationishigherforafirmLpair,thismeansthatfirmLpairsaremoresimilar. 39

40 becauseitwentbankruptin2001aftertheenronaccountingscandal.thereare108,299firmsthatare audited by a big 4 audit firm. First I exclude all firms that have less than 10 million dollar in assets. Furthermore I exclude all observations with a lack of data to calculate the discretionary and total accruals.thefirstyearauditofafirmcouldnottrulyrepresentthe auditstyle ofacompany.therefore I exclude the firmlyear observation where a firm switched audit firm. Next, I exclude all firmlyear observationsthathavelessthantwentyfirmsinanytwoldigitsicinanygivenyear. ToeliminatetheeffectofoutliersIwinsorizethevariablesat1percentand99percent.Afterallthe variablesarecalculated,allfirmsarepairedbasedontheirindustrylyearinawaythatissimilartothat offrancisetal.(2014).eachfirmispairedwithintheirindustryandyear.theremainingfirmsallconsist offirmsintheperiod2000l2014.noteveryfirminthatperiodhasobservationsinallyears.asfirmsare pairedperyear,thisdoesnotaffecttheresult.thecontrolvariablesthatcontainstandarddeviations arecalculatedwithquarterlydata.oneinterpolationisnecessaryincalculatingthequarterlyoperating cash flow. The COMPUSTAT database only contains the cumulative cash flows of all the quarters. Thereforethedifferencesofeachquarterinyearlyoperatingcashflow(OANCFY)providetheoperating cashflowperquarter.thequarterlydatawillbemergedwiththeyearlydatabasedonthefirmandthe quarterofafiscalyear.allthedifferencesinvariables thatarecalculatedbetweenfirmscontainthe absolutedifference. 40

41 Table1 DerivationofUSSample,2000L2014 FirmLyearobservationsobtainedfromCompustatNorthAmerica FirmLyearsthatarefromtheUSandhaveabig4auditfirmminusholdingsandfirms withlessthan10millionofassets. 342, ,242 FirmLyearsafterexcludingfirmLyearsinwhichthefirmswitchedauditfirm,thatlack datatocalculatetotalanddiscretionaryaccrualsandobservationsthatdonothave 31,829 availabledataforthemarketvalue. FirmLyearsthatcontainover20firmsinthesame2LdigitSICcode. 26,179 TwoLdigitSICgroupsthathaveover20firms. 32 Numberoffirms 4,236 AllfirmLpaircombinationsforeachindustryLyear 1,741,170 FirmLpairsaftertruncationofthecontrolvariablesthatlackdata. 1,569,017 AlldataisobtainedfromCompustatNorthAmerica. 5.5MethodologyUK FirstIstartwithalltheyearlyobservationsofUKfirmsfromtheCOMPUSTATglobaldatabase.43,656UK firmsareavailableincompustatglobal.therearecertainitemsthatareavailableinthecompustat NorthAmericadatabase,butunavailableintheCOMPUSTATglobaldatabase.Notalltheitemsthatare necessaryformyresearchareavailableinthecompustatglobaldatabase.themissingitemsarethe marketvalueoffirmsandtheauditfirmacompanyhas. 12 Themarketvalueofeachfirmisobtained throughdatastreamandthedatathatprovidestheauditfirmofeachcompanyisprovidedbytheaudit Quality Review Team of the Financial Reporting Council. This data is handlcollected by the FRC and drawnfromanumberofpubliclyavailablesources.thedatafromthefrc(±800companiesperyear)is merged manually with COMPUSTAT based on the company name. The companies that are in the UK samplearealllistedcompanies.thiscontainslistedcompaniesatthelondonstockexchange(lse),but also those traded at Alternative Investment Market (AIM) or a Specialist Fund Market (SFM). The 12 TheseitemsareshowninCOMPUSTATNorthAmericaasMKVALT(MarketValue)andAU(Auditfirm). 41

42 companiesthathaveamarketcapitalizationlessthan 100millionandtradedinanAIMarenotinthe sample.thoseukcompaniesthatareauditedbyabig4auditfirmwhichisbasedinthecaymanislands (36companies),Ireland(9companies)orLuxembourg(2companies)areexcluded.Thecompaniesthat areauditedbyanauditfirmfromthecaymanislandsaremainlytrustsandlargeprivateequityholdings. Basedontheaveragecurrencyratebetweenthepoundandthedollar,allfirmsthathavelessthan7 million pounds of total assets will be excluded. As the data of the FRC is collected since 2005, the samplelperiodforukfirmsis2005l2014.duetolessfirmsintheuk,onlyfirmswith10orlessfirmlyear observationsineachtwoldigitsicwillbeexcludedfromthesample. Table2 DerivationofUKsample,2005L2014 FirmLyearobservationsobtainedfromCompustatGlobal FirmLyearsthatarefromtheUnitedKingdom FirmLyearsthathaveabig4auditfirm,morethan7millionpoundsofassetsandare notaholding. FirmLyearsafterexcludingfirmLyearsinwhichthefirmswitchedauditfirm,thatlack datatocalculatetotalanddiscretionaryaccrualsandobservationsthatdonothave availabledataforthemarketvalue. Numberofindustriesthatcontainover10firmsinthesame2LdigitSICcode. Numberoffirms AllfirmLpaircombinationsforeachindustryLyear 507,690 43,656 5,940 2, ,664 FirmLpairsaftertruncationofthecontrolvariablesthatlackdata. 6,238 DataisobtainedfromCompustatGlobal,DatastreamandtheFRC. 5.6Conclusion Theresearchdesignandmethodologyisexplainedinthischapter.Thefinancialstatementcomparability inthisresearchwillbemeasuredbyusingtheabsolutedifferenceintotalanddiscretionaryaccruals. ThecalculationofdiscretionaryaccrualsisconductedwithamodifiedJones(1991)modelthatcontrols for contemporaneous performance(kothariet al., 2005). It is explained in the methodology howthe finalsampleisderived.duetolowerdataavailabilityintheukandthemergersofseveraldatabases, thetotalsampleoftheukisrelativelysmallcomparedtotheussample.however,thesampleisstillbig anddiverseenoughtoprovidevalidconclusions. 42

43 6.$Results$ 6.1Introduction The literature study examined the impact of standards and the audit firm on financial statement comparability. The prediction is made that the effect of the audit firm on the financial statement comparability will be more severe when the accounting standards are principleslbased. This chapter shows the results that are obtained by using the model previously explained. First the descriptive statisticsofboththeusanduksettingwillbeprovided, secondthe findings of thisresearch will be shownandlastlythischapterprovidesananalysisoftheresults. 6.2AssumptionsOLSregression This section provides an overview of the assumptions of the Ordinary Least Square (OLS) regression model. Firstly, it is checked whether there is multicollinearity among the variables. Multicollinearity existswhentwovariablesarealmostnearlyidenticallinearcombinationsofeachother.multicollinearity istestedwithavarianceinflationfactor(vif)(seeappendixtable10.3,11.3,12.3&13.3).theresults show that there is no multicollinearity. To test heteroscedasticity the Cook and Weisberg test for heteroscedasticitywillbedone.theplvalueofthecookandweisbergtestislow,sothismeansthat heterescedasticityexists(seeappendixtable10.2,11.2,12.2&13.2).thismeansthattheerrortermsdo nothaveaconstantvariance.whentherobuststandarderrorsareaddedtotheregression,theresults remainsimilar.thenormalityassumptionwillbeexaminedwiththestandardizednormalprobability.it isclearthatthereareproblemsconcerningnormalityoftheresidualswhentheshapirolwilkwtestis done. The ShapiroLWilkWtestrejectsthenullhypothesisthattheresiduals are normally distributed (seeappendixtable10.1,11.1,12.1&13.1).apossibleexplanationforthisisthelargesamplesizeused inmyresearch.whenalargesamplehasasmalldeviationfromnormality,thiswillcauseasignificant result.asshownintheappendixthehistogram(figure1.1,2.1,3.1&4.1)oftheresidualsdoesprovide signsofanormaldistribution. 6.3DescriptivestatisticsUS Table3showsthedescriptivestatisticsforthevariablesthatareusedintheUSsample.Intotalthere are 1,569,017 observations obtained over the 2000L2014 period. The descriptive statistics show that 27%ofthepairedfirmshavethesamebig4auditfirm.Theabsolutedifferenceintotalaccrualsand 43

44 discretionary accruals are similar to the results of DeFranco et al. (2014). The control variables are generallyasexpected.anexplanationofeachcontrolvariableisprovidedintheappendix(table9). Table3 DescriptiveStatistics Variable Mean STD Min. 25% Median 75% Max. DependentVariables DTA DDA TestVariables SameBig ControlVariables Mintacc L L0.56 L0.17 L0.10 L Sizedif MinSize Leveragedif MinLeverage MarkettoBookdif minmarkettobook L scaledoancfdif minscaledoancf L L0.71 L LOSSPROBdif minlossprob SD_SALEdif minsd_sale SD_OANCFdif minsd_oancf SD_SALEGRdif minsd_salegr ThetablepresentsthedescriptivestatisticsofallthevariablesthatareusedinthecrossLsectionalanalysesoftheUS.Allthe variables are based on US firms in the 2000L2014 sample period. Explanation of the control variables is provided in the appendix.thestatisticsarebasedon1,569,017firmlpairs. 6.4DescriptivestatisticsUK Table4showsthedescriptivestatisticsoftheUKfirms.Theamountoffirmsthathavethesamebig4 audit firm is 28%. This is similar to the US. The mean of the differences in total and discretionary accrualsislowercomparedtotheussample.thissuggeststhattheoverallabsolutedifferenceintotal 44

45 anddiscretionaryaccrualsbetweenpairedfirmsislessinauksettingcomparedtotheus.themeans andstandarddeviationsofthecontrolvariablesingeneralsimilartotheussample. Table4 DescriptiveStatistics Variable Mean STD Min. 25% Median 75% Max. DependentVariables DTA DDA TestVariables SameBig ControlVariables MinTacc L L0.33 L0.12 L0.07 L Sizedif MinSize Leveragedif MinLeverage MarkettoBookdif minmarkettobook L scaledoancfdif minscaledoancf L LOSSPROBdif minlossprob SD_SALEdif minsd_sale SD_OANCFdif minsd_oancf SD_SALEGRdif minsd_salegr ThetablepresentsthedescriptivestatisticsofallthevariablesthatareusedinthecrossLsectionalanalysesoftheUK.Allthe variables are based on UK firms in the 2005L2014 sample period. Explanation of the control variables is provided in the appendix.thestatisticsarebasedon6,238firmlpairs. 45

46 6.5Findings The results of the effect on the differences in total and discretionary accruals in the US sample are providedintable5. Expected sign Table5 ResultsofOrdinaryLeastSquarestestsUS DifferenceTotal Accruals tlstat. Difference Discretionary Accruals tlstat. SameBig4 L L (3.00)** L (3.60)** Mintacc L L0.665 (1,175.81)** L0.255 (477.98)** Sizedif + L0.001 (18.57)** L0.002 (39.76)** MinSize L L0.001 (18.08)** L0.002 (38.46)** Leveragedif (24.32)** (16.01)** MinLeverage L L0.013 (36.30)** L0.008 (23.76)** MarkettoBookdif (15.18)** (11.04)** minmarkettobook L (8.86)** (4.88)** scaledoancfdif + L0.034 (54.19)** (209.58)** minscaledoancf L L0.121 (195.79)** L0.01 (17.96)** LOSSPROBdif + L0.004 (17.19)** L0.008 (36.96)** minlossprob L L0.015 (43.49)** (41.00)** SD_SALEdif (6.42)** (1.66) minsd_sale L (5.64)** (8.45)** SD_OANCFdif (5.82)** (1.47) minsd_oancf L (2.40)* (3.32)** SD_SALEGRdif (4.75)** L0.001 (17.03)** minsd_salegr L (5.00)** (22.89)** _cons (98.12)** (152.14)** AdjustedR N 1,569,017 1,569,017 *p<0.05;**p<0.01 ThetablepresentstheresultsofthefirstregressionthatarerelatedtotheUSsample.Thedifferenceintotalaccrualsisthe dependentvariableandwhetherfirmshavethesamebig4auditfirmistheindependentvariable.thevariablesamebig4is1 whenfirmlpairshavethesamebig4auditfirmand0whenafirmlpairhasadifferentbig4auditfirm.thedefinitionofthe controlvariablesareprovidedintheappendixtable9.table14intheappendixshowtheresultswheninsteadoftheminimum value,theaveragevalueisusedinthecalculationofthecontrolvariables.theresultsremainsimilar. Hypothesis1expectsthatfirmswhoareauditedbythesamebig4auditfirmhavemorecomparable financialstatements.table5showsthatifthepairedfirmshavethesamebig4auditfirm,theabsolute differenceintotal(discretionary)accrualsarel (l )less.bothresultsarestatistically 46

47 significant(tlstatistic=3.00and3.60;plvalue=0.000and0.003).francisetal.(2014)showthatpairs withthesamebig4auditfirmhavel0.001lowerdifferenceintotalanddiscretionaryaccruals.where myresearchshowscoefficientsofl andl ,theresearchoffrancisetal.(2014)show L0.001ascoefficient.ThecontrolvariablesMintacc,MinLeverage,andminscaledOANCFareallnegative and significant. These variables are generally as expected and also consistent with the Francis et al. (2014).Whenthetotalaccrualsarelow,thedifferenceintotal/discretionaryaccrualsofbothfirmsis lessaswell.additionally,whenthefirmlpairhasahigherminimumindebtltoltotalassetsratiothereis alowerdifferenceintotalanddiscretionaryaccruals.theresultsshowthatwhentheseminimumsare higher, the firmlpairs have less accruals. The results above show a (small) significant decrease in total/discretionary accrual differences between firms when firms have the same big 4 audit firm, so therefore the first hypothesis can be accepted. Although the absolute differences in size, scaledoancfdif and LOSSPROBdif show a small significant contradictory result, the results are consistentwiththeresultsoffrancisetal.(2014). In line with the first hypothesis I examine the same relation in a UK setting. The results of the first hypothesisareshownintable6.theresultsshowthatwhenthefirmlpairhasthesamebig4auditfirm in a UK setting there are L (L ) less total (discretionary) accruals. The results are statistically significant (tlstatistic = 2.68 and 2.75; plvalue = and 0.006). The results in the UK sampleshowthatfirmlpairshavealowerabsolutedifferenceintotalanddiscretionaryaccrualswhen theyhavethesamebig4auditfirm.thesefindingareinlinewithhypothesis1. 47

48 Table6 ResultsofOrdinaryLeastSquarestestsUK Expected sign Difference Total Accruals tlstat. Difference Discretionary Accruals tlstat. SameBig4 L L (2.68)** L (2.75)** Mintacc L L0.695 (69.34)** L0.255 (26.37)** Sizedif + L0.001 (1.24) L0.003 (5.88)** MinSize L L0.003 (7.24)** L0.001 (1.88) Leveragedif (4.35)** (2.06)* MinLeverage L L0.002 (0.65) L0.006 (1.74) MarkettoBookdif (4.41)** (0.26) minmarkettobook L (5.51)** (3.16)** scaledoancfdif + L0.054 (6.59)** (14.60)** minscaledoancf L L0.377 (36.91)** L0.133 (13.48)** LOSSPROBdif + L0.053 (18.19)** L0.033 (11.74)** minlossprob L L0.099 (14.06)** L0.029 (4.23)** SD_SALEdif (2.54)* (2.08)* minsd_sale L (1.76) (2.31)* SD_OANCFdif (3.22)** (3.90)** minsd_oancf L (2.38)* (1.23) SD_SALEGRdif + L0.002 (6.27)** L0.002 (5.75)** minsd_salegr L (2.67)** (1.76) _cons (17.33)** (13.30)** AdjustedR N 6,238 6,238 *p<0.05;**p<0.01 ThetablepresentstheresultsofthefirstregressionthatarerelatedtotheUKsample.Thedifferenceintotalaccrualsisthe dependentvariableandwhetherfirmshavethesamebig4auditfirmistheindependentvariable.thevariablesamebig4is1 whenfirmlpairshavethesamebig4auditfirmand0whenafirmlpairhasadifferentbig4auditfirm.thedefinitionofthe controlvariablesareprovidedintheappendixtable9.table15intheappendixshowtheresultswheninsteadoftheminimum value,theaveragevalueisusedinthecalculationofthecontrolvariables.theresultsremainsimilar. Thesecondhypothesisassumesthatthedecreaseoffirmswiththesamebig4auditfirmintheabsolute differenceoftotalanddiscretionaryaccrualsislessinauksetting.thesuggestedreasonbehindthisis that principleslbased standards lead to more impact of the workinglrules of the audit firm on the financialstatements.thedecreaseofboththe absolute differenceintotalaccrualsanddiscretionary 48

49 accrualsislargerintheuksetting(table7).thesefindingsareinlinewiththepredictionofhypothesis 2. Table7 ComparisonofresultsUSandUK DifferenceTotal Accruals tlstat. Difference Discretionary Accruals tlstat. SameBig4UK L (2.68)** L (2.75)** SameBig4US L (3.00)** L (3.60)** *p<0.05;**p< Robustness Firstly,themethodtomeasurediscretionaryaccrualswillbeexamined.WhereFrancisetal.(2014)usea Jones (1991) model controlling for contemporaneous performance, in this research a modified Jones (1991) model with controlling for contemporaneous performance is used. Both the results in the US sample and the UK sample are nearly identical and statistically significant. The intercept in the calculation of nonldiscretionary accruals is not included. When this intercept is included, it does not affect the results in the US sample, but it does have marginal effect for the UK sample. Taking into account the intercept parameter for the calculation of the nonldiscretionary accruals, the variable SameBig4isinbothregressionssignificantata5%pLvalue. Theauditstyleofanauditfirmhasaneffectonthecomparabilitybetweenfirmsduetosubjectivityin theearningscomponentofafirm.inordertobesurewhetherthesameauditfirmhasnoeffectonthe cashlflows,thesamerobustnesstestoffrancisetal.(2014)willbedone.insteadofthedifferencein accrualsasthedependentvariablethedifferenceinoperatingcashflowswillbetakenasdependent variable.bothintheusandtheuktheresultsarenotsignificant(table18).thismeansthattheaudit style of a big 4 audit firm has no effect on the difference in operating cashlflows of a firmlpair. As mentionedbefore,bypairingthefirmsonindustryandfiscalyeariscontrolledforeconomicshocks.to be sure that the financial crisis does not have an impact on the findings, I exclude all firmlyear observationsoffiscallyear2007and2008.theresultsremainsimilar(table19&20). There is a difference in the number of industries in both samples. As shown in the derivation of the samplesthereare32differentindustriesintheussampleand15differentindustriesintheuksample. Bothsampleshave12industriesincommon.WhenIonlykeeptheindustriesthatarebothintheUSas 49

50 in the UK sample (12 industries), the results remain similar (table 16 & 17). An overview of all the industriesinboththeukandtheussampleisshownintheappendix(table9). 6.7Conclusion Wheretheexistingliteraturehasmainlyfocusedontheeffectofaccountingstandardsonthefinancial statementcomparability,myresearchexamineswhetherprincipleslbasedstandardsincreasestheeffect of the audit firm on the comparability of financial statements. The results show that the absolute differenceintotalanddiscretionaryaccrualsdecreaseswhenfirmshavethesamebig4auditfirm.the resultsfortheussettinginmyresearcharenearlyidenticaltotheresultsfoundbyfrancisetal.(2014). WhereFrancisetal.(2014)showthatthediscretionaryandtotalaccrualsare0.001lowerwhenfirmsL pairshavethesamebig4auditfirm,inmyresearchthiscoefficientisslightlyclosertozero.apossible explanationisthesampleperiod.francisetal.(2014)examinedthedatafrom1987,takingintoaccount morebigauditfirmsthatwhereactive.overallbothresultsareinlinewithpriorliteratureandresearch. Inlinewiththepredictions,theUKfirmswiththesameauditfirmshowalowerdifferenceintotaland discretionaryaccrualscomparedtousfirms.assumingthatprincipleslbasedstandardshaveanegative effect on the financial statement comparability due to more permissible accounting policies and increasing potential for manipulation, the result show that the audit firm has more influence on the financialstatementwhentheaccountingstandardsareprincipleslbased. 50

51 7.$Summary$and$conclusion$ 7.1Summary This research aims to provide an answer as to whether a big 4 audit firm influences the financial statementcomparability.wherefrancisetal.(2014)showthatfirmsthathavethesamebig4auditfirm havemorecomparablefinancialstatements,myresearchexamineswhetherthiseffectislargerinauk setting.toenhancetheefficiencyandeffectivenessoftheaudit,eachauditfirmimplementsworking rules.inordertoworkefficiently,eachauditfirmhastheirownguidelinestointerprettheaccounting standards. Moreover, audit firms differ in their IT systems and they have their own quality and interpretationoftheaccounting/auditingstandards.wherestandardsettersandregulatorsaimtomake financialstatementsmorecomparablewithuniformaccountingstandardsandqualityreviewsofaudit firms,therearestillstructuraldifferencesbetweenauditfirms.theworkinglrulesofeachseparateaudit firmisdefinedbyfrancisetal.(2014)asthe auditstyle ofanauditfirm.duetotheworkinglrulesofan auditfirmonecouldarguethatthewaytoconductanauditissystematicallydifferentamongthefour big audit firms. Moreover the workinglrules of the audit firm increase the likelihood that there is consistencyintheclientlerrorsanauditfirmdetects. Considering that US GAAP is relatively more based on rules and IFRS is relatively more based on principles, the assumption is made that IFRS provides more possibilities for the audit firm to apply professional judgment. This professional judgment results in more impact of the audit firm on the financialstatements.thereforethepredictioninthisresearchismadethatabig4auditfirmhasalarger effectonthefinancialstatementcomparabilityinaprincipleslbasedsetting.theresearchquestionthat isinvestigatedinthisthesisis: Does% the% audit% style % of% a% Big% 4% audit% firm% have% a% stronger% effect% on% the% financial% statements% comparability%when%the%accounting%standards%are%more%principles<based%instead%of%rules<based?% % Based on the difference in total and discretionary accruals I calculated whether firmlpairs have comparablefinancialstatements.intheregression,adummyvariableisusedtodeterminewhethera firmlpair,matchedonindustrylyear,hasthesamebig4auditfirm.thefindingsshowthatfirmswiththe samebig4auditfirmhavemorecomparablefinancialstatements.theeffectofthesamebig4audit firmonthefinancialstatementcomparabilityislargerintheukcomparedtotheus.thisisinlinewith the research question, which predicts a larger effect of the audit firm on the financial statement comparability when the accounting standards are principleslbased standards. Although this research 51

52 expectsthattheprincipleslbasedaccountingstandardsleadtoahigherinfluenceoftheauditfirmon financialstatementcomparability,itmightbethecasethattheresultiscausedbyotherfactors.based onpriorliteratureisuggestthatfactorsmightbetheregulationinacountry,litigationriskforanaudit firmandtheexpertiseofanauditfirm. 7.2Limitations The effect of regulation, litigation risk and expertise of the audit firm on financial statement comparabilityisnotinvestigatedinthisresearch.thepotentialeffectsofthesefactorscouldhavean effectonthefindingsofmyresearch. Thedescriptivestatisticsshowthatfirmsinthesameindustryaremorelikelytohavethesameaudit firm.thisisinlinewithpriorresearch,showingthatauditfirmsareindustryspecialists.accordingto Neal and Riley (2004) an audit firm is an industry specialist when it has 1.2 times the inverse of the numberofbignauditors.sowhenthereare4auditfirms,anauditfirmisanindustryspecialistwhenit has30%(1.2*(1/4)=0.3)marketshareintheindustry.althoughthemeaninboththeusandukis lowerthan30%,itmightstillbethecasethatthereareindustriesinthesamplethatcontainindustry specialists. Where the US contains a large sample, the sample of the UK is substantially smaller. Although the statisticsaresimilarcomparedtotheussample,itmightbethatduetoalackofdataavailabilitythe validityoftheukfindingsislower.moreover,theukdataisobtainedfromthreedifferentsources.the datathatcontainsthebig4auditfirmofukfirmsisprovidedbythefrc.asthisdatadoesnotcontain companyidentifiers,thedataismatchedmanuallybasedoncompanyname.eventhoughmostfirms matchedexactly,thereweresomedataitemswherejudgmentwasnecessary.incaseofdoubtabout thematchingofthefirms,thedataitemsarenotincludedinthesample. 7.3Furtherresearch This research shows that audit style has an effect on the financial statement comparability. Where financial statement comparability is measured with earnings comparability, it might be the case that auditfirmshaveconsistencyinauditingcertainfinancialstatementlineitems.furtherresearchcould examine whether there is consistency in accounting policy choices among firms with the same audit firm.moreover,financialstatementcomparabilityinrelationtootherfactorsthanaccountingstandards isnotinvestigatedextensively.thecontrolvariablesinthisresearcharebasedontheresearchoffrancis 52

53 et al. (2014) and aim to capture economic fundamentals of firms. Further research could examine whetherthesecontrolvariablesareeffectiveandwhetherothercontrolvariablesshouldbeaddedto themodel. Prior literature also shows that countrylspecific items influence the comparability of financial statements between countries. To assess whether the assumption of this research holds, other countriesthatadoptedifrscouldbeinvestigated.additionally,furtherresearchcouldelaborateonthe question whether the audit style of an audit firm influences the quality of financial statements. This research does not examine whether principleslbased or ruleslbased standards are higher quality standards.furtherresearchcouldexaminetherelationofprofessionaljudgmentversusstrictguidelines. This could be done by taking into account whether twolfirms with the same audit firm have higher qualityfinancialstatementswhentheaccountingstandardsareprincipleslbased. 53

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59 59 Appendices Controlvariables Table8 Controlvariable Definition Mintacc ThelowesttotalaccrualsperfirmLpair. Sizedif The(absolute)differenceofsizeperfirmLpair. MinSize ThelowestsizeperfirmLpair. Leveragedif Leverageiscalculatedwith:totaldebt/totalassets.Leveragedifisthe (absolute)differenceofleveragelratioperfirmlpair. MinLeverage ThelowestleverageLratioperfirmLpair. MarkettoBookdif MarketLtoLbookratioiscalculatedwith:marketvalue/equity. MarkettoBookdifisthe(absolute)differenceofmarketLtoLbookratioper firmlpair. minmarkettobook ThelowestmarketLtoLbookratioperfirmLpair. scaledoancfdif ScaledoperatingcashLflowsarecalculatedwith:operatingcashflow/ laggedtotalassets.scaledoancfdifisthe(absolute)differenceofscaled operatingcashlflowsperfirmlpair. minscaledoancf ThelowestscaledoperatingcashLflowperfirmLpair. LOSSPROBdif Lossprobabilityiscalculatedastheprobabilitythatthefirmreporteda loss(negativenetincomebeforeextraordinaryitems)duringthelast16 quarters.lossprobdifisthe(absolute)differenceinlossprobabilityper firmlpair. minlossprob ThelowestlossprobabilityperfirmLpair. SD_SALEdif Thestandarddeviationofsalesbasedonthesalesofthelast16 quarters.sd_saledifisthe(absolute)differenceofthestandard deviationofsalesperfirmlpair. minsd_sale TheloweststandarddeviationofsalesperfirmLpair. SD_OANCFdif Thestandarddeviationofoperatingcashflowisbasedontheoperating cashflowofthelast16quarters.sd_oancfdifisthe(absolute) differenceofthestandarddeviationofoperatingcashflowperfirmlpair. minsd_oancf TheloweststandarddeviationofoperatingcashflowperfirmLpair. SD_SALEGRdif Thestandarddeviationofsalesgrowthisbasedonthesalesgrowthof thelast16quarters.sd_salegrdifisthe(absolute)differenceofthe standarddeviationofsalesgrowthperfirmlpair. minsd_salegr TheloweststandarddeviationofsalesgrowthperfirmLpair.

60 Industries Table9 Industriesrepresentedinsamples(industryLnamesretrievedfromwebsiteNorthCarolinaState University). First2digitSICcode Industryname UKsample USsample 10 Metal,Mining 13 Oil&GasExtraction 15 GeneralBuildingContractors 20 Food&KindredProducts 23 TextileMillProducts 26 Paper&AlliedProducts 27 Printing&Publishing 28 Chemical&AlliedProducts 30 Rubber&MiscellaneousPlasticsProducts 33 PrimaryMetalIndustries 34 FabricatedMetalProducts 35 IndustrialMachinery&Equipment 36 Electronic&OtherElectricEquipment 37 TransportationEquipment 38 Instruments&RelatedProducts 39 MiscellaneousManufacturingIndustries 42 Trucking&Warehousing 45 TransportationbyAir 48 Communications 49 Electric,Gas,&SanitaryServices 50 WholesaleTradeLDurableGoods 51 WholesaleTradeLNondurableGoods 53 GeneralMerchandiseStores 56 Apparel&AccessoryStores 58 Eating&DrinkingPlaces 59 MiscellaneousRetail 62 Security&CommodityBrokers 63 InsuranceCarriers 65 RealEstate 67 Holding&OtherInvestment 73 BusinessServices 79 Amusement&Recreation 80 HealthServices 87 Engineering&Management 60

61 OLSassumptions RegressionwithdifferenceintotalaccrualsinUSsample. Normalityofresiduals Histogram Figure1.1 PLPPlot Figure1.2 ShapiroLWilkWtestfornormality Table10.1 Variable Obs W V Z Prob>z Residuals Heteroscedasticity Table10.2 BreuschLPagan/CookLWeisbergtestforheteroskedasticity H0:Constantvariance Variables:fittedvaluesofDTA Chi2(1) Prob>Chi

62 Multicolinearity Table10.3 Variable VIF 1/VIF minscaledo~f scaledoanc~f SD_OANCFdif SD_SALEdif minsd_oancf minsd_sale MinSize Sizedif minlossprob Leveragedif MarkettoBo~f MinLeverage LOSSPROBdif minmarkett~k SD_SALEGRdif minsd_salegr Mintacc dummy MeanVIF 2.05 RegressionwithdifferenceindiscretionaryaccrualsinUSsample. Normalityofresiduals Histogram Figure2.1 PLPPlot Figure2.2 62

63 ShapiroLWilkWtestfornormality Table11.1 Variable Obs W V z Prob>z Residuals Heteroscedasticity Table11.2 BreuschLPagan/CookLWeisbergtestforheteroskedasticity H0:Constantvariance Variables:fittedvaluesofDDA Chi2(1) Prob>Chi Multicolinearity Table11.3 Variable VIF 1/VIF minscaledo~f scaledoanc~f SD_OANCFdif SD_SALEdif minsd_oancf minsd_sale MinSize Sizedif minlossprob Leveragedif MarkettoBo~f MinLeverage LOSSPROBdif minmarkett~k SD_SALEGRdif minsd_salegr Mintacc dummy MeanVIF

64 RegressionwithdifferenceintotalaccrualsinUKsample. Normalityofresiduals Histogram Figure3.1 PLPPlot Figure3.2 ShapiroLWilkWtestfornormality Table12.1 Variable Obs W V z Prob>z Residuals Heteroscedasticity Table12.2 BreuschLPagan/CookLWeisbergtestforheteroskedasticity H0:Constantvariance Variables:fittedvaluesofDTA Chi2(1) Prob>Chi

65 Multicolinearity Table12.3 Variable VIF 1/VIF SD_OANCFdif SD_SALEdif minsd_sale minsd_oancf minscaledo~f scaledoanc~f MarkettoBo~f Mintacc Sizedif LOSSPROBdif minmarkett~k Leveragedif MinLeverage minlossprob MinSize minsd_salegr SD_SALEGRdif dummy MeanVIF 1.96 RegressionwithdifferenceindiscretionaryaccrualsinUKsample. Normalityofresiduals Histogram Figure4.1 PLPPlot Figure4.2 65