The Impact of the Annual Report Readability on the Audit Engagement Risk Measures

Document Type : Research Paper

Authors

1 Ph.D., Department of Accounting, Ghazvin Branch, Faculty of Management and Accounting, Islamic Azad University, Ghazvin, Iran.

2 Assistant Prof, Department of Accounting, Rozbeh Higher Education Institute , Zanjan, Iran.

3 Assistant Prof., Department of Accounting, Faculty of Economic and Social Sciences, Bu-Ali Sina University, Hamadan, Iran.

4 MSc, Department of Accounting, Faculty of Literature and Humanities, Islamic Azad University, Hamadan, Iran.

Abstract

Objective: Complex financial reporting and low readability increases auditor efforts to manage Audit Engagement Risk. Accordingly, considering the importance of financial reporting and readability, and its understandability for stakeholders, as well as the role of auditors in attestation of financial statements, the purpose of this study is to investigate the effect of annual report readabilityon the audit engagement risk measures.
Methods: Based on the theoretical and empirical bases of the research, the audit report lag, audit fees, going concern opinion and auditor turnover were selected as the risk criteria for the audit engagement. The data was collected from the firms listed in the Tehran Stock Exchange during the period 1391 to 1397 and the research hypotheses were tested using panel data and multiple regression and logistic regression.
Results: The results of the study indicate that in companies where the readability of financial reporting is lower, more audit fees, longer audit report lag and more likelihood of going concern opinion have received and more audits are more likely to change than the other companies. These results indicate that in firms with the less financial reporting readability, the auditors will face more audit risk and they need to work harder.
Conclusion: The findings indicate that the readability of financial reporting provides information about the risk of auditing and affects the decisions of auditors. These findings are suitable for Linguistic development, improving the readability and disclosure in financial reporting for auditors, legislators and auditors for auditing and accounting standards setting. It also highlights the importance of qualitative information characteristics on the effectiveness of investors' analysis and decisions.

Keywords

References

Abdi, M., Zalaghi, H., & Kazemi Olum, M. (2018). The relationship of conservatism with the auditor's strategies to deal with the client risk. Journal of Financial Accounting Knowledge, 5(1), 101-125.(in Persian)
Abernathy, J.L., Guo, F., Kubick, T.R. & Masli, A. (2019). Financial statement footnote readability and corporate audit outcomes. Auditing: A Journal of Practice and Theory, 38(2), 1-26.
Ahmadi, A., Ghaemi, M. H. (2019). Real Earnings Management and Financial Reporting Readability. Applied Research in Financial Reporting, 7(2), 45-72. (in Persian)
Asay, S., Elliott, B. & Rennekamp, K. (2018). Firm performance, reporting goals and language choices in narrative disclosures. Journal of Accounting and Economics, 65(2), 380-398.
Ashton, R.H., Willingham, J.J., & Elliott, R.K. (1987). An empirical analysis of audit delay. Journal of Accounting Research, 25(2), 275-292.
Bagheri Azghandi, A., Hesarzadeh, R., & Abbaszadeh, M. R. (2019). Readability of Financial Statements and the Sensitivity of Investors to Use of Accounting Information. Financial Management Perspective, 8(23), 87-103. (in Persian)
Ball, R., & Brown, P. (1968). An empirical evaluation of accounting incomnumbers. Journal of Accounting Research, 6(2), 159-178.
Banimahd, B., Arabi, M. & Hassanpoor, SH. (2016). Common Mistakes in Accounting Empirical Researches. Journal of Financial Accounting Knowledge, 3(1), 21-45. 
(in Persian)
Banimahd, B., Arabi, M. & Hassanpoor, SH. (2016). Emprical researche and methodology in accounting. Tehran, Terme press. (in Persian)
Blanco, B., & Dhole, S. (2017). Financial Statement Comparability, Readability and Accounting Fraud. AFAANZ Conference, Working Paper, https://www.afaanz.org/ openconf/2017/modules/request.php?module=oc_program&action=summary.php&id=4
Blay, A. D., Geiger, M. A., & North, D. S. (2011). The auditor's going-concern opinion as a communication of risk. Auditing: A Journal of Practice & Theory, 30(2), 77-102.
Bloomfield, R. (2008). Discussion of annual report readability, current earnings, and earnings persistence. Journal of Accounting and Economics, 45(2-3), 248-252.
Bloomfield, R.J. (2002). The incomplete revelation hypothesis’ and financial reporting. Accounting Horizons, 16, 233–243.
Boubaker, S., Gounopoulos, D., & Rjiba, H. (2019). Annual report readability and stock liquidity. Financial Markets, Insitutions and Instruments, 28(2), 159-186. 
Callen, J. L., Khan, M. & Lu, H. (2013). Accounting quality, stock price delay and future stock returns. Contemporary Accounting Research, 30(1), 269-295.
Carcello, J. V., & Palmrose, Z. V. (1994). Auditor litigation and modified reporting on bankrupt clients. Journal of Accounting Research, 32(3),1-30.
Carson, E., Fargher, N., Geiger, M., Lennox, C., Raghunandan, K. & Willekens, M. (2013). Audit Reporting for Going-Concern Uncertainty: A Research Synthesis. Auditing: A Journal of Practice & Theory, 32 (Supplement 1), 353–384.
Davis, L. R., Ricchiute, D. N., & Trompeter, G. (1993). Audit effort, audit fees, and the provision of nonaudit services to audit clients. The Accounting Review, 68, 135–150.
DeFond, M. L., Chee, Y. L. & Zaang, Y. (2016). Client Conservatism and Auditor-Client Contracting. The Accounting Review, 90(1), 69–98.
Faghfour Maghrebi, Y., Sajadi, S., Asnaashari, H., Rezaeian, A. (2020). Investigating the Mediating Role of Understanding, Processing Fluency and Credibility of an Earnings Press Release on the Relationship between Language Sentiment, Readability, Sophistication and Investors’ Judgment and Decision-making. Accounting and Auditing Review, 27(1), 87-113. (in Persian)
Firtel, K. (1999). Plain English: A reappraisal of the intended audience of disclosure under the Securities Act of 1933. Southern California Law Review, 72, 851–897.
Habib, A., & Hasan, M.M. (2018). Business strategies and annual report readability. Accounting and Finance, Forthcoming. Available at https://ssrn.com/abstract=3183253.
Hasan, M. M. (2017). Managerial Ability, Annual Report Readability and Disclosure Tone. Available at SSRN: https://ssrn.com/abstract=2957135.
Hasas Yegane, Y., Hasani Alghar, M. & Marfoe, M. (2015). Overconfidence Management and Audit Fee. Quarterly Journal of The Iranian Accounting and Auditing Review, 22(3), 363–384. (in Persian)
Hennes, K. M., Leone, A. J. & Miller, B. P. (2014). Determinants and market consequences of auditor dismissals after accounting restatements. The Accounting Review, 89(3), 1051-1082.
Hillegeist, S. A. (1999). Financial reporting and auditing under alternative damage appointment rules. The Accounting Review, 74(3), 347-369.
Hoitash, R. & Hoitash, U. (2015). A new measure of accounting complexity. Working paper. Bentley University.
Imani Barandagh, M., Abdi, M., & Kazemi Olum, M. (2017). Investigating the Impact of Gender Diversity in the Audit Committee on the Audit Fees of Companies Listed in Tehran Stock Exchange. Quarterly Journal of The Iranian Accounting & Auditing Review, 24(1), 303–322. (in Persian)
Johnstone, K. M. & Bedard, J. C. (2004). Earnings manipulation risk, corporate governance risk, and auditors’ planning and pricing decisions. The Accounting Review, 78(4), 1003-1025.
Kaplan, S. & Williams, D. (2013). Do going concern audit reports protect auditors from litigation? A simultaneous equations approach. The Accounting Review, 88(1),199-232.
Kashanipoor, M., Aghaee, M., Mohseni Namaghi, D. (2020). Information Disclosure Tone and Future Performance. Accounting and Auditing Review, 26(4), 570-594. doi: 10.22059/acctgrev.2020.278084.1008146. (in Persian)
Kawada, B. S. & Jundong, J.W. (2020). Annual report readability subsequent to going- concern opinions. Managerial Auditing Journal, 35(1), 24-42.
Kim, Y. & Park, M. S. (2014). Real activities manipulation and auditors' client-retention decisions. The Accounting Review, 89(1), 367-401.
Knechel, W. R., & Payne, J. L. (2001). Additional evidence on audit report lag. Auditing: A Journal of Practice & Theory, 20(1), 137-146.
Knechel, W. R., Rouse, P., & Schelleman, C. (2009). A modified audit production framework: Evaluating the relative efficiency of audit engagements. The Accounting Review, 84(5), 1607-1638.
Koonce, L., Leitter, Z., & White, B. (2018). The effect of a cautionary notice on investors’ reactions to more and less readable disclosures. Available at SSRN: https://ssrn.com/abstract=2711542.
Kordestani, G., Khatami, Z. (2016). The Relationship quality of accounting information and accounting conservative with stock prices crash risk. Journal of Financial Accounting Knowledge, 3(2), 109-129. (in Persian)
Krishnan, J., & Krishnan, J. (1997). Litigation risk and auditor resignations. The Accounting Review, 72(4), 539-560.
Lawrence, A. (2013). Individual investors and financial disclosure. Journal of Accounting and Economics, 56(1), 130-147.
Lee, T. A., & Tweedie, D. P. (1975). Accounting information: an investigation of private shareholder usage. Accounting and Business Research, 5(20), 280-291.
Lehavy, R., Li, F. & Merkley, K. (2011). The effect of annual report readability on analyst following and the properties of their earnings forecasts. The Accounting Review, 86 (3), 1087-1115.
Li, F. (2008). Annual report readability, current earnings, and earnings persistence. Journal of Accounting and Economics, 45 (2–3), 221–247.
Li, F. (2010). Textual analysis of corporate disclosure: A survey of the literature. Journal of Accounting Literature, 29, 143–165.
Lo, K., Ramos, F., & Rogo, R. (2017). Earnings management and annual report readability. Journal of Accounting and Economics, 63, 1–25.
Lobo, G.J., & Zhao, Y. (2013). Relation between audit effort and financial report misstatements: Evidence from quarterly and annual restatements. The Accounting  Review, 88(4), 1385-1412.
Loughran, T., & McDonald, B. (2014). Measuring readability in financial disclosures. The Journal of Finance, 69(4), 1643-1671.
Miller, P. B. (2010). The effects of reporting complexity on small and large investor trading. The Accounting Review, 85(6), 2107–2143.
Mohammadrezaei, F., Tanani, M., Aliabadi, A. (2018). Audit Failure: Audit Report Lag and Moderating Role of Family Ownership. Accounting and Auditing Review, 25(1), 51-70. doi: 10.22059/acctgrev.2018.252507.1007839. (in Persian)
Moradi, M., Osoolian, M., Norouzi, M. (2014). Audit Opinion and Earnings Management: Uncertainty in Going-concern. Accounting and Auditing Review, 21(3), 313-328. doi: 10.22059/acctgrev.2014.52384. (in Persian)
Nazieh Ezat, A. (2019). The impact of earnings quality on the association between readability and cost of capital: Evidence from Egypt. Journal of Accounting in Emerging Economies, https://doi.org/10.1108/JAEE-12-2018-0136.
Norouzi, M., Azinfar, K., Abbasi, E., & Dadashi, I. (2020). Modeling the Moderating Role of Management Ability in the Relationship between Financial Reporting Readability and Agency Cost. Journal of Financial Accounting Research, 12(1), 1-18. doi: 10.22108/far.2019.116175.1433. (in Persian)
Previts, G. J., Bricker, R. J., Robinson, T. R. & Young, S. J. (1994). A content analysis of sell-side financial analysts company reports. Accounting Horizons, 8(2), 55–70.
Rennekamp, K. (2012). Processing fluency and investors’ reactions to disclosure readability. Journal of Accounting Research, 50,1319–1354.
Rezaei Pitenoei, Y., & Safari Gerayli, M. (2019). Financial reporting readability and the likelihood of fraudulent financial reporting. Journal of Financial Accounting Research, 10(4), 43-58. doi: 10.22108/far.2019.113858.1337. (in Persian)
Rogers, J., Van Buskirk, A., & Zechman, S. C. (2011). Disclosure Tone and Shareholder Litigation. The Accounting Review, 86(6), 2155-2183.
Sarvi, A., Talebnia, G., Pourzamani, Z., Jahanshad, A. (2019). Assessment Readability and Understandability of Accounting Standards by Accountants and Auditors Using Flesch and Cloze Indexes. Applied Research in Financial Reporting, 7(2), 241-274. (in Persian)
Seetharaman, A., Gul, F., & Lynn, S. (2002). Litigation risk and audit fees: Evidence from U.K. firms crosslisted on U.S. markets. Journal of Accounting & Economics, 33(1), 91–115.
Shu, S. Z. (2000). Auditor resignations: Clientele effects and legal liability. Journal of Accounting and Economics, 29(2), 173-205.
Simunic, D. (1980). The pricing of audit services: Theory and evidence. Journal of Accounting Research, 18(1), 161-190.
Simunic, D. A., & Stein, M. T. (1987). The Impact of Litigation Risk on Audit Pricing: A Review of the Economics and the Evidence. Auditing: A Journal of Practice & Theory, 15, 120–134.
Xu, Q., Fernando, G., Tam, K. & Zhang, W. (2020). Financial report readability and audit fees: a simultaneous equation approach. Managerial Auditing Journal, 35(3), 345-372.
You, H., & Zhang, X. (2009). Financial reporting complexity and investor underreaction to 10-K information. Review of Accounting Studies, 14(4), 559–586.
You, T.T., & Yi, S.J. (2010). Readability analysis of internal control self-assessment report Commun. Finance Account, 3, 112–114.
Accounting and Auditing Review
Volume 27, Issue 2
2020
Pages 202-230

Files

Share

How to cite

Statistics