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    Auditor Style and Financial Statement Comparability.
    research summary posted July 17, 2015 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual, 05.08 Impact of Office Size 
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    Title:
    Auditor Style and Financial Statement Comparability.
    Practical Implications:

    The authors find support for the idea that auditors develop in-house rules to facilitate comparability within their clientele. These auditor style effects also appear to reduce comparability between clients audited by different auditors. Big 4 accounting firms may have an effect on another earnings attribute that has not previously been investigated, namely, accounting comparability. The authors find that firms audited by Big 4 auditors have greater accounting comparability than firms audited by non-Big 4 auditors, which suggests another dimension in which the two auditor groups differ. It is also the case that each Big 4 audit firm has its own style, which affects accounting comparability and is therefore another source of variation within the Big 4 group of auditors.

    Citation:

    Francis, J. R., Pinnuck, M. L., & Watanabe, O. 2014. Auditor Style and Financial Statement Comparability. Accounting Review 89 (2): 605-633.

    Keywords:
    big 4 accounting firms, comparability, earnings, expertise
    Purpose of the Study:

    Comparability is defined by the Financial Accounting Standards Board (FASB) as the quality of information that enables users to identify similarities and differences in the financial performance of two firms. The FASB states that comparability in financial reporting is the primary reason for developing accounting standards, and the centrality of comparability is stressed in accounting textbooks, particularly financial statement analysis texts accounting standards on their own do not fully determine financial reporting outcomes; economic agents and institutional incentives also play an important role.

    This motivates the investigation of the role that auditors play in the implementation of comparability in the United States. For the purpose of this study the authors define accounting comparability as the closeness of two firms’ reported earnings due to the consistency with which rules are applied across firms. In the empirical context, this means that firm-pairs in the same industry and fiscal year, and therefore subject to the same general economic shocks, are expected to have a similar accruals and earnings structure, all things being equal. The study focuses on the role of the auditor, the authors argue that each Big 4 audit firm has its own unique set of internal working rules that guide and standardize the auditor’s application of auditing and accounting standards.

    Design/Method/ Approach:

    The authors use a regression model to examine the relation between accounting comparability and auditor style. The primary tests are based on pairs of firm-year observations from Compustat in the same industry-year for the period 1987 to 2011.

    Findings:

    The authors find that two firms in the same industry-year and audited by the same Big 4 auditor have more comparable earnings than two firms audited by two different Big 4 auditors. Pairs of firms in the same industry-year with the same Big 4 auditor have more similar total and abnormal accruals; firm-pairs with the same Big 4 auditor have a higher covariation in earnings over time; and auditor fixed effects are a statistically significant determinant of accruals.  Big 4 auditors have a greater effect on accounting comparability than non-Big 4 auditors.

    A single set of uniform accounting standards is often advocated as a means to increase comparability of financial statements, reflecting the rationale for the FASB-IASB convergence project. This study documents that the role of an economic agent, the auditor, is also important in facilitating the production of accounting comparability. The authors argue that the Big 4 style effect arises from each audit firm having its own unique set of in-house rules with respect to the interpretation and implementation of GAAS (auditing standards) and the interpretation and enforcement of GAAP (accounting standards).

    Category:
    Audit Team Composition
    Sub-category:
    Impact of Office Size, Industry Expertise – Firm and Individual