Electronic copy available at: http://ssrn.

com/abstract=1098868
1
An Empirical Investigation of Greek Municipalities Quality of Financial
Reporting
Sandra Cohen
1
and Nikolaos Kaimenakis
2
Correspondence address
Sandra Cohen
Lecturer of Accounting
Athens University of Economics and Business
76, Patission St.
Athens 104-34
Greece
Tel: +30/210/8203168,
Fax: +30/210/8203164
E-mail: scohen@aueb.gr
1
S. Cohen is a Lecturer of Accounting in the Department of Accounting and Finance in
Athens University of Economics and Business
2
N. Kaimenakis is a PhD student in the Department of Accounting and Finance in Athens
University of Economics and Business
Electronic copy available at: http://ssrn.com/abstract=1098868
2
An Empirical Investigation of Greek Municipalities Quality of Financial
Reporting
Abstract
Local governments on the municipal level were among the first organizations to
take part in the accounting reform in Greece that sought the transformation of the
traditional budgetary cash accounting system to a new system that combines cash
and accrual accounting information. In this paper we examine the level of
information quality obtained by the end-of-the-year accrual financial statements of
Greek municipalities in terms of accounting principles compliance measured by
three alternative compliance indices. In addition to that, we investigate the role of
external auditors in terms of the informational quality of the financial reports.
Moreover, based on previous studies we investigate the effect of certain factors on
the three alternative compliance indices. Our results indicate that there is plenty of
room for improvement in relation to the quality of the information content of
municipalities financial reports. A better presentation of the magnitude of
deviations from accounting standards in auditor reports could serve towards this
direction. Additionally, variables that relate to the auditor size as well as to the
municipality size, wealth and experience in accrual accounting were found to
exhibit an influential role on the level of comprehensiveness of the accounting
information provided to stakeholders through end-of-the-year financial statements.
Keywords: accrual accounting, compliance indices, audit reports, quality of
financial reporting, municipalities, Greece.
3
An Empirical Investigation of Greek Municipalities Quality of Financial
Reporting
Introduction
The continuum of problems faced by many governments worldwide such as the
squander, the misallocation and the embezzlement of funds, the provision of
services to taxpayers that do not represent value for money and so on, has led to a
public demand for radical changes towards the improvement of public sector
activities. More specifically, pressure has being applied to governments to become
more effective, efficient and accountable for the use of publicly generated funds
(Hoque and Moll, 2001). The answer to these problems came through the private
sector despite its fundamental differences in relation to its public counterpart in
terms of the nature of its activities and the goals it pursues (Carnegie and West,
2003). The techniques and management systems that have been developed within
the private sector are perceived to be able to enhance quality, profitability and
accountability even when applied to the public sector. The transfer of these
techniques from the private sector realm to the public one has been known as the
New Public Management (hereafter NPM) the utility and results of which are still
under debate in the relevant literature (see for example on the topic of accounting
reforms in the NPM context: Lapsley, 1999; Caccia and Steccolini, 2003; Carlin,
2005).
Among the most important changes NPM brought to public sector organizations
was the transformation of the traditional budgetary cash accounting systems to
systems that support accruals. This change was deemed necessary because of the
key role accounting information plays in decision making (Pettersen, 2001);
providing decision makers with more relevant and of higher quality accounting
information can ultimately enhance the appropriation of taxpayers funds. This
4
rationale was based on the assumption that cash accounting exclusively tracks cash
revenues and expenditures that occur within the fiscal period, whereas accrual
accounting has the advantage of focusing on resource flows according to the period
in which they are generated or consumed which in turn allows for a better
understanding of the cost of services provided (Guthrie, 1998). It is contended that
without accrual accounting a vast array of important information which can be used
to improve decision making is lost (Guthrie, 1998). In addition to that, reports
generated on the basis of accrual accounting improve disclosure to stakeholders in
relation to the financial condition of public sector organizations and therefore
improve accountability. This, according to Chan (2003), can potentially lead to
debates on intergenerational equity that is the extent to which decision makers serve
the needs of the current generation without adding financial burdens to future
taxpayers. Moreover, as Hood (1995) notes, there is a conception among NPM
supporters that the private business accounting methods allow for the close costing
and evaluation of the activities of public sector servants and professionals.
However, many researchers have challenged these assumptions. This is mainly
because of the unique nature of public sector organizations and activities where the
goal is the improvement of taxpayers quality of life and not the profit as in the
private sector firms (see for example Aiken and Capitanio, 1995; Guthrie, 1998;
Carnegie and West, 2003; Carlin, 2005). Also, other scholars have argued on the
lack of a solid theoretical basis for the perceived superiority of accrual accounting
figures (Guthrie, 1998). Nevertheless, despite the considerable criticism, accruals
appear to be on their way of becoming the new basis of depiction of public sector
entities financial position and performance.
In line with the NPM philosophy, the Greek government during the previous years
applied a number of changes in government subsidized entities among which the
evolution of their traditional single-entry budgetary accounting systems to double-
5
entry accounting systems that combined cash and accrual information was included.
Within this dual system cash accounting and accrual accounting would operate
simultaneously but independently from one another. The public sector entities
involved in the project were supposed to issue businesslike end-of-the-year
statements based on the accrual concept. Independent external audit firms would
review these statements; thus, reliability to the accounting figures would be
provided. The Presidential Decree 315/99 (hereafter PD 315/99), which defined the
nature and operation of the dual accounting system in municipalities had as an
effective date that of January 1
st
2000 and was to be applied under specific
restrictions
1
. However the implementation of the new system exhibited considerable
delay that was the outcome of several shortcomings (see Cohen et. al. 2007 for more
details).
The scope of the study is twofold. Firstly we seek to examine the informative
quality of Greek municipalities end-of-the-year financial statements. For this
purpose a thorough study of the audit reports of the financial statements that were
published by Greek Municipalities for the fiscal year 2003 was conducted. The
results of this study provide a comprehensive view on the issue of quality of
accounting information in the context of Greek municipalities where cash and
accrual accounting coexist. In parallel, we analyze the extent to which external
auditors have contributed to the improvement of the quality of accounting
information provided by Greek municipalities. Secondly, we investigate the factors
that exert an influential role to the level of accounting standards compliance. More
specifically, we try to identify relations among several endogenous and exogenous
characteristics of municipalities and the level of the compliance they exhibit
towards accounting standards.
6
The present study adds to the literature of accrual accounting innovations in the
public sector in a number of ways. Firstly, it provides an evaluation of the quality of
accrual accounting information in a setting where not only accrual and cash
accounting operate simultaneously but where they are both used for decision
making purposes. This builds on the studies that have examined the adoption of
accrual accounting systems in a setting where cash accounting is still existent (Jones
and Pendlebury, 1991; Christiaens, 1999; Christiaens, 2000; Christiaens and Van
Peteghem, 2007). This coexistence of the two accounting systems is quite a unique
phenomenon since in most cases throughout the world the accrual accounting
systems have actually replaced the cash accounting ones; in this sense our study
gives the reader the opportunity to view the quality of accrual accounting
information when cash accounting is still used in the same way as it used to
traditionally operate. Moreover, our examination goes further than most studies that
deal with compliance with accounting standards in order to assess the informative
quality of accounting reports; even though we evaluate the quality of accounting
information from a compliance perspective ourselves, we also ascertain whether the
external auditors that serve as a quality assurance function are actually fulfilling
their role. Finally, we build on the relevant literature by determining the effect of
certain factors on compliance thus contributing to comparisons with similar studies.
The remainder of this paper is structured as follows: the next section provides a
review of the literature while the third section describes the research questions and
the hypotheses development. The methodology employed is described and the
results are presented in the fourth and fifth section respectively. Finally the two last
sections host the discussion of the results of the study and our concluding remarks.
7
Literature review
Accounting reforms in the public sector aim at the improvement of information
provided to decision makers and to stakeholders; this improvement is a necessary
condition for the enhancement of public sector organizations accountability and
performance since accounting information plays a key role in decision making in
organizations (Pettersen, 2001). In this spirit the traditional cash budgetary systems
that essentially focus on inputs, are transformed to output orientated accrual
accounting systems that closely resemble those of the private sector. This also
represents a shift from accountability in terms of process accountability to results
accountability (Hood, 1995). Even though the strict adoption of accruals in public
sector entities is not advisable due to measurement problems, lack of theoretical
support and increased subjectivity (Chan, 2003), the expected benefits are
overwhelmingly more significant in comparison to the drawbacks.
Despite the amount of studies in the public sector accounting literature that focus on
the implementation of accounting reforms, there is a distinct lack of evaluation of
the results. More specifically, apart from a few studies discussed later in this
section, little attention has been paid towards the manner of the implementation of
these reforms in terms of compliance. This is a matter of utmost significance; it is
imperative that the resulting accrual accounting systems provide decision makers
with relevant and reliable information. It is easy to see why the resulting
information is so important. The expected benefits of an accounting reform cannot
be obtained solely by introducing accruals accounting in public sector entities;
accounting principles should be applied without any deviations that would seriously
alter the reliability of end-of-the-year statements and thus hinder decision making.
As Christiaens and Van Peteghem (2007: 376) point out: Without an adequate
implementation, all the efforts made, the presupposed goals of the reform and the
8
created expectations will be lost. Bearing in mind the importance of accounting
information for decision making purposes (Pettersen, 2001), it is evident that low-
quality information is bound to lead to erroneous judgments regarding the allocation
of public sector organizations resources.
Even though, as we noted earlier, compliance issues are often overlooked in public
sector accounting literature, a number of studies have evaluated the adherence of
public sector organizations to accounting standards. Ingrams (1984) seminal study
tested an extensive list of variables in order to determine the factors that affect the
accounting practices in the United States. More specifically, Ingram tested the
influence of these factors on local governments disclosure of accounting
information. Disclosure was measured via a simple dichotomous scoring index that
has been used (mostly modified) in a number of studies such as those conducted by
Robbins and Austin (1986), Ingram and DeJong (1987), Giroux (1989), Cheng
(1992), Allen and Sanders (1994), Coy et al. (1994), Christiaens (1999), Coy and
Dixon (2004), Ryan et al. (2002), and Christiaens and Van Peteghem (2007).
Through these studies it has become evident that the quality of reporting by public
sector organizations is not perfect; nevertheless, it seems that time has a beneficial
effect over compliance (Ryan et al., 2002).
Compliance is crucial in order for financial statements to be informative. However,
the figures on the financial statements are not the only source of reliable accounting
information for the stakeholders. Even if compliance with accounting standards is
not fully achieved and an entity issues low-quality accounting data, the opinion
expressed by external auditors can serve as a buffer to stakeholders. The audit report
annexed to the annual financial statements contains useful information in relation to
an entitys adherence to accounting standards. This data can be used by the
stakeholders to reckon the window dressing of the financial position of a given
9
public sector organization. Even though it is not possible for an external auditor to
identify every single case of material misstatement (Wright and Wright, 1997), the
audit report serves as a proxy of the quality of the accounting statements and
therefore provides legitimization to an entity that has fully complied with
accounting standards.
The importance of the external auditors function can be illustrated easily by
considering a situation where the financial statements would not be audited: in such
a case a stakeholder would be unable to determine the reliability of a given
statement. A low-quality financial statement would be treated in the same manner as
a statement issued with total adherence to accounting standards. Therefore,
accounting information would be of high risk and as a result of this it would be
rendered useless. Auditors attest the credibility of the accounting figures reported by
public sector organizations in order to deal with the problems that arise from the
principal-agent relationship that exists between the management of these entities
and their various stakeholders (The Institute of Internal Auditors, 2006). Moreover,
external auditors provide through their opinion a degree of comfort to
stakeholders as to the reliability of accounting figures (Power, 1997: 124). Thus,
high-quality municipalities financial reports should not only comply with the
accounting standards but at the same time they should be accompanied by external
auditors reports that comment on their adherence to them.
As regards the effects of a plethora of external and internal factors that have been
tested in previous studies as having an influential role on the level of compliance
with accounting standards the empirical results found in literature do not coincide.
More specifically, Ingram, (1984), Ingram and DeJong, (1987) and Christiaens
(1999) did not find any statistical relationship between the municipalities reliance
on dept and compliance. On the contrary, the empirical evidence in the studies of
10
Robbins and Austin (1986) and Cheng (1992) supported such a relationship. Ingram
(1984) and Robbins and Austin (1986) assumed but they did not succeed in
supporting with empirical evidence a positive relationship between compliance and
municipal wealth. Also, the relevant literature remains inconclusive as to the effect
of an organizations size on compliance with accounting standards. More
specifically, even though Christiaens (1999) revealed a positive relationship,
Robbins and Austin (1986) and Ingram and DeJong (1987) did not find such a
relationship.
The literature also includes surveys that provide corroborative evidence that
external auditors influence the quality of the financial statements issued by their
clients (Beattie et al. 2000). However, this research stream is mainly concentrated
on the private sector. Becker et al. (1998) and Francis et al. (1999) have shown that
the external auditor size acts as a constraint to the clients earnings management
practices. Possible explanations for that are the higher losses audit firms may incur
in case of an audit failure such as quasi rents (DeAngelo, 1981) or brand name
reputation decline (Klein & Leffler, 1981). However, in the public sector realm
Robbins and Austin (1986) did not reveal such a relationship.
As to the influence of the attitude of politicians towards the level of compliance
with the accounting principles and with the accounting reform in general, Hepworth
(2003) claims that it is imperative that politicians accept the need and recognize the
benefits of such a reform. Finally, Christiaens and Van Peteghem (2007) who tested
the effect of a municipalitys accrual accounting experience on its compliance to
accounting standards were inconclusive regarding the effect of experience on
compliance. However, Ryan et al. (2002) found a positive association between the
years of accrual accounting experience and compliance.
11
Research objectives and hypotheses development
The accounting reform in Greek municipalities aimed at the improvement of
accounting information provided to decision makers; this was expected to enhance
fund management and improve accountability. However, for this to happen, the
output of the accounting system should provide relevant and useful information.
The present research study seeks to determine the quality of accounting information
provided by Greek municipalities end-of-the-year financial statements. For this
purpose we examine on the one hand whether Greek municipalities have deviated
from accounting standards, while on the other hand we ascertain the quality of
information provided by audit reports. We also try to assess the factors that
influence municipalities compliance level. Therefore we will study the following
three research questions:
RQ1: At what extend have Greek municipalities adhered to the accounting
standards set out in the PD 315/99?
The quality of Greek municipalities financial reporting is dependent on compliance
with accounting standards. A low (high) level of compliance with the standards that
were established through PD 315/99 will be the indicator of poor (good) informative
quality of the accounting data. In other words, we want to measure the
development gap (Ter Bogt and Van Helden, 2000) that is the difference between
the ideal concept of accounting changes and its ultimate development. In order to
determine the level of compliance with accounting standards we employ compliance
indices. Compliance indices have been used in previous studies (such as those by
Christiaens, 1999; Christiaens and Van Peteghem, 2007) and can serve as objective
measures of the quantification of the extent of adherence to accounting standards.
Through such measures it is also possible to draw comparisons among various
municipalities. Bearing in mind though that by using a single compliance index we
12
may fail to accurately capture the full breadth of adherence with standards we use
alternative indices that are expected to encapsulate both in quantitative and
qualitative terms the extent of adherence to accounting standards.
RQ2: What is the informative quality of the audit reports that accompany the
financial statements of Greek municipalities?
The Greek central government has established compulsory reviews by external
auditors of the municipalities annual financial statements. The audit must be
performed according to the Generally Accepted Auditing Standards, which have
been established by the Greek Institute of Certified Auditors and Accountants. The
audit opinion provides assurance that the financial statements have been prepared
according to the Generally Accepted Accounting Principles of the Greek State and
the PD 315/99, and that they fairly present the financial position, the results of
operations, and the disposal of surplus or deficit of the audited firm. The comments
presented in the audit opinion refer to material items and disclose instances where
generally accepted accounting principles and/or the laws of the Greek state have not
been followed. Examples of such instances include the following: incorrect
accounting treatments or estimates, insufficient provisions, insufficient disclosure of
material financial statement information, and so on. Therefore, the audit report plays
an important role by acting as a buffer against low-quality information. However, a
necessary precondition in this quality assurance process is that the audit reports
provide information that assist stakeholders to accurately evaluate the reliability of
the accounting information issued by an entity. Thus, our aim here is to determine
whether the audit reports of Greek municipalities:
(a) Contain quantitative information related to a municipalitys deviations from
the accounting standards it should adhere to. This information should provide
13
adequate input for proper adjustments to be made as to derive to the actual
financial condition and position of the entity, and
(b) Provide an audit opinion that summarizes the quality of financial reporting.
RQ3: Which factors exhibit an influential role on the level of compliance with the
accrual accounting standards?
This study also aims at determining the impact on the quality of accounting
information of certain factors cited in previous studies. For this purpose we examine
the following hypotheses:
H1: Municipality reliance on debt positively affects its compliance with accounting
standards.
A municipality that relies on debt in order to finance its operations should be
expected to be subject to tight control by financial institutions. Therefore it would
be restricted in applying standards without deviations that could seriously influence
its financial position and performance.
H2: Municipality wealth is expected to be positively associated with compliance.
Municipalities that do not heavily rely on government subsidies are expected to be
keen in showing their good financial health and therefore be more willing to comply
with accounting standards so as not to cast doubts in relation to their true financial
condition to all interested stakeholders. This behavior is also expected to be driven
by mayors who wish to politically benefit from their municipalities good financial
health.
H3: Municipality size positively affects its compliance with accounting standards.
14
municipality with a large population is expected to maintain an equivalently
large number of employees who can work in preparing high quality end-of-the-year
statements. In addition to that, it could be argued that municipalities of a significant
size draw more attention from the press in comparison to smaller ones and are
therefore more inclined to comply with standards so as to avoid any negative
publicity.
H4: External auditor size positively influences the accuracy of municipalitys end-
of-the-year statements.
The size of the auditor is expected to exert a positive effect on compliance. Larger
audit firms are assumed to possess higher level of competence in comparison to
smaller audit firms. Moreover, audit firms of a significant size are less dependent on
specific clients and therefore can provide more high-quality services. Finally, in
case of an audit failure larger audit firms have more to lose than auditors of a
smaller size.
H5: Municipalities comply with accounting standards more readily if their mayors
were elected with support from the ruling political party.
The accounting reform process is expected to be more favorably appreciated by
mayors who originate from the political party that governs. In Greek municipalities
the elected mayors are the driving force behind the overwhelming majority of the
projects these entities undertake. Local government elections in Greece are to a
great extent a political arena of the major parties in which they antagonize for
political control of the municipalities. The mayors are almost exclusively elected
with the support of the major political parties that comprise the Greek Parliament. If
a mayor has chances of retaining the support of a major political party he/she must
show active support to the partys agenda. This leads us to assume that mayors who
15
get elected with the support of the ruling party will actively seek the success of the
reform so as to show commitment to the governmental program. Therefore it should
be expected that in such cases municipalities exhibit a higher compliance with the
accounting standards in comparison to municipalities whose mayors belong to
opposition parties.
H6: Municipalities with long-term experience in accrual accounting will exhibit
higher compliance with accounting standards.
We expect that local governments faced such a plethora of shortcomings when they
had an accrual accounting system installed for the first time that had potentially lead
them to exhibit deviations from accounting standards. However, it is likely that
these problems were dealt with in later periods thanks to the familiarization of
municipalities with the accrual concept. For instance, it is possible that asset
valuations in the first balance sheet issued by a municipality have not been
performed with absolute adherence to accounting standards due to the lack of
experience of the accounting personnel or the lack of the necessary data.
Nevertheless, these difficulties should be progressively overcome as a municipality
is getting familiarized with the new accounting system.
Methodology
For the purposes of our study we examined the audit reports of Greek
municipalities end-of-the-year financial statements for the fiscal year 2003. These
audit reports contain monetary and qualitative information that can be utilized in
order to evaluate the degree to which a municipality adheres to accounting
standards. Even though according to studies conducted in the private sector (Wright
and Wright, 1997) auditors do not report on every single material misstatement, we
16
expect that the audit reports will give a good indication of the extent of adherence to
accounting standards. Thus, our review of the audit reports will provide an
indication of the quality of the audit work conducted on Greek municipalities
annual accounting statements.
The overall evaluation of the informative quality of audit reports will be conducted
in parallel with the assessment of the municipalities compliance to standards; on
the one hand we will ascertain whether the external auditor has provided ample
information to quantify deviations from accounting principles, while on the other
we will use this data to develop the compliance indices for the municipalities.
In order to answer our two first research questions that is to what extend the Greek
municipalities have adhered to the accounting standards set out in the PD 315/99
and what is the informative quality of the audit reports that accompany the financial
statements of Greek municipalities we constructed three alternative compliance
indices.
The first compliance index (C1) attempts to quantify the deviations from accounting
principles as a percentage of the municipalitys equity. More specifically, this
compliance index is calculated by the following ratio:
) 1 (
equity ty Municipali of Value
principles accounting from deviations of Value
1 C =
The data source for the calculation of the Value of deviations from accounting
principles is the audit report of every municipality for the fiscal year 2003. In order
to calculate the value of the numerator we algebraically add up the values of all
amounts that are included in the auditors notes indicating the value differences
between the resulting accounting numbers provided principles were correctly
followed and the reported amounts. The Value of Municipality equity refers to the
17
reported value of equity at the end-of-the-year 2003. This index provides
information that can be used to assess the degree to which a municipality has
misstated its financial condition. A result of zero should indicate, at least
theoretically, that the municipality closely adheres to accounting standards. In cases
that the index takes values different from zero, the municipality exhibits deviations
in relation to the application of standards. Yet, it should be noted that the index has
informative power as regards to the quality of a given municipality annual financial
reports as long as the auditors have identified, reported and quantified every
material misstatement that exists in these reports. Otherwise, a value of zero would
be nothing more but the result of deviations from standards quantification failure.
The importance of this compliance index can be illustrated by considering the
conclusion of Ghicas et al. (2008) in their research related to the relevance of
quantifiable audit qualifications in Greek IPOs. According to their study the practice
of reporting quantifiable qualifications in audit opinions is expected to be a valuable
feature in any audit setting. They base their argument on the fact that the amounts
reported in the opinion indicate to the market participants (in our case stakeholders)
exactly how much is missing from the financial statements (which is quantitatively
indicated in the auditors opinion) and not only the information that something is
missing.
For the second compliance index (C2), we use the number of audit remarks as a
proxy of municipalities adherence to accounting standards. Even though this index
fails to encapsulate in monetary terms the deviations from accounting standards it
offers a qualitative approach as to the overall quality of the end-of-the-year financial
statements. Moreover, it summarizes not only the cases where the municipality has
intentionally or not misstated its financial position, but it also includes cases where
the municipality does not operate in satisfactory terms (for example, the auditors
would comment on the quality of the internal control function of a municipality). It
18
is clear that a municipality that is the subject of a large number of auditor comments
regarding the accuracy of its financial reports produces low-quality data for the
assessment of its performance by internal and external stakeholders. However, in
cases where the audit report contains only a small number of comments in relation
to the reliability of the municipalitys accounting figures, this is a proxy of high-
quality information.
C2 = Sum of the number of comments (2)
The third alternative index (C3) was constructed on the basis of the dichotomous
scoring compliance index based on Ingram (1984). In particular, after a careful
examination of the content of the audit reports for the fiscal year 2003, we
summarized 15 distinct items-remarks where auditors have identified that Greek
municipalities failed to adhere to accounting standards. For every item-remark we
used a dichotomous variable of 0 and 1; when a municipality failed to comply with
the relevant accounting standard it would take a mark of zero while if it complied it
would take a mark of 1. The overall compliance index was calculated for every
municipality as the sum of its scores in all dichotomous variables; a municipalitys
index would take the value of 15 if it adhered to all accounting standards. The
items-remarks (R1 to R15) that were used in order to construct the compliance
index C3 are the following:
(R1) Existence of internal audit function
(R2) Accurate valuation of investments
(R3) Calculation of provisions
(R4) Accurate valuation of accounts receivables
(R5) Proper cash account management
19
(R6) Accurate fixed assets valuation
(R7) Proper operation of the double entry accounting system
(R8) Accurate valuation of liabilities
(R9) Identification of contingent liabilities
(R10) Proper operation of computer information systems
(R11) Accurate recognition of revenues
(R12) Accurate recognition of expenses
(R13) Accurate calculation of depreciation - amortization
(R14) Operation of a cost accounting system
(R15) Miscellaneous issues

=
=
15
1
C3
i
i
R (3)
Where:
R
i
corresponds to each one of the 15 aforementioned items-remarks (i=1 to 15).
R
i
take the value of 1 if the municipality adheres to the accounting standard,
whereas R
i
takes the value of 0 if the municipality fails to comply with the
relevant accounting requirement.
It should be noted however that according to Coy et al. (2003) the methodology of
using dichotomous indices (such as indices C2 and C3) suffers from the lack of
20
discrimination in terms of the importance of the items it includes as well as from the
inability to quantify the extent of a misstatement. However, index C1 does not
suffer from this shortcoming.
In order to answer our third research question that is which factors exhibit an
influential role on the level of compliance with the accrual accounting standards we
developed multivariate regressions that examine the effect of the factors that were
presented in the previous section on the alternative compliance indices. In
particular, we used the compliance indices discussed above as dependent variables
and the following six variables that correspond to the hypotheses H1 to H6
described in the previous section as independent variables in our multivariate
regressions:
(1) Long term Debt per capita was used as a measure of a municipalitys
dependence on external financial institutions in order to finance its
operations. It is calculated by dividing the long-term debt of the
municipality by the number of the municipality inhabitants.
(2) Own revenues/Total revenues ratio was used as a measure of dependence on
governmental funds; those municipalities that exhibit a high ratio are not
solely dependent on intergovernmental funds in order to finance their
operations. The nominator of this ratio is the value of the total municipality
operating revenues. The denominator is the sum of municipality operating
revenues plus the subsidies it receives from the central government. This
measure is considered as a proxy for wealth.
(3) Population per square kilometer was used as a proxy of municipality size.
In order to calculate this variable we divided each municipality population
by its size in square kilometers.
21
(4) A dichotomous variable named Auditor was used in order to determine the
external auditors size. Those municipalities that had their annual reports
audited by SOL
2
that is considered one of the biggest audit firms in Greece
had a mark of 1 while those that were not received a mark of 0.
(5) A dichotomous variable named Mayor was used to indicate whether a
mayor is supported or not by the central government. In cases where such a
support existed we gave a mark of 1 while the remaining cases received a
mark of 0.
(6) In order to test for learning effects we used a dichotomous variable named
Learning Effects that takes the value of 1 when a municipality has issued
accounting statements based on the accrual concept in previous operating
periods and 0 when year 2003 was its first issuance year.
Statistical Results
We obtained through the Ministry of Interior Public Administration and
Decentralization the annual accounting statements of 185 Greek municipalities
issued for the fiscal year 2003. A thorough examination of their corresponding audit
reports was conducted so as to construct the three alternative compliance indices.
The data for the construction of the independent variables that could not be
retrieved from the financial statements was obtained through the National Statistical
Bureau. The following table (Table 1) summarizes some basic descriptive statistics
of the three alternative compliance indices:
Insert Table 1 approximately here
Indices C2 and C3 indicate that the annual accounting statements of Greek
municipalities in general deviate from the accounting standards; the descriptive
22
statistics show that on average the audit reports include a number of remarks in
relation to the municipalities compliance. However, the descriptive statistics of
index C1 indicate that the municipalities do not seem to have engaged in accounting
practices that result in material misstatements. A closer examination of the audit
reports has led us to the conclusion that the low values of this index were the result
of the lack of quantifiable deviations information provided by external auditors.
More specifically, even though the audit reports provide ample information as
regards the various accounting practices that have resulted in misstatements, we
came across very few cases of quantification of these misstatements. For example, it
was observed in many instances that a municipality had not valued its long-term
investments appropriately but no quantitative information was provided in the
auditors reports as to the magnitude of this effect on the organizations equity. As
most municipalities audit reports contained notes relating to deviations from
accounting standards but failed to offer any quantification of these deviations, the
first compliance index was inoperable since its explanatory power became
undermined by the lack of numerical data. Furthermore, it has to be noted that
regardless of the severity of the deviations from the accounting practices that were
identified in certain audit reports, the auditors expressed an unqualified
3
opinion
concerning the accuracy of the respective accounting statements. For instance, an
unqualified opinion was issued when a municipality failed to provide evidence
regarding the true amount of its assets or its liabilities, or when there was no internal
audit function. To make matters worse, the same opinion was also stated even in
instances where the very accrual accounting system was essentially non-existent
which meant that the accounting statements under review were not retrieved from a
formal accrual system but by adjusting cash accounting data. Nevertheless, this is
not a unique phenomenon in the Greek context; the private sector audits follow the
same pattern with our findings with one, albeit, major in terms of significance
difference. The remarks in the auditors reports that accompany private sector
23
financial statements also reveal the areas where accounting information deviates
from the accounting policies that come from legislation
4
but such deviations are
always quantified (see also Ghicas et al., 2008). However, even though these reports
were regarded as of unqualified opinion in Greece, they would be considered in
USA and UK as audit qualifications (Owusu-Ansah and Leventis, 2006).
The issuance of poor audit reports constitute a very interesting phenomenon since it
is indicative of either a not in depth approach by external auditors, or an attempt not
to displease their clients by presenting data that would seriously undermine the
reliability of the accounting figures contained in annual statements. This could also
be attributed to the lack of third party reviews of the audit reports issued by external
auditors, or by the lack of sanctions for poor quality work (Deis, Jr. and Giroux,
1992). Moreover, this could be indicative of the external auditors lack of expertise
in public sector organizations accounting systems. According to Krishnan (2003)
and Carcello and Nagy (2004) the specialization of the external auditor in a certain
industry significantly improves the quality of the audit work; bearing in mind that
the accrual accounting systems of Greek municipalities have only recently become
operational, it can be assumed that no audit firm possesses extensive relevant
expertise. Thus it could be expected that, at least in the short term, the audit reports
issued for Greek municipalities would not achieve a highly informative power.
Since the first compliance index was rendered inoperable due to the lack of
sufficient data, we concentrated our analysis of the compliance of municipalities on
the other two indices. The descriptive statistics (see Table 1) clearly indicate that
even though external auditors failed to provide quantitative information concerning
the municipalities adherence to accounting standards, they did not refrain from
revealing areas of non-compliance. The following table (Table 2) shows the issues
covered by the auditors remarks where it is shown that valuation issues and the
24
non-existence of the internal control function were the most encountered issues by
the external auditors.
Insert Table 2 approximately here
We tested whether the two indices C2 and C3 have a negative linear relationship
5
,
which could indicate that even though they measure different aspects of compliance
they are actually closely measuring the same phenomenon. The statistical results
indicate that a strong negative linear relationship actually exists (Pearson correlation
coefficient: -0.933 significant at 1%, Spearman correlation coefficient: -0.969
significant at 1%). Even though one could argue that such a result should be
expected since index C3 relies heavily on index C2, it has to be noted that in many
cases one specific audit remark referred to two or more accounting practices that
resulted in misstatement of its accounts. However, in other cases, these remarks
were exclusively informational on various aspects (such as that a municipality was
issuing accrual based accounting statements for the first time ever) bearing no
information regarding deviations from standards.
As regards the effect of the six factors described in our research hypotheses on the
extent of compliance with accounting standards, we ran two multivariate
regressions where the dependent variable was either index C2 or index C3 and
independent variables were the six contextual variables discussed in the previous
section.
The OLS regression results are presented in the table below (Table 3):
Insert Table 3 approximately here
The results presented in Table 3 indicate that among the six variables which were
tested for effects on a municipalities compliance with accounting standards, the
25
municipality size and wealth, the size of the external auditor and the learning effects
were the most significant in statistical terms. More specifically, our hypothesis H4
was verified since both regressions exhibited that a higher level of compliance is
positively related with the size of the auditor. However, our results go against
hypotheses H2, H3 and H6 since our empirical evidence supports that municipalities
that are either of a considerable size, or are affluent, or have acquired
familiarization with accrual accounting end-of-the-year statements in previous
periods, did not actually deliver better quality reports in year 2003. Possible
explanations for this phenomenon concerning the wealth and size of the
municipalities could be that on the one hand wealthy municipalities do not rely on
government subsidies to finance their operations and have therefore no pressure
from the central government to apply the standards. On the other hand, larger
municipalities are possibly experiencing bureaucratic problems that make the
adoption process more rigid in comparison to smaller local governments where
there is more flexibility. Finally, the adversely expected result evidenced in relation
to the learning effects could be indicative of an unwillingness of municipalities to
improve the quality of their accounting statements throughout time. This finding
would be justified on the grounds that municipalities perceive accrual accounting as
just a legitimate obligation they have to comply with and they do not strive towards
information improvement. Moreover, any deviations from accounting standards
that would be excused or overlooked by audit firms during the first year of accrual
accounting implementation would be identified in audit reports in the following
years when auditors discovered that their recommendations were not seriously taken
into account.
Discussion
26
The present research study focused on the outcome of the accounting reform that
took place in Greek municipalities. More specifically, we examined the quality of
end-of-the-year statements issued by these entities for the fiscal year 2003.
Moreover, we tested whether a number of factors previously cited in the relevant
literature influence municipalities compliance with accounting standards. Our
results indicate that the majority of municipalities under review have clearly failed
to provide high-quality data to their stakeholders. This finding has severe
implications regarding the success of the accounting reform since the main
objective was to provide the municipalities stakeholders with high-quality
accounting information; this however does not seem to have been accomplished.
Therefore, it is rational to assume that the other expected benefits from the reform
such as the improvement of accountability, which depends on the enhancement of
accounting information have not been achieved, at least to the desired extend,
either.
Moreover, our empirical evidence cast doubts upon the quality of external auditors
assessments of local governments end-of-the-year statements. The examination we
conducted on the municipalities audit reports revealed that the deviations from
accounting standards that were disclosed by the external auditors were mostly not
quantified; thus it is not possible to ascertain the magnitude of these organizations
attempts to distort their true financial condition. In addition to that, the opinions that
were issued by external auditors regarding the reliability of the municipalities
financial statements were in every single case unqualified regardless of the severity
of certain issues revealed in the reports. These findings clearly demonstrate the
strong need for improvement of the external auditor assessments; the current
situation leaves the municipalities stakeholders exposed to potentially low-quality
accounting data that cannot be considered as a solid basis for decision making.
27
The prerequisite for the improvement of effectiveness, efficiency, economy and
accountability in these public sector organizations is the enhancement of
information that their accounting systems provide. Our findings however reveal that
this has not been accomplished since the municipalities on the one hand and their
respective external auditors on the other do not seem to have fulfilled their roles in
full scale. Of these two parties however, the responsibility of the external auditor
may be much greater; even if the window dressing is managements goal in order to
ameliorate the financial performance and position of an entity, it is up to the
external auditor to ensure that stakeholders could accurately interpret this set of
data. The case of Greek municipalities as discussed in this paper strongly supports
the conclusion that Jones and Pendlebury (2004) came to; that as long as preparers
of financial statements and auditors are content with the underlying accounting, any
non-compliance with financial reporting policies is an irrelevance.
As regards the factors that affect municipalities compliance with accounting
standards, this study demonstrated a relationship with the auditor size, as well as
with the municipality size, wealth, and previous experience in issuing accrual
accounting end-of-the-year statements. In particular, the auditor size was found to
be positively related with compliance, while municipal size, wealth and experience
with accruals accounting exhibited a negative relationship. Larger municipalities are
probably experiencing bureaucratic problems that inhibit the reform process and
therefore the financial reports produced are of low informative quality. Wealthier
municipalities could have approached the implementation issue rather superficially
since they do not heavily depend on state financing and are therefore less inclined to
satisfy the central government which is the main source of financing for the less
affluent local governments. Moreover, even though the negative relationship
concerning the accrual accounting experience rejects our initial hypothesis, it is
worth mentioning that the results presented in Christiaens and Van Peteghem (2007)
28
show that compliance fluctuates through time. The two other variables we tested
(namely: dependence on debt financing and mayor support by the central
government) were not found to be statistically associated with compliance.
Finally, it is worth mentioning that even though the central government has
established fines in the event that a municipality fails to adhere to the accounting
standards set out by PD 315/99, no such action has been taken. This situation could
also be another reason why municipalities have failed to fully adhere to accounting
standards as exhibited in our statistical results. As Berry and Jacobs (1981)
comments, the absence of an enforcement system is a leading reason of non-
compliance.
Conclusions
This study contributes to the literature of accrual accounting reforms in public
sector organizations through the examination of the quality of the accrual
accounting end-of-the-year financial statements. It has been argued throughout the
study that these reforms can be considered successful in delivering high quality
information to decision makers only when the issuing organizations comply with
accounting standards and when their respective external auditors provide ample
information concerning the extent of their clients compliance. However, experience
on a worldwide basis has shown that accruals accounting cannot be easily
transferred into the public sector realm. Even when this happens, the transition is
considered far from successful since the quality of information provided by the new
accounting systems is rather low and therefore its use for decision making purposes
should be made with caution.
This is the case in Greek municipalities where the advent of accrual accounting
cannot easily be characterized as successful due to their inability or unwillingness to
29
fully adhere to the new accounting standards. Moreover, the audit reports that are
supposed to provide a reliable basis for stakeholders to review the accounting data
provided by the municipalities are also of questionable quality. Concerning this
phenomenon it could be expected that the familiarization of auditors with the
municipalities accounting systems will significantly improve the current situation.
The quality of audit reports can be expected to improve through the establishment
of a system where the reports are subject to third party reviews and sanctions are
imposed to audit firms in the event they issue low quality reports. Furthermore, our
results indicate that compliance is affected by the external auditor size, as well as by
the municipality size, wealth and experience in accrual accounting. However, even
though these results provide interesting implications, the low availability of data
beyond the fiscal year 2003 limits the ability to generalize our findings. Thus, a
follow up study conducted on the municipalities of our sample could provide a
useful perspective concerning the over-the-time effect of the variables that are
expected to influence compliance, as well as the long-term evolvement of the
informative quality of municipalities financial reporting. In addition to that, it
would be interesting to further research on the way shareholders and managements
perceived usefulness of accrual accounting financial reports influences Greek
municipalities adherence to accounting standards.
30
Endnotes
1
The reform was mandatory for all municipalities that met the criteria of more than
5,000 citizens or revenues of more than 1.5 million .
2
The Greek audit market is dominated by a few major firms, which with the
exception of the audit firm SOL S.A. have shown little interest in entering the
market of municipal audits. Thus the municipalities audits have been undertaken by
either SOL S.A. or by small audit firms.
3
The audit reports conclude by stating that: taking into consideration our
aforementioned remarks we believe that the present financial statements represent
the true and fair financial position of the municipality. This same wording,
accordingly adjusted, is customarily used to express an unqualified opinion in the
private sector as well.
4
It is a customary practice in Greece for auditors to make remarks in their audit
reports in accordance with the Hellenic Auditing Standards and Professional Ethics
(The Institute of Certified Auditors in Greece, 1999, p. 180).
5
We refer to a negative relationship since in the compliance index C3 a
municipality is considered to be fully compliant with accounting standards when it
takes a mark of 15 and to be totally non-compliant when it takes a mark of 0.
31
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36
Table 1: Descriptive statistics for the three alternative compliance indices
Compliance
Index N Minimum Maximum Mean
Std.
Deviation
C1 185 0.00 0.15 0.0076 0.0189
C2 185 0.00 11.00 3.7243 2.4394
C3 185 4.00 15.00 11.5405 2.0825
Where:
C1 is the ratio of Value form deviations from accounting principles/Value of Municipality
equity.
C2 is the number of the auditors comments.
C3 is the overall compliance index that is calculated as the sum of the 15 dichotomous
variables that refer to the municipalities compliance with accounting practices.
37
Table 2: Areas of non-compliance contained in audit reports
Auditors Remark Number of
municipalities
that adhered to
the accounting
standard
Number of
municipalities that
failed to adhere to the
accounting standard
1. Existence of internal audit
function
97 (52.43%) 88 (47.57%)
2. Accurate valuation of
investments
71 (38.38%) 114 (61.62%)
3. Calculation of provisions 164 (88.65%) 21 (11.35%)
4. Accurate valuation of
accounts receivables
46 (24.86%) 139 (75.14%)
5. Proper cash account
management
162 (87.57%) 23 (12.43%)
6. Accurate fixed assets
valuation
156 (84.32%) 29 (15.68%)
7. Proper operation of the
double entry accounting
system
140 (75.68%) 45 (24.32%)
8. Accurate valuation of
liabilities
157 (84.86%) 28 (15.14%)
9. Identification of contingent
liabilities
166 (89.73%) 19 (10.27%)
10. Proper operation of
computer information
systems
176 (95.14%) 9 (4.86%)
11. Accurate recognition of
revenues
168 (90.81%) 17 (9.19%)
12. Accurate recognition of
expenses
170 (91.89%) 15 (8.11%)
13. Accurate calculation of
depreciation - amortization
168 (90.81%) 17 (9.19%)
14. Operation of a cost
accounting system
177 (95.68%) 8 (4.32%)
15. Miscellaneous issues 117 (63.24%) 68 (36.76%)
38
Table 3: OLS regression results
C
2
= a + b Long term Debt per capita + c Own
revenues/Total revenues + d Population per square
kilometer + e Auditor + f Mayor + g Learning Effects +
u
C
3
= a + b Long term Debt per capita + c Own
revenues/Total revenues + d Population per square
kilometer + e Auditor + f Mayor + g Learning Effects +
u
a 2.957*** (4.448) 12.133*** (21.082)
b -0.000567 (-0.192) 0.000941 (0.368)
c 2.281** (2.180) -1.556* (-1.717)
d 0.000082* (1.690) -0.000088** (-2.092)
e -1.148*** (-3.087) 0.734** (2.279)
f -0.401 (-0.938) 0.561 (1.518)
g 0.601* (1.670) -0.595* (-1.910)
R
2
adjusted
0.137 0.110
F-Value 5.783*** 4.723***
***,**,* indicate that the result is statistically significant at the 1%, 5%, and 10% level respectively
t-values are shown in brackets
Where:
C2 is the number of the auditors comments.
C3 is the overall compliance index that is calculated as the sum of the 15 dichotomous variables that
refer to the municipalities compliance with accounting practices (see Table 2).
Long term Debt per capita: The ratio Long term debt/Population is a measure of the debt burden of
the municipality.
Own revenues/Total revenues: This ratio shows the ability of the municipality to generate wealth
through its own means.
Population per square kilometer: We proxy for the size of the municipality by dividing the number of
a municipalitys inhabitants to its geographical size.
Auditor: This determines the external auditors size. A value of 1 is given when a municipality is
audited by SOL S.A. which is the largest audit firm conducting municipal audits while a value of
0 is given when it has been audited by a smaller audit firm.
Mayor: This variable indicates whether a mayor is supported or not by the central government. A
value of 1 is given when a mayor has been elected with the central government support. Otherwise a
value of 0 is given.
Learning Effects: This variable shows whether the municipality has issued accrual based financial
statements prior to 2003. A value of 1 is given when it has issued statements prior to 2003.
Otherwise, a value of 0 is given.
39