Professional Documents
Culture Documents
Sati P. Bandyopadhyay
University of Waterloo
Efrim Boritz
University of Waterloo
Guoping Liu
Ryerson University
December 2007
We gratefully acknowledge the financial assistance of the CICA under the CICA/CAAA
research grant program.
1. Introduction
Reporting on interim financial statements originated in the US, where public
accounting firms required an interim review engagement as a condition for undertaking
the year-end audit. However, prior to 2000, the US Securities and Exchange Commission
(SEC) allowed SEC registrants to have their interim financial statements either to be
reviewed prior to their filing (timely review) or to delay the review (retrospective
review) till the end of the fiscal year at the time of the annual audit. With effect from
March 2000, SEC registrants must have timely reviews of their interim financial
information except for SEC registrants that qualify as foreign private issuers that are
not subject to these mandatory review requirements.
Under current Canadian securities regulatory requirements, public companies are
able to choose whether to have their interim financial statements reviewed by external
auditors on a quarter by quarter basis, but they must disclose when there has been no
review performed. These disclosure rules were promulgated in March 2004. In other
words, Canadian regulators currently provide a similar level of flexibility regarding
auditor involvement with interim statements to Canadian firms that were available to
SEC registrants prior to 2000. About 55% of Canadian companies voluntarily have their
interim financial statements reviewed by their auditor (Boritz, 2006). Canadian public
companies that have not had a review performed must disclose this fact by a one-line
disclosure on the cover of the financial statements that the financial statements were not
reviewed by the companys auditor.1 In this study we compare the quality of reviewed
versus non-reviewed interim earnings. This issue is important in the context of a global
trend towards harmonization of accounting, auditing and securities regulations.
Regulators in not only Canada, but those in Japan, Europe and other jurisdictions are
considering following the US mandatory assurance approach.
A number of commentators have argued that auditor involvement with the entitys
financial statements can improve the quality of the reported earnings as well as the
credibility of the reported earnings. As far back as 1987, the Treadway Commission
(1987) concluded that review of interim financial statements will improve reliability of
quarterly statements and increase the likelihood of detection of fraudulent financial
reporting. This view was endorsed by the Blue Ribbon Committee set up by the SEC,
which reported its conclusions in 1999. This view is also echoed in academic literature.
For example, Manry, Tiras and Wheatley (2003) argue that timely review of interim
statements curbs earnings management. Mendenhall and Nichols (1988) conclude that
managers have greater opportunity to manipulate interim earnings when earnings reports
are unaudited.
Others argue that the current level of auditor involvement with respect to the
quarterly financial statements is insufficient and that review engagements add so little value
that they not be relied upon. Also, some regulators have expressed dissatisfaction about the
extent of audit work required in a review engagement.
This disclosure may not adequately distinguish entities that have had a review from those that have not.
Because even reviewed financial statements carry the unaudited disclaimer, readers may not realize that
an additional one-line disclosure, saying that the statements were not reviewed by the auditor, implies
additional risk.
While many of the foregoing commentators and authors predict that there will be
less earnings management when interim earnings are reviewed prior their release as
compared to when they are not, no study so far has conducted a direct comparison of the
magnitude of earnings management adopted by these two groups of firms. For example,
Manry, Tiras and Wheatley (2003) use the strength of the contemporaneous correlation
between returns and earnings as a measure of earnings quality. Ettredge, Simon, Smith and
Stone (2000a) use the frequency of occurrence of extraordinary and other items to measure
the propensity of managers to manipulate earnings. Our paper contributes to this literature
by explicitly comparing the magnitude of discretionary accruals between Canadian firms
that voluntarily decide to have their interim statements reviewed versus those that do not.
This paper contributes in another way. The review/no-review decision is not a
random choice by firms but is motivated by differences in firm characteristics that cause
firms to self-select into the two groups. Ettredge, Simon, Smith and Stone (1994) provide
evidence of differences in firm characteristics between timely reviewed and retrospectively
reviewed SEC registrants in the pre-2000 period. A straightforward comparison of means
across the two groups is subject to self-selection estimation bias. In order to control for
potential self-selection bias we use a two-stage treatment effects model (Maddala, 1983;
Greene, 1997; Hogan, 1997; Kim et al., 2003). Neither Manry et al (2003) nor
Mendenhall and Nichols (1988) control for self-selection bias in their empirical tests
We provide evidence that after controlling for estimated bias arising from potential
self-selection of firms into the two groups, the voluntary choice mechanism permits
Canadian firms to report high quality quarterly earnings numbers through their review
choice. Consistent with Larcker and Richardson (2004), earnings quality is measured as
the magnitude of discretionary accruals (Jones 1991, Dechow, Sloan, and Sweeney 1995)
adopted by sample firms.
We also provide indirect evidence of the signalling benefits of voluntary reviews
versus mandatory reviews. We find that discretionary accruals of Canadian SEC
registrants that reviewed their interim statements are significantly greater than those of
other Canadian firms that also reviewed their interim statements. If we can assume that
the Canadian SEC registrants reviews are less voluntary than those of Canadian nonSEC registrant firms due to the higher regulatory and litigation pressures in the U.S.,
(Baginski, Hassell and Kimbrough 2002)2 then these provide some indirect evidence that
voluntarily reviewed quarterly earnings are superior quality as compared to less voluntary
or quasi-mandatorily reviewed earnings.
When earnings are required by regulatory authorities to be reviewed, all firms
will likely purchase the lowest level of review from their external auditors in order to
satisfy the minimum regulatory requirements. On the other hand, when review is
voluntary, firms that choose to review will probably purchase the highest quality review
from their auditors in order to signal quality to the market and distinguish themselves
from other firms.
The relative accrual quality hypothesis relating to voluntary review versus nonreview is tested with financial statement data for 127, 130 and 130 Canadian firms from
the first, second and third quarters of 2005, respectively, the first full fiscal year for
which the regulation is in effect, that have the necessary quarterly financial statement
data on Canadian COMPUSTAT. Canadian SEC registrants are excluded from this
2
Canadian securities laws and judicial interpretations create a far less litigious environment than exists in
the U.S.(page 25)
analysis for the following reasons. Clarkson and Simunic (1994) argue that Canadian
managers face less litigation-related costs than US managers. This argument applies
equally well to managers of Canadian firms that arte registered with the SEC. PaskellMede (1994, 1999) and Grossman (1996) also conclude that Canadian managers face a
less litigious environment than their counterparts in the USA. There have also been
comments about less effective regulatory enforcement environment in Canada. Thus,
SEC registrants that decide to review possibly do so in order to reduce potential litigation
costs by providing evidence of due diligence rather than signal high quality to the market.
For this reason, quarterly earnings of Canadian SEC registrants are used as proxies for
mandatorily reviewed earnings in our comparison of quality of mandatorily reviewed
versus voluntarily reviewed quarterly earnings. We find from our empirical tests that the
discretionary accruals of 37 SEC Canadian registrants that have their statements reviewed
are greater than those of 84 other TSX listed firms Canadian firms, after controlling for
potentially confounding variables in multivariate tests.
This latter results, though preliminary, suggests that Canadian regulators proceed
cautiously before any decision is made to harmonize this regulation with the SEC.
Several other jurisdictions are also contemplating whether to require US style mandatory
review of quarterly financial statements. But, doing so might deprive firms the
opportunity to signal quality through their choice of reviewing or not reviewing of their
statements. However, our tests in this regard are preliminary and at best, indirect. We
plan on providing more direct evidence on the issue of mandatory versus voluntary
review of interim earnings by designing appropriate empirical tests to compare American
firms quarterly earnings that have to be reviewed under SEC regulations and those of
Canadian firms that voluntarily to get their interim statements reviewed.
Another cost of reviewing statements that we have not considered in this version of
this paper is its potential adverse effect on timeliness of interim reporting because
involvement of external auditors with interim statements might delay the release date of
interim earnings of reviewing firms relative to non-reviewing firms reduce earnings
relevance. However, an estimation of how much earnings timeliness is affected by the
review decision needs to control for the different filing deadlines faced by TSX Venture
exchange listed firms (60 days from fiscal quarter end date) versus other firms (45 firms).
Currently, we are collecting the necessary data to perform this analysis.3
The balance of this paper is organized in the following manner. Section 2 describes
the relationship of this research with prior research. Section 3 lays out the institutional
practises in Canada. Section 4 describes the research design and empirical models.
Section 5 describes the sample and Section 6 reports the results of empirical tests.
Chapter 7 provides compares earnings quality of voluntarily reviewed versus mandatorily
reviewed earnings. Conclusions are contained in Section 8.
Ettredge et al (2000a, note 3) argue that timely reviews might be delayed if there are significant fiscal
quarter-end accruals. These authors indeed report that timely review firms in the USA release their interim
statements two days, on average, earlier than those that are retrospectively reviewed, contrary to
predictions of opponents of timely review. However, the propensity of firms to release interim earnings
within the statutory period depends on the litigation environment that exists in a jurisdiction and the
intensity of enforcement of regulatory mechanisms. As stated earlier Clarkson et. al(1994) report that
Canadian managers face less litigation-related costs than US managers. Paskell-Mede (1994, 1999) and
Grosssman (1996) also arrives at similar conclusions. Thus, it not clear that the findings for US firms carry
over to a Canadian setting. Thus, an examination of the effect of the review decision by Canadian firms on
timeliness of their earnings is warranted. Moreover, the issue of timeliness is not simply a matter of
counting the number of days elapsed between the fiscal quarter-end date and the earnings release date.
Timeliness relates to the speed with which accounting information is reflected in security prices (see for
example, Butler, Kraft and Weiss 2007). While our current small sample size does not permit estimation of
models suggested by Butler, Kraft and Weiss (2007), we plan to do so when we complete collection of data
for our larger sample.
3. Institutional Practises
While securities regulations permit the board to delegate approval of the interim financial statements and
MD&A to the audit committee, some companies require both the board and audit committee to approve
these documents.
Assurance Practices
Canadian securities regulators do not require auditors to conduct a review
engagement on interim financial statements. If a review is not performed, however, they
do require that this be disclosed in a notice accompanying the financial statements.9 An
examination of a sample of public company filings on System for Electronic Document
Analysis and Retrieval or SEDAR (a Canadian database of regulatory filings for listed
firms) for Q1 of 2005 indicates that most TSX-listed public companies have interim
review engagements, although some Canadian SEC registrants that qualify as foreign
private issuers opt out of having such a review performed. Overall, we found about 40%
exception rates.
It is noteworthy that the opt-out rate is so high for entities that could benefit from
having reviews performed. Such benefits include a more reliable quarterly financial
reporting process and more reliable quarterly financial statements, especially in terms of
the quality of estimates, accruals and earnings, which are key contributors to information
risk. In addition to benefits for the interim reports, there would be flow-through benefits
for the reliability of the annual financial statements and a potential reduction in the
frequency of both quarterly and annual financial statement restatements. For many
companies, the additional cost of having quarterly reviews could be offset by potential
cost reductions derived from improved financial reporting processes, better distribution
of audit effort, other efficiency gains and reductions in the cost of capital.
CICA Handbook Section 7050 sets out requirements for a review of interim
financial statements that are very similar to the US standards. Section 7050 sets out the
9
This requirement came into effect in March 2004. Prior to that, it was impossible to distinguish which
companies had a review and which ones did not. A review of a sample of interim financial statements for
Q1 of 2003 indicated that virtually none of them reported that no review was performed.
procedures to be undertaken and provides for an oral or written report to the audit
committee. The work effort prescribed by Section 7050 suggests various procedures,
including some audit procedures associated with an annual audit (e.g., reading
shareholder and director minutes). When auditors conduct a review of interim financial
statements, they must also comply with CICA Handbook Section 7500, which includes a
requirement to read the MD&A to see whether any information is inconsistent with the
financial statements.
Some audit firms exceed the work effort required by the review standard, the
scope being determined by the audit committee and the audit firm. Common issues that
involve additional audit work at quarter ends include revenue recognition, legal claims
and other contingencies, inventory valuations, taxes, accounts receivable allowances,
derivatives, foreign exchange and consolidation issues. The nature and extent of the
additional procedures appears to vary significantly among the firms and, perhaps, among
clients of the same firm. In some cases, the additional work is restricted to enquiry-based
review procedures. In others, however, auditors execute some audit procedures at the
same time as they conduct the review engagement. These could include examination of
material transactions undertaken in the period or in respect of the initial application of
accounting policies. When audit procedures are undertaken, documentation is usually
segregated between that required for the review engagement and that prepared as a result
of the procedures conducted as part of the annual audit. When major transactions are
examined, this activity may occur within the reporting period, rather than at its
conclusion.
The time auditors spend at quarter ends varies according to the nature of the
assignment and the extent to which they are involved with the audit committees review.
When a client wants a formal report for its audit committee, additional time is required,
as is the case when an audit or additional review procedures are performed. The range
appears to be 2-10 days.
Enquiries that extend to assessing changes in internal control over disclosures
(ICOD) and internal control over financial reporting (ICOFR) could add one to six days
to an engagement (CICA Handbook paragraph 7050.35 requires enquiry about internal
control and changes in internal control). This large range reflects the need for firms to
call in their systems group when there are changes in the IT-based internal control
processes.
The foregoing suggests that there are ample opportunities under current standards
and practices for companies to voluntarily vary the scope of the review engagement.
Thus, although the minimum requirements are low, actual practices may be high.
Form of Reporting
In both Canada and US, the results of the auditors reviews are communicated
privately to audit committees. No public reports are issued except in unusual
circumstances. Those communications can be oral or written, although we understand
that most are written. Also, when an auditor performs extended procedures during an
interim period, the extent of the procedures and the findings of those procedures are not
required to be communicated to the audit committee.
Overall, auditors report whether, based on their review, they have become aware
of any material modification that needs to be made for the financial statements to be in
accordance with generally accepted accounting principles (GAAP). A written report
would normally conclude that the auditor is not aware of any material modification that
needs to be made for the interim financial statements to be in accordance with GAAP.
Before that, however, it would explain that an interim review does not provide assurance
that the auditor would become aware of any or all significant matters that might be
identified in an audit. To some, this appears to be a convoluted, responsibility-avoiding
message. Others counter that it is designed to protect the auditor against litigation driven
by unreasonable expectations. A public report is not contemplated and the current
standard does not permit the auditor to consent to the release of a review engagement
report to third parties with the companys interim financial statements unless required
pursuant to securities legislation, and requires inclusion in the report of a disclaimer of
any obligation on the part of the auditor to any third party who may rely on it.
10
Huron Consulting Group, 2004 Report on Financial Reporting Matters (February 28, 2005),
www.huronconsultinggroup.com, 1-866-229-8700.
11
A study by Joshua Livnat and Christine Tan (Restatements of Quarterly Earnings: Evidence on Earnings
Quality and Market Reactions to the Originally Reported Earnings Unpublished Manuscript Stern School
of Business Administration, 2004) of restatements of quarterly earnings by US companies between 1988
and 2002 reports a quarterly restatement rate of 3.4%. (Note that companies with mergers and acquisitions,
discontinued operations and fiscal-year changes were specifically excluded.) Quarterly restatements are
typically smaller than annual restatements and are often not announced in press releases, becoming known
only when a Form 8-K is filed with earnings that differ from those released in the quarterly earnings
announcement. The restating companies are generally smaller. Most (62%) of the restatements are
downward to correct previously overstated earnings. The most frequently restated components of earnings
were cost of goods sold and tax expense. The fourth quarter had noticeably fewer restatements than the
other quarters, presumably due to the auditors involvement in that quarter. (Note that, during most of the
period of the study, auditors were not required to perform a timely quarterly review (i.e., at the end of the
quarter the financial statements were issued), but could do it in retrospect as part of their annual/fourth
quarter audit. This was changed starting March 15, 2000.)
The minimum review procedures under section 7050 might not add sufficient
value to the interim reporting of entities that currently are not having reviews done and
some securities regulators in Canada would like to see the work effort prescribed in the
current review engagement standard expanded. As mentioned in the previous section, this
is consistent with many companies existing practices. To avoid surprise fourth-quarter
restatements, they often request their auditors to perform more than the minimum effort
required by Section 7050. Since there are no established standards for the extended
procedures, however, the extent of the additional procedures can vary from auditor to
auditor and even from client to client for the same auditor.
In summary, there is an important, unresolved question about the value of the
review engagement. This paper addresses this question by investigating the impact of
reviews on the financial statements of companies that voluntarily choose to have such
reviews performed compared with companies that do not.
4. Hypotheses Development
As stated earlier, Canadian firms can use the voluntary choice mechanism allowed
by the Canadian regulators to signal the quality of their financial statements. Firms with
lower financial statement quality electing to have a review will face questions from their
auditors about higher discretionary accruals or potential misstatements. Mendenhall and
Nichols (1988) discuss numerous cases of expenses and revenues that require managers
judgement and use of estimates in reporting quarterly earnings. This implies that
managers have significant opportunities to manipulate interim earnings. Involvements of
auditors in the process are likely to reduce incidents of earnings manipulations.
5. Research Design
Two-stage treatment effects model
The foregoing hypothesis is tested by regressing a measure of earnings
management on a dummy revision/no-revision variable and other control variables.
However, since firms self select into the review and the non-review groups, estimated
OLS regression coefficients will be biased. To control for the potential self-selection
bias, we use a two-stage treatment effects model (Maddala, 1983; Greene, 1997; Hogan,
1997; Kim et al., 2003).
monitoring such firms (Gaver and Gaver 1993; Lehn, Patro and Zhao 2003; Yang, Linck
and Netter 2004 ). Managers can use accounting discretion for opportunistic
manipulation (i.e., opportunism) or communicating private inside information (i.e.,
signalling). We use the ratio of market value of equity to book value of equity (MB) to
reflect the extent of growth opportunities (see e.g., Lehn, Patro and Zhao 2003; Yang,
Linck and Netter 2004). Further, auditing can provide not only assurance services but
also a type of insurance service (Doogar, Sougiannis and Xie 2003; Asthana, Balsam and
Krishnan 2003). Following DeAngelo (1986), we use the change in total accruals
(ChgTac) to reflect the extent of assurance needs for audit and consistent with Doogar,
Sougiannis, and Xie (2003), we use free cash flow (FCF) to reflect the extent of either
insurance or assurance value of review engagements.
We include the Leverage, Auditor (Big 4 or not), USlist (SEC Registrant or not),
and TSXV (TSX Venture exchange listed or not) in the model to control for the potential
effects of corporate financing policy, auditor type, and listing status on companies
incentives to have their interim financial statements reviewed. We also add industry
dummies in the model to control for industry effects.
Consistent with Chung and Kallapur (2002) and others12, the absolute value of
DACC is used as the dependent variable. Chung and Kallapur (2002: 939) argue that this
is the appropriate measure of discretionary accruals because managers often adopt both
positive and negative accruals in order to undertake cookie-jar accounting.
Total assets, OCF, ROA and leverage have been added to the right hand side of
equations (1) and (2) to control for factors that might affect the magnitude of
discretionary accruals (Chung and Kallapur, 2002, and Dechow, Richardson and Tuna
2003). A negative and significant value of 1 is consistent with the hypothesis that
earnings quality of reviewed statements is superior to those of non-reviewed statements,
after controlling for covariates. Note that consistent with Chung and Kallapur (2002) we
allow firms with positive and negative OCF to have different coefficients by including
the OCF+ dummy variable. PriorACC (and Prior ACC+ dummy) allows for normal
relation between successive accruals.
12
See, for example, Cohen et al (2005), Chung and Kallapur (2003), , Dechow and
Dichev (2002), Frankel et al. (2002) and Becker et al. (1998).
(3)
Canadian SEC registrants for reasons discussed earlier. Missing observations reduce our
sample to 127, 130 and 130 firms for the first, second and third quarters of 2005
respectively.
We examined the interim financial statements published on SEDAR to identify
whether these firms 2005 Q1, Q2 and Q3 financial statements had been reviewed by the
companys auditor.13 About 61% of these firms had their quarter one statements
reviewed and the balance did not (Table 1, panel A). The corresponding percentages for
quarters 2 and 3 are 58% and 60%. About 76% of the sample firms are TSX listed (Table
1, panel B). Table 1, panel C shows that about 40% of the sample belongs to the mining
sector.
13
Oral reporting as contemplated by Section 7050 can lead to vagueness as to whether or not a complete
review in accordance with Section 7050 was conducted. This can lead to anomalies in situations where a
company that has not had a formal Section 7050 review sends the interim financial statements to its auditor
to read. In some such cases, companies may not include a notice in their interim filings to the effect that no
review was performed because they believe that any auditor involvement with interim financial statements
constitutes a review, taking comfort in the fact that the statement are marked unaudited.
(median leverage of 0.59, 0.093 and 0.094) than those of non reviewed firms (0.000,
0.000 and 0.000) at p<.01, p<.10, p<.05 and p<.05 in quarters 1, 2 and 3 respectively.
Four proxies of earnings management are reported in table 2. Unsigned values of
modified Jones discretionary accruals (DACC), absolute values of discretionary accruals
(|DACC|), positive values of discretionary accruals (+ DACC) and negative values of
discretionary accruals (-DACC). Of the four measures, the DACC and the DACC
variables are indistinguishably different between the review and non-reviewed firms in
all the three quarters. The mean and median +DACC variable for Review firms are not
significantly different from those of non-Review firms in the second quarter but is greater
in both the first quarter and third quarters. The median values of DACC+ are 0.014 and
0.063 for reviewed firms as compared to 0.044 and 0.077 for non-reviewed firms in the
first and third quarters respectively. This is consistent with the notion that non-reviewed
firms undertake more income increasing discretionary accruals than reviewed firms.
The median values of |DACC| for reviewed firms are 0.018 and 0.053, significantly
lower (p<.05) as compared to 0.030 and 0.077 for non reviewed firms in the first and
third quarters respectively.
are at the univariate level. Multivariate analyses after controlling for potetial self
selection bias are reported in table 5.
Panel B of Table 2 shows that reviewed firms (non reviewed) tend to be audited by
Big 4 (non-Big 4) auditors. A chi-square test rejects the null of no-relation between
review and auditor selection decison ar p <.01 level in every quarter.
Correlations
Table 3 provides the correlation matrix of independent and dependent variables for
quarter 3. The correlations matrix is similar for the other quarters. Many of the
explanatory variables are correlated. As a result there is concern about the
multicollinearity in the data matrix. The effect of multicollenearity on estimated
coefficients is discussed in a later section.
Results:
First stage logistic regression
Results of the first stage logistic regression are reported in table 4. The TSXV
variable is the only significant variable (coefficients of -0.72, -0.73 and -0.69 in the first,
second and third quarters respectively, significant at the p<.01 level). The model Chisquare is significant for all quarters (Ch-square values of 21.54, 27.31 and 26.71 in the
first, second and third quarters. The -2log likelihood values are also significant in every
quarter. These results indicate that the Canadian firms decision to have interim
statements reviewed is not a random decision and there is need to control for the resulting
self-selection bias whenn regresssing earnings management proxies on the Review
variable. This is accomplished by including the inverse Mills ratio values obtained from
estimating equation (1) as a right hand side variable in equation (2).
control for potential self-selection bias by including the inverse Mills Ratio (the lambda
variable) in the specifications. However, the adjusted R square for the revised model 1 is
lower in all quarters and results for model 1 is discussed below. The adjusted R square of
model 1 varies from .20 to .35.
The PriorACC+ variable is significant in all 3 quarters and positive. The
coefficient on this variable are 0.89, 0.48 and 0.48 in the 3 quarterly respectively at
p<.01, p<.10 and p<.10. The Leverage variable is positive (0.07, 0.08 and 0.08) and
significant at p<.05 level.
Consistent with H1, Review is negative (-0.17, -0.17) and significant at p<.05 and p<
.10 levels in the first and third quarters respectively. These results indicate that
discretionary accruals of reviewed statements are, on average, smaller than those of nonreviewed statements after controlling for covariates and self-selection bias. This result is
consistent with the hypothesis that earnings quality of firms with reviewed earnings is
superior to that of firms that do not have reviews of their quarterly financial statements.
The condition indices for none of the models in any quarter exceed 40, whereas Belsely,
Kuh and Welsch (1980) suggest that 100 is the condition index at which multicollinearity
starts harming the estimation process. These authors also point out that if estimated
coefficents are significant and have the hypothesized sign, the hypothesized effects must
be strong enough to overcome any harmful effects of multicollinearity.
evidence that voluntarily reviewed quarterly earnings are superior quality as compared to
less voluntary or quasi-mandatorily reviewed earnings.
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Table 1
Sample Descriptions
Panel A: Frequencies and percents of firms whose 2005 Q1-Q3 financial statements were
reviewed or not reviewed by auditors
2005 Q1
77
50
127
2005 Q2
75
55
130
2005 Q3
78
52
130
2005 Q2
98
32
130
2005Q3
96
34
130
2005 Q1
96
31
127
Mining
Finance, Insurance, and Real Estate
Manufacturing
Services
2005 Q1
53
26
25
11
2005 Q2
55
28
25
10
2005 Q3
56
28
24
11
2
1
127
2
1
130
2
1
130
Table 2
Descriptive Statistics and Comparisons
Panel A: Descriptive statistics and comparisons on continuous variables between firms with and
without audit review
2005 Q1
Variable
Group
DACC
Reviewed
Not reviewed
t
Z
Reviewed
Not reviewed
t
Z
Reviewed
|DACC|
+DACC
Not reviewed
-DACC
t
Z
Reviewed
Not reviewed
t
Z
Log(TA ) Reviewed
Not reviewed
t
Z
OCF
Reviewed
Not reviewed
t
Z
PriorACC Reviewed
Not reviewed
t
Z
ROA
Reviewed
Not reviewed
t
Z
2005 Q2
2005 Q3
Mean
Median
Mean
Median
Mean
Median
0.01152
0.00481
0.00685
0.00205
0.01043
0.01630
0.00823
0.00005
0.01657
0.01498
0.02221
0.02713
`1.68^
1.62
1.621
0.63
1.447
0.901
0.033030
0.017691
0.055037
0.026091
0.078983
0.053024
0.052239
0.030397
0.066950
0.035753
0.106588
0.077647
1.67^
0.92
1.74*
1.042
1.762^
0.022545
(n=34)
0.014643
1.190
0.060628
(n=36)
0.030164
0.072782
(n=33)
0.054923
(n=25)
0.034714
0.060660
0.044119
(n=20)
0.098643
(n=18)
0.00
1.33
2.74*
2.370*
0.03846
(n=43)
0.03847
(n=25)
0 00
0.00
0.453
0.063663
0.077685
1.438
0.02036
0.04278
(n=39)
0.02609
0.07145
(n=45)
0.05147
0.01311
0.06070
(n=35)
0.02800
0.08620
(n=34)
0.07512
0.776
1.34
0.99
1.018
1.0556
4.922619
5.273779
5.083090
5.312156
5.077995
5.381996
3.589106
3.798183
3.424483
3.786550
3.475065
3.670233
3.91**
4.81**
4.64**
3.812**
4.581**
4.423**
0.013308
0.011973
0.03396
0.03681
0.051635
0.057914
0.00590
0.00054
0.01056
0.00287
0.00296
0.00213
1.57
2.72**
2.58*
2.657**
3.228**
2.764**
0.07368
0.07740
0.02712
0.01544
0.02993
0.02859
0.03292
0.02823
0.00671
0.00022
0.01650
0.01337
2.26*
3.62**
2.284*
1.02
3.685**
1.695^
0.00552
0.00730
0.00509
0.00452
0.00028
0.00730
0.03196
0.00429
0.00992
0.00452
0.02082
0.00525
2.16*
0.59
2.13*
2.059*
0.943
2.716**
Leverage
Reviewed
Not reviewed
t
Z
0.171303
0.059016
0.205789
0.109117
0.000000
0.121113
1.64
2.10*
1.735^
0.093792
0.000000
2.221*
0.192144
0.094820
0.109289
0.000000
2.23*
2.376*
Panel B: Frequency distributions and chi-square tests on dummy variables between firms with
and without audit review
2005 Q1
Reviewed
Non-reviewed
Total
Chi-square
2005 Q2
Big 4
Auditor
Non-Big 4
Auditor
Big 4
Auditor
Non-Big 4
Auditor
Big 4
Auditor
Non-Big 4
Auditor
58
30
88
19
20
39
58
32
90
17
23
40
61
28
89
17
24
41
3.3458^
5.4635*
2005 Q1
Reviewed
Non-reviewed
Total
Chi-square
2005 Q3
2005 Q2
TSX
TSX
Venture
67
29
96
10
21
31
13.8298**
8.5740**
2005 Q3
TSX
TSX
Venture
TSX
TSX
Venture
67
31
98
8
24
32
68
28
96
10
24
34
18.5875**
17.9493**
PriorACC+: Equals 0 if negative PriorACC and retains the original value of PriorACC
otherwise;
ROA: Net Income in quarter q-1 divided by TA in quarter q-2;
ROA+: Equals 0 if negative ROA and retains the original value of ROA otherwise;
Leverage: Total Long Term Debt in quarter q divided by TA in quarter q-1.
**, *, ^: significant at 1%, 5% and 10%, respectively (two-tailed).
Table 3
Correlations
(Based on 2005 Q1 data)
|DACC|
|DACC|
Review
0.33375**
OCF
0.03164
+
0.03667
PriorACC
+
PriorACC
ROA
ROA
Leverage
Lambda
Industry
dummy
Log(TA)
OCF
OCF+
PriorACC
0.16152^
0.33795**
0.10856
0.19809*
0.12422
0.09300
Log(TA)
OCF
Review
0.05877
0.24568**
0.02297
0.05593
0.10422
0.05659
0.03899
0.08086**
0.33984**
0.23695**
0.26282**
0.20374*
0.18996*
0.18365*
0.15113^
0.15483^
0.84625**
0.06974
0.13913
0.34268**
0.36827**
0.30082**
0.30590**
0.58087**
0.38783**
0.28075**
0.65078**
0.11354
0.24611**
0.14471
0.00936
0.76650**
0.97434**
0.48131**
0.42140**
0.54847**
0.51300**
0.04712
0.10372
0.02004
0.20330*
0.34474**
0.37204**
0.28561**
0.52053**
0.50916**
0.02483
0.16245^
0.04157
0.25256**
0.18230*
0.53117**
0.33826**
0.03213
0.76391**
0.48567**
0.37886**
PriorACC+
0.77141**
0.28544**
0.26182**
0.02149
0.10107
0.11750
ROA
ROA+
0.22355*
0.05184
0.20031*
0.56068**
0.55806**
0.25044**
0.26036**
0.40004**
0.36957**
0.30601**
0.24905**
0.04009
0.11671
0.07691
0.10316
0.41506**
0.42276**
0.19858*
0.14678^
0.60754**
0.96338**
0.10912
0.05073
0.22706*
Leverage
Lambda
0.06243
0.07522
0.14412
0.96823**
0.59182**
0.12533
0.05242
0.07656
0.12564
0.15645^
0.00965
0.14720^
0.20656*
0.08678
0.18110*
0.07537
0.13995
0.07239
0.01192
0.07554
0.07305
0.24610**
0.22577*
0.3883**
Industry
dummy
0.08086
0.06974
0.23209**
0.07547
0.09857
0.15140^
0.01501
0.13577
0.11903
0.33896**
0.03972
0.02091
Sample size N=56. Pearson correlations are above the diagonal line and Spearman correlations are below it. **, *, and ^: significant at 1%, 5%, and 10%, respectively (two-tailed).
Table 4
Logistic Regressions
(Wald-stat in parentheses)
Variable
2005Q1
2005Q2
2005Q3
Constant
-0.2608
(0.2736)
0.1198
(1.8470)
-0.1786
(0.0785)
0.0367
(0.4631)
0.5964
(0.1132)
0.2235
(0.1007)
0.8122
(2.3283)
-0.1998
(0.3762)
-0.7273
(4.8016)*
Included
n.s.
-0.6614
(1.6603)
0.1818
(4.1693)*
-0.1180
(0.0299)
0.0165
(0.1085)
1.3893
(0.8247)
-0.3114
(0.3083)
0.6117
(1.2519)
-0.1783
(0.3004)
-0.7317
(4.7329)*
Included
n.s.
-0.6141
(1.3495)
0.1365
(2.3416)
0.4312
(0.3911)
-0.0108
(0.0541)
-0.5571
(0.1851)
-0.7515
(2.2655)
0.6052
(1.1444)
0.0660
(0.0424)
-0.6974
(4.3349)*
Included
n.s.
147
172.891
21.5451*
149
170.932
27.3130**
149
169.884
26.7092**
Size
Invrec
MB
Chgtac
FCF
Leverage
Auditor
TSXV
Industry dummy
N
-2 log likelihood
Chi-square
Model:
Review = b0 + b1Size + b2Invrec + b3MB + b4Chgtac + b5FCF + b6Lev + b7Auditor +
b8TSXV + Industry Dummies + error
where,
Review: 1 if current quarters interim financial statements are reviewed by auditors and 0
otherwise;
Size: Log of total average assets;
Invrec: (Inventory + Receivables) / Total assets in q-4;
MB: Market value of equity / Book value of equity;
Chgtac: Change in total accruals from q-4 to the current quarter, deflated by the total
assets in q-4, where total accruals are calculated as (Income before
extraordinary items net cash flows from operating activities);
FCF : (Net cash from operating activity + interest paid + net cash flow from investing
activity capitalized interest ) / Total assets in q-4;
41
42
Table 5
Quarterly Regression Results
(t statistics in parentheses)
Variable
Q1 2005
Parameter Estimate
Model 1
Constant
Review
Lambda
Log(TA)
OCF
OCF+
PriorACC
PriorACC+
ROA
ROA+
Leverage
Auditor
Industry
dummy
N
Adjusted R2
0.12056
(3.50)**
-0.17176
(-2.29)*
0.05708
(2.11)*
-0.00220
(-0.42)
-0.43430
(-2.93)**
0.89395
(3.76)**
-0.00711
(-0.08)
0.00210
(0.01)
0.06668
(0.50)
0.05190
(0.13)
0.07630
(2.43)*
-0.00137
(-0.11)
Revised
Model 1
0.15742
(4.84)**
-0.15824
(-2.02)*
Q2 2005
Parameter Estimate
Model 1
Revised
Model 1
Model 1
Revised
Model 1
0.07309
(2.20)*
-0.00038
(-0.03)
0.12885
(3.81)**
-0.16956
(-1.89)^
0.06169
(1.90)^
-0.00345
(-0.49)
-0.31217
(-1.73)^
0.48286
(1.86)^
-0.47583
(-2.68)**
0.75372
(2.12)*
0.46556
(1.62)
-0.14693
(-0.23)
0.08303
(2.48)*
-0.00020
(-0.01)
Included
n.s.
Included
n.s.
Included
n.s.
Included
n.s.
Included
n.s.
Included
n.s.
127
`127
130
130
130
130
0.2401
0.1331
0.2056
0.1300
0.3497
0.2171
0.05554
(1.96)^
-0.00796
(-1.48)
0.04449
(0.49)
n/a
-0.03261
(-0.56)
n/a
-0.00240
(-0.02)
n/a
43
0.17948
(5.84)**
-0.14927
(-1.63)
0.05707
(1.71)^
-0.01053
(-1.48)
-0.05355
(-0.44)
n/a
Q3 2005
Parameter Estimate
0.21113
(5.51)**
-0.00691
(-0.07)
0.00459
(0.13)
-0.02736
(-3.79)**
0.14089
(1.01)
n/a
0.08732
(2.50)*
-0.00615
(-0.37)
0.16879
(4.61)**
-0.08692
(-0.94)
0.02979
(0.89)
0.01882
(-2.76)**
-0.12703
(-0.58)
0.47787
(1.69)^
-0.28861
(-1.51)
1.31325
(3.16)**
0.33655
(1.24)
-0.90984
(-1.32)
0.06966
(1.68)^
0.01477
(0.80)
-0.22323
(-1.43)
n/a
0.45552
(1.86)^
n/a
0.11432
(0.75)
n/a
-0.02904
(-0.12)
n/a
0.04837
(1.09)
0.00304
(0.15)
Model 1:
|DACC| = 0 + 1 Review + 2 Lamba + 3 Log (TA) + 4 OCF + 5 OCF+ + 6
PriorACC + 7 PriorACC+ + 8 ROA + 9 ROA + + 10Leverage + 11Auditor
+ 12 Industry dummy +
Revised Model 1:
|DACC| = 0 + 1 Review + 2 Lamba + 3 Log (TA) + 4 OCF + 5 PriorACC + 6
ROA + 7Leverage + 8 Auditor + 9 Industry dummy +
where,
Review: 1 if reviewed in quarter q and 0 otherwise;
Log(TA): Log of total assets in quarter q;
OCF: Operating Cash Flow in quarter q, deflated by TA in quarter q-1;
OCF+: Equals 0 if negative OCF and retains the original value of OCF otherwise;
PriorACC: Total Accruals in quarter q-1, deflated by TA in quarter q-2;
PriorACC+: Equals 0 if negative PriorACC and retains the original value of PriorACC
otherwise;
ROA: Net Income in quarter q-1 divided by TA in quarter q-2;
ROA+: Equals 0 if negative ROA and retains the original value of ROA otherwise;
Leverage: Total Long Term Debt in quarter q divided by TA in quarter q-1;
Auditor: 1 if the auditor is Big 4 and 0 otherwise;
Industry dummy: 1 if one-digit sic is 1, and 0 otherwise (all n<10).
**, *, ^: significant at 1%, 5% and 10%, respectively (two-tailed).
44
Table 6
All Reviewed Firms
Revised Model 1:
|DACC| = 0 + 1 SEC Registrant + 2 Log (TA) + 3 OCF + 4 PriorACC + 5 ROA +
6Leverage + 7 TSXV + 8 Auditor + 9 Industry dummy +
Variable
Constant
Canadian SEC
Registrant
Log(TA)
OCF
PriorACC
ROA
Leverage
TSXV
Auditor
Industry
dummy
N
Adjusted R2
Q1 2005
Parameter Estimate
Q2 2005
Parameter Estimate
Q3 2005
Parameter Estimate
Revised Model 1
Revised Model 1
Revised Model 1
0.09147
(5.81)**
0.02708
(2.61)*
-0.01176
(-3.21)**
0.29971
(3.70)**
0.04205
(0.74)
-0.33606
(-4.06)**
0.03327
(1.28)
-0.04233
(-2.55)*
0.0006
(0.05)
0.08499
(3.48)**
0.00754
(0.54)
-0.00207
(-0.41)
-0.12160
(-0.85)
-0.34201
(-1.90)^
0.17944
(0.65)
-0.01488
(-0.44)
-0.01104
(-0.48)
-0.01967
(-1.13)
0.15989
(5.85)**
0.01767
(1.02)
-0.01582
(-2.61)*
-0.00004
(-0.00)
-0.00454
(-0.03)
-0.04151
(-0.17)
-0.00346
(-0.08)
0.01309
(0.46)
0.00521
(0.26)
Included
n.s.
Included
n.s.
Included
n.s.
121
118
118
0.3842
0.0285
0.1178
Canadian SEC Registrant= 1 if the sample firm is Canadian US registrant that had its quarterly
statements reviewed and zero if the firm is not a SEC registrant.(Non reviewed firms are not in
this sample)
Log(TA): Log of total assets in quarter q;
OCF: Operating Cash Flow in quarter q, deflated by TA in quarter q-1;
PriorACC: Total Accruals in quarter q-1, deflated by TA in quarter q-2;
45
46