Alfaifi, Abeer Salman F (2022) The Impact of International Standards on Auditing Adoption on Audit Quality and Earnings Management in Saudi Arabia. PhD thesis, Victoria University.

Abstract

Globalization has increased the need for harmonization of reporting in order to understand financial information. As a result, most countries in recent years, including Saudi Arabia, have adopted a uniform set of standards such as International Standards on Auditing (ISA) and International Financial Reporting Standards (IFRS). However, unlike research on IFRS, little research has been undertaken in ISA. Therefore, one significant question that needs to be addressed is, “to what extent have audit quality and REM practices been influenced post ISA implementation?”. Furthermore, the adoption of ISA by developing countries has been the motivation to focus on the impact of ISA. Hence, this study examines audit quality and REM practices post-ISA adoption and the effects of audit quality dimensions on REM in Saudi Arabia. The study has four objectives: firstly, to investigate whether the adoption of ISA has improved the contents of the audit report and reduced REM; secondly, to investigate whether the contents of the audit report reduces REM post ISA adoption; thirdly, to examine the impact of external audit attributes (Big4, audit firm rotation and specialised industry auditors) and internal audit characteristics (size, meetings, independence, experience, multiple directorships, rotation, stock ownership, diversity of audit committee (AC) and internal audit function (IAF)); and finally, to examine the incremental effect of ISA adoption on the relationship between REM and audit characteristics. To achieve this a quantitative approach was used to collect and analyse data from the annual reports of 96 non-financial listed companies from 2014 to 2019 (576 observations). Since ISA was adopted in 2017 in Saudi Arabia, this study considers the three years pre- and post-2017. The study’s hypotheses were formulated using agency theory with agency, institutional and stakeholder theory adopted for interpretation. REM was estimated using Roychowdhury’s (2006) models (abnormal inventory cost, discretionary costs, and operating cash flow). To measure the level of content improvement in audit reports post ISA adoption, the study used content analysis and a disclosure index. To measure the impact of audit quality dimensions on REM, four regression models were constructed, testing: the relationship between ISA and REM (Model 1); the contents of audit reports and REM post ISA (Model 2); audit factors and REM (Model 3); and Model 4 tested the interaction effect of ISA with audit factors. ISA adoption has resulted in an improvement of the content of audit reports. Also, post ISA adoption, the contents of audit reports, Big 4 firms and Audit Committee stock ownership has resulted in a reduction of managing real earnings. This outcome is also evident when, all factors of the three indexes for internal and external audit are considered. On the other hand, when some individual factors for internal audit (i.e., expertise, multiple directorships of AC and IAF) are considered there is evidence of managing real earnings. The remaining audit factors did not affect REM practices. The findings suggest that analysing each element of audit factors individually is not effective and/or useful in managing real earnings in Saudi Arabia. Therefore, both internal and external audit factors should be analysed cumulatively and simultaneously since they are complementary. This study is one of the first to examine whether ISA adoption has improved audit quality and reduced REM practice in one of the emerging countries. It should be noted that this study makes a theoretical contribution to determining how ISA implementation affects the contents of audit reports and examines its impact on REM post ISA adoption. Accordingly, this study contributes timely and relevant information to governing bodies, investors, audit professionals and regulatory authorities (SOCPA and CMA).

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