Audit delay and earnings announcement
timeliness
The central role that the auditor is playing in the timing of earnings
announcements
University of Amsterdam
Faculty of Business Economics and Bedrijfskunde
J. Hartsuiker
Studentnr: 9874186
Date: June 4, 2007
Subject: Auditing
Section: Accountancy
Business Economics
First supervisor: dr. P. Klijnsmit RA
Second supervisor: prof. dr. P. Wallage RA
Table of Contents
1 INTRODUCTION ... 4
2 TRADE OFF BETWEEN RELIABILITY AND TIMELY INFORMATION ... 6
-2.1 INTRODUCTION ... -6-
2.2 FINANCIAL STATEMENT INFORMATION ... -7-
2.3 FINANCIAL STATEMENTS INFORMATION AND MANAGEMENT PAY-OFF ... -8-
2.4 WHO DEMANDS RELIABLE FINANCIAL INFORMATION ... -9-
2.5 FINANCIAL REPORTING TIMELINES ... -9-
2.6 TIMELINESS AND STAKEHOLDERS PAY-OFF ... -11-
2.7 SUMMARY ... -12-
3 AUDIT DELAY MEASUREMENT ... 12
-3.1 INTRODUCTION ... -12-
3.2 AUDIT DELAY ... -13-
3.3 FINANCIAL STATEMENTS PREPARATION AND AUDIT EFFORTS... -14-
3.4 DIFFERENCE BETWEEN AUDIT DELAY AND REPORTING DELAY ... -14-
3.5 SUMMARY ... -15-
4 WHAT CAUSES AUDIT DELAY? ... 16
-4.1 INTRODUCTION ... -16-
4.2 AUDIT PLANNING ... -17-
4.3 MATERIALITY ... -18-
4.4 AUDIT RISK ... -18-
4.4.1 Inherent risk ... - 19 -
4.4.1.1 Size and type of business ... 20
-4.4.1.2 Stakeholders pressure and management payoff ... 21
-4.4.1.3 Lines of business ... 21
-4.4.1.4 Financial condition ... 21
-4.4.2 Control risk ... - 22 -
4.4.3 Detection risk ... - 23 -
4.4.3.1 Audit technology and efficiency ... 24
-4.5 SUBSTANTIVE TESTING ... -25-
4.5.1.1 Yearend ... 27
-4.5.1.2 Client leverage with Auditor ... 27
-4.5.1.3 Type of assets ... 27
-4.6 AUDIT OPINION ... -27-
4.6.1.1 Audit opinion and audit delay ... 28
-4.7 SUMMARY ... -29-
5 SUMMARY AND CONCLUSION ... 30 BIBLIOGRAPHY ... 35
-1 Introduction
Since the separation of ownership and management the security markets and credit-granting institutions are serving the financial needs of large national and international
corporations. For an efficient allocation of financial resources through the security markets reliable information is needed from entity’s management. The financial statements which are part of the annual report contain financial information that can be issued by management to inform the stakeholders. To increase the reliability of the financial statements information, the auditor is providing it with an independent and expert opinion (Hayes, Schilder, Dassen, Wallage, 1999, p. 1).
But an important qualitative attribute of financial statements is timeliness, which requires that information should be made available to financial statements users as rapidly as possible. Both analytical and empirical evidence suggest that decisions based upon financial statement information may be affected by the timeliness of information release (Carslaw, Kaplan, 1991, p. 21). Thus financial statements usefulness is strongly related to timeliness of financial statements release.
In relation to the usefulness this means that a shorter time lag between accounting year-end and earnings announcement date, reporting delay, the more benefits can be derived from an audited annual report1. This is in comparison with empirical research of Givoly and Palmon (1982) which provides evidence that shorter timeliness affects security prices in a positive way.
However, it is not possible to release annual reports unless it is certified as accurate by professional chartered auditors2. Thus the accounts of the entity need to be audited before the entity can publish its financial statements. Therefore the auditor is fulfilling an important position in the timeliness of information release. This is confirmed by Givoly and Palmon (1982) who suggested that the variability in the length of the annual external audit is a determinant that explains variability in reporting delay. They maintained that the “single most important determinant of the timeliness of the earnings announcement is the length of the audit” (Givoly, Palmon, 1982, p. 491).
Thus the separation of ownership and management has created the need for reliable
1 Reporting delay is the length of time from (accounting) year-end to the public release of earnings
information (Ashton, Graul, Newton, 1989, p. 657)
2 In the Netherlands all N.V.s and B.V.s except those classified as small by the size criteria are subject to
audit. Previously, only members of Royal NIVRA or foreign accountants approved by the Minister of Economic Affairs were allowed to act as auditor. Since the implementation of the 8 EU Directives in 1993, this privilege has been extended to appropriate members of the NOVAA. In the Netherlands Auditors are in principal appointed by the annual general meeting of shareholders (Nobes, Parker, 2000,
p. 173).
financial information. Due to the audit the financial statements contain reliable information. On the other hand the audit is a time consuming activity and therefore earnings announcements will be delayed which will negatively influence shareholders pay-off3. Therefore it is necessary to understand the influence of the audit on the timeliness of earnings announcement and the influence of the audit on the information value of audited financial statements.
By performing a literature research the central role that the auditor fulfils in the timing of earnings announcements will be investigated. The research starts with a description of the central role of the audit on the timeliness of earnings announcements. Also the relation between stakeholders pay-off and the timeliness of earnings announcements will be discussed in this chapter4. The measurement of the audit influence on earnings announcements timeliness is described in the third chapter. In the fourth chapter the three concepts of risk, evidence and materiality will be discussed. These concepts measure the necessary level of substantive testing and the determinants that will have a direct relation with the substantive testing.
2 Trade off between reliability and timely information
2.1 Introduction
3 The requirement that annual financial statements be subjected to external audit can conflict with the
requirement of timely reporting. To the extent that the auditing is a time consuming activity, the release of the earning announcements and the financial statement will be delayed (Givoly, Palmon, 1982, p. 491).
4 Beaver (1968) states that delay in releasing financial statements is likely to increase the level of
uncertainty associated with decisions for which the financial statements provides information. As a result, decisions might be non-optimal or be delayed (Beaver, 1968, p. 74)
To be sure that the stakeholders receive information from entities management Common Law, national- and international guidelines on financial reporting and stock exchange requirements oblige entities management to issue an annual report5. The annual report is used by management to communicate financial information to the shareholders6. To increase the reliability of this financial information, they are provided with an independent and expert opinion of the auditor.
The information is used by the stakeholders for decision making and the timing of the release will have a direct influence on the stakeholders pay-off7. A delay in the release of the financial statements is likely to increase the level of uncertainty associated with decisions for which the financial statements provides information. As a result, decisions might be non optimal or might be delayed and this will influence the stakeholders pay-off (Beaver, 1968, p. 74). Therefore it is necessary to understand the influence of the auditor on the timeliness of financial statements earning announcements and the value of the financial statements information.
2.2 Financial statement information
For an efficient allocation of financial resources through the security markets reliable financial reports are needed from entities management8. To make sure that information from those reports is reliable Common Law obliges entities management to audit their financial statements reports. The objective of an audit is to enable the auditor to express
5 An entity ordinarily issues on an annual basis a document which includes its audited financial statement
together with the auditor’s report thereon. This document is frequently referred to as the annual report (ISA 720, paragraph 4).
6 The principal document used by public companies to communicate financial statements information to
shareholders. It includes financial data organized into one or more balance sheets, income statements and cash flow statements. Narrative information on subsidiary activities, product plans, important operating information, and, if applicable, research and development activities. Furthermore the SEC requires public corporations to file this report within 90 days of the end of the company’s fiscal year ( http://www.sec-nasd-regulations.com/glossery.htm).
7 It has been shown analytically that timeliness can affect a decision maker’s action choices and expected
pay-off (Carslaw, Kaplan, 1991, p. 21).
8
The fourth EU directive covers public and private companies in all EU countries. Its articles include those referring to valuation rules, formats of published financial statements, on a yearly basis, and disclosure requirements (Nobes, Parker, 2000, p. 85-86).
an opinion whether the financial statements are prepared, in all material respects, in accordance with an identified financial framework (ISA 200, paragraph 2). When the auditor concludes that entities financial statements are giving a true and fair view the auditor expresses an unqualified opinion9. In general the auditor is able to express one of the five standard audit opinions in the audit report: unqualified-, modified unqualified-, qualified- and adverse- or disclaimer of opinion (Kneckel, 2001, p. 74).
2.3 Financial statements information and management pay-off
The audit is necessary because management can scarcely be expected to take an impartial view in preparing the financial statements information because it measures the effectiveness of management’s performance and in turn the management pay-off10.
An explanation for this impartial management behaviour could be found in the agency theory. According to this theory a company is viewed as the result of more or less formal contracts, in which several groups make some kind of contribution to the company, given a certain price. The objective of company’s management is to get these contributions under optimum conditions for management. In these relationships, management is seen as the “agent” trying to obtain contributions from “principals” such as bankers, stockholders and employees (Hayes, Schilder, Dassen, Wallage, 1999, p. 37). Maximizing the contribution from the principals’ results in a pay-off for management and therefore it is reasonable to assume that management has the incentive to overstate entities performance. Hereby must be taken into account that management is able to control the accounting systems and has the authority to determine the precise nature of the representation that goes into the financial statements. Thus management can stipulate the necessary performance level which is needed to achieve the performance targets.
9 Unqualified Report is used when the auditor concludes that the evidence obtained supports the fairness
and completeness of all management assertions, that is, the auditor is satisfied that all audit objectives have been achieved (Kneckel, 2001, p. 74).
10 The financial statements reports measure the effectiveness of management’s performance of its duties
and in turn financial reports will have an important influence on management’s salaries, on the value of their shareholdings in the enterprise and even on their continued employment with the company (Hayes, Schilder, Dassen, Wallage, 1999, p.1).
As a result of this behaviour information asymmetry is created between management and stakeholders11. Due to the audit of the financial statement information asymmetry can be avoided. Furthermore the audit will increase stockholders confidence.
2.4 Who demands reliable financial information
The shareholders, the owners of the entity, are the first major group who demand reliable financial information. Besides shareholders nowadays more categories of stakeholders can be identified who demand financial statements information. For example suppliers, employees, local- and national government and the tax department can be identified as concerned parties. This is in comparison with the Johnson and Scholes (1999) stakeholders’ definition. According to this definition the stakeholders are those individuals or groups who depend on the organisation to fulfil their own goal and on whom, in turn, the organisation depends (Johnson, Scholes, 1999, p. 213).
However the question remains why non-shareholders demand financial information from entities management. An answer to this question can be found in the way the financial information will influence the pay-off of the stakeholders. For example the supplier debtor risk will be positively influenced when the entity presents positive financial results. Also employees will be directly influenced by financial statements information. Especially when salary is dependable on the organisation profit or when the entities management will report a restructuring provision which can influence the continuity of their jobs. In the next paragraph will be discussed when the entities management should prepare, audit and distribute the financial statements information.
2.5 Financial reporting timelines
The audit will start when the subject matter, the financial statements, are prepared by entity’s management. Dutch Common Law states that under normal circumstances
11 Information asymmetry can be described as a condition in which at least some relevant information is
known to some but not all parties involved. Information asymmetry causes markets to become inefficient, since all the market participants do not have access to the information the need for their decision making processes (http://www.investorwords.com/2461/information_asymmetry.html).
entity’s management has five months to prepare their financial statements12. Under special circumstances the shareholders meeting can decide to extend this period with a maximum of six months. As a result the maximum period for the preparations of the financial statements is eleven months.
After management has prepared their financial statements the auditor can effectively audit the financial statements. However the length of the audit is not endless. According to article 2:394 paragraph 2 of Dutch Common Law entity’s management must send their financial statements to the shareholders meeting, with an audit opinion enclosed, within two months after the maximum preparation period has ended. An enclosed audit opinion is necessary because a shareholder meeting is only allowed to approve financial statements with an enclosed audit opinion13. Thus when entities management is using the maximum preparation period the auditor has only two months to audit the financial statements.
After the shareholders meeting has approved the financial statements entities management must publish the financial statements. The publication is fulfilled when the annual report including the financial statements, directors’ report and the auditor’s report, is filed for public inspection by the Commercial Registry. Another possibility that satisfy Common Law in this matter is the widely distribution of the annual report to all kinds of stakeholders or to a large but formally closed circle of stakeholders. Figure one is presenting an overview that is visualizing the different phases of the reporting timeliness as mentioned in this paragraph.
Also stock exchanges provide additional requirements for listed entities regarding the publication of the audited financial statements. For example the New York Stock Exchange (NYSE) requires US issuers to publish their annual report once a year and the annual report must be distributed to its shareholders no later than 90 days after the close of each fiscal year14. As a result American listed entities must prepare, audit and
12 Article 2:101 paragraph 1 Dutch Common Law: The maximum preparations period of the financial
statements is five months. In case of special circumstances the shareholders meeting can decide to extend this period with a maximum of six months.
13 Article 2:393 paragraph 6 Dutch Common Law: The shareholders meeting is not allowed to approve
the financial statement when there is no audit report enclosed.
14 The NYSE company manual requires each listed company to publish an annual report within three
distribute their financial statements within four months after fiscal year-end which is shorter than the maximum period prescribed by Dutch Common Law.
Jan Feb Mrt Apr May Jun Jul Aug Sept Oct Nov Dec Jan Feb
Nr. of Month 1 2 3 4 5 6 7 8 9 10 11 12 13 14
Standard Preparation Period Additional Preparation
Period
Assessment
Publication* 8 days 8 days
* After assessment entities management has the obligation to distribute the financial statement within 8 days.
Figure 1: Overview reporting timeliness based on Dutch Common Law.
2.6 Timeliness and stakeholders pay-off
According to Givoly and Palmon (1982) timeliness of annual reports is an important determinant of their usefulness. From their research they concluded that length of time between year-end and earnings announcement date, reporting delay, will influence the value of the information from the financial statements15. This is in comparison with research of Beaver (1968) and Kneckel and Payne (2001). Beaver (1968) states that delay in releasing financial statements is likely to increase the level of uncertainty associated with decisions for which the financial statements provide information. As a result, decisions might be non-optimal or be delayed (Beaver, 1968, p. 74). On the other hand Kneckel and Payne (2001) concluded that the value of information from the audited financial statements will decline as audit delay increases since competitively oriented users may obtain substitute sources of information (Kneckel, Payne, 2001, p. 137)16. Thus the audit is giving assurance that the financial statements contain reliable financial information. On the other hand the audit is a time consuming activity and as a result earnings announcements will be delayed which will have a negative impact on the
months of year-end (Chambers, Pennan, 1984, p. 25).
15 Reporting delay is the length of time from year-end to the public release of earnings information
(Ashton, Graul, Newton, 1989, p 657).
16
The information can be provided either through search activity by investors, through other voluntary disclosures by firms, or through predictions of the earnings supplied by earning releases of earlier reporting firms (Chambers, Pennan, 1984, p. 22).
stakeholders pay-off17. Therefore it is necessary to understand the influence of the audit on the timeliness of earnings announcement and the related pay-off.
2.7 Summary
The flow of investor funds to the corporations and the whole process of allocation of financial resources through the securities markets have become dependent to a very large extent on reports prepared by entity’s management (Hayes, Schilder, Dassen, Wallage, 2001, p 1). Because management can scarcely be expected to play an impartial role in the financial reporting process Common Law, Audit- and financial reporting guidelines and stock exchange requirements oblige entity’s management to audit their financial statements. To prevent information asymmetry the auditor’s assurance services are necessary to make sure that reliable and proper information is provided to the stakeholders. The information is used by the stakeholder to make optimal decisions. On the other hand, due to the audit, the information could be out of date which will influence the stakeholders pay-off. However research of Chamber and Pennan (1984) and Givoly and Palmon (1982) noted that the annual report still contains information which is not provided by other information sources, regardless of the time lag of the report (Chambers, Pennan, 1984, pp. 21-22). The period of time between balance date and the distribution date of the annual report is defined as reporting delay.
3 Audit delay measurement 3.1 Introduction
Because management can scarcely be expected to play an impartial role in the financial
17 The requirement that annual financial statements are subjected to external audit can conflict with the
requirement of timely reporting. To the extent that the auditing is a time consuming activity, the release of the earning announcements and the financial statement will be delayed (Ashton, Willingham, Elliot, 1987, p. 276).
reporting process the auditor’s assurance services are necessary to prevent information asymmetry between management and the entities stakeholders. By using identified suitable criteria the auditor will evaluate the financial statements, and express an audit opinion that provides the stakeholder with a level of assurance (ISA 100, paragraph 4).
Despite the increased level of assurance also a remark can be made. Due to the efforts of the auditor the stakeholders will receive the audited financial statements information a long while after fiscal year-end and therefore stakeholders pay-off will be influenced18. This is confirmed by Givoly and Palmon who suggested that the single most important determinant of the timeliness of the earnings announcement is the length of the audit (Givoly, Palmon, 1982, p. 491). Therefore the influence of the auditor on the earnings timeliness of entities will be discussed in this chapter.
3.2 Audit delay
Researchers have been interested for over twenty years to measure the auditor’s influence on the timeliness of public disclosures (Henderson, Kaplan, 2000, p. 159). To determine the influence of the audit on the timeliness of earnings announcements audit delay is used. Audit delay is the length of time from year-end up and including the audit report date (Bamber, Bamber, Schoderbek, 1993, p. 1). The reason for choosing audit delay can be motivated by prior research and International Standards on Auditing.
Ashton, Graul and Newton (1989), Bamber, Bamber and Schoderbek (1993) and Kneckel and Payne (2001) are using audit delay to examine the determinants of audit delay. During time researchers have recognised audit delay as the time lag that is necessary to complete the audit by the external auditor.
According to the International Standards on Auditing the audit date is a basic element of the auditor’s report and the auditor should date the report as of the completion date of the audit to inform the stakeholder that the auditor has considered the effect on the financial statements and on the report of events and transactions of which the auditor became aware and that occurred up to that date (ISA 700, paragraph
18 Chambers and Pennan (1984) state that this time lag has a major impact on the price variability of
entities stock-price which will influence stakeholders pay-off.
23)19. So there is a strong and clear relationship between the completion date of the audit and the audit date and due to the requirement that the audit date is a basic element of the audit report audit delay is easy to determine. Still the question remains whether audit delay is representing the time to audit entities financial statements. An answer to this question is given in the next paragraph.
3.3 Financial statements preparation and audit efforts
The time lag between fiscal year-end and audit date consists of the preparation phase of entity’s financial statements and the necessary time to audit the entities financial statements. Thus audit delay does not only reflect the time necessary to audit the financial statements but also the time necessary to prepare the subject matter, the financial statements. Because the precise form and content of the audit plan will vary according to the size of the entity, the complexity of the audit and the experience of the auditor in planning the audit and thus the audit plan will not be influenced by the necessary preparation time of the financial statements.
Reporting Timeliness
Reporting delay**
Audit delay*
Preparation Period
Audit
Substantive testing period
Negotiation Period
* Audit delay is the period between fiscal year-end and the audit report date. ** Reporting delay is the period between fiscal year- end and the public announcement of earnings.
Figure 2: Reporting delay timeliness.
3.4 Difference between audit delay and reporting delay
Givoly and Palmon (1982) state that reporting delay is the period between fiscal year-end and the earnings announcement date. On the earnings announcement date the
19
Since the auditor’s responsibility is to report on the financial statements as prepared and presented by management, the auditor should not date the report earlier than the date on which the financial statement are signed or approved by management (ISA 700, paragraph 24).
annual report will be available for the stakeholder. Because the annual report contains information which can be used by the stakeholder to make decisions pay-off could be created on and after the earnings announcement date.
Audit delay will measure the influence of the auditor on the timeliness of the earnings announcements of entities. Because the auditor should date the report as of the completion date of the audit and the entity’s management has the incentive to publish the statement as soon as possible especially when the financial statements are representing good news20. Therefore the expectation is that there is only a small time gap between the audit report date and reporting date. This is confirmed by Givoly and Palmon (1982) who have investigated the difference between reporting delay and audit delay and the outcome of their survey was that although reporting delay and audit delay are likely to be highly correlated, empirical evidence suggests that they are not identical. Garsombke (1981) found a mean difference of 2.4 days between the reporting delay and audit delay of a sample of U.S. firms.
3.5 Summary
Givoly and Palmon (1982) suggested that the single most important determinant of the timeliness of the earnings announcement is the length of the audit (Givoly, Palmon, 1982, p. 491). To measure the influence of the auditor on the earnings announcement audit delay is introduced. Audit delay consists of the period between fiscal year-end and the audit date. This period does not only consist of the time necessary to perform an audit but also the necessary time to prepare the subject matter, the financial statements. Between the preparation- and audit period there is no correlation but the preparation period will have a minor impact on audit delay when the size of entities increases. Due to greater external pressure and the stronger internal controls management of large entities is more motivated and able to prepare their financial statements more quickly (Dyer, Mchugh, 1975). From the surveys of Givoly and Palmon (1982), Garsombke (1981) and Ashton, Graul and Newton (1989) can be concluded that the length of audit-
20
On average, firms announce favourable earnings news earlier than expected, but announce unfavourable earnings news later than expected. This is consistent with managers’ incentive to maximize their personnel pay-off by using good news to increase company’s stock price (Bamber, Bamber, Schoderbek, 1993, p. 7).
and reporting delay are highly correlated but as empirical research shows there is still a sizeable difference between audit- and reporting delay.
4 What causes audit delay?
4.1 Introduction
According to the International standards on auditing the auditor should develop and
document an overall audit plan describing the expected scope and conduct of the audit. This plan is used as a guideline for the substantive procedures that must be performed. In planning the audit, the auditor should use professional judgement and his business knowledge to assess the appropriate level of audit risk21. During the audit it could be necessary to revise the planning because there are circumstances which could have an impact on audit risk and will influence the required level of substantive testing. To get an understanding of this process it is necessary to describe the three concepts of risk, evidence and materiality. When there is a relation between identified determinants and their influence on inherent-, control- or detection risk the determinants will be mentioned. But first the audit starts with a preparation of the audit plan.
4.2 Audit planning
The main objective of the planning is to determine the amount and type of evidence and review that is necessary to give the auditor assurance that the financial statements does not contain a material misstatement. Information is material if its omission or misstatement could influence the economic decision of users taken on the basis of the financial statements.
To make sure that the necessary substantive testing is performed the sufficiently detailed audit plan will be used as a guideline for the substantive procedures that must be performed. The precise form and content of the audit plan will vary depending on the size of the entity, the complexity of the audit and the specific methodology and technology used by the auditor (ISA 300, paragraph 8). This corresponds with research of Ashton, Willingham and Elliot (1987), Ashton, Graul and Newton (1989) and Bamber, Bamber and Schoderbek (1993) These researchers have investigated the relation between audit delay and size and complexity of the entity and concluded that unique aspects of different industries affect the relative importance of financial statements components and the associated levels of inherent and control risk. Due to interaction of risk, evidence and materiality it is sometimes necessary to revise the
21
Substantive testing is an audit procedure designed to test for financial errors affecting the correctness of accounts balances. This can include tests of transactions, direct test of account balances and analytical review procedures (http://www.internalaudit.utoronto.ca/)
planning during the course of the audit.
4.3 Materiality
Information is material if its omission or misstatement could influence economic decisions of users taken on the basis of the financial statements. To be certain that financial statements do not contain material misstatements the auditor should consider materiality at both the overall financial statements level and in relation to individual account balances, classes of transactions and disclosures (Hayes, Schilder, Dassen, Wallage, 1999, p. 179). The reason for this is that materiality depends on the size of the item or error judged in the particular circumstances of its omission or misstatements. Furthermore the auditor should consider materiality and its relationship with audit risk when conducting an audit. Audit risk is the complement of the reliability that the auditor expects in its audit. Audit risk includes: inherent-, control- and detection risk and will be discussed in the next paragraph.
4.4 Audit risk
The objective of an audit of financial statements is to enable the auditor to express an opinion whether the financial is prepared, in all material respects, in accordance with an identified financial reporting framework (ISA 320, paragraph 4). Because the audit opinion is not providing the stakeholder absolute assurance the auditor will accept some level of uncertainty in performing the audit function22. Uncertainty could consist of the competence of evidence, about the effectiveness of a client’s internal control structure and, in the end, as to whether the financial statements are fairly stated. Therefore the purpose of identifying audit risk is to enable the auditor to determine the nature, timing and amount of audit procedures that are necessary to arrive at an acceptable level of reliability in the audit (Hayes, Schilder, Dassen, Wallage, 1999, p. 106).Audit risk is
22 The audit is planned and performed to obtain reasonable assurance about whether the financial
statements are free of material misstatements. Reasonable assurance means that the auditor provides with an audit a high, but not absolute, level of assurance that the financial statements subject to audit are free of material misstatements (ISA 700, paragraph 13).
the risk that the auditor gives an inappropriate audit opinion when the financial statements are materially misstated (ISA 400, paragraph 13). When the auditor concludes that there is a high level of audit risk the auditor has to collect more audit evidence to reduce the risk of not finding a material misstatement which results in longer audit delay. Therefore the auditor, by using his professional judgement to determine audit risk, will directly influence audit delay and because the auditor’s professional judgement is used audit risk has a substantive character. Therefore it is interesting to determine the factors that will influence auditor’s decision in determining the audit risk level.
Kneckel (2001) has identified several factors that will influence auditor’s judgement regarding the determination of audit risk. First of all the auditor is using his professional judgement to determine audit risk and therefore his attitude towards risk will influence his decision in determining the audit risk level. Also the number of external users who will be relying on the financial statements should be considered as factor setting the desired audit risk. For example, the more external users there are, the larger the number of people who will be adversely affected if the auditor issues an incorrect opinion. Furthermore entities financial condition should also be considered by the auditor when setting desired audit risk. For example, when the likelihood that the client will suffer financial difficulties in the near future the potential cost of issuing an incorrect opinion will increase.
Overall the auditor will prefer lower audit risk whenever the potential cost of issuing an incorrect opinion is high. An incorrect opinion may lead to lost engagement, negative publicity or litigation. Obviously, the auditor will try to avoid these situations. The more likely the auditor is to face such sanctions in the event of audit errors, the lower the desired audit risk will be (Kneckel, 2001, p. 133).
4.4.1 Inherent risk
The audit will start when the financial statements are prepared by entities management. There will be some risk, due to errors of entities management, that an account balance or class of transactions contains a material misstatement (Hayes, Schilder, Dassen, Wallage, 1999, p. 106). This type of risk is indicated as inherent risk.
To prevent inherent risk entity’s management will implement internal control measures to detect material errors23. For example, control systems should detect any material errors before they enter entity’s financial statements. When these systems work properly the auditor can rely on financial statements information. Thus proper designed internal control measures will reduce audit risk.
Several determinants will influence inherent risk. In the following paragraphs the relation between the determinant and inherent risk is explained.
4.4.1.1 Size and type of business
According to Ashton, Graul and Newton (1989) and Carslaw and Kaplan (1991) there are two determinants, size and type of industry, that have a positive influence on inherent risk. Despite what may be suspected there is a negative relation between the size of the entity and audit delay. Due to the implementation of stronger and more internal control measures the auditor could place more reliance on interim compliance tests than on substantive tests of year-end balances. As a result of less audit risk audit delay will be reduced.
Also the type of organisation, financial or non financial could have an impact on inherent risk. According to Ashton, Willingham and Elliot (1987) and Bamber, Bamber and Schoderbek (1993) unique aspects of different industries affect the relative importance of financial statements components and the associated level of audit risk. For example financials do have a significant shorter audit delay than non financials because they have less diversified transactions, stronger internal controls, highly centralised accounting systems and financials hold little inventory of fixed assets which will be more easily to audit (Bamber, Bamber, Schoderbek, 1993, p. 6) 24. Thus size as
23 Internal control is a process, affected by entity’s board or directors, management and other personnel,
designed to provide reasonable assurance regarding the achievements of objectives in the following categories: effectiveness and efficiency of operations, reliability of financial reporting compliance with applicable laws and regulations, and the safeguarding of assets (Hayes, Schilder, Dassen, Wallage, 1999, p. 155).
24 Groenen en Langedijk (2004) state that retail and production companies which are holding a relative
large position of inventory and account receivable are less easy to audit than company’s that are holding a relative large number of fixed and current assets like current stock and cash.
well as the type of organisation will have an impact on the inherent risk which in the end will have an influence on the necessary level of substantive testing.
4.4.1.2 Stakeholders pressure and management pay-off
Due to more stakeholders management of large entities is facing more external pressure than small entities to report earnings quickly. Therefore entities management will have the incentive to reduce audit delay (Newton, Ashton, 1989). On the other hand the reduction of audit delay will also have a positive influence on the management pay-off because the value of management’s stock plan will be positively influenced when stockholder’s expectations are met25.
4.4.1.3 Lines of business
Another determinant that will have an influence on audit delay is the number of lines of business. Bamber and Bylinski (1982) state that due to greater diversity of the client’s operations, more audit team’s coordination and control requirement are needed and this results in longer audit delay.
4.4.1.4 Financial condition
According to Arens and Loebbecke (1991) the weaker or more vulnerable the client’s financial position, the higher audit risk, and in turn longer expected audit delay. This is confirmed by Jaggi and Tsui (1999) who investigated the relation between audit delay and the financial condition of entities founded in Hong Kong. The outcome of their research shows that when entities fever financial distress audit delay will increase. Thus companies that fever financial distress will probably have longer audit delays.
Despite the clear relationship between audit delay and entities financial conditions
25
Chambers and Pennan (1984) state that when reports are published earlier than expected, they tend to have larger price effects than when they are published on time or later than expected. Further, unexpectedly early reports are characterized by good news, whereas unexpectedly late reports tend to bear bad news (Chambers, Pennan, 1984, pp. 45-46).
still the question remains how to measure entities financial condition. The research of Bamber, Bamber and Schoderbek (1993), Carslaw and Kaplan (1991) and Asthon, Graul and Newton (1989) is providing an answer to this question. The financial condition index of Zmijewki is used by Bamber, Bamber and Schoderbek (1993) to measure the influence of entities financial condition on audit delay. Jaggi and Tsui (1999) are the first who used debt proportion as an explanatory variable for audit delay and Ashton, Graul and Newton (1989) are using income to measure the influence of entities health on audit delay.
These three determinants do have a negative relation with audit delay. For example, losses are raising concern about material misstatements and are often associated with client’s problems such as inventory obsolesces and therefore more audit efforts will be required to satisfy such concern (Ahston, Graul, Newton, 1989). The same explanation could be given for the influence of debt on audit delay. The relative proportion of debt to total assets may be indicative of the financial health and when the proportion is increasing additional concerns that the financial statements may be less reliable than normal may raise in the auditor’s mind. Such concern would tend to increase the length of the audit (Caslaw, Kaplan, 1991).
4.4.2 Control risk
Despite the implementation of internal controls an auditor should be aware of material errors in the financial statements. For example, internal control procedures that are designed to detect and remove material errors could fail when a new type of error occurs. This risk is defined as control risk. By performing substantive procedures the auditor will prevent control risk. These procedures consist of tests to obtain audit evidence which will help detecting material misstatements in the financial statements.
Control risk will also be affected by factors that affect inherent risk. For example stronger and more internal controls and highly centralized accounting systems, which is common for financial entities, will have a positive influence on control risk. Due to stronger and more internal controls there is a higher chance that material errors will be detected and removed before they enter into the financial statements. Thus, as the example shows control risk depends on control policies and procedures which are
established and placed in operation to carry out the actions necessary to address risk to the achievement of the company objectives. Control activities are policies and procedures that help to ensure that management directives are carried out. According to Hayes, Schilder Dassen and Wallage (1999) there are potentially many control activities, but they generally fall into five categories:
1. Adequate separations of duties – Duties are divided, or segregated among different people to reduce risk or error or inappropriate actions. For example entities funds can be transferred to employees bank account when there is no separation between front- and back-office;
2. Proper authorization of transactions and activities – Appropriate delegation of authority sets limits on the employees delegated to authorize the main types of business transactions;
3. Adequate documents and records – Well designed documents on which to enter and summarize transactions;
4. Physical control over assets and records – Safeguarding assets can be arranged by only allowing authorized employees to have access to entities assets;
5. Independent checks on performance – Review of controls will help bring them up to date and personnel will pay attention to the controls they are required to perform if someone observes and evaluates their performance.
But even when the control components are working properly there could be a threat that the auditor, in assessing entities control risk, fails to understand the source of potential threats to the control environment26. In this case the auditor has little insight into potential control problems. Resulting substantive testing will be general and undirected, and may fail to address the biggest sources of risk in the engagement in adequate details (Kneckel, 2001, p. 333).
4.4.3 Detection risk
In case of the auditor fails to detect a misstatement that exists in an account balance or
26 The internal control components are: the control environment, risk assessment, control activities,
information and communication and monitoring (Hayes, Schilder, Dassen, Wallage, 1999. p. 228).
class of transaction that could be material, individually or when aggregated with misstatements in other balances or classes this is measured as detection risk (Arens, Elder, Beasley, 2005, p. 255). Hereby must be noted that detection risk will always be there even if an auditor is able to examine 100 percent of the account balance or class of transactions because, for example, most audit evidence is persuasive rather than conclusive. Furthermore a positive relation exists between audit risk and the number of evidence that should be gathered. When audit risk increases more evidence should be collected.
4.4.3.1 Audit technology and efficiency
The auditor can use a structured or unstructured approach to audit the subject matter27. Prior research of Davies and Whittred (1980), Newton and Ashton (1989) and Bamber, Bamber and Schoderbek (1993) investigated the relation between audit firm structure and audit delay. According to Bamber, Bamber and Schoderbek (1993) on average, longer audit delay is associated with smaller clients, non financial clients, existence of extraordinary items, and structured audit firms (Bamber, Bamber, Schoderbek, 1993, p.3). But is it still valid to use the audit structure determinant to measure the influence of the used audit approach on audit delay?
In the surveys of Newton and Aston (1989) and Bamber, Bamber and Schoderbek (1993) a measure of audit-firm structure is used that is based on data that is representative of audit technology in the early 1980`s which was used by eight big audit firms (Henderson, Kaplan, 2000, p. 163). Since then technology improved and therefore audit firms changed their audit technology, rendering the original structure ratings invalid to measure the currently used audit structure (Cushing, 1989). Also three of the former Big eight accounting firms were involved in mergers since the late 1980s which may have affected audit technology (Lawrence and Glover, 1998). Due to the merger of
27 Cushing and Loebbecke (1986) refer to audit structure methodology as a systematic approach to
auditing characteristics by prescribed logical sequence of procedures, decisions and documentation steps and by comprehensive and integrated set of audit policies and tools to assist the auditor in completing the audit . The audit technology refers to the degree of audit structure of the firm’s audit approach (Cushing, Loebbecke, 1986, p. 32).
Andersen and Deloitte in 2002 nowadays only four big audit firms remain28.
Using audit structure would therefore be problematic and out of date. Also empirical data shows that most listed companies nowadays are using “Big Four” audit firms to audit their financial statements29. Therefore it is not valid to make a distinction between structured and unstructured audit approach because “Big Four” audit firms are using more or less the same audit technology.
4.5 Substantive testing
The objective of planning the audit is to determine the amount and type of evidence and review required to give the auditor assurance that there is no material misstatement of the financial statements. The planning also helps to ensure that appropriate attention is devoted to important areas of the audit, that potential problems are identified and it also serves as set of instructions for the assistants involved in the audit as a mean to control and record the proper execution of the substantive procedures.
The substantive procedures are tests performed to obtain audit evidence to detect material misstatements in the financial statements. By performing substantive procedures control risk is prevented30. The time necessary to perform the substantive procedures is reflecting a major part of total audit delay.
Audit evidence is the information used by the auditor in arriving at the conclusion on which the audit opinion is based. To obtain audit evidence there are two types of tests that could be used: test of details of transactions and balances and analytical procedures.
Test of details of transactions and balances
28
The partners of the Dutch subsidiary of the Andersen audit firm have decided as from the second of June 2002 to merge with Deloitte & Touche the Netherlands as from the first of June 2002 (http://www.perssupport.anp.nl/Home/Persberichten/Actueel?itemId=40349).
29 As from 20 March 2007 twenty five entities are listed on the Amsterdam Euronext of which four
companies are audited by E & Y, six by Deloitte, seven by KPMG and PWC is auditing the financial statements of eight entities.
30
Control risk is the risk that a misstatement, that could occur in an account balance or class of transaction and that could be material individually or when aggregated with misstatements in other balances or classes, will not prevent or detected and corrected on a timely basis by accounting and internal control systems (ISA 400, paragraph 5).
The planned audit procedures must be sufficient to satisfy each of the balance-related audit objectives. The design of these procedures is difficult and subjective which requires considerable professional judgment (Arens, Elder, Beasly, 2005, p. 381).
The test of transactions are audit procedures related to examining the processing of particular classes of transactions through the accounting system and are usually performed for accounts such as property and equipment, long term debt and equity accounts. Tests of balances are audit tests that substantiate the ending balance of a general ledger account or line item in a financial statement (Hayes, Schilder, Dassen, Wallage, 1999, p 302).
Analytical procedures
Analytical procedures consist of the analysis of significant ratios and trends including the resulting investigation of fluctuation and relationship that are inconsistent with other relevant information or deviate from predictable amounts. When the outcome of the procedures is used as a part of the assurance gained through substantive testing, it is important that the data used in the calculation is considered sufficiently reliable. This is important for all data, especially non financial data (Arens, Elder, Beasly, 2005, p. 381). When the substantive procedures are performed the auditor should make sure that the audit has obtained sufficient appropriate audit evidence to be able to draw a reasonable conclusion on which to base the audit opinion on (ISA 500, paragraph 2).
Due to substantive procedures the auditor is able to obtain sufficient appropriate evidence on which the auditor will base his audit opinion. On the other hand obtaining evidence is very time consuming and audit delay will be the result. Despite the fact that it is necessary to perform substantive procedures for ever audit there are determinants identified that will have their influence on the length of the necessary substantive procedures that should be performed. For example the determinants year-end, client leverage and type of assets could have their influence on the planning of the necessary substantive testing procedures and as a result these planning changes will have their influence on audit delay.
4.5.1.1 Year-end
Garsombke (1981) states that entities in the United States which are having their financial year-end after the peak demand for auditing services could demand more audit personnel and therefore it is reasonable to assume that these companies will have a shorter audit delay31.
4.5.1.2 Client leverage with Auditor
Also clients leverage with the auditor will have an influence on audit delay. According to Newton and Ashton (1989) management of large entities should be able to demand more timely completion of the audit. Due to this leverage they are able to demand more or more experienced audit staff. Thus audit delay is not only a function of the extent of audit work required, but also is influenced by the extent to which the audit resources are planned. For example the planning of large audit is more flexible because the auditor is more flexible in timing the audit work. Therefore more audit work will not immediately lead to longer audit delay (Ashton, Graul, Newton, 1989, p. 660).
4.5.1.3 Type of assets
The type of assets that should be audited will also have an influence on audit delay. Because the audit of debt is more involved and complicated it takes more audit efforts than the audit of equity. When the debt ratio, debt to total assets, of entities is higher this results in a longer audit delay (Jaggi, Tsui, 1999).
4.6 Audit opinion
The auditor’s report should contain a clear written expression of opinion on the financial statements taken as a whole. The auditor can issue several types of audit
31
To capture the potential effect of the busy season on audit delay Garsombke (1981) distinguished between those companies with year-ends in December and the companies with the year-end balances in the month March and thereafter.
reports to express his judgement32. According to Kneckel (2001) and Davis (2004) in most engagements the auditor will issue a standard unqualified report33.
This result in the following question: “what is the value of the unqualified opinion for the stakeholder?” According to the international standards on auditing this type of opinion is issued in a clear and affirmative manner when the auditor is satisfied in all material respects that: the financial information has been prepared using acceptable accounting policies, consistently applied; the financial information complies with relevant regulations and statutory requirements; the view presented by the financial information as a whole is consistent with the auditor’s knowledge of the business of the entity; and there is adequate disclosure of all material matters relevant to the proper presentation of the financial information (Hayes, Schilder, Dassen, Wallage, 1999, p. 395). But what is the relation between the audit opinion and audit delay?
4.6.1.1 Audit opinion and audit delay
Qualified opinions, whether due to problems satisfying GAAP or GAAS, are not likely to be issued until after the auditor has spent considerable time and efforts pursuing additional audit procedures and other reporting alternatives in an effort to avoid qualifications. Thus, qualified opinions are expected to be associated with longer audit delay. This is confirmed by Ashton Willingham and Elliot (1991). The outcome of their survey indicates that companies that received a qualified audit opinion are associated with longer audit delay (Ashton, Willingham, Elliot, 1987, p. 284).
But also when the auditor has issued an unqualified opinion audit delay can increase. This has to do with the necessary negotiation time that is directly influenced by the seriousness of the impending qualification. When the qualification, which is related to uncertainties in the financial statements, is more serious an apparent increase
32 The following audit reports can be issued: standard unqualified report (ISA: unqualified auditors
report), modified unqualified report (ISA: unqualified auditors report), qualified audit report (ISA: qualified auditors report), disclaimer audit report (ISA: disclaimer of opinion) and an adverse report (ISA: adverse auditors report) (Kneckel, 2001, p. 564).
33 Davis (2004) noted that the number of issued disclaimers for non-financial entities listed on the NYSE,
during the period 1976 to 2001, have not changed significantly over the years. The average number of disclaimers was approximately 13 during 1980 to 2001. Despite that the number of companies listed on the NYSE increased from 1570 to 2798 (Davis, 2004, p. 3).
in the year-end audit time is expected as well as an increase in auditor-client negotiation time. Thus additional audit time and costs are likely to be a result of underlying uncertainties of which an audit qualification is merely a signal. Consequently, removal of the qualification may not lead to expected cost reduction (Whittred, 1980, p. 576).
4.7 Summary
The auditor should develop and document an audit program setting out the nature, timing and extent of planned audit procedures required to implement the overall audit plan. The audit program may also contain the audit objectives for each area and a time budget in which hours are budgeted for the various audit areas or procedures. In preparing the audit program, the auditor should consider the specific assessments of inherent and control risk and the required level of assurance to be provided by substantive procedures. During the substantive procedures audit evidence is obtained by performing analytical procedures and test of details of transactions and balances to detect material misstatements in the financial statements.
The number of substantive procedures that is necessary to arrive at an acceptable level of reliability in the audit depends on the auditor’s judgement on audit risk. Audit risk is the risk that the auditor gives an inappropriate audit opinion when the financial statements are materially misstated. Audit risk has three components: inherent-, control- and detection risk.
When inherent- and control risk are high more substantive testing needs to be preformed by the auditor. The specific assessment of risk is directly related to the company profile and as a result the auditor must be capable and experienced enough to assess the audit risk of the audit client.
The next step in the audit process is the expression of an opinion on the financial statements. Based on obtained audit evidence the auditor will obtain an expression of an opinion on the financial statements. This is done by reviewing and assessing the conclusion drawn from the audit evidence. This shows that the substantive procedures can be recognised as the fundaments for the auditor’s expression of an opinion on the financial statements.
Determinants Effecting Audit Delay
Risk Sign * Relation Audit Delay
Audit Risk
Inherent Risk and Control Risk ***
Determinant
1. Client Firm Size - Large audit clients face greater external pressure to reports earnings
quickly
2. Industry (Financial vs. Non Financial)
-
Unique aspects of different industries affect the relative importance of financial statement components and the associated levels of inherent and control risk. Due to the implementation of more internal controls and centralised accounting systems financials companies are able to report more quickly than non financials.
3. Number of client lines of Business
+ The greater the diversity of the client’s operations, the greater the audit team`s coordination and control requirements.
4. Financial condition **
+ The weaker or more vulnerable the client’s financial position, the higher the auditor business risk, and in turn the longer expected audit delay. ** The Determinants Debt Proportion, Net income and Financial Condition Index can be used to measure the
influence of the entities financial condition on audit delay.
Detection Risk
Determinant
5. Audit Technology (Audit
Structure) NA
Nowadays audit firms use more or less the same structured audit approach. In the past an unstructured audit approach resulted in shorter audit delays.
Other
Determinant
6. Audit Opinion
+ When an Qualified is raised more substantive efforts and negotiation time is necessary
7. Client Leverage with Audit Firm
- Given that large clients have more leverage with their auditor, large clients should be able to demand more timely completion of their audit. 8. Types of Assets + Audit of debt is more involved and complicated to audit than equities. 9. Year-End
-
Performing audits during the busy season could results in either increase or decreased audit delay, depending on whether the increased workload is handled by increased overtime or more audit staff.
* Sign is reflecting the relation between the determinant and audit delay.
*** The Determinants which affecting Inherent Risk will also affect Control Risk. Figure 3: Determinants and their relation with audit delay.
5 Summary and conclusion
Summary
The flow of investor funds to the corporations and the whole process of allocation of financial resources through the securities markets has become dependent to a very large
extent on reports prepared by entity’s management (Hayes, Schilder, Dassen, Wallage, 2001, p 1). Because management can scarcely be expected to play an impartial role in the financial reporting process Common Law, Audit- and financial reporting guidelines and stock exchange requirements oblige entity’s management to audit their financial statements. To prevent information asymmetry between management and stakeholders the audit of the financial statements is necessary to make sure that reliable and proper information is provided. On the other hand, due to the audit, the information could be out of date which will influence the stakeholders pay-off. Therefore it is necessary to understand the influence of the audit on the timeliness of earnings announcement and the information value of the financial statements. By performing a literature research the central role that the auditor fulfils in the timing of earnings announcements will be investigated. The research starts with a description of the central role of the audit on the timeliness of earnings announcements.
Givoly and Palmon (1982) suggested that the single most important determinant of the timeliness of the earnings announcement is the length of the audit (Givoly, Palmon, 1982, p. 491). To measure the influence of the auditor on the earnings announcement audit delay is introduced. Audit delay consists of the period between fiscal year-end and the audit date. This period does not only consist of the time necessary to perform an audit but also the necessary time to prepare the subject matter, the financial statements. Between the preparation- and audit period there is no correlation but the preparation period will have a minor impact on audit delay when the size of entities increases. Due to greater external pressure and the stronger internal controls management of large entities is more motivated and able to prepare their financial statements more quickly than smaller entities (Dyer, Mchugh, 1975). From the surveys of Givoly and Palmon (1982), Garsombke (1981) and Ashton, Graul and Newton (1989) can be concluded that the length of audit- and reporting delay are highly correlated but as empirical shows there is still a sizeable difference between audit- and reporting delay.
Thus audit delay is a good reflection of the time necessary to audit the financial statements of large entities but still the question remains how the auditor determines the number of substantive procedures that is necessary to arrive at an acceptable level of reliability. An answer to this question could be give by describing the audit plan.
Before the auditor starts with the substantive procedures to obtain the audit evidence he will start with developing and documenting an audit program setting out the nature, timing and extent of planned audit procedures required to implement the overall audit plan. The audit program may also contain the audit objectives for each area and a time budget in which hours are budgeted for the various audit areas or procedures. In preparing the audit program, the auditor should consider the specific assessments of inherent and control risk and the required level of assurance to be provided by substantive procedures. During the substantive procedures audit evidence is obtained by performing analytical procedures and tests of details of transactions and balances to detect material misstatements in the financial statements.
The number of substantive procedures that is necessary to arrive at an acceptable level of reliability in the audit depends on the auditor’s judgement on audit risk. Audit risk is the risk that the auditor gives an inappropriate audit opinion when the financial statements are materially misstated. Audit risk has three components: inherent-, control- and detection risk.
When inherent- and control risk are high more substantive testing needs to be performed by the auditor. The specific assessment of risk is directly related to the company profile and as a result the auditor must be capable and experienced enough to assess the audit risk of the audit client.
The next step in the audit process is the expression of an opinion on the financial statements. Based on the audit evidence obtained from the substantive testing procedures the auditor will obtain an expression of an opinion on the financial statements. This is done by reviewing and assessing the conclusion drawn from the audit evidence. This shows that the substantive procedures can be recognised as the fundaments for the auditor’s expression of an opinion on the financial statements.
Motivation for further research
As described in the literature research stakeholders are using the information of the annual report for decisions making purposes. Due to these decisions the stakeholders will realise a pay-off and therefore they demand reliable and timely information. To make sure that entities management is providing the stakeholders with reliable and
proper financial statement information the audit necessary. On the other hand, due to the audit, the information could be out of date which will influence the stakeholders pay-off34. Thus the timeliness of audit reports is considered to be important because it affects the timeliness of financial statements which contains financial statement information to investors. The timeliness of audit reports, however, is influenced by a number of factors. An understanding of these factors can assist in improving the audit planning process and in enhancing the efficiency of audit work. In addition, an analysis of these factors may also help investors to understand the causes of delays in audit reports (Jaggi, Tsui, 1999, p. 17).
European Research
By using a comprehensive model of audit delay researchers in Australia, Canada and the United States have identified several determinants that will have an influence on audit delay of Australian, Canadian and American entities. Surprisingly there is no research identified that is using an European dataset and therefore an investigation that will use already identified determinants, to determine their influence on the audit delay of European entities is unique.
Using an European dataset could also be very interesting because for example accounting is affected by its environment, including the culture of the country in which it operates and therefore the relation between audit delay and the already identified determinants will also be affected (Nobes, Parker, 2000, p. 16). Other factors that cause international differences are the legal systems, taxation and the role of the providers of finance. All these factors will have their influence on the determinants. To illustrate the affect of accounting differences the expected influence of the determinants debt proportion and the public determinant on the audit delay of European entities will be described in the next paragraph.
Debt Proportion
For example from a historical perspective German companies are financed with relative
34
Delay in releasing financial statements is likely to increase the level of uncertainty associated with decision for which the financial statements provide information. As a result, decisions might be non optimal or delayed (Beaver (1968, p. 74).
more debt than Dutch or English companies35. Therefore the expectations are that German entities will have a longer audit delay than Dutch or English entities. The reason for this is two folded. The audit of debt is more involved and complicated than the audit of equity and a high proportion of debt to total assets will increase company’s likelihood of failures and may raise additional concern that the financial statements may be less reliable and therefore more substantive testing is necessary.
Public companies
Research of Ashton, Graul and Newton (1989) under Canadian entities has expelled that a structural difference existed between the audit delay of entities of which the share capital is entirely held by private investors (public) and of which the share capital is entirely or partially held by the government (non public). The outcome of their survey was that audit delays of public entities are shorter than non-public entities.
The first reason for shorter audit delay of public clients is that public entities face greater external pressure from stakeholders to report earnings quickly (Dyer and Mchugh 1975; Newton and Ashton, 1989). Second, most of all private entities are larger than non public entities and therefore they have more leverage with their auditors. As a result large clients should be able to demand more timely completion of their audits.
Because it is more common in Europe, especially in France, Belgium, Germany and the Scandinavian countries that national or local government will hold stake in an entity the public determinant the expectation is that the public determinant will have more influence on audit delay than in American research.
Thus an investigation that will identify the influence of several determinants on audit delay is unique and it is also interesting to compare the outcome of the European research with already performed American, Australian and Canadian research. Also the use of the comprehensive model of Bamber, Bamber and Schoderbek (1993), which is explaining 43 percent of the variation in audit delay, will probably also have a positive impact on the outcome of the survey.
35 In Germany, France and Italy, capital provided by banks is very significant. By contrast, in the United
States and the United Kingdom there are large numbers of companies that rely on millions of private shareholders for finance (Nobes, Parker, 2000, p. 20).
