Abstract

This paper investigates the effect of the submission of unaudited financial statements to the “Securities and Futures Commission”(hereafter in this paper referred to as “SFC”) on audit quality. The rule is introduced by amendment of “Act on External Audit of Stock Companies”(hereafter in this paper referred to as‘External Audit Act’). The purpose of this External Audit Act is to prevent the self-review threat of the auditors over the financial statements to improve the independence of the external auditors, and to let the external auditors have the sufficient audit hour for improving audit quality. The purpose of this paper investigates whether amendment of External Audit Act improves audit quality. We estimate discretionary accruals of Kothari et al. (2005) for audit quality and use size and signal of discretionary accruals. For empirical analyses, we collect 5,710 listed and 28,534 non-listed in Korean Stock Exchange firm-year observations over the period of year 2011 to 2014. We test whether discretionary accruals of the first year (2014) of the submission of unaudited financial statements to SFC are smaller than other year (2011-2013). Findings of this paper are follows. First, there isn’t significant difference between the size of discretionary accruals (2014, the year of the submission of unaudited financial statements to SFC) and the size of discretionary accruals (2011-2013, the previous year of the submission of unaudited financial statements to SFC) of listed companies. The size of discretionary accruals (2014) is smaller than the size of discretionary accruals (2011). Second, the difference of the size of discretionary accruals between 2011 and 2014 mainly comes from increase in negative discretionary accruals. Third, there is no evidence that the size of discretionary accruals of listed firms and non-listed firms is different between 2013 and 2014. In sum, the results of this paper indicate that there is limited evidence for the effect of the submission of unaudited financial statements to SFC when we test listed firms. This implies that the effect of External Audit Act is limited. There is no evidence for the effect of the submission of unaudited financial statements to SFC when we investigate non-listed firms. This paper contributes to the literature by examining the effectiveness of External Audit Act using discretionary accruals. These findings would provide valuable insights to academics, companies, external auditors, and regulators. And academics can also apply the discussion in this paper for related researches.

Keywords

• Unaudited Financial Statements
• Audit Quality
• Listed Firms
• Non-listed Firms

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