Accounting and Auditing Framework Quiz

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Questions and Answers

What is the primary focus of the earnings conservatism framework?

Recognizing good news more quickly than bad news

Deferring the recognition of all earnings until realized

Ensuring equal recognition of gains and losses

Recognizing bad news more quickly than good news (correct)

Investor protection mechanisms have no impact on earnings quality.

False

What effect does the choice of a Big 4 auditor have on firm earnings quality?

It can mediate the effects of investor protection on earnings quality.

Earnings conservatism is a feature that allows for the immediate recognition of _ while deferring the recognition of _ until realized.

losses, gains Signup and view all the answers

Match the following terms with their corresponding definitions:

Investor Protection = Mechanisms that help safeguard the interests of investors Big 4 Auditors = The four largest international accounting and professional services firms Earnings Management = The manipulation of financial reports to present a desired image Earnings Conservatism = Timely recognition of bad news over good news in accounting Signup and view all the answers

What legislation was passed in 1995 that provided relief for auditors from litigation?

Private Securities Litigation Reform Act Signup and view all the answers

The legal environment in the United States is considered an extreme outlier for auditor behavior.

True Signup and view all the answers

Name one of the Big 4 accounting firms mentioned.

Deloitte Touche Signup and view all the answers

Big 4 auditors are likely to impose higher __________ quality on clients due to institutional incentives.

earnings Signup and view all the answers

Which viewpoint suggests that Big 4 firms maintain uniform reputations globally?

Uniform international practices Signup and view all the answers

Match the Big 4 firms with their respective characteristics:

Arthur Andersen = Failed due to scandals KPMG = Known for tax services Ernst & Young = Advisory services Price Waterhouse = Merged to form PwC Signup and view all the answers

What do the negative coefficients on 'Investor ProtectionRDR' indicate for firms with non-Big 4 auditors?

Less earnings conservatism as investor protection increases Signup and view all the answers

Non–Big 4 auditors have a higher reputation capital at stake than Big 4 firms.

False Signup and view all the answers

What is one reason why Big 4 auditors might impose greater accounting conservatism?

Stricter investor protection regimes Signup and view all the answers

Firms with Big 4 auditors report less conservative earnings as investor protection regimes strengthen.

False Signup and view all the answers

What is the significance level at which the coefficients are significant for Big 4 clients in most models?

p < 0.01 Signup and view all the answers

The term 'Investor ProtectionRBIG4*DR' tests the incremental earnings conservatism of ___ clients relative to non-Big 4 clients.

Big 4 Signup and view all the answers

What was observed regarding signed abnormal accruals for firms with Big 4 auditors?

They become smaller as investor protection strengthens Signup and view all the answers

All clients must follow applicable accounting standards, regardless of their auditor type.

True Signup and view all the answers

What framework is used to test accounting conservatism mentioned in the content?

Basu 1997 framework Signup and view all the answers

Study Notes

Investor Protection and Big 4 Audits

Earnings quality is affected by investor protection and auditor choice (Big 4 vs. non-Big 4).
Countries with stronger investor protection have higher earnings quality, particularly for firms audited by Big 4 auditors.
Big 4 auditors are more sensitive to client misreporting and its effect on their reputation.
They are more likely to enforce higher earnings quality in stronger investor protection environments.
Non-Big 4 auditors are less affected by investor protection because their reputation capital is at risk.

Earnings Quality Measures

Magnitude of signed abnormal accruals (Frankel, Johnson, and Nelson 2002)
Likelihood of reporting a loss (Burgstahler and Dichev 1997)
Earnings conservatism using the Basu 1997 framework (Ball, Kothari, and Robin 2000)

Role of Auditing

Auditors enforce proper accounting policies.
Managers may prefer discretion in earnings reporting.
Auditors may accommodate earnings management to avoid dismissal.
Auditor incentives change with stricter investor protection (more punishment for client misreporting).

Investor Protection Variables

Study examines if earnings quality improves in countries with stronger investor protection.
Stronger enforcement reduces earnings manipulation.
Multiple measures are used to account for measurement error (legal tradition, corporate law, securities law).

Sample and Research Design

Sample of firms from 42 countries between 1994 and 2004.
Data obtained from COMPUSTAT Global Industrial and Commercial file.
Excludes: Observations with missing values, non-fully consolidated statements, and non-audited firms.
Exclusion of countries with limited Big 4 presence (Japan, South Korea, etc.).
Financial institutions excluded.

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Description

Test your knowledge on the earnings conservatism framework and its implications on auditor behavior and firm earnings quality. The quiz covers topics like the Big 4 accounting firms, investor protection mechanisms, and key legislation affecting auditors. Explore the relationships between these factors to deepen your understanding of accounting practices.