Financial Restatements And Audit Firms' Risk Management Strategy

Since the last mid-90,Regulatory auditor and academics has paid more attentionto financial restatements.Through reviewing existing literature about financialrestatements,we find that the focus of current research is on the relationship betweencorporate governance mechanisms and financial restatements.However,as animportant corporate governance mechanism,there are few studies to research therelationship between audit and financial restatements,especial the relationshipbetween client risk management of audit firm and financial restatements.We shouldanalysis auditor firms' risk evaluation and risk reaction for financial restatementsdeeply.It not only helps prevent the occurrence of financial restatements,but alsohelps us understand and play the role of external corporate governance of audit.With a sample of A-share listed corporations from 2003 to 2006,this dissertationdevelops a conceptual model for studying the relationship between financialrestatements and client risk management of audit firms,which is based on audit firmportfolio management theory,professional standards,and the practices of audit firms,and intend to test the following questions:(1)Could audit firms identify the risk offinancial restatements and use proper risk-management strategies to moderate the riskof financial restatements?(2)Whether audit firm could select differentrisk-management strategies for financial restatements of different causes? (3)Whetherthe promulgation of New Auditing Standards could improve audit firms' riskmanagement for financial restatements.This dissertation finds that:(1)Audit firms charge higher audit fees for thecorporations of financial restatements;Meanwhile the corporations of financialrestatements are more likely to be given modified opinion;Also audit firms are morelikely eliminate client which occur financial restatements from their client portfolio.This means that audit firms could identify the risk of financial restatements and use aseries of risk-management strategies to moderate risk.(2)Audit firms could identifyand distinguish between different causes of financial restatements,and chose differentrisk-management strategies,which can be showed in the following results:firstlyaudit firms would not chose any risk-management strategies for restatements causedby the characteristics of accounting standard;secondly audit firms would only choseaudit fees strategy for restatements caused by transaction complexity;Thirdly auditfirms would chose audit fees and modified opinion strategy for restatements caused by internal control weakness;finally audit firms would chose modified opinion andresignation strategy for restatements caused by earning manipulation.(3)After theenactment of New Audit Standard,the risk adjustment of audit fees increased forrestatement corporations significantly.And audit firms were more likely issuemodified opinion for restatement corporations.This means that New Audit Standardraised the level of risk management of audit firms.The main innovations and contributions are presented as follows:firstly thispaper studies the relationship between financial restatements and audit firm risk-management strategy,which expand existing literature about financial restatements;secondly this paper focuses on auditors' risk-management decision to audit risk,which enrich the research of client portfolio;thirdly this paper clarifies the underlyingcauses of financial restatements;fourthly this paper provides evidence for theselective use of risk-management strategies;lastly but not the least,this paperprovides indirect evidence for efficiency of New Audit Standard.