The Effect Of The Accounting Firm Reform In China From Limited Liability To Limited Liability Partnership On Audit Quality

Since the full implementation of deregulation reform in1988, most of theaccounting firms in China are in the organizational form of limited liability. However,under this organizational form, the auditors only assume limited liability for the debtdue to audit failure to the extent of their respective capital contributions, so that it’s hardto ensure the audit quality because of the lack of legal risks and highly restriction to theauditors’ occupational behavior. In2010, the Ministry of Finance (MOF) of Chinaissued the provisional regulations on encouraging large and medium-sized accountingfirms to reform to limited liability partnership (LLP), claiming that the large-sizedaccounting firms reform to LLP before Dec.31st,2010; and medium-sized accountingfirms reform to LLP before Dec.31st,2011. On Jan.2012, MOF and China SecuritiesRegulatory Commission (CSRC) announced that one of the application conditions forengaging in securities and futures is that the accounting firm must be in theorganizational form of LLP. These stipulations promote the large and medium-sizedaccounting firms in China to reform the organizational form from limited liability toLLP.Under LLP, the auditors assume unlimited liability for the accounting firm debtdue to intentional misconduct or gross negligence, and all the partners assume unlimitedjoint and several liability for the debt not caused by intentional misconduct or grossnegligence. It shows that the auditors’ legal liability is much heavier than that underlimited liability. Existing related researches have shown that, increasing the legal risksof auditors will lead to higher audit quality. So it can be concluded in theory that reformfrom limited liability to LLP will improve the audit quality of the accounting firms inChinaThe theoretical analysis above should be tested by empirical method. However,most of the existing researches on organizational form of accounting firms in China aretheoretical comparative analysis between each type of organizational form from theaspect of the auditor’s legal liability; there are few empirical researches on thecorrelations between reform and audit quality, even fewer on the effect of reform fromlimited liability to LLP on audit quality. So in this paper, we study the difference inaudit quality, through empirical method, not only between the accounting firms beforeand after the reform, but also between that in the organizational form of limited liability and LLP, using three proxies for audit quality: the earnings management, the type ofaudit opinion and the accounting conservations. The conclusions are as below：(1) After the vertical comparation of audit quality between the accounting firmsbefore and after the reform, we only get weak evidence to support the hypothesis thatthe audit quality of the accouting firms after the reform is significantly higher than thatbefore the reform. In the model based on the proxies of earnings management, theconclusion is that the earnings management of the companies audited by the accountingfirms after the reform is significantly less than that before the reform. However theresults from the other two linear regression models respectively based on the type ofaudit opinion and accounting conservation support the conclusion that there are nosignificantly differences in the audit quality between the accounting firms before andafter the reform.(2) After horizontal comparation of audit quality between accounting firms inorganizational form of limited liability and LLP, it’s concluded that there are nosignificant difference in audit quality between accounting firms in organizational formof limited liability and LLP. The results from all the three linear regression modelsrespectively based on the proxies of earnings management, type of audit opinion andaccounting conservation support this conclusion.To sum up, the reform of accounting firms from limited liability to LLP in Chinahas no significant effect on the audit quality. The probable reasons are as following：(1)the reform of accounting firms in China has just started in a short time;(2) the relevantlegal mechanism in China does not sound;(3) the accounting firms are lack of effectiveinternal controls. In order to improve the audit quality, it’s suggested that we shouldaccelerate perfecting LLP and enhance the positive effects of the reform by improvingthe professional quality of the auditors, establishing and perfecting the relevant legalmechanism and strengthening supervision of CPA industry.