Does Mandatory IFRS Adoption Affect Audit Effort and Its Effectiveness to Constrain Earnings Management? Evidence from Italy.

• In Event: Accounting Standards and Audit Quality

Abstract

We examine the effect IFRS adoption has had on audit effort, hourly billing rates, and the effectiveness of audit effort to constrain earnings management. While there is a rich literature on the costs and benefits of IFRS adoption, it is unclear whether IFRS adoption affects the efficiency of the audit engagement, and the effectiveness in constraining earnings management. We find that following Italy’s adoption of IFRS, audit hours increased while the hourly rate did not significantly change, suggesting that audit effort (in audit hours) increased following IFRS adoption. Consistent with prior literature (Caramanis and Lennox 2008), we find more audit effort is associated with less abnormal accruals. More importantly, after Italy adopted IFRS, audit hours were less associated with lower abnormal accruals, suggesting that the IFRS adoption dampened the auditor’s effectiveness to constrain managers from inflating earnings. Collectively, our empirical analysis suggests that IFRS lead to an increase in audit effort with an unintended consequence of weakening its effectiveness to constrain earnings management.

Authors

• Kenneth J Reichelt, Louisiana State University

• Dechun Wang, Texas A&M University

• Tatiana Mazza, Free University of Bozen

• Stefano Azzali, University of Parma