Auditors’ Audit Adjustment Decisions and Financial Reporting Quality: Comparative Analysis on Pre-and Post-Audit Financial Information

Audit process is unobservable to external financial information users. As a result, despite numerous prior works on auditing, little is known about the characteristics of audit adjustments and their consequences. Exploiting private data on pre-audit financial information from the Korea Institute of Certified Public Accountants, this study provides direct evidence about the determinants of auditors’ audit adjustment and its impact on firms’ financial reporting quality. Our main findings are as follows. First, during our sample period from 2014 to 2021, more than 80% of the Korean listed firms have experienced audit adjustments that affect net income. Among those audit adjustment cases, the portion of downward (upward) adjustments to decrease (increase) net income is higher (lower), suggesting auditors’ conservative approach to audit adjustments. Second, audit adjustments vary with various factors such as firm size, financial stability, profitability, listed market, and auditor-characteristics in a direction that is overall consistent with prior studies. Third, after audit adjustments, the magnitude of accruals decresases, earnings persistence increases, and small profits (losses) decrease (increases). These results collectively suggest auditors in Korea contribute to enhanced financial reporting quality by hampering managers’ earnings management and strengthening predictability of financial information. However, the decrease of post-audit accrual quality measured by the Dechow and Dichev (2002) model indicates the possibility of auditors’ excessive audit adjustments. Using externally unobservable pre-audit financial data, this study sheds light on existing audit studies by presenting the descriptives of audit adjustments for the Korean listed firms and providing direct evidence on the effects of audit adjustments on financial reporting quality.