The Role of Audit Committees in the Interaction Between Auditors and Management in Malaysian Publicly Listed Companies

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Stewart, Jenny

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McManus, Lisa

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2009
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Abstract

Audited financial statements are a product of the auditor-client interaction process (Antle & Nalebuff, 1991). The external auditor and the client’s management interact to determine the final contents of the audited financial statements. In some circumstances both parties have opposing preferences on certain contentious issues. As a result, the quality of financial reporting “depends on the proper resolution of contentious accounting and disclosure matters” in auditor-client interactions (Brown & Wright, 2008, p.91). A primary concern of auditor-client interactions is auditor independence, in particular, the auditor’s ability to resist management pressure when discussing major contentious issues that affect financial statement disclosures and the audit report (Kleinman & Palmon, 2001). With the current strengthening of corporate governance, auditors need to communicate audit findings to audit committees and audit committees are required to play a greater oversight role in the financial reporting process. It is assumed that by requiring audit committees to play a greater role in the auditors and management interaction to produce audited financial statements it will improve auditor independence, which in turn leads to improved financial reporting quality (Spira, 2002). Despite the importance of audit committee oversight roles in the financial reporting process, the knowledge of the role of audit committees in the auditor-client interactions has been limited. This has motivated the study to (i) explore the role of the audit committee in resolving disputed accounting issues between auditors and management to enhance the understanding of the nature of interactions between auditors, management and the audit committee, and (ii) examine in greater depth the perceived importance of audit committee expertise on the role of the audit committee in auditor-client interactions. This study is conducted in two stages – first, in-depth interviews and, second, an experimental technique. Qualitative data collected through the interviews was used to explore the audit committee role in auditor-client interactions. The interviews were conducted in seven publicly listed companies in Malaysia, with the interviewees comprising a member of the management responsible for financial statement preparation, a member of the audit committee and the company’s external auditor. Hence, a total of 21 interviews were conducted. This data was analysed using thematic analysis. Quantitative data collected through the experiments was used for testing the effect of two factors – financial expertise and industry expertise – on audit committee mediating roles. Sixty one auditors from the Big Four firms and the Non-big Four firms took part in the study. This data was analysed using ANOVAs. The interview results suggest that auditor-client negotiation over contentious accounting issues is commonplace and generally occurs when issues lack authoritative guidance from accounting standards. Only very material issues that cannot be resolved are raised with the audit committee and the committee then plays a mediating role using techniques such as controlling the agenda, gathering information, advising, problem solving and taking sides. The outcome from the negotiation and mediation process is generally a compromise solution. Next, the experimental results found that both financial expertise and industry expertise are perceived by external auditors to influence the mediation role of the audit committee. However, the study found that external auditors do not perceive any effect of either financial expertise or industry expertise on the final outcome of the mediation process. The findings of this study have implications for both research and practice. The study provides original research examining the triadic relationship of the CFO, the auditor and the audit committee to supplement the audit committee and auditor-client interactions literature. By employing behavioural theories, this study should form the basis for future research because a strong theoretical understanding underpins the study. In relation to contributions to the practice, the findings of the study provide current information regarding the implementation of best practice recommendations for audit committees to practitioners and policy makers.

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Thesis (PhD Doctorate)

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Doctor of Philosophy (PhD)

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Griffith Business School

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The author owns the copyright in this thesis, unless stated otherwise.

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Subject

Audited financial statements

Publicly listed companies Malaysia

Audit committees

Corporate governance

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