Impact of Audit Quality on Firm Value

The assignment focuses on analyzing the impact of audit quality on firm value. It delves into the relationship between mandatory audit firm rotation, auditor fees, and reporting quality, among other aspects. The analysis draws upon empirical evidence from various studies and aims to understand how different factors contribute to audit quality and its subsequent effect on firm value.

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Table of Contents
Introduction......................................................................................................................................2
Objectives of Financial Statement...................................................................................................2
Difference between Accounting and Auditing................................................................................2
Review of Management Assertions.................................................................................................4
Implications of auditing on Firm’s performance.............................................................................7
Conclusions......................................................................................................................................8
References......................................................................................................................................10

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Introduction
A literature review have been given on management’s assertion and the differences
between accounting and auditing is being discussed. The objective behind this literature review
is to develop a learner’s ability on management’s assertion, a clear view of objectives of
financial statement in auditing terms, a detailed discussion of differences of auditing and
accounting has been done (Siagian, Siregar, and Rahadian, 2013). The management assertions
are defined on the basis of existence, completeness, its valuation and presentation. The impacts
of auditing which helps to improve the firm’s performance have been discussed here under (Haji,
2014).
Objectives of Financial Statement
The general purpose of preparing financial statement for the year is to provide few
information about the financial position and financial performance of the entity to the third party
users in order to make informed economic decisions. According to the author Noor Adwa
Sulaiman, Zarina Zakaria and University Malaya. They have mentioned in the chapter that the
objectives of financial statement in auditing is to ensure the reliability of the financial statements
that they are made in with the compliance of accounting standards and Financial Reporting Act
1997 which has establish the foundation of this act and based on Malaysian Accounting
Standards Board (MASB); Though each statement has its own particular objective to serve but
they are interconnected that the sole purpose of statement can be fulfilled and looked as a whole
not to be considered separately. The financial statement should depict true and fair value of the
organization’s financial position and it should be free from the material misstatements. Also it
showcases the flow of cash of the organization which affects the financial performance of the
entity. The statement shows the company affairs which are regulated by the Companies Act
1965; so that third party users can rely upon the financial statement of the company and the
entity itself can make economic decisions (Weil, Schipper, and Francis, 2013).
Difference between Accounting and Auditing
Generally, when the process of accounting ends and the auditing process begins for the
sole purpose of defining the true and fair view of books of accounts. It is basically an activity of
recording, preparing, classifying and presenting the financial statements. Accounting is used to

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keep the track of monetary transactions and audit on the other hand means an inspection of the
books of accounts and the financial statement of an entity with an intention to reveal the fact that
at what extent does financial statement is giving a fair picture of an organization. According to
the author the distinction between accounting and auditing is that, accounting is a process of
recording, classifying and summarizing the transactions or events in a manner that fulfilment of
the purpose of providing financial statement to third party users for decision making (Yu-Shu,
Chyi-Lin, and Altan-Uya, 2015). Whereas audit is a process of improving the trustworthiness of
financial statements. A thorough understanding of accounting principles and the rules of law is
must in evaluating the relevancy of financial information that the statements are depicting the
true value of an organization. The economic events that have been occurred in the accounting
period are also covered in by the auditors while auditing (Wang, and Huang, 2014).
The standards and procedures of accounting and auditing are correlated. This integrated system
of both help managing the accounts of a company. The application of GAAP (generally accepted
accounting principles) is only being determined by applying the auditing procedures in
company’s financial statements.
According to the author Weirich, (Weirich, Pearson, and Churyk, 2013). In his Accounting and
auditing research, accounting is one studied language of business whose purpose is to provide
economic activities carried on by the entity. It captures the day to day monetary transactions of
business by classifying those transactions into groups and summarize them in a way that in case
of urgency one can refer to them easily. Thereafter analyzing the results of financial statement
made and communicate the same to the interesting parties. The key function of accounting is to
help in decision making by providing material information of financial nature. There are varied
field of accounting namely Cost Accounting, Management Accounting, Human Resource
Accounting, so it can be said that the scope of accounting is wide in nature. Objectives of
Accounting are maintaining proper record in Journal, Ledger books and Trial Balance and
determining the profitability position from these records by preparing Trading and Profit & Loss
Account. Lastly, Balance Sheet is prepared to showcase the financial position of the entity, as it
provides necessary information regarding insolvency and liquidity position to the interested
parties (Turner, 2013).

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On the other hand, auditing is known to be a methodical procedure of examining financial
information with an intention of giving an opinion about the truthfulness and fairness of the
financial statement. Auditing is critical in nature and an unbiased thorough investigation of each
and every aspect starting from vouchers, receipts, account books that needs to be verified with an
objective of spotting the reliability and validity of the financial statement. A detailed scrutiny is
done to detect frauds, errors and manipulation if any. The accuracy and transparency is being
inspected in compliance with the accounting principles and standards. After all the inspection of
books of accounts and financial records, auditor gives his opinion in the form of a report. The
report made by the auditor for the person who has appointed auditor to carry on the auditing
process in his organization (Brooks, Cheng, and Reichelt, 2013). The report are of two types
called as Unmodified and Modified, it can be conducted internally and externally depending
upon the requirements of organization. If management wants to improve their accounting as well
as internal control systems then auditor is appointed to do auditing internally within a specific
time decided by directors (Cassell, Drake, and Dyer, 2014). The external auditor is appointed by
the shareholders of the company because they are the interested parties who need the true and
fair picture of financial statement to make formed economic decision for the company. The
scope of Auditing is not as wide as of Accounting.
It is being concluded from the articles and theory given by the mentioned authors that:
 Accounting is more of a simplified task whereas Auditing is a complex one.
 The purpose of accounting is revealing the profitability position and performance of an
entity where auditing is done to check the correctness and detect errors and frauds in the
financial statement.
 Auditing seems to be a periodic activity unlike accounting which is a continuous activity.
 Auditing governs auditing and accounting is governed by Accounting principles and
standards.
 Accounting is an orderly preparations of monetary transactions and on the other hand
auditing is an analytical task involves evaluation of financial statement independently
(Farouk, and Hassan, 2014).

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Review of Management Assertions
The definition pounded by the author ‘Leow’ that Management Assertions are mere
representations in the annual report made through the financial statements (Leow, and Khong,
2015). The directors do so to discharge their responsibility towards shareholders of the company.
These representations may be implicit or explicit by the management which are exemplified in
the financial reports of the company. These assertions are broadly classified into five categories
which are as follows:
1. Existence;
2. Completeness;
3. Allocation;
4. Presentations or Disclosures.
These assertions are further explained by Leow in his journal article where author tried to
explain Management assertions are the claims made by members in relation to certain aspects of
a company. When audit is conducted, auditors rely on the variety of assertions in regard to
business. The concept of management assertions is to provide a source while applying audit
procedure in the company. But before applying such assertions, auditors make sure by
conducting audit tests on given assertions and check the reliability of these assertions.
Management assertions are further classified into three levels named as Transaction-level
assertions, Account balance assertions and Presentation and disclosure assertions.
In Transaction-level assertions, the assertions are related to transaction which are mostly in
relation to income statement and they are as follows:
 Existence: Here the accuracy in assertions is measured in a way that it detects the error
presented in transactions and the existence of reported assets and liabilities whether they
exist at the balance sheet date or not or occurred in the period which was covered by
financial statement.
 Completeness: Every transaction and account must be complete and there should not be
any undisclosed assets, transactions or liabilities.
 Valuation: All transactions and assets, liabilities, revenues and expenses must be valued
properly.

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 Presentation: The transactions must be presented in a proper way and disclosed all the
facts necessary in the financial statements of the organization (Sayyar, Basiruddin, Rasid,
and Sayyar, 2014).
In Account balance assertion, the assertions related to the end balance of accounts and
mainly relates with the balance sheet only.
 Existence: The account balances must exist for assets, liabilities and equity.
 Completeness: Here the assertion is that the balances of all assets, equity and
liabilities must be completed and fully reported.
 Valuation: The balances of asset, liabilities and equity should have been recorded
properly at their exact valuations.
 Rights and obligations: The rights and obligations under this assertion is that the
entity has all the rights and obligations over assets and liabilities (MBA, 2013).
In Presentation and disclosure assertion, the information under financial statement must
be presented and disclosed with the compliance of accounting standards.
 Accuracy: All the information presented in financial statement should be
disclosed correctly in terms of amounts and time period, proper values along with
it.
 Completeness: The assertion here is that the transactions that needs to be
disclosed must be there with the disclosure and an explanation with the same.
 Occurrence: The assertion in here is that the transactions which are recorded and
have been disclosed, must be occurred specifying the time they had occurred.
 Understandability: The information which includes financial statements has been
presented appropriately which is clearly understandable and with no question of
doubts (Martinez, and de Jesus Moraes, 2014).
The author said in a clear way these assertions may sound almost same or may show repetition
in the types of assertions which are categorize in three levels. Although they are repetitive in
nature but they do carry a different aspect of the financial statements. As discussed they carry
these three sets accordingly, the first set which is related to income statement and the second set

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to the balance sheet. Lastly, the third set to the presentations and disclosures (Mahzan, and Binti
Hassan, 2015).
It is the responsibility of senior management to provide auditor appointed the letter containing
management assertions. Because without the management assertions the auditor cannot proceed
with the audit activities (Kwon, Lim, and Simnett, 2014). The management assertion letter is
sort of an indicator that the management practices are engaged in fraud in the preparation of
financial statements. The letter makes auditor able to perform their task in an orderly and well
manner with a quite intensive examination to detect errors at the first place only. Management
assertions are a sufficient evidence to support the audit procedure and every material component
of financial statements.
Implications of auditing on Firm’s performance
Author Knechel (Knechel, and Salterio, 2016) has said in his study that there are few
implications of audit on firm’s performance. Researcher supported the theory of auditing that
how auditors help and contribute to a company’s audit system in various ways. These
implications are as follows:
 Fulfilment of business objectives: An effective audit system enables the firm to
pursue their corporate objectives. Varied business processes need internal controls
matching to the business processes and facilitate monitoring, supervising and
detecting, preventing errors or irregular transactions at the point of occurrence.
Later they measure the ongoing performance and maintain required business
records to make improvement by correcting irregularities if any. In this way audit
affects firm’s performance.
 Assessment of risk misstatement: In order to create reliable financial reports for
many purposes there is a requirement of system of internal controls, where
auditors assess financial statements to found out the risk of misstatement. This
assessment help firm to allocate their resources in a profitable segment or product
lines which is of great importance for a firm (Mahamud, and Salad, 2013).
 Prevention of frauds: Auditing serves an important aspect to companies by
preventing frauds and errors. A periodic analysis of operations in a company and
maintain a rigorous systems of internal control can help detect, prevent varied

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forms of frauds and other irregularities in accounts. For the purpose of preventing
frauds at an earlier stage of its occurrence there is an high need of audit
professionals who would design and modify the internal control system. The
implications of such modified internal control system come as profitable and
smooth flow of business activities also it helps in gaining the trust of interested
third parties. An effective audit system in firm will not allow an employee to
attempt any kind of fraud scheme (Nyakundi, Nyamita, and Tinega, 2014).
 Cost of Capital: Regardless of the size of a company the cost of capital is an
important key aspect for a company. The cost of capital comprises high amount of
risk associated with the investment. Higher the investment is, the requirement of
investor will be higher rate of return in order to invest. Only a rigid and strong
audit system can reduce the varied forms of risk in a firm. As discussed above, it
will also reduce the risk of material misstatement in financial statement (Ojong,
2014). Whereas the risk of misappropriation of assets, fraud and risk of
insufficient information in management process can be reduced by an effective
audit system in a firm.
Conclusions
From the Literature review, there are several researchers who have seem to found out that
audit and financial performance of an organization are inter-related. It is concluded after
confirming from the empirical evidence that was obtained from the research. However it can be
seen that there are very few studies done on this study.

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