1. Erbil Polytechnic University, Iraq; fatmamagdi@gmail.com
2. Erbil Polytechnic University, Iraq; Ibrahim_huma9869@gmail.com

*             Correspondence: fatmamagdi@gmail.com

Keywords: audit quality, modifications, Iraq, companies

1. INTRODUCTION

Authorities have been worried about the quality of audit services for a long time, which is why major modifications to audit reporting standards have been implemented globally by standard-setters to enhance the overall quality of the process and raise the transparency of audited financial reports. For example, the Public Company Accounting Oversight Board in the US implemented a new auditor reporting standard in 2017 that required the auditors to describe the key audit matters in the audit report [1], and the Financial Reporting Council (FRC) in the UK set a new standard in 2013 requiring audit firms to disclose risks of material misstatement in their audit reports [2]. These two mandatory processes emphasise the importance of thorough audit reports, particularly in circumstances where there is a greater possibility of financial report fraud. Put another way, the PCAOB Final Rule in the 2019 Auditor’s Report argues that if auditors are informed about the major audit issues, they may be further encouraged to demonstrate the level of professional scepticism necessary for high-quality audits in those areas. [3]. Empirical research also highlights how crucial audit quality is to financial reporting systems. A comprehensive meta-analysis by [4] indicates that in this situation, the size, experience, and specialisation of the audit firm are more likely to improve the quality of audit services. In a further attempt, [5] show that the audit quality level is less likely to be impacted by factors such as financial reporting quality and audit fee stickiness. Researchers also point out that audit quality may have a big impact on other things including audit fees [6–8], company performance [9], and corporate governance practices [10]. The current study examines the phenomenon’s effect on the audit quality of financial statements since the population and users look for the best auditors possible so that they may rely on their report when making the most significant investment decisions. Audit quality is a fundamental value of the International Auditing and Assurance Standards Board (IAASB). Thus, in order to provide the auditors’ observation, the board asserts that “the board’s purpose is to focus on professional complaints and control the audit quality” and that “it is necessary to increase the audit quality in line with the public interests”. The board’s 2014 audit quality framework takes into account the functions of auditing firms and auditors, in addition to the audit quality of other stakeholders. It offers an explanation of the important content components. This framework outlines the inputs, processes, and outcomes that affect the audit quality at the business unit, audit firm, and worldwide levels that affect the audited financial statements. The importance of numerous factors and the requirement for sufficient stakeholder involvement are also highlighted by this framework. [11]. The importance of audit quality and deciding variables has increased in the discourse on auditing among academics and supervisors following the reported failures in this field in recent years. Consequently, a number of developments in the financial reporting industry, the auditing profession, and the regulatory bodies that set standards and guidelines improve the calibre of the auditor. Among these authorities is the International Auditing and Assurance Standards Board (IAASB), which published a framework for audit quality in 2014 that covered pertinent areas of audit quality in practical contexts. A 2008 Financial Reporting Council essay on the objectives and framework of auditor quality contained a description of the key components of audit quality. The Institute of Chartered Accountants’ England published a report on audit performance principles and factors that was comparable to this one [12]. A number of scholarly investigators [13–15] have examined audit quality firms. Because users base their decisions about whether to sell or hold onto their investments on the auditor’s commentary on the financial statements, this study looks at the effect of audit adjustments on the quality of services provided by Iraqi audit firms. Put another way, the aim of this research is to ascertain whether these audit modifications affect the audit quality. When an auditor asks a firm to provide results before the year-end audit, audit adjustments are incorporated with other data and reported earnings quality in financial statements. The financial accounting and auditing literature [16] outlines the criteria for quantifying audit adjustments, which include the combined index of accounting earnings, accruals quality, earnings volatility, earnings smoothing, and earnings liquidity. Auditing financial statements improves their credibility and reliability, making them a valuable tool for the financial markets that provide reliable and incisive information about the choices made in the financial statements. It is thought to be among the main goals of financial reporting. Understanding the current situation of the auditing services market and the level of competition within the auditing sector is essential. Auditing will be able to identify, evaluate, and convey these significant audit modifications, claims [17, 18]. This is one of the first studies to look into how audit adjustments, particularly in emerging economies like Iraq, impact the quality of audit reports. There are several sources that bolster this assertion: To the best of the authors’ knowledge, the closest conducted paper to this study may be the study of [30], which looks at how Lennox and Wu, for example, [18] calculate the audit adjust (1) Prior research has primarily focused on the impact of audit efforts [19], cross-year updates of analysts’ EPS forecasts [20], client importance [21], and auditor’s communication mode [22] on the audit adjustment level. (2) Prior research has mostly shown that indicators related to auditors, such as audit specialisation, tenure, and audit firm size [24], audit fee stickiness [25], audit market concentration [26], and client-related features, like board size, client firm size [27], technology enhancement client firm size [28], board diversity, and audit committee characteristics [29]; 3. In contrast, the purpose of this study is to investigate how audit adjustment directly affects the quality of auditors’ reports. This suggests that the current study will likely add a little to the corpus of information regarding financial reporting and auditing.

2. LITERATURE REVIEW

One of the main issues facing auditing firms, regulations, investors, and regulators is mastering audit quality, a major theme in the accounting literature [32]. Audit quality improves financial reporting by increasing the financial accounts’ accuracy and dependability [33]. The quality of the audit may theoretically be influenced by the accounting processes (such as accounting systems, internal controls, financial activities, and regulations), as well as by the staff members of audit firms and the business units of their clients that handle those processes (accountants, auditors, and managers) [32]. These individuals might therefore be crucial to the auditing process. The audit staff’s work is also very important. One of the primary duties of the auditing profession is hiring and training audit staff members [33]. The experience and calibre of auditing professionals can be improved since audit quality greatly supports the confidence in the truth and accuracy of the financial statements, which are crucial to improving business units [34]. Because of the audit quality, users of the financial statements can trust the auditor’s report when making investment decisions [35]. Audit quality is the term used to describe the services provided to the organisation by the participating auditors. The business divisions require higher-quality audits because of their experience and standards. Employing a first-rate auditor boosts investment, improves organisational performance, and improves the business unit’s reputation [36]. As a result of the experience and reputation that higher quality accounting firms have built, investors and stakeholders trust and rely on these businesses [37]. A number of studies [38–42] have been conducted to enhance understanding of the concept of audit quality, and several definitions have been offered, such as the following: Audit quality was first defined as “assessing the market for the auditor’s ability to detect significant distortions and report detected distortions” [43]. Furthermore, [43] emphasises that the auditor will be objective regarding the meaning of the word by recognising and revealing flaws and distortions. Consequently, audit quality enhances the audit’s ability to detect accounting irregularities and evaluate the population’s independence and competency, claims [43]. The essential tenet of DeAngelo’s definition of quality is that audit quality reflects the real quality of the auditing process [44]. The likelihood that there won’t be a substantial misrepresentation in the financial statements and the level of confidence in the accuracy of the financial statements are what [45] define as audit quality. The definition is used in practice because of the auditing procedure. On the other hand, the financial statements that the auditor provides to management and the governing body are altered through audit adjustments [46]. The auditor makes this adjustment in light of the information acquired during the audit phases. This could lead to the financial statements being resubmitted or even management claiming that the amounts for the financial statements of the different accounts should be categorised differently. These improvements should be relatively expensive because there’s a chance the owner won’t make the required changes [47]. Auditing studies indicate a close relationship between the auditing sector and audit quality. The quality of audits is improved by growing expertise in the audit industry [48]. Further research has also shown that the size and wealth of the client have an effect on the quality of the audit. Furthermore, some research has shown that the auditor’s size or stature has no bearing on the audit quality. [49] examine how audit modifications impact the calibre of financial statements and audits in Chinese enterprises. His research indicates that audit modifications have a favourable and significant correlation with both audit quality and earning quality, while also lessening earnings management. Furthermore, [50] provided evidence of how audit improvements enhance earning quality and improve financial reporting accuracy. The results of the study show that managers are not as likely to make adjustments for audits. According to the agency representative, auditing reduces agency costs and decreases the possibility that management may generate automated reports. Research [49] indicates that prospects for accrual earnings management are enhanced when management claims higher revenues and lower expenses—a strategy that has been especially prevalent since accrual accounting. Therefore, if the auditors reduce agency expenses, we expect them to reduce accrual earnings management through audit adjustments. However, in their capacity as impartial delegates, the auditors will search for and reveal earnings management to maintain their credibility as stakeholders and to avoid legal issues. In order to prevent damage to their reputation and legal action, the auditors conduct higher-quality audits. Put another way, the fear of losing their reputation and the potential for legal action motivate the auditors to improve the quality of their audits throughout the audit process [50]. According to agency theory, auditing is a technique that management of all commercial, for-profit, and nonprofit departments and units uses to reduce agency expenses and stop any unrealistic reporting. Because the public sector has a weaker incentive structure than the private sector, the surplus account of income approaches zero as it falls. Since commitment accounting gained popularity and created new opportunities for earnings management, it has evolved. Government agencies have employed accrual earnings management, or “accumulation earnings management,” more frequently and aggressively than private enterprises, according to a number of data points in this field. Therefore, if management wants to reduce the agency charges, we expect the auditor to haggle to have these items changed in the financial statements. It is crucial to remember that auditors protect their own interests, work to stay out of legal trouble, and maintain their good name. As a result, the auditor could act as a supervisory agent in his own best interests rather than following the rules and regulations. On the other hand, some individuals also believe that auditors can prevent business unit managers from putting their earnings management plans into practice by using audit modifications. Furthermore, the audit adjustment may not be approved by the firm’s management, especially if it results in a reduction in the management’s annual remuneration or even in the amount of credit financing borrowed. As a result, in these situations, the auditor should consider whether or not these audit adjustments have a substantial impact on the financial statements’ accuracy and correctness, or whether or not they will ultimately enable the auditor to form a reasonable and accurate opinion regarding the unit’s financial statements [49]. Naturally, the owner is happy to hear that the auditor thinks well of herself, therefore she usually agrees to the audit revisions. The financial statement auditors negotiate the modifications with the audit committees of the business units, if any. The committee members also examine the accuracy of transaction recordings by examining any control issues or other circumstances in order to evaluate the effectiveness of the accounting unit. The process might lead to a management change in the accounting department. The last discussion about the audit adjustments will include a review of the original account balances at the beginning of the next year to ensure the owner has appropriately documented all of the adjustments. If these modifications are not documented, the report will be impacted and the auditor’s opinion will be changed [48]. If an audit is able to identify and reveal substantial misstatements in the financial records without the need for outside funding, it will be very effective and of the highest calibre. This is what [43] refers to as audit quality. Put otherwise, the first and second sections of this description address the auditor’s independence and degree of ability. Being informed about the issues and providing an opinion that deviates from the owner’s expectations are what define the quality of the audit. According to the definition, an auditor’s ability to identify significant distortions that require an adjustment to the financial accounts is based on their level of independence and competency. As a result, audit adjustments and quality are closely related [48]. The following studies have been carried out across multiple countries: The study found a substantial and positive correlation between the quality of audit adjustments and public sector audits. Additionally, it was discovered that audit changes improve earning quality and strengthen the firm’s financial reporting. The study discovered no relationship between additional profit audit adjustments and firm funding. Furthermore, there is no discernible relationship between the companies’ funding and the audit adjustments for upward and negative results. Conversely, there is a substantial association between the loan financing of enterprises and the profit downward audit adjustments. A research [45] claims that the annual changes prevent business unit managers from making a profit and make auditors more cautious. Trusts with a pre-audit surplus show no signs of this happening, according to Donatella (2021), who looked at how audit firms reduce management bias in public sector financial reports. When it comes to trusts with a pre-audit deficit, auditors intervene to counteract management bias. Furthermore, they find that the likelihood of issuing a modified audit opinion increases in the absence of an audit adjustment, with audit effort generally having no discernable impact on the issue of changed audit opinions. They also find that the impact of audit effort on audit quality is lessened by larger audit firms and more complex clientele. All of their statistics emphasise how crucial audit effort is to improving audit quality by having an impact on audit processes and outcomes. [46] There is a higher likelihood of financial statement misstatements in audits that are not as complete at the time of the earnings announcement in audit areas that are typically finished at the conclusion of audit fieldwork. We also find that there is a higher likelihood of auditor turnover in the next year. The results show that companies that declare profits before the audit is finished typically have lower-quality financial reporting and audits, as well as more auditor turnover. The requirement that auditors publicly disclose internal control weaknesses made it more difficult for them to find and correct misstatements in their clients’ pre-audit financial statements, which in turn made auditor-client conflicts worse, according to a different study that examines whether audit adjustments are a mechanism that links the impact of required internal control audits on the quality of financial reporting. They bolster this argument by finding significant declines in audit adjustments following the progressive deployment of required internal control audits. They also find that there is a significant rise in major misstatements following mandated internal control audits, which is accompanied by a decline in audit adjustments. Conversely, they find that the number of material misstatements among clients who did not experience a decline in audit adjustments considerably fell when internal control audits were mandated. The combined effect of these two reasons explains why, when internal control audits became mandatory, there was no overall improvement in the calibre of financial reporting. However, [44] find that waived adjustments are linked to incentives to reach or surpass profit targets, to lower quality financial reporting ascertained by material misstatements, and to the audit process as assessed by higher audit work and fees as well as recommended changes for the upcoming quarter. The audit technique has been modified in accordance with the auditors’ response to the increased risk associated with waived adjustments. After controlling for the number of recommended changes, they find in their initial analysis that there is a negative relationship between auditor resignations and waived changes.

3. CONCLUSION

The report suggests that in order to improve the accuracy and openness of financial statements, board members and equity owners should select audit firms that offer a greater number of audit modifications. In order to produce more audit adjustments and maybe grow their market share and revenues, audit companies can further enhance their services by carrying out more reviews and analyses. Comparisons are hampered, though, by factors like the small number of firms listed on the Iraqi stock exchange and the restricted pool of academic credentials. Given that improved audit quality is associated with increasing market concentration and fees, future research should examine the impact of audit adjustment on market growth and fees.

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