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AULA ORIENTALIS

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ISSN: 0212-5730
Vol. 1, Page: 150-158 (2015)

THE RELATIONSHIP BETWEEN THE INTERNAL AUDIT


OPERATIONS QUALITY AND EARNINGS MANAGEMENT OF
COMPANIES IMPORTING HOME APPLIANCES IN IRAN
Babak Pourbahrami1
1

Department of Accounting, Islamic Azad University, Parand Branch, Parand, Iran

ABSTRACT

This paper examines the impact of internal audit quality on earnings management. In this study, earnings
management is measured by discretionary accruals. Benefit accruals from on one hand allow managers to
calculated interest so that it indicates the actual value of the enterprise and on the other hand they let the
managers to exploit flexibility of the accepted accounting methods and principles and change the
information content. The Board also can not directly control the opportunistic behavior of managers.
Therefore, the company's internal audit unit can operate with precision and quality to reduce the accruals
used by managers and limit management earnings. The modified Jones model is used to estimate
discretionary accruals. Quality of internal audit is measured by the five criteria of auditor experience,
having a degree of official accounting, reporting method, average firm size and training hours. In this
study, Multiple Regression was used and a correlation method is used to test the hypothesis. Findings of
the study indicate a strong correlation between the quality of the internal audit and earnings management.
Key words: internal audit, earnings management.

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INTRODUCTION
Due to the turbulent world of today and the uncertainty of the market, creating competitive advantage
through cost reduction seems necessary. Today, competition and technological change are increasing
pressure on organizations and their various methods to increase the productivity of their human
capital. The labor force of organizations is expected to be more effective in the products and services
they offer, as well. That is what makes competence important in the competitive environment. Human
resources environment of Iran is also affected by this change and is changing aimed to keep pace with
global developments.
Over the past 50 years, the primary focus of financial reporting has been on information about
business performance produced through measures of income and its components. The subject of this
thesis is to investigate the relationship between internal audit and earning management of the Bam
and Pars Ofogh companies. Therefore, if the relationship between internal audit and earning
management is approved, internal audit functions can be used to reduce earnings management.
However, to whom the auditor reports their results of operations and which reports are important for
them and the pursuit of flaws are important cases in the research.
SIGNIFICANCE OF THE STUDY
The company from the legal point of view is an independent and separate legal entity, however, Cass
(1937), Watts and Zimmerman (1986) believed that the company can be regarded as a series of
agreements between the various parties. The most important of these agreements, are contracts
between managers and other stakeholders for the separation of ownership and company management
that will be formed based on agency theory. Shareholders in their contracts gave the corporate
governance to the representatives (managers) and instead have the right to be answered about the
performance of managers. Management commitment to attempt to maximize the wealth of the
capitalists and shareholders commitment to pay them in the form of compensation are one of the
conditions mentioned in these types of contracts. Accounting and audit play a fundamental role of all
such contracts and determination of contracts in monitoring implementation of the agreement.
For example, in the contract between shareholders and company management, accounting earnings as
the best index of economic performance measurement which is the product of financial accounting
processes plays an essential role for various purposes such as compensation schemes (bonus) and to
assess the management task of stewardship. Thus, due to the importance of accounting earnings and
decisive role in terms of the contract between shareholders and management, this strong assumption is
created that because of a conflict of interest between shareholders and managers and the expectations
of self-interest, managers affect the quality of earnings. Enterprises have realized that to establish full
compliance with procedures and policies, the internal audit department is essential for its cooperation
with the firm persistence, persistence and follow-up flaws.
RESEARCH OBJECTIVES
The aim of study was to evaluate the impact of internal audit quality on earnings management. In this
study earnings management will be measured by discretionary accruals. Benefit accruals from on one
hand allow managers to calculated interest so that it indicates the actual value of the enterprise and on
the other hand they let the managers to exploit flexibility of the accepted accounting methods and
principles and change the information content. Specific objectives are as follows:

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Determining the relationship between auditors experience and earning management in Pars
Ofogh and Bam companies.

Determining the relationship between the reporting and earnings management in Pars Ofogh
and Bam companies.

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Determining the relationship between CPA and earnings management in Pars Ofogh and Bam
companies.

Determining the relationship between training hours and earnings management in Pars Ofogh
and Bam companies.

Determining the relationship between firm size and earnings management in Pars Ofogh and
Bam companies.

Research model
Research model is as follows

:
RESEARCH HYPOTHESES
MAIN HYPOTHESIS

There is a relationship between internal audit quality and earning management in Pars Ofogh
and Bam companies.

SECONDARY HYPOTHESES

There is a relationship between auditors experience and earning management in Pars Ofogh
and Bam companies.

There is a relationship between the reporting and earnings management in Pars Ofogh and
Bam companies.

There is a relationship between CPA and earnings management in Pars Ofogh and Bam
companies.

There is a relationship between training hours and earnings management in Pars Ofogh and
Bam companies.

There is a relationship between firm size and earnings management in Pars Ofogh and Bam
companies.

SCOPE OF RESEARCH
TIME PERIOD OF RESEARCH
Studying the earnings management and accounting practices quality as since February 2013 to
September 2014, or in other words the time period of this study is cross-sectional.
THE SPATIAL DOMAIN
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Pars Ofogh and Bam companies 1-8-3Qlmrv topic


THE SUBJECT DOMAIN
Earnings management, audit and internal audit
INTERNAL AUDIT
The company from the legal point of view is an independent and separate legal entity, however, Cass
(1937), Watts and Zimmerman (1986) believed that the company can be regarded as a series of
agreements between the various parties. The most important of these agreements, are contracts
between managers and other stakeholders for the separation of ownership and company management
that will be formed based on agency theory. Shareholders in their contracts gave the corporate
governance to the representatives (managers) and instead have the right to be answered about the
performance of managers. Management commitment to attempt to maximize the wealth of the
capitalists and shareholders commitment to pay them in the form of compensation are one of the
conditions mentioned in these types of contracts. Accounting and audit play a fundamental role of all
such contracts and determination of contracts in monitoring implementation of the agreement.
Hussein Kasiri defined internal audit as the following:
Internal accrual is traditionally a part of internal control system which helps the management of the
economic units by investigating and evaluating the internal controls. Concurrent with the introduction
of new ideas "Governance Board" and the "leading organization" in the literature of management,
internal audit transformation occurred in the last decade. When the concept of corporate literature was
formed, internal audit was an integral part of the "leading organization". The simple task of guiding
and steering mechanism that controls the organization toward its goal of creating value for
shareholders is their primary goal. The steering system components, including the board, audit
committee, senior management, external auditors, internal auditors and internal organs were defined
and tested from the proper perspective of economic, efficient and effective use of resources.
INTERNAL AUDIT OBJECTIVES
In other words, the existence of an internal control system can cause the organization to achieve its
objectives and programs. Given the definition of internal auditing should be noted that the internal
control system of an organization exists to serve all parts and covers the administration of the
organization in a way that enables efficient, effective and economic control and operation. In other
words, the existence of an internal control system can cause the organization to achieve its objectives
and programs. The purpose and scope of the internal accrual as a part of control system is defined
based on predetermined objectives and programs of the organization. Internal audit objectives and
aims of the program are inextricably bound. In addition, it is noteworthy that the internal audit
activities are done in different legal and cultural environment, with the difference in purpose, size and
structure, by the people within the organization or outside of it. Such differences may affect the
operation of internal auditing in each environment. But with all these qualities are as follows for the
establishment of a strong internal control system:
Policy actions and policies of the organization;

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Identification and recognition of the principles and values of the organization;

Compliance with laws and regulations;

Accurate and reliable financial statements and other information which will be published;

Efficient and effective management of human resources and other resources;

Social issues, including environmental compliance

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EARNINGS FROM THE PERSPECTIVE OF ACCOUNTING


Measurable benefit to businesses in the form of periodic accounting process is perhaps the prime
target. Non-fixed term benefit of the concepts in the corporate world. Accounting earnings is
measured based on the assumption of liability and under GAAP. Earnings from excess revenues over
expenses for a given accounting period which represents a net increase in equity and earnings from
ongoing business activities and ancillary operations, random events and other activities, events and
circumstances affecting the business unit which can be identified and measured in accordance with
Generally Accepted Accounting Principles (GAAP). In general we can say that the purpose of
measuring Earnings is to determine how much the status of an entity is improved as a result of
operations carried out during a given period.
THE ECONOMIC CONCEPT OF EARNINGS
The economic concept of earnings has always been regarded by economists. Adam Smith was the first
to know the economic benefits to be defined as an increase in wealth. For example, they have
separated fixed capital and working capital and emphasized the realization of physical capital and
earnings interest and considered it as the reason for the identification (registration) of the future.
In the early twentieth century ideas were offered about the benefits. Fisher, Lindale and Hicks offered
a new perspective on the nature of the economic benefits. Fisher defined economic benefit as a series
of events that are related to different modes: Enjoying the benefits of physical, real interest and
dividend payments.
Psychological benefits include the actual consumption of goods and services that cause pleasure and
mental demands. Psychological benefit is a psychological concept that cannot be expressed as
approximate. The real benefit is to describe events that cause or increase the mental pleasure. The real
benefit would be the best possible measure of the cost of living. In other words, by paying the money
to purchase goods or services before or after use, one can calculate the interest gained by
psychological benefit satisfaction. Hence, psychological interest, real income and interest expense are
the different stages of life. The monetary benefit represents all the money that is going to be used in
order to meet the cost of living. However, psychological interest is the most basic interest and money
earnings is a stage of interest which is often considered as income, Fisher assumed that the real
earnings has more practical application for accountants.
Lindale defined concept of earnings in the form of "guaranteed income (interest)," and purpose, is to
increase capital goods over time. This view has caused that the accepted economic benefit is
discussed in terms of use in addition to the savings that are expected to occur over a specified time
period. Savings is equal to the change in the economic capital. This concept can be expressed as
follows:
In this regard:
Ye: economic earnings
C: usage
Kt: capital in period t
Kt-1: t-1 capital in period
Hicks, English economist and Nobel Prize winner, suggested the General Theory of "economic
benefit" using the concepts proposed by Fisher and Lindale which can be explained as follows:

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Earnings is the maximum amount that a person can bring to the consumer over a specified period as
his wealth at the end of the period is same as his wealth at the beginning.
THEORY OF EARNINGS QUALITY
Earnings quality theory first propounded by financial analysts and stock brokers, they felt that the
amount of earnings a company's reported earnings do not show their imagination.
They found that the expected future earnings on the basis of the reported results is difficult.
Meanwhile, analysts found that analysis of the company's financial statements is difficult due to
numerous weaknesses in the accounting measurement.
The big question is why financial analysts in their assessment do not use the reported net earnings or
earnings per share (without adjustment).
The answer that the value of the company is not only determined by the quantity of interest but its
quality should also be noted. The quality of earnings and dividend growth potential areas of future
earnings is likely to happen.
In other words, the value of a share depends not only on the company's earnings per share this year
but it depends on our expectations of future profitability of the company and future years and
confidence about the future earnings.
Financial analysts are trying to assess the outlook for corporate earnings. The outlook refers desirable
and undesirable features combined with net income. For example, a company with stable elements in
benefit and loss has higher earnings quality compared to the company with unstable elements. This
would allow analysts predict the future earnings of the company more confidently.
QUALITY OF EARNINGS
Suitable fields for "earnings" due to conflicts of interest and also due to some inherent limitations of
accounting including a) the failure of the process, estimates and projections of future b) possibility to
use multiple methods of accounting caused the real benefit of an economic unit differ from the
income reported in the financial statements. Accounting professionals, researchers and practitioners
consider benefit as one of the most important measures of performance and value the company
inevitably to evaluate the benefits reported by economic units. To assess the benefits, the concept of
earnings quality is used.

In various articles, in definition of interest to two features have been mentioned:


Among these are decisions and beneficial and profitable relationship between the two concepts and
economic benefit considered by Mr. Hicks.
In other words, the quality of earnings is the honest expression of reported earnings from the benefit
considered by Mr. Hicks. It means correspondence between the descriptive and what they claim it is.
High earnings reflect the quality of information useful for decision-earnings use and also more
consistent with Hicks economic benefit.
But because they use in different the information for decision making, there is no possibility of
defining a earnings.
RESEARCH METHOD
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The study based on the nature and purpose of application is cross - correlation, because it discussed
and described what is being. Descriptive study included a set of methods aimed at describing the
situation or phenomenon under investigation. Implementation of the descriptive study can help further
understanding of existing conditions and the decision making process.
RESEARCH VARIABLES

Dependent variables

independent variables

earnings Management Internal Audit

RESEARCH POPULATION
The present research is studying the earnings management and accounting practices quality since
February 2013 to September 2014. The research population by considering the constraints to increase
the reliability of the applied research is determined as follows:
1. Data available from the beginning of 2007 to the end of 2013
2. The data should be available so the data not available for 36 periods was eliminated.

TIME PERIOD OF THE STUDY


The present research is studying the earnings management and accounting practices quality since
February 2013 to September 2014. The purpose of this study was to investigate the three-year period
near the present time. It should also be noted that taking into account the different time periods, such
as daily, weekly, monthly or yearly periods would not affect the results but considering that it was
easier to achieve monthly returns and due to the limitation of population, more information can be
found in the number of returns available for the entire period of study and so monthly data are used.
Since for the validity of the financial information, it is needed to study 30 to 36 time period (Hakimi,
2010), the study hold information about the course with a 36-month period to significantly reduce the
problems related to the validity of the study.
DATA COLLECTION
Since the input data for this research are the information related to the period of two 36 one-month
periods SEVEN soft is used.
TECHNICAL SPECIFICATIONS OF MEASURING INSTRUMENTS
VALIDITY
The validity refers to the term used to achieve the purpose of the test and a test has validity which is
appropriate for measuring what is considered. Validity indicates the size of a concept and how it is
covered. In other words, a test has validity which appropriate for measuring what is considered.
Therefore, for validity assessment, one should answer the question that does the tool must measure
what it aimed to? To answer this question, the test questions were examined with input from a number
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of professors and experts and its ambiguities were resolved, this indicated that the test has an
acceptable content validity.
RELIABILITY
Reliability is one of the technical characteristics of measuring instruments and deals with the fact that
the measurement instrument gets the same results in the same condition. This means the accuracy,
reliability, stability and reproducibility of test results. The reliability coefficient indicates that to what
extent measurement tool characteristics are stable or measure the attributes of a variable. Using
questionnaires data obtained from SPSS software, Cronbach's alpha reliability coefficient method was
calculated as an index of reliability and Cronbach's alpha for the total scale as 85.1% indicating the
stability and internal consistency of the questionnaire. The alpha coefficient of variance of scores for
each subset of the Questionnaire and the total variance should be calculated.
DATA ANALYSIS
In order to analyze the data collected, after the valuation of options from number one to five for
strongly disagree to strongly agree, the data was collected using Software 18 SPSS.
Suggestions
Based on the results of the present study, it is suggested
1. Considering the first hypothesis that there is a relationship between earnings management and
quality audit which has been approved, it is suggested other definitions of earnings quality and other
models should be used to measure performance.
2. Using criteria P / B instead of P / E ratio for the classification of companies.
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