The impact of audit exemption on micro-firm earnings quality

The current Finnish auditing act, which came into power in 2007, allows for smaller firms to use an audit exemption if they fall below certain limits. Small private firms have various incentives to manage earnings and previous studies have shown that earnings management occurs among private firms. As one of the main purposes of auditing is to assess the correctness and reliability of the information disclosed by the management, opting out auditing might lead to a deterioration of the firms’ earnings quality. The purpose of this study is to examine changes in earnings quality for Finnish micro-firms that have used the audit exemption. The changes in earnings quality is examined from one year prior to opting out to two years after opting out. The data set comprises 458 Finnish limited firms that have opted out auditing between 2007 and 2009. The results show that firms that have used the audit exemption show a significant decrease in earnings quality during the first year after opting out. The results also show that a pre-opting out certified auditor or opting out when above the audit exemption limits do not significantly affect the post-opting out earnings quality.