Role of Audit Regulation on the Effect of Corporate Governance and Audit Quality on Earnings Management

14 Pages Posted: 20 Nov 2017

See all articles by Bambang Prayogo

Bambang Prayogo

Trisakti University - Faculty of Economic and Business (FEB)

Sukrisno Agoes

Tarumanagara University - Faculty of Economic and Business

Date Written: October 30, 2017

Abstract

The Government of Indonesia through the Ministry of Finance shall regulate the audit services with the issuance of Decree of the Minister of Finance No. 423/KMK.06/2002 on Public Accounting Services, which was subsequently revised by KMK No. 359/KMK.06/2003 with the aim to realize a professional public accountant and independent public accounting firm. Regulatory reforms were carried out in the wake of the globalization crisis in 2008 in the implementation of Law No. 5 of 2011 and lastly, also issued Government Regulation No. 20 of 2015.

Based on the audit department's data (2017) found when the enactment of Law No. 5 of 2011, the number of public accounting firms that received warning sanctions increased and over time decreased. This indicates an improvement through the audit regulation. In addition, through the enactment of Government Regulation No. 20 of 2015, found the existence of a violating public accounting firm so that it is subject to freezing sanctions in June 2015 and sanction of revocation in December 2015.

The same impact also applies to public accountants where in the period of application of Regulation of the Minister of Finance No.17 of 2008 there is only one freezing sanction on Public Accountant. This is because there is no criminal sanction in the audit regulation. However, in the period of the implementation of Law No. 5 of 2011, there was an increase in the number of sanctions against public accountant, although still in an insignificant number. In the period of enactment of Government Regulation No. 20 of 2015, there is an increase in the number of sanctions against public accountant compared to the previous regulation. And after the 2017 OJK regulation strengthens Government Regulation No. 20 of 2015, the number of sanctions on public accountants increases significantly in the first semester of 2017. This indicates that the enactment of the latest audit regulation proved to improve the quality of audit through the early and broadly detection of audit service violations.

In agency theory, agency relationships can lead to a conflict of interest that is when the manager as an agent performs an opportunistic act of doing earnings management in order to achieve targets charged by the principal (Meisser et al, 2006). This can occur because of the information asymmetry between the principal and the agent in which the agent knows more information than the principal and vice versa. The conflicts of interest can be minimized by a mechanism capable of aligning the interests of shareholders as owners with management interests. This mechanism is known for corporate governance in running its business. It is expected that the corporate control mechanism is effective through the monitoring role by the board of commissioners and audit committee (Dechow et al, 1995). The role of corporate governance as an internal factor of the firm in limiting or reducing earnings management activities (Klein, 2002; Xie et al., 2003).

Beside that in the agency theory, an independent auditor is a third party capable of safeguarding the interests of principals and agents in managing corporate finances where independent auditors can perform monitoring functions of agency work using a means in the form of financial statements (Setiawan, 2006). An auditor tests that the figures for financial statements used in the contract have been calculated in accordance with applicable procedures, and the possibility of violations in the terms set out in the contract (Watts and Zimmerman, 1986). The audit of financial statements by the public accounting firm has a monitoring role in testing the credibility of accounting information generated by the agent so as to provide a fundamental role in ensuring reliable financial reporting with reduced agency costs (Jensen and Meckling, 1976;Imhoff, 2003).

This study was to examine the role of audit regulation on the effect of corporate governance and audit quality on earnings management. This study examined using structural equation modeling method with the approach of partial least squares (SEM-PLS). And also analyze differences test by using One Way ANOVA where is use to examine the differences audit regulation period on the effect of audit quality on earnings management such before and after implementation of Act No.5, 2011 and Government Regulation No. 20, 2015. The research sample is purposive with a total of 79 manufacture companies listed on the Indonesia Stock Exchange in period 2008-2015 with 480 observation years.

The results showed a significant and negative relationship between independent commissioner and earnings management, while audit committee and earnings management shows no significant. Audit quality influences negatively and significantly on earnings management. Beside it, One Way ANOVA test shows that audit quality influences negatively and significantly on earning management especially in implementation of audit regulation during period 2008-2010 and period 2011-2014. Overall, research conclude that the changes of audit quality is significantly effect on earnings management mitigation in companies.

Keywords: Audit Regulation, Audit Quality, Corporate Governance, Earnings Management

Suggested Citation

Prayogo, Bambang and Agoes, Sukrisno, Role of Audit Regulation on the Effect of Corporate Governance and Audit Quality on Earnings Management (October 30, 2017). OIDA International Journal of Sustainable Development, Vol. 10, No. 10, pp. 53-66, 2017, Available at SSRN: https://ssrn.com/abstract=3072717

Bambang Prayogo (Contact Author)

Trisakti University - Faculty of Economic and Business (FEB) ( email )

West Jakarta, 11440
Indonesia

Sukrisno Agoes

Tarumanagara University - Faculty of Economic and Business ( email )

Jl. Letjen S. Parman No.1
Jl. Tanjung Duren Utara No. 1
Jakarta, IN DKI Jakarta 11470
Indonesia

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