Audit adjustments and earnings quality

While there are many alternative proxies for “earnings quality”, there is little evidence as to what auditors consider to be indicative of high earnings quality. To answer this, we examine the adjustments that auditors require companies to make to earnings during year-end audits. There are three findings. First, audit adjustments serve to increase earnings persistence, smoothness, and accrual quality. This is consistent with auditors helping to make earnings more useful for the purposes of valuation. Second, audit adjustments have a larger effect on signed accruals than absolute accruals. Third, audit adjustments have no effect on the discontinuity in the earnings distribution around zero. These findings should prove useful to future researchers intending to use earnings quality metrics as proxies for audit quality.