Effect of Auditor Opinion on Discretionary Accruals Behavior of Distressed Firms: Empirical Evidences from Iran

The present study attempts to determine the discretionary accruals behavior (as a proxy for earnings management) of Iranian failing firms (defined here as pre-bankruptcy firms) in years prior to bankruptcy, and factors that lead to this behavior as well. For this purpose, we selected a sample composed of 68 bankrupt firms and 68 non-bankrupt firms (matched in terms of firms’ industry and size) and examined the magnitude of discretionary accruals in a period of 5 years prior to bankruptcy for each firm. The results showed that: first, during the distressed period, failing firms are more engaged in earnings management than non-failing firms are; secondly, failing firms utilize decreasing earnings management - distressed firms use accruals to understate income figures; and most importantly, in failing firms, evidences showed a significant relationship between decreasing earnings management and auditor opinion. These results suggest that under the pressure of audit opinion, distressed firms are compelled to employ conservatism procedures in earnings reporting.