Information Quality of Interim Financial Statements

Abstract

Expressing concern about the Canadian capital market environment, Boritz (2006) suggested that the accounting and auditing profession may be paying limited attention to quarterly reports. This study investigates whether fourth-quarter adjustments are significantly different from the previous three, thereby limiting the reliability or faithful representation of the firms' results for each quarter. This study includes four years (2003)(2004)(2005)(2006) of quarterly financial information of 353 Canadian public companies. Our results indicate that the volatility of net income in each of the first three quarters is considerably lower than in the final quarter. While lower volatility can improve predictability, the resulting relevance may be limited. The low volatility of reported earnings in the first three quarters suggests that either earnings management is taking place or that management may not be exercising sufficient care at the end of each of the first three quarters on the measurements that generally accepted accounting principles call for and readers of financial statements expect. This could result in quarterly financial statements that do not faithfully represent the underlying resources and obligations of the reporting firms at the end of the quarter, or the firm's performance during the quarter. Our findings support Boritz's proposition for increased audit requirements for interim reports and changes in the approach to the annual audit to integrate it more closely with interim financial reporting. QUALITÉ DE L'INFORMATION LIVRÉE DANS LES ÉTATS FINANCIERS INTERMÉDIAIRES RÉSUMÉExprimant ses pre´occupations a`l'e´gard de l'environnement des marche´s de capitaux canadiens, Boritz (2006) a avance´que le milieu professionnel de la comptabi-lite´et de l'audit faisait peu de cas des rapports trimestriels. Les auteurs effectuent une e´tude empirique visant a`de´terminer si les ajustements du quatrie`me trimestre sont sensiblement diffe´rents de ceux des trois trimestres pre´ce´dents, ce qui pourrait indiquer que les e´tats financiers interme´diaires ne sont pas complets et, par conse´quent, ne donnent une image ni fiable ni fide`le des re´sultats de chaque trimestre.

Investors’ response on the deviation between quarterly and annual earnings

“…Traditionally, financial accounts are prepared for external users on an annual basis and this has been a common practice across countries. However, annual accounts suffer from timely problem, whereby some of the information reported by the accounts may become irrelevant at the time of production [2]. To overcome this timely problem, interim reporting is required.…”

“…As noted by [2]: "while interim reports increase the relevance of the financial statements through more timely communication of position and results, their usefulness to users is also a function of their reliability" (p.268). The concern on the reliability of quarterly accounts arises mainly due to nature that quarterly accounts are not required to be audited by external auditors in most jurisdictions.…”

“…Frequent information helps to reduce uncertainties [1]. Timely information increases the relevance of the information [2]. It can be observed that many countries have mandatorily required their listed companies to produce quarterly reports.…”

“…Despite the benefits of frequent and timely information, many have questioned the reliability of quarterly accounts [2,4,5]. Earlier studies by [5] and [6] assess the reliability of quarterly accounts based on the occurrence of earnings deviation between audited annual accounts and cumulative quarterly accounts.…”

Events after Reporting Period, Misstatements and Earnings Deviation between Quarterly and Annual Accounts

“…As a result, the issue of the reliability of quarterly accounts has been raised. As highlighted by (Lightstone, 2012) "While interim reports increase the relevance of the financial statements through more timely communication of position and results, their usefulness to users is also a function of their reliability" (p. 298).…”