A research note on earnings quality of private SMEs: the impact of IFRS adoption and Big Four auditor presence

Abstract

This study analyzes whether International Financial Reporting Standards (IFRS) adoption and the presence of Big Four auditors affect the earnings quality of UK private small and medium-sized enterprises (SMEs). Using data covering 2011–2018, we show that IFRS adoption is not significantly associated with earnings quality. This may be because SMEs’ smaller size and simpler business model mean that only a few accounting rules are relevant for them. The high quality of UK domestic accounting standards may also explain this result. Furthermore, we find that the presence of Big Four auditors results in lower earnings quality, in contrast to prior research results. The advisory role played by Big Four auditors for SMEs and UK tax authorities’ less monitoring of financial statements may contribute to this result. Our findings offer new insights into the potential impact of IFRS adoption on private SMEs’ earnings quality and suggest that policymakers aiming to enhance earnings quality should carefully consider the advisory role of auditors in SMEs’ financial reporting.

Keywords:

• SME
• private firm
• IFRS
• earnings quality
• Big 4 auditor

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 Private firms and SMEs are two different terms. The former are firms that do not trade publicly. The latter are firms that are smaller in terms of size and are defined as firms with fewer than 250 employees (House of Commons Library, 2021). Although private firms tend to be smaller than public firms and are often SMEs, not all private firms are SMEs and vice versa.

2 The earliest data we can access are from 2010. The literature suggests that companies’ earnings quality may be affected by the global financial crisis from 2008 to 2010 (Arthur et al., 2015); starting our sample in 2011 can prevent our results from being affected by the crisis. Furthermore, Brexit, initially expected to happen in 2019, could significantly affect accounting practice (Nurunnabi, 2019), and the rapid developments related to Brexit in 2019 also caused high uncertainty in the markets. Hence, to alleviate the impact of Brexit on the results, our sample ends in 2018.