Interplay Between Accounting Conservatism, Auditing Conservatism and Quality of Earnings in Oman

International Journal of Economics, Management and Accounting 29, no.
1 (2021): 167-205
© 2021 by The International Islamic University Malaysia
INTERPLAY BETWEEN ACCOUNTING

CONSERVATISM, AUDITING CONSERVATISM AND
QUALITY OF EARNINGS IN OMAN
Mawih Kareem Al Ania and H Gin Chongb

a
Department of Accounting, Dhofar University, PO Box: 2509,
Salalah, Oman. (Email: mawih@du.edu.om)
b
Department of Accounting, Finance and MIS, Prairie View A&M
University, Texas, USA. (Email: hgchong@pvamu.edu)
ABSTRACT
This paper examines the impact of accounting conservatism and

auditing conservatism on earnings quality. Four proxies were used to
measure earnings quality; persistence, accrual quality, value
relevance and earnings smoothness. We use the published annual
reports of all the listed firms in the Muscat Securities Market (MSM)
for the 6-year period from 2012-2017 to assess the interplay between
accounting conservatism, auditing conservatism and earnings quality.
The result reveals a positive and significant effect of auditing
conservatism on earnings quality but no significant effect of
accounting conservatism on earnings quality in terms earnings
smoothness. This implies users tend to rely on auditors’ reports when
assessing earnings quality. Our results are robust to the inclusion of
four control variables; size of the firm, risk, audit firm size and
industry type, the use of an additional analysis of one special case of
auditing conservatism and earnings quality, and tests of potential
relationship between auditing conservatism. The findings have
implications to regulators when formulating standards and
guidelines, auditors in the course of an audit, investors in reviewing
the financial statements, and preparers when preparing their financial
reports. The study recommends that Omani stockholders as well as
international stockholders rely heavily on auditing conservatism
which means that stockholders are prepared to receive modified audit
reports.
JEL Classification: M21, M41, M42, G31

168 International Journal of Economics, Management and Accounting 29, no. 1 (2021)
Key words: Accounting conservatism, Auditing conservatism, Quality of

earnings, Oman, Emerging economy
1. INTRODUCTION
This paper assesses the interplay between accounting conservatism

(AC) and auditing conservatism (AuC) on earnings quality (EQ).
Basu (1997) defines AC as a higher degree of verification for
recognizing good news for earnings and assets, while Vishnani and
Misra (2016, 1002) expand the definition by adding the “recognition
of expenses and liabilities prudently, even if there is uncertainty
about the outcome, incomes and assets are recognized only when
there is full surety of receiving them”. In short, AC is an accounting
process whereby preparers of financial statements have considered
and included all the possible uncertainties and risks when estimating
and reporting them in the financial statements. AuC is the extent of
conservatism that auditors apply to their audit approaches in
compliance with regulations and guidelines when assessing
reliability and relevance of information and estimations, and when
reporting material accounting departure and limitations on the scope
of completing an audit. Earnings quality (EQ) is the extent of
reliability of a firm’s reported earnings. Reliability of EQ depends
on the extent of disclosing material information in the financial
statements, compliance with regulatory requirements and meeting
user needs. Put together, accounting conservatism depends on the
extent preparers measure and report the financial items, while
auditing conservatism depends on the extent auditors exercise
reservations and skepticism during audits. These two conservatisms,
in totality or individually, could impact on the fair presentations of
earnings quality in financial statements.
Because of information asymmetry between preparers
responsible for measuring and reporting the financial details and
stockholders who are recipients of financial reports, auditors serve
as agents to ensure preparers exercise conservatism in their
estimations and transparency in disclosing financial details. This
means that accounting conservatism and audit conservatism
contribute to earnings quality. In practice, however, there is possible
disparity between the interplay among the three variables. Preparers
tend to project a better financial performance in a particular quarter
for keeping the earnings trend by adopting different accounting
choices in their estimations. The intention is to smooth the income
figures. Though not ethically appropriate, the intention is to
Interplay between Accounting Conservatism, Auditing Conservatism and Quality… 169
maintain the firm’s profile on income predictions, profitability,

returns and growth to avoid unnecessary divestments and market
reactions (Chong, 2006). The process will involve either preparers
compromising their conservatism in exercising their measuring and
reporting obligations, or auditors in relaxing their audit
conservatism, or both parties working in tandem to compromise
their responsibilities for the firms’ long term growth and survival.
Prior findings tend to use either AC or AuC as a single
variable to assess the effects on EQ, but the results remain mixed.
Further, there is no known study evaluating the coexistence of AC
and AuC on the impact of a firm’s EQ. We fill this gap by using
both AC and AuC to assess EQ and the interplay between AC and
AuC on EQ of the published financial reports of all the firms listed
in the Muscat Securities Market (MSM) for the 6-year period from
2012-2017. Before 2012, more than 90% of audit reports of Omani
companies were unmodified as the auditors stated that the company
financial statements are presented fairly in all material aspects
according to the international financial reporting standards and other
adopted rules and regulations. This means that neither AC nor AuC
are presented in the financial reports of Omani listed companies.
After that, some amendments in the Code of Corporate governance
were introduced by the Capital Market authority (CMA). These
amendments gave the CMA more power to control audit firms; then
CMA started to examine output of these audit firms and estimate the
litigation potential for them. One of the most important changes of
this new situation is that the AuC is introduced in the audit reports
and most of these reports have changed into modified audit reports.
The result of this study reveals AC does not have any significant
effect on EQ, but AuC has a significant impact on EQ. This implies
Omani stockholders tend to rely on auditors’ conservatism more than
accounting conservatism, reflecting the extent of agency
relationships between auditors who serve as agents and investors
who are principals of the audit contracts, and the returns on quasi
rents that the principals have paid for the audit services. Though the
results of this study solely come from the Omani perspective, the
findings have significant implications to regulators, preparers,
auditors and the stockholder investors both within the country, and
outside the region and around the world. We organize the study as
follows. Section two reviews the Omani perspective while section
three reviews relevant literature and develops the hypotheses
concerning the association between accounting conservatism,
auditing conservatism and earnings quality. Section four presents the

research method, sample selection and variables definitions. Section
five discusses the empirical analysis and results. Section six
concludes the paper, besides discussing the limitations and
suggesting avenues for future research.
2. THE OMANI PERSPECTIVE
Though auditing plays a crucial role in financial statement

credibility, the government agencies that publish accounting
standards and auditing guidelines have yet to exercise their judicial
duties in monitoring performance of those not meeting the stipulated
requirements. In Oman, the Ministry of Commerce and Industry
(MoCI) is responsible for publishing the accounting standards and
the Capital Market Authority (CMA) is issuing the auditing
guidelines. Preparers are expected to measure and report the firm’s
assets and liabilities, while auditors are required to ensure the
financial statements present a fair picture on the valuation and
disclosure of material items to the stockholders; accounting
conservatism does not seem to exist, but audit conservatism does.
The lopsided emphasis could be attributed to a lack of
communication between MoCI and CMA, or could be due to a lack
of heavy fines and penalties on defaulters. The Ministry itself may
not have the skilled manpower for prosecuting those who failed to
exercise the duties of care on accounting conservatism. Except for
listed firms, the non-listed are not expected to comply with the
International Standards of Accounting in measuring and reporting
items in financial statements. So far, there are no known litigations
on preparers who failed in the compliance process in Oman. Though
in 2016, the Ministry has approved the formation of the Association
of Chartered Accountants of Oman, an independent organization, to
formulate and oversee the quality of assurance services, the OACPA
merely serves as a professional body to organize exams for students
to provide continuing professional education for its members. Apart
from the Ministry and the professional body, auditors in Oman use
the International Auditing Standards, the Commercial Company Law
(Article 209, No. 18, 2019) and its amendments, the Accounting and
Auditing law (Royal Decree No 77, 1986) and its amendments, and
the Capital Market Authority (CMA) Code of Corporate Governance
Regulation (2002) and its amendments for conducting audit
assessments. These laws and amendments expect auditors to be
independent, maintain high audit quality, be accountable and ethical
in their work, continue with their professional training and education

and assess effectiveness of audit committees and internal control
systems of the auditees. Nothing has been mentioned about how
auditing conservatism should apply in practice or when reporting. As
far as the auditing market is concerned, Article 209 of Omani
Commercial Company Law number 18, 2019 requires all joint-stock
and limited liability firms to be subject to external audits by a local
or a foreign qualified and recognized auditor.
As at 2017, CMA and the Ministry have recognized 19 audit
firms. These firms are categorized in 3 separate groups, namely Big
4 audit firms, non-big 4 audit firms and local audit firms. A non-Big
4 firm is a local practice that links to an international audit firm and
has offices in various cities in Oman, while a local audit firm is a
local practice not affiliated with any international audit firm. A
typical local firm is mainly operated by a sole practitioner or a few
local partners. By the end of 2017, 73% of the listed firms’ financial
statements were audited by the Big 4 while the remaining by the non-
Big 4 audit firms (MSM Guide report, 2018); none was audited by a
local audit firm. The market is dominated by the Big 4.
The Capital Market Authority has mandated that all listed
firms must appoint external auditors, and audit firms themselves
need to rotate the engagement partners every four years. Apart from
providing assurance services, CMA allows audit firms to extend their
non-audit services including assessing adequacy of internal control
systems, taxation advisory, and investigations arising from an audit
finding. All findings relating to audits and non-audit services should
be reported directly to the audit committee for reviews and approvals
before inclusion in the audit reports. Without the committees’
consent, auditors are disallowed from including these weaknesses in
their reports. To a certain extent, audit conservatism is being
constrained by the clients’ audit committees rather than auditors
exercising their duties in reporting directly to the principals (Hegazy,
Chong, and Hegazy, 2014). To a certain extent, the Omani auditors
have lost their rights for servicing directly to the stockholders.
External auditors are supposedly reporting to the stockholders who
are the principals not the audit committees who are serving as an
agent for the stockholders. The agency theory on the relationship
between the external auditors and stockholders seems to fade away
due to interceptions by the audit committees, who also serve as an
agent of the stockholders. The Ministry needs to fix this issue to
restore stockholder confidence in auditors’ work.
With regard to market saturation, similar to many other

emerging economies, most audits for listed firms are dominated
either by Big 4 firms or local firms associated with an international
firm. In Oman, the ratio of audit firms to the number of listed firms is
1:17 reflecting the extent of competition among audit firms to
provide quality reports within short durations (Baatwah, 2016). With
the market concentrations and a lack of accounting constraints on
reporting directly to the stockholders, auditing conservatism remains
an important issue.
Put together, earnings quality appears with high level of
accounting conservatism and audit conservatism. In Oman, the
weight of conservatism seems to rely on audit more than accounting
though external auditors have the opportunity to express their
concerns through audit committees. Auditors are only responsible for
expressing opinion on the fairness in measuring and reporting the
financial information; the bulk of measuring and reporting, and
design and implementation of internal control systems should rest on
the preparers. With these lop-sided interplay, we assess the extent of
accounting conservatism and audit conservatism toward earnings
quality in Oman, and the extent of audit willingness in compromising
their audit conservatism in exchanging for earnings quality and
accounting conservatism.
3. LITERATURE REVIEWS AND HYPOTHESES

DEVELOPMENT
3.1 EARNINGS QUALITY
Preparers are expected to exercise conservatism when estimating

liabilities and risks, and present a fair report to the stockholders.
Essentially earnings quality depends on the extent of reliability,
relevance, completeness and accuracy of the statements. Auditors are
expected to exercise conservatism in assessing the information
presented by the preparers before attesting them. It is important that
both preparers and auditors exert conservatism to ensure quality of
earnings (EQ). Stockholders need a reliable source of financial
information and earnings quality to make professional decisions in
maximizing their investment returns and evaluating firm
performance (Rajaram, Suganthi, and Chong, 2015). Dechow, Ge,
and Schrand (2010) find that EQ serves as a function of a firm’s
performance, while both Nwaobia, Kwarbai, and Ogundajo (2016)
and Jaballah, Yousefi, and Zarai (2014) conclude that there is a
positive and strong association between earnings quality and

investors’ decisions.
Though preparers use EQ to determine the choice of
accounting to measure and report earnings, different stockholders
may have different perspectives on EQs. Stockholders use EQ to
determine a firm’s investment decisions, financial analysts rely on
EQ to assess its going concerns, profitability, predictability and
growth, regulators ensure EQs were derived based on accounting
standards and audit guidelines, while economists use EQ to evaluate
the firm’s real value of profit or economic profit. Though the bottom
line remains the crucial factor in decision making, Dechow et al.
(2010) caution that relying solely on EQ is meaningless. Pagalung
and Sudibdyo (2012) suggest stockholders should assess EQ together
with other variables including the nature and extent of inherent and
control risk, and firm performance, age and size. Kamarudin and
Ismail (2014) and An (2017) conclude that EQ should be measured
based on both short term and long term sustainable returns. All these
depend on the extent of both preparers’ and auditors’ willingness in
exercising conservatism while discharging their duties of care.
Positive interplay exists between AC, AuC and EQ and the duration
of interplay between the three elements depends on internal factors
including the extent of preparers in applying conservatism in their
accounting policies, and external factors including to what extent
external auditors apply conservatism in their audit approaches. Both
accounting and auditing conservatism enhance quality of earnings.
Many proxies are used to measure earnings quality. Dechow
et al. (2010) list and discuss many of these proxies such as
persistence, accrual quality, timely loss recognition, smoothness,
earnings surprise and benchmarks. Dechow et al. (2010) assert that
using different EQ proxies is required to demonstrate different angles
of earnings quality. For example, they explained that researchers
should use various proxies of EQ because they do not work equally
in all circumstances. The decision models of the decision-makers are
also different, and thus using different proxies is critical to cover the
majority of these models. A decision-maker can use earnings
persistence as a proxy to evaluate earnings stability and value
relevance to evaluate the usefulness of accounting information and
reflect the variations in returns.
Considering availability of information in Oman, this study
uses only four approaches. The first is the persistence of earnings
which is receiving growing attention from researchers in developed
markets (Ebaid, 2011). Persistence means how much of existing

profits will persist into the future and proceed from period to period
(An, 2017). The slope β coefficient of earnings is used to measure
persistence as a higher β implies a more persistent earnings stream.
The logic behind this approach is that the existing earnings are
indicators for future performance of the firm and the investors are
very concerned with earnings sustainability where the value of β
close to 1 indicates highly persistent earnings or sustainability, while
value of β close to 0 represents highly transitory earnings
(Richardson, 2003).
The second approach is accrual quality. The difference
between accounting earnings and cash flows from operations
refers to accrual quality. This approach focuses on the relationship
between the earnings and cash flows from operating activities.
Dechow and Dichev (2002, 38) defined accrual quality as the
“extent to which accrual map into cash flow realizations where a
poor match signifies low accrual quality”. They argue that
earnings will be more representative of future cash flows when
accruals contain lower estimation error as higher accruals quality
is considered when accruals quickly convert into cash.
The third approach is smoothness of earnings. Smoothness is
the ratio of standard deviation of net income divided by total assets
to standard deviation of cash flow divided by total assets (Francis et
al., 2004). A lower value indicates more smoothing of the earnings
stream relative to cash flows and small value indicates good earnings
quality (Dechow et al., 2010).
The fourth approach is value relevance which indicates the
explanatory power of earnings and book value of equity for share
returns. Value relevance is measured by using R2 of earnings or book
value of share returns as large (small) R2 reflects more (less) value-
relevant earnings (An, 2017). Despite the previous studies giving
mixed results regarding value relevance of earnings, earnings per
share and book value are common measures of earnings quality.
Therefore, we will use R2 of earnings or book value, whichever is
higher, to reflect more value relevant earnings.
3.2 ACCOUNTING CONSERVATISM AND EARNINGS QUALITY
Basu (1997) defines accounting conservatism as an anticipation of no

profit, but recognizes all foreseeable losses. Vishnani and Misra
(2016, 1002) expand Basu’s (1997) definition by “recognizing
expenses and liabilities prudently, even if there is uncertainty about
the outcome; but incomes and assets are recognized only when there
is full surety of receiving them”. This means, preparers of financial
statements should be prudent in recognizing both revenues and
assets, and expenses and liabilities, by exercising caution and
certainty when measuring and recording items in financial
statements. They should record only those realized assets and
revenue, and recognize all foreseeable losses and liabilities.
Preparers should exercise accounting conservatism in all situations.
Hejranijamil et al. (2020) pointed out that AC has been demanded by
many stakeholders such as investors, auditors and authorities in order
to minimize agency costs by reducing information asymmetry and
promoting corporate governance. Not only should preparers exercise
AC but the financial analysts find that AC is an important factor in
making good earnings forecast; Jung et al. (2017) indicate that
incorporating AC into earnings forecasts of the analysts is an
important reflection of analyst expertise and professional success.
In view of EQ being subject to estimations and uncertainty,
Chi, Liu, and Wang (2009) find that conservatism is one of the most
prominent characteristics of financial accounting that preparers are
urged to be prudent in their accounting approach, in particular in
situations where judgments such as depreciation calculations,
accruals, and valuing slow-moving inventories are needed.
Accounting conservatism is not intended to manipulate the dollar
amount or timing of reporting, but serves as a guidance to ensure
preparers remain professional in situations or times of recognizing
uncertainty and risk. According to Cerqueira and Pereira (2020) AC
helps the firms to recover in periods of economic downturn and it is
used as a governance mechanism to reduce managers’ incentives to
manipulate financial statements.
Watts (2003), Kim et al. (2013) and Zhong and Li (2017)
explore the opportunistic behavior of managers on accounting
conservatism and EQs, and they find a strong relationship between
AC and EQ. They conclude that a positive relationship between AC
and EQ leads to a significant reduction in agency costs on potential
conflicts and misunderstandings between preparers and stockholders.
A reduction in potential conflicts would lead to an increased level of
trust. Preparers need to constantly exercise conservatism in preparing
financial statements by complying with the underlying accounting
policies and principles. Safdar and Yan (2016) and Chong (2006)
find a positive relationship between income smoothing as an
accounting conservatism practice and reported earnings. This
implies firms that use income smoothing have lower volatility in

reporting earnings. Daryaei et al. (2020) assert that AC has
impact on EQ as it enhances the value of firm cash flow. Shubita
(2015) concluded that income smoothing improves EQ among the
GCC countries. This shows income smoothing has a positive and
significant impact on EQ. In Oman, all listed firms are required to
prepare their financial statements in line with the IFRS guidelines on
measuring and reporting financial items. The International
Accounting Standards Board (IASB) argues that conservatism should
not be one of the financial reporting characteristics since using
conservatism against uncertainty will reduce the future orientation of
financial information and relevance of information for decision
making purposes. Andre, Filip, and Paugam, 2015; Zeghal and
Lahmar (2016) and Cerqueira and Pereira (2020) find that those
European firms that adopt the IFRS have reduced accounting
conservatism. Since 2016, the Capital Market Authority (CMA) in
Oman observed a reduction in litigation risks against preparers and
auditors due to preparers being expected to comply with IFRS
standards while auditors are expected to meet the International
Auditing Standards requirements. The Corporate Governance (CG)
Code has insisted that auditors assess the audit risks, thereby
reducing the number of modified audit reports. Both accounting
conservatism through CMA and auditing conservatism through the
CG Code have impacted on the financial reporting and auditing
environment in Oman. Transparency, accountability and the level of
trust in measuring and reporting items, and the audit processes have
contributed to quality of earnings. However, we could not ascertain
that accounting conservatism is the main determinant for earnings
quality in Oman.
As this study uses four proxies to measure EQ; earnings
persistence, accrual quality, value relevance and earnings
smoothness, the hypotheses of association between accounting
conservatism, auditing conservatism and each proxy is discussed as
follows:
3.2.1 ACCOUNTING CONSERVATISM AND EARNINGS

PERSISTENCE
The main issue with respect to conservatism and earnings persistence

is that the conservatism created asymmetric persistence in earnings.
Basu (1997) asserts that more conservatism results in asymmetric
persistence between good and bad news events as bad news events
are associated with less persistent earnings. In contrast, accounting

conservatism in reporting may also be associated with increased
earnings persistence. If the firms postpone the recognition for good
news events in the current period due to conservatism, the increased
earnings persistence will be more in the future periods. Mora and
Walker (2015) find that asymmetric persistence in earnings will
make earnings forecasting more difficult for analysts and investors.
In the GAAP environment, Chen et al. (2014) and Heflin, Hsu, and
Jin (2015) find that firms with more conservative accounting
generate less persistent earnings than firms with less conservative
accounting as accounting conservatism reduces GAAP earnings
persistence. In the IFRS environment, such as Oman, prior studies
(Zeghal and Lahmar, 2016; Andre et al. (2015); Preiato, Brown, and
Tarca, 2015) reported that using of accounting conservatism is
reduced because of IFRS indicating that accounting conservatism
become less attractive and important and therefore the effect of it on
earnings persistence is not expected. Also, Cerqueira and Pereira
(2020) and Astuti (2020) assert that because IFRS adopts fair value
accounting, accounting conservatism is reduced and omitted from the
conceptual framework of IASB as the firms did not use it in financial
reporting. Therefore, the hypothesis is:
H1: There is no association between accounting conservatism and

earnings persistence.
3.2.2 ACCOUNTING CONSERVATISM AND ACCRUAL QUALITY
Dimitropoulos (2008) finds no association between accounting

conservatism and accruals of earnings. Large positive accruals are a
case when earnings are higher than cash flows generated by the firm
indicating there is a difference between earnings and cash flow. The
large accruals are caused by managers’ decisions about magnitude
and timeliness of disclosure of revenues and costs in financial
statements. Accordingly, Dimitropoulos (2008) found that earnings
accruals were not influenced by conservatism because they were
generated according to the realization basis not cash flows basis.
Ahn and Kwon (2010) examined the earnings persistence-market
reaction association with respect to accruals and cash flows in Korea.
They found that the Korean stock market has a high level of earnings
persistence and this is more attributed to cash flows than accruals.
Also, Soderstrom and Sun (2007), Fuad and Wijanarto (2017), Santy,
Tawakkal, and Pontoh (2016) and Brad et al. (2014) found positive
impact of IFRS adoption on accounting quality. One of the important
reasons for this positive impact is that IFRS limits discretionary
behavior in earnings management because IFRS reduces the scope of
conservatism. Therefore, the hypothesis is:

accrual quality.
3.2.3 ACCOUNTING CONSERVATISM AND VALUE RELEVANCE
Prior studies examining the association between accounting

conservatism and value relevance have yielded mixed results.
Manganaris, Floropoulos, and Smaragdi (2011) found negative
association between accounting conservatism and value relevance
indicating that more accounting conservatism is associated with less
value relevance. Brown, He, and Teitel (2006) find that accounting
conservatism reduces managers’ opportunistic behavior, hence
increasing the value relevance. Kousenidis, Ladas, and Negakis
(2009) indicate that an association exists between accounting
conservatism and value relevance of earnings. Hejranijamil et al.
(2020) however find negative relationship between accounting
conservatism and value relevance as value relevance rises. This has
declined for those high-conservative firms. Balachandran and
Mohanram (2011) find no evidence that firms with increasing
accounting conservatism present greater declines in value relevance.
They attribute the result to increase the importance of relevance and
reliability as financial information characteristics which makes the
trade-off between them very difficult. Therefore, the hypothesis is:

value relevance of earnings.
3.2.4 ACCOUNTING CONSERVATISM AND SMOOTHNESS
The main issue with earnings smoothness is that the manager uses it
to reduce the earnings variability. Using the smoothness, earnings
will be more representative, more useful and uncertainty about
earnings will be eliminated (Francis et al., 2004). On the other hand,
accounting conservatism improves the quality of accounting
information by reducing manager optimistic behavior (Cerqueira and
Pereira, 2020; Rostami, Rezaei, and Khalatbari, 2019; Hsu,
Novoselov, and Wang, 2017; Pashaki and Kheradyar, 2015; Lara,

Osma, and Penalva, 2014). For example, Hsu et al. (2017) point out
that firms exercising accounting conservatism show better cash flow
performance. Also, Lara et al. (2014) found that accounting
conservatism allows investors to make good assessment for future
firm performance by reducing information asymmetries between
managers and investors. Cerqueira and Pereira (2020) conclude that
accounting conservatism is preferable because it is used to avoid
violation of debt covenants and minimizes the risk of opportunistic
payments in the form of compensation and dividends. Accordingly,
both accounting conservatism and smoothness have the same
incentives and direction as the firms use both to reduce optimism in
financial statements.
In IFRS environments, Capkun, Collins, and Jeanjean (2016)
and and Kronbauer, Marquezan, Barbosa, and Diehl (2011) point out
that prior research on the association between IFRS and earnings
smoothing provide mixed evidence on whether IFRS increases or
decreases the earnings smoothing. In GCC markets, as IFRS
environments, Alareeni (2018) asserts that smoothness is practiced in
GCC but for the managers’ benefit rather than stakeholders’ benefit.
On the other hand, Hamdan (2017) finds that increased accounting
conservatism in GCC has positive effect on reducing information
asymmetry and increasing financial reporting credibility. Shubita
(2015) examined the association between income smoothing as a
case of earnings smoothness and quality of earnings and concluded
that smoothness improves earnings quality in the GCC. Therefore,
the hypothesis is:

earnings smoothness.
3.3 AUDITING CONSERVATISM AND EARNINGS QUALITY
An audit serves as a mechanism in mitigating conflicts between

preparers being the agents of the firms, and stockholders being the
principals of the firms, by attesting their opinions on financial
statement credibility. Audit opinions should be objective, unbiased,
independent, clear, reliable and dependable. Auditors need to
exercise audit conservatism in the audit approaches and in expressing
their opinions. Suhardianto and Leung (2020) assert that the auditor
uses auditing conservatism (AuC) to maintain the audit risk at an
acceptable level. AuC is the extent to which the auditors comply with
the audit guidelines in the course of an audit to ensure financial
statements are fairly presented. Sun, Cahan, and Xu (2016) supported
this situation as they concluded that the auditors in China have
increased AuC to comply with sanctions imposed by the China
Securities Regulatory Commission. In the case of a high level of
managerial opportunistic behavior and information asymmetry
between preparers and stockholders, auditors need to be more
conservative in their audit approach and reporting. This means that
auditors should expand the sample size, extend the audit inquiries
and observations, and be ready to issue modified reports if the
situation is warranted. Users of audit reports have placed their trust
on auditors in providing assurance services and auditors are seen as
an independent third party.
In Oman, the auditors need to express whether a report is an
unqualified or clean audit report, or a modified audit report. An
unqualified report means the auditors have conducted various audit
approaches and are satisfied that the financial statements are fairly
presented. A modified audit report means the auditors have some
reservations on the quality of the financial statements due to non-
compliance with measuring or reporting items in the statements. On
top of that, auditors are expected to express whether it is a positive or
a negative modified report. If it is a positive modified report, the
auditor feels there is a material departure from GAAP or unable to
form an opinion that warrant an adverse or qualified opinion. For a
negative modified report, this means the degree of objectivity in
measuring and reporting the financial items is low. Apart from those
unqualified or clean audit reports, Omani auditors are expected to
disclose the rationales for expressing the modified reports and
implications of those non-compliance on the financial statements as a
whole. Failure to discharge these responsibilities might expose
auditors to litigation, liabilities and lost reputation. To avoid this,
auditors need to exercise a higher level of audit conservatism to even
out the lack of accounting conservatism to ensure quality of earnings.
Both Fafatas (2010), and Kausar and Lennox (2017) conclude that
auditors use AuC in compensating for a lack of accounting
conservatism, in particular, in the case where auditors issue a going
concern opinion if the book values of a firm’s assets are higher than
its expected liquidation values. Elfouzi and Zarai (2009) find that
auditors in Tunisia issue a modified audit for those firms that have
relatively poor AC and EQ. Auditors use modified audit reports as a
mechanism to alert stockholders on the earnings quality. Salehi,
Tarighi, and Sahebkar (2018) assert that auditors in Iran use AuC to
reflect the economic facts about financially distressed firms. In short,
AuC and EQ exist in a positive manner but we need to understand
the extent of this relationship as it appears in Oman. Again, as this
study uses four EQ proxies, the hypotheses were developed as below.
3.3.1 AUDITING CONSERVATISM AND EARNINGS PERSISTENCE
Vichitsarawong and Pornupatham (2015) find that the firms with

modified audit report have low earnings persistence. Issuing a
modified audit report reflects different degrees of problematic issues
in clients’ firms. For example, if the adverse audit report (as one of
the riskiest modified audit reports) was issued, the degree of earnings
persistence is high reflecting that the degree of clients’ problems is
high. Gallizo and Saladrigues (2016) pointed out that the probability
of receiving a modified audit report is high if the firm has frequent
losses. Occurrence of losses reflects low client ability to continue as
a going concern which means that the company might be under
liquidation in the foreseeable future. Here, the auditor uses a
modified audit report or auditing conservatism to protect the
investors and guide them to take a right decision about their
investment. Therefore, the hypothesis is:
H5: There is positive association between auditing conservatism

and earnings persistence.
3.3.2 AUDITING CONSERVATISM AND ACCRUAL QUALITY
Prior studies (Kausar and Lennox, 2017; Chen et al., 2014; Menon
and Williams, 2010) document significant negative market reactions
to the issuance of modified audit report especially going concern
report, indicating that such opinions convey bad news to investors.
Many reasons are behind issuance of this type of audit report such as
technical violation of a debt covenant, problem with obtaining
financing (Menon and Williams, 2010) and having large accruals
(Kausar and Lennox, 2017). If the firms have more accruals, the
auditors are more likely to issue a modified audit report which means
that the auditing conservatism is positively associated with greater
accruals. Francis and Krishnan (1999) pointed out that more
accounting accruals means more uncertainty and estimation error
because of potential estimation error and a greater chance that high‐
accrual firms have undetected asset realization and/or going concern

problems. These firms are under a case of risk exposure and the
auditors can compensate for this risk by issuing a modified audit
report. Therefore, the hypothesis is:

and accruals quality.
3.3.3 AUDITING CONSERVATISM AND VALUE RELEVANCE
Turning to the association between auditing conservatism and value

relevance, the literature reviews have discussed this association and
find that it is positive and significant; for example, Ittonen (2012)
pointed out that the modified audit report includes valuable
information about estimation and risk of future cash flow which is
very important investor information. Robu and Robu (2015) assert
that the modified audit report gives positive signal about the going
concern of the firm in the foreseeable future. In this regard, a
modified audit report enhances investor confidence considering that
auditors have reasonable evaluation of firms’ internal information.
The modified audit report is important because it provides new
information to the investors. Investors might change their decisions
upon receiving new information. Hapsoro and Suryanto (2017) give
some examples of changing investor decision when the firms receive
modified audit report indicating that this type of audit report has
good news for those investors. Therefore, the hypothesis is:

and value relevance of earnings.
3.3.4 AUDITING CONSERVATISM AND EARNINGS SMOOTHNESS
Goel and Thakor (2003) pointed out that earnings smoothing is one
case of earnings management which is used to make earnings look
less variable over time. Basically, there is a positive association
between earnings smoothing and earnings management. Mendes,
Rodrigues, and Esteban (2012) assert that the management uses
income smoothing practices to increase income in some bad years
and decrease it in good years, in order to minimize the long-term
fluctuations. Reguera-Alvarado, de Fuentes, and Laffarga (2018) find
that external auditing is an important mechanism to minimize
earnings management by improving the quality of accounting
information. More specifically, they find that auditors use

conservatism (auditor conservatism) to minimize the earnings
management. Lopes (2018) finds that with high quality audit, the
earnings management reduces because the earnings management is
one type of manipulation of results and therefore the auditor should
report this case in the audit report. Kanagaretnam, Yeow, and Lobo
(2010) find that the auditor constrains earnings management when
the firm is using income increasing earnings management practices
as this will affect the reputation of the auditor and the auditor has an
important role in mitigating the risk resulting from earnings
management practices. Therefore, the hypothesis is:

and earnings smoothness.
4. RESEARCH METHODOLOGY
4.1 SAMPLE AND DATA
The study examines the financial statements of all the 109 listed
firms on the Muscat Securities Market (MSM) in Oman for the 6-
year period from 2012 to 2017. Altogether we have 35 firms from
the financial sector, 40 from the industrial sector and 34 from the
services sector. The study eliminated 2 from the financial sector and
1 from the industrial sector because they were listed on the MSM
only from 2017. With this, we have 106 firms’ reports generating a
total of 636 firm-year observations. The study extracts the firms’
details from the MSM Companies’ Guides (2017 and 2018), and the
financial reports at Mendeley Data (2020).
The study uses three key variables. These are accounting
conservatism (AC), auditing conservatism (AuC), and earnings
quality (EQ). For AC, accruals are used to measure the extent of
conservatism because preparers could use accrual to smooth the
earnings. In line with both Givoly and Hayn (2000) and Givoly,
Hayn, and Natarajan (2007) we define accrual as income before
extraordinary items and discontinued operations plus depreciation
expenses minus operating cash flows (operational accruals). The
total of which is divided by total asset at beginning of the accounting
period. For AuC, we use modified audit reports to be in line with
prior studies including Basu, Hwang, and Jan (2005), Sen (2005),
and Kausar and Lennox (2017).
For EQ, we use earnings per share (Kamarudin and Ismail,

2014) as a measurement of earnings persistence. Though each of the
variables has its limitations including reliability and accuracy in
measuring and reporting assets and liabilities and incomes, we could
not access fair values of these items in the financial statements. With
this, we use size of the firms measured by an algorithm of the total
assets, type of audit firm that is Big 4 and non-Big 4, and risk which
is measured by debt to equity ratio to assess the interplay between
the three variables. Table 1 maps the variables, definitions and
measurements that we have included in the evaluation process.
TABLE 1
Definition and Measurement of Variables
Variable Code Measure Method of measurement

Independent variable
Accounting AC Total Accruals Income before
conservatism extraordinary item and
discontinued operations
plus depreciation
expenses minus operating
cash flows (operational
accruals) and divided by
total asset at beginning of
period. (Givoly et al.,
2007)
Auditing AuC Issuing modified audit Binary variable, 1 if

conservatism report modified audit report
otherwise 0 (Lennox and
Kausar, 2017)
Dependent Variable: Earnings Quality

Persistence PER β measures persistence Earningst+ 1= a +
βEarningst +et (Dechow
et al., 2010)
Accrual AQ Accrual items (Net income before
Quality extraordinary items- cash
flow from operation)/
Total Assets
(Richardson, 2003).
Value VR explanatory power of R- square of Earning or
Relevance regression (R2) book value of shares
whichever high (An,
2017)
TABLE 1 (continued)
Variable Code Measure Method of measurement

Smoothness SM Standard Deviation (SD)of SD(Net income before
earnings and cash flow extraordinary items)/Total
Assets)/SD(Cash flow
from operation/Total
Assets) (Dechow et al.,
2010)
Control variables
Size S Total assets algorithm of Total assets
Risk R debt to equity ratio Debts/ equity
Audit firm BIG4 Binary variable 1 if big 4 otherwise 0
size
Industry ACTV Binary variable 1 if non-financial firm
Type otherwise 0
4.2 MODEL SPECIFICATION
With this, we construct the following models for assessing the

interplay between accounting conservatism (AC), auditing
conservatism (AuC) and quality of earnings (EQ).
(1) EQ(PER)it = αit + β1ACit + β2AuCit + β3Sit + β4Rit +

β5BIG4it + β6ACTVit + ϵit
(2) EQ(AQ)it = αit + β1ACit + β2AuCit + β3Sit + β4Rit +
(3) EQ(VR)it = αit + β1ACit + β2AuCit + β3Sit + β4Rit +
(4) EQ(SM)it = αit + β1ACit + β2AuCit + β3Sit + β4Rit +
We have also taken the following into considerations to

account for any unaccountable variables and constraints.
αit = Constant
β = Beta Coefficient
εit = Error term
ith = Firm
tth = Period
The study uses a multiple regression econometric model to

assess the interplay between AC and AuC on EQ on all the 636 firm-
year observations. The multiple regression econometric model helps

identify changes or variations in the values of any variables, whether
it is a dependent variable (earnings quality) or independent variables
(accounting conservatism and auditing conservatism) due to control
variables (size, risk, size of auditor and industry type). The
dependent variable is a linear function of the independent variables,
and these will reveal the extent of interplay between the three
variables.
5. EMPIRICAL RESULTS
5.1 DESCRIPTIVE STATISTICS
Table 2 provides a summary of the descriptive statistics of the firms

examined. With a mean of AC (0.018), this shows a low level of
accounting conservatism among the Omani firms. This means a
relatively small proportion of listed firms using AC though the mean
level of risk (R) is at 32%. The high R value indicates some firms, in
particular banks and financial institutions may face financial threats
but not at the going concern level. Big 4 audits the financial
statements of most of these firms. We look at the audit reports;
74.5% of the reports are modified due to auditees deemed not to be a
going concern. For the earnings quality, measured by persistence or
PER, accrual quality AQ, reflect a negative sign -0.09 and -0.82
respectively and value relevance VR (Book value of share),
smoothness SM reflect a positive sign of 0.11 and 0.51, respectively
meaning though the EQ level remains marginally positive (except for
PER and AQ) during the period of study, Omani listed firms could
sustain their earnings trend and survive in the short term.
It would be interesting to assess the survival and growth rate
among firms. Persistence, measured as the slope-coefficient (β1) is
equal to -0.09. This result is highly close to zero which implies that
earnings of Omani firms are much less persistent and extremely
transitory. As a result, earnings quality as decision usefulness is
relatively poor; and thus does not provide valuable financial
information to stakeholders. The absolute value of accrual quality
(AQ) is 0.82 which is relatively high and indicates lower earnings
quality of Omani firms. The R2 of value relevance in terms of book
value is low (10.8%) indicating less earnings quality as the value-
relevance of Omani firms is not high, thus earnings quality as
decision usefulness is low. In terms of smoothness, the mean (0.51)
is relatively high which indicates low earnings quality of Omani
firms. Mean assets are about OMR 5.321 billion. Since the
distribution is highly skewed, we take the natural log of real assets,
which brings the mean to 4.80. With the firm size of 4.80, this shows
firms have adequate assets to sustain their growth and survival, at
least in the short term though the bulk of the firms come from non-
financial sectors with the industry type of 0.70. This supports the
notion that the Omani government and private sector need to
diversify the economy not to rely heavily on energy, transportation
and services sectors but on the financial sectors including banking
and insurance. Despite the perfect value of skewness being zero, in
the real world this value is greater or less than zero. According to the
results in Table 2, the value of skewness of all variables is either
positive or negative but not zero which mean that the values are
skewed. Also, Table 2 shows that the values of kurtosis of the
variables are positive or negative and it is near to the normal
distribution except for EQ and AC. Ivanovski, Stojanovski, and
Narasanov (2015) pointed out that in the real world of investment
and business, investors prefer the positive skewed value of earnings
to the negative ones because they believe that the actual earnings are
greater than the expected. On the other hand, the investors prefer the
lower values of kurtosis which are not far away from the mean. In
conclusion, the value of skewness and kurtosis of EQ are reliable for
further analysis.
TABLE 2
Descriptive Statistics
Std.
Minimum Maximum Mean Skewness Kurtosis
Variables Deviation
Statistic Statistic Statistic Statistic Statistic Std. Error Statistic Std. Error
AuC 0.00 1.00 0.75 0.44 -1.14 0.23 -0.71 0.46
AC -0.005 0.19 0.018 0.04 3.30 0.23 11.84 0.46
S 2.24 7.08 4.80 0.85 0.25 0.23 0.44 0.46
R 0.016 1.70 0.32 0.29 1.51 0.23 3.36 0.46
Big4 0.00 1.00 0.75 0.43 -1.20 0.23 -0.57 0.46
ACTV 0.00 1.00 0.70 0.46 -0.88 0.23 -1.26 0.46
PER(β) -7.44 1.68 -0.09 0.79 -7.64 0.23 17.8 0.46
AQ -11.64 7.70 -0.82 3.06 -1.20 0.23 2.88 0.46
VR-BV(R2 ) -0.29 4.71 0.11 0.47 8.94 0.23 18.80 0.46
SM 0.28 1.47 0.51 0.24 1.89 0.23 2.97 0.46
Observations 636 636 636 636 636 636 636 636
5.2 CORRELATION AND MULTICOLLINEARITY
This study uses the Pearson’s correlation matrix to assess the degree
of associations among the independent variables (AC and AuC) and
the control variables. A low or moderate association suggests a lack
of multicollinearity between the independent variables and the
control variables. Table 3 shows that the relationship between the
AuC and SM is positive and statistically significant at the 5% as the
coefficient is 0.201, but there is no effect of AC on EQ. With this, we
support the first hypothesis that in Oman, AuC has a positive and
significant impact on EQ in terms of smoothness but AC doesn’t
have effect on the EQ. This suggests the need of government
agencies and professional bodies to emphasize that preparers
exercise conservatism in the course of measuring and reporting
financial details, while auditors need to remain vigilant in
discharging their due diligence and duties of care. For the type of
audit firms, Big4 is negatively related to EQ (VR) at the 5%
significance level and with a coefficient = -0.231 with a p-value of
0.017. This shows Big 4 tends to focus more on audit conservatism
than those non-Big 4 and local firms. This could due to the Big 4
firms’ reputations and availability of resources in comparison to their
local counterparts. Type of industry (ACTV) has positive
relationship with AC at the 0.05 level of significance which means
that in non-financial sector, the management prefers to use
accounting conservatism firms. Also, ACTV has positive
relationship with EQ (PER) and (SM) at the 0.05 significance level
and with a coefficient = 0.208 and 0.193 respectively which means
that the current earnings in the non-financial firms will persist into
the future and continue from period to period. Finally, firm size has
negative relationship with EQ (SM) and (PER) with a coefficient of -
0.303 and-0.227 respectively. This result shows that the larger firms
tend to keep EQ in a high level to avoid any earnings volatility. For
the remaining independent, control and dependent variables, they are
insignificant at either 1% or 5% level of significance thus signifying
no relationship exists among the variables. Table 3 summarizes the
results of the correlations and multicollinearity between AC, AuC
and EQ in all four proxies.
TABLE 3
Correlation Matrix
Variables AuC AC S R Big4 ACTV PER AQ SM VR

AuC 1
AC -0.195* 1
S 0.034 -0.161 1
R 0.178 -0.173 0.304 ** 1
Big4 -0.132 0.181 0.155 0.110 1
ACTV * ** *
-0.007 0.201 -0.542 -0.221 -0.232* 1
PER -0.09 0.082 -0.227** -0.088 -0.080 0.208* 1
AQ -0.019 -0.155 0.046 -0.012 0.146 -0.158 -0.033 1
SM * ** *
0.201 0.021 -0.303 -0.062 0.071 0.193 0.046 0.13 1
VR -0.170 0.030 -0.062 -0.098 -0.231* 0.189* 0.028 0.02 -0.01 1
*. Correlation is significant at the 0.05 level (2-tailed).
**. Correlation is significant at the 0.01 level (2-tailed).
5.3 REGRESSION ANALYSIS RESULTS
5.3.1 MODEL 1: EQ -PERSISTENCE
Table 4 shows the results of the association between AC, AuC and
EQ in terms of persistence. Persistence is measured as the slope-
coefficient of earnings as used by Dechow et al. (2010).
Table 4 shows that the model is insignificant as the F- value
0.533 with significant 0.782 (p-value > 0.05) and the R-square is
only 3.1% indicating that only 3.1% of the dependent variable is
predictable by the independent variables. The results of table 4
indicate that neither AC nor AuC have any effect on EQ in terms of
persistence which means that the accounting conservatism and
auditing conservatism did not support the persistence of earnings
quality. Therefore, H1 is accepted as there is no effect of AC on EQ
which indicate that EQ will not sustain by using conservative
accounting practices. On the other hand, H5 is rejected as there is no
relationship between AuC and EQ in terms of persistence. The users
of financial statements cannot depend on AuC to make their
decisions about the sustainability of EQ and AuC will not improve
the expectations of those users toward EQ.
TABLE 4
Regression Results of Model 1 (EQ = Persistence)
Model B T Sig.
(Constant) 1.283 0.453 0.652
AuC -0.815 -1.012 0.314
AC -9.202 -0.955 0.342
S 0.032 0.065 0.948
R 0.345 0.276 0.783
1 Big4 -0.700 -0.833 0.407
ACTV -0.466 -0.516 0.607
R-Square 3.1%
Adjusted R2 -2.7%
F-value 0.533
Sig. 0.782
5.3.2 MODEL 2: EQ -ACCRUAL QUALITY
EQ in terms of accrual quality. The study measures accrual quality
using similar method used by Richardson (2003).
Table 5 shows that the model is insignificant as F- value is
1.269 with significance 0.279 (p-value > 0.05). The R-square is only
7.1% indicating only 7.1% of the dependent variable is predictable
by the independent variables. This result shows that AC and AuC are
not good indicators for EQ in terms of accrual quality. As shown in
table 5, H2 is accepted that there is no association between AC and
EQ which means that AC did not raise the EQ and it did not support
the conversion of accrual into cash to help the investors in their
decision making. H6 is rejected as AuC did not support the idea of
sending bad news to investors about earnings quality. Therefore, the
investor cannot depend on issuing a modified audit report to ensure
the earnings quality. The results indicate neither AC nor AuC
provides useful information in measuring the quality of accruals.
TABLE 5
Regression Results of Model 2 (EQ = Accrual Quality)
Model B T Sig.
(Constant) 0.505 0.204 0.839
AuC -0.136 -0.194 0.847
AC -14.810 -1.757 0.082
S -0.206 -0.482 0.631
R -0.732 -0.669 0.505
2 Big4 1.156 1.575 0.118
ACTV -0.864 -1.093 0.277
R-Square 7.1%
2
Adjusted R 1.5%
F-value 1.269
Sig. 0.278
5.3.3 MODEL 3: EQ - VALUE RELEVANCE
The study measures value relevance using similar method used by

Ali and Hwang (2000) and An (2017) as value-relevance is the
explanatory power of earnings and book value of equity for stock
returns. The study tested explanatory power of earnings and book
value through regression of R2 as it found that R2 of earnings is equal
to -.010 whereas the R2 of book value is equal to 22.4% which means
that the explanatory power of book value explains 22.4% of variation
of EQ. Therefore, the study will use book value of equity to test the
effect of AC and AuC on EQ (VR). Table 6 shows the results of the
association between AC, AuC and EQ in terms of value relevance.
Table 6 shows that the model is insignificant as F- value is
1.793 with level of significance 0.108 (p-value > 0.05) and the R-
square is only 9.8% indicating that only 9.8% of the dependent
variable is predictable by the independent variables. This result
shows that AC and AuC are not in a good position to evaluate the EQ
in terms of value relevance. The results of table 6 indicated that H3 is
accepted as there is no association between AC and EQ which means
that the conservative accounting practices did not improve the value
relevance in terms of book value of equity. On the other hand, H7 is
rejected as there is no association between AuC and EQ which
means that AuC did not give an indicator for the investors to predict
the value relevance of earnings.
TABLE 6
Regression Results of Model 3 (EQ = Value Relevance)
Model B T Sig.
(Constant) 0.376 0.993 0.323
AuC 0-.209 -1.947 0.054
AC 0.326 0.253 0.801
S 0.014 0.208 0.836
R -0.044 -0.265 0.792
3 Big4 0.097 1.762 0.081
ACTV 0.054 0.447 0.656
R-Square 9.8%
Adjusted R2 4.3%
F-value 1.793
Sig. 0.108
5.3.4 MODEL 4: EQ – SMOOTHNESS
EQ in terms of smoothness. The study proceeds to regress the results
and find that the model is significant at the 0.01 (p < 0.01) level of
significance.
The, F-statistic (3.240), R2 equals to 16.4% and adjusted R2
equals to 11.3% indicating that only 16.4% of the dependent variable
is predictable from the independent variables. This result indicates
that a measure of the observed outcomes is replicated by the model,
based on the proportion of total variation of outcomes. Even with the
adjusted R2 of 11.3% by taking into account the phenomenon of
explanatory variables including firms’ size, Big 4 versus non Big 4
and sectors, the results show no biasness in the estimations of the
population value. Table 7 shows that there is a positive and
significant effect of AuC on EQ while no significant AC effect was
found on EQ at the 0.01 level of significance. In sum, users rely
more on AuC when determining EQ. With this, it supports H8 but
not H4. This posits that the level of audit conservatism is greater than
accounting conservatism when users assess the EQ.
Table 7 shows that AC does not have effect on EQ which

means that H4 is accepted while AuC has effect on EQ in terms of
smoothness as the t-value 2.433 is significant at 0.05 which indicates
that H8 is accepted. This result indicates that when the auditor not
the management uses AuC but not AC to ensure that there are no
irregular variations in the earnings then the decision usefulness will
improve.
TABLE 7
Regression Results of Model 4 (EQ=Smoothness)
Model B T Sig.
(Constant) 0.725 3.906 0.000
AuC 0.128 2.433 0.017
AC -0.204 -0.323 0.748
S 0-.084 -2.625 0.010
R -0.018 -0.214 0.831
4 Big4 -0.273 -2.439 0.017
ACTV 0.040 0.683 0.496
R-Square 16.40%
2
Adjusted R 11.30%
F-value 3.240
Sig. 0.006
5.4 TESTING OF CONTROL VARIABLES
For the control variables, we use size of the company, risk, industry
type and size of audit firm (Big 4 vs. non-Big 4 audit firm). The
coefficient for Audit firm size is negative and statistically significant
at the 0.05 significance level, indicating EQ are negatively related to
audit firms’ size whether it is a Big 4 or a non-Big 4 audit firm.
Clients of Big 4 auditors have expected a lower level of EQ which
means users expect a higher earnings trend if the financial reports
were audited by a non-Big 4 audit firm. This could be due to 65% of
the Big 4 audit firm issued modified audit reports during the period
of study indicating that EQ of their clients is questionable. The result
is not in alignment with those findings by Slaheddine (2015) who
concluded a positive relationship existed between audits by a Big 4
audit firm and the firms’ EQ. This could also be due to Big 4 firms
tending to follow strictly on the AuC in line with their international
practice and reputations. Consistent with the findings of Gajevszky
(2014) and Gerayli, Yanesari, and Ma'atoofi (2011), firms audited
by Big 4 auditors find that Big 4 auditors tend to audit firms with a
higher EQ than those non- Big 4 auditors.
For the remaining three control variables (firm size,
industry type and risk), we find there is no relationship between
these three variables and EQ, though both Nelson and George
(2013), and Shehu (2012) detected a positive association between
risk and EQ. The positive relationship between risk and EQ could be
due to the signaling theory, whereby a high level of risk may
improve the level of EQ and eventually giving the firms
opportunities to attract more investments (Hassan and Farouk,
2014). In this study, risk does not have any significant relation to EQ
due to the moderate level of risk among the Omani financial sector
and the business environment. The local geopolitical scenario and
landscape reflect the market stability and investor confidence in the
level of reported EQ.
For the firm size, we use firm total assets for measurement.
Though prior literature yields mixed findings, we find no significant
relationship between a firm’s size and EQ in all its proxies except
for smoothness of earnings as there is a negative effect between size
and smoothness; t-value is -2.625 which is significant at the 0.05
level. This shows that the larger the firm, the lower the likelihood of
income smoothing. Large companies have little need for earnings
smoothing. This aligns with the Pradipta and Susanto (2019)
findings. This means users focus on EQ for all sizes of the firms for
their decision making process. For the firms’ industry, our finding is
consistent with Bamiatzi, Bozos, and Cavusgil (2016) who conclude
that firms’ industry has a weak effect on the individual firm’s EQ.
Finally, we find no significant relationship between industry type
and EQ. This is not in alignment with Pagalung and Sudibdyo
(2012) who find a negative relationship between these two variables
and Gu, Lee, and Rosett (2002) who conclude significant industry
differences as non-financial industries have a higher variability.
5.5 DISCUSSION OF THE RESULTS
Preparers of financial statements are expected to use accounting

conservatism (AC) and auditors are required to ensure fairness in the
financial statements to enhance earnings quality (EQ). However, in

cases where AC is absent, auditors step in by imposing a higher level
of auditing conservatism (AuC) to counter balance the fairness in the
estimations and reporting of EQ. Using all the financial reports of
listed firms in Oman for the 6-year period from 2012 to 2017, this
study finds a positive and significant effect of auditing conservatism
on earnings quality in terms of earnings smoothness but no
relationship between accounting conservatism and earnings quality.
This means the Omani auditors play a major role in ensuring the
fairness of the financial status, and in alerting stockholders on the
lack of accounting conservatism and minimize the earnings
management resulted from earnings smoothness. Omani auditors
issue modified audit reports to ensure both preparers and users are
aware of the importance of high earnings quality and earnings
smoothness. Our results are consistent with Kausar and Lennox
(2017) who find that those auditors who issued modified reports in
particular going concern audit reports, help to compensate for a lack
of accounting conservatism. Also, this result is in line with Lopes
(2018) and Reguera-Alvarado et al. (2018) who find that auditors
play an important role in minimizing earnings management resulted
from income smoothing. This could be because “auditors have
incentives to determine earnings more conservatively than managers
do, because of their greater legal liability exposure” (Basu et al.,
2005, 217).
With regard to the association between AuC and earnings
persistence, our findings deviate from both Vichitsarawong and
Pornupatham (2015) and Gallizo and Saladrigues (2016) who
conclude that a firm’s earnings are impacted negatively upon
receiving a modified audit report. Also, the result of association
between AuC and value relevance is not in line with Robu and Robu
(2015) and Ittonen (2012) who find that a modified audit report gives
good information to investors about firm survival and growth. With
regard to the association between AuC and accrual quality, the result
is not in line with Menon and Williams (2010) and Chen et al. (2014)
who find that for firms having a large amount of accrual, the auditors
tend to issue a modified audit report on their going concern problem.
The finding is not in line with Asri (2019) and Shubita (2015) who
find a positive association between accounting conservatism and
earnings quality. They stipulate that accounting conservatism will
help improve earnings quality because it serves as alert warnings and
signals to both the preparers and users. However, both Gajevszky

(2014), and Salehi et al. (2018) conclude that there is a negative
relationship between accounting conservatism and earnings quality
due to preparers being motivated by earnings management for their
own personal gains and returns. On the other hand, the result of AC
is in line with some prior studies with respect to earnings persistence
(e.g., Zeghal and Lahmar, 2016; Andre et al., 2015; Preiato et al.,
2015) who find that using of AC in the environment of IFRS is
reduced because it has effect of neutrality of financial statements and
therefore it is expected that AC does not have impact on earnings
persistence. With respect to association with value relevance, the
result conflicts with Hejranijamil et al. (2020) and Brown et al.
(2006) who find negative association between them. Also, the result
is consistent with Dimitropoulos (2008) who find that earnings
accruals are not influenced by conservatism because they are
generated according to the realization basis and not cash flow basis.
Turning to the association between AC and smoothness, the result of
this study is inconsistent with prior studies (e.g., Cerqueira and
Pereira, 2020; Rostami et al., 2019; Hsu et al., 2017; Pashaki and
Kheradyar, 2015; Lara et al., 2014) who find that AC improves the
quality of accounting information by reducing manager optimistic
behavior. Put together, both AC and AuC serve an important role in
ensuring EQ and earnings persistency. Both preparers and auditors
need to put their efforts in ensuring the financial statements reflect
fair presentation on the status as at the balance sheet dates. Failure to
assert the needed efforts could mean a heavier reliance on another
party to balance the quality of financial statements and earnings.
Finally, the results indicate that conservatism, whether it is
accounting or auditing, is important to improve the EQ. More
specifically, the Omani stockholders rely heavily on auditing
conservatism which means stockholders are prepared to receive
modified audit reports. Preparers should play their roles in ensuring a
proper and reliable design and implementations of internal control
systems. However, Omani regulatory bodies have adopted IFRS
where there is no emphasis on accounting conservatism in its
conceptual frameworks. This means stockholders may have to rely
more on auditing conservatism. For the auditors, due to the high
regulated business environment within and outside Oman, Omani
auditors tend to issue modified audit reports to save themselves from
litigation risk and to safeguard their reputations and branding.
6. CONCLUSION
This study examines the effects of auditing conservatism (AuC)

measured by modified audit report, accounting conservatism (AC)
measured by total accruals on earnings quality (EQ) measured by
four common proxies; persistence, accrual quality, value-relevance
and smoothness among all the 106 Omani listed firms for the period
from 2012-2017. We use firm size, risk and audit firms as control
variables to assess the interplay between AuC, AC and EQ. We find
a positive and significant effect of AuC on EQ (SM) but no
significant impact of AC on EQ. This means users tend to rely on
audit reports for EQ, and the audit reports for flagging any lack of
AC in the course of estimating and reporting the financial results.
The study provides additional evidence from analyzing all companies
in the sample where it pointed out that the presence of auditing
conservatism and absence of accounting conservatism is preferable
for the larger sized firms which are audited by big 4 audit firms.
Modified audit reports become the tool for alerting users on any
deficiency in EQ, and for reflecting on individual firm’s lack of
proper internal control systems and on poor earnings persistency
strategy.
The study uses Omani environment as our laboratory due
to its prowess in the economy, continuing efforts in its accounting
and auditing reporting systems, and its relative insulation from
geopolitical exposure. Also, this is the first study of this nature in
Oman. This could help international investors to understand and
appreciate the seriousness of the Sultanate in taking appropriate
steps to emphasize accounting conservatism and audit conservatism
that would eventually lead to earnings quality and confidence in the
reported results. The findings have implications to audit and
accounting regulators preparers, auditors and users for the need to
re-emphasize conservatism. Immediate and positive actions should
be taken from what we have learned from the literature and this
finding.
This study suffers from some limitations which are common in
research using publicly available data to make conclusions about
earnings quality. The study uses the client financial reports including
auditor reports to measure to the main variable of the study. Further,
this study focuses on one measure of auditor conservatism which is
issuing the modified audit report, one measure of accounting
conservatism which is total accrual and only four measures of
earnings quality. Other measures of auditor conservatism, accounting

conservatism and earnings quality may yield different results and
provide additional insights into earnings quality. Another limitation
is that little is known about the nature of audit failure cases which are
filed against the auditor; therefore we use dummy variable to
measure this variable.
Though this is the first known study of its type in Oman,
we suggest similar studies should be conducted in other emerging
economies. Future research could include focus group forum, semi
structured interviews with key players in estimating and reporting
of financial information including regulators, auditors, and financial
statement users (Chong, 2006). The process will help us to learn
from one another and to expand our vision and understanding on
key purposes of reporting EQ. All these inputs could project a
positive image of the accounting and auditing professions, and
provide better measuring and reporting service to the stakeholders.
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International Journal of Economics, Management and Accounting 29, no.

INTERPLAY BETWEEN ACCOUNTING

Mawih Kareem Al Ania and H Gin Chongb

This paper examines the impact of accounting conservatism and

JEL Classification: M21, M41, M42, G31

Key words: Accounting conservatism, Auditing conservatism, Quality of

This paper assesses the interplay between accounting conservatism

maintain the firm’s profile on income predictions, profitability,

auditing conservatism and earnings quality. Section four presents the

2. THE OMANI PERSPECTIVE

Though auditing plays a crucial role in financial statement

in their work, continue with their professional training and education

With regard to market saturation, similar to many other

3. LITERATURE REVIEWS AND HYPOTHESES

3.1 EARNINGS QUALITY

Preparers are expected to exercise conservatism when estimating

positive and strong association between earnings quality and

markets (Ebaid, 2011). Persistence means how much of existing

3.2 ACCOUNTING CONSERVATISM AND EARNINGS QUALITY

Basu (1997) defines accounting conservatism as an anticipation of no

implies firms that use income smoothing have lower volatility in

3.2.1 ACCOUNTING CONSERVATISM AND EARNINGS

The main issue with respect to conservatism and earnings persistence

are associated with less persistent earnings. In contrast, accounting

H1: There is no association between accounting conservatism and

3.2.2 ACCOUNTING CONSERVATISM AND ACCRUAL QUALITY

Dimitropoulos (2008) finds no association between accounting

H2: There is no association between accounting conservatism and

3.2.3 ACCOUNTING CONSERVATISM AND VALUE RELEVANCE

Prior studies examining the association between accounting

H3: There is no association between accounting conservatism and

3.2.4 ACCOUNTING CONSERVATISM AND SMOOTHNESS

Novoselov, and Wang, 2017; Pashaki and Kheradyar, 2015; Lara,

H4: There is no association between accounting conservatism and

3.3 AUDITING CONSERVATISM AND EARNINGS QUALITY

An audit serves as a mechanism in mitigating conflicts between

3.3.1 AUDITING CONSERVATISM AND EARNINGS PERSISTENCE

Vichitsarawong and Pornupatham (2015) find that the firms with

H5: There is positive association between auditing conservatism

3.3.2 AUDITING CONSERVATISM AND ACCRUAL QUALITY

accrual firms have undetected asset realization and/or going concern

H6: There is positive association between auditing conservatism

3.3.3 AUDITING CONSERVATISM AND VALUE RELEVANCE

Turning to the association between auditing conservatism and value

H7: There is positive association between auditing conservatism

3.3.4 AUDITING CONSERVATISM AND EARNINGS SMOOTHNESS

information. More specifically, they find that auditors use

H8: There is positive association between auditing conservatism

4.1 SAMPLE AND DATA

For EQ, we use earnings per share (Kamarudin and Ismail,

Variable Code Measure Method of measurement

Auditing AuC Issuing modified audit Binary variable, 1 if

Dependent Variable: Earnings Quality

Variable Code Measure Method of measurement

4.2 MODEL SPECIFICATION

With this, we construct the following models for assessing the

(1) EQ(PER)it = αit + β1ACit + β2AuCit + β3Sit + β4Rit +

We have also taken the following into considerations to