Auditing Related Party Transactions: Evidence from Audit Opinions and Restatements

58 Pages Posted: 17 Apr 2017 Last revised: 3 Mar 2021

See all articles by Junxiong Fang

Junxiong Fang

Fudan University - School of Management

Gerald J. Lobo

University of Houston - C.T. Bauer College of Business

Yinqi Zhang

American University

Yuping Zhao

University of Houston

Date Written: April 14, 2017

Abstract

Using data from the Chinese market where related party transactions (RPTs) are particularly prevalent, we examine how the independent auditor responds to the potentially heightened risk of RPTs and the efficacy of the auditor’s response. First, we find that the auditor is more likely to issue a modified audit opinion that specifically discusses RPTs (RPTMAO) to firms reporting higher related sales or related lending, but not to firms reporting higher RPTs of other categories (i.e., related purchases, related borrowing, and related assets/equity transactions), suggesting that the auditor alerts investors to the possibility of earnings management and/or expropriation risk from related sales or related lending through audit opinions. The positive relation between related sales and RPTMAO is driven by related sales with non-market-based or undisclosed pricing policy and related sales above the industry average. Second, RPTMAO has robust predictive power for future RPT-related restatements, and the predictive power is greater than that of modified opinions that do not specifically discuss RPTs, suggesting that the auditor is effective at communicating the risk associated with RPTs through opinion modifications, especially RPTMAOs.

Keywords: Related party transactions; audit risk; audit opinion; restatements

JEL Classification: M49

Suggested Citation

Fang, Junxiong and Lobo, Gerald J. and Zhang, Yinqi and Zhao, Yuping, Auditing Related Party Transactions: Evidence from Audit Opinions and Restatements (April 14, 2017). AUDITING: A Journal of Practice & Theory, Volume 37, Issue 2, pp. 73–106, 2018 , Available at SSRN: https://ssrn.com/abstract=2953134

Junxiong Fang

Fudan University - School of Management ( email )

No. 670, Guoshun Road
No.670 Guoshun Road
Shanghai, 200433
China

Gerald J. Lobo

University of Houston - C.T. Bauer College of Business ( email )

Houston, TX 77204-6021
United States
713-743-4838 (Phone)
713-743-4828 (Fax)

HOME PAGE: http://www.bauer.uh.edu/acct/acctprofile.asp?search=Gerald%20Lobo

Yinqi Zhang (Contact Author)

American University ( email )

4400 Massachusetts Ave NW
Washington, DC 20016
United States

Yuping Zhao

University of Houston ( email )

334 Melcher Hall
Houston, TX 77204
United States
713-743-2166 (Phone)
713-743-4828 (Fax)

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