F. D.JUAN FORT

There is a compelling evidence to suggest that audit review practice in the UK is increasing.

For example, Hussey and Woolfe (1994) found only 1.8% of their sample having involved auditors. Revisiting their results, Hussey and Woolfe (1998) realised that the number of UK companies with an audit review in interim reports had grown substantially to 29%². Likewise, Bagshaw (1999) established that 73% of 30 FTSE 100 companies in their study had involved auditors in their interim reporting. These studies suggest that large UK companies include auditors in the process of preparing their interim results for publication.

2 It should be noted that Hussey and Woolfe (1994) sample included both small and large companies. However, the results of the analysis suggest that the practice was prevalent in large companies

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Although literature reviewed above suggested that interim reports are useful and there is evidence of increasing audit involvement, there are still studies (e.g. Atiase et al. 2005; Opong 1995) that argue for a case of unreliability in interim reporting due to the lack of mandatory audit edict. Particularly in the UK, Opong (1995) suggests that investor may be apprehensive in using interim information due to concerns of lack of third party authentication. The research (e.g. Atrill 1986; Hussey and Woolfe 1994; Manry et al. 2003) is focused on the argument for a review or full audit report on interim disclosures.

Ettredge et al (1994) criticise the relevance of the audit review from its procedural approach.

Their concern was that the review examines neither internal control structures nor corroborative evidence nor balances and transactions. Such a faint analytical approach therefore is less convincing about value-addition of the audit review. Givoly et al (1978) empirically examined the influence of auditor involvement on predictive capacity and income smoothing in interim reporting. A comparative approach between companies with and without an audit review showed no significant variation. This resulted in a conclusion that auditor involvement does not improve the predictive ability of interim reports. Findings by Alford and Edmonds (1981) also rejected the notion that audit involvement increases the quality of interim reports numbers. Even in a later study by Edmonds (1983) there was no difference with the findings from these studies that established lack of predictive ability in interim reporting audit involvement. Fabozzi and Fonfeder (1983) were motivated to examine the predictive ability of audit involvement by the aggressive stance the Security and Exchange Commission in the United States had taken to recommend audit involvement in quarterly reporting. Like the studies above, there was no evidence in the results supporting the conception that audit reviews improve predictive ability of quarterly reports. Further, they advocated that in light of the costs and delays attached to audit involvement, there is need for regulation to alter its position. Studies that are more recent have a similar reverberation that audit involvement has no impact on the predictive power of interim reports. For example, Ettredge et al (2000) suggest that the lack of attention to detail demeans the relevance of interim audit review since investors may not be able to identify significant differences between firms that include the review from those that do not.

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Since March 2000, SEC required that US quarterly reports should be audited prior to filing (timely review). Prior to that, firms could have their interim reports reviewed at the end of the financial year (retrospective review). Empirical literature (e.g. Manry et al. 2003; Ready and Rock 2003) shows that timely reviews have more information than retrospective audit reports.

Manry et al (2003) established that the timeliness of the audit review influences its reliability and relevancy, thereby degree of informativeness to returns. The study conjectured that when timely reviews are provided, they detect and correct errors that would have waited until the annual report, hence explaining their usefulness. In confirmation, results showed that timely review for each of the four quarters were informative to returns. On the contrary, retrospective reviews had less or no significance to returns, reflecting that they have no economic relevant information due to their reference to historic information. Alves and Teixeira dos Santos (2008) provide a distinctive scenario of examining information content of audit involvement. Their study is based on Portuguese quarterly reports for which the second quarter is subject to a limited audit involvement, the fourth quarter (annual report) requires a full audit involvement but the first and third quarter require no audit participation. The findings suggested that the annual report with a full audit had more information content than the unaudited first and third quarters. To the contrary, the second quarter reports with limited audit involvement were only relatively more informative than the unaudited reports for small firms. This finding arguably is evident to the conjecture that audit involvement in interim reports is not universally relevant to investors. Cornell and Landsman (1989) examination on share price reaction to quarterly earnings established that fourth quarter reports provided had more information content than other interim reports. The reasons were that fourth quarter disclosures provided more information to analysts and it corrected any mistakes in earlier announcements. The capability to correct mistakes was attributed to audit involvement in fourth quarter reports.

Irrespective of the mixed findings on the usefulness of audit involvement in interim reporting, a number of reasons have been fostered to justify the practice. Mendenhall and Nichols (1988) argued that unaudited interim reports present an opportunity for manipulation by management. Manry et al (2003) connote that retrospective audit reviews are economically

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detrimental thereby implying that audit reviews accompanying the respective interim reports are beneficial to users. Further, Ettredge et al (2000) asserted that the provision encourages increased frequency and proportion of fourth quarter adjustments. This debatably, makes earlier unaudited interim reports less relevant and a likelihood of more unfavourable fourth adjustment surprises. As a credibility check, interim audit reviews fulfil various functions:

useful to investment analysts as a third party authentication (e.g. Ettredge et al. 2000), improve the quality of interim report disclosures (e.g. Mcewen and Schwartz 1992), correct errors and detect fraud (e.g. Bagshaw 1999; Borgia 1991).