Opcion, Año 35, Especial Nº 19 (2019):2899-2921

ISSN 1012-1587/ISSNe: 2477-9385

The Moderating Effect Of Audit Quality On Audit Commit-

tee And Financial Reporting Quality In Malaysia

Shahanif Hasan1, Citrawati Jatiningrum2*, Fauzi3, Mohamad Ali

Abdul-Hamid4

1)Faculty of Business and Accounting. University of Selangor, Malay-

sia
2,3) Department of Information Suystem. STMIK Pringsewu Lam-
pung, Indonesia
3)Department of Accounting, University of Sarjah, Uni Emirat Arab
*Correspondent Author: [email protected]

Abstract
This study investigates the exsistence of audit quality on the relationship between
audit committee and financial reporting quality (FRQ) in Malaysia companies.
Specifically, this study has examined several the mechanism of Corporate Govern-
ance in Malaysia to the earnings management as proxied of FRQ. The study used
93 of listed trading companies on bursa Malaysia and the data analyzed with mul-
tiple regression analytical technique. The results show that corporate governance
mechanism (audit committee independence, audit committee financial expertise,
audit committee size) not supported and insignificant result with FRQ. While, audit
committee meeting has a significant result on FRQ. However, this study also re-
veals that a decreased of FRQ would be a result of arisen discretionary accruals and
poor of audit quality companies. Despite the absence of influenced the audit quality
as moderating, but the finding show that Audit Quality increasing the relationship.
These finding expected to help regulators better understand EM in Malaysian com-
panies and this study may help them reconsider and review the accounting stand-
ards across different sectors and to develop more effective techniques for quality
financial reporting for Malaysian listed companies to enhance the credibility of
financial reports.

Keywords: Audit Committee, Audit Quality, Eranings Management, Quality of Fi-

nancial Reporting Quality,
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El Efecto Moderador De La Calidad De La Auditoría

En El Comité De Auditoría Y La Calidad De La Infor-
mación Financiera En Malasia
Resumen
Este estudio investiga la existencia de la calidad de la auditoría en la rel-
ación entre el comité de auditoría y la calidad de la información financiera
(FRQ) en las empresas de Malasia. Específicamente, este estudio ha ex-
aminado varios mecanismos de gobierno corporativo en Malasia para la
gestión de ganancias como representación de FRQ. El estudio utilizó 93
de las empresas comerciales que cotizan en bolsa en Malasia y los datos
analizados con la técnica analítica de regresión múltiple. Los resultados
muestran que el mecanismo de gobierno corporativo (independencia del
comité de auditoría, experiencia financiera del comité de auditoría, tamaño
del comité de auditoría) no es compatible y resulta insignificante con FRQ.
Mientras, la reunión del comité de auditoría tiene un resultado significati-
vo en FRQ. Sin embargo, este estudio también revela que una disminución
de la FRQ sería el resultado de las acumulaciones discrecionales surgidas
y de las compañías con mala calidad de auditoría. A pesar de la ausencia de
influencia en la calidad de la auditoría como moderadora, pero el hallazgo
muestra que la calidad de la auditoría aumenta la relación. Este hallazgo
esperaba ayudar a los reguladores a comprender mejor la EM en las em-
presas de Malasia y este estudio puede ayudarlos a reconsiderar y revisar
los estándares de contabilidad en diferentes sectores y desarrollar técnicas
más efectivas para la presentación de informes financieros de calidad para
las empresas que cotizan en Malasia para mejorar la credibilidad de los
informes financieros.

Palabras clave: Comité de Auditoría, Calidad de Auditoría, Gestión de

Eranings, Calidad de la Calidad de la Información Financiera,

I. INTRODUCTION
The financial report is the critical information which is a primary tool of-
fering insight into the workings of a company and is crucial for invest-
ment decisions. It should serve as a guide to those interested in investing
by detailing how a company performs and manages its resources. Behav-
ior management is thus essentially earnings management. [1] claims that
non-capital providers may also benefit from financial reporting. Definition
Performance Management of Community Counselors (Case Study: Balai
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of audit committee contains a detailed approach to deal with literature con-

cerning its effectiveness. The Malaysian Code of Corporate Governance
(MCCG) (2001) and the 2007 revised code emphasized that the AC should
ensure high-level internal monitoring and risk management systems. Also,
the MCCG (2012) and MCCG (2016) highlighted that the AC should en-
sure that the relevant standards of reporting observed when producing fi-
nancial reports. This stresses the importance of determining how the au-
dit committee because oversees the quality of financial reporting as well
as the auditor’s independence. On the other hand, Financial accounting
standards allow the choice of accounting policies when preparing financial
statements. The chosen policy may provide flexibility to the management
in manipulating the company’s financial statement figures, including the
company’s profit. It occurs when managers given the discretion to select
their approach to accounting for which they then alter financial reports to
mislead stakeholders for some personal gain is given discretion [2]. There-
fore, to manage a business effectively and smoothly, forming several com-
mittees may be helpful with a view to assisting the execution of the board’s
various responsibilities. This is aligned with the requirement of Malaysia
Code on Corporate Governance 2012 (MCCG 2012) which states that all
public listed companies should clarify the role of the board in providing
leadership skills as well as to enhance board effectiveness (refer to MCCG
2012, principle 1). Based on the regulation, the board may delegate cer-
tain responsibilities to the committees to operate within the defined terms
of references. Aside from the audit committee which has been mandated
since 1993, MCCG 2012 also recommends the formation of remuneration
and nomination committee where their roles are to assist the boards (refer
to MCCG 2012, principle 2).
Earnings management constitutes a very important aspect of financial re-
porting, which reflects its integrity and quality. It further minimizes asym-
metry in information as well as agency conflicts among management,
owners, and the majority and minority shareholders. The issue of earn-
ings management has become an essential concern of corporate govern-
ance as audit committees’ (AC) effectiveness primarily assessed by their
role in ensuring the quality of financial reporting. Although there is a rich
body of literature on audit committee and earnings management issues in
Malaysia, discussions on the relationship between audit quality have not
extensively explored but another country already discuss regarding this
issues [3][4][5]. According to [6] the main aim of the audit committee
is to achieve the legal responsibilities of the board of directors regarding
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the credibility and objectivity of the financial reports. According to the

previous research and numerous weaknesses in Malaysia’s corporate gov-
ernance practices. It included a fragile financial structure, over-leveraging,
and lack of transparency, disclosure, and accountability [3][4][7] and in
particular with [6]. One of the techniques to counter financial scandals is
to improve the reporting of earnings management through the improve-
ment in corporate governance quality. In this regard, corporate governance
(CG) has identified as playing a crucial part in ensuring the uptake of eth-
ical practices within an organization across all its operations. It also helps
imbibe the staff with moral accountability. From here, this paper gives
empirical evidence aims to investigate the audit quality in Malaysian listed
companies. More specifically this study shall examine how audit quality
moderates the relationship between Audit Committee (AC) and quality of
financial reporting (FRQ).
Based on the issue above and some of the inclusive result from previous
study, this study aims to investigate the impact of audit quality on the
relationship between the audit committee and financial reporting quali-
ty. Specifically, investigated the impact of audit quality as moderating on
the Audit Committee and Financial Reporting Quality (Earning Manage-
ment). This study contributes to the existing literature is threefold. First, as
noted above, we systematically examine the direct impact of AC and FRQ.
Second, this study advances

II. LITERATURE REVIEW

A. The Relationship between the Audit Committee and Quality of
Financial Reporting (Earnings Management)
a. Audit Committee Independence (ACIND)
[8] argue that audit committees must pursue a course of action independ-
ent from the management to function efficiently. [9] found that a signif-
icant factor in improving its role in inhibiting financial statement fraud.
Some studies found that committee independence correlated negatively
with audit committee independence and earnings management [10][11].
[12] and [13] found a positive association between earnings management
and audit committee independence. Others found that the independence of
audit committee was not significantly related to earnings management [5]
[12][14] [15]. Hence, it is hypothesized that:
H1a: Audit Committee Independence is negative with earnings manage-
ment among Malaysian listed companies.
Performance Management of Community Counselors (Case Study: Balai
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b. Audit Committee Financial Expertise (ACFEX)

Independent directors with financial backgrounds might be monitors with
good intentions. It is desirable for monitors to have sophistication in fi-
nancial matters to detect financially. Audit committees in previous study
stated the excellent characteristics of audit committees are associated with
good company performance [16]. [17] gives evidence that company’s per-
formance is driven by specific audit committee characteristics. Howev-
er, in some of previous research documented that [14] and [5] stated that
no negative relationship between audit committee financial expertise and
earnings management. Therefore, the following hypothesis formulated:
H1b: Audit Committee financial expertise is negatively associated with
earnings management among Malaysian listed companies.
c. Audit Committee Meetings (ACMEET)
Audit committees are intended to ensure constant communication among
the board, internal auditors, and external auditors so that there are fre-
quent committee meetings with the auditors. [18] and [19] argued that the
frequency of audit committee meetings is related to a decrease in discre-
tionary current accrual levels. They anticipate that active controls supple-
ment effective audit committees. Likewise, [20] reveal that the frequency
of committee meetings affected the effectiveness of the audit committee.
An increase in frequency is an indication that the committee is more ef-
ficient and committed to producing quality performance[21][22]. In line
with [23] indicated that more frequently of audit committee meeting are
better company informed and provide financial statement activities. How-
ever, [24] found that audit committee meeting no significant relationship
with the level of earnings management proxied by discretionary accruals.
The following hypothesis is examined:
H1c: Audit Committee Meeting is positively associated with earning man-
agement among Malaysian listed companies.
d. Audit Committee Size (ACSIZE)
[27] stated that companies with large audit committees attract additional
interest regarding the reputation of auditors. [28] argued that audit com-
mittees with more members are better positioned to discover and resolve
issues in financial reporting by possessing more skills due to its diverse
members and a by producing a broader umbrella to monitor operations.
Audit committees comprising one or two members are subject to greater
pressure from management. This has led some studies to conclude that
small audit committees are more prone to earnings management. [5] [11]
[29] found no significant relationship between the size of the audit com-
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mittee. [30] found the negative members in an auditing committee might

be pertinent to FRQ. However, [31] gives evidance that audit committee
size has a negative significant to the level of earnings management. This
led to formulating the hypothesis:
H1d: Audit Committee Size is negatively associated with earning manage-
ment among Malaysian listed companies.

e. Audit Quality as Moderating Variable

[32] argue that an audit firm acts as a good corporate governance mech-
anism to reduce agency costs and to provide oversight by mitigating the
opportunistic behavior of managers. The literature argues that larger and
more well-known international auditing firms act as sources of inspiration
for companies to disclose more financial instrument risk information to
maintain the audit firm’s reputation and to avoid unnecessary reputation
cost [33]. Other studies found that larger size did not considerably re-
duce EM. However, any statically significant relationship has a negative
directional sign. Several studies suggest that audit quality is influenced
by corporate governance to mitigate EM [34]. Therefore, more and bet-
ter disclosure information is an effective factor for economic decisions
(Soheilyfar et al., 2014). Therefore, auditing has impact on controlling
managerial discretion. Its value is expected to vary with the quality of the
audit firm. The higher quality of auditors will tend to reduce the practice of
managerial decretion [35]. [36] also found that audit quality has a relation-
ship between the manipulation of financial statement and the finding also
show that the accruals reduce when the auditor is large of audit company.
Asare, [37] presented the internal auditors’ critical position and incentive
to manage to misreport of financial statements. In different findings by
[38] documented that audit quality has no significant as moderating on
the relationship between Audit Committee and Discretionary in Malaysia
companies. However, internal auditors were critical to variances in the
quality of audit committee and would invested in their valuation of fraud
risk and audit scheme. This discussion led to formulating the hypothesis:
H2a: Audit quality significantly negatively moderates the relationship
between AC independence and FRQ.
H2b: Audit quality significantly negatively moderates the relationship be-
tween AC financial expertise and FRQ.
H2c: Audit quality significantly negatively moderates the relationship be-
tween AC meetings and FRQ.
H2d: Audit quality significantly negatively moderates the relationship be-
Performance Management of Community Counselors (Case Study: Balai
Pemasyarakatan Jakarta Timur-Utara) 2905

tween AC size and FRQ.

According to some of previous research, this research examines audit
quality as a moderating variable on the relationship between audit com-
mittee and FRQ (measured by earnings management) in Malaysia. The
conceptual framework developed as shown below:

III. RESEARCH METHOD

3.1 Data & Sample
Data were manually collected from the Bursa Malaysia issued guides of
the shareholding companies in Malaysia and the companies’ yearly re-
ports. Bursa Malaysia has a strong mandate to ensure a culture of corporate
governance. The Asian Corporate Governance Association in collabora-
tion with CLSA Asia-Pacific (ACGA CG Watch) acknowledged Malaysia
as having recorded consistent GC improvements with an increase of 52%
in 2013 to 55% in 2014, and from 38% in 2013 to 43% in 2014. Data col-
lected from the yearly financial reports that the listed companies in Bursa
Malaysia published from 2013 to 2015. After compiling data for all nec-
essary variables (dependent, independent, and moderating variables), 93
companies were found to have complete data for all the variables required.
The final sample observation comprises of 279. This study also collect-
ed data from the audited financial statements of the purposively sampled
firms. The financial statements of 2012 are used to calculate the delta or
difference (t1- t t-1) with the previous year for calculating the earnings
management variable.
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Following with previous studies, earnings management measured by dis-

cretionary accrual. Discretionary accruals in this study proxied by the
Modified Jones’ model [41]. This model uses total accruals (TAC) as
the total of type discretionary component, which is discretionary accru-
al (DTAC) and non-discretionary (NDTAC). The formula to detection of
earnings management as follows:

TAC = NDTAC + DTAC (1)

TACCit = EBXTit – OCFit (2)

TAC t /TA t-1 = a1 [1/TA t-1] + a2 [ ∆REVt /TA t-1] + a3 [PPE t / TA t-1]
+ φ (3)

NDTAC= α1 [1/TA t-1] + α2 [ (∆RE t - ∆REC t) /TA t-1] + α3 [PPE t / TA

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t-1 ](4)

DTAC=ACt/TAt-1 – NDTAC (5)

IV. FINDING AND RESULT

4.1 Descriptive Analysis
Descriptive statistics for the dependent, independent, moderating, and
control variables presented in the table. Based on descriptive statis-
tics, minimum amount -1.011 is DTAC, maximum amount is LOGFEE
(2386000.00) and the mean for ACFEX 2.21505 with a minimum of 1 and
maximum of 4 with the overall standard deviation is 0.867264.

a. Testing of The Relationship between AC and EM

The Classic assumption testing is necessary done before hypothesis test-
ing, and there is normality test, multicollinearity test, heteroscedasticity
test, autocorrelation test. The result for all the test stated that the regression
model is fit for the subsequent test. Furthermore, The Table 4 showed the
result of regression on the directly relationship between Audit Committee
(AC) and earnings management (EM), and shown in Table 6 to answer
hypothesis (H1a, H1b, H1c, H1d).
Performance Management of Community Counselors (Case Study: Balai
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Based on Table 4 presents the results for testing of F Significance. Based

on the table, it can be seen that the calculated value of F is 4.165. Mean-
while, the F table value at df 1= 6 and df 2 = 272 is 2.405 at a probability
level of 0.05. The result of F calculated (4.165) > F table (2.405) is high
and p-value significant .001 at the level 0.05. The testing of the coefficient
of determination (R2) is below:

The results of the unstandardized coefficient positive value are 0.113 and
Discretionary Accruals (EM) being worth 11.3% if audit committee inde-
pendence, audit committee size, audit committee financial expertise, and
the number of audit committee meetings is equal to zero. Based on the ta-
ble shows that the beta coefficient of ACIND, ACFEX, ACMEET are neg-
ative in its direction, which indicates that audit committee independence,
audit committee meetings, audit committee size have an adverse effect on
discretionary accruals. The beta value of ACFEX is positive, indicating
that the audit committee’s financial expertise has a positive effect on dis-
cretionary accruals.
Results of the hypothesis testing show the result of the audit committee in-
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2910 Opcion, Año 35, Especial Nº 19 (2019): 2899-2921

dependence for t-value is -0.230 and value of significance is 0.519 > 0.05.
The result documented that ACIND no significant related to EM practic-
es. This finding is corroborated by previous studies (Bedard et al., 2004;
Bradbury et al., 2006; Habbash, 2010; Klein, 2002; Soliman & Raga.,
2014) can be useful to constrain EM practices. ACFEX shows t value is
0.935 and value of significance is 0.351 > 0.05. This finding mean that
ACFEX is not significant and negatively related with EM, this result study
line with previous studies (Habbash, 2010; Lo et al., 2010, Hasan, 2017)
which document that the Audit Committee of financial expertise is effec-
tive in curbing EM activity. Meanwhile, Audit Committee meeting (AC-
MEET) shows t-value = -2.345 and value of significance is 0.020<0.05.
That means is positive and significant relationship. This finding might
support the proposition that audit committee meeting numbers extensive-
ly reduce EM. Furthermore, the test of Audit Committee Size (ACSIZE)
shows t-value = -0.189 and value of significance is 0.850 > 0.05. This find-
ing states that ACSIZE is not significant. This result is similar to Hasan
(2017) study. Other studies found that the audit committee’s larger size
does not considerably reduce EM. However, since any relationship with
statistical significance is absent, the coefficient has taken negative direc-
tional sign. The result is similar to a vast majority of studies (Alkadi et al.,
2012; Habbash et al., 2013) that did not discover a major impact on the
size of the audit committee on EM. This Finding found the proposition
that the audit committees’ larger size does not reduce EM considerably.

4.3 The Moderating of Audit Quality on the Relationship between AC and

EM
Increased audit quality shows an increase in the quality and transparency
of financial information issued by companies. This study uses interaction
as a moderating variable and uses Moderated Regression Analysis (MRA).
MRA is a special application of multiple linear regression where the re-
gression equation contains elements of interaction (multiplication of two
or more independent variables). Testing of the Coefficient of Determina-
tion (R2) is below:
Performance Management of Community Counselors (Case Study: Balai
Pemasyarakatan Jakarta Timur-Utara) 2911

This result shows an R-square of 0.208 or 20.8%. This result indicates that
the moderating audit quality mechanisms on the relationship between AC
with discretionary accrual is upward (13.4% to 20.8%) while moderated
with audit quality. This can be interpreted that audit quality strengthen au-
dit committee functions to reduce earnings management activities.
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2912 Opcion, Año 35, Especial Nº 19 (2019): 2899-2921

* Significant at 0.10 (one-tailed)

** Significant at 0.05 (one-tailed)
*** Significant 0.01 (one-tailed)
a. Dependent Variable: DTAC

According to the findings, ACIND shows t-value is -0.630 is less than t =

1.972 and value of significance is 0.319 > 0.05 or hypothesis is rejected. It
may be concluded that the audit committee independence has no effect on
earnings management The finding is consistent with previous studies done
by [6][37][38]. Since the t-value ACFEX of 1.135 is less than the t-value
in the table (1.972), and the significance value of 0.162 (>0.05). It may be
concluded that the audit committee’s financial expertise has no effect on
earnings management. The result shows a negative and significant rela-
tionship between the financial expertise of the audit committee and lower
discretionary accruals. This finding is in line with previous studies which
found that the financial expertise of audit committee is effective in curbing
EM activity [11][38] [47]. This finding might be affected through various
EM types or the small samples size. However, ACMEET shows t-value is
-3.345 is higher than t = 1.972 and value of significance is 0.020 < 0.05.
There is relationship which is statistically significant, the directional sign
is detected as negative. This finding might support the proposition that au-
dit committee numbers would extensively reduce EM. Furthermore, AC-
SIZE with t-value is -0.069, which is less than t = 1.972 at a significance
value of 0.437 (> 0.05). This finding states that a negative correlation and
no significantly between audit committee size and EM. This finding is
similar to [48][38]. Other studies found that audit committee size did not
considerably reduce EM. However, even if any relationship with statistical
significance is absent, the coefficient has taken a negative directional sign.
The finding is similar to the vast of majority of studies which could not
discover a major ACSIZE [11][14][38][49].

According to the audit quality is treated as a moderating, there is no sig-

nificant effect on the relationship between Audit Committee and Earnings
Mangament, this result consistent with [38]. This findings gives evidance
that financial reporting in Malaysia was prepared according to generally
accepted accounting standards. Therefore, improving the audit quality in
Malaysia is a dire need, and the findings also indicated that audit quality
could not mitigate the level of the discretionary accrual. In response to this
study, the low quality of audits shows behavior and motivation that lead to
Performance Management of Community Counselors (Case Study: Balai
Pemasyarakatan Jakarta Timur-Utara) 2913

accounting fraud and the level of discretionary accruals that will have con-
sequences not only for the company itself, but also for potential investors
[50]. However, the result indicates that increasing in relationship based
on the level of R-square. The result documented before moderate impact
to the relationship between the audit committee and quality of financial
reporting (EM: Discretionary Accruals) R-Square is 13.4% and after au-
dit quality moderate the relationship up to 20.8%. Meanwhile, the result
showed no support for the hypothesis, but the value for R-Square recorded
a moderate increase 7.4%. This finding helps regulators better understand
the earnings management (EM) of Malaysian companies. It contributes aid
in the reconsideration and review of accounting standards across the var-
ious sectors and corporate governance regulations which help improved
quality of financial reporting by Malaysian listed companies. This can lead
to a reduced reliance on earnings management (EM) and thus increase the
credibility of financial reports.

V. CONCLUSION
The primary purpose of this study has been to investigate the moderat-
ing effect of audit quality (audit fee) on the relationship between the au-
dit committee and quality of financial reporting (earnings management)
among listed firms in Malaysia. The study was conducted on a sample of
279 listed trading companies in Malaysia. Having tested several of hypoth-
esized, this research has helped create a more inclusive global picture of
the relationship between the AC and FRQ. The findings reveal that audit
committee independence, audit committee financial expertise, audit com-
mittee size is no significance, only audit committee meeting have a signif-
icant effect on FRQ. The mean findings concluded that the audit quality
have insignificant effect to the relationship between audit committee and
earnings management.
This study provides evidence for the view that the company audit commit-
tee size and audit committee expertise in Malaysia should be improved the
company performance. Therefore, these findings also contribute to regu-
lators to improve regulations relating to the role of audit committees in
Malaysian companies

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Revista de Ciencias Humanas y Sociales

Año 35, Especial N° 19, 2019

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