Modified Audit Reports in the Case of Joint Municipal Authorities: Empirical Evidence from Finland

• Published date: 01 July 2016
• DOI: http://doi.org/10.1111/ijau.12062
• Author: Mikko Paananen
• Date: 01 July 2016

Modified Audit Reports in the Case of Joint Municipal Authorities: Empirical

Evidence from Finland

Mikko Paananen

LappeenrantaUniversity of Technology

This paper exploresthe determinants of modified audit reportsamong joint municipal authorities (JMAs)in Finland.

Research in this area has traditionally focused on private-sector corporations, and surprisingly little is known about

the practicein municipalities, let aloneJMAs. Here is a clear research gap.This study takes the first stepsin identifying

the determinants ofsuch modifications in Finnish municipal administration. The focus of the analysis is on whether

some traditionaldeterminants found among corporations also applyto JMAs. A long audit report lag, auditfirm size,

and a large organizational size seem to increase the likelihood of a modified audit opinion,whereashighleverage,a

large organizational size, and the male gender of the principal auditor increase the likelihood of modified results of

the audit.

Key words: Auditing, jointmunicipal authority, municipal, auditor’s report,modification, determinant,going concern

1. INTRODUCTION

The aim in this paper is to identify the determinants of

modified audit reports

1

among joint municipal authorities

(JMAs).

2

There is a long research tradition in the private

sector (e.g., Dopuch, Holthausen & Leftwich, 1987; Bell &

Tabor, 1991; LaSalle, Anandarajan & Miller, 1996) that has

revealed several determinants including audit report

lag, size, leverage, profitability, audit fees, auditor

independence, auditor tenure, and the size of the audit

firm, among others (for recent summaries, see Carson

et al., 2013 and Habib, 2013).Meanwhile, the issue remains

neglected in the caseof municipalities and other municipal

organizations such as JMAs.

3

Most studies dealing with

municipal auditing thus far focus on fees, quality, delay,

and other issues but not on the determinants of modified

audit reports(e.g., Rubin, 1988; Deis & Giroux,1992; Ward,

Elder & Kattelus, 1994; Jensen & Payne, 2005; Mizrahi &

Ness-Weisman, 2007). This modest research interest in

municipal organizations is rather surprising given that

they tend to be major economic and socialoperators.

JMAs in particularhave a pivotal role in the production

of public services, fulfilling the statutory and voluntary

functions of municipalities. Among other things they are

responsible for specialized medical care, special care,

regional development, and regional land-use planning

across the country. They are economically significant

entities representing 25 percent of the total expenditure of

municipalities in Finland (Valtionvarainministeriö, 2015).

The lack of research on municipal organizations such as

JMAs constitutes a significant research gap for several

reasons. First, such organizations are publicly funded and

are accountable to taxpayers and voters. It is essential for

the public to understand the reasons why and the

mechanisms through which the auditors’reports of these

organizations are modified. Second, recent examples of

major municipal bankruptcies (e.g., Yubari in 2007 in

Japan; Jefferson County in 2011 in the US; Stockton in

2012, City of Detroit in 2013, and see Noble & Baum, 2013;

Stevens, 2013; Emsden, 2014) highlight the importance of

going-concern evaluations of auditors in municipal

organizations in accordance with international standards

of auditing (ISA 570

4

).

It should be noted, however, that municipalities cannot

go bankrupt in some countries, and may be protected by

state intervention mechanisms (e.g., Canada, Germany,

and Finland; see also Shafort, 2014). In other words,

public-sector distinctions should be taken into account

when evaluatingthe going concern of public-sector entities.

There may be times when conventional tests of liquidity

and solvencyappear unfavorable, but other factorssuggest

that the entity is nonetheless a going conc ern: the power to

levy rates or taxes, for example, may confer such a status

even though the entities concerned may operate for

extended periods with negative equity (IPSAS 1).

5,6

The

fact that municipalities cannot go bankrupt reflects

observations made in prior research that public-sector

organizations tend to be immortal in nature; there is

evidence that US government organizations rarely, if ever,

die, for example (Kaufman, 1976).

Third, public-sector organizations differ from private-

sector corporations in characteristics such as ownership,

goals, structure, processes, and values (Rainey, Backoff &

Levine, 1976; Rainey & Bozeman, 2000; Boyne, 2002). For

example, JMAs are owned by member municipalities

rather than private investors, they are not, in principle,

established to generate excess profits for their owners,

and their organizational structures include political bodies

that are actively involved in decision making. Given these

fundamental differences, there is a clear need for separate

research into the question of whether the determinants of

modifications are similar in corporations and municipal

organizations.

In sum, researchers should conduct separate inves-

tigations into the determinants of audit modifications in

municipal organizations. As a first step, this paper focuses

on Finnish JMAs, giving interesting insights into such

modifications in countries with similar, strong local

government systems (such as the Nordic countries). The

paper is organized as follows. Following this introductory

section setting out the purpose of the research, Section 2

discusses audit regulation with regard to modified reports

in Finnish municipal administration. Section 3 briefly

reviews the previous literature related to modified audit

Correspondence to: Mikko Paananen, Lappeenranta University of

Technology, School of Business, Skinnarilankatu 34, Lappeenranta 53850,

Finland. Email:mikko.paananen@lut.fi

International Journal of Auditing doi: 10.1111/ijau.12062

Int. J. Audit. 20:149–157 (2016)

©2016 John Wiley& Sons Ltd ISSN 1090-6738