An Analysis of Auditing Environment and Modified Audit Opinions in China: Underlying Reasons and Lessons

One of the most notable changes that economic reform in China has brought about is the revival of its accounting profession. The rapid development of independent auditing over the past two decades has been phenomenal, and from 1995 to 2000, about 15% of listed Chinese companies received modified audit opinions (MAOs) on their annual reports every year. The aim of this current study is to conduct a comprehensive analysis of the auditing environment to explain, through descriptive evidence, the motivating forces and underlying reasons behind the large number of MAOs in China. First, we review important events during this rapid development to facilitate a better understanding of the Chinese auditing environment. Second, we analyze the auditing environment and identify government regulations as the primary driving force behind the high percentage of MAOs. Finally, we conduct a further analysis of MAOs and demonstrate additional motivations and underlying reasons for the large number of MAOs that implicate both auditors and preparers in China. This study not only facilitates our understanding of accounting and auditing in China, but also offers lessons and implications for other countries with emerging accounting institutions and stock markets. While government may have an irreplaceable role to play in an emerging market where market forces are relatively weak, local environments and unique factors must be identified and analyzed to fully understand the implications of independent auditing. This study presents such an analysis in the case of China.