Is the Conditional Audit Policy Necessary in a Two-Period Audit Scenario?

Abstract

It seems common sense that previous audit experience has some impact on the current audit decision. In other words, the principal tends to enhance the probability of auditing agent if the latter has a ”bad” audit record, e.g. has previously concealed some truth. This paper intends to gain an insight into how previous audit experience influences the principal's audit decision in a two-period audit scenario. Under the basic assumptions and setting, the paper shows that it's not necessary for the principal to use a conditional audit in an optimal audit policy; i.e., the audit policy for the second period doesn't necessarily depend on the audit result in the first period. Although the result appears counterintuitive and even surprising, it's a reasonable choice of the principal under the assumption of self-interested and rational behavior. This paper will try to explicate the theoretical implications in the conclusion.