When Inconvenient Observation Meets Comfortable Myth - A Fresh Look at Audit Quality

Abstract

By convention, the quality of an audit is understood to relate to the joint probability that its conduct results in the detection and reporting of material financial statement errors. Early research into this phenomenon suggested a positive relationship between audit firm size and audit quality. This has resulted in a plethora of studies in which a fundamental element of the research design has been to segment data samples into portions relating to and small audit firms and to test for evidence of audit quality differences apparently associated with the size of the firm conducting the audit. Many such studies have concluded that larger audit firms do indeed provide higher quality audit services. Typically however, the quality of audit services provided by firms (of which there are very few) has been assumed to be or treated as homogenous. While the collapse of Arthur Andersen lead to some work which questioned this approach, on the whole, the large firm homogenous quality assumption stands. This paper examines the quality of disclosures pertaining to the high risk issue of goodwill impairment testing made by a sample of large Australian listed corporations in the first year after their transition to A-IFRS. All firms in the sample were clients of Big 4 auditors. However, disclosure quality and compliance levels varied substantially, with audit firm identity appearing to explain a substantial proportion of observed cross sectional variation.