Auditor-client Relationship Research Articles

Challenges, Opportunities, and Strategies of Audit Engagement in the Time of Crisis

The audit process during the Covid-19 pandemic has changed due to various government regulations regarding social restrictions. These changes impact the audit process, especially related to audit procedures due to social and mobility restrictions. Despite various challenges, auditors must maintain the audit quality. This study aims to investigate the challenges, opportunities, and strategies of audit engagement during the Covid-19 pandemic. This study conducts interviews with auditors from Big Four and Non-Big Four to investigate the challenges, opportunities, and strategies during audit engagement related to audit evidence, auditor independence, going concern opinion, and auditor-client relationships. This study applies institutional logic to generate an understanding pertaining to challenges, opportunities, and strategies during audit engagement in a time of crisis. Auditors make various efforts to adjust to the pandemic situation by carrying out various alternative procedures. Institutional logic embedded in public accounting firms has changed due to routines, relationship systems, and artifacts that are depicted in how auditors think and work because they have to adjust to the Covid-19 pandemic

PENGARUH HUBUNGAN DEKAT AUDITOR DAN KLIEN TERHADAP INDEPENDENSI AUDITOR

Auditor independence is clearly defined in the Code of Ethics and Financial Reporting Auditing Standards. Independence should be interpreted as no one is interested in incentives, impacts, or audits. If the auditor follows the client's intentions, contrary to his discretion, the auditor's opinion is meaningless. The independence of the auditor can only be considered to be violated if the reporting auditor knows or should know of circumstances or relationships that could affect his independence. The accountant needs to make an independent assessment of whether the risk is significant and whether the risk of the situation or relationship can be measured through safeguards that reduce risk in exchange for approval or rejection of the contract. The purpose of this study was to determine whether the auditor-client relationship will affect auditor independence.

The politics of profit production

PurposeThis paper aims to analyze the process of producing a reported profit number to understand how different actors overcome the tensions arising from the often conflicting value frames that apply in different situations during this process and how the actors can benefit from the ensuing friction.Design/methodology/approachThe tensions found in the profit production process are theorized in terms of dissonance (Stark, 2009), emphasizing how multiple voices, drawing on different value frames, contribute to the search for a profit number. The authors study this by means of a case study of a large listed company in the construction industry, where, because of how judgment pervades the profit production process, the search for profit is particularly exposed.FindingsThe authors find three important value frames – caution, control and compliance – which managers, accountants and auditors draw on in the profit production process, depending on the situation they find themselves in. With this finding, the authors contribute to the previous research on financial reporting and management work and the production of profits by demonstrating how the relationships between the involved actors – primarily the auditor–client relationship – can be characterized by principled and constructive rivalry in which competing value frames can coexist alongside each other and how the dissonance created in these situations can produce generative and productive friction.Originality/valuePrevious research has mostly focused on profit measurement, taking the existence of a “true” profit number for granted. The auditor–client negotiation literature typically suggests that actors endeavor to solve situations in a zero-sum game where different value frames are present. This paper, drawing on an incipient theoretical approach to accounting research which emphasizes multivocality and perspective, contributes to the nascent research on financial accounting and management work in general and the profit production process in particular. With empirical illustrations of the dissonance found in this process, this paper suggests that tensions resulting from dissonance (Stark, 2009) may be a resource in situations like the profit production process.

The coherence of the auditor-client relationship quality and auditor tenure with client’s perceptions on added-value in SME audits: a sociological perspective

PurposeThe purpose of this paper is gaining more insight into the impact of the strength of the auditor–client relationship on the client’s perceptions about added-value of the auditor service including the role of auditor tenure.Design/methodology/approachThis study is based on both archival data (auditor tenure) and interview data (strength of the auditor–client relationship and client’s perceptions on added-value). The data comprise 497 small- and medium-sized entity (SME) audit engagements in The Netherlands.FindingsThis study finds evidence of a positive relationship between the strength of the auditor–client relationship and client’s perceptions on added-value. The data do not suggest a main effect of auditor tenure on client’s perceptions on added-value. This study finds evidence that auditor tenure, combined with the strength of the auditor–client relationship, has a strong positive influence on the perceived added-value. Therefore, this study argues that a longer tenure turns out to positively influence the auditor’s client-specific knowledge. The findings are relevant to auditing research by extending the scope of application of social exchange theory (SET) to SME settings, and by suggesting that the auditor–client relationship may capture more an audit quality dimension than auditor tenure. Findings are also relevant for audit practitioners in showing the contribution of a strong auditor–client relationship to client satisfaction in terms of perceived added-value. Standard setters may consider the results of this study in proper designing a specific auditing standard for smaller, less complex entities.Originality/valueThis study fits into a development in auditing research where auditing is viewed as a service. Prior studies in this area were mainly build on marketing concepts (e.g. Grönroos 2007). This study uses a sociological lens, particularly building on SET. In particular, this study focuses on the impact of relationship quality on perceived added value. Using this perspective sheds light on the importance of interactions between auditors and their clients. Both the product (audit opinion) and the process of collecting sufficient appropriate audit evidence in interaction with the client are important. This relationship perspective may serve as an explanation to why long auditor tenure can turn out to improve audit quality. Future research may build on this sociological perspective and particularly examine what conditions need to be present to realize benefits of the relationship approach and when a more transactional approach is more suitable.

Audit Quality: An Analysis of Audit Partner Cultural Proximity to Client Executives

We find that cultural proximity between auditors and CFOs is associated with audit quality. We use recent mandated PCAOB disclosures of engagement audit partners to construct cultural proximity between engagement audit partners and client executives. Building on an extensive literature on homophily in social connections, we hypothesize that when an engagement audit partner is culturally close to client executives, the accounting negotiation is more efficient, resulting in higher audit quality. Consistent with this prediction, we find that audited earnings are of higher quality when the engagement audit partner is culturally close to the CFO. We, however, do not find similar evidence when the engagement audit partner is culturally close to the CEO. Our findings are consistent across several alternative measures of audit quality and cultural proximity. These findings suggest that interpersonal factors from the auditor–client relationship are important for audit outcomes. Our study supports the PCAOB’s position that mandatory disclosures of engagement audit partner identity are helpful in understanding audit quality.

Audit-Employee Turnover, Audit Quality, and the Auditor-Client Relationship

Audit-Employee Turnover, Audit Quality, and the Auditor-Client Relationship

The impact of audit rotation on the comparability of financial reports,

Abstract This study aims to assess the effect of the rotation and tenure of audit firm and audit partner on the comparability and consistency of financial reports. Several studies have addressed the effect of auditor rotation on the quality of financial reports, but none of them focused specifically on the impact on the comparability and consistency of financial reports. Around the world, the impact of mandatory rotation of audit partner and audit firm is being discussed in academia and regulatory bodies. The peculiarity of the Brazilian regulatory environment allows us to contribute to the discussions on the effects of implementing mandatory auditor rotation. Our sample included 50 companies for which we analyzed data from 2012 to 2018. To measure comparability, we used the similarity of the accounting function model by DeFranco, Kothari and Verdi (2011), and to measure consistency we used the adaptations to this model proposed by Ribeiro (2014). For data analysis, we used descriptive statistics and multivariate panel analysis. Our results suggest that the rotation (mandatory and voluntary) of audit firm and audit partner does not affect the comparability and consistency of financial reports. Results also suggest that auditor-client relationships of up to three years contribute to a significant increase in comparability and consistency, indicating that mandatory rotation does not impair investors’ ability to compare the information concerning their investments. In addition, regulators are shown that a possible reduction in the mandatory rotation term (from five to three years, as in Italy) would be in line with market practices and would imply an increase in the comparability and consistency of financial information.

Disciplining Role of Auditor Tenure and Mandatory Auditor Rotation

ABSTRACT This study addresses the international debate over whether the rotation of audit firms should be mandatory. Mandatory rotation rules have been adopted by the European Union, but these rules have not been established in the United States. Proponents of the policy believe that a long-tenure auditor-client relationship leads to the auditor building an excessive economic bond with the client, which may then erode auditor independence. Motivated by this claim, I build a theoretical model that compares auditor incentives to issue independent reports under regimes with and without mandatory rotation. The model demonstrates conditions under which mandatory rotation could actually impair auditor independence, contrary to the popular view.

Earnings announcement delays and implications for the auditor-client relationship

Earnings announcement delays and implications for the auditor-client relationship

Close auditor-client relationships: adverse effects and the potential mitigating role of partner rotation

PurposeThis paper aims to investigate whether close auditor-client relationships affect audit quality over the tenure of the audit partner and the potential role of partner rotation in mitigating this effect.Design/methodology/approachUsing the Chinese mandatory audit partner rotation setting, the authors identify the existence of a close auditor-client relationship if the audit partner tenure with a client is larger than the audit firm tenure with that client. The sample period (1998–2009) is divided into voluntary and mandatory rotation periods when examining the effects of audit partner tenure on audit quality for the normal and close auditor-client relationship subsamples, respectively. The authors also conduct a propensity score matching analysis to address a selection issue.FindingsThe paper finds that under the voluntary partner rotation regime, audit quality decreases with audit partner tenure for the subsample with close auditor-client relationships, whereas this effect is not shown in the normal relationship subsample. However, audit quality no longer declines with audit partner tenure under the mandatory partner rotation regime.Originality/valueThis is the first study that directly examines the effect of audit partner tenure on audit quality associated with close auditor-client relationships under the voluntary and mandatory partner rotation regimes.

What Happens When Managers Are Informed? Effects of Critical Audit Matter Awareness and Auditor Relationship on Managers' Accounting Estimates

ABSTRACTWe examine how managers' accounting estimates are affected by whether they are informed about an impending critical audit matter (CAM) disclosure from a close or distant auditor. A close (distant) auditor is one who has a smaller (greater) social distance from the client in terms of their working relationship. We predict and find that being informed about an impending CAM by a close (distant) auditor leads to more (less) aggressive estimates than if managers are not informed. With a close auditor-client relationship, managers perceive a CAM disclosure as forewarning investors about estimate subjectivity, thus providing a moral license to report more aggressively. With a distant relationship, a CAM disclosure does not provide a moral license, but signals greater auditor scrutiny, which leads to less aggressive reporting. Our results inform regulators and standard setters about the effects of CAM on managers' reporting decisions in the presence of a close auditor-client relationship.

Auditor-client relationship and related party transactions disclosure: the role of family controlling shareholders from a network perspective

PurposeThis study aims to examine the effect of the auditor-client relationship (ACR) on related party transaction (RPT) types of disclosure, either RPT-efficient or RPT-conflict. This study also examines whether family controlling shareholders (FCS) negatively affect the ACR in RPT types of disclosure.Design/methodology/approachThis study uses multivariate regression on 2,203 year-observations of companies listed in Malaysia during the period 2014–2017.FindingsThis study finds weak evidence that auditors can mitigate companies’ RPT type (RPT-efficient and RPT-conflict) disclosure while maintaining a close ACR. However, an interaction between FCS and ACR reduces the RPT-conflict disclosure. Additionally, the Big 4 auditors slightly increase the RPT-conflict disclosure, however, the relationships are inversed if the close ACR involves the FCS. The Big 4 auditors also increase RPT-efficient disclosure although in a close ACR with FCS. Meanwhile, an interaction between non-Big 4 auditors and FCS in close ACR reduces both types of RPT disclosures.Research limitations/implicationsThe findings suggest that a close relationship between auditors and clients in firms with significant family control could compromise auditor’s skepticism. The FCS can easily influence the auditors to agree with the ways they treat the RPT disclosure. Therefore, policymakers may have to revisit auditors’ rotation policies in Malaysia, especially those involving FCS.Originality/valueTrust, familiarity and future fee dependency are significant threats to auditor independence in a close ACR. This study contributes to the literature by examining the effect of a close ACR on RPT types of disclosure from a network theory perspective.

Relative Influences of Review and Engagement Auditor Rotation on Audit Quality: Evidence from China

Manuscript type: Research paper Research aims: This study focuses on the effects of audit partner rotation on audit quality (AQ) in China. In particular, we examine the effects of review auditors (RAs) and engagement auditors (EAs) on AQ when they voluntarily and mandatorily rotate. Design/Methodology/Approach: The data in this study are retrieved from the Chinese Stock Market and Accounting Research (CSMAR) database. We develop an OLS regression model and logit model respectively to test the hypotheses developed. Finally, we have 13,856 firm-year observations collected for the first regression model, and 16,893 firm-year observations gathered for the second logit model from 2003 to 2015. Research findings: Findings show that RAs are more likely to behave opportunistically to retain clients by weighing up the benefits and costs of compromising audit quality in the first year after a rotation. The results imply that RAs may have an incentive to acquiesce the clients’ accounting irregularities in their first year of audit engagement when they are mandatorily rotated. However, we do not find this trend in terms of EAs’ rotation, suggesting that EAs are less affected by the auditor-client relationship compared to RAs. In addition, we find that RAs are less likely to issue modified audit opinions (MOPI) as the magnitude of negative discretionary accruals (DA) increases when they are voluntarily rotated. Theoretical contribution/Originality: Previous studies have investigated the relationship between mandatory audit partner rotation and audit quality. The results are mixed and inconclusive. Our study contributes to the extant literature by considering RAs’ opportunistic behaviour after mandatory rotation, which has not been explored in previous studies. In China, only a few studies have examined the relationship between mandatory audit partner rotation and audit quality. Our study is one of the first study focusing on the RA’s influence on AQ. Practitioner/Policy implication: The findings of our study can help Chinese authorities, listed firms and academics gain more understanding on whether mandatory audit partner rotation improves audit quality in practice. Since RAs have greater incentive to retain the existing client, we propose that RAs should bear more responsibility for the audit work, instead of the equally shared responsibility with EAs. Research limitation/Implications: Our study is subject to some limitations. First, our study adopts the performance-adjusted discretionary accruals as a proxy for audit quality. However, there can be a measurement error in estimating discretionary accruals. Second, we focus on the auditor rotation and exclude the case of audit firm rotation. Since the AQ can be affected by various factors, audit firm rotation can also affect AQ. Third, although we test the relative effects of RAs and EAs in audit work, we do not examine the effect of RAs’ characteristics such as their professional experience, educational background, and years of service. AQ can be affected by RAs’ characteristics.

Exploratory insights into audit fee increases: A field study into board member perceptions of auditor pricing practices

Audit research documents audit fee discounts associated with an auditor change, and that audit fees revert to average levels within a few years. This paper provides exploratory insights into the perceptions of board members vis‐à‐vis pricing practices used by auditors to achieve audit fee increases. In semi‐structured interviews with 12 respondents (10 board members and two audit managers), we elicit perceptions on initial audit fee discounts, auditor pricing practices and client reactions to these pricing practices. The key findings indicate that auditors combine two pricing practices to achieve audit fee increases. First, they negotiate higher fees prior to the annual audit cycle, citing changes in client structure/size and the institutional environment. Second, they charge higher than negotiated fees after completing the audit (‘extra‐billing’), citing justifications such as chargeable hour overruns and findings warranting additional work. Potentially, such auditor pricing practices have negative implications for audit quality and damage the auditor–client relationship.

Organizational Resilience of Audit Firms - Evidence from the Outbreak of COVID-19

This paper examines the organizational resilience of audit firms during the outbreak of the COVID-19 pandemic. The unexpected restrictions to travelling and on-site working imposed unanticipated barriers for auditors in Hong Kong. Management research suggests that companies with more organizational resilience can respond to and learn from unexpected situations and resume expected performance levels or even create new opportunities. Using a sample of firms listed on the Hong Kong Stock Exchange (HKEX), we examine auditor-client characteristics contributing to organizational resilience. Firstly, our full-sample results suggest that larger auditors, industry specialists and auditors with closer relationships to clients have more timely audit reports during the COVID-19 outbreak. Second, analyzing a subsample of companies that initially had to publish unaudited financial statements, we find evidence that industry expertise and longer auditor-client relationship significantly reduced the need for year-end audit adjustments. These findings provide unique evidence of audit firm characteristics associated with capacity for organizational resilience and maintaining expected performance levels. Moreover, examining auditor resignations we find that larger auditors were more likely to offload clients, whereas industry specialists were more likely to keep the clients that operate within their specialization. Finally, we do not find any evidence that investors would price having more resilient auditors. To conclude, our findings indicate that during the unexpected outbreak of the COVID-19 pandemic larger auditors, industry specialists, and auditors with closer ties to the clients, exhibit higher levels of resilience and are able maintain the expected performance levels.

In auditor we trust: 44 years of research on the auditor-client relationship and future research directions

PurposeThis study aims to review the auditor-client relationship (ACR) literature spanning 1976 to 2019 to provide future research directions.Design/methodology/approachThe study analysed 140 articles from the Web of Science database, authored by 259 scholars across 28 countries and published in 47 journals. It identified three major research streams to understand the ACR dynamics: auditor tenure, ACR attributes and auditor-client negotiation.FindingsThree major findings emerged based on this review. First, few studies examine auditor-client negotiation relative to other streams; thus, it offers scope for further research. Second, given that various fields have used diverse frameworks as theoretical underpinnings in prior studies, continuing this trend can better portray ACR from multiple perspectives. Finally, despite strong international regulations on ACR aspects such as auditor independence, tenure and rotation, implementation in several countries warrants special considerations, specifically on legal enforcement and investor protection, given diverse cultures and country-level institutional environments.Originality/valueThis study contributes to the synthesis of existing and emerging research streams and provides future research suggestions.

Corporate social impact and auditor changes

AbstractCorporate social impact has great influence on companies’ financial and litigation risk. Especially, corporate social irresponsibility raises auditors’ concerns about audit risk. Prior research finds that auditors charge higher audit fees to companies engaging in social irresponsible activities. In this study, we investigate the potential effects of corporate social impact on auditor–client relationship. Our results suggest that the likelihood of auditor changes is greater for the socially irresponsible companies and increases with severity. Additional tests suggest that socially irresponsible companies are more likely to have disagreements with their departing auditors and change to smaller auditors. Our findings are robust under different measures and specifications. Our study contributes to the literature by providing incremental evidence that auditors integrate clients’ social impact into their risk management and client selection. Our findings suggest that corporate social impact has become another determinant of auditor–client relationship and has profound effect on audit market competition.

External auditors' reliance on management's experts: The effects of an early‐stage conversation and past auditor–client relationship

This study examines the impact of an early‐stage conversation with a management's expert on auditors' decisions within the context of auditor–client relationships. We conducted a 2 × 2 between‐subjects experiment with 69 experienced auditors in Australia. Our results suggest that an early‐stage conversation can adversely affect perceived client flexibility towards proposed audit adjustments, particularly under contentious client conditions. Our results further indicate that an early‐stage conversation results in auditors relaxing, which otherwise might be a more contentious approach towards difficult clients. While we do not find direct evidence that auditors succumb to pressure and accept the work of the management's expert without any changes, our results suggest that auditors are willing to propose an adjustment that meets the interests of both auditor and client.

What Happens When Managers Are Informed? Effects of Critical Audit Matter Awareness and Auditor Relationship on Managers’ Accounting Estimates

We examine how managers’ accounting estimates are affected by whether they are informed about an impending critical audit matter (CAM) disclosure from a close or distant auditor. A close (distant) auditor is one who has a smaller (greater) social distance from the client in terms of their working relationship. We predict and find that being informed about an impending CAM by a close (distant) auditor leads to more (less) aggressive estimates than if managers are not informed. With a close auditor-client relationship, managers perceive a CAM disclosure as forewarning investors about estimate subjectivity, thus providing a moral license to report more aggressively. With a distant relationship, a CAM disclosure does not provide a moral license but signals greater auditor scrutiny, which leads to less aggressive reporting. Our results inform regulators and standard setters about the effects of CAM on managers’ reporting decisions in the presence of a close auditor-client relationship.

The Impact of Extra-Billing and the Quality of the Auditor-Client Relationship on Client-Initiated Auditor Changes

This paper examines how the quality of the auditor-board member relationship and auditor extra-billing affects client-initiated auditor changes. Extra-billing is an auditor billing practice where the auditor invoices a higher amount than originally negotiated with the client. Although extra-billing is common in audit practice, it has not yet received much attention in audit research. Drawing on marketing theory, we identify these two factors as instrumental in creating or preventing bonding, which influences the repeat purchasing behaviour of a client, such as retaining an incumbent auditor. Seventy-eight board members responsible for audit matters completed a case that varied the quality of the auditor-board member relationship (good or bad relationship) and auditor extra-billing (no extra-billing or extra-billing). The results show that both extra-billing and a bad auditor-board member relationship increase the likelihood of a client-initiated auditor change. These results have important implications for auditors, auditees, audit regulators and researchers.