Large Audit Firms Research Articles

Developing a Cognitive Assistant for the Audit Plan Brainstorming Session

With technological advances, audit firms have been able to increase the level of decision support embedded within the firms’ audit support tools (Dowling et al., 2008). Large audit firms have been investing substantive resources into the utilization of Artificial Intelligence (AI) to take advantage of their past audit experience and industry knowledge (Kokina and Davenport, 2017; Appelbaum, 2017). During the initial stages of an audit, the engagement team will meet to update their understanding of the client through brainstorming sessions. Audit firms are required by SAS No. 99 and SAS No. 109 to use brainstorming sessions to evaluate risk factors and discuss the susceptibility of the entity’s financial statements to material misstatement, either as a result of error or fraud (AICPA, 2012). At present, the most commonly used decision support tool for audit plan brainstorming is the checklist (Bellovary and Johnstone, 2007), which has shown limitations (Dowling and Leech, 2007; Seow, 2011; Landis, 2008). To improve audit plan effectiveness, this study proposes an audit domain cognitive assistant system to provide interactive decision support for information retrieval and risk assessment in audit brainstorming session. Cognitive Assistants are speech-enabled technologies that can understand voice commands, recognize conversation’s context, and answer questions in a personable manner (Garrido et al., 2010; Myers et al., 2007)

Why The Big 4 Are Leaders In The Audit Market? A Literature Review

The leadership of the large audit firms has generated great interest in the accounting doctrine to explain about the concentration factors of the audit market. The objective of this paper was to make an extensive review about the empirical studies published in the international literature about the reasons why the Big 4 are leaders in the audit market. The methodology used to review the literature contains an important theoretical background, since it is based on a thorough documentary review of the most relevant theoretical and conceptual approaches of international literature. The results indicate that the leadership of the Big 4 in the audit market is due to factors such as; the concentration of the market, the specialization of the audit service by sector and size of the companies audited, the economies of scale, the structured audit methodologies, the demand for the audit service with differentiated quality and the demand of an auditor with reputation.

Influence of Internal and External Governance Mechanisms on Corporate Governance Disclosure among Islamic and Conventional Banks

The purpose of this paper is to investigate the extent of corporate governance disclosure in the annual reports of listed conventional and Islamic banks in Bangladesh. Out of fifty-six scheduled banks in Bangladesh, a sample of thirty-nine banks is selected, and data for the sample is extracted from the annual reports covering a period of 2011 to 2014. As such, the study focused on the extent of CGC after the stock market crisis in 2010 in Bangladesh. This results in the final observations of 116 which were used to perform balanced panel regression analysis. Fixed effect model is found significant for the balanced panel model which indicates that appointment of large audit firms negatively affects the extent of corporate governance compliance. Pooled OLS regression established that while profitability has a negative influence, the size of banks positively affects the extent of CGC. This study has focused on the commercial banks and thus results obtained from the study may not be representative for public and foreign banks operating in Bangladesh. Statistical evidence provided by the study provides guidelines for the policymakers toward necessary governance reforms required for banks to successfully operate in a post-crisis environment. Factors established by the study that influences corporate governance compliance using a balanced panel model are unique in the context of developing countries. Evidence of a difference in governance compliance between Islamic and conventional banks in Bangladesh establishes a new research arena and a necessary shift from the traditional performance comparisons.

Publicity and Auditor Behavior: The Case of Hurun Rich List in China

Adverse client publicity can entail regulatory scrutiny over audited financial statements and impose political costs on auditors. We use the changes in client publicity caused by their controlling owners’ presence on the Hurun Rich List (the rich listing) in China to test the hypothesis that auditor conservatism increases with client publicity. Our evidence indicates auditors issue more adverse audit opinions to clients and charge higher fees following the rich listing events. Moreover, we observe that auditors strategically respond to clients with different attributes — for clients whose owners accumulated wealth in a more questionable manner, auditors choose more stringent audit reporting to better defend themselves from regulatory scrutiny; for clients without such attributes, auditors primarily rely on increasing audit fees to cope with any post‐listing increase in audit risks. Our analyses also suggest the impacts of rich listings tend to be concentrated among large audit firms with stronger reputation concerns or among engagement auditors with more conservative reporting styles. By showing how auditors manage political risks associated with heightened public scrutiny, we contribute to both the auditing and political cost literature.

Are Audits of Financial Statements Born Unequal?

Audit is getting more and more importance in assuring the reliability of financial information including financial statements for all parties. Commonly, quality of an audit is viewed as probability that financial reports are free from material irregularities. In the previous literature, there is a positive relationship between size of audit firm and audit quality that has long been understood. This has resulted in many publications to gather evidence of differential audit quality relating to audit firm size. In consequence, the conclusion has been focused that bigger audit firms produce higher audit quality than smaller ones. However, the collapse of many big international audit firms, typically Arthur Andersen has reduced the statement that large audit firms have higher audit quality than small ones. Therefore, this study looks into audit quality basing on the extent of compliance with disclosure requirements pertaining to goodwill impairment of large listed firms in Hong Kong context in the second year transition to IFRS. We found that audit firm identity appears to be a substantial variation, in which compliance levels changed significantly among auditors in the context of Hong Kong.

Reputation Incentives of the PCAOB and Large Audit Firms: Preliminary Evidence from Inspection Findings

Responsive regulation (RR) theory posits that effective regulators enforce compliance by escalating penalties only if persuasion fails, otherwise risking formation of a culture of resentment. Using RR theory as a lens, we examine the interactions between large audit firms and the PCAOB during the initial years of PCAOB regulation, when annually-inspected auditors utilized negative tone within their inspection response letters to express public disagreement with their inspection reports. Consistent with our expectations, we find that negative tone within response letters is positively associated with (1) future Part I inspection findings that result in a restatement of a client’s financial statements and (2) the likelihood that Part II of a future inspection report will be publicly disclosed. We triangulate these results and the underlying theory in semi-structured interviews of eight PCAOB inspectors and six audit partners involved in these early interactions between the largest firms and the PCAOB. Consistent with RR theory, the PCAOB viewed public disagreement as indicators of noncompliance, incorporated public disagreement into subsequent inspections, and escalated penalties for noncompliance. Contrary to RR theory’s prescriptions, the PCAOB did not use persuasion as a first reaction to noncompliance. In response, the firms stopped publicly disagreeing, but may have formed a culture of resentment toward the PCAOB.

Offshoring of Audit Work in Australia: Preliminary Insights from Literature and Interviews

Addressing a gap in research, this study explores the issue of offshoring audit work in Australia. We conduct a review of extant largely US-based literature and interviews with auditors at Australian firms to understand the extent of offshoring activity, the drivers of the decision to offshore audit work, the perceived benefits, the risks, and the impact upon audit quality. We find that offshoring is pervasive amongst large audit firms in Australia, whereas smaller audit firms are not engaging in the activity. The main drivers of offshoring audit work are cost savings and staff availability, stemming from the underlying pressure to maintain audit fees while continuing to deliver excellent service. While the quality of work performed offshore is perceived by some auditors to be of lower standard and those not offshoring, this potential risk is outweighed by the cost savings which then enables firms to increase the review of work performed offshore while still improving profitability.

Do big 4 audit companies detect earnings management and report it in the audit opinion? Empirical evidence from italian non-listed firms

One of the earliest theories in the audit literature is that Big 4 auditors, due to their larger size and better training programmes, provide higher audit quality than other auditors in listed companies (e.g. Dopuch and Simunic, 1982; Davidson and Neu, 1993; Becker et al., 1998; Francis and Krishnan, 1999; Bauwhede et al., 2003; Cai et al., 2005). The argument is that larger audit firms have more reputation to lose by sacrificing their independence on any given audit engagement, thus Big 4 auditors’ higher levels of audit quality should be associated with lower levels of earnings management. To the extent that managers want to mislead some stakeholders about the underlying economic performance of the company or to influence contractual outcomes that depend on reported accounting numbers (Healy and Wahlen, 1999, p. 368), earnings will also be managed in non-listed firms. Bank financing is usually a major source of finance in privately held companies (Van Tendeloo and Vanstraelen, 2008), resulting in agency conflicts between bankers and owners, and between bankers and management (Vander Bauwhede and Willekens, 2004), which could also create earnings management incentives. The audit quality is the joint probability that the auditor detects an anomaly (first dimension) in financial statements, and then reveals it to the external users (second dimension) (DeAngelo, 1981). Analysing a panel sample of Italian non-listed firms over the years 2007-2012, our main findings suggest that Big 4 auditors are more likely to discover (auditor’s technical capabilities) earnings management initiatives than other auditors (a non- Big 4 auditor and statutory auditors), because a Big 4 auditor is negatively associated with the absolute value of discretionary accruals (Jones, 1991; Dechow et al., 1995). Analysing the same sample firms, a logistic panel regression suggests that, according to previous literature, the absolute value of discretionary accruals is positively associated with the probability that a qualified audit report is issued, meaning that the absolute value of discretionary accruals explains the issuance of qualified opinion for materially misstated financial statements. The panel logistic regression also suggests that the association of the absolute value of discretionary accruals and of a Big 4 auditor is positively associated with the probability that a qualified audit opinion is issued, meaning that when a Big 4 auditor discovers an accounting anomaly in the financial statements, it is reported in the audit opinion (auditor independence). Our findings also show that the audit opinion in previous years also affects, on average, the audit opinion of the year of the analysis.

A view from practice - What audit firm leaders expect from audit research and how they see their role in strengthening the bridge between practice and science

The eight largest audit firms in the Netherlands (Deloitte, EY, KPMG, PwC and Baker Tilly Berk, BDO, Grant Thornton and Mazars jointly) have taken the initiative to establish the Foundation for Auditing Research (FAR) by providing the necessary research funds and research data. Stichting Accountantsfonds has recenty joint them. Affiliation with FAR is furthermore open for all audit firms and departments, both large and small, public audit firms as well as internal audit functions and government audit departments. With that, FAR provides for a unique collaboration between practice and science, strengthening the learning curve of the audit industry and its stakeholders, feeding accountancy education, and bolstering the accountancy research community in the Netherlands and abroad. The affiliated firms will arrange access to relevant audit firm data for well-defined research projects. Audit firms have agreed to open up the “black box” of the audit in order to make significant steps forward.

Adopting generalized audit software: an Indonesian perspective

PurposeThis paper aims to identify key factors driving auditors’ adoption of Generalized Audit Software (GAS) in a large developing country, Indonesia, through the lens of the technology, organization and environment (TOE) framework.Design/methodology/approachResults of this study are based on semi-structured in-depth interviews conducted in Indonesia with audit firms of varying sizes.FindingsKey study findings included the identification of highly influential adoption factors, especially environmental factors, such as availability of information technology-skilled auditors in the local market, client needs and expectations and client size. This study has also identified factors, not identified in previous research, as being influential including the importance of GAS availability in a range of languages and the necessity of a supportive professional and regulatory environment.Originality/valueThis study makes several contributions to the literature including that it identifies new influential factors in the TOE framework. This framework has not been widely applied in auditing research and looks beyond the individual perspective to that of the organization as a whole. Moreover, the present study takes a developing country perspective and examines a range of audit firms. In contrast, most studies to date in the area have taken a Western focus and have concentrated on large audit firms. Additionally, this study provides an in-depth analysis through the use of semi-structured interviews, whereas prior studies have relied on surveys.

Audit quality differences amongst audit firms in a developing economy

Purpose– The purpose of this paper is to report findings of audit quality differences amongst audit firms in a developing country. Specifically, the authors examine the assumption of marked audit quality differences amongst large audit firms (Big 4s) and the small and medium practices (SMPs).Design/methodology/approach– First, the authors develop scales for assessing perceived audit quality in the financial services sector based on qualitative data obtained from 106 audit practitioners, 31 credit analysts and 13 board members. The authors use NVivo© to analyse the 13 transcribed interviews and follow “cross-case analysis” to visualize dimensions and scales of audit quality. Then the authors use measurement scales developed and obtain quantitative data from 183 board members and top executives in the financial services sector and test for perceived audit quality differences amongst audit firms using a Mann-WhitneyUtest.Findings– The findings suggest that audit quality is a multi-dimensional construct comprising of levels of discretionary accruals; compliance of audited accounts to accounting standards, law and regulations; and audit fees. Based on these measures, the authors find that Big 4 audit firms ensure more compliance with accounting standards, law and other regulatory requirements than SMPs. However, taking all the three audit quality dimensions together reveals no significant differences in audit quality levels between Big 4 and SMPs.Research limitations/implications– In terms of auditor selection and retention, it is important that audit firms are assessed based on their ability to constrain discretionary accruals, to produce audited accounts that comply with requirements of accounting standards, the law and regulations; and to examine the fees they charge in relation to quality of service, than on their size. Also, as the results of this study suggest that Big 4 audit firms might be needed for compliance with accounting standards, law and other regulatory requirements, their audit ties in with the most basic level of auditing requiring probity and legality which, in practice, requires a low level of judgement to be exercised by those performing the audit. It might be useful for Big 4 and other audit firms to embark also on higher level of auditing requiring higher level of judgement. Future research may wish to examine auditing firms’ proclivity to higher level judgment audit.Originality/value– Previous research reveals no consistent way of measuring audit quality and has been inconclusive on the subject of audit quality differential amongst audit firms. The authors create audit quality scales which can be used in assessing perceived audit quality in a developing country context and provide initial evidence of no significant differences between large audit firms and the SMPs regarding audit quality in Uganda.

The Economic Consequences of Audit Firms’ Quality Control System Deficiencies

This study seeks to determine the role of audit firms’ quality control (QC) system deficiencies, as measured by the Public Company Accounting Oversight Board (PCAOB) inspection program, on audit quality and profitability. Using a unique data set of firmwide QC deficiencies identified by the PCAOB during its inspections of audit firms, I find a negative association between QC deficiencies, mainly performance related, and audit quality. Furthermore, audits conducted by larger audit firms with more organization-level deficiencies appear less profitable, evidenced by more hours worked on the engagements, leading to lower fees per hour. These results appear to be partly explained by deficiencies in the tone at the top (a proxy for culture) and the audit methodology. Further evidence suggests that a lack of remediation of QC system deficiencies has a negative influence on audit quality. This paper was accepted by Suraj Srinivasan, accounting.

The Work Environment in Large Audit Firms: Current Perceptions and Possible Improvements

SUMMARY This study examines the work environment in the audit division of large public accounting firms. Based on 18 semi-structured interviews (eight partners and ten staff auditors currently or recently employed by large public accounting firms), we find that the interviewees cite several positive aspects of auditing careers including the people, intellectual stimulation, challenge, and responsibility. However, they also cite significant negatives, including PCAOB regulation, stress, and hours. None of the staff interviewees plans to stay in public accounting long term, and while all of the partners would recommend public accounting to others, most focused only on public accounting as a place to start a career. The findings raise a number of concerns regarding the profession's ability to sustain the quality of its human capital, especially since there are no signs of a radically improved work environment in public accounting that may appeal to Millennials. We conclude by discussing possible improvements in the public accounting work environment that would address the issues raised in the interviews.

Standards of Innovation in Auditing

SUMMARYThis paper examines the impact of the development of Business Risk Auditing (BRA) on international audit standard setting and the implications regarding the potential for innovation in auditing practice. BRA was an audit methodology development promoted by the large international audit firms in the late 1990s as a significant innovation but, ultimately, it did not have the degree of impact on practice initially promised. Our analysis demonstrates that professional and regulatory priorities at the time interacted in ways that led to the most innovative elements of BRA not being advanced for inclusion in formal standards. Intriguingly this outcome was clear well before the critical attention given to auditing following Enron, which was the explanation offered for the fate of BRA in previous studies. We conclude that the capacity for innovative ideas to have a substantive influence on audit practice is highly dependent on interactions between a shifting mix of professional and regulatory interests and preferences. The BRA case illustrates how lasting innovation requires a willingness and commitment both to develop the scope of the audit and to accept variations in aspects of its execution. This will not happen if standardization per se is seen as an essential validation of successful innovation.

Auditors’ perceptions of the impact of continuous auditing on the quality of Internet reported financial information in Egypt

Purpose – The purpose of this paper is to explore the perceptions of auditors in Egypt toward the role that continuous auditing (CA) can play in offsetting the challenges facing the quality of Internet-reported financial information. The paper also examines the impact of audit firm type and years of experience on these perceptions. Design/methodology/approach – Ninety-six auditors working in the Big 4 and large local audit firms are surveyed to attain their perceptions on the issues examined. Chi-square, Mann–Whitney and t-test are used to test the research hypotheses. Findings – The overall results indicate that the majority of auditors in Egypt agree that implementing CA can offset the challenges associated with the Internet financial reporting (IFR) environment. The results also reveal that there are significant differences between auditors working in Big 4 audit firms and those working in local firms regarding the perceptions of the effect of CA on some aspects of the timeliness of information. Research limitations/implications – The paper extends the stream of research on both CA and IFR that confirms that the widespread use of the Internet in disclosing financial information continues to be a worrisome problem for auditing firms. Practical implications – The paper provides insights into the challenges facing auditing in the IFR environment and how implementing CA can help offset these challenges. Originality/value – To the best of our knowledge, this paper is the first to examine issues related to CA in the IFR environment in the Middle East and, in particular, Egypt.

Does the Organization and Culture of the Largest Audit Firms Influence Their Audit Quality and Efficiency?

This study investigates the association between the largest audit firms’ internal organization and audit quality and efficiency. Using a unique dataset of firm-wide deficiencies in the quality control (QC) systems identified by the PCAOB during its inspections of audit firms, I find a negative association between firm-level QC deficiencies and audit quality. Furthermore, audits conducted by audit firms with more organization-level deficiencies are less efficient, as evidenced by more hours worked on the engagements, despite audit fees remaining unchanged. These results appear to be partly driven by deficiencies in the tone at the top (a proxy for culture) and the audit methodology. In contrast, audit firms with more deficiencies of a practical nature (audit performance issues) do not appear to spend enough effort on their audit, consistent with a “shirking” hypothesis. Overall, these results suggest that while both practical-level and organization-level deficiencies negatively influence audit quality, their root causes are different. In particular, audit firms may have the possibility to improve their profits once they remediate the organization-level deficiencies identified by the PCAOB.

Going, Going, Still Here? Determinants and Reactions to Consecutive Going Concern Opinions

This study examines whether audit firm knowledge and resources affect the likelihood a company receives consecutive going concern opinions. We also consider whether consecutive going concern opinions are useful to financial statement users. Recent comments from the FASB and PCAOB question the usefulness of going concern opinions to financial statement users. While going concern opinions are issued when substantial doubt exists about a client's viability beyond the next reporting period, little is known about why some companies receive consecutive going concern opinions. We find larger audit firms and audit firms with greater expertise issue fewer consecutive going concern opinions to their clients, and smaller audit firms issue consecutive going concern opinions to a greater proportion of clients at higher risk of bankruptcy and misstatements. This result suggests companies audited by firms with fewer resources operate longer with going concern uncertainty. We also find the initial market reactions to going concern opinions decrease with consecutive going concern opinions and disappear when consecutive going concerns exceed three. These results are consistent with FASB and PCAOB concerns. This study provides initial evidence on one source of the reduced value of going concern opinions.

Insights into Large Audit Firm Sampling Policies

SUMMARY Changes in the audit profession after Sarbanes-Oxley, including mandatory audits of internal control over financial reporting and PCAOB oversight and inspection of audit work, have potentially changed the nature and extent of audit sampling in the largest accounting firms. In our study, “Behind the Numbers: Insights into Large Audit Firm Sampling Policies” (Christensen, Elder, and Glover 2015), we administered an extensive, open-ended survey to the national offices of the Big 4 and two other international accounting firms regarding their firm's audit sampling policies. We find variation among the largest firms' policies in their use of different sampling methods and in inputs used in the sampling applications that could result in different sample sizes. We also provide evidence of some of the sampling topics firms find most problematic, as well as changes to firms' policies regarding revenue testing due to PCAOB inspections. Our evidence provides important insights into current sampling policies, which may be helpful to audit firms in evaluating their sampling inputs and overall sampling approaches.

Spatial Competition at the Intersection of the Large and Small Audit Firm Markets

SUMMARYIn this paper, we study spatial competition in the U.S. audit market while accounting for its two-tiered nature. We provide evidence on the differential impact that market share distances within and between the players in the large and small audit markets have on competition. We find that the market share distance from small audit firm competitors has a greater effect on the Big 4's audit fees than distances from other Big 4 competitors. This finding suggests that small audit firms play a significant part in the competitive landscape in local markets. Further, we find that audit fees are increasing with the distance between a small audit firm and its closest competing small audit firm while audit fees are decreasing with the distance between a small audit firm and its closest competing large audit firm. This suggests that while obtaining separation in market space from competing small audit firms reduces competitive pressure from other small audit firms, as a small audit firm gets closer to the market space of a large audit firm it is perceived as being more like the larger audit firm and is able to obtain a fee premium like that attained by the larger audit firms.JEL Classifications: M4; M40; M41; M42; M49.

Audit Quality Differences Among Auditors: The Case of Hong Kong

Audits play a critical role in satisfying the public interest in strengthening accountability and supporting confidence in financial reporting. Conventionally, audit quality is defined as a probability that financial statements are free from material misstatements. The existence of a positive relationship between audit firm size and audit quality has long been accepted in previous literature. This has resulted in numerous studies collecting evidence of differential audit quality relative to the size of audit firms, both large and small. Consequently, the conclusion has been asserted that larger audit firms produce a higher and more homogenous audit quality. The collapse of Arthur Andersen, however, has undermined the premise that large audit firms provide higher audit quality than smaller firms. This research investigates audit quality based on the extent of compliance levels with disclosure requirements pertaining to goodwill impairment of large listed Hong Kong firms in the third year transition to International Financial Reporting Standards (IFRS). The result found that audit firm identity appears to be a significant proportion of cross-sectional variation, in which compliance levels and disclosure quality varied considerably among auditors.