Measures Of Audit Quality Research Articles

Drivers of Audit Quality for the Development of the Audit Quality Framework based on the International Standards

Audit quality has a role so important that various parties, including investors, creditors, regulators, and management, depend on financial information generated by the auditor to make decisions. Although it plays a very important role in auditing, the measurement of audit quality has not yet been agreed upon. By adopting various standards and perspectives developed by various world-leading institutions, this study revisits the importance of the role of building a theoretical model of audit quality in the midst of its complexity. In this context, this study seeks to develop a theoretical review of the factors driving audit quality and develop a model framework for the development of auditing and audit quality research in future accounting scientific research.

Reducing Underreporting by Aggregating Budgeted Time

ABSTRACTUnderreporting, or reporting fewer hours than actually worked, is a prevalent behavior among auditors at all levels. Underreporting can result in negative consequences, such as tight budgets and reductions in future audit quality. In this paper, I propose a low-cost budget formatting procedure that reduces underreporting. Using an experiment, I document that individuals with higher underreporting incentives underreport less when given an aggregated budget relative to a disaggregated budget. When individuals have lower underreporting incentives, aggregating the budget has a smaller effect on underreporting. I also provide evidence of the process by performing a mediation analysis. In a second experiment, I examine a budget formatting procedure that reduces underreporting while also mitigating the loss of data richness that results from aggregation. This study provides important insights to audit firms, partners, managers, and regulators who rely on audit hours for budgets, measures of staff efficiency, and measures of audit quality.

Predict Audit Quality Using Machine Learning Algorithms

Audit quality has always been the focus of audit research, especially since the passage of the Sarbanes-Oxley Act in 2002. Much research has been done to measure and predict audit quality, and the existing predictive models commonly use regression. By contrast, this paper uses various supervised learning algorithms to predict audit quality, which is proxied by restatements, the best measure of audit quality that is publicly available (Aobdia, 2015). Using 14,028 firm-year observations from 2008 to 2016 in the United States and ten different supervised learning algorithms, the research mainly shows that Random Forest algorithm can predict audit quality more accurately than logistic regression and that audit-related variables are better than financial variables in predicting audit quality. The results of this paper can provide regulators, investors, and other stakeholders a more effective tool than the traditional logistic regression to assess and predict audit quality, thus better protecting the benefit of the general public and ensuring the healthy functioning of the capital market.

Reducing Underreporting by Aggregating Budgeted Time

Underreporting, or reporting fewer hours than actually worked, is a prevalent behavior among auditors at all levels. Underreporting can result in negative consequences such as tight budgets and reductions in future audit quality. In this paper, I propose a low-cost budget formatting procedure that reduces underreporting. Using an experiment, I document that individuals with higher underreporting incentives, underreport less when given an aggregated budget relative to a disaggregated budget. When individuals have lower underreporting incentives, aggregating the budget has a smaller effect on underreporting. I also provide evidence of the process by performing a mediation analysis. In a second experiment, I examine a budget formatting procedure that reduces underreporting while also mitigating the loss of data richness that results from aggregation. This study provides important insights to audit firms, partners, managers, and regulators who rely on audit hours for budgets, measures of staff efficiency, and measures of audit quality.

Do Client Bankruptcies Preceded by Clean Audit Opinions Damage Auditor Reputation?

There is a maintained assumption within the accounting literature that client bankruptcies preceded by clean audit opinions (Type II GCO errors) damage an auditor’s reputation. Consistent with this view, the PCAOB proposes that stakeholders may use Type II GCO errors as indicators of low audit quality. This study examines audit committee and investor responses to Type II GCO errors. I find no evidence that audit offices with Type II GCOs are more likely to be dismissed, have lower subsequent audit fees, or have a lower likelihood of being selected for new audit engagements. These findings are consistent with audit committees not using Type II GCO errors as indicators of low auditor quality. Using event study analysis, I find evidence of modest incremental negative investor responses for clients of audit offices with Type II GCO errors. However, these negative investor responses are found only during the financial crisis period of 2008–2010 and are observed only within windows of 30 days or less. Given this limited evidence that stakeholders do respond to Type II GCO errors, I examine whether stakeholders should respond to Type II GCO errors. I find that audit office Type II GCO errors are positively associated with subsequent restatements, an established measure of low audit quality. Taking the results as a whole, I do not find that audit offices incur substantial reputational costs for Type II GCO errors. However, the negative investor response and the positive association with restatements provide some evidence that Type II GCO errors may serve as indicators of low audit quality.

The Impact of Transportation Infrastructure Development on Auditor Effort and Audit Quality: Evidence from a Natural Experiment

We rely on the launch of high speed railway (HSR) services in China as a natural experiment to examine the role that transportation infrastructure development plays in shaping auditor effort and audit quality. In a staggered difference-in-difference framework, we find that auditor effort evident in the number of days spent on the engagement rises after the launch of an HSR route to the city where the client is located. In measuring audit quality with restatements and discretionary accruals, we document that actual audit quality improves after HSR services become available. Consistent with capital market participants rewarding firms that narrow information asymmetry by improving accounting transparency, we find that the launch of the HSR program also leads to higher perceived audit quality in the form of clients enjoying cheaper borrowing costs and higher valuations. Our core results hold under extensive sensitivity analysis, including when we implement propensity score matching to control for variation in client characteristics and re-estimate the regressions for falsified HSR launch dates. Collectively, our evidence implies that improving transportation infrastructure to facilitate travel translates into auditors working harder on engagements and delivering stricter external monitoring of the financial reporting process.

Impact of the disclosure of audit engagement partners on audit quality: Evidence from the USA

The debate concerning the recent regulation in the USA mandating accounting firms to disclose engagement partners' identity is ongoing. We examine the impact of the Public Company Accounting Oversight Board's (PCAOB's) requirement of disclosing engagement partners' names on Form AP on the quality of audit engagements. Using two measures of audit quality (abnormal accruals and the probability of detecting material weaknesses in internal control), we find that disclosing engagement partners' names is associated with a lower level of abnormal accruals and a higher probability of accounting firms detecting material weaknesses in internal control. Our study extends the contemporary research on the disclosure of engagement partners' identification by providing additional evidence to the literature on this issue in the U.S. setting. Our study also provides evidence supporting the PCAOB's perception that this disclosure leads to higher audit quality.

Experience of Audit Committee Members and Audit Quality

We investigate whether the experience of audit committee members is associated with audit quality. In order to comprehensively analyse the experience of audit committee members, we include audit committee member tenure, age and multiple-directorships in our analysis. Using observations from 2001 to 2012, we undertake analysis on 13,155 firm-year observations and find that all our proxies of audit committee member experience are positively associated with audit fees. A range of additional tests, including using discretionary accruals as an alternative measure of audit quality and differences-in-differences analysis, support our main findings and our results consequently make a number of contributions to both the literature and policy making. One possible policy contribution is that regulators may wish to consider audit committee characteristics representing experience when framing recommendations to improve audit quality and thereby, financial reporting by firms.

PENGARUH ATURAN ETIKA TERHADAP KUALITAS AUDIT YANG DIMEDIASI OLEH PENGENDALIAN MUTU (SURVEI PADA AUDITOR BPK RI)

The fraud cases involving government auditors certainly erode public trust. The importance of improving audit quality to increase the public trust makes author interested in conducting research that seeks to measure the determinants of audit quality. Before Enron and Worldcom’s accounting scandal on 2001-2002, studies that measured audit quality generally still use KAP-size proxies. DeAngelo's (1981: 186), states that: "The quality of audit services is defined as a market-assessed joint venture, which will both (a) discover a breed of client's accounting system, and (b) report the breach". Ethical rules become independent variables in this study. In addition, author also added Expectancy Theory to mediate the relationship between ethical rules and audit quality represented by quality control variables. This model was inspired by Aldhizer et al. (1995) where the measure of audit quality can also be assessed from how much the level of adherence and appropriateness of the client's financial statements to the rules, laws, and applicable standards. The results of the study indicate that ethical rules have an influence on audit quality by mediating by quality control.Keywords : Ethics, Control, Audit.

English

English

Does the Length of the Cooling-Off Period Impact Audit Quality?

Several countries have implemented a policy of mandatory partner rotation (MPR) in response to concerns around auditor independence. Integrated within MPR requirements, minimum cooling-off periods regulate audit quality at the time of a rotation-back. Within the context of a proposed extension to the minimum cooling-off period, we examine the association between the length of the cooling-off period and audit quality. We use Australian data as the partner can be identified and there is variation in cooling-off periods since the inception of MPR. We consider the merits of an extended cooling-off period by measuring audit quality both at the time of a rotation-back and at the expiration of a cooling-off period. Consistent with prior literature, we measure audit quality as abnormal working capital accruals and the auditor’s propensity to issue a going-concern opinion for financially distressed firms. For rotation-back observations, we find no evidence of an association between the length of the cooling-off period and audit quality. For cooling-off period observations, we find some evidence of larger abnormal working capital accruals and a lower propensity to issue a going-concern opinion, consistent with a deterioration in audit quality associated with longer cooling-off periods. We provide preliminary evidence that extending the cooling-off period does not enhance audit quality when a partner rotates-back on to a client and uncover an unintended consequence of the effect of this policy during the cooling-off period.

The effects of audit quality on the costs of capital of firms in Ghana

PurposeThis paper aims to investigate the effects of audit quality on the cost of capital in Ghana.Design/methodology/approachNon-financial firms listed on the Ghana Stock Exchange (GSE) as well as non-listed firms from the database of Ghana Club 100 were included in the sample. Series are yearly, covering a sample of 40 firms during the six-year period, 2008-2013. The study employed the positivist research paradigm to establish the relationship between audit quality and the cost of capital.FindingsThere is evidence to suggest that the cost of debt and the overall cost of capital of firms in Ghana can be explained by the quality of the external auditors. The results also show that the large size of the board is associated with low cost of debt.Research limitations/implicationsThe fact that the choice of quality measure is based on firm size only and other measurements of audit quality could not be measured. Future research may examine how other approaches to measuring audit quality affect cost of capital.Practical implicationsThe results significant for those charged with assurance and regulation, as well as lenders and managers of companies.Originality/valueThe authors investigate how external auditing quality affects the cost of capital of firms operating in Ghana.

The Impact of Auditor Quality on Audit Quality —— Evidence from China Based on Data from 2014-2016

This paper studies the impact of auditors’ own quality on audit quality. Through the test of relevant models, it is necessary to find out whether the conclusions of predecessors have practical significance in improving the quality of auditing as time goes by and other relevant influencing factors of the market. The paper collects relevant data from multiple dimensions such as the age level of the auditors, the accumulation of audit experience, and the level of education by collecting the relevant data of the 2016 A-share listed companies and the top 100 CPA firms in 2014-2016. An empirical test was conducted. According to the results of the empirical test, the discussion and research will be carried out, and further opinions and suggestions on how to improve the quality of the auditor should be put forward. The innovation of the research is that the level of earnings management is used as a measure of audit quality, and non-recurring gains and losses are used as explanatory variables. On the basis of previous studies, time and environmental institutional variables were further introduced for further verification.

The Influence of Institutional Regulatory Pressure on Nonprofit Hospital Audit Quality

ABSTRACTThis paper investigates whether the influence of institutional regulatory pressures emanating from the enactment of the Sarbanes-Oxley Act and subsequent nonprofit legislation and disclosure requirements improves nonprofit hospital audit quality. Drawing on institutional theory, we argue that increased regulatory attention can shift the audit firm's judgment regarding the choice and inference of previously acceptable audit procedures and heighten the importance of reputational capital as an incentive for audit firms to improve audit quality. We examine two measures of audit quality: internal control deficiencies and discretionary accruals. The results reveal that the audit quality of nonprofit hospitals improves, suggesting that audit firms have responded to regulatory pressures and enhanced their audit and engagement practices for the benefit of nonprofit hospitals and stakeholders. The findings provide regulators and public interest groups with evidence that desired nonprofit oversight and accountability may have already been attained via improved audit quality.Data Availability: Data are available from public sources cited in the text.

Global trends in audit quality, supervision, and standard setting

The following topics are currently high on the agenda of IFIAR: global trends in audit quality (and measuring audit quality) and global trends in supervision and standard setting. In her key note speech, Janine van Diggelen provided her personal insights and perspectives on these issues. 

Do practitioner assessments agree with academic proxies for audit quality? Evidence from PCAOB and internal inspections

This study investigates the degree of concordance between fifteen measures of audit quality used in academia and two measures of audit process quality determined either by audit firms’ internal inspections or by Public Company Accounting Oversight Board inspections of individual engagements. Using two confidential datasets of these assessments of audit process quality, I find that three of the measures of audit quality used by academics have significant associations with both measures of audit process deficiencies used by auditors and regulators: (i) the propensity to restate financial statements, (ii) the propensity to meet or beat the zero earnings threshold, and (iii) audit fees. Seven academic proxies are significantly associated with only one audit process quality measure, and five have insignificant associations with both practitioner assessments. Overall, the significant associations indicate that practitioners and academics share common ground in identifying low-quality audits. These findings can provide guidance for future studies in selecting audit-quality proxies suitable for different research questions.

Audit Quality and Specialist Tenure

ABSTRACT We argue that the association between auditor industry specialization and audit quality depends on how long the auditor has been a specialist. We measure audit quality using absolute discretionary accruals, income-increasing discretionary accruals, and book-tax differences. Our results, based on a sample of Big 4 audit clients from 2003–2015, indicate that auditors who have only recently gained the specialist designation produce a level of audit quality that does not surpass that produced by non-specialist auditors, and is generally lower than the audit quality produced by seasoned specialists. We estimate that the seasoning process takes two to three years. In contrast to prior research that finds no effect of specialization after propensity score matching, we find that seasoned specialists generally produce higher-quality audits than other auditors even after matching. This suggests that the audit quality effect associated with seasoned industry specialist auditors is not due to differences in client characteristics. JEL Classifications: M42. Data Availability: Data used in this study are available from public sources identified in the text.

The impact of litigation risk on the association between audit quality and auditor size: Evidence from China

AbstractWe examine whether audit quality varies across different sizes of CPA firms under high or low auditor‐specific litigation risk exposure. We measure audit quality by the issuance of modified audit opinions and the audit fees charged to clients, and we use the organizational form of CPA firms as the proxy for auditors’ litigation risk exposure, where a partnership (limited liability) CPA firm represents a high (low) litigation risk exposure. Built on Choi, Kim, Liu, and Simunic's (2008) theoretical framework, we hypothesize that the litigation risk exposure of CPA firm moderates the association between auditor size and audit quality. Our results show that when the auditor's liability is capped (i.e., registered as a limited liability form of CPA firm), larger size CPA firms are associated with higher audit quality when compared to smaller size CPA firms. However, this positive association between auditor size and audit quality disappears for audit firms that are subject to high litigation risk exposures (i.e., registered as a partnership form of CPA firm). Our research provides new insights on the impact of auditor‐specific litigation risks on the relation between audit quality and auditor size. In particular, we show that only when auditor‐specific litigation risk is limited, do large CPA firms appear to perform higher quality audits than small CPA firms.

Can clients of economically dependent auditors benefit from voluntary audit firm rotation? An experiment with lenders

This study utilizes a nationwide random selection of 111 lenders in a 2 × 2 between-subjects experiment to determine whether the level of an auditor's economic dependence on a client and type of auditor rotation affect lenders’ independence and reliability perceptions and decisions to lend money to a potential borrower. Previous literature shows that financial statement users use client importance as a measure of audit quality when revenue streams are not equal across clients. This can negatively affect perceptions of independence and financial statement reliability. As United States regulators look for ways to improve audit quality under the current partner rotation mandate, this study explores whether an audited entity that voluntarily adopts a policy of firm rotation can mitigate the negative effects of the auditor's dependence on the client. Findings suggest that lenders view clients of economically dependent auditors (CEDA) as less independent from its auditor and perceive its financials as less reliable than clients without a dependent auditor (non-CEDA). Lenders are less likely to grant a loan to CEDA. However, under firm rotation, there is not only an increase in lenders’ perceptions of reliability of CEDA financials, but also no difference in perceptions of reliability of CEDA and non-CEDA financials.

Fixed Costs, Audit Production, and Audit Markets: Theory and Evidence

We analyze the role of discretionary fixed costs in audit production. Such costs are common (or joint) across a set of clients serviced by an accounting firm during a period. Our motivation is to better understand the implications of common discretionary fixed costs for the production and supply of audit services and audit market outcomes, such as the assurance level provided (audit quality) and audit costs and pricing, we conjecture that discretionary fixed costs are associated with the technology and other types of investments used by the auditor to transform audit effort (hours) into assurance for a portfolio of clients. We assume that such investments (and resulting costs) influence production primarily through the efficiency of audit effort (process improvements). We formally analyze the audit production problem in the context of auditor profit maximization and a more simple expected cost minimization formulation, and use examples, simulation methods, as well as explanatory figures to understand the implications of these models. Also, we use monotone comparative statics (Milgrom and Shannon [1994] to show the implications of client-specific losses (the auditor’s loss function) and the number of clients in an auditor’s portfolio on the level of fixed investments and audit assurance. The assumption that discretionary fixed costs are an important feature of audit service production yields a rich mix of interesting insights into the audit service market that are not found in the existing literature. Based on these analyses, we develop four testable hypotheses concerning the relations between audit quality and (1) the magnitude of client-specific possible losses from servicing a client; (2) the average client losses in an audit firm’s portfolio; (3) the number of clients in an audit firm’s portfolio; and (4) the variability of client losses in an audit firm’s portfolio. Using the absolute value of discretionary accruals as the proxy for audit quality and client size as the proxy for auditor losses, we find evidence consistent with the four hypotheses. In addition, using restatements as the measure of audit quality, we find some (weaker) evidence consistent with hypotheses 3 and 4.