Reduced Audit Quality Research Articles

Auditor Fees and Fraud Firms

The issue of whether auditor fees affect auditor independence has been extensively debated by regulators, investors, investment professionals, auditors, and researchers. The revised SEC requirements that resulted from the implementation of the Sarbanes-Oxley Act (2002) limit non-audit services (NAS) and mandate NAS fee disclosure. The SEC’s requirements are based on the argument that auditor independence could be impairedand hence audit quality may be reducedwhen auditors audit their own work. Economic bonding leads to reduced independence, which may in turn lead to reduced audit quality. We study a sample of firms sanctioned by the SEC for fraudulent financial reporting in Accounting and Auditing Enforcement Releases (SEC-sanctioned fraud firms) and examine whether there is a relationship between auditor fee variables and the likelihood of being sanctioned by the SEC for fraud. We use SEC sanction as a measure of audit quality that has not previously been used in the literature and is more precise than some of the other proxies used for flawed financial/auditor reporting. We find, in univariate tests, that fraud firms paid significantly higher (total, audit, and NAS) fees. However, in multivariate tests, when controlling for other fraud determinants and endogeneity among the fraud, NAS, and audit fee variables, we find that, while NAS fees and total fees are positively and significantly related to the likelihood of being sanctioned by the SEC for fraud, audit fees are not. These findings suggest that higher NAS fees may cause economic bonding, leading to reduced audit quality, while higher audit fees do not appear to have the same effect. Our findings of significantly higher NAS fees in fraud firms hold after controlling for latent size effects and other rigorous testing. These results contribute to the literature that examines the SEC’s concerns about NAS, and can be used by policy makers for additional consideration.

The Effect of Tenure and Reputation of Public Accounting Firms toward Audit Quality: Case Mandatory Rotation of Auditors in Indonesia

The finance minister of Indonesia has issued a series of regulations governing the compulsory rotation of public accounting firms and auditors since 2003. It culminates with the issuance of finance minister regulation No.17/Menkeu.01/2008, which limits the provision of auditing services to three years for auditors and six years for public accounting firms. This study is motivated by the issuance of the finance minister rules and the equivocal of research findings. This study examines whether auditor tenure reduces audit quality in Indonesia. Further, this research investigates the effect of firm's reputation on audit quality. Using 455 firm-years in manufacturing industries listed in the Indonesian Stock Exchange, this research shows that audit tenure negatively affects audit quality. However, we find that reputation does not affect audit quality.

Perilaku Auditor atas Penerapan Sistem Review Bertingkat dalam Manajemen KAP (Dalam Perspektif Teori Kelas)

This research is a case study of Public Accounting Firm management behavior assessment in operational practices and management behavior analysis especially for audit practices implementation of hierarchical review system. The failure of the auditor in implementing audit process is called reduced audit quality (RAQ). The research object is one of the local Public Accounting Firm in Malang which has not applied fair and appropriate organization structure and reward system yet. Public Accountant Firm is a full professional organization, but in fact, based on Public Accountant Firm practice and existence, especially in Malang, the organization structure, system and procedure as professionalism guarantee is informal organized, thus in developing and practicing, the element of management is organized based on board interest. Along with Hierarchical Review System implementation, auditor staff as an audit field worker would think this implementation as some form of suppression for them, mentally and financially. On Marx’s Class Theory perspective, hierarchical review system implementation showed different level of classes, higher and lower level. This different level of classes showed many problems and conflict of interest caused by unfair payment and job distribution. This problem can also cause Reduced Audit Quality (RAQ).

Audit Fees for Initial Audit Engagements Before and After SOX

SUMMARY: Legislators, regulators, and the media have expressed concerns that auditors “lowball” the fees for initial-year audits and that such fee discounts can lead to reduced audit quality. We hypothesize that initial-year audit fee discounts will be less likely in the post-SOX period than in the pre-SOX period. Using both fee-levels and fee-changes models, we find that Big 4 clients receive initial-year audit fee discounts of about 24 percent in 2001; this finding is consistent with results from many prior studies that have examined various periods prior to SOX. However, we find that in 2005–2006 Big 4 clients pay an initial-year audit fee premium of around 16 percent. We also document that the Big 4 are much less likely to serve as a successor, following an auditor change, in 2005–2006 than in 2001. Overall, the findings suggest that concerns about initial-year audit fee discounts are not supported by empirical evidence in the post-SOX period. The results also suggest that the Big 4 have become more conservative in the post-SOX period with respect to client acceptance and pricing decisions.

Does Increased Audit Partner Tenure Reduce Audit Quality?

The Sarbanes-Oxley Act of 2002 requires the lead audit or coordinating partner and the reviewing partner to rotate off the audit every five years so the engagement can be viewed “with fresh and skeptical eyes.” Using data obtained from actual audits by multiple U.S. offices of three large international audit firms, we examine whether there is a relationship between evidence of reduced audit quality, measured by estimated discretionary accruals, and audit partner tenure with a specific client. We find that estimated discretionary accruals are significantly and negatively associated with the lead audit partner's tenure with a specific client. Thus, audit quality appears to increase with increased partner tenure. After controlling for client size and engagement risk, we find audit partner tenure significantly and negatively associated with estimated discretionary accruals only for small clients with partner tenure of greater than seven years, regardless of risk level. We also find that tenure is not significantly associated with estimated discretionary accruals for large clients. This suggests that as partner tenure increases, auditors of small client firms become less willing to accept more aggressive financial statement assertions by managers, and that partner tenure does not affect audit quality for large clients or for shorter-tenure smaller clients. Our results relating to audit partner tenure are consistent with the conclusions about audit firm tenure by Geiger and Raghunandan (2002); Johnson, Khurana, and Reynolds (2002);Myers, Myers, and Omer (2003); and Nagy (2005) and extend their findings by focusing on individual audit partners rather than on audit firms.

The Moral Intensity of Reduced Audit Quality Acts

Underlying attributes of reduced audit quality (RAQ) acts are investigated in this research paper. Since RAQ acts may result from ethical judgments, we examine whether they could vary because of differences in moral intensity. Moral intensity was proposed by Jones (1991) in a model that looked at the attributes of the moral issue itself. This study examines whether auditors perceive seven different RAQ acts to differ on three components of Jones' model (social consensus, magnitude of consequences, and probability of effect). Little variation was found on the social consensus dimension showing that auditors think the acts equally wrong. However, significant differences in perceptions about the RAQ acts relating to the probability of effect and the magnitude of consequences were found. The results suggest that RAQ acts differ in terms of their moral intensity, and hence auditors' decisions to undertake RAQ behavior may be issue-contingent. The study provides empirical support for Jones' model by showing, in an audit context, that moral intensity factors vary with the moral issue.

Time budget pressure, auditors' personality type, and the incidence of reduced audit quality practices

PurposeThis paper aims to extend the literature on reduced audit quality practices (RAQPs) by examining the relationship between time budget pressure, auditors' personality types, and the incidence of two RAQPs – premature sign‐off of an audit step (PSO) and accepting a weak client explanation (WCE).Design/methodology/approachThe aim of this paper is to collect data. A research instrument was developed and administered to audit practitioners in New Zealand using postal and web link methods. The research instrument included several hypothetical audit scenarios and Blumenthal's Type A Self‐Rating Inventory Scale (TASRI).FindingsThe paper finds that a significant relationship is present between time budget pressure and PSO only. Significant relationships are also found among auditors' personality types and the incidence of the two RAQPs. These results suggest that the audit environment is complex and that time budget pressure is only one of several explanations for the incidence of RAQPs.Research limitations/implicationsThe research instrument of this paper has not been used before in its entirety. This may raise issues of validity of the findings. Also, defining and measuring time budget pressure in terms of two categories (high/low) as opposed to a continuum may have implications on results reported in this study.Originality/valueThe paper provides results that show the importance of auditors' personality type in understanding more about the incidence of RAQPs.

Audit firm tenure and financial restatements: An analysis of industry specialization and fee effects

This study investigates the relation between audit firm tenure and clients’ financial restatements. Specifically, we extend the audit tenure literature by assessing restatement-based reporting failures using dimensions of auditor expertise and independence previously assumed to underlie short and long audit tenure problems. Short tenure expertise and independence effects are hypothesized using audit firm industry specialization and audit fees as proxies. Long tenure independence effects are hypothesized using nonaudit fees as a proxy. Using matched-sample logistic regression and 382 companies with and without financial restatements during 2000–2004, the results support prior findings by indicating a negative relation between the length of the auditor–client relationship and the likelihood of restatement. For short tenure engagements, we find that auditor industry specialization and audit fees are negatively related to the likelihood of restatement. This result is consistent with concerns about reduced audit quality due to a lack of client-specific knowledge and low audit fees on new audit engagements. Alternatively, the long tenure results indicate an insignificant relation between nonaudit fees and the likelihood of restatement. This finding contradicts independence concerns about nonaudit fees paid to entrenched auditors.

Unintended Consequences of Accelerated Filings: Are Mandatory Reductions in Audit Delay Associated with Reductions in Earnings Quality?

Using publicly available data from annual reports, we find that SEC rule changes (33-8128 and 33-8644) that impose time pressure on the audits of registered firms have a negative impact on earnings quality, which we interpret as evidence of lower audit quality. Consistent with our predictions, we find that the 10-K accelerations reduced audit quality only when it actually reduced the number of days from year-end to audit report date, and that this effect was more acute for smaller, accelerated filers and during the initial deadline change (relative to the second). We also provide insights into the quality of these audits by conducting a survey of thirty-two retired audit partners. Survey results underscore the challenges time pressure imposes on receiving and evaluating complex valuations (such as for derivatives, pensions, and goodwill) and resolving audit adjustments.

Penghentian Prematur atas Prosedur Audit

Premature sign off of audit procedure is one form of Reduced Audit Quality / RAQ behaviors. This act refers to falsely signing off a required audit step, which is not covered by other steps, without completing the work or noting the omisson of the procedures. However, auditor dares to express an opinion based on those procedures. An auditor can make a wrong opinion on the financial statement if he conducts such act. As a result, litigation risk faced by an auditor will increase because of issuing a wrong opinion. The objectives of this research are : first, to know the sequence of audit procedures which most are often signed off and second, to test the effect of time pressure, audit risk, materiality, review procedure and quality control on premature sign off of audit procedure. The result of this research indicates that there is a priority sequence of discontinued audit procedure in time pressure conditions. The audit procedure which is often omitted is understanding business’s client and the audit procedure which is seldom omitted is physical examination. The logistic regression shows that time pressure, audit risk, materiality, review procedure and quality control have an effect on prematurly signed off audit procedure.

The Effect of Risk of Misstatement on the Propensity to Commit Reduced Audit Quality Acts under Time Budget Pressure

This paper examines the effects of time budget pressure and risk of misstatement on the propensity of auditors to commit reduced audit quality (RAQ) acts. Understanding the different conditions under which time budget pressure can impact on auditors' behavior is important because of the emphasis on meeting budgets in practice. A 2×2×2 mixed design was used with two between-subjects variables for time budget pressure and risk and a repeated measure for the type of RAQ (accepting doubtful audit evidence and truncating a selected sample). The dependent variable was the propensity to commit RAQ. The results support the contention that, under time budget pressure, the likelihood of RAQ is lower when the risk of misstatement is higher. However, this effect was observed for only one of the two RAQ acts examined, suggesting that these RAQ acts are not seen to be the same by auditors. Different risk responses conditioned on the type of RAQ may be indicative of a strategic response to use of RAQ under time budget pressure.

Incentive Compensation and the Quality of Disclosure

Investors typically base executive compensation on performance measures reported by managers and verified by third-party monitors. This paper explicitly examines how compensation influences the reporting behavior of managers and auditors and finds that (1) strengthening the link between pay and reported performance can result in a weaker link between pay and actual performance and, consequently, lower managerial effort; (2) conservatism among auditors improves performance measurement; (3) in contrast to auditors, raising penalties on managers for overstating earnings can reduce audit quality and harm investors; and (4) side agreements between auditors and managers bias auditors, but increase their access to information and may improve investor welfare. These results, in turn, have a number of important implications for the reform of corporate governance.

Contracting Out Municipal Auditing

This article evaluates the contracting out of municipal auditing. It draws upon the organizational economics (theory of the firm) tradition, specifically agency theory and transaction cost analysis. In order to systematically assess the effects of contracting out municipal auditing, a conceptual framework of municipal auditing is developed. Some empirical evidence is then discussed in relation to this framework. In general, enhanced competition and contracting out municipal activities seem to lead to an increase in both cost-efficiency and effectiveness. However, there are potential problems related to market contracting of municipal auditing, i.e. the prospect of reduced auditor independence, reduced audit quality and in particular less performance auditing. Finally, the article presents suggestions for future research, indicating the need for further empirical studies, especially on how the contracting out of municipal auditing affects auditor independence and performance auditing, and how mixed ownership/plural governance structures affect audit outcomes.

An Empirical Investigation of IPO Underpricing and the Change to the LLP Organization of Audit Firms

This paper examines the relationship between the 1994 change in audit firm legal structure from general partnerships to limited liability partnerships (LLPs) on underpricing in the initial public offering (IPO) market. The change in legal structure of audit firms reduces an audit firm's wealth at risk from litigation damages and reduces the incentives for intrafirm monitoring by partners within an audit firm. Prior research suggests that underpricing protects underwriters from litigation damages, and that the level of underpricing varies inversely with both the amount of implicit insurance provided by the audit firm and the quality of the audit services provided. We hypothesize the change in audit firm legal structure reduced the assets available from audit firms in IPO-related litigation and indirectly reduced audit quality by lowering intrafirm monitoring. As a result, underwriters have incentives as a joint and several defendant with the audit firms to increase IPO underpricing, particularly for high-litigation-risk IPOs, following audit firms' shifts to LLP status. Our findings are consistent with this hypothesis.

A Survey of Time Budget Pressure and Reduced Audit Quality Among Australian Auditors

This paper reports the results of a survey of Australian auditors' perceptions of their time‐budget pressure, as well as whether they had exhibited “reduced audit quality” (RAQ) behaviours. Further questions examined why RAQ practices were used and what areas of the audit were likely to be subject to these practices. There appears to be a high level of time‐budget pressure on auditors, and many auditors have at some time performed RAQ practices, potentially having implications for the quality of the audit function. These results point to the importance of placing an appropriate value on the audit function to ensure that time budgets are adequate.

PROFESSIONAL SOCIALISATION, COMMERCIAL PRESSURES AND JUNIOR STAFF'S TIME-PRESSURED IRREGULAR AUDITING—A CONTEXTUAL INTERPRETATION

Research suggests a correlation between commercial concerns, time pressures and junior staff's ‘irregular auditing’ that results in audit failures. This article examines junior staff's irregular auditing in the context of trainees' normal auditing responsibilities and the specific nature of time pressures at their firms. The discussion recognises that omnipresent commercial concerns often leads to adoption of new audit methods that may militate against time pressures. Empirical evidence from in-depth interviews is used to highlight that firms that use risk-based auditing expect their trainees to help realise commercial gains by focusing audit work on areas where material misstatements could occur. The evidence shows that trainees do concentrate work on areas where material misstatements could occur. Acts that reduce audit quality occur in other areas and may often be seen by senior staff who may sanction extra work, if necessary. The article uses these findings to infer that junior staff do not have low regard for audit protocol.

Non-audit fees, disclosure and audit quality

This paper investigates the effect of non-audit services on audit quality. Following the announcement of the requirement to disclose non-audit fees, approximately one-third of UK quoted companies disclosed before the requirement became effective. Whilst distressed companies were more likely to disclose early, auditor size, directors' shareholdings and non-audit fees were not significantly correlated with early disclosure. These results cast doubt on the view that voluntary disclosure of non-audit fees was used to signal audit quality. The evidence also indicates a positive weakly significant relationship between disclosed non-audit fees and audit qualifications. This suggests that when non-audit fees are disclosed, the provision of non-audit services does not reduce audit quality.

An Analysis of Auditor Liability Rules

This paper models auditor litigation brought under Section 10(b) of Securities Exchange Act 1934 and Rule lOb-5. It considers audit quality under the current and liability regime and the proposed liability regime. This issue is relevant because the U.S. Congress is considering legislation which would provide relief to accountants from the joint and several liability rule.1 Although experts have testified before the Senate that moving to proportionate liability would reduce audit quality, I show that doing so may actually increase audit quality. The reason is that under the proportionate liability regime the auditor's litigation cost is more sensitive to his effort than it is under the joint and several liability regime. There always exist rules of apportioning liability between the auditor and the company that ensure higher audit quality under proportionate liability than under joint

Agency Problems, Auditing, and the Theory of the Firm: Some Evidence

Agency Problems, Auditing, and the Theory of the Firm: Some EvidenceAuthor(s): Ross L. Watts and Jerold L. ZimmermanSource: Journal of Law and Economics, Vol. 26, No. 3, (Oct., 1983), pp. 613-633Published by: The University of Chicago PressStable URL: http://www.jstor.org/stable/725039Accessed: 29/06/2008 23:14