Auditors' Liability, Vague Due Care, and Auditing Standards

This paper expands the set of previously considered liability rules to include a negligence liability rule with a vague specification of due care. Auditors who are negligent in conducting their audit are liable for losses that result from reliance on misstated financial statements. However, what constitutes negligence for auditors is not clearly specified in the law. Consequently, courts often resort to Generally Accepted Auditing Standards (GAAS) and Statements on Auditing Standards (SAS) as benchmarks for determining due care. A liability regime that consists of a vague negligence rule supports and amplifies the credibility of auditing standards. While auditing standards alleviate some of the vagueness that is inherent in the legal standard, they also form a lower bound on due care, since an audit of a quality that is lower than the quality that auditing standards require would be considered negligent. Thus, the vague specification of due care enables auditors to commit to audit quality as pronounced in auditing standards. This paper explores this link between professional standards and auditors' legal liability. It establishes that the commitment to auditing standards could not have been as credible as it is, if auditors' liability was determined based on the strict liability rule, or based on a negligence rule with a clearly specified due care, since under these two liability rules courts would not need to refer to auditing standards to establish fault. The paper also demonstrates that a legal regime where audit standards are used as a benchmark to evaluate negligence is not the same as a legal regime where due care is defined clearly. Therefore, previous studies that assumed a negligence regime with clear due care may have overstated the effort level that is induced by legal liability.     

Quis Auditoret Ipsos Auditores? Can Auditors Be Trusted?

This article explores the extent to which the audit profession and its practices promote public trust in audits. Differences between auditors and non‐auditors as to beliefs about the role of a financial report audit have long been discussed under the term ‘expectations gap’. However, this prior debate has tended to focus on non‐auditors’ alleged misunderstanding of audit processes without a corresponding understanding on the part of the profession as to why the public might place its trust in auditors. The study explores the nature of trust in an auditing context and notes that like any profession, auditing faces practical limitations but the inability to directly observe the conduct of audits combined with professional status create an ‘over trust’ expectation in the public. Changes in audit practices and culture have also exposed the profession to criticism. The article seeks to offer one approach by which the auditing profession can restore public confidence; namely, evidence‐based practice, which has proven effective in improving the quality of practice in medicine. Adoption of a reflective evidence‐based approach to audit practice offers the promise of greater audit quality and an improvement in the profession's accountability and public confidence.     

Group audits: Are audit quality and price associated with the Lead auditor’s decision to accept responsibility?

Lead auditors frequently rely on work performed by Other auditors, especially when auditing clients with operations in multiple countries. The PCAOB has expressed concern that the quality of such group audits may differ depending on whether the Lead auditor accepts or declines responsibility for work done by Other auditors. The PCAOB also has been concerned with the venue through which Lead auditors and Other auditors disclose their participation in group audits, including disclosure of whether Lead auditors accept or decline responsibility. To investigate these issues, we employ a sample consisting entirely of group audit engagements. We identify Lead auditors taking responsibility from PCAOB Form 2, filed by Other auditors of U.S. registrants for fiscal years 2009 to 2017. We identify Lead auditors not accepting responsibility from audit report disclosures during the same period. The results suggest that Lead auditors accepting responsibility charge higher audit fees but provide audits of no higher quality, and possibly of even lower quality. These results are robust to various additional analyses. Our research contributes to the ongoing debate over how the participation of Other auditors affects audit quality.     

Do auditors’ early-life socioeconomic opportunities improve audit quality? Evidence from China

Prior research documents significant variation in audit outcomes based on individual auditors' demographic features, working experience, educational background, and social connections. This study examines whether individual auditors' early-life socioeconomic opportunities also affect audit practices. We expect that auditors from big cities have more access to socioeconomic opportunities and accumulate more human capital in early life, thus are more capable of providing high-quality audits after they start careers. Consistent with this hypothesis, we find that auditors from big cities make more audit adjustments to earnings compared with auditors from small towns. Additional tests suggest that this early-life effect on audit quality is moderated when auditors receive higher education or gain more auditing experience and is more pronounced in downward adjustments than in upward adjustments. We also find a fee premium for auditors from big cities. Overall, this paper provides evidence that auditors’ early-life socioeconomic opportunities have a far-reaching influence on audit quality.     

Auditor Size,Market Segmentation and Litigation Patterns: A Theoretical Analysis

We provide a theoretical rationale for the observed audit industry structure where well-capitalized auditors hold an extremely large market share. Our analysis focuses on the economics of trading in an adverse selection market where audit quality is unobservable. We show that concentration of market share can arise even if well-capitalized auditors have no relative advantage with regard to supplying high-quality audits, and that the strategy of attracting a narrow base of high-margin clients is typically unsustainable in rational expectations equilibrium. Other results derived from our analysis of strategic competition for clients also conform (qualitatively) with empirical findings regarding audit fee structures and litigation rates. In particular, we show that better-capitalized auditors get a dominant market share, produce more accurate reports and are more profitable. In addition, we show that the imposition of high minimum standards increases the market power of wealthy auditors, even though smaller auditors can potentially provide the same level of audit quality at lower fees. All these results are demonstrated within a framework that endogenizes both a securities trading market and profit-maximizing auditors who strategically compete for clients.JEL Classification: C72, D43, D82, K23, K41, L15     

Responsiveness of Auditors to the Audit Risk Standards: Unique Evidence from Big 4 Audit Firms

We examine the effect of changes in audit risk standards on the conduct of financial statement audits in a European setting. We investigate this by analysing the audit hours and audit fees for clients of Big 4 audit firms in Finland in 1996 and 2010. Our results show that audit firms became more sensitive to clients’ business risk due to the introduction of the new audit risk standards, with more audit hours allocated to owner-managed companies in 2010 than in 1996, and fewer audit hours allocated to low-risk clients in 2010 than in 1996. Also, the labour mix in the audit team changed for owner-managed companies, with a greater work load carried by junior auditors in 2010 than in 1996. Regarding the price of audit, we find an increase in audit fees for clients with high business risk, while audit fees remained at roughly the same level for low-risk clients. These findings should be of interest to the auditing profession and those involved in the development of auditing regulations.     

Embedding process mining into financial statement audits

The audit of financial statements is a complex and highly specialized process. Digitalization and the increasing automation of transaction processing create new challenges for auditors who carry out those audits. New data analysis techniques offer the opportunity to improve the auditing of financial statements and to overcome the limitations of traditional audit procedures when faced with increasingly large amounts of financially relevant transactions that are processed automatically or semi-automatically by computer systems. This study discusses process mining as a novel data analysis technique which has been receiving increased attention in the audit practice. Process mining makes it possible to analyse business processes in an automated manner. This study investigates how process mining can be integrated into contemporary audits by reviewing the relevant audit standards and incorporating the results from a field study. It demonstrates the feasibility of embodying process mining within financial statement audits in accordance with contemporary audit standards and generally accepted audit practices. Implementation of process mining increases the reliability of the audit conclusions and improves the robustness of audit evidence by replacing manual audit procedures. Process mining as novel data mining technique provides auditors the means to keep pace with current technological developments and challenges.     

Audit Standards and Auditor Liability: A Theoretical Model

The business of auditing is heavily regulated. Auditor regulation exists through licensing, professional standards and liability. The auditor's liability for losses to financial statement users from audit failure is subject to a test of negligence. What constitutes due audit care is, however, not generally well-specified. Furthermore, reviews of litigation against auditors conclude that compliance with professional audit standards does not always act as a complete defence to allegations of negligence. The current situation can be described as one where (ex ante)—from the point of view of the auditor—uncertainty exists about the ‘legal’ standard of due audit quality (as seen by the courts in the event of litigation). This uncertainty about legal standards fundamentally affects audit behaviour in ways that are not immediately intuitive. This paper draws on insights from the economics and law literature (e.g., Kolstad et al., 1990; Shavell, 1984a, 1984b and 1987; Calfee and Craswell, 1984 and 1986) and provides an analysis of the effects of uncertainty about auditor negligence on the produced level of audit quality and on audit fees. The auditor subject to a negligence rule will produce too low or too high an audit quality level, as compared to the socially optimal level. It is shown that uncertainty about the legal standard of ‘due audit quality’ is fundamental to understanding audit quality supplied. This uncertainty is the explicator of an insurance component in audit fees. A surprising insight is that a large uncertainty about the legal standard of care can reduce rather than increase the quality of audit work supplied and increase the insurance component. Relying on insurance premiums can be more effective than direct expenditure in reducing risk. The effect of the imposition of ex ante precise audit quality standards, in combination with an uncertain negligence rule, is discussed. Since the influence of ex ante standards is indirect through its effect on ex post liability, auditing standards cannot be analysed independently of ‘legal’ standards. If the legal standard of care were clear, there would be no role for audit standards. Audit standards only affect audit behaviour if legal standards of care are unclear, and they help to clarify the legal standard. An effective combination is for ex ante standards to be set below the ex post standards of care so that they provide a lower bound on acceptable work. Under a lowest common denominator approach set too far below legal standards, audit standards would be irrelevant as far as operational decisions were concerned. As the level of standards are raised, so costs are first imposed on the lowest quality providers.     

Financial crisis and the silence of the auditors

Against the backdrop of the current financial crisis, this paper seeks to stimulate debates about contemporary auditing practices. It notes that many financial enterprises have sought state support within a short period of receiving unqualified audit opinion. Auditors collected large amounts in audit and non-audit fees. The events raise questions about the value of company audits, auditor independence and quality of audit work, economic incentives for good audits and the knowledge base of auditors.     

The CLERP 9 Audit Reforms: Benefits and Costs Through the Eyes of Regulators,Standard Setters and Audit Service Suppliers

Over the past decade or more Australia amongst other jurisdictions has experienced substantial reforms to auditing regulation in an effort to boost public confidence in the auditing profession. This paper aims to examine whether these changes in the Australian regulatory environment for audits have (a) provided enhanced confidence in reported financial data, (b) impacted audit costs and (c) not limited competition in the market for audit services. Using qualitative interview data, this study reports on the perceptions of auditors, auditing standard setters and regulators in relation to the CLERP 9 reforms to the Australian auditing regime in the later part of the 2000s. A theoretical framework is developed to evaluate whether these reforms are substantive enough in nature to effect public confidence in reported financial data and market competition in audits.     

An Audit Framework for Expert Systems

Expert systems moved from research laboratories to widespread use in the business world during the previous decade. Current data indicate that use will continue to increase in the foreseeable future. However, auditors have not comprehensively addressed the need for and feasibility of independent audits of these systems. This paper discusses factors that will soon create a demand for independent audits of expert systems. It then identifies a framework present in current professional standards that appears to be appropriate for proceeding with the auditing of expert systems. A hypothetical case is subsequently presented to illustrate one possibility of how measurement criteria, audit procedures and an audit report developed under these professional standards might appear. Potential practice problems and research issues are identified throughout the paper.     

Standard-setting in auditing: Insights from PCAOB inspections

We explore whether the Public Company Accounting Oversight Board (PCAOB) consistently follows its own standard-setting policies. We do this using a methodology that combines the reports of audit partners, the timing of enacted auditing standards, and the issuance of PCAOB inspection findings. Rules governing standard-setting are critical to ensure that auditing standards are appropriate, efficient, and are therefore likely to be generally accepted. Our results suggest that in some instances auditors were penalized for omitting evidence from their working papers which is not specified in the standards, in effect, changing or removing auditor judgment in the amount and nature of audit evidence to be gathered in corroboration of management’s assertions and creating new auditing standards outside of the formal standard-setting process. Beyond the societal benefits of standard-setters adhering to their own policy-making rules, changes in auditing procedures impact the behavior of both auditors’ and managers and is costly. Although subject to limitations, we believe our results are informative to policy makers and other participants in PCAOB standard-setting.     

Measuring audit quality of local governments in England and Wales

The purpose of this paper is to model and test the audit quality provided to local governments in England and Wales. A key question is: are there major differences in audit quality provided? The Audit Commission, a national public body under Parliament, regulates the audits. It sets audit standards, appoints the auditors, and (although each auditor and client local government set the specific audit fee for that client) it establishes a formula to determine standard audit fees. The Audit Commission also conducts an annual review of the audit quality provided by the selected auditors, as well as a survey of client satisfaction. The majority of audits are conducted by District Auditors (public sector employees of the Audit Commission). About a quarter of local governments are audited by one of six private sector auditors (including three of the Big 4). Actual results indicate that audit quality differences are associated with the number of governmental audit clients and local government type. Generally, there were modest quality differences by auditor category.     

The attitude of Libyan auditors to inherent control risk assessment

Previous empirical evidence contradicts the practices of audit risk assessment recommended by the professional auditing standards. Key differences represent the presumption that auditors can readily distinguish between different categories of risk, how they assess such risks in practice, their application to the different account levels and their capacity to differentiate between what may constitute potentially high or low risks. The paper addresses these differences in the context of the Libyan auditors’ perceptions and practices. The nature and development of the audit profession in Libya makes this a good comparator for the US and UK contexts of audit behaviour. Equally importantly, the religious, political and socio-cultural context combined with Libya's role as an emergent economy is representative of many other economies in the world, thus providing a good comparator for assessing the validity and applicability of the established auditing management principles and procedures. One hundred and sixty four practicing auditors in Libya were investigated, initially by questionnaire and subsequently interview of a smaller sample of 20 auditors. The evidence reinforces prior empirical evidence that inherent and control risks are assessed interdependently, auditors are aware of the risk differentials depending on the level of account and are cognizant of factors normally associated with potentially high and low risk levels.     

Is the quality of female auditors really better? Evidence based on the Chinese A-share market

Unlike previous studies in which a single index was used to measure audit quality, this study establishes a new comprehensive index to measure audit quality via Discretionary Accrual, as estimated by Jones’ basic model (1991) and Audit Opinions. The former is used to measure the quality of financial statements, and the latter is used to measure the auditors’ independence in the mainstream international literature. We examine whether and how an auditor’s gender affects the quality of his or her audits under the framework of empathy theory and gender role socialization theory. Using a large sample of 9861 auditor-firm-year observations from Chinese A-share–listed companies from 2011 to 2015, we find that the audit quality of signed auditors shows significant gender differences: these significant gender differences differ from the findings of previous studies that female auditors could provide a higher-quality audit than male auditors; that is, in our study the audit quality of the male auditors exceeds that of the female auditors. After distinguishing the positive and negative directions of the Discretionary Accrual, we find no significant gender differences in audit quality between male and female auditors when the earnings had been adjusted upward by the client; that is, female and male auditors had the same audit risk perception. However, when the client adjusted earnings downward, which indicates a lower audit risk for the auditor, the audit quality of female auditors was significantly lower than that of the male auditors. After controlling for the age and position of the auditors, we also find that the gender differences in the auditors’ audit quality decreased significantly or even disappeared when the auditor’s age exceeded 45?years and/or their position was manager or above. These results are consistent with the empathy theory and gender role socialization theory.     

An empirical study of audit expectation-performance gap: The case of Libya

The purpose of this research is to empirically examine the causes of the audit expectation gap in Libya. The study builds on the frameworks developed by Porter (1993) and Porter & Gowthorpe (2004) to investigate the influence of the audit expectation gap to the auditing profession in the case of Libya. The data was collected through a questionnaire survey randomly selected members of four broad interest groups including auditors, auditees and audit beneficiaries both inside and outside the financial community were followed by in-depth interviews. A total of 988 questionnaires were distributed from which 431 questionnaires with usable responses were received from four groups. The overall usable response rate was 44%, ranging from 47% for the financial community audit beneficiaries to 41% for the auditors group. The findings of the study revealed that there exists audit expectation-performance gap and that the gap is as result of the following factors in different levels of percentages. Deficiency standards and deficient performance gaps constitute 49% and 15%, respectively, of the audit expectation-performance gap. The audit expectation-performance gap derives from society having unreasonable expectations of auditor’s significant proportion 36% of the gap. As result of the following interviews demonstrated that the objectives of auditing are not as clear to the financial statement users as they are to the auditors and the financial statement preparers in Libyan business environment. Further, we observe that reducing the expectations gap is to improve knowledge responsibilities between the auditors and user groups and understanding of the auditor’s role and responsibilities through the provision of auditing illegal acts.     

Busy auditors,financial reporting timeliness and quality

We investigate whether audit partners with multiple clients are able to complete their audits in a timely fashion, an important but largely unexplored area of academic research. One view is that having multiple clients increases the knowledge and experience of the audit partner resulting in a more efficient and therefore, quicker audit. On the other hand, having multiple clients may over-burden an audit partner resulting in a slower audit process and longer completion times. We find that audit partners with multiple clients take longer to complete their annual audit. More importantly, we also find that companies with busy auditors who take longer to complete their audits also have poorer levels of financial reporting quality. Additionally, in terms of consequences for busy auditors, firms with lengthy audit report lag switched their auditors the next year suggesting that busy audit partners may lose clients if their workload is excessive and they are not able to maintain audit quality. Our results are robust to alternative measures for both audit report lag and audit partner busyness and a range of endogeneity tests. We also undertake simultaneous quantile regression to assess changes in audit report lag depending on the number of audit clients per partner where we find preliminary evidence of a knowledge spill-over effect. Consequently, our results have implications for companies, audit firms, regulators and other key stakeholders.     

Social Relations and the Differential Local Impact of Global Standards: The Case of International Standards on Auditing

This article contributes to the literature exploring the contextual conditions that lead international standards to produce a differential impact with regard to inducing convergence in local practice. The article documents three types of responses by local audit firms to the implementation of International Standards on Auditing (ISAs) in Russia, namely: (1) those that claim to follow the national auditing standards modelled on ISAs and mandated by audit law; (2) those that voluntarily provide ISA audits in accordance with original ISAs; and (3) those that provide pseudo audits (‘black audits’) and ignore auditing standards. The study investigates a link between these different responses and the degree of the indigenous firms' social embeddedness in relation to the international audit firms that first introduced ISAs to Russia. The article argues that the higher the embeddedness levels the more likely the audit firms will genuinely commit to following the standards. It also shows that social embeddedness is influenced by a number of conditions, including geographical proximity between the indigenous and international audit firms, as well as commonalities in their professional characteristics, such as aspiration to intraprofessional status and target clientele. The study's findings demonstrate that the local impact of international standards is dependent not just on the characteristics of the local institutional environments in which the adopters operate but also on the social structures and relationships within which they are embedded.     

效益审计标准的选择和确定--以某单位国家建设项目设备效益审计为案例研究

在效益审计中,选择和确定合适的审计(评价)标准是非常重要的环节。它是保证效益审计质量的一个必要条件,也是审计人员提出审计意见、做出恰当审计结论的基本依据。本文以某单位国家建设项目设备效益审计作为案例,结合《世界审计组织效益审计指南》,对审计标准问题进行了分析和探讨。最后,就我国政府审计机关在效益审计中如何选择和确定“合适的”审计标准提出几条建议,以期抛砖引玉。