Audit committee diligence around initial audit engagement

Studies focusing on governance mechanisms argue that auditor monitoring is one of several governance mechanisms that exist in the firm, and these mechanisms supplement each other. Extending this argument, I examine whether firms support auditor monitoring with audit committee monitoring when auditor oversight is deemed to be weak. Prior auditing literature argues that audit quality is affected by auditors' lack of familiarity with their clients' activities. Since lack of auditor–client familiarity exists in the first year of auditor–client tenure, I examine whether firms increase their audit committee monitoring during the year of auditor change. For a sample of firms that changed auditors between 2006 and 2012, the findings show that audit committees meet more frequently in the first year of audit engagement. Further tests show that firms' past reporting behavior play a significant role in the demand for more audit committee meetings and the increase in the audit committee meetings in the initial year of auditor engagement positively affects reporting quality.     

How individual auditor characteristics impact the likelihood of audit failure: Evidence from China

Audit failure imposes a severe loss on investors and damages market participants' confidence in financial reporting quality. This study investigates the impacts of individual auditor characteristics on the likelihood of audit failure. Chinese regulators mandate listed firms to disclose the engagement auditors' identity. Furthermore, the information regarding individual auditor characteristics in China is also publicly available. Utilizing this unique setting, we examine the relationship between individual auditor characteristics and the likelihood of audit failure in China during the period from 2000 to 2009. We document that individual auditors with more auditing experience are less likely associated with audit failure. We also find a weaker negative relationship between auditor education level and audit failure. Our study has important implications for both auditors and regulators by shedding lights on the determinants of audit failure and by providing guidance to the human resource management in audit firms.     

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.     

Intersections of law and accountancy: Unlimited auditor liability in the United Kingdom

In recent years, considerable pressure has grown within the British auditing industry for limitation of liability arising from negligent mis-statements in audit reports. Under British company law, auditors are forbidden from contracting with companies for their liability to be restricted. This legal provision was introduced in the Companies Act 1929 as a byproduct of legislation relating to directors' liability. The paper explores the background to this legal provision, observing that auditor liability cannot be viewed as a self-contained matter of interest only to a limited community. Attitudes to auditor liability have been shaped against a background of changes in the law of negligence, some, but by no means all, arising from cases involving auditors. Moreover, changing concepts of the position of the auditor within corporate governance structures have at different times encouraged and discouraged the assimilation of the legal treatments of auditors and directors. These concepts themselves reflect differing notions of what actually constitutes the “company”: a collectivity of shareholders or a separate entity controlled by directors. These notions emerged against a background of corporate failure and the need to allocate losses among various parties with different degrees of culpability for failure. However, legal developments do not account by themselves for changing attitudes within the auditing industry towards unlimited liability; acceptance of full responsibility for one's statements, adopted as a badge of professional status, has more recently been seen as inhibiting the commercial development of British auditing.     

The dominant senior manager and the reasonably careful, skilful, and cautious auditor

This paper examines a paradox in corporate audit history that threatens the credibility of the current audit as a means of protecting stakeholders from corrupt senior managers. Using a historical analysis of legal cases of fraudulent reporting and subsequent public accountancy responses, the study reveals the paradox of a corporate auditor denying or limiting responsibility to detect material accounting misstatement (MAM) facilitated by dominant senior managers (DSM), while relying on the honesty of senior managers. The primary finding of the legal case analysis is the persistent presence of a DSM or team of DSM in the context of various contributing features, and the creation by Victorian lawyers of a model of excuses for the corporate auditor. The primary finding from the responses of public accountants is, within the context of the model of excuses and the assumption of managerial honesty, continuous denial, or limitation of auditor responsibility for detecting MAM facilitated by DSM. The consequence of this history is that DSM intent on MAM currently face corporate auditors generally untrained to assess the audit risk of managerial domination facilitating MAM. The paper's single recommendation is that corporate auditors be educated and trained to assess the audit risk associated with DSM facilitating MAM. The paper's contribution to corporate auditing is its use of historical analysis to bring together previously known but relatively disparate matters into a coherent whole that signals a fatal flaw in existing practice.     

An Empirical Investigation of the Interface Between Internal and External Auditors

Professional standards place specific responsibilities on auditors for the discovery of material mis-statements in reports of corporate financial performance. Certain factors have been shown to increase the likelihood of fraudulent financial reporting. One warning sign is the potentially pervasive effect of a weak internal control environment consistent with a weak internal audit group. This study investigates the impact of internal audit department quality differences on auditors ‘willingness to place reliance on the work performed by internal auditors. The study also gives consideration to auditors’ recent experiences with material errors and irregularities and examines the influence of two previously untested individual auditor differences on audit judgment decisions: (1) conflict management style and (2) perception of internal/external auditor communication barriers. The results indicate that auditors attend to internal audit department quality differences and that individual auditor differences exhibit significant influence over auditor judgments. Implications for audit practice are considered and directions for future research are suggested.     

Public Attention 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.     

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.     

The influence of auditor narcissism and moral disengagement on risk assessments of a narcissistic client CFO

Global capital markets rely heavily on independent and skeptical auditors as gatekeepers to provide assurance that corporate financial reports are free of material fraud. The rise of narcissism among the ranks of both client and audit professionals challenge this gatekeeper function. In addition, auditor moral disengagement may undermine auditor skepticism, further eroding public confidence in the integrity of financial reporting and the audit process. We conduct a quasi-experiment with 118 auditors from three international audit firms. In a simulated interview with a client CFO, we examine whether auditors underestimate risks of fraudulent financial statements due to the interactive effects of (1) client narcissism (manipulated verbally and nonverbally) and (2) auditor narcissism. We also examine the influence of auditor moral disengagement on client risk assessments. Results indicate that CFO verbal and nonverbal narcissism significantly influenced auditors’ assessment of management-related client risk. Moreover, auditor narcissism was found to interactively influence client risk inferences such that auditors higher in narcissism exhibited narcissistic tolerance (lower risk assessments) when the hypothetical CFO displayed high verbal narcissism. Auditor moral disengagement was negatively associated with client risk assessments. We discuss the implication of these findings on future audit judgment research, audit firm policy and training on maintaining auditor skepticism, and the audit oversight role of standard-setters.     

SEC communications to the independent auditors: An analysis of enforcement actions

All 415 SEC releases issued between the end of 1972 and the end of 1989 were analyzed to clarify the SEC's philosophy of independent auditing and to document the violations of generally accepted auditing standards (GAAS) reported in the releases. Among the findings are 1) the SEC consistently concluded that the primary purpose of an independent audit is to enhance the efficiency of the capital markets and help protect the investing public by providing reasonable assurance concerning the integrity of the financial statements and related disclosures; 2) the SEC attributed many independent audit failures to questionable independent auditor judgement in adhering to professional standards, most often because of insufficient gathering of audit evidence due to over-reliance on management representations; 3) the large majority of cases in which the SEC associated the auditor with fraudulent financial reporting (usually constructive fraud) involved smaller audit firms; 4) the large majority of cases of management fraud in which the auditors were deceived by clients involved large audit firms. In the final section of this paper, we discuss the influence of enforcement releases on independent audit standard setting and possible implications for the audit profession in the future.     

Anomalies in the Oversight of Australian Auditors

This commentary identifies and comments on anomalies in the oversight of Australian auditors and audit firms. Regulatory and professional oversight and inspection of Australian auditors and audit firms arise from a number of sources, highlighting its multi‐faceted nature. This makes it impossible to identify a single body with ultimate responsibility for auditor oversight. Three recent Australian reviews commissioned by the Financial Reporting Council, together with an evaluation of the roles of the various regulatory and professional bodies, are used in this commentary as a platform from which to identify a number of significant anomalies in oversight processes. Major anomalies highlighted arise from the overlapping nature of the duties and functions of the various bodies and the variation in oversight across different categories of audit service providers. Policymakers should closely examine the issues raised in the paper if auditor oversight is to be undertaken in an effective and efficient manner.     

PERCEPTIONS OF EXTERNAL AUDITORS’ INDEPENDENCE: SOME CROSS-CULTURAL EVIDENCE

The objective of our paper is to contribute to the accounting education literature by demonstrating that there are significant differences among final year undergraduate accounting students in the United Kingdom, Australia, India, and Malaysia with respect to an important concept in auditing, namely, perceptions of external auditors’ independence. To attain this objective, we make an original contribution to accounting cross-cultural studies by operationalizing culture in terms ofindependent and interdependent construals of selfhood. These fundamental core cultural differences are important because they play a major role in regulating psychological processes including perceptions. Additionally, to gain insight into the evolving complexities associated with understanding culture in a global economy, the concept of acculturation is invoked in hypothesis formulation. We find support for the hypothesis that students from countries with greater political, economic and socio–cultural interactions (UK and Australia) are likely to have greater similarities (i.e., lesser variations) in their perceptions of external auditors’ independence, compared to students from countries that have less acculturation (other pairs of countries). The results have implications for improving learning and teaching of auditing in the four countries. Specifically, accounting educators may like to ensure that the meaning intended in the various national and international auditing pronouncements with respect to external auditors’ independence is effectively communicated to students within specific national cultural contexts. Our findings may also be useful to various international bodies whose objectives are to harmonize auditor education. The results also suggest that there is a need to critically question the assumptions made by professional accounting firms operating cross-nationally that it is possible to attain a single global set of audit procedures and codes of professional conduct.     

Does Ethical Culture in Audit Firms Support Auditor Objectivity?

The suggested cause of constrained auditor objectivity has been centred on auditors' financial incentives and long audit tenure. Recent research has challenged those assumptions and questioned the effectiveness of auditor rotation to counteract short-tenure threats to auditor objectivity. Audit firms and regulators need to adopt methods for enhancing auditor objectivity that are effective in various auditor–client relationships. This study examines whether audit firm ethical culture is positively related to auditor objectivity. Based on the responses of 281 practising auditors, the findings indicate that auditors are more likely to make objective judgments in ethical cultures characterized by the rewarding of ethical behaviour and punishment of unethical behaviour, prevalence of ethical norms, visible ethical leadership, and low emphasis on obedience to authority. In conclusion, evidence indicates that auditors in audit firms with a strong ethical culture are more likely to maintain auditor objectivity than are auditors in less supportive cultures. This suggests that audit firms should promote a strong ethical culture to reduce the risk of constrained auditor judgment.     

Internal auditors’ roles: From watchdogs to helpers and protectors of the top manager

The purpose of this paper is to understand the governance roles of internal auditors in public sector organizations. An analysis of 42 in-depth semi-structured interviews conducted with experienced internal auditors working in public administration in Quebec indicates that internal auditors perform two key roles: a protector role, further subdivided into two roles, protective shield and keeper of secrets, and a helper role, also subdivided into two roles, support of organizational performance and guide. The analysis also shows that internal auditors have developed a nuanced conception of independence defined as ‘grey independence’ in order to perform their roles. Internal auditors consider that their primary role is to serve the top manager and the organization and that they must prioritize the top manager at the expense of audit committee members. Therefore, this paper contributes to the literature on internal auditor independence. Overall, the findings suggest that internal auditing is not the governance watchdog expected by the regulatory bodies since this is not the role performed by internal auditors.     

The influence of judges' attitudes on liability assessments related to failed audits exhibiting significant audit team over-time or significant use of off-shore auditors

This study provides evidence on how audit firms' decisions to use offshore (outsourced) auditors or to assign on-site (local) auditors extensive overtime affect judges' evaluation of auditor legal liability I conduct a behavioral experiment in which actual judges responded to a hypothetical audit lawsuit. The results suggest auditors may be penalized during the litigation process depending on the extent of overtime or off-shoring and judges' attitude toward the public accounting profession. Judges with a positive attitude toward public accounting assessed more liability for an audit firm that used offshore (outsourced) auditors than for the use of extensive overtime for on-site auditors or a control condition. However, judges with a negative attitude toward the auditing profession assessed higher liability for auditors except when on-site auditors bore significant overtime in the final weeks of the audit.     

Australian corporate collapse: The case of HIH Insurance

‘Australia's current financial reporting framework is recognised as amongst the world's best, but this obviously did not and cannot offer immunity from corporate failure’. There are numerous individual factors that can have and are having an impact on the reporting framework and should be addressed. Specifically, the auditor's role is to add credibility to the financial reports prepared and signed off by the company's directors and to provide a high level of assurance that the financial reports are free from material misstatement. Auditors may be unfairly or harshly judged for not foreseeing the collapse and warning the market and shareholders. In some instances there are clear cases of complacency on the auditors' part or outright negligence on the part of the auditor. The HIH Insurance collapse in 2001 has significantly influenced the audit profession, especially in the area of audit independence, audit committee and the legal liabilities of auditors and this case leads to a number of lessons that need to be learnt regarding the audit profession and the responsibilities of auditors.     

Former auditors on the audit committee and earnings management: Evidence from African banks

This paper investigates whether former auditors on the audit committee constrain earnings management through loan loss provisions. Based on an analysis of the annual reports of 82 African listed banks over the period 2011–2016, findings show that the presence of former auditors on an audit committee is associated with lower earnings management. This result suggests that audit committee members with auditing expertise and background contribute to effective monitoring of management’s accounting practices. Furthermore, results reveal that the reducing effect on earnings management of former auditors is strongest for directors who are unaffiliated with the bank’s current external auditor.     

Auditor Fees, Market Microstructure, and Firm Transparency

Abstract:  Auditors, as corporate insiders, have access to private information regarding the firm's financial and business opacity that is unavailable to outside investors. We test whether auditors price their knowledge of firm opacity in their audit fees by examining two competing hypotheses. The first states that higher audit fees may reflect the greater risk that the auditor faces in auditing an opaque firm. Under this hypothesis, market based measures of opacity will be positively correlated with higher fees. The second hypothesis states that firms buy reputational capital from their auditor by paying high fees in an attempt to improve the market's perception of the firm's transparency. In this case, higher audit fees are negatively correlated with market based measures of opacity. Our results are consistent with the first hypothesis, that auditors price opacity risk into their fees.     

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.