Assessing critical views on auditing

Category: Accounting

''Auditing Firms' Fraud Risk Assessment Practices'', Sandra Waller Shelton, O. Ray Whittington, and David Landsittel. American Accounting Association, Accounting Horizons i, Vol. 15 No. 1, March 2001, pp. 19-33

The article analyses auditing firms' fraud risk assessment practices on example of Big 5 accounting firms and two second-tier accounting firms. It pays particular attention to the contribution of Statement on Auditing Standards No.82 (adopted on December 15, 1997) in improving fraud risk assessment methodology and implementation of the methodology by auditing firms. The article makes some differentiation within auditing firms based on fraud risk assessment methodology, which will help me to make classification of auditing sector. Results of this study indicate that audit firms differ as to (1) whether their practice aids for fraud risk assessment are separate or integrated with other risk assessment practice aids, (2) the timing of the fraud risk assessment, and {3) the method of assessing fraud risk.

''Ownership Concentration in Privatized Firms: The Role of Disclosure Standards, Auditor Choice, and Auditing Infrastructure'' Omrane Guedhami and Jeffrey A. Pittman, Journal of Accounting Research, Vol. 44 No. 5 December 2006, Printed in U.S.A.

The article relies on a unique data set to estimate the impact of disclosure standards and auditor-related characteristics on ownership concentration in 190 privatized firms from 31 countries. The article mainly refers to ownership structure in privatized firms, and the role of audit in this context. It is obvious that choice of audit firm can play a decisive role in alleviating agency problems which may arise as a result of confronting interests between minority investors and controlling shareholders. The authors imply that a strong auditing firm (like the ones in Big 5) can curtail controlling shareholders' ability to abuse their control on a firm.

''Determinants of Auditor Choice: Evidence from a Small Client Market'', W. Robert Knechel, Lasse Niemi and Stefan Sundgren, International Journal of Auditing, Int. J. Audit. 12: 65-88 (2008)

This paper analyzes the auditor choices for a sample of 2,333 predominantly small and mid-sized Finnish firms. The sample for analysis is chosen taking into account the liberality of Finish legislation referring to the smallest firms, which can make an audit firm choice from four types of audit firms: first tier international firms, first tier national firms, second tier local auditors and non-certified auditors. The study is of particular interest for my topic, because this spectrum of choice can demonstrate the factors of audit firm choice in one of European countries. The article explains both benefits (improvement of financial statements, potential reduction of cost of capital, reduction of internal agency problems etc.) and losses from auditing (e.g. information disclosure to competitors) for different types of firms.

''Does leverage influence auditor choice? A cross-country analysis'', Gerraldine Broye and Laurent Weill, Applied Financial Economics, 2008, 18, 715-731.

This article investigates the impact of legal environment on the relationship between leverage and auditor choice in 10 European countries. The relationship between the choice of a high-quality auditor and firm leverage varies significantly across countries. This finding suggests the absence of a systematic demand for auditing to mitigate agency problems between insiders and debt holders. The results provide evidence that the stronger the protection of creditor rights and disclosure requirements, the higher the demand for audit quality by highly-leveraged companies. Inversely, the auditor liability exposure has a negative impact on the link between leverage and auditor choice.

''An Examination of Auditor Choice using Evidence from Andersen's Demise'', Kathryn Bewley, Janne Chung and Susan McCracken, International Journal of Auditing Int. J. Audit. 12: 89-110 (2008).

The article investigates the Enron and Andersen scandal, which provides us with a unique opportunity to study the reason why management chooses a particular auditor. The literature suggests that management's choice of auditor sends a signal to the investing public regarding the quality of its financial statements. Not surprisingly, many clients dismissed Andersen quickly after Enron declared bankruptcy - in some cases even before a replacement auditor was engaged - and lawsuits against the audit firm were mounted. However, many clients did not dismiss Andersen until its auditing practice was shut down by the court. This phenomenon can act as a sign of awareness and caution of a firm regarding audit firms. The article can provide my topic with some information about reverse connection between a firm and a chosen audit firm.

Auditing and earnings management: an empirical studies in publicly-traded companies audited by the big four and other auditing firms /Juan Carlos Goes de Almeida, august 2009/

This paper investigates the relations between auditing firms and their ability to mitigate earnings management. In this context, they analyze if discretionary accruals of publicly traded companies audited by the "Big Four" (Deloitte Touche Tohmatsu, Ernst & young, KPMG and PricewaterhouseCoopers) and other auditing firms are statistically different. The final sample consists of 1,414 observations collected from the 1999-2005 period: 897 observations for publicly-traded companies audited by the "Big Four" and 517 representing other publicly traded companies audited by other firms. They use KS model with instruments and non-parametric tests to verify the difference in discretionary accruals between these groups of firms. The results indicate that companies audited by the "Big Four" have a lower level of discretionary accruals than companies audited by other auditing firms, suggesting the capacity to mitigate earnings management. Additionally, they verify that there is little research in this subject in Brazil.

/unfortunately this paper is available only in Spanish/


Brown, G.R. Changing audit objectives and techniques. The accounting review, v.37, n.4, oct.1962

Bushman, R.M.; Smith, A.J. Financial accounting information and corporate governance. Journal of Accounting and Economics, v.32, 2001

Chan, P.M.; Ezzamel, M.; Gwilliam, D. Determinants of ausit fees for quoted UK companies. Journal of Business Finance and Accounting, v. 20, n.6, 1993

Deangelo,L Auditor size audit quality Journal of Accounting and Economics, v.3, 1981

Comunale, C.L.; Sexton, T.R. Current accounting investigations: effect on big 5 market shares. Managerial Auditing Journal, v.18, 2003

Ferguson, A.; Stokes, D. Brand name audit pricing, industry specialization and industry leadership premiums post big 8 and big 6 mergers. Contemporary Accounting Research, v.11, 1994

Krishnan, G. V. Does big 6 auditor expertise constrain earnings management? Accounting Horizons, v.17, 2003

Leventis, S.; Caramanis, C. Determinants of audit time as a proxy of audit quality. Managerial Auditing Journal, v.20, n.5, 2005

Palmrose, Z. Audit fees and ausitor size: further evidence. Journal of Accounting Research, v.24, n.1, a986

------------- An analysis of auditor litigation and audit service quality. The accounting Review, v. 63, n.1, Jan, 1988

-----------The relation of audit contract type to audit fees and hours. -------------------------------- v. 64, n.3, July 1989

Teoh, S.H.; Wong, T.J. Auditor size and the earnings response coefficient. The Accounting Review, v.68, 1993

Financial Effects of External Auditing (First, Incomplete Draft), Gorazd Brumen and Leon Bogdan Stacescu University of Z¨urich, Swiss Banking Institute, March 2008

The paper develops a model of optimal auditing behavior when the economic environment adds a noise term to the firm's cash flows, which can be reduced by employing an external auditor. The paper connects the optimal auditing policy and share prices of the firm and auditor's compensation. Results show that the optimal auditing amount is below the amount needed to totally eliminate the noise in the economy. Moreover there exists a cut-off point for the auditing costs (economic noise) above (below) which auditing is not anymore optimal. In the presence of incomplete information setting, the theory of global games is used to determine the optimal auditing behavior. There are some interesting empirical models concerning auditing firms and and shareholders, and the preference of hiring an additional external auditor, its relationship with the investors' risk coefficient, the best auditing effort, etc.

Kaplan, R. S., 1993, Statistical sampling in auditing with auxiliary information estimates, Journal of Accounting Research 11, 238-258.

The Role of Auditing in Small Private Family Firms: Is it about Quality or Credibility? Mervi Niskanen Jukka Karjalainen Jyrki Niskanen University of Kuopio July 1, 2009

The results suggest that family firms are less likely to use Big 4 audit firms than the non-family firms in their sample of small private Finnish firms. They find that an increase in family ownership decreases the likelihood that a Big 4 audit firm will be engaged. Because of the Finnish database it's also possible to differentiate between the demand for the Big 4 audit firms, other highly qualified certified auditors and non-certified auditors. This suggests that higher quality audits are used to overcome agency costs induced by information asymmetries when ownership dispersion increases. The results also suggest that the demand for Big 4 auditors and the other certified auditors in family firms is different. It seems that the demand for Big 4 audits is driven by family ownership and export activities, whereas the demand for certified audits is driven by firm size, age and debt maturity. This implies that non-family owners and foreign stakeholders are given extra assurance by employing Big 4 auditors. The results show that family ownership has no impact on the demand for certified auditor services. Also, contrary to most previous studies on the demand of audit quality in private firms, leverage does not have a significant effect in this sample of small private family firms. A number of empirical studies have investigated the role that auditors, and audit quality more specifically, have in this context. /There is also an empirical model built for the family-owned firms.