Audit Quality: A supply and demand system

Category: Accounting

Audit quality can be divided into two main areas of research in supply and demand research. supply research focuses on factors affecting the auditor's ability to deliver a quality audit. On the contrary, the investigation of the claim relates primarily to the factors affecting the client and the audit report users, such as shareholders, creditors, and regulators. Several studies on audit quality in each area are presented below to illustrate the diverse research on the subject..

Supply-side studiesÂ

There are many factors that can affect the quality of the audit, the auditor's perspective, including the ability of auditors and financial incentives (Yardley et al. 1992). A large body of research examines the quality of audit decisions and their impact on audit efficiency and effectiveness. Many of the decisions of these studies did not test audit quality directly, but implicitly improvement associated with increased audit quality. For example, Libby and Frederick (1990) found that more experienced auditors have a greater understanding of financial statement errors, suggesting that the auditor decision quality can be improved with experience. Many studies investigate the audit quality by examining supply factors directly. Lys and Watts (1994) examines the relationship between the trials, an inaccurate proxy for audit quality and auditor characteristics of the offer. They found that auditors use less structured audit technology associated with an increased likelihood of litigation. This result suggests that audit quality can be improved with more structured audit technologies. The inverse relationship between implied quality audit and risk of litigation has also been examined in the literature of experimental economics. For example, King and Schwartz (1999) investigated auditors

One of the characteristics of supply that appears to affect audit quality is the size of the auditor. For example, numerous studies (e. g. , DeAngelo 1981, Davidson and Neu 1993, Becker et al. 1998) empirically support a positive association between the size of the audit firm and audit quality. DeAngelo (1981) suggests that large audit firms produce higher quality audits because of their desire to maintain a good reputation in the market, and because of the large audit firms have a broad customer base and are not overly influenced by the prospect of losing an individual customer. Davidson and Neu (1993) found that the association of large companies with large customer forecast errors can be due to market perception of the quality of audits of larger companies

Demand-side studies

A stronger body of research examines the demand factors (e. g. , Client-business and investor characteristics) that affect audit quality. Willenborg (1999) examined the demand for higher audit quality associated with initial public offerings (IPOs) and found evidence that the choice of auditor impacts both IPO underpricing and auditor compensation. Specifically, their findings indicated that IPOs with national auditors are not associated with an increased lowering. This suggests that the use of non-national audit firms in the IPO provides investors with a potentially lower level of damages for auditors (i. e. , Less than a deep pocket) in the case of an audit failure. For a higher quality audit, sometimes clients change auditors. Several studies find that the selection of auditors is associated with the agency cost variables and the need for signaling (DeFond 1992, Firth and Smith, 1992, Francis and Wilson 1988). For example, DeFond (1992) found that changes in institutional ownership and leverage are positively associated with changes in audit quality. This finding suggests that owners and institutional debt holders are active monitors of the companies they finance. As institutional ownership and increase the influence, both institutional investors and creditors may have greater financial incentive to control the behavior of firms. Therefore, these interest groups increased demand for audit quality. On the other hand, DeFond results could be attributed to the management to take a proactive stance and demanding a higher quality audit to indicate their desire to provide reliable financial information.

Abbott and Parker (1999) also investigated the auditor changes and found that the presence of active audit committees and independent is associated with increased audit quality at the time of auditor changes. Their finding, according to agency theory suggests that effective corporate governance acts to limit the operation of the dysfunctional behavior. Thus, the presence of a strong audit committee can create a demand for higher audit quality, ensuring that the audit firm maintains its objectivity and not unduly acquiesce to the wishes of the administration. Abbott and Parker (1999) also investigated the auditor changes and found that the presence of active audit committees and independent is associated with increased audit quality at the time of auditor changes. Their finding, according to agency theory suggests that effective corporate governance acts to limit the operation of the dysfunctional behavior. Thus, the presence of a strong audit committee can create a demand for higher audit quality, ensuring that the audit firm maintains its objectivity and not unduly acquiesce to the wishes of the administration.

Future Research on Audit QualityÂ

New studies of audit quality are appearing, due to constant changes in the audit. Changes include, but are not limited to, the expansion of security services provided by auditors, the audit process modification, and adoption of new technologies. While there are many possible avenues for future research on audit quality, several potentially rich areas are discussed below.

Modeling Audit QualityÂ

Although many factors influence audit quality, few studies have focused on developing a conceptual framework or model to capture audit quality build. The development and testing of models that capture the quality audit is an area ripe for further research. Catanach and Walker (1999) provides a proven model that suggests audit quality is a function of two determinants of performance audit: auditors ability (including knowledge, experience, adaptability and mastery of technology) and professional conduct (including independence, objectivity, due professional care, conflicts of interest, and trial). In addition to the factors that determine the performance, the model also includes the impact of economic incentives (e. g. , Fees, costs, efficiencies, litigation and consulting services), market structure (e. g. , The competition, industry concentration, economies of scale, and regulatory mechanisms) and audit tenure on audit quality build. While many of the components included in the model have been studied, this framework captures many of the complexities listed in the audit quality literature. Researchers interested in modeling audit quality can test hypotheses and the links of the Catanach and Walker (1999) model. The question of what factors have more influence on the quality of the audit is a promising avenue of research. In addition, their model should be tested under various conditions to determine its robustness, with modifications, if necessary.

Internal Audit QualityÂ

Research on audit quality could also be expanded in the domain of internal audit. While the results in the field of internal auditing would benefit the profession of internal auditing, could also help the external auditors rely on internal auditors' work. Although the factors that influence the quality of internal audit is likely to be similar to those affecting the quality of external audit (e. g. , Training, experience), some important differences can arise. For example, the level of management that internal auditors report may affect their objectivity, as well as internal auditors receive incentive-based compensation (at DeZoort et al. 2000).

Client Structure and Auditor SpecializationÂ

Finally, further research on specialization auditor can give an idea of audit quality. In contrast to studies using the expertise of the auditor of the industry as the supply factor, future research should focus more on how demand factors affect the customers' need for specialists of the auditor. Customers can growing demand for audit quality through the use of industry specialists for many reasons (e. g. , The wishes of the owners and holders of corporate debt). For example, companies with financial difficulties can hire specialized auditors to indicate their desire to release financial information more reliable. Evidence of an association between audit quality and industry specialist auditors can help audit practitioners to better meet the needs of its customers.

SummaryÂ

Many factors play a role in determining the quality of the audit. While studies have examined various aspects of audit quality, powers covering quality of the audit should be conducted. For example, the development of comprehensive models of audit quality could capture many of the complexities found in research on audit quality. Furthermore, what constitutes quality audit to an audit of traditional financial statements may differ from what constitutes quality of audits in internal control reviews or performance of specific commitments. Therefore, there is still much to understand about audit quality and there is ample room for further research on the subject. undefined While studies have examined various aspects of audit quality, powers covering quality of the audit should be conducted. For example, the development of comprehensive models of audit quality could capture many of the complexities found in research on audit quality,Furthermore, what constitutes quality of the audit for a traditional audit of financial statements may differ from what constitutes quality of audits in internal control reviews or performance of special commitments. Therefore, there is still much to understand about audit quality and there is ample room for further research on the subject.