Corresponding author: Anna Gold ( anna.gold@vu.nl ) Academic editor: Barbara Majoor
© 2021 Dominic Detzen, Anna Gold.
This is an open access article distributed under the terms of the Creative Commons Attribution License (CC BY-NC-ND 4.0), which permits to copy and distribute the article for non-commercial purposes, provided that the article is not altered or modified and the original author and source are credited.
Citation:
Detzen D, Gold A (2021) The different shades of audit quality: A review of the academic literature. Maandblad Voor Accountancy en Bedrijfseconomie 95(1/2): 5-15. https://doi.org/10.5117/mab.95.60608
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This paper reviews the academic literature on the different conceptualizations of audit quality. We argue that these discussions are rooted in the historical development of the audit profession, which has shown the need for audit quality indicators. However, we also demonstrate that audit quality means different things to different people, such that different conceptualizations of audit quality may lead to conflicts, as these views meet and need to be reconciled. The literature largely recognizes the multi-faceted nature of audit quality, which cannot be simply measured by a focus on adverse outcomes, such as restatements or fraud incidents. Instead, it is the combination of process, people and motivation that drives the quality of audit services provided by firms. Finally, the qualitative audit literature emphasizes that audit practice needs to be understood as a set of social interactions, which are embedded in a diverse set of organizational and contextual factors that together determine audit judgments and auditor behavior.
audit quality, audit quality indicators, literature review
Our literature review is relevant for audit practice by highlighting that definitions of, and efforts to improve, audit quality need to pay heed to its versatile drivers, rather than adhere to stark or reductionist understandings of the concept.
“Audit quality is much debated, but little understood” (
Overall, our review leads us to the following conclusions. First, there is a rich history of debates about the shortcomings of the audit profession, which resonate well with contemporary debates and attempts to change auditing (section 2). Second, audit quality means different things to different people, which may lead to conflicts when these views meet or need to be reconciled (section 3). Third, academic conceptualizations of audit quality recognize the multi-faceted nature of auditing, where attention needs to be paid to process, people and motivation, rather than an exclusive focus on for example adverse outcomes (e.g., restatements, accounting scandals) (section 3). Finally, qualitative research highlights that audit judgments need to be understood as a set of social interactions, which are embedded in a range of organizational and contextual factors that together determine auditor behavior (section 4).1
Before proceeding we emphasize that ‘audit quality’ constitutes a rather broad topic in the auditing literature, and different streams tend to conceptualize it in vastly different manners. As such, it is a challenge to synthesize the literature in a compact and coherent way. Hence, we largely refrain from citing individual academic studies for the sake of brevity (esp. in section 3); instead, we refer the reader to the respective review articles for the relevant sources. Per definition, a literature synthesis includes some level of interpretation by the authors to be informative. Further, much of the research cited focuses on countries other than the Netherlands, which means that the institutional contexts and regulatory environments differ. Nevertheless, it is believed that the findings of those studies apply by extension also to the Dutch audit environment, especially given their focus on the relatively universal concept of ‘audit quality’.
Auditing as a self-regulated activity can be traced back to the emergence of the regulatory framework of financial reporting and securities regulation. In the United States (on which most of the research focuses), this occurred in the 1930s, when the Securities Acts emerged following the stock market crash of 1929. Legislators adopted a model of “participatory regulation” (
Yet this setup relied strongly on the independence of auditors, so attempts were made early on to eliminate conflicts of interest, arising for example from financial relationships between auditor and client (
In the aftermath of these accounting scandals, academics engaged in a historical-critical analysis of ‘what went wrong’ (e.g.,
It is thus largely accepted in the academic literature that, over time, commercial values have emerged as a significant factor in the audit firms, where they potentially conflict with professional values (
Notably, several issues and debates in auditing are recurring and seem to reflect tensions in the fundamental construction of the audit function (
In sum, this brief historical review implies that the increased emphasis of commercial attitudes in audit firms has resulted in several scandals that triggered the need to focus on and measure audit quality to safeguard the audit function. In the next section, we provide a summary of how the auditing literature defines and conceptualizes audit quality and its indicators.
As
Academic research on auditing began in earnest in the early 1980s with Linda
More recent audit quality frameworks agree that the concept of audit quality is best understood by conceptualizing auditing as a process and examining factors belonging to the various elements of this process. These factors are often labeled audit quality indicators (
In the following, we first summarize the four audit process elements (3.1- audit inputs, 3.2- audit process, 3.3- audit outputs, and 3.4- context) and their respective audit quality indicators, closely following
Next, we extend
Conceptualization of audit quality (adapted from
Each audit client is unique (“idiosyncratic”), as is the level of risk associated with each engagement. Hence, the resources required to audit a given client and obtain reasonable assurance by definition vary per engagement. What goes into the audit (audit inputs or auditor supply) will obviously affect the quality of the audit (
Recent behavioral research in auditing has focused on auditors’ professional skepticism as an important indicator of audit quality in the input phase, documenting a positive association between professional skepticism and audit quality (e.g.,
Not surprisingly,
An audit consists of several predefined phases, ranging from client acceptance, through audit planning and audit testing, to audit completion and reporting. Based on
Generally, auditing research has established that a variety of factors influence the nature of the audit production process, which is typically assessed by the nature and extent of testing, assignment of expert staff or specialists to the audit etc. Research concludes that the interaction of risk factors and circumstances (e.g., client attributes, audit team structure, etc.) determines the auditor’s production plan.
The auditor’s assessment of risk is an important determinant of the nature, extent and timing of audit procedures, which in turn have a direct influence on the delivered audit quality. Prior research demonstrates that the approach used to assess risks (e.g., holistic versus decomposed) results in different assessments (e.g.,
Just as any human being, auditors are subject to heuristics and biases in their decision-making, some of which can serve as barriers to the quality of an audit. The behavioral auditing literature has indeed documented that auditors are susceptible to variety of judgment biases (e.g., confirmation, anchoring, etc.). One audit phase in which biases have received extensive attention is the application of analytical procedures, during which auditors tend to anchor on “inherited” information rather than developing their own expectations (see
Audit firms have powerful control and monitoring mechanisms in place to ensure high audit quality, and much research demonstrates such positive effects. However, some research also points to adverse effects on judgment quality. For example, while the purpose of the review process is to detect auditor errors and make timely corrections and to increase auditor accountability (and hence effort), research finds that reviewees are sometimes biased when made aware of their reviewers’ preferences (e.g.,
Finally, a large body of research has examined the negotiation between auditor and client, and the factors that lead to superior auditor negotiation performance, such as interpersonal factors, auditor characteristics, client characteristics, but also the negotiation strategies that are used (see
Examining the output of an audit is arguably the most direct indicator of audit quality. While most of the research discussed thus far entails experimental efforts to examine audit quality by looking at auditor judgments, there is considerable archival research on audit outcomes based on a variety of publicly available proxies. The most important proxies are audit failures, financial reporting quality, and audit reports.
First, researchers can approximate audit failures by measuring binary indicators for extreme, negative audit quality outcomes (or audit failures), such as (1) the presence of an accounting restatement, (2) litigation against an auditor, (3) regulator (e.g., SEC) enforcement action against an auditor or audit firm, and, more recently, oversight inspection results. In summary, the overall evidence points to a very low audit failure rate. However, it is unclear how high the “true” failure rate is, since not all cases are reasonably observable.4 As a result,
One way to measure audit quality on a more continuous scale is to turn to the client’s audited financial statements. The premise is that the production of the financial statements is a joint product by clients and their auditors; hence their quality also reflects the quality exerted by the auditor (
A third way to assess audit quality is to directly examine the audit report issued by the audit firm. While most report modifications are rare, researchers have primarily turned to the issuance of going-concern audit reports (which is not a modification in the strict sense, but rather an emphasis of matter; see
While the elements discussed thus far concern the indicators of audit quality related to the auditor, a range of studies have examined the exogenous demand for auditing. In theory, “the value of auditing arises from its ability to assure that the financial statements faithfully reflect the client’s underlying economics. These assurances reduce information risk, which ultimately improves resource allocation efficiency, including contracting efficiency” (
Client demand for audit quality was clearly affected by the introduction of SOX. For example, stricter audit committee requirements (e.g., increased independence from client management) changed how auditors were selected, retained and fired. Research finds that more independent audit committees indeed are more likely to hire industry specialists, pay higher audit fees, purchase less non-audit services, and hire fewer former audit employees.
While auditing is mandated for a large range of clients,
More recently,
The regulation of audit markets intends to improve audit quality by aligning auditors’ and clients’ market-based incentives and competencies (
First, auditor independence entails avoiding, or mitigating, the conflicts of interest that auditors are subject to. Both
Second, the position of audit clients’ audit committees has been strengthened by recent reforms, such that these committees now formally appoint the auditor in companies, which has direct consequences for client demand (see section 3.5). While a range of studies have documented benefits of effective audit committees for financial reporting quality (
Third, a major change in the audit framework occurred when, starting with the PCAOB in 2002, audit oversight bodies were installed that conducted independent inspections of audit files. Early archival findings as to the efficacy of the PCAOB inspection regime are somewhat inconclusive (e.g.,
Notably, however, markets and decision-makers have remained skeptical of the audit profession as well as such inspections (
Regulatory intervention thus tends to have an uncertain outcome for audit quality (
This section provides additional insights from the qualitative auditing literature, which tends not to explicitly use the term “audit quality”. Yet, given its prevalent use of case/field study, interview, or observation methodologies, this literature stream seems highly suited to shed light on the process, people and motivation, which have been revealed as contributing to the services provided by audit firms. Accordingly, this literature understands auditing as a social practice, which is influenced by social interactions (section 4.1), and examines how individual auditors are embedded in the organizational context of audit firms (section 4.2), all of which affect the work of auditors, their judgments and their behavior, and hence also audit quality.
Auditing can be viewed from a micro-perspective as a set of practices and routines. Such notions point to the affective or emotional dimension of auditing, which is hence constituted of micro-rituals that, once completed, give ‘comfort’ to the auditor (
Likewise, there is a perennial debate as to how much audit practice should be standardized and how much room for judgment should be given to auditors (
Related to this is the question of understanding auditing as a business, where cost controls and quality objectives push audit firms in different directions. This trade-off is visible in time budgeting, planning and reporting processes, and is embedded in the management control system of the firms, where it is (invisibly) imposed on individual auditors and resolved on the spot (i.e. on individual audit engagements). Arguably, this has given rise to a business risk audit approach (e.g.,
Based on these insights,
Another (qualitative) literature stream outlines the ways in which the organizational context of audit firms affects the behavior of individual auditors and conceptions of what it means to be a professional. Much of this literature is about how newcomers are socialized into audit firms, i.e. how they are made familiar with what is expected of them by the environment they just joined (e.g.,
Once auditors advance through the ranks, other aspects of audit practice need to be incorporated in auditors’ understanding of their work. As such, managers need to navigate and manage a complex network that includes supervision of juniors and interactions with clients, and being an essential link to audit partners (
It is thus the organizational environment that weaves “a web of control” around audit firm members (
This paper has argued that many of auditing’s intricate dilemmas, such as the expectation gap, the trade-off between professionalism and commercialism, or auditor independence, are in fact inherent in the audit function and have persisted in different forms throughout the decades. Whereas auditing was initially considered to be part of the regulatory solution to safeguard investors’ trust in firms’ financial statements, it soon was at the receiving end of regulation. For a long time, the audit profession managed to deflect fundamental regulatory intervention, thus preserving its status quo. As some of the more critical voices in the academic literature argue, this became more problematic over the decades, as commercialism increased in the firms, leading up to the accounting and audit scandals in the early 2000s. Since then, a range of regulatory changes have been enacted, but the academic literature casts doubt on the effectiveness of regulatory intervention, that is its ability to resolve these longstanding problems of the audit function (
We have also demonstrated the multi-faceted nature of audit quality, implying that there is no one superior way to measure and assess it. Notably, the academic literature consistently highlights a procedural conceptualization of audit quality, and we concur with
We also outlined two qualitative research streams that have a bearing on audit quality. On the one hand, it is suggested that auditing is a social practice that consists of human interactions in a social context. In their daily practice, auditors face the difficult task of balancing structure against judgment, as firm policies and procedures may dictate one thing, while their professional judgment may guide them elsewhere. Likewise, practice is based on a set of routine interactions that auditors have come to appreciate as part of creating sufficient ‘comfort’ to approve a client’s financial statements. On the other hand, the qualitative literature points to the organizational context of auditing, where the values, rules and norms embedded in the audit firms are conveyed to individual auditors by a range of (more or less subtle) social control mechanisms. Compliance with these norms has been documented to have a strong impact on auditors’ career trajectories. In sum, this literature argues that the social and organizational context of auditing has a strong impact on the work of auditors, their judgments and their behavior, and thus also on audit quality, however defined.
In sum, our literature review has been targeted at raising awareness of the multi-faceted nature of the concept of audit quality. Despite its widespread and conversational use, the term escapes a simple definition. Following our review, we believe that efforts to improve audit quality should devote attention to the entire audit function, that is, the process, people and motivation that together affect the services provided by auditors and the quality thereof. While research and practice may prefer a simple set of measures or dials that can be turned to ‘improve’ audit quality, we caution against such a simplistic and reductionist understanding of the concept. This may make reform efforts more cumbersome and complex, but it reduces the fuzziness of discussions and prevents the binary labeling of audit quality as ‘high’ or ‘low’. As such, we advocate a holistic understanding of the audit function, which may increase appreciation of auditing as a people’s business, a social practice that is integral to the functioning of capital markets and wider business processes.
Dr. Dominic Detzen is associate professor of accounting at Vrije Universiteit Amsterdam.
Prof. dr. Anna Gold is full professor of auditing at Vrije Universiteit Amsterdam and adjunct professor at Norwegian School of Economics (NHH).
This paper is based on the report that the Commissie Toekomst Accountancysector (CTA) commissioned us to prepare for their consultations on the Dutch audit sector (CTA 2020). We thank the CTA for granting us permission to re-use the material from our report for the purposes of the current article. Also, we thank the reviewers for valuable comments on an earlier draft of this article.
The current paper is an abbreviated and slightly adjusted version of the report written for the Commissie Toekomst Accountancysector (CTA). The CTA used our report in the development of their recommendations on the future of the auditing profession in the Netherlands (CTA 2020).
Per category, we refer to a selection of relevant extant papers reviewed by
For example, the majority of lawsuits against auditors are settled outside the court; the SEC may not have the resources to pursue all cases.