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Summary advanced auditing

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Vrije Universiteit Amsterdam (VU)

I offer my summary of the course 'advanced auditing' for sale. The summary is 88 pages long and contains all the MANDATORY articles of the advanced auditing course (it excludes notes of the lectures and of the non-mandatory articles!). Sometimes I refer in this summary to a specific image or graph ...

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Summary advanced auditing
Audit quality: insights from the academic literature (Knechel et al., 2013)

This study presents a review of academic research on audit quality (definitions, general
frameworks, indicators, and suggestions future research).

Audit quality is much debated but little understood. No consensus about definition and
measurement. All stakeholders in the financial reporting process may have very different views
as to what constitutes audit quality, this influence types of indicators used.
 All perspectives on audit quality are correct to an extent but are also incomplete.
Characteristics that could influence audit quality:
- Incentives matter: economically motivated response to risk.
- Outcome is uncertain and unobservable.
- Uniqueness matters: each engagement is different.
- Process matters: audit is a systematic activity.
- Professional judgment matters.

There is diversity in definitions.
DeAngelo (1981) defines audit quality as “the market assessed joint probability that a given
auditor will both discover a breach in a client’s accounting system, and report the breach”. This
definition consists of two components:
1. The likelihood that an auditor discovers existing misstatements.
2. Appropriately acts on the discovery.
 Different aspects of the audit can influence overall audit quality.
There are a number of definitions of audit quality in the literature that reference the
responsibilities of the auditor in terms of the audit process or the goal of the audit.
And some researchers focus on defining “poor audit quality” by identifying adverse outcomes
from an audit.
 There is currently no unified definition of audit quality.
Different frameworks are developed for establishing audit quality.

,For each driver, the FRC identified several potential indicators of audit quality.

Francis (2011) proposed a framework where he noticed that audit quality is a complex concept
and there are gradations of audit quality across a continuum.

 Various frameworks for audit quality highlight that the evaluation of audit quality is a
multi-dimensional challenge from both a theoretical and practical perspective.
 A balanced scorecard for auditing might provide a way in which to simultaneously
address different stakeholder viewpoints. This consist of four categories: inputs,
process, outcomes and context.
 The indicators included in a scorecard include both financial and non-financial
measures.

,Inputs: A presumption of the audit risk model that drives audit planning and evidence gathering
is that the riskiness of each client is unique (idiosyncratic). The resources needed to obtain
“reasonable assurance” vary across engagements. An audit is a knowledge based professional
service producing an uncertain and unobservable outcome.
 The inputs of audit quality cannot be defined in strictly quantitative terms.
 Incentives and motivation
 Auditor judgments can be impacted by incentives that in turn can negatively or
positively influence the quality of the audit process.
 Professional skepticism
 Existing research has documented a positive relation between professional
skepticism and audit quality.
 It is proven that an auditor’s experience with a client and other situational factors
are stronger determinants of an auditor’s level of professional skepticism than are
dispositional factors.
 Knowledge and expertise: Auditor knowledge and expertise have a direct bearing on
the quality of the audit.
 Domain specific knowledge.
 Industry expertise.
 The quality of an auditor’s judgment is also influenced by pressures emanating from
the firm itself. These pressures can arise from immediate supervisors on the audit
team or the overall evaluation process used by the firm.
 In general: improvements in inputs should lead to improvements in other indicators of
audit quality such as outcomes.
Process: an audit consists of a number of phases.
 Judgment in the audit process.
Auditors have been found to be susceptible to two common heuristics: anchoring
and adjustments, and representativeness.
 Systematic biases in auditor judgment also can occur as a result of knowledge of
certain information.
 Audit production.
The degree of client complexity and risk significantly influence audit production in
terms of 1. The planned extent or hours of testing. 2. The nature of planned testing.
3. The personnel assigned to the audit.
 Auditors adjust their production plan in response to increased risk factors.
 Assessing risk.
Auditor risk assessments are important because they determine the nature, extent,
and timing of planned procedures. There are a few factors that impair the quality of
auditor risk assessments.
 Analytical procedures.
Analytical procedures are an integral component of the audit process and greatly
benefit risk assessments made by the auditor.
 Obtaining and evaluating audit evidence.
An audit methodology is specifically designed to help an audit team cope with the
uncertainty in an audit in a systematic manner.

,  Auditor-client negotiations.
As part of the audit process, auditors negotiate with their client to produce the
resulting financial statements. Auditor client negotiations are influenced by several
contextual features.
 Review and quality control.
Much research demonstrates the positive effects of good quality control and review
processes on audit quality.
 Because of large amounts of uncertainty, both during the audit process and in audit
outcomes, auditors’ judgments are susceptible to individual cognitive biases.
Outcomes: the literature has viewed the presence of higher audit quality in terms of lacking
certain negative outcomes or having certain positive outcomes.
 Adverse outcomes.
 Proxy for negative audit quality is the presence of an accounting restatement.
 Another potential adverse outcome suggesting negative audit quality is litigation
against an auditor.
 Financial reporting quality.
 In general, research has shown a negative relation between the level of discretionary
accruals in total, or income increasing accruals alone, and proxies for audit quality
including Big N auditors, auditor specialization, auditor tenure and audit office size.
 Audit reports.
The accuracy of audit reports is often viewed as a signal for audit quality.
 Some people argue that the effectiveness of the auditor’s report, as an indicator of
audit quality is limited due to the restricted content of the report, i.e. it is essentially
a pass/fail report.
 Regulatory reviews of audit firms.
 Perhaps the most direct outcomes of audit quality are the results of regulatory
reviews of audit firms.
 Researchers are just beginning to examine the effectiveness of the PCAOB
inspections process despite the empirical challenges. Research studies suggest that
PCAOB inspections may improve audit quality, especially for small audit firms.
 Because the outcome of an audit is uncertain and unobservable, researchers turn to
indirect, but measurable proxies for audit outcomes. They tend to identify what high
audit quality is not rather than what it is.
The common measures of audit outcomes (proxy for low audit quality) include the
presence of financial statements restatements, auditor related litigation, poor financial
reporting quality, inaccurate audit reports and audit deficiencies identified during
regulatory reviews.
Context.
 Audit partner compensation.
Currently, there is little evidence documenting a direct link between partner
incentives and audit quality.
 Abnormal audit fees.
 Researchers have documented that abnormal audit fees can be indicative of
financial reporting problems within a firm.

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