Audit Quality, Reports and Standards

Abstract

This paper will critically examine the meaning and importance of audit quality as well as the implications of audit report in respect of the compliance with the audit standards. Drawing from the academic, professional and relevant literature as well as the expert analysis the paper will first explore the various contrasting aspect of audit quality, the implications in the current practice, criticisms as well as the measures that corresponds to the criticisms. Moreover, the paper will provide measures that have been put in place to ensure effectiveness of the system.

Introduction

Following various corporate scandals and the resultant collapse of some firms, the need for high quality audit increased. Some examples of the collapses and corporate scandals that were attributed to the lack of quality audit standards materialized in the cases of corporations such as Andersen Corp. collapse and Enron Corp debacle. Considerable attention has also been given to various factors that could have affected the audit quality. In essence, almost all professional accountants agree that quality audit is the production of financial information devoid of any financial misstatement, omission or biases (Francis & Simon 1987, p.147).

Indeed, the meaning of audit quality can be drawn from various perspectives, either from the agency perspective, client perspective or the public. According to Francis (2004, p.351), audited financial statements are the mechanisms for evaluations that provides the assurance to the financial statement users. Francis et al. (1990, p.373) describes the audit quality from two perspectives. The first perspective is the identification of the financial misstatements and errors while the second perspective is the reporting of these material financial misstatement and errors.

Audit quality has various characteristics though researchers have used various proxies to measure the audit quality. According to the Geiger and Raghunandan (2002, p.189) audit quality has these characteristics, significance, reliability, objectivity, scope, timeliness, clarity and efficiency. However, audit quality can be measured by the audit outcome or output (Herrbach 2001, p.809). The audit output is the attainment of the audit objectives. The attainment of the audit objectives will depend on the audit firm leadership responsibilities to uphold quality, compliance with various relevant ethical requirements, accepting the continuation of the relationship with the client on specific engagements, the firm’s human resources, the engagement performance and the monitoring of the whole auditing process (Hilary & Lennox 2005, p.213).

The investigations on the audit quality have been done through different perspectives. For instance, there exists a vast literature on audit independence, audit reduced quality, ethics, judgments, public sector and the client services. According to Knechel (2000, p.697), most researchers by and large accept the fact that the brand name or the size of the audit firms contributes hugely to the audit quality. The major aim of this article is to provide comprehensive critical evaluation of the relevant literature on audit quality as well as the existing relationship to the current auditing practices.

Audit quality defined

Knechel et al. (2007, p.22) assert that audit quality is the market-assessed joint probability that a given auditor will detect material misstatement in the client’s financial statements and have the ability to report that material misstatement. In regards to this definition, it is the function of the auditor to provide quality auditing through the detection of the material misstatement and reporting the errors. In general, the audit quality is the principal function of the auditor to provide technical abilities (detect material misstatement) through the use of auditors independence.

Given the fact that audit quality purpose is to offer quality assurance on the financial statements, Krishnan & Schauer 2000, p.11) defines audit quality as the likelihood that financial statements hold no material misstatement. This description of the audit quality draws from the results of the auditing and the reliability characteristic of audited financial statement to reflect the audit quality. This definition seems to reflect the actual audit quality because the audit quality could not be seen before and during the time it is being performed. Therefore, a valid proxy is required to examine the relationships that are exists between the actual audit quality in addition to extra factors (Lowensohn et al. 2007, p.707).

Based on the guidelines provided by the IAASB, compliance with the legal and ethical standards is what is perceived as high audit quality. According to the IAASB, audit quality can be viewed from three primary aspects that comprise content factors inputs and outputs. The most important inputs to audit quality are the compliance to audit standards. Another important input is required personal attributes of the auditor such as the skills, competence, experience, mindset and the ethical values (Miettinen, 2008). Besides, audit process forms the fundamental input to the audit quality. The audit process are concerned with issues that includes the quality of the audit methodology, how the audit tools used are effective, the ease of use of the technical support and how all these are directed towards supporting quality audit.

The audit quality is essentially influential since the stakeholders frequently use the output in assessing the quality of the financial statements which in essence is the audit quality. For instance, if the audit quality clearly expresses the audit outcome, then it is positively viewed as influencing the audit quality. Equally, the communication of the auditor to the authorities on such issues concerning the qualitative aspects of financial reporting of an entity, deficiencies and practices in the internal control is also perceived as the positive influence on the audit quality (Krishnan 2003, p.7).

Content factors like sound corporate governance are good facilitators of the audit quality. When Sound governance creates a climate of transparency and ethical behavior within the firm, then it positively influences the audit quality. Law and regulations can also positively influence the audit quality. Law and regulations creates structures within which quality auditing can effectively be conducted. In addition, the quality of appropriate frameworks for financial reporting has effect on the audit quality (Miettinen, 2008). Financial reporting that discourages robust and transparent disclosure of financial statements could have adverse effects on the audit quality.

According to Watts and Zimmerman (1986, p.9), audit quality is the process where the auditors apply mechanisms through which financial statements are evaluated to help in reducing the asymmetric information. In addition to the monitoring of the financial statements, audit quality protects the interest of the potential stakeholders through the provision of reasonable assurance that managements financial statements are devoid of material misstatements (Watts & Zimmerman, 1986).

The monitoring function of the audit quality performance varies. In essence, audit quality defines the process through which auditors detect and report the material misstatements found within the financial statements, drastically decreases the information asymmetry between stakeholders and management of an entity (Warming-Rasmussen & Jensen, 1998). In this sense, the audit quality helps in protecting the interest of stakeholders.

High audit quality is normally being associated with high information quality concerning the financial statements (Warming-Rasmussen & Jensen, 1998). The reason is that the financial statements audited by high quality auditors have slight probability of containing material misstatements. The increase in the audit quality is due to the reduced information asymmetry and increased information quality on the financial statements. For example, Becker et al. (1998) used the discretionary accruals as the measure for the management earnings. They found that there is negative relationship between the audit quality and the income-increasing discretionary accruals. The indication is that there is indirect correlation between high audit quality and low information asymmetry (Roshan & Jubb, 1998).

Schelluch and Thorpe (1995) claim that the perceived audit quality is normally founded on how the users perceive the financial statements. Conversely, the actual audit quality is the ability of the auditors to detect and report accounting misstatements. In regards, to the perceived audit quality, the users of financial statements lack access to the information audited and to the evidences that are gathered during the audit process. In this case, the users of financial statements cannot have a proper assessment of direct audit quality.

The definition of audit quality by De Angelo that audit quality as the market-assessed probability that auditors will detect material misstatement and reports the errors in the client financial statement is a perceived audit quality. Consistent with De Angelo (1981) arguments, reporting the material statements is the independence characteristic of the auditor. Therefore, the audit quality is the function of the auditor ability of detecting material misstatement.

Audit quality standards

Quality audit are usually derived from quality standards that assume various formal international and national standards. Examples of international audit quality standards are ISO-900x and IAASB. However, such quality standards hardly generate audit quality themselves. The reason behind this assertion is that the processes thru which organizations would time and again deliver the preferred quality of its products or services should clearly be defined (Fernando, 2007). Rarely does maximum quality become corporations preferred objective given that it might take too long and cost too much.

Furthermore, Standard authorities hardly request to make business judgments as well as to implement them on the business. This is merely done in cases where some minimum quality standards are supposed to be met. Thus, audit quality standard stipulates that all organizations should use controlled procedures to create for all the quality audit processes. In fact, the underlined procedures need to deliver the sought after quality (Behn et al., 1997, p.15). Therefore, the audit quality standards would warrant properly defined, applied, conversed and restricted procedures.

Importance of audit quality

Any corporation that desires to develop its processes, identify the problematic areas and hence become more efficient must spend ample time to perform self inspections. Audit quality permits business enterprises to exactly do that (Deis & Giroux, 1992, p.463). Basically, quality audit serves as a useful tool by helping and promoting the continual improvement purpose. It is after auditing has been completed that corporate management evaluates the companies performances based on the audit results and subsequently make decisive business decisions derived from them. Consequently, audit quality main objective is to determine the organization management efficacy. Through processes inspections, companies have the capacities to identify any area that requires improvement (Craswell 1999, p.34). When quality audits are conducted by corporations, they are capable of policing themselves without necessarily involving other external firms.

Audit quality greatly enhances the chances that auditing results could be depended on and recommendations for improvements might be seriously considered for implementations (DeAngelo, 1981, p.183). The reputation of an organization based on the provision of consistent high quality audit work assists in ensuring that decision makers will assuredly and more readily accept the audit findings and aptly implement all the recommendations (Beattie & Fearnley, 1995).

This implies that, over time, reputations are built via generating consistent high quality audit work. In fact, hard earned reputations are in line with every commodity that an organization produces. Hence, for the maintenance and continual building of excellence, every member of an organization as well as the formed teams must be totally committed (Carcello, Hermanson & McGrath, 1992).

Various challenges to the audit findings together with the proffered recommendations are usually anticipated. As organizations progressively manage more sensitive and tougher audit issues that accrue due to quality audit, challenges to their works increase. It is hardly unusual for any constituency to think that it might be better off when the quality audit results are called into serious questioning or could be disapproved (Behn et al., 1999, p.587). A triumphant challenge which demonstrates inconsistencies or minor errors can probably call into the questioning of the audit work quality which supports the principal audit recommendations or findings.

Irrespective of the reasons for challenging audit reports, if an audit report has no quality, it could be refuted successfully by demonstrating that the conclusions, recommendations and findings are supported and warranted. It is therefore true that effective audit quality control systems are the foundations for making certain that audit results aptly meet the needs of the clients each moment and endure the challenges which are directed towards them (Behn et al., 1997, p.15).

Top management involvement

The audit quality control systems ought to be deeply anchored on the expectations of the top management and should insist on the procedures, policies and principles through which it could be realized as well as appraised (Fernando, 2007). The system guidance must establish and proffer what are anticipated at every audit assignment stages or phases and leave ample room to initiate and create how they should be carried out. The communicating system guidance needs to be readily accessible by each staff member at every organizational level.

Supporting arguments for the importance of audit quality

The perception and importance and effectiveness of auditing to the capital markets and industrial operations are well recognized. For instance, Balsam, Krishnan and Yang (2003) and Colbert and Murray (1998) assert that devoid of high quality audit, corporations could be facing higher capital costs and they could thus be very inefficient. Duff (2004) in the same way made a conclusion that audit quality directly affects the reliability financial information that sequentially have critical role in various firms.

Thus, audit quality materializes to fundamental in the provision of confidence that participants in both goods and capital markets require. Audit quality equally plays a considerable task appertaining to effective economic resources allocation. This has led to the discernment that poor audit quality is one of the causes of the corporate failure (Barkess & Simnett 1994, p.102).

Recommendations

To ensure that audit quality standards are adhered to, the audit quality standards must observed as a construct that is multidimensional. This means, organizations should avoid seeing quality audit as a perception that relates to independence and technical competence. Besides, audit firms ought to lay much emphasis on the basic quality audit elements to both the stakeholders and customers when they endorse their services. In fact, capability and reputation should be perceived as the utmost technical dimensions. The auditor must be obliged to institute systems which can improve and monitor audit quality. Finally, follow-ups and monitoring the audit systems should be deemed as an audit priority. These can be achieved thru the commitment of the partaking parties.

Conclusions

A number of attempts have been made to define the term audit quality. However, none of these definitions can be said to be comprehensive and holistically capture all that is required in the audit quality. In other words, none of the definitions provided have been universally accepted and recognized. In essence, the audit quality is a concept that is complex and multifaceted. In as much as many people will put more emphasis on the direct influences of the audit quality in the firm’s management, the single perspective is not significantly sufficient to the conclusion that the audit quality has been achieved in its broadest contest.

Moreover, the perceptions of the concept of audit quality differ among the stakeholders. The stakeholder’s perceptions of the audit quality depend on the level of their direct involvement with the audit and the methods as well as the procedures through which they evaluate the audit quality. The differences in the perceptions of the stakeholders on audit quality clearly shows that no single item should be assumed as having dominant influence on the audit quality. In essence, a more holistic study of the concept is required to have a deeper and better understanding of the complexities and nuances of the topic. Hence, taking into consideration of all others point of view on the concept is vital in enhancing the audit quality.

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