The purpose of this chapter is to review the literature in the area of the determinants of audit quality. This review of the literature establishes the framework for the study and highlights the apparent strengths and weaknesses of the previous studies, which, in turn, help in clearly identifying the gap in the literature.
The review has three sections. The first section presents a theoretical frame work, which will have as a components like audit quality and the determinants of audit quality components i.e level of independence, auditor competence, audit quality assurance review, and audit firm characteristics. This is followed by a review of the relevant empirical studies (evidences) on determinants of audit quality which will be seen in the second section. Finally, conclusions on the literature review and knowledge gaps are presented in the last section
2.2 Audit quality
There is a vast body of literature relating to audit quality and its measurement. Despite the extent of availability of literature, no single generally accepted definition or generally accepted measure of audit quality has emerged. Much of the audit quality literature derives from DeAngelo’s definition. He defines audit quality as “the joint probability that an auditor will both discover and report a breach in the client’s accounting system. The discovery of a misstatement measures quality in terms of auditor’s knowledge and ability, while reporting the misstatement depends on the auditor’s incentives to disclose” (DeAngelo, 1981). This definition is appropriate for external financial statement audits; it can be expanded to include other types of auditors (e.g., internal auditors) and audits (e.g., compliance and operational audits). Despite the lack of a comprehensive definition of audit quality covering all types of audits and auditors, it is reasonable to assume this term incorporates compliance with relevant audit procedures and standards. Audit Quality as an agency relationship arises when one or more principals (e.g. an owner) engage another person as their agent (or steward) to perform a service on their behalf. Performance of this service results in the delegation of some decision-making authority to the agent. This delegation of responsibility by the principal and the resulting division of labor are helpful in promoting an efficient and productive economy. However, such delegation also means that the principal needs to place trust in an agent to act in the principal’s best interests. What happens when concerns arise over the motives of agents and cause principals to question the trust they place in them? Yamani (1991) concluded that the auditor’s independency and auditing quality are considered important factors that affect auditor selection, and reflect the confidence level in the financial reports.
The IAASB makes specific reference to the issue of audit quality in its latest annual report published in June 2014. The IAASB chairman, Arnold Schlider, in his chairman’s statement, discusses audit quality as a key issue that the IAASB is focusing on. He refers to the IAASB publication entitled “A Framework for Audit Quality”, the objective of which is to raise awareness of the key elements of audit quality; encourage stakeholders to reflect on ways to improve audit quality; and facilitate greater dialogue among stakeholders on the topic. He also mentions the IAASB webpage, ‘Focus on Audit Quality,’ which was launched in early 2014 to provide supplemental material supporting awareness and use of the framework. It is clear that the IAASB want to engage not only with auditors but also with users and preparers of financial statements to encourage debate on audit quality.
The IAASB Work Plan for 2015–16 is entitled “Enhancing Audit Quality and Preparing for the Future”, emphasizing the prominence of audit quality in the work program of the IAASB. In addition, the board has recently commenced a survey on audit quality, focusing on how audit firms apply ISQC1 and the difficulties faced by smaller audit firms in meeting the requirements. It is not just the IAASB that perceives audit quality as a matter of debate. Other regulatory bodies such as the UK Financial Reporting Council (FRC) is interested in promoting audit quality and its Annual Reports on Audit Quality Inspections feature detailed commentary on the improvements that audit firms can make to enhance audit quality.
Framework for Audit Quality (IAASB,2013)
Auditors are responsible for the quality of individual audits, and should aim to ensure that quality audits are consistently performed. A quality audit is likely to be achieved when the auditor’s opinion on the financial statements can be relied upon as it was based on sufficient appropriate audit evidence obtained by an engagement team that:
? Exhibited appropriate values, ethics and attitudes;
? Was sufficiently knowledgeable and experienced and had sufficient time allocated to perform the audit work;
? Applied a rigorous audit process and quality control procedures;
? Provided valuable and timely reports; and
? Interacted appropriately with a variety of different stakeholders.
Many factors contribute to enhancing audit quality within a jurisdiction, and increasing the likelihood of quality audits being consistently performed. The IAASB believes there is value in describing these factors and thereby encouraging audit firms and other stakeholders to challenge themselves about whether there is more they can do to increase audit quality in their particular environments.
The Framework for Audit Quality describes the key attributes that are conducive to audit quality, reflecting the different perspectives of stakeholders (IAASB, 2013). The objectives of the Framework include:
? Raising awareness of the key elements of audit quality;
? Encouraging key stakeholders to explore ways to improve audit quality; and
? Facilitating greater dialogue between key stakeholders on the topic.
The Framework applies to audits of all entities and all audit firms regardless of size, including audit firms that are part of a network or association. However, the attributes can vary in importance and affect audit quality in subtly different ways.
While the quality of an individual audit will be influenced by the inputs, outputs and interactions described in this Framework, the Audit Quality Framework, by itself, will not be sufficient for the purpose of evaluating the quality of an individual audit. This is because detailed consideration will need to be given to matters such as the nature and extent of audit evidence obtained in response to the risks of material misstatement in a particular entity, the appropriateness of the relevant audit. The Frame work distinguishes the following three elements (Figure 1):
Inputs are grouped into the following categories:
a) The values, ethics and attitudes of auditors, which in turn, are influenced by the culture prevailing within the audit firm;
b) The knowledge and experience of auditors and the time allocated for them to perform the audit; and
c) The effectiveness of the audit process and quality control procedures.
Within these categories, quality attributes are further organized between those that apply directly at:
a) The audit engagement level;
b) The level of an audit firm, and therefore indirectly to all audits undertaken by that audit firm; and
c) The national (or jurisdictional) level and therefore indirectly to all audit firms operating in that country and the audits they undertake.
d) The inputs to audit quality will be influenced by the context in which an audit is performed, the interactions with key stakeholders and the outputs. For example, law and regulations (context) may require specific reports (output) that influence the skills (input) utilized.