What Auditors Think about Audit Quality--A New Perspective on an Old Issue.
From a practical perspective, one has to assume that audit quality is implicated in the audit failures and restatements that have plagued financial reporting for some time. Audits, through the going-concern test, are supposed to warn the investing community about sudden corporate failure. Audits, if done correctly, should help clients avoid costly financial statement revisions. In several ways, insufficient quality also has proven costly for auditors (Treadway 1984; Beasley et al., 2008; Humphrey et al., 1993).
Unfortunately, audit quality has not been squarely within the sights of accounting academics in this spirit. While the construct has made, and continues to make, regular appearances, it tends not to be used as a dependent variable. Rather than seeking explanations and antecedents of audit quality, the construct is typically made into an independent variable for a host of other purposes. This sort of repurposing reduces the focus on audit quality per se. In this view, since audit quality merely possesses relevance to other phenomena, less concern exists for its particular contours. Thus, no surprise should exist that the measurement of audit quality has been oblique and indirect.
Simultaneously, concern over the state of auditing continues to grow. The notion that the audit is the cornerstone of all efforts to make corporations accountable and to make financial reporting useful has existed for some time (Sikka et al., 1998). The increased turbulence of worldwide economics and their constituent organizations since the turn of the century has not reduced the collective reliance on auditing. Countries have chosen to believe that auditing is too important to be left to the self-governance of those that do auditing. The social strategy that "doubles down" on auditing as the best answer recommends that the study of audit quality be brought back to the forefront of academic work.
Perhaps because accounting professionals have been so economically dependent upon effective audits (see Power, 1997), the rhetoric that surrounds their provision of this service has reached new heights. That the value of an external verification is delimited by its independence from the original production process has been well established as the core value of accountants (Carey, 1946). Nonetheless, what independence means for the accounting profession has been greatly contested in recent years (Fogarty and Rigsby, 2016). Independence is often juxtaposed against the more generalized ethical obligations of practitioners in performing audit work. Perhaps responsive to the many temptations for auditors to bend to the will of financial statement preparers, practitioners are expected to be in the possession of strong moral fiber and well-developed integrity (Mautz and Sharaf, 1961). In addition, researchers should make the assumption that audits are conducted by superbly competent individuals who have been well-trained and whose efforts are well-organized by their superiors (Lee and Stone, 1995). An audit is the confluence of the correct behaviors and the proper values. Therefore, its performance is by no means simple or merely technical.
The purpose of this paper is to take an approach, which is both intuitive and radical, to examine the importance of the coveted qualities of individual auditors such as independence, objectivity, and integrity on the quality of financial statement auditing. Existing audit quality literature suggests that the need for a construct that obtains results closer to the actual work of the audit seemed necessary. Rather than accept the official beliefs espoused by audit firms, a turn toward values enacted by those in the field was made. Furthermore, avoiding the US-centric nature of the literature's prevailing ideas of audit quality seemed very appropriate. A survey on audit quality to practicing auditors on three continents was designed and administered to obtain an idea about the factors that underlie quality work. As part of this, an effort was also attempted to be open to the existence of factors that might impede a quality audit.
The research approach taken by this paper is to allow auditors to self-rate the quality of audits and to look for antecedents in the qualities that auditors are supposed to possess and the conditions that surround the audit process. Using a survey distributed to auditors in three countries, the results show that audit quality is related to auditor integrity, but not to auditor independence or objectivity. However, audit quality is reduced by constraints exerted on the audit process, both directly and indirectly.
The rest of this paper is organized into five subsequent sections. The first offers a literature review that supports the expression of hypotheses. The second details the method used to test these expectations. The third describe the results obtained from the data analysis. The last two sections discuss these results and their implications, respectively.
LITERATURE REVIEW AND HYPOTHESIS DEVELOPMENT
An Audit Quality Model
Every writer on audit quality has noted its inherent complexity as a prelude to its analysis. Thus, any singular definition will have its shortcomings. Certain choices are nonetheless necessary to establish boundaries for the concept. Following Francis (2004), this paper discounts the appropriateness of binary quality classifications, in favor of a continuous view of the concept. Since the purpose of this research is to explain audit quality rather than to demonstrate its consequences, input measures are favored over output ones, as described below.
An audit is the aggregation of a large number of processes, each entailing the examination of evidence using professional judgment. Christensen et al. (2016) report that the strongest consensus on quality resides in the characteristics possessed by those performing the audit. The current research elevates this view toward a sociological vein by problematizing the normative structures that guide audit performance by individuals. These structures exist in the professional community rather than in specific firms or in the generalized environment (Francis, 2011). However, the recognition that auditing serves the interests of the capital markets, and itself must be conducted as a profit-making private enterprise should not be ignored. Thus, a proper view on audit quality needs to satisfy different perspectives and levels of analysis (see Gaynor et al., 2016).
Any definition of audit quality must explicitly eschew alternative ideas that have gained acceptance. Putting audit quality into service for the explanation of earnings quality tends to particularize the focus on auditing, even if the recursive relationship between these two spheres is important to many (Gaynor et al., 2016). By not prioritizing financial reporting, the concerns of investors in audit quality are also not elevated among stakeholders. If anything, this paper asserts the primacy of auditors as the most informed group about audit quality. However, this perspective does not reside in their selection of best practices. It instead concerns the values that auditors bring to their work. Far in the distance are downstream consequences of audit quality such as restatements and adverse regulatory response, both of which are seen to have more to do with the business environment of clients and the agendas of regulatory bodies.
The model of audit quality adopted by this paper places the audit itself in the center, using rather open-ended elements of importance, upward trajectory, and technological improvability. This approach allows an inquiry into how quality might be penetrated by the core concepts of professional value. In keeping with Mautz and Sharaf (1961), one should take audit quality as an objective that is beyond debate. Whether it is affected by the qualities that auditors should have, as designated by their own professional ideology, remains an open question. The premise here is that audit quality can be improved by better auditors, or at least by auditors more steeped in the values that auditors are supposed to have. To avoid such a perspective from excessive idealism, external constraints for the audit must be explicitly recognized. In other words, the field upon which values affect behaviors and then outcomes have to be restricted to the plausible.
Figure I illustrates the conceptual picture of audit quality. If the states of mind and cognitive orientations that have been extolled in accounting have gravity, they should be associated with the production of higher quality audits. Strong normative agreement should surround the connection between independence, integrity, and objectivity respectively upon audit quality. Environmental conditions, collectively referenced as external constraints are expected to deteriorate audit quality directly, and indirectly by interfering with the positive values and audit quality.
Audit Quality in the Literature
For many, audit quality is a measure unable to differentiate anything other than the size of the audit firm. DeAngelo (1981) was among the first to reason that large firms must provide higher audit quality because they received a premium for these services, and because large firms had more to lose for deficient quality. This way of measuring audit quality also gained credibility when experiencing less litigation became the barometer of success (see Palmrose, 1988).
Large size is said to be relevant to audit quality in that it allows for the presence of more in-house audit administrative expertise (Francis and Yu, 2009) and the ability to withstand client pressure (Goldman and Bariev, 1974). Large firms also get credit for higher levels of industry specialization, a factor that helps explain fee premiums (Craswell et al, 1995). The idea that large firms provide higher quality has ironically distracted researchers from audit quality and toward whether or not this firm-size effect is plausible (see Davidson and Neu, 1993) and constant. Recently, the big firm-small firm distinction as a pathway to understanding audit quality has been cast into doubt by the salience of client characteristics, known to vary by audit firm size (Lawrence et al., 2011).
Audit quality sometimes is deduced from some characteristics of the audit clients' financial statements. Most regularly, some measure of abnormal discretionary accruals denote audit quality (e.g., Choi et al, 2010; Reichelt and Wang, 2010). Another means of evaluating what the audit must have done can be seen in Carey and Simnetts' (2006) use of barely beating analysis forecasts, apparently a signal of earnings management that may have been opposed or blessed by auditors. Here, accounting research has indicated more interest in the mechanisms of the market than in audit quality, the latter serving as a means to other ends. These collateral purposes include the degree of earnings management attempted by clients (Becker et al., 1998), the market pricing of discretionary accruals (Krishnan, 2003), and analyst forecast errors (Behn et al., 2008).
Audit quality has been related to audit report outcomes. For example, higher audit quality is believed to exist when more going-concern opinions are issued (Carey and Simnett, 2006; Knechel and Vanstraelen, 2007). However, with very few going-concern opinions issued, this approach tells researchers next to nothing about most audits.
Very little government oversight of audit quality exists except in rare moments of public sector state programs (Deis and Giroux, 1992). The few studies that try to explain audit quality have sourced this pursuit outside audit behavior. For example, O'Sullivan (2000) looks at corporate governance characteristics as motivations to pursue high quality auditor work. Others suggest that audit firm tenure is an antecedent of high quality (Knechel and Vanstraelen, 2007). This effect however might be intertwined with client size (Nagy, 2005). Even when researchers endeavor to study investor perceptions of audit quality, they choose market calculations that are said to proxy for perceptions (e.g., Ghosh and Moon, 2005).
In sum, to say that great difficulty exists in determining if the average degree of audit quality is sufficiently high (Francis, 2004) may be an understatement. Perhaps this conclusion is the result of its very indirect measure that bypasses those that work on it. Audit quality remains deeply embedded within the "black box" that academic research cannot open (Francis, 2011).
Auditing Standards and Audit Quality
The entire effort by the auditing community to articulate and enforce standards could be understood as a quality control exercise. Those empowered to act on behalf of a profession in possession of self-regulatory privileges should act to taper divergent practices and even mandate procedures that work and should be present in every audit engagement. Therefore, having and following the authoritative statements should lead all firms to a higher level of audit quality. Ceteris paribus, auditing standards should lead an audit firm through an investigation with a high probability of detecting errors, irregularities, and inadequacies in the financial statements of clients. This process should be the confluence of general, field, and procedural standards that guide the auditor in planning the audit, having the right resources for the work, making critical scope decisions, and matching elements of the assertions with an appropriate test. This line of thought would have one believe that all audits should be high quality as long as all the professional standards are diligently followed.
Notwithstanding the divergent definitions and descriptions of audit quality, auditors' perceptions of audit quality may be based on the dictates of Statement of Auditing Standards 1 (AU Sec 110). This standard describes the purpose of financial statement auditing as "to render an opinion about a financial statements conformity with generally accepted accounting principles (GAAP)." To arrive at this conclusion, auditors must apply certain auditing techniques considered to be in conformity with generally accepted auditing standards, and to ensure that any existing material misstatements due to errors or fraud in the financial statement will be revealed. The standard also requires that the existence of such misstatements be reported in the audit report.
Although the tendency of public accounting firms to settle claims against them on an out-of-court basis muddies the ability to discern the merits, one has to accept the idea that audit failures provide evidence that the perfectly harmonious world of invariably high audit quality does not exist (see also Palmrose, 1988). In fact, audit quality may be quite decoupled from legal liability litigation results (Kadous, 2000). Although this inquiry is beyond the scope of this paper, one can point to the vagueness and permissiveness of the standards themselves, as well as the limited motivation of auditors in following their spirit. Clearly, the mere existence of standards and the assumed professionalism of auditors do not ensure audit quality. Thus, theoretical audit quality is aspirational and achieved audit quality is variable.
That audit quality cannot be directly observed by the public exists as an understatement that both motivates and bedevils this inquiry. Unlike phenomena that audits depend upon such as client profitability and continued existence, audit quality has no observable metric that even roughly parallels relative performance. Further obscuring the prospect of measuring quality is the systematic mismatch between public perceptions about the audit and its more limited capabilities. The so-called "expectation gap" interposes sustained differences about the audit and its purpose between auditors and their constituents (Humphrey et al., 1993), making audit quality even more difficult to perceive.
Independence and Audit Quality
Although the professionalism of auditors requires financial and psychological separation from their clients, many reasons exist to treat independence as an empirical issue. Independence is a complex construct with objective and perceptive dimensionality. Standards require auditors to be independent in fact and in appearance (AICPA, 1973). Independence also has macro-level challenges with firms seeking to leverage audit engagements with consulting work, the net result can be considerable financial dependence on individual clients. These contingencies complicate the understanding of the micro-level at which an individual auditor in the field might not possess sufficient skepticism to make a judgment that runs counter to the client's interest.
The importance of independence to the accounting profession may be a mixed blessing. When independence is present and believed in by constituents, auditors tend to embody the pathway whereby those who have been entrusted with the resources belonging to others (i.e., corporate management) can account for their stewardship. However, the very consequentialness of independence can be seen as heavy baggage to be carried by the auditor. The mere fact that audit firms are paid by the same client from whom they have to achieve independence creates difficulty with the concept (Fogarty et al., 1991). Indeed, the very macro-level conception of independence may threaten its irrelevancy as a part of the micro-level conduct of audit process.
The promotion of independence as the sine qua non of an audit's value has been done by academics and by the accounting profession's leadership. But where being independent matters most is at the point of tangency between audit test and the clients' trial balance. Preparers and users of audits seem to place greater weight on the importance of independence than do auditors (Carcello et al., 1992). The possibility exists that all the debates over the proper formulation of independence are not highly relevant to the caliber of the audit work. Audit independence could be important to the legitimacy of the profession, and therefore to its support for the privileges bestowed uniquely on practitioners, without penetrating the technical core where the work is actually performed. Accordingly, the first hypothesis poses a simple question that can be formulated as:
H1: Auditors' perceptions about the importance of independence are positively related to perceptions of high audit quality.
Independence notwithstanding, auditors are expected to behave in an ethical fashion. As professionals, auditors must be of good moral character to enter the ranks of the fully certified. Moreover, most states require ongoing ethical training in the form of continuing professional education for an accountant to maintain certification. A code of ethics exists that demands adherence in many forms of accountant behavior.
Perhaps because ethics are primarily understood as a set of proscriptions relevant to the individual auditor, they may resonate better as a matter pertaining to audit quality. Auditors might reason that good people produce good work, with good embracing the possession of the correct character. At its essence, auditing is moral work that cannot be reduced to its technical component (Francis, 1990).
Ethical behavior itself tends to be diffuse, offering a large set of positive and negative suggestions. To make this domain manageable, a focus upon integrity captures its essence with better focus. A person with personal integrity can be counted on to do the right thing in the circumstances. Integrity implies pervasive honesty, internal consistency, and sound moral principles at work (McFall, 1987). Simon et al. (2001) privilege the alignment of words and actions as the core of integrity. Others lean on trustworthiness and credibility (Davis and Rothstein, 2006). To test the relevance of what could be seen as a very important auditor characteristic, the following can be anticipated:
H2: Auditors' beliefs in the importance of auditor integrity is positively correlated with perceptions of high audit quality.
Personal integrity, and to a lesser extent, independence both build value-based arguments about how audit quality is constructed. In short, the right people supported by a right-minded firm can be said to be positioned to do the work that society expects in the audit engagement. However, others may believe that quality audits are not primarily a matter of auditor character. If audits are evidence-based around what must be established to accept a client's assertion, values and attitudes might not be properly positioned at the center of the investigation into audit quality.
Stressing objectivity would suggest that quality audits are engagements free of systematic bias. Auditors should be trained to search for the correct evidence and to see it for what it is. Audits should be designed to suppress the subjectivity of audit staff about information (Kolbe and Burnett, 1991). This position implicitly asserts an objectivist view upon reality (Robinson et al., 1948) and would diminish the influence of past personal experiences, idiosyncratic worldviews, or data-less opinions (e.g., Fiss, 1982). While objectivist tendencies would not eliminate the role of judgment, they would insist upon a fairly clear grounding in fact for all key audit decisions.
How individuals doing audits are distributed on the continuum of evidence versus intuition is unknown. Whereas few could oppose objectivity in the absolute, the following hypothesis will allow its association with audit quality to be considered relative to those anticipated in the previous hypotheses:
H3: Auditors' perceptions about the importance of auditor objectivity are positively correlated with perceptions of high audit quality.
Auditing in theory can be understood as a high-minded endeavor that draws upon and integrates all of the social sciences (see Mautz and Sharaf, 1961). However, the provision of audits is also a private-sector business. As such, auditing needs to focus on efficiency and effectiveness rather than upon the esoteric search for the truth. Along these lines, pressure must be exerted by those who manage audits upon staff to absorb uncertainty and to make critical judgments within a budgeted amount of time. Only in this way can audits generate the profits that will sustain the partnership over time. Although these realities have the potential of reducing audit quality, they cannot be ignored in this inquiry.
Audits need to be performed under conditions of constrained resources. Here resources could include the number of staff available, the amount of time that can be devoted to the work, and even the time devoted to understand the audited entity, its transactions, and its environment. Although auditors can be expected to be adept at coping with these constraints, and adjusting in ways that preserve reputations and make the best compromises, such balancing acts impose continuing difficulty.
Constraints may be relevant to audit quality in different ways, many of which could be considered quality reduction acts. At one extreme, auditors may skip or minimize work in a particular area. These actions would necessitate some distortions of the documented audit work papers, and therefore constitute a premature signoff of the necessary work. A more advanced variation would be the failure to follow up on matters that strike a discordant note. Here warning flags may or may not be indicative of larger issues, but are certain to consume more time, and therefore may be tempting to ignore. Research has indicated that auditors tend to prioritize the more important and risk sensitive portions of their work when they are unable to complete all of it in the allotted time (Kelley and Margheim, 1987). However, one has to believe that the importance of each component of the audit is prima facie, and that ad hoc judgments about relative risk by staff members are not what firm leaders had in mind. Research also suggests that auditors will under-report their time in an effort to complete more work than time allowances facilitate (McNair, 1991; Otley and Pierce, 1996). While efforts not to be limited by budgetary constraints are laudable, such contributions cannot be counted upon and by their very nature distort the audit's official production function. One has to believe that being unable to bring their efforts to their maximum potential, in an open and forthright manner, troubles auditors. Unlike the other expected antecedents of audit quality, the existence of material constraints is expected to run counter to good audit work. Therefore, this research suggests:
H4: Auditors who perceive important constraints in the performance of audit work will report lower levels of audit quality.
As the research expects three independent variables to positively impact audit quality, it is appropriate to assume that combining two or more of these variables would lead to a stronger positive effect on audit quality if the variables complement each other. The complimentary effect of variables is where changes in one variable lead to changes in another variable (Milgrom and Roberts, 1995).
The first three variables discussed in this research constitute the set of conceivable interactions that would combine toward a more positive effect on audit quality. For these purposes, objectivity would seem to best combine with one of the two states of mind. Whereas the other two influences are normative states of mind uniquely valuable to accounting, they might provide a reason for a person to be objective. Independence, as the attribute least likely to be an a priori characteristic of the person, stands out as the main purpose for objectivity. Thus, Hypothesis 5 asserts that:
H5: Auditors who report both high levels of the importance of independence and objectivity will also report the highest levels of audit quality.
In addition to expecting a negative audit quality consequence of audit constraints, constraints can be expected to interact with the positive effects on audit quality. These constraints may disrupt the normative order of relationships. Constraints such as time pressure on auditors can be seen as a disruptive influence that undermines the effort of auditors to bring quality through proper arrangements with other parties, proper values to the work, and even the desire to be strictly rational. Interaction effects may help explain how governmental-rated audit quality was found unrelated to hours spent on the engagement by Deis and Giroux (1996). Specifically, the expected indirect effects of constraints can be formally stated as following:
H6: Auditors who perceive important constraints in the performance of audit work will weaken or completely offset the influence of any significant and positive effect on audit quality.
In sum, the six hypotheses developed by this research constitute a model of effects that should be understood as a whole. Figure I depicts the totality of the relationships that are to be tested. The first four hypotheses are direct effects that require testing independently of the possible impact of quality inhibiting interaction effects. The full model incorporates these interactions, suggesting a tapering of the three positive direct effects shown in Figure t. Here, all possible Hypothesis 6 interactions are depicted in advance of the empirical knowledge of their significance for audit quality.
The most important element of this research is the value of getting knowledgeable people to reveal the nature of the work that has important consequences to society. Therefore, a survey was designed to test the hypothesized relationships. Practicing auditors were sought to provide their perceptions of audit quality and its antecedents. A direct solicitation was attempted since public accounting firms have grown very reluctant to endorse such work unless it is likely to promote their interests. The primary means of solicitation was through three online forums whose subjects were likely to attract auditors. In addition to that, surveys were sent to auditors known to the authors. With the latter, a snowball approach was taken by asking these contacts to recommend other auditors who might be willing to serve as respondents.
Respondents were solicited from the United States, the United Kingdom, and Ghana with the cooperation of professional audit associations that allowed the authors to reach out to their membership rosters. Data collection was done in more than just the United States in order to avoid the limitations created by specific legislation and accounting standards. The use of three nations counters the tendency for audit quality to be patterned mainly by the specific institutional forces of the United States (Chen et al., 2010). The novel approach to audit quality taken by this research required self-designed measures for each of the variables. Realizing that no single inquiry could capture the complexity of these constructs, five or six different items were designed for each. To represent the variables, items in each group were summed and averaged after the necessary reverse coding were performed.
Due to the large number of specially designed questions, considerable pre-testing was conducted. Following Suh and Trabasso (1993), three "talk aloud" sessions with practitioners and non-academic lay people were organized. In these events, vocalizing the instrument is believed to help identify discrepancies between author intentions and respondent's understanding. Second, the Q-sort procedure (Thomas and Watson, 2002) was conducted. Here, participants were asked how they would group individual questions as a way of assessing convergent and discriminant validity (Waters et al., 1983). Finally, an on-line pre-test was conducted using administrative procedures very similar to that of the study. All of these pre-test methods resulted in many changes to the wording, order, and composition of the instrument. Appendix A contains the full set of questions used in this research, all of which were presented to respondents using a five-item Likert scale for their completion.
Following the deletion of incomplete instruments, 211 responses were obtained from the survey effort. Given the dependence on resident agents that organized the solicitation and distribution, a response rate could not be estimated. These groups were reviewed for skewness, kurtosis, and normality. Tests for homoschedasticity and multicollinearity were conducted, using standards recommended by Hair et al. (2009). As shown in Table 1 Panel A, more responses were received from auditors in the UK (60.3%), from men (66.7%), and from those at the managerial ranks (55%). The typical respondent was a CPA or CA with between three and ten years of audit experience. A good portion (44.0%) had "Big 4" accounting firm experience. Table 1 Panel B shows the demographic variations for the sample across the three nations.
An extrinsic effort was made to specify the measurement model, following procedures and thresholds suggested by Hair et al. (2009). Exploratory factor analysis was conducted to ensure construct validity, a procedure especially necessary due to the self-design of much of the instrumentation. The specified set of constructs (Figure I) outperformed the model that had no distinctions among the independent variables. Though the pattern matrix initially showed a number of cross loadings among the variables, the model as specified, with separate independence, integrity, objectivity, and external constraints constructs had considerable data adequacy, validity, and reliability. The specified model reports a KMO of 0.721, Barttlet test of Sphericity of 1385.354, degree of freedom of 325, and significance level of 0.000. The factor correlations (found in Appendix B) show reasonable correlation between the five factors specified in the conceptual model. Strength of the model is reasonable as well with the model explaining more than 46% of the cumulative percentage of the initial eigenvalues and more than 35% of the extracted squared loadings. Appendix C shows the degree of the variance explained.
Table 2 Panel A reports the means and standard deviation of the variables employed in the research. The means, as judged by that which is possible on the five-point Likert scale, do not exhibit extreme central tendencies. These range from a low of 3.27 for Objectivity to a high of 3.96 for Audit Quality. There is also sufficient variation in the data. Respondents were notably in more agreement about Objectivity (sd=0.37) than about the other four variables (average sd=0.56).
An analysis was conducted to identity important deviations from the total descriptive results discussed above if the data was divided by the respondent's country of origin. No significant differences were detected. Therefore, the data is used as a single sample.
Direct Effects (Hypotheses 1-4)
The first of the analyses tests the direct effects of auditor independence, objectivity, integrity, and external constraints on audit quality without interactions as posited in Hypothesis 1 through Hypothesis 4 and depicted by Figure I. Table 2 Panel B contains the results of the direct effects in the first test. Without interaction effects, the model offered explains 13.4% of the variance in auditors' perceptions about audit quality.
Two of the four direct effects are significantly related to perceptions of audit quality. Auditor integrity beliefs are significant (p<0.01) in their association with the audit quality outcome. This provides support for Hypothesis 2. Along similar levels, perceptions of importance of external constraints on audit work are also related in the negative direction, at the p<0.01 level, to audit quality impressions. This result offers evidence consistent with Hypothesis 4. On the other hand, the results do not support the independence effect that was anticipated by Hypothesis 1. Independence and audit quality are not significantly related (p>0.10). They also provide no evidence consistent with the idea that objectivity is an important believed antecedent of high audit quality (H3) with the coefficient not significant (p>0.10).
Interaction Effects (Hypotheses 5 and 6)
Analyses of the relationships in Figure I complicated matters when the possibility of interaction effects were anticipated in Hypotheses 5 and 6. Assessment of the interaction effect of independence and objectivity on audit quality shows the interaction variable has a strong effect on audit quality. The explanatory power of the conceptual model, increased from 13.4% to 18.2% after interacting independence and objectivity. A plot of this interaction effect (not shown) confirmed that independence strengthens the positive relationship between objectivity and audit quality. This supports H5.
Whereas Figure I showed several possible interaction effects involving external constraints, the test of H6 only needed to be performed for previously discovered significant relationships. One such test of the relationships involved the interaction effects of external constraints and auditors' integrity (from H2). The other test examined the interaction effects of external constraints with the interaction variable of independence and objectivity (from H5). The results from the test of interaction effects show that interacting the external constraints variable with the independence and objectivity interaction variable reduces the positive effects of the interaction variable of independence and objectivity on audit quality. In other words, external constraints moderate the interaction effects of independence and objectivity on audit quality. The results also show that external constraints do not significantly impact the relationship between auditors' integrity and audit quality. A summary of the interaction results is presented in Table 3. Some support for the incremental expectations was produced. External constraints combined with objectivity and independence proves significant at p<0.05, yet combining external constraints with integrity proves insignificant at p>0.05.
Explanatory power, after interacting external constraints with independent variables, increased from 13.4% to 18.2%. When external constraints interact with the combined variable of independence and objectivity while integrity is present, the explanatory power of research model increases to 27.8%, indicating the importance of these human characteristics to the quality of financial statement auditing.
Plotting the moderating relationship between external constraints and objectivity show that external constraints weaken the positive relationship between objectivity and audit quality. The resulting re-specified conceptual model is shown on Figure II.
Since the control variables do not have significant direct effect on the relationships between the independent variables and audit quality (see Table 3), the values reported in Figure II do not include the effects of the control variables.
This research argues for a different approach to audit quality research. This paper attempted to ground the appreciation for this widely-debated construct in the knowledge of practitioners and in their adherence to certain values. To do this, the research juxtaposes concepts that have been developed about auditing and auditors into a new relevance for the caliber of their work.
The results support some ideas that have been believed about auditing for decades. Specifically, auditors believe that having a group of ethical practitioners is very important in the production of high audit quality. Good moral character is the foundation of the outcome sought by society pertaining to the trustworthiness of financial statements. Auditing is not just a technical craft or a field for judgment and decision processes, it is a moral endeavor.
Despite a long debate about auditor independence from their clients, auditors do not perceive the presence of independence to be an important antecedent to audit quality. The fact that integrity and independence do not have similar consequences for audit quality suggests that independence is not a test of an auditor's moral fiber. Research suggesting that independence may have changed meaning since the advent of the Public Companies Audit Oversight Board (Fogarty and Rigsby, 2016) would be consistent with this finding.
Why strong objectivity is not related to high audit quality poses more deep questions about audit quality. One's first inclination to say that auditors assume their objectivity is undermined by the low mean score for that variable. What is more likely is that auditors are suggesting that more objectivity is simply not relevant to higher audit quality. In other words, the problem with audits lies elsewhere.
Auditors who are put under pressure to perform their work are not as likely to create high quality audits compared to auditors who are not put under such pressure. Good audit work takes time and needs to be free from undue constraints that being driven by efficiency sometimes creates. Whereas the failure of two of three positive auditor attributes to contribute to audit quality contradicted hypothesized expectations, the negative direction effect rang true.
This research attempted to use interaction effects strategically. This was done first to juxtapose a "hard" attribute (objectivity) with a "soft" one (independence). The significance of this interaction suggests that what drives quality audits is not just objectivity for its own sake, but objectivity armed with the purpose of doing the right thing in the face of opposition. This interaction restores some degree of the intuitive position that accounting at its core involves measurable truths, and that auditing's value exists only if it is not dependent upon the wishes of the client.
The balance of the interactions that were tested tried to counter the relevance of a significant positive effect on audit quality with the existence of external constraints. This involved reconsidering the Hypothesis 2 results for Integrity, and the Hypothesis 5 results for the interaction of Independence and Objectivity. In the case of the latter, this effort proved especially consequential. A previously significant two-way interaction in the positive direction became significant in the negative direction when External Constraints were introduced. Although three-way interactions are difficult to interpret, the salience of External Constraints on Audit Quality is difficult to ignore. The introduction of External Constraints also contravenes the positive effect of Integrity on Audit Quality, but only to the point of a non-significant interaction.
The results collectively show that audit quality is difficult to achieve in the presence of adverse conditions faced by auditors. Auditors are relating that external factors that put the audit under pressure will tend to lower audit quality without any consideration of auditor values. Apparently, constraints such as budget pressure also make it more difficult for auditors who want to "do the right thing" to make a difference. The findings suggest that good people are defeated in their desires to bring about good results when not given sufficient time and opportunity to act.
This paper's results also cast some doubts upon the relevance of that which academics tend to believe in the absence of empirical validation. For example, independence and objectivity as stand-alone constructs do not seem to resonate for individual auditors as a feature relevant to the work. Although this finding does not suggest their lack of importance to the profession as a whole, independence and objectivity fail to find grounding at the individual auditor level of analysis in the audit engagement. Apparently, the things that auditors tell their clients, and that which they want to believe about themselves, somehow get lost in translation to the work product.
The significant interacting effect of independence and objectivity on audit quality suggests that auditors' interpretation of their clients' financial results is subjective at best. Independence may not be so universally valuable to the audit as it is often stated. Its influence might be limited to situations calling for heightened objectivity.
Many of the limitations of this paper pertain to the well-known issues of survey research. Although the sample is not small, it represents only a small slice of all those that audit financial statements. The sample was also too small to deploy a structural equations approach which could have brought greater insight regarding measurement and overall model performance. In any event, care should be taken in generalizing the results to the population. The expedience of data collection also prevented the survey from being random. Along similar lines, this paper offers respondents from three countries with different technical auditing standards. However, many more countries exist from which no data was collected. The exploratory nature of the instrumentation had to be self-designed. In an ideal situation, more a priori knowledge about these scales would have existed. However, because the perceptions of practitioners possess primary importance, the development of new scales becomes necessary.
The study sought to understand how often promoted auditor's characteristics of independence, integrity, and objectivity affect the quality of financial statement auditing. Responses from auditing professionals from three continents has shown that auditor character can be a critical component of audit quality. However, the study shows that the focus on auditors' independence is inconsistent with the beliefs of auditors about the determinants of audit quality. Independence may be more culturally specific. Audit professionals everywhere regard auditor's integrity as a critical determinant of audit quality compared to auditor's independence and objectivity. The study also shows that time and resource constraints have significant direct effect on audit quality. These constraints impact the amount of work that willing auditors are able to perform on an audit engagement. The paper shows these constraints affect the importance of auditors' integrity for the determination of audit quality. This study did not hypothesize how external constraints might affect the other positive attributes (independence and objectivity) because of the absence of a significant direct effect.
The most general implication from this research is the implicit questioning of academic approaches that promote somewhat esoteric attributes of auditor values. The development of abstract concepts like independence and objectivity that do not exist in the awareness of practitioners necessarily heightens the schism between practice and academe. If one wants to inform practice, academic work must be grounded in the world of those that create practice. If other efforts can have value, they must strain to analogize themselves back to practice. Ironically, by doing so, they conveniently ignore most of practice. Rather than insisting that practitioners work harder to understand the hyper-reality of the academy (e.g., Moehrle et al., 2009), the academy needs to avoid the promulgation of a shadow alternative to practice whenever possible.
The research proposed a total of six hypotheses of which two were not supported. In addition, those that involved interaction effects served to undermine two other hypotheses that were supported. That which the paper has not supported might be an invitation to question that which most people would have found intuitive. Why these were not supported could have been attributed to the measurement or sample issues discussed above. Only more research that continues this line of reasoning will be able to inform these possibilities. Until then, one might say that the point of this research has been to debunk the simple notion that all it takes is good people to produce audit quality. In other words, the reader should entertain the idea that the modern audit has exceeded the limits of human attributes. If the possession of the right values and skills no longer can lead to quality outcomes, academics need to look to systems properties of what public accounting has created in this engagement. Perhaps the whole is more than the sum of its parts. Alternatively, the audit may have become a free standing social construction that defies conventional definitions of quality.
Appendix A Survey Items Organized into Scales Independence (IND) 1. As long as auditors are competent and audit work is well planned, independence is overrated as an important attribute* 2. The single most important thing an auditor has to be is independent 3. If an auditor does not have financial conflicts of interest with a client, the auditor need not worry about independence * 4. An auditor needs to appear to be independent as well as be independent in fact 5. Audit clients should be allowed to purchase consulting services from the same public accounting firm * Integrity (INT) 1. Most auditors I have met are honorable people 2. Auditors are not likely to say one thing and do another 3. Auditors are unlikely to be tempted by clients to depart from the "straight and narrow" 4. Like other professionals, auditors can be forced by circumstances to do things that they regret * 5. People are promoted in public accounting in part because they possess the right values Objectivity (OBJ) 1. Auditors are sufficiently objective when reviewing client internal control systems 2. Auditors are sufficiently objective when reviewing related party transactions 3. Auditors do not consider how important client revenue is to their firm when making audit decisions * 4. Auditors can believe client assertions when no other obvious reason exists to doubt them * 5. Auditors rarely gather insufficient evidence pertaining to the existence of assets 6. Auditors have sufficient expertise to measure the fair value of assets when appropriate Audit Quality (AQ) 1. Most audits are better than the public realizes 2. Audits are critical to investors 3. Audits are important to reduce to chances of financial statement manipulation by management 4. Audits are much better now than they were ten years ago 5. The technology used to conduct audits has greatly improved their overall quality External Constraints (EC) 1. Auditors could greatly improve the quality of their work if time budgets were not so tight 2. Auditors without sufficient time to do their work sometimes "sign off' on work that they have not really performed 3. Auditors often fail to adequately follow up on situations that require more work 4. Clients believe that audits are commodities for trying to reduce audit fees 5. The profession could do better if firms would dedicate resources to develop audit staff 6. Clients rarely engage in "earnings management" * * Reverse coded item Appendix B Factor Correlations Audit External Factor Quality Objectivity Constraints Audit Quality 1.000 0.356 0.023 Objectivity 0.356 1.000 -0.219 External Constraints 0.023 -0.219 1.000 Independence 0.256 0.320 -0.101 Integrity 0.383 0.403 -0.157 Factor Independence Integrity Audit Quality 0.256 0.383 Objectivity 0.320 0.403 External Constraints -0.101 -0.157 Independence 1.000 0.169 Integrity 0.169 1.000 Extraction Method: Principal Axis Factoring. Rotation Method: Promax with Kaiser Normalization. Appendix C Variance Explained Initial Eigenvalues % of Cumulative Factor Total Variance % Audit Quality 4.507 17.334 17.334 Objectivity 2.570 9.886 27.220 External 1.935 7.443 34.663 Constraints Independence 1.607 6.180 40.843 Integrity 1.550 5.963 46.807 Extraction Sums of Squared Rotation Loadings Sums of Squared %of Cumulative Loadings Factor Total Variance % Total Audit Quality 3.925 15.095 15.095 2.943 Objectivity 1.963 7.548 22.643 2.833 External 1.262 4.853 27.495 1.810 Constraints Independence 1.061 4.082 31.577 1.963 Integrity 0.970 3.730 35.307 2.391 Extraction Method: Principal Axis Factoring.
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George K. Baah
Assistant Professor of Accounting
Timothy J. Fogarty
Professor of Accountancy
Case Western Reserve University
Caption: Figure I: Conceptual Model
Caption: Figure II: Final Research Model
Table 1 Summary of Demographic Information Panel A: Combined Sample # Description Measurement Percentage (%) Regional Respondents United States, United 29/60/ 11 1 Kingdom, Ghana 2 Gender Male / Female 67/33 3 Big 4 Experience Yes / No 44/56 4 Accounting Certification Yes / No 88/12 Professional Ranking Associate / Senior / 19/27/39/ 15 Manager / Partner 6 Tenure <2yrs / 3-10 yrs / 23/60/ 17 > lOyrs Panel B: Sample by Region # Description Categories USA (%) UK (%) 1 Gender Male / Female 60/40 68/32 2 Big 4 Yes / No 47/53 40/60 Experience 3 Accounting Yes / No 68/32 95/5 Certification 4 Professional Associate / Senior / 27/28/33/12 17/25/41/17 Ranking Manager / Partner 5 Tenure <2yrs / 3-10 yrs / 40/27/33 38/31/31 > 10yrs # Ghana(%) 1 75/25 2 65/35 3 90/10 4 20/30/35/15 5 40/40/20 Table 2 Panel A: Descriptive Statistics Mean Std. Deviation N AQ 3.9592 0.57441 211 IND 3.7280 0.56038 211 INT 3.3479 0.58500 211 OBJ 3.2709 0.36649 211 EC 3.4750 0.51469 211 Panel B: Summary of Direct Effects on Audit Quality Hypothesis Relationship Result Effect Hypothesis 1 IND [right arrow] AQ 0.056(0.556) Insignificant Hypothesis 2 INT [right arrow] AQ 0.359(***) Significant Hypothesis 3 OBJ [right arrow] AQ 0.081(0.389) Insignificant Hypothesis 4 EC [right arrow] AQ -0.182(0.044) Significant Hypothesis Conclusion Hypothesis 1 Does not support H1 Hypothesis 2 Supports H2, correct direction Hypothesis 3 Does not support H3 Hypothesis 4 Supports H4, correct direction Control variables and their significance: Size = (0.548); Region = (0.165); Certification = (0.832): R-squared = 0.134 Table 3 Summary of Interaction Effects on Audit Quality Hypothesis Relationship Result Effect Hypothesis 5 IND_x_OBJ 0.252(0.005) Significant Hypothesis 6a INT_x_EC 0.145(0.127) Insignificant Hypothesis 6b IN D_x_OBJ_x_EC -0.349(0.001) Significant Hypothesis Conclusion Hypothesis 5 Supports H5 Hypothesis 6a Supports H6 Hypothesis 6b Supports H6 Control variables and their significance: Size = (0.548); Region = (0.165);
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|Author:||Baah, George K.; Fogarty, Timothy J.|
|Publication:||Journal of Managerial Issues|
|Date:||Dec 22, 2018|
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