Summary Assurcance Aritcles

extract of the Papers

• Lennox (2011)  voluntary vs. mandatory (signalling)

• Switch form mandatory audit to voluntary audit
• Mandatory audit prevents signalling

• In voluntary audit, the Management choose to be audited →extra cost

• Low risk firms are more likely to be audited because it can reduce the cost of debt
• High risk firms are less likely to be audited

• Voluntary audited increase  the credit rating  of the firm → lower cost of debt
• Exceptional: firms which cost of debt is lower than the audit cost can choose to not be audited ( cost/ benefit analysis)

• Wallace (1980) Demand for Audit

• Reasons for audit demand

• Conflict of interest
• Consequences (economic)
• Complexity
• Remoteness

• Hypotheses for  audit demand

• Agency theory hypotheses
• Information hypotheses
• Insurance hypotheses

• Chi (2011) accrual- vs. real earnings management

• High quality audits are more likely to have lower accrual based earnings management
• Response of management to meet or beat the expectations of the analyst forecast is to use real earnings management

• Can cause long-term damage

• No effect of low balling on the quality of audit
• Result suggest that shortened audit tenure could associated with lower real earnings management

• DeAngelo(1981) Low Balling

• Audit regulators states that low balling impair audit independence

• Low balling creates a receivable ( future quasi rents ) which impaires the independence of the audit
• Quasi rents = excess revenues above avoidable costs, Inc. opportunity costs. Because :

• Costly contracting
• Client specific start-up costs
• Transaction costs of switching auditors

• Regulators actions to increase independence

• Governing auditor changes → increase disclosure→ increase switching cost → increase client specific quasi rents
• Governing audit-client fee relationship→ more monopoly profits on price dimentions

• Low balling = stetting audit fees below current total cost on the initial audit engagement
• Conclusion : low balling does not impair the independence of auditor because there is no casual relation, low balling occurs to get rights to earn quasi specific rents

• Francis(2013)

• Client restatements are less likely occur at large audit offices
• The quality difference of BIG4 and NON-BIG4 differ only for the upper quartile of the largest offices
• Reason for quality difference in office size can be trough the limitation of effective knowledge sharing

Gul (2009) audit tenure and audit quality

• Shorter audit tenure is associated with lower audit quality

• Weaker for firms audited by industry specialists

• Auditor tenure:

• Learning theory: Short-tenured auditors lack client-specific knowledge
• Low balling:  The auditor can be more lax so that he retain his job long enough to make up for the losses. (No support)
• Firms with higher quality earnings are more likely to retain the high-quality auditors.
• Auditors’ industry expertise:

• Achievement of product differentiation and provide higher quality audits
• Investments → Enables detecting irregularities and misrepresentations more easily

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• Abbott (2011) Internal audit provided assistance

• Internal audit function reduces audit fees

• Only if: The effect is stronger if the internal audit function has a strong position of in the organization (status)
• Stronger if higher resources in hours

• Blokdijk (2003)  (hoeft niet te leren voor de eerste tentamen)

• Johnstone (2003) Risk management in client acceptance

• Increased importance in client acceptance
• Risk affect the likelihood of the client acceptance

• Audit risk
• Client business risk
• Audit business risk

• If risk is higher than acceptable risk level → decline client or use risk management strategy

• Apply additional audit investments ( specialist)

• Moderates fraud risk and error risk

• Ask higher fee

• Moderates client business risk and auditor business risk

• Note: no evidence that specialist personnel moderates client business risk and client acceptance

• Possible through that firms of high going concern-risk are chosen

• Shu (2000) auditor resignation

• Audit resignations

• Clientele adjustments hypotheses (supported)

• Auditors are more likely to drop clients who expose the auditors to increase litigation risk
• Client engagement in small auditor because the smaller auditor has less litigation cost
• Capital market reaction: drop in client stick price

• Litigation hypothesis

• Examination of impact market reactions & successor auditors (supported)

• Changes in audit industry

• Technological advances
• Demand for non- audit services

• Auditor are more likely to drop client whose demand for audit ad non-audit work becomes inconsistent with the auditors targets clienteles

• Ashbaught (2008) ICMW and accrual quality

• Internal control deficiencies lead to unintentional errors
• Accrual quality improves if ICMWs are resolved

• Doyle (2007)

• Companies with ICMWs have lower accrual quality

• Intentional ( lack of segregation of duties )
• Unintentional ( lack of experience in estimating bad debt expense provision)

• Material weaknesses

• Company level ICMW ( may not be auditable)
• Account specific ICMW (auditable)

• SOX 302 has stronger effect than SOX 404

• Section 302-> officers certify financial statements
• Section 404 -> management issues a report, auditors attest their findings
• Under SOX Section 404, Auditors report more weaknesses that are not related to real financial reporting consequence
• Bias in sampling (404 reporters are bigger and financially stronger)
• Many firms not report SOX Section 302 and therefore SOX Section 302 may cause more serious effect on Accrual Quality
• Driven by company level weaknesses ( not account- specific weaknesses)

• Keune (2012)

• Likelihood of waiving misstatement influence bu:

• Analyst following (+)
• Audit fee (-)
• Interaction fee * analyst (-)
• Audit committee financial expertise

• Carcello (2013)

• Audit partner signature (UK)
• Argument for APS : increase in accountability and transparency
• Argument against APS: focus on one member of the engagement team
• Influence

• Abnormal accruals (decrease)
• Propensity to meet earnings thresholds (decrease)
• Earnings in formativeness (increase)
• Propensity of auditor to issue a qualified report (increase)
• Audit fees (increase)

• Chaney (2002) auditor reputation

• Enron bankruptcy and bad behaviour of  Arthur Andersen (BIG8) caused a damage in the auditors reputation
• Reaction of the investors: a negative capital market reaction on the firms which were audited by Arthur Andersen ( negative cumulative abnormal return)

• Investors downgraded the audit quality of Arthur Andersen
• Office Houston, which audited Enron suffer the most of the investors reactions

• Humphrey (2011) Audit market reform

• Financial crisis (2007/2008) was a good crisis for the auditor, no big blames on the auditor. However, if the auditor performs well, why is there a financial crisis? Major financial institutions with “clean audit opinion” failed
• What is the value of audit ?
• Emphasis on:

• Importance of providing better insight into the work done by the auditor
• The need for better insight of regulatory changes on the audit

• Knechel (2010): while the quality of audit processes determine the quality of the audit, regulatory efforts to make audit processes more standardized may have the effect of reducing the quality of audit outcomes
• Revised 8th EU directive (2006)

• Improve audit independence  (audit- / non-audit services)
• Report on audit- and non-audit fees

• Green paper

• Divide audit arena into 3 elements:

• The audit market

• Market competition & Concentration

• Regulation of auditing

• Mandatory rotation, Joint audits, Provision Non-Audit Services, Audit Firm governance, Public oversight

• Professional practice & auditor judgment

• Need for auditors to actively challenge management
• Use of professional skepticism

• … see slides college 5

• Markelevich (2013) audit fee & fraud firms

• Research question:

• Do higher audit fees / NAS fees impact the likelihood to be sanctioned by the SEC for fraud

• Relevance

• Concerns about the independence of the auditor

• Audit and Non-audit services have a negative impact on the independence of the auditor

• Theoretical framework

• Theory 1: Economic bonding: Economic bonding from audit fees increased after SOX
• Theory 2: Knowledge spillover effects NAS : Spillover vs. Professional skepticism
• Theory 3: Audit effort – Audit Quality: Higher fees – Higher (perceived) audit quality + audit effort
• Theory 4: Audit risk: Higher fee to compensate for increased risk

• Conclusion :

• Support for Economics Bonding Theory:

• Auditor independence impaired
• Support for limiting NAS fees

• Support for Audit Risk Theory

• Risk premium

• Limitations:

• External validity: extreme fraud sample
• Only 14% of companies in sample relate to audit failures

• Weber (2008) auditor reputation

• reputation effect in Germany

• limited liability risk for auditors (max 4 mln)
• negative capital market reaction
• loss of clients

• Overall conclusion: The overall conclusion is that German investors react to revelations of substandard audits by a firm with a reputation for high quality. This conclusion is important because previous research done by different authors had dificulty isolating value of audit reputation to investors.

• Zerni (2012) joint audits

• Argments for joint audits

• Rotating and safeguard auditor indeoencene
• The threat of economic bonding will be reduced
• Less sensitivity for client pressure
• Game theory

•  If you don’t react independently, the other auditor will react independently → recognition of lack in independence

• Arguments against joint audit

• Free rider problem
• Corporation difficulties

• Conclusion

• Conservatism

• Potential free-rider problem:

• One of the auditors attempts to ‘shirk’: rely on the other auditor’s effort during the audit

• Close cooperation: difficult for two competitive audit firms

• Insufficient information exchange: conflicts

• Burgstahler (2000)  
• Carcello (2009)

Summary of the Papers

Lennox (2011) voluntary vs. mandatory (signalling)

Relevance

The demand for auditing arise endogenous and exogenous reasoning’s.  According to the in information theory, audit demand arises from investors and stakeholders. They want to have information for their decision making. The management provide their stakeholders with financial information in the annual report. However the provided information can be manipulated and therefor need to be audited. The auditor which gives an independent opinion in whether the financial statement represent fairly, in materially respect, the financial position, the results of the operation and  the financial changes are accordance GAAP.