Economic Consequences Of Audit Outcomes Accounting Essay

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With the worldwide financial scandals exposed continuously, the independent audit process has gained more and more attention from all sectors of society. Many factors affect the quality of audits regarding systematic analysis. There is a need to actively explore effective ways to improve audit quality and measures.

In the past few decades, rapid growth of publicly traded firms in China has led to a sharp increase in the demand for external audits. According to the 2011 report by China Securities Regulatory Commission (CSRC), the number of listed company in the Shanghai and Shenzhen Stock Exchange reached 2465, which is 2.2 times that of in 2002. The stock market value of listed firms in both stock exchanges reached RMB 2,0492 billion, 4.78 times that of in 2002. With the rapid development in economy, China has played a progressively increasingly important role in the world economic stage. By the end of 2006, the number of certified public accountants (CPAs) was over 73,000 and more than 4,200 public accounting firms were established in China. According to the recent report provided by the Chinese Institute of Certified Public Accountants (CICPA), over 600,000 people participate in the CPA Uniform Examination annually.

As a fast developing economy, decision makers are more likely to receive unreliable information due to remoteness of information, biases and motives of the information provider, voluminous data, and the existence of complex exchange transactions This leads to an increased demand for audit service. Accordingly, audit firm in China plays a critical role in the efficient allocation of capital. Under the new economic landscape of substantial growth in both demand for and supply of audit service, how to create and sustain competitive advantage constitutes a critical lesson for both the practitioners and the academics.

1.2 Audit Quality

The financial statement audit is a monitoring mechanism that helps reduce information asymmetry and protect the interests of the principals, specifically, stockholders and potential stockholders, by providing reasonable assurance that management's financial statements are free from material misstatements (Watts and Zimmerman, 1986).

The performance quality of this monitoring function may vary. Audit quality describes how well an audit detects and reports material misstatements of financial statements, reduces information asymmetry between management and stockholders and therefore helps protect the interests of stockholders. One survey of financial statement users (Epstein and Geiger, 1994) indicated that 70% of investors believe that audits should provide absolute assurance that there are no material misstatements or fraud in the financial statements. High audit quality should be associated with high information quality of financial statements because financial statements audited by high quality auditors should be less likely to contain material misstatements.

The auditor's effort, expertise and incentives, and the client's firm characteristics and incentives, all have a direct impact on the assurance level. For example, if a client's financial reporting system has sufficient control procedures in place, competent personnel, and little management discretion, the assurance level could be very high even though its auditor only carries out the audit in accordance with the minimum that is required by Generally Accepted Auditing Standards (GAAS). On the other hand, despite the fact that an auditor was rigorous in exceeding the minimum required by GAAS, the assurance level could be low if a client has a poor quality financial reporting system or if it has significant management discretion that compromises the controls and reporting decisions.

Since audit quality is unobservable, researchers look at indicators of audit quality, such as credibility (Wilson 1983), discretionary accruals (Healy 1985, Deangelo 1986, Krishnan 2003Jong-Hang et al. 2010), auditor industry specialization (Gramling and stone 1998, Hogan and Jeter 1999), accounting firm size (Lennox 1999, Krishanan and Schauer 2000). For the present study, the audit quality indicator will be discussed in detail in next chapter.

1.3 Current Development on the Topic

In the 2011 Big four firms performance analysis by Big team, in the United States, the Big Four holds 98% market share with total revenue of 41 billion dollars (Big 4, 2012). By service line, audit service revenue accounts for 47% of total revenues with tax and advisory services shares comprising the remainder (Big 4, 2012). The Big Four originally were the Big Eight prior to 1989, the Big Six from 1989-1997, the Big Five from 1998-2001, and the Big Four since Arthur Andersen failed in 2002.

As Enron went bankrupt in 2001 and the related collapse of Arthur Anderson in 2002, the audit quality has been criticized for accounting firms, especially the large international Big Four firms. Indeed, this criticism encouraged the regulation change in the United States with the Sarbanes-Oxley Act of 2002 (Public Law No. 107-204). Sarbanes-Oxley introduced major changes to the regulation amendments of financial practices and corporate governance. Table 1-1 shows the Big Four revenue in China and allocation of revenue.

In China, before the economic reform and opening of the economy in the late 1970s, there was no need for independent accounting and auditing as China was a central planning economy. China's first audit firm was established in Shanghai in January 1981, and then the international Big 8 were allowed to establish representative offices whose activities were limited to local liaison and non-attest related services. In the early 1980s, the government allowed China's audit firms to serve only business entities with a foreign affiliation. The Chinese Institute of Certified Public Accountants (CICPA) was established in 1989 to respond to the need for independent auditing information of domestic individual investors.

Independent auditing was not needed for most state-owned enterprises (SOEs) at that time because these enterprises were still financed through government budgets and policy-directed bank loans. Since, the reform financial audit of SOEs was confined mainly to the decentralization of decision-making authority to managers, with privatization not occurring yet. As a result, there was no demand for investor- and credit-oriented auditing information. (Chuntao Li, 2005)

Beginning in the mid-1990s, China accelerated reforms in the financial sector, in which market forces started to play an increasingly important role in the allocation of funds. Ownership reforms of SOEs, for example, the formation of joint ventures, the conversion of SOEs into shareholding firms, mergers and acquisitions, liquidations, and so on were also introduced gradually. (Chuntao Li, 2005) The financial liberalization and SOE ownership reforms created a substantial increase in the demand for public accounting and audit services. By the end of 2003, there were nearly 5,000 accounting/auditing firms and 131,000 CPAs across the country. (CICPA, Oct, 2004)

Table 1-1 2011 Big Four Analysis in U.S. Dollars





Revenue increase(10%)





Employees (in 10,000)





Total revenue ( in 100 million)





Audit revenue (%)





Tax revenue (%)





Consulting revenue (%)





Audit revenue (in 100 million)





Tax revenue (in 100 million)





Consulting revenue (in 100 million)





2010 total revenue in China





In percent of total revenue





China's publicly listed firms are the most sought-after clients of China's audit firms. This market, however, is not open to all audit firms. The Ministry of Finance (MOF) and the China Securities Regulatory Commission (CSRC) require that listed firms be audited by specially designated audit firms that have been established for at least three years, with capital of no less than $33,000 for a limited liability firm and $17,000 for partnerships. The firm also needs to employ at least 20 CPAs who are qualified to audit public firms and at least 40 auditor under age 40. Furthermore, it must show sales at least $1.3 million in previous years and no violation of laws for the last three years. (MOF, 2000)

Before 1997 almost all audit firms in China were established or sponsored by the departments in charge of public finance, taxation, or state-asset management agencies. The close financial and personnel links between the firms and sponsoring government agencies created several obstacles that impeded the supply of high-quality audits. First, the sponsorship agreement means that the government owned both audit firms and listed firms, which inevitably resulted in government interference in business decisions and compromises in audit firm independence. As a result, audit firms have only limited latitude to choose the quality of the services that they wanted to offer (DeFond et al.(2000), Yang,et al. (2001),. Second, government ownership of both audit firms and clients was conducive to protectionism; that is, a government department could require business entities under its control to be audited by audit firms also under its control (Yang, et al.(2001).

In response to criticism of the audit firm-government association, a program to disaffiliate audit firms from their sponsoring bodies began in 1997. Under this program, an audit firm could gain full recognition from CICPA only if it disaffiliated itself from its sponsors in terms of both personal and economic interest. The disaffiliation process was completed at the end of 1999, at which point 107 disaffiliated audit firms were certified by CICPA as qualified to audit publicly listed firms.13 After cutting ties with the parent government bodies, the disaffiliated firms organized as private professional firms in the form of either a partnership or a limited liability firm. They enjoy greater business decision-making autonomy and therefore greater latitude to choose quality of their services. The possibility of increasing of market share created incentives for the firms to provide high-quality audits.

Table 1-2.02-07 Big Four Revenue v.s. local firms in China (in RMB 10,000)







Big 4







Chinese local firms







Big 4 audit firms have to form joint ventures with domestic audit firms when they offer audit services in China. In 2012, the largest Chinese local firm BDO China Shu Lun Pan Certified Public Accounts LLP announced the total revenue in 180 million RMB, however, the KPMG 2011 total revenue was only 19.3 million RMB. The local firms are growth rapidly and catching the Big four.

1.4 Problems and Business Dilemmas

In 2005, one Chinese local CPA firm had failed audit Kelon Co. Kelon Electric Co is a public trade company in China; its business focuses on manufacturing home appliances. In 2005, the Kelon Electrical Co. stock was suspended by the China Securities Regulatory Commission due to its virtually increased revenue (62 million in 2002, 47 million in 2003, and 79 million in 2004), falsified profit of about 18 million in 2002, 14 million in 2003 and 18 million in 2004. From 2002 to 2004, Kelon and Greencool Capital Limited Co. which is controlled by the Chairman of Kelon, had major investments and acquisitions that not been disclosed properly. Within 4 years, Greencool Capital Limited Co. suspected embezzlement of 500 million of Kelon's assets. However, Deloitte China still issued the audit report with a qualified opinion to Kelon Electrical Co in 2002 and 2004, and in 2003 issued the unqualified opinion audit report. Similar to the Kelon case, in 2001 the Chinese Regulatory Commission announced that Yin Guang Xia Industry Corporation falsified profit for 90 million during 1999-2000. Its auditor, the Zhongtianqin CPA firm, which was the largest local auditor firm of China in 2000, was partly responsible for the misrepresentations. Thereby, the Ministry of Finance suspended the license of the Zhongtianqin CPA firm.

The number of forced audit firm changes in China is of sufficient magnitude to allow

a meaningful empirical comparison to be conducted. In 2001, eight Chinese audit firms had their licenses to audit listed companies terminated or suspended for significant audit failures or other regulatory violations. As a result, over 170 companies (nearly 15 percent of listed Chinese companies) had to find a new audit firm for their 2001 annual reporting audit. The situation in which clients were forced to switch auditors in China is similar to that caused by the Arthur Anderson collapse in the U.S., an event that has been examined in a number of recent studies (e.g., Nagy 2005; Cahan and Zhang 2006; BGR 2007; Krishnan et al. 2007; Vermeer 2008; Vermeer et al. 2008). The CSRC has established a web-based system in which basic information such as the work experience (including across-firm turnover) of individual auditors currently licensed to audit listed companies is made available to the public, thus ensuring that CPA firm and year movements of partners who sign audit reports can be tracked.

According to recent news, in January 2012, PwC UK was fined £1.4 million for audit failure to discover billions of dollars of client funds that had not been preserved properly at JP Morgan Chase Bank. Also, PwC UK was fined £33 million. (Adam Jones, 2012). The worst case of audit failure is Arthur Andersen failing to detect and report Enron's billions of fictitious profits and debts.

All these real audit failures have motivated researchers to find a better solution to improve audit quality.

1.5 Issues and Challenges

The audit environment is characterized by competition and audit fee pressure (Elliott and Jacobson, 1994-1995). To survive and compete successfully in this market, audit firms must make great efforts to achieve client expectations and maximize client satisfaction. The challenge for all audit firms is to understand the determinants of client satisfaction (Bruce et al. 1997).

In China, the listed company's audit requirements of the accounting statements are mostly from the CSRC. DeFond et al.(2000) offered evidence that China's audit market in the mid-1990s was characterized by a lack of demand for audit quality from controlling shareholders and managers So far there have been low-quality audit services. The demand will inevitably lead to lower quality services provided by the auditor toward the direction of fraud.

For China's listed companies, the certified public accountants audit market structure is irrational. Currently for the listed companies, the accounting firms' audit qualifications are low level. In this way, a listed company has plenty of room for choice, and they can always find one willing to meet the wishes of their improper auditing firm to provide them with 'service'.

In the current audit system of China, listed companies' audits by certified public accountants are less reliable, cannot truly serve to improve the financial and accounting information quality, and protect the interests of investors, especially the role of small and medium investors. China has to confront the significant issues of how to establish and improve corporate governance structure, optimize internal control, promote effective use of corporate resources, and avoid fraud and waste.

The challenge of Chinese auditors is independent. The Chinese cultural context is widely recognized to be more relation based than regulation based. The audit market in China is controlled by the government. State ownership of a corporation may have a direct effect on CPA behavior. Prior research found state owned companies are like to receive clean audit opinions (Liao and Wang 2008). Thereby, keeping external auditors independent for field service is a challenge for Chinese auditors.

1.6 Motivation

A properly configured audit quality infrastructure will ensure orderly growth and sustainable economic progress for China. The Chinese Accounting Firm will evaluate audit quality and services based upon the ability of reporting misstatement and detecting misstatement. All Big Four Accounting Firms: PricewaterhouseCoopers, KPMG, Ernst & Young, andhave local offices in Beijing, China. In addition, according to the Chinese Institute of Certified Public Accountants, the Big Four accounting firms absorb 33.5% service revenue of the total accounting firms in China.

The audited report information is essential to society. Reliable accounting and financial reporting aid society in allocating resources in an efficient manner. A primary goal is to allocate limited capital resources to the production of those goods and services for which demand is great. Economic resources are attracted to the industries, the geographic areas, and the organizational entities that are shown by financial measurements to be capable of using the resources to the best advantage. The contribution of the high quality audit is to provide credibility to information to public sectors. Credibility information means those financial statements can be believed, it can be relied upon by outsiders such as investors, creditors, government regulators, and other interested third parties.

1.7 A Proposed Conceptual Model

In the present study, a conceptual model was created and was turned to empirical verification via a survey of randomly selected CPA auditors who were currently practicing auditing in China accountancy service industry. With various statistical analyses, investigations were made with companies that show the success for adopting the audit quality concepts and practices.

1.8 Findings and Expected Findings

The data of the present study will be analyzed by EFA and SEM. It is expected that the various factors included in the empirical investigation will find the most significant factors that impact audit quality, at the same time provide suggestion for management to improve audit quality.

1.9 Research Questions

Thus, the findings and discussions mentioned above have paved the way for the following research questions:

RQ1: What factors affect accounting firms' audit quality?

RQ2: How to improve audit quality?

1.10 Study's Mission and Objectives

A properly configured audit service quality infrastructure will ensure orderly growth and sustainable economic progress for China. Consumers will evaluate audit service products and services based upon audit learning, pricing, and professional knowledge.

To ensure success, Chinese audit firms must provide a blueprint for all customers and third-party vendors to follow. The author will apply quantitative methods with empirical investigation to this research and target Silicon Valley and Beijing accounting firms. A survey questionnaire tapped the CPAs' perspectives. Through the survey feedback, the CPAs' technical knowledge, abilities, professional attitudes, behaviors, partner tenure, and independence were examined. Furthermore, the present study includes an analysis, based on the structural equation model, of the impact of the psychological factors and audit quality. Understanding the relationship between factors and audit quality will be helpful to improve the accounting firms audit service quality. Hopefully, the results of this study will contribute to audit services as well as future on this topic.

1.11 Research Processes and Designs

This dissertation includes five chapters. Chapter One: Introduction, describes the audit services development in China and identifies the objectives of the present study and motivations. Chapter Two is a review of the literature on factors and audit quality, also including the previous research findings. Chapter Three outlines a conceptual model and delineates statistical methods for data analyses. Chapter Four presents the results of hypothesis testing. Chapter Five includes the conclusions, limitations, and suggestions for future research. Figure 1-3 summarizes the research process of the present study.


Define research objectives, motivations, and problems

Chapter 2

Literature review and constructing a conceptual framework

Chapter 3

Research methodology design, hypotheses design, questionnaire design, and pilot test

Chapter 4

Data analyses and results

Chapter 5

Conclusions, suggestions, and limitations

Figure 1-1. Research Process of the Present Study.


This chapter begins with the review of the previous research of the audit quality model, following the literature review of variances associated with audit quality. At the end of the chapter, a summary of literature review will be provided.

2.1 Theoretical Backgrounds

Audit quality can be conceptualized from low to high. Generally, the audit service is when the audit party examines the clients' financial statement either meeting or not meeting minimum regulation and professional requirements. DeAngelo (1981) defines audit service quality by the probability that auditor "a) discover a breach in the client's accounting system, b) report the breach." Wooten (2003) built the Audit Quality Model based on the DeAngelo Model, and explores more detailed factors that will affect audit quality. Based on the research, the author defines audit firm size; the audit team factor will affect the ability to detect misstatements. The independent factor will significantly affect the ability to report misstatement. The author summarized audit team factors including: client experience, industry experience professionalism, planning and performing, and supervision are the key stimuli of ability detecting misstatement. Meanwhile, the independence is the key stimuli for reporting misstatements.

In addition to DeAngelo's theory, other researchers added two more dimensions of audit quality: c) the accuracy of the auditor's report [Titman and Trueman (1986), Krinsky and Rotenbery (1989), Davidson and Neu (1993)], and d) the ability of auditor improve accuracy of accounting data without bias (Wallace 1980). Watkins et al (2004) developed the audit quality framework in Figure 2-2.

Detecting Misstatements

Audit Quality

Reporting Misstatement

Figure 2-1. Model 1 DeAngelo (1981) Model.

The author adopts Wallace's (1980) theory that auditor monitoring strength, which is determined by auditor competence and independence, would influence information quality. The auditor monitoring strength represents the auditors' ability to detect and report the clients' real economic financial situations.

Audit Quality

Auditor Reputation

Perceived Competence

Perceived Independence

Auditor Monitoring Strength

Auditor Competence

Auditor Independence

Information Quality

Information Credibility

Financial Statements

Figure 2-2. Model 2, Watkins et al. Model.

Following DeAngelo's theory, Francis (2011) states that audit quality is achieved when the "appropriate" audit reports are issued on the client's compliance with generally accepted accounting principles. An audit failure occurs in two situations: 1) when generally accepted accounting principles are not enforced by the auditor, 2) the auditor fails to issue an audit report in appropriate condition. Francis (2011) conducts the framework to understanding audit quality.

Audit Inputs

Audit tests

Engagement team personnel

Audit Processes

Implementation of audit tests by engagement team personnel

Accounting Firms

Engagement teams work in accounting firms

Accounting firms hire, train, and compensate auditors, and develop audit guidance (testing


Audit reports are issued in name of accounting firms

Audit Industry and Audit Markets

Accounting firms constitute an industry

Industry structure affects markets and economic behavior


Institutions affect auditing and incentives for quality, e.g., State Boards of Accountancy, the AICPA,

FASB, SEC, and PCAOB, as well as the broader legal system

Economic Consequences of Audit Outcomes

Audit outcomes affect clients and users of audited accounting information

Figure 2-3. Francis (2011) Framework.

The author states audit quality is affected at each level of framework. At input level, auditors with great competence and independence implement an audit test procedure that is capable and reliable. The audit input flows through the audit process; auditors with great quality of the engagement team make excellent judgments of audit tests to be implemented and properly evaluate the evidence from these tests in guidance of the audit report. Audit quality also affected by the accounting firms. The accounting firms recruit, train auditors, and develop the audit test procedures that are implemented in audit engagements. In additional, audit reports are issued under the name of firms. Institutions such as AICPA, FASB, SEC, and PCAOB regulate and control audit service provided by accounting firms and individual auditors. Finally, audit outcome, which is a public audit report, also represents audit quality. Dodd et al. (1984) and Loudder et al. (1992) document the market response negatively to a qualified audit report.

Balsam (2003) examines audit quality by brand name and industry specialization through earning management indicator - discretionary accruals. Previous research already provides evidence showing that there is a positive association between auditor brand name and the earning response coefficient; therefore, the auditor brand name indicates better earning quality, hence, greater audit quality [Becker et al (1998), Reynold and Francis (2000), Teoh and Wong (1993)]. However, Ann et al. (2004) argued that due to the recent Arthur Andersen collapse, an auditor firm with great reputation also could provide weak monitoring strength in a particular engagement case. As a result, the unqualified information is perceived by the market and is misleading to the investors.

Balsam (2003) found that industry specialists have a lower level of discretionary accruals and a higher earning response coefficient because the industry specialists could provide a better audit quality than a non-specialist. This funding contributes to Big Four firms that industry specialization could have a favorable impact their earning.

Figure 2-4. Model 3, Balsam (2003) et al. Model.Auditor Industry Specialization

Audit Quality

Brand Name

Quality of Financial Reporting

After Arthur Andersen's collapse, the U.S House of Representatives passed the Sarbanes-Oxley Act of 2002; this act shifted the mandatory seven-year rotation with a two-year cooling-off period to a five-year rotation and a five-year cooling-off period (U.S. House of Representatives 2002). Daugherty et al (2012) completed a field survey to determine direct and indirect consequences of rotation to audit quality among 170 auditors of 14 firms, including Big Four and other national firms. They found the rotation is positively associated with partner's independence and resulting positive impact on audit quality. However, the reduced client-specific knowledge negatively reduces audit quality. One key finding of this research is the audit quality will be impacted when auditors are forced to do retraining, but not for relocation. If the auditor maintains the industry expertise, the audit quality would not be affected.

Partner Rotation

Audit Quality

Independence and Fresh Look

Client Specific Knowledge

Figure 2-5. Model 4, Daugherty et al (2012) Model.

From the survey results, partners agreed with client knowledge loss due to rotation, and longer auditor tenure would increase audit quality. Specifically, surveyed partners emphasize the importance of relationship building between the firm and client. They also agree that rotation will improve auditor independence that reflects audit quality. However, the research limits audit quality proxy by independence. Future search could adopt more indicators of audit quality.

Professional Knowledge

Personal Ethics

Audit Quality

Personal Continuous Improvement

Sustainable Reputation

Figure 2-6. Model 5, Tangpinyoputtikhun, Y. and C. Thammavinyu (2010) Model.

Tangpinyoputtikhun and Thammavinyu (2010) examine the influence that both professional knowledge and personal ethics have on sustainable reputation through audit quality. The author finds that there is a positive effect on the relationship between professional knowledge and audit quality. Additionally, personal ethics has a positive effect on audit quality. Moreover, both professional knowledge and personal ethics have an overall positive effect on audit quality. These findings indicate that different levels of auditing do not influence sustainable reputation. According to the findings, if the individual has a high level of professional knowledge and personal ethics, it will lead to audit quality and reflect on their sustainable reputation as well.

Audit Learning

Process and technical attentions

Integrative thinking system

Semantic and episodic memory

Problem solving reasoning

Audit Judgment

Audit Competency

Audit Quality

Professional Image


Figure 2-7. Model 6, Ussahawanitchakit, P. and S. Thaweechan (2010) Model.

This study examined the effects of audit learning on professional image of CPAs in Thailand. The results indicate that audit learning has a significant positive impact on professional image through audit judgment, audit competency, and audit quality as the mediator. The auditor-stakeholder communication shows partially positive supported effects on audit quality and professional image. For an auditor, they must not only develop skills and knowledge but must also be concerned about the new techniques to support audit tasks and may use auditor-stakeholder communication as an independent variable relationship test.

Information Technology Expertise

New Audit Knowledge Innovation

Technological Adaptation Efficiency

Continuous Audit Improvement

Dynamic Technological Change

Audit Service Quality

Figure 2-8. Model 7, Chaveerug and Khunthong (2010) Model.

On another approach, Chaveerug and Khunthong researched the relationships between information technology expertise on audit service quality via the mediating influence of the continuous audit improvement, technological adaptation efficiency, and new audit knowledge innovation. Based on the study, the results show information technology expertise has positive relationships with audit service quality and is significant on continuous audit improvement, technological adaptation efficiency, and new audit knowledge innovation.

Figure 2-9. Model 8, Sudsomboon and Ussahawanitchakit (2009) Model.Audit Learning

Process and technical attention

Integrative thinking system

Semantic and episodic memory

Problem solving reasoning

Audit Judgment

Audit Competency

Audit Quality

Professional Image


The objective of this study is to investigate the effects of PAC (professional audit competencies) on audit success via the mediating influences of audit quality and audit reputation. Audit knowledge, self-experience, and individual learning are hypothesized to become the antecedents of PAC. Also, professional regulation, stakeholder force, and professional competitive are the moderators of the relationship.

The results show that PAC has a positive influence on audit quality and reputation which effects audit success. In addition, audit knowledge, self-experience, and individual learning have positive relationships with PAC. Both the professional regulation and stakeholder force have a significant impact on the relationship between antecedents and PAC, but professional competitive is not a moderating effect of the relationships. Finally, this study suggests that auditors should develop and concentrate on how to increase professional competencies in auditing so as to survive in the audit market.

2.1.2 Summary of the Models and Conceptual Framework

Based on the previous model review, the author summarizes the model and develops the rest of the chapter sections based on this summary.

Figure 2-10. Summary of Models.2.2 Auditor Competence (from Model 2,7)

2.3 Professional Knowledge

(from Model 1, 5)

Audit Quality

2.5 IT and Resources

(from Model 7)

2.4 Planning and Ethics

(from Model 1)

2.6 Partner Rotation

(from Model 5)

2.2 Audit Competence

Prior researchers defined auditor competency as "Cluster of behaviors, skills, and knowledge which are needed to undertake a job effectively" (Butler, 2007). Additionally, for audit standard compliance, expertise judgment commitment, ethical and value awareness, client linkage efficiency and audit technique implementation effectiveness are necessary (Sudsombbon and Ussahawanitchakit, 2009). Moreover, Bedard et al (2003) define audit competency as auditor's ability to apply such as accountant knowledge, finance knowledge and personnel knowledge, including for adequate training and experience in all facets of an auditor's work (Mansouri et al., 2009). Noor (1996) identifies three main points as audit successes including advanced information; continuing professional education and minimum levels of professional qualification. The three points are covered through auditor's education, training and admission to profession after obtaining desired qualification. Based on prior research, an auditor needs greater processing audit competency.

2.2.1 Written Expression and Oral Expression

Organizational communication is important to public accountants and often influences job satisfaction. Auditors must communicate with client personnel and with other professionals in the firm. Lack of communication between accountants could have dangerous consequences for the firm as well as inhibiting the ability of accountants to accomplish their jobs properly. In addition to issuing a report on the financial statement, the auditor is required by professional standards to discuss certain matters with an audit committee, or with individuals possessing a level of authority and responsibility equivalent to that of an audit committee, such as board of directors, and board of trustees. The AICPA's core competencies for individuals entering the accounting profession requires auditors should have the skills necessary to give and exchange information within a meaningful context and with appropriate delivery. Professional CPAs should have the ability to listen, deliver powerful presentations, and produce examples of effective business writing (AICPA, 2005). Two attributes represents an auditor's communication effectiveness, "written expression" and "oral expression". The written and oral skills are emphasized by Abodolmohammadi et al. (2004) and Tang (1999).

2.2.2 Leverage Technology

AICPA (2005) also requires professional auditors' technological adaptability for today's accounting. As technology advances, the accounting professional must acquire new skills and determine how new technologies should be best incorporated into their practices. This commitment to continual technological learning will enhance the development and application of other personal competencies. Many large CPA firms use generalized audit software (computer programs) that can be used to test the reliability of the client's programs as well as to perform many specific audit function. This audit software is suited for use on a wide variety of IT-based systems. The significant value of generalized audit software lines in the fact that auditors are able to conduct independent processing of live data. Often, the verification of the client's output would be too large a task to undertaken manually, but it can be down efficiently using generalized audit software. ACL and IDEA are two widely used commercial products.

2.2.3 Independence

Stoel et al. (2012) find out independence is the most crucial factor for IT audit, but also the independence concept has been recognized as important in prior research on financial statement audit quality (Schroeder et al., 1986; Carcello et al., 1992; Behn et al., 1997; Chen et al., 2001; Samelson et al., 2006). It includes items related to the objective and proper conduct of the audit emphasizing the independence of the audit team from influence by the auditee management. Independence is usually defined as when the audit team is independent from the auditee and reports to an appropriate, responsible entity. Two attributes in independence category are very similar to attributes used by Stoel et al. (2012) which are: "Do not advocate for audit" and "avoid actions that compromise independence".

2.3 Client Experience

The experts reported that experience with a specific client leads to a higher-quality audit (Wooten, 2003). The author found audits are more likely to gain a better understanding of how the client's business processes work and the particular strengths and weaknesses in the client's accounting systems. They are able to more readily identify the areas that had the most risk and errors from the previous year and then devote additional time to these areas.

2.3.1 Interaction

Frecka and Nichols (2004) states that graduate programs in accounting place a great deal of emphasis on learning of the competencies of teamwork and group interaction. Recruiters on university campuses use interviews to assess personal competencies to client interaction and communication skills. For experienced auditors, positive client interaction is essential during the different forms of negotiation (Brown and Wright, 2008). Client interaction skills are also important for tax professionals (Bertolini et al. 2010). AICPA core competency requires accounting professionals accounting professionals must be able to work with others to accomplish objectives. This requires them to act as valuable business partners within organizations and markets and work in teams to provide business solutions. Thus, individuals entering the accounting profession should demonstrate an ability to work productively with individuals in a diversity of roles and with varying interests in the outcome (AICPA, 2005). Three attributes are addressed interaction skills: "client business awareness" indicates interesting of clients' business, "convince client" captures the perception that client problems and concerns are understood, "communication between audit team and audit committee" represents needs for communication skills.

2.3.2 Problem Solving

Accounting professionals are often asked to discern the true nature of a situation and then determine the principles and techniques needed to solve problems or make judgments. Thus, individuals entering the accounting profession should display effective problem solving and decision-making skills, good insight, and judgment, as well as innovative and creative thinking (AICPA, 2005). The author adopt "problem-solving ability" used by Abdolmohammadi et al. (2004) and Tan (1999) to measure the core technical capability of performing audit task (Bonner and Lewis, 1990).

2.3.3 Internal Control

Public companies now are entering the era of internal control audits required by Section 404 of the Sarbanes-Oxley Act. External auditors are issuing audit opinions on the effectiveness of internal control over financial reporting, and many internal auditors have been involved in internal control documentation and testing in the periods leading up to the initial external audit opinion on internal control. Internal control is a process, affected by an entity's board of directors, management, and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in: reliability of financial reporting, compliance with applicable laws and regulations, effectiveness and efficiency of operation (AICPA, 1992). The International Auditing and Assurance Standards Board (IAASB) states that "internal control can positively influence audit quality" (IAASB, 2011). Section 404 of the Sarbanes-Oxley Act (U.S. Congress, 2002), denoted SOX requires that public company financial statements filing on Form 10-K and Form 10-Q contain an assessment by management of the design and operating effectiveness of its internal control over financial reporting. Section 404 also requires that the external auditor, on an annual basis, provide an opinion on management's assessment of internal control (Securities and Exchange Commission (SEC), 2003). The author adopts "knowledge of internal control" and "internal control audit" to state how "internal control" contributes to audit quality. It also is important to appreciate some of the ways that internal control audits may help organizations to prevent or detect fraud, especially fraudulent financial reporting, and to improve their overall corporate governance. The work done to comply with Section 404 will provide important benefits to external auditors, audit committees, and internal auditors - each of whom is focused on fraud prevention and detection.

2.4 Professional Knowledge

Professional knowledge is "that body of knowledge and skills which is needed in order to function successfully in particular profession". (Tamir, 1991).Professional knowledge in accounting is a part of auditor expertise. Expert panels also identify the integrity of the individuals assigned to the engagement as a factor in detecting material misstatements. Wooten (2003) shows those that exhibit a high level of professionalism are more likely to perform their audit tasks correctly and not sign off on uncompleted audit steps. Similarly, he also maintains persistent skepticism is less likely to accept insufficient evidence.

The impact of the knowledge and skill of audit personnel on audit quality has been addressed in prior research, again primarily in the financial audit research (Carcello et al., 1992; Chen et al., 2001; Havelka and Merhout, 2009; Hun-Tong and Kao, 1999; Knapp, 1991; Merhout and Havelka, 2008; Samelson et al., 2006). Specifically, Carcello et al. identified two factors that are similar to the factor found in our study: 1) compliance with general auditing standards and 2) individual team members' characteristics (that included knowledge of accounting and auditing). Chen et al. also found two factors that are similar to ours: 1) knowledgeable and ethical (auditors) and 2) qualification and risk control. The only IT audit-oriented research including Accounting Knowledge and Audit Skills was exploratory (Havelka and Merhout, 2009).

2.4.1 Accounting Knowledge

The audit personnel's knowledge of accounting and auditing in general, their understanding of the accounting system being audited in specific, and their ability to perform tasks and exercise professional judgment as auditors. Individuals entering the accounting profession should behave in a manner that is consistent with the character and standards of the discipline of accounting, as well as the norms of the environment in which they interact (AICPA, 2005). As the requirement of become as a CPA, the following accounting knowledge including in the examination: SEC regulations, GAAP, GAAS, federal and state income tax law, etc. Therefore, the author determines that auditors' should be knowledgeable for those principals and regulations.

2.4.2 Technical Analysis

Tan and Libby (1997) found that managerial knowledge is important for superior performance at the manager level; in addition, the author found that while technical skills are important for superior performance at the staff level. The author states auditors should be able to process technical ability in preparing financial statements.

2.5 Planning and Ethics

GAAS states that the audit must be properly planned and performed to have a reasonable assurance of detecting material misstatements. Firms that have strong audit firm factors will likely have the people and processes in place to ensure proper planning and performance. (Wooten, T. C 2003)

Ethics has been defined as the study of moral principles and values that govern the actions and decisions of an individual or group. While personal ethics vary from individual to individual at any point in time, most people within a society are able to agree about what is considered ethical and unethical behavior.

2.5.1 Planning

The activities required to define the work to be performed and the specific deliverables to be produced, including the use of a standard approach and guidelines for executing the audit. Planning was identified by Merhout and Havelka (2008) as a theoretical factor for IT audit quality. Shroeder et al. (1986) also included Planning as a factor in their comparison of audit committee chairs' and CPA partners' perceptions of important audit quality factors. Other research found that the planning of audit procedures is related to the identification of particular risk factors (Bedard et al., 2005).

2.5.2 Ethics

Each of profession has specific ethic codes which promote members of that profession reach highest standards. Ethics in accounting is of utmost importance to accounting professionals and those who rely on their services. Certified Public Accountants (CPAs) and other accounting professionals know that people who use their services, especially decision makers using financial statements, expect them to be highly competent, reliable, and objective. Those who work in the field of accounting must not only be well qualified but must also possess a high degree of professional integrity. A professional's good reputation is one of his or her most important possessions.

The AICPA's Code of Professional Conduct defines the ethical responsibilities to governs AICPA members. In the U.S., most state boards of accountancy have adopted rules that are similar to the AICPA code, but they may differ in unique respects. If an auditor is auditing a public company, the auditor must conform to SEC and PCAOB regulations and rules. A code of ethics is necessary and appropriate for the auditing profession.

2.5.3 Control of Audit Work

GAAS requires a firm to maintain a quality control system and requires auditors to adequately plan their audits. Carcello et al. (1995) found that a more structured audit approach is associated with firms that have a higher propensity to issue ongoing concern opinions. Krishnan and Schauer (2000) noted that a firm participating in a peer-review process is more likely to correctly report financial disclosures. Firms that closely monitored the outcome of the audit process were associated with higher quality. Malone and Rebors (1996) found that auditors with stronger quality control systems were less likely to participate in reduced audit quality behaviors.

2.5.4 Skepticism

The Auditing Standards Board states that the auditor should maintain the attitude of "professional skepticism" (AICPA 1988). In addition, skepticism is necessary to perform the social role expected of auditors (United States vs. Arthur Yong, 1984). Auditors who are more skeptical will search for more persuasive evidence, suspending judgment until sufficient evidence is available for a judgment or decision (Hurtt 2010). Nelson (2009) states that high professional skepticism, which is revealed by skeptical behavior, is an aspect of auditor job performance. Auditors that maintain persistent skepticism are less likely to accept insufficient evidence (Wooten, 2003)

2.6 IT and Resources

While the use of information technology in the business world has grown exponentially in the past two decades, the extent to which auditors have adopted IT, such as computer assisted auditing techniques to meet this growth, remains an empirical question [Arnold and Sutton, (1998), Curtis and Payne, (2008), Janvrin et al. (2009)]. The computerized assisted auditing is computer tools that extract and analyze data from computer applications (Braun and Davis, 2003). Technology permits auditors to increase their productivity as well as that of the audit function (Zhao et al. 2004). For example, computerized assisted auditing can automate previously manual audit tests, reducing total audit hours expended. They enable auditors to test 100 percent of the population rather than a sample, thereby increasing the reliability of conclusions based on the test [AICPA, (2001), Curtis and Payne, (2008)] In addition, the computerized assisted auditing may be used to select sample transactions meeting specific criteria, sort transactions with specific characteristics, obtain evidence about control effectiveness, and evaluate inventory existence and completeness (AICPA, 2006).

The audit environment is one of increased responsibility and workload for audit teams, including enhanced responsibilities for detecting fraud required by SAS NO. 99 and internal control attestation now required under Section 404 of the Sarbanes-Oxley Act. One approach to meeting this increased demand is through the use of audit technologies, which can greatly improve the efficiency and effectiveness of an audit (Banker et al. 2002). While the current audit environment intensifies the need for firms to employ techniques that can reduce workload, including those affecting technology implementation decisions, the culture of public accounting may create impediments to the adoption of new technology by audit teams (Vendrzyk and Bagranoff, 2003).

2.6.1 Risk Assessment

Generally accepted auditing standards (AU312) require audit risk assessment in conducting an audit. Risk assessment procedures are designed to help the auditor assess the risk of material misstatement in an assertion. Higher preliminary risk assessments are indicated to collect more persuasive evidence. Once the auditor has made decisions about overall audit risk, the auditor uses the risk model to guide decisions about the audit evidence that is need to restrict detection risk to an appropriately low level. Ramos (2009) noted the aim of the risk assessment auditing standards was to improve the quality and effectiveness of audits by substantially changing audit practice.

2.6.2 Information Technology and Accounting Systems

The author define this factor as audit personnel's level of understanding of specific applications, systems software, and technologies and how these support and control business processes. Much research has identified IT and Controls Knowledge as critical to audit quality (Carnaghan, 2004; Curtis et al., 2009; Greenstein and Mckee, 2004; Merhout and Havelka, 2008; Samelson et al., 2006; Sutton, 1993; Vendrzyk and Bagranoff, 2003). Most of these studies have emphasized the importance of IT skills and knowledge (and the lack of them) for financial auditors (Carnaghan, 2004; Curtis et al., 2009; Greenstein and Mckee, 2004). Related studies would include Hermanson et al.'s (2000a; b) study of IT-related activities by internal auditors, Hunton et al.'s (2004b) investigation of financial auditor's ability to assess risks of ERP systems (they tend to be overconfident), and Messier et al.'s (2004) investigation of the effect of IT on internal controls and auditors' ability to detect misstatements in the financial statements.

2.6.3 Geographical and Cultural factors

Culture is an important environment factor influencing accounting practices and the management control system. Chan et al. (2001) indicated that people from different cultural backgrounds have different preferences of management practices. Chan (2003) found that culture dimensions have a significant impact on auditor-detected accounting errors. The auditor should include geographical and cultural factors when they conduct audit fieldwork. Increased internationalization of audit clients and the firms themselves has resulted in auditors more frequently interacting with individuals from different cultures. Culture is likely to have an impact on audit groups, negotiation tactics, and justification and accountability relationships.

2.6.4 Available Resources

As the auditors adopt risk assessment, they need to allocate the available resources to the audit work. For example, time available from critical auditee, human resources, databases, software, and internal support personnel are needed to perform specific tasks or provide information. Hackenbrack (1997) examines the empirical relationship between auditor's resource allocations and selected engagement factors. The author found labor cost changed due to variety of client size, industry, complexity, and risk.

2.8 Audit Quality

The audit services are demanded by the possible conflicts of interest between the shareholders and the investors. DeAngelo (1981) documents that audit quality depends on the probability of detection and reveal the misstatement. The probability of detection is related to auditor competence such as auditors' technological capabilities, knowledge, etc.

2.8.1 Credibility of Auditor

AICPA stated to improve audit quality by improving the audit practice monitoring (AICPA, 1989), and proposed increasing the ability of profession (Wall Street Journal, June, 1993). Wilson (1983) defined a firm's credibility by auditors' profession and represents the audit quality due to the fact that investors do not have the complete information of a firm's audit. Watts and Zimmerman (1983) stated that it was very difficult for each individual auditor to build credibility and provide high-quality audit service. Furthermore, Watt and Zimmerman suggested this problem could be reduced by the auditor serving as the member of an accreditation organization, such as the American Institute of Certified Public Accountant (AICPA). Then, the individual auditor's credibility could transfer to an audit firm. Grant, Bicker and Shiptsova (1996) defined credibility as a forward looking estimate of audit quality. In this search, they selected profession as the standard of auditor credibility and found out the high-quality audits are always provided with excellent self-regulatory settings. They also recommended improving audit quality by the provision of economical and effective regulation to monitor and discipline audit practice. In summary, all studies suggest the greater the credibility of audit firm, the higher audit quality.

2.8.2 Discretionary Accruals

Earning management is mostly used as an indicator of quality management. The discretionary accruals are used to shift reported income (Bartov et al. 2001). Accruals allow managers to use non-public information to improve the ability of a company's earnings, thereby reflecting potential economic benefits. In addition, it is difficult for the public to observe those accruals; as the result, auditing plays an important role to investigate and disclose discretionary accruals. Krishnan (2003) examined the relationship between discretionary accruals by cross-sectional variation of the Jones (1991) model. He found the positive association between stock returns and discretionary accruals. Future, the previous research indicates that high discretionary accruals indicate manipulation earnings (e.g. Healy 1985, DeAngelo 1986).

Therefore, the discretionary accruals associate with audit quality. Antle and Nalebuff (1991) used abnormal accruals as the proxy for audit quality and found out the audited financial statement was the output of the audit firm and company management. For this reason, earnings management is influenced by audit firm and reflects audit quality (Wuchun et al.) Recently, numerous studies use discretionary accruals as the proxy for audit quality. For example, Jong-Hang et al. (2010) documented there is no significant association between audit quality proxy by discretionary accruals and abnormal audit fee.

2.8.3 Auditor Industry Specialization

Gramling and Stone (1998) suggest the industry specialist auditors could provide better audit service for three reasons: (1) excellent audit skills, (2) low costs through economies-of-scale, (3) superior industry knowledge. Further, several studies determine there is positive relationship between auditor industry knowledge and audit service. For example, Johnson et al. (1991) and Owhoso et al (2002) found that industry-specialized auditor teams detect breach more effectively and the performance of audit team declined without specialists. Other scholars also suggest that industry specialization play an important role in audit quality (Solomon et al.1999). Hogan and Jeter (1999) suggest audit firms invest in specialization due to the higher concentration levels of audit firm and more market share.

O'Keefe et al. stated audit quality measured by compliance with GAAS is increasing with specialization. For recent studies, financial analysts rank clients with industry specialists audit firms higher than those clients without industry specialization (Dunn et al. 2000). For earnings management, the industry specialists predict future financial status more accurately than non-specialist auditors. However, Lys and Watts (1994) argues that there is no significant difference of auditor litigation between industry specialist and non-specialist.

Working on multiple clients within the same industry allows the staff to become expert in the processes and procedures unique to that industry. By understanding the common weaknesses, risks, and issues faced by a particular industry, an auditor can be more confident and persistent when assessing the evidence presented by the client.

2.8.4 Accounting Firms' Brand Name and Firm Size

In 1979, Arnett and Danos argue the firm size should not be the prime determination for audit success. In addition, they argue that if the non-Big Eight firms maintain the professional standards and audit compliance with GASS, they should not be distinguished by Big Eights. In contrast, numerous studies examined the relationship between audit quality, audit firm size, and brand name. They both agree that the firm size is significantly associated with audit quality. DeAngelo 1981 stated that the larger audit firm has greater incentives to detect and reveal the breach; therefore, larger firms perform better audits because they have a greater reputation. In addition, because larger firms have more resources at their disposal, they can attract more employees with excellent competence. Others have theorized that large auditors attract a fee premium because their greater wealth reduces clients' exposures in litigation (Lennox, 1999). In addition, St. Pierre and Anderson (1984) found Big Four auditors have lower probability of litigation than non-Big four.

Others have found that there is no real audit quality difference, but the acknowledgement exists because large firms are well known and have gained a reputation for high quality service. Indeed, the AICPA has maintained that audit quality is independent of firm size. On the whole, the evidence is mixed, but it does appear that there is some relationship between size and quality. What is unclear is whether this difference is actual or perceived.

Krishnan and Schauer (2000) studied the relationship between firm size and compliance with reporting requirements by not for-profit entities. They found that compliance increases with firm size. Hardiman et al. (1987) found a higher rate of reporting format noncompliance by smaller firms when reviewing audit reports submitted to the GAO, indicating that the larger firms have a process in place to ensure that the financial statements are in compliance with GAAP. These studies, however, address the compliance of financial reports to current GAAP rather than the competence and sufficiency of audit evidence or its documentation.

Mutchler et al. (1997) found that Big Four auditors are more likely than non-Big Six auditors to issue going concern opinions. This indicates that the larger firms are willing to take a more aggressive stance in issuing the appropriate opinion, have better technical ability to detect the going concern issue, or have more clients with such issues. Francis and Wilson (1988) pointed out large audit firms have already established the bread reputation and have motive to maintain it by providing high standard audit services.

2.8.5 Auditor Independence

As DeAngelo defines the level of auditor independence as "the conditional probability that, given a breach has been discovered, the auditor will report the breach" (DeAngelo, 1981). The author argues that larger auditors are more economically independent from their clients and, therefore, deliver more reliable, higher quality audits. On other hand, Watts and Simmerman argues that auditor cannot perfectly independent from their client (Watts and Simmerman 1980). DeAngelo states that there are economic benefits for auditor independence to have greater incentives for telling the truth. If the auditor always announces "good news" to the market, the value of the auditors' opinion will be worthless for the investors. Since the more independent the auditor is associated with clients, the better audit quality will be evaluated by the public. Monitoring the auditor's independence, could be a necessary issue for the Big Four. Audit firms need to train their auditors to learn reorganization of independence. As an example, KPMG in 2004 implemented automation tools, such as Sentinel and Client & Engagement Acceptance/Continuance to monitor and enforce global compliance with regulations and procedures (KPMG International 2004 Annual Report, p. 45).

2.8.6 Auditor Partner Tenure

In 1970s, the American Institute of Certified Public Accounts reported that partner and manager attention to the engagement is associated with audit quality. GAAS requires that audits be properly supervised and assigned.

China is one of the few audit markets where the leading audit partners for an audit

engagement are required to disclose their names in the audit report. According to applicable regulations, at least two Chinese certified public accountants must sign the audit report, and one of these two signatory auditors should serve as the leading auditor in charge of field work, with the other being at least a deputy executive of the audit firm and serving as an engagement reviewer. These two individual auditors assume the same legal liabilities (unless one can demonstrate that the situation should be otherwise). This requirement enables researchers to differentiate clients who continue to be audited by their former partner from those who do not.

Tenure relates to both audit team factors and independence. Audit failure appears more common with short tenures a