The history and review of audit quality

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Right from the days the world recognized "quality" as the weapon to fight the global competitive war (Dunk, 2002). It

is applicable to every aspect; especially to auditing and accounting.

Summing up, it turns out that we know more about audit quality than we might have originally suspected:

• Auditing is relative inexpensive, less than 1/10 of one percent of aggregate client sales;

• Outright audit failures with material economic consequences are very infrequent;

• Audit reports are informative, despite the presence of false positive and negatives;

• Audit quality is positively associated with earnings quality;

• Audit quality is affected by legal regimes and the incentives they create;

• There is evidence of differential audit quality by Big 4 firms and industry experts, and differential audit quality across

individual offices of Big 4 firms and across different legal regimes;

• Academic research has had little impact on regulations and policy-making in the US, although it may have had more

influence in other countries such as the United Kingdom (Francis, 2004); and

• Audit quality is much related to audit committee.

The importance of perceptions of independence

External auditors hold themselves out to be professionals in every sense of the word. They subscribe to codes of ethics

which provide guidance in maintaining a professional attitude and stature. In the United States the ethical code calls for

auditor independence from client management (American Institute of Certified Public Accountants, 1983). Not only

must an auditor be independent, however, but he or she must be perceived as independent as well. The external auditor's

professional opinion would be of little value to statement users if they believe the auditor is not wholly independent of

management. Users can only have faith in an auditor's representations when confidence exists that the auditor has acted

as an impartial judge, basing conclusions on objective evidence. Perry (1984), state that the five most common reasons

for audit failures which they are as follows: scope restrictions; incompetence; auditing by conversation; not critically

evaluating transactions; and lack of Objectivity and skepticism. Each of the Perry acts can be directly linked to the

concept of auditor independence. Which is one element of an auditing firm's quality control system, is defined by

the accounting/auditing profession in the United States as "the ability to act with integrity and objectivity" (AICPA,

1985). Independence, Further, if the auditors are independence then they can do the best job in their career.

Brief history of auditing

Accounting in the world has a background of 6000 years and the first accounting documents were discovered 3600

years before Christ's birth. Documents of ancient Iran show that in 500 B.C (Mashayekhi and Mashayekh, 2008). Here

we are going to explain brief history of auditing in Iran after Revolution.

Islamic Revolution of Iran in 1979 resulted in electing governmental managers for some companies, expropriating

companies belonging to a number of capitalists affiliated to the past Shah's Regimen and nationalizing some of the

industrial entities. Proprietorship of public economical entities necessitated the formation of institutes to audit the

accounts of the national economic or expropriated companies and entities, and formation of audit institutes of National

Industries and Planning Organization, Foundation of the Oppressed and Martyr's Foundation was necessitated

from1980 to 1983.

The case of merging the audit bodies of public division was propounded in 1983, and law of founding the audit

organization was approved. By approving the statutes of the Audit Organization in 1987, public audit bodies merged

and the Audit Organization was established.

In the Certified Statutes and Act of Audit Organization, the responsibilities of Certified Inspector and audit affairs of all

agencies and apparatuses, which were under the public proprietorship, were ceded to the Audit Organization.

Furthermore, the Audit Organization was recognized as a specialized and official reference to compile principles, and

regulations of accounting and auditing. Hence, for the first time, legal inspection tasks and audit were in practice

consolidated, and an organization to audit the financial institutions of public division and an official reference to

compile principles and standards of accounting and auditing were ordained.

After the Islamic revolution of Iran in 1979, according to a bill ratified by the Revolutionary Council, many enterprises

were confiscated or came under direct supervision of Government. To audit and perform statutory examination of these

enterprises, three audit firms were established in the public sector, i.e., Nationalized Industries and Plan Organization

Audit Firm in1980, Mostazafan Foundation Audit Firm in1981, Shahed Audit Firm in 1983.

In 1983 an act was ratified by the Parliament, to merge and embody these three audit firms together with Audit

Company (established in 1971 to audit government corporations) to establish Audit Organization. Audit Organization's

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by-laws were also approved by the Parliament in 1987 and the Organization was established as a legal entity with

financial independence, affiliated to the Ministry of Economic Affairs and Finance to follow those audit firms functions

and pursue the activities legislated in the Organization's Act and by-laws.

Audit Organization's by-laws were revised and approved by the Council of Ministers in 2003 to comply with the Article

4 of the Third Economic, Social and Cultural Development Plan and the Organization's legal status changed to State

Owned Limited Company.

The Organization's main objectives are: (i) To provide government with basic needs in the field of auditing and

specialized financial services for state owned and government supervised entities; (ii) To set Accounting and Auditing

Standards and Professional Ethics in compliance with Islamic Rules as well; and (iii) To conduct research in scientific

and practical methods of accounting to enhance accountancy compatible with country's needs.

The Board of Governors comprises of Minister of Economic Affairs and Finance as chairman, Head of Management

and Planning Organization, Minister of Petroleum, Minister of Industries and Mines and Minister of Commerce. The

Board sets policies of the Organization; approves plans, manuals and financial statements of the Organization; and

appoints members of the Board of Executives Accounting and Auditing Standards and also the Board of Governors

should approve the Organization's Code of Ethics and its disciplinary rules.

The Board of Executives comprises of Chairman and Chief Executive Officer of the Organization and four or six expert

accountants, all appointed by the Board of Governors. The Board is responsible for planning, organizing, preparing

manuals, managing and execution of programs. Each Board member directs and supervises a part of the Organization's

activities Exposure drafts of accounting and auditing standards should be reviewed and confirmed by the Board of

Executives before submission to the Board of Governors.

High Supervisory Council comprises of three expert accountants appointed by the Board of Governors and is

responsible for continuous supervision of the Audit Organization's activities, review of internal control system, statutory

examination of the Organization's financial statements and reporting its findings to the Board of Governors and where

appropriate to the regulatory bodies.

In fulfilling its main function to audit and statutory examination of state owned companies in 2003-04, Audit

Organization has audited banks; insurance companies; oil, gas and petrochemical companies; regional water and power

corporations; post, telegraph and telephone companies; and steel, tobacco and many other large corporations. Social

Security Organization, Mostazafan and Janbazan Foundation, Shahid Foundation, and 15th Khordad Foundation and

their affiliated companies are another major group of entities audited by the Organization. Investment companies and

other enterprises controlled by banking system are also among those entities audited by the Organization.

3. Review of literature

Alford and Strawer (1990, p.70) carried out a survey which results shows in the US, points out that with increasing the

minimum educational requirements for CPA membership may be a direct result of the recent expansion enjoyed by the

accounting profession. Expansion of accounting and auditing services and products requires auditing to expand their

technical education. Therefore, the education is directly affected on audit competence which it caused to high quality of

audit practice. Further, Prior research has suggested that large multinational audit firms give higher audit quality (e.g.

Leuz and Verrecchia, 2000; Asbaugh and Warfield, 2003). Watts and Zimmerman (1986) predict that large audit firms

supply a higher quality audit because of greater monitoring ability. These companies may have more resources

(Palmrose, 1986) and they may use higher quality staff (Chan et al., 1993). Francis and Wilson (1988) suggest that audit

firms invest in their brand name reputation in order to command fee levels for higher quality assurance. Such firms will

then provide a high quality audit in order to protect their brand name and also future revenues (Palmrose, 1986). Large

multinational audit firms have also been found to be more independent (e.g. Shockey, 1981) which might suggest that

they are less willing to negotiate audit matters with clients. Moreover, Teoh and Wong (1993) find that companies

audited by Big Eight have higher earnings response coefficients i.e. investors and their announcements more convincing.

As regards to relevant research in Greece, Caramanis (1997 and 1998) has found that in the early years after the

liberalization reforms of 1992 there was no significant difference between local and international firms in terms of audit

quality. However, relatively newer evidence is more in line with the results of research in other markets (Citron and

Manalis, 2001).

One factor that may affect to audit quality is fraud detection which Dechow et al. (1996) report that auditors are more

likely to have detected accounting problems and Klein (2002) finds that abnormal accruals are smaller (implying less

earnings management) when boards are more independent.

According to SAS No. 53 the Auditor's Responsibility to Detect and Report Errors and Irregularities (AICPA, 1988),

the auditor had the responsibility to plan and perform the audit to obtain reasonable assurance that any material

misstatements (including those caused by fraud) would be detected. This document also offers illustrative client

business risk factors that may indicate an elevated fraud risk. In SAS No. 82 Consideration of Fraud in a Financial

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Statement Audit, the AICPA (1997) attempted to further clarify the auditor's responsibility by stating that the auditor

should specifically assess the risk of material misstatements that are due to fraud. This pronouncement also required the

auditor to document the fraud risk assessment. SAS No. 99 Consideration of Fraud in a Financial Statement Audit

(AICPA, 2002) is a more recent attempt to spell out what society expects from the auditor with respect to

financial-statement fraud. Two of its main innovations require the auditor to brainstorm about the risk of material

misstatement due to fraud, regardless of any past honest dealings with entity management. It's utility for improving the

auditor's assessment of fraud risk, however, remains an open question.

Groveman (1996) explored how the auditors can detect misstatement in financial statements. The author highlighted

that the most frequent causes of audit failures are due to inexperienced staff assigned to audits and a lack of professional

scepticism. In order to maintain the appropriate degree of scepticism, auditors should not assume client management is

dishonest and also should not unquestioningly expect honesty. However, the audit team must evaluate evidence

objectively to determine whether or not financial statements are free of material misstatement. Regarding to the audit

independence and audit quality Lacy (1990) examined the effects of investment by the CPA partners and client

principals on the perception of auditor independence. Specifically examined were the effects of a joint investment by a

CPA partner and a client's Chief Financial Officer (CFO) in a limited partnership unrelated to the audit client, and a

direct investment by a CPA in a client company. The results showed an inconsistency between the respondents'

perception of risk of losing the independence and the AICPA independence rules. The respondents were more concerned

about the certain joint investments, which were acceptable under the AICPA rules, than they were about small

percentage, financially immaterial direct investments which were unacceptable under the AICPA rules. The CPAs

perceived that the risk of losing the independence when there was a direct ownership of stock by a CPA was greater

than that of any other group who perceived the risk to be. A survey was conducted by Abu Bakar et al. (2005) among

116 loan officers in Malaysia. The results showed that 75.60 per cent of the respondents indicated that the size of the

audit firm did affect the auditor independence and 74.40 per cent of them mentioned that the level of competition in the

audit service market influenced the auditor independence. Furthermore, the results indicated that the provision of MAS

had a negative effect on the auditor independence in Malaysia. Sajadi and Ebrahimimand (2005) elicited 98 Iranian

Certified Public Accountants' viewpoints on the factors increasing auditors' independence. The objective of the study

was to identify the factors which increased/would increase the auditors' independence. The results showed that the

factors such as audit committee, client size, the size and experience of audit firms increased the auditors' independence,

and other factors, namely, competition among the auditing firms decreased the auditors' independence. A survey was

carried out by Sajadi and Naseh (2003) in Iran regarding the effectiveness of certified auditing of financial statements

among 51 managers. The conclusion was that independent auditors would be effective in the detection and reduction of

illicit acts and offences as well as the exercise of precise appraisal of bases used in accounting estimates. However, such

auditing would not serve the purpose of improving internal control system reducing the likelihood of errors omission.

The study by Mojtahedzadeh and Aghaei (2005) focused on the factors influencing independent audit quality. The study

covered the perceptions of 90 investors, 71 creditors, and 92 auditors in Iran selected on the basis of random sampling.

The study showed that the investors and the creditors strongly believed that any other services affected auditor


Another survey was carried out by Hassas-Yeganeh and Khaleghi (2004) in Iran regarding the attest function of the

independent auditors and the respondents included auditors and investors. The results indicated that there was an

expectation gap between the auditors and users on the attest function of the independent auditors. The results also

showed that there were significant differences between the auditors and users regarding the reliability of the audited

financial statements and the comparability of the audited financial statements. The users believed that if the audited

financial statements were re-audited by others, they would show a different picture.

4. Research methodology and objective

Since the main objective of this research is determination of relationship between audit competence and audit quality in

Iranian environment, therefore the research question as follows: Q1: Do audit expertise detect more fraud in auditing?

Q2: Do audit Effectiveness can detect major distortions?

Q3: Do more audit competence cause more fraud detection?

According to the above literature and the objective of this study the useful data was collected. So far accurate answer to

this question, the authors design and developed a questionnaire based on method used in previous researchers. The

questionnaire contains two parts namely (A) bio-data and (B) this section includes some questions regarding to audit

expertise and fraud detection, audit effectiveness and fraud detection, and audit competence and fraud detection.

In this research at first step the important factor that is related to auditing quality were explored by studying technical

contexts; further, the validity of explored title assessed by Delphi group that includes Iranian Association of Certified

Public Accounting (IACPA) members. in the Delphi session title in Iran environment. Using gained viewpoints the

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elementary group asked to determine the relation and importance of detected index regulated. Hence we can say, those

factors that conduct research hypotheses are those factors that are completely compatible to Iran environment. In this

research participants at the first step requested to determine their idea (agreement or disagreement to the effects of

independent variable on detecting important distortions), then according to their ideas requested to determine degree of

agreement and disagreement for assessing degree of disagreement and agreement we used the Range of integer number

from -9 to 9 which -9 represent highly disagreement and 9 represent highly agreement to the hypotheses while zero

represent none of them.

To the bases of important factor we conducted three hypotheses including:

H1: Specialization of IACPA member affects on their ability on detecting important fraud.

H2: Audit efficiency (audit profit to expenditure ratio) affects on IACPA member auditing to detecting important fraud.

H3: The competency of IACPA member affects on detecting important fraud.

4.1 Results of the study

180 respondents were completed the research questionnaire. Among these 180 participants , there were 29 expert or

having auditing knowledge (16.10 percent) which they worked as an independent auditor , the rest 30 ( 16.8 percent)

were worked as an internal auditor, 60 were in financial and banking management (62.40 percent participants), 30

numbers of them were in faculty member and 31of them were accounting student. According to Table 1 out of 180

participants 55 were male (30.60 percent) and 125were female (69.4 percent). Further, 135 participants were younger

than 40 (75.00 percent) and 45 participants elder than 40 ( 25percent). Among these 52.50 percent had less than one

year experience, 36percent had experience between 10 to 20 years and 21.50 percent had more than 20 years


As Table 1 reveals the majority of participant had sufficient academic degrees. Out of 180 participants 113participant,

were holding bachelor degree in accounting or related subjects (62.5 percent) and 67 were holding M.A or PhD degrees

(47.50 percent). Demographic characteristics of participant are summarized in Table 1.

Insert Table 1

The binomial test was first conducted to assess how many percent of participant accept the effects of independent

factors on dependent ones. For this purpose we divided participants into two groups including agreeing and disagreeing

with hypotheses. The results revealed that 171 participant (95.00 percent) were agree that the effect of specialization on

detecting important fraud (H1 ); then the effect of specialization on detecting important fraud significantly confirmed

(p<0.05). Mean degree of agreement for this hypothesis was 3.94 (SD= 2.21, 95 percent of confidence interval from 3.6

to 4.26).

For the second hypothesis 105 participant (58.00 percent) were disagree to the effect of audit efficiency on auditor

willingness to detecting important fraud; then this hypothesis rejected (H2) and mean degree of disagreement for this

hypothesis was -0.644 (S.D= 6.61 , 95 percent of confidence interval from -1.6 to 0.32) .

About third hypothesis, majority of participants confirmed the effect of auditor competencies on exploring important

distortion (H13). 151 participants (84.00 percent) agreed to this hypothesis, then this hypothesis were significantly

confirmed (p<0.05) and mean degree of agreement was 4.25 (S.D= 3.8, 95.00 percent of confidence interval from 3.68

to 4.88).

The result of testing hypotheses by binomial test showed in Table 2.

Insert Table 2

In this stage as mentioned before, participants requested to determine degree of agreement or disagreement to the

questions. Table 3 represents the mean degree of agreement or disagreement according to their idea to the research

questionnaire with calculating Mean Value, S.D, and interval confidence.

Insert Table 3

As Table 3 shows positive numbers represent mean degree of agreement while negative number represents mean degree

of disagreement.

As shown in upon table the competency of auditor has the most effect on detecting important fraud by auditors.

5. Conclusion and remarks

Shaw (1995) expressed that recent high profile and unexpected corporate collapses were not created by audit failures.

However, it was created by a number of failures of the executive management and of corporate bonds. But the audit

failures, at least, delayed corrective action and often allowed the guilty to escape the punishment. However, unexpected

collapse of an important company listed on a stock exchange (i.e. Enron collapse) will undermine the credibility and

reliability of the information and the regulatory system, which is put in place to protect the investors. Therefore the

International Journal of Business and Management February, 2009


auditors should do in a manner that they keep audit prestige. In such a condition they have to follow as well as obey

their regulations and framework. Further Arruñada (1999, 2000), has argued that audit regulation should consider three

basic characteristics of auditing: professional judgment, the specific nature of audit quality and the existence and

effectiveness of private quality-assurance techniques. The results of this study showed that from the view point of

participants' specialization of IACPA member affects on the ability of IACPA member for detecting important frauds. In

such a condition the Iranian legislators should force the IACPA member for attending up-to day accounting and auditing

short time courses. In addition, as results showed the second hypothesis is rejected, furthermore, regarding to the third

hypothesis, the majority of strongly belief that competency of IACPA member affects on detecting important fraud. By

the way, as mentioned before the independence of auditors also may cause to detection fraud. One of the weakness of

Iranian accounting and auditing environment is the lack of audit committee which audit committee can keep external

auditors independence; in fact as well as in appearance. For solving such a problem it is highly suggested to Iranian

legislators form audit committee which it improve audit independence as well as audit quality.