SMALL AUDIT FIRMS AND AUDIT PRACTICE QUALITY CUE

Suzanne N. Cory Saint Mary'S University

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file:///A:/92swi211.txt Page 1 of 10SMALL AUDIT FIRMS AND AUDIT PRACTICE QUALITY CUE IMPORTANCE Suzanne N. Cory Saint Mary's University ABSTRACT There is ample evidence in the literature that audit practice quality is an important issue. Previous researchers have attempted to equate audit quality directly with audit firm size. However, research results have been mixed. This paper examines responses from audit partners from non-national and national audit firms regarding the relative importance of twelve attributes of audit practice quality. Seven of the twelve attributes are ranked differently between these two sectors of public accounting. INTRODUCTION Both the professional and academic accounting literature indicate that quality of public accounting practice is a current issue of importance to academicians, public accountants, public policy makers, and professional associations such as the American Institute of Certified Public Accountants (AICPA). The United States General Accounting Office (GOA) established and Audit Quality Task Force in 1984. The Task Force's findings were dismal. "One out of every five audits that the [regional inspectors general] quality control reviewed was not accepted until the auditor (1) performed more audit work, (2) clarified work performed, or (3) provided more support for the audit work performed. A few were in fact never accepted" [7, p. 16]. Audit quality was also one of several issues addressed by the ...

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• Publié par: Cipot
• Nombre de lectures: 37
• Langue: English

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SMALL AUDIT FIRMS AND AUDIT PRACTICE QUALITY CUE IMPORTANCE

ABSTRACT

Suzanne N. Cory Saint Mary's University

There is ample evidence in the literature that audit practice quality is an important issue. Previous researchers have attempted to equate audit quality directly with audit firm size. However, research results have been mixed. This paper examines responses from audit partners from non-national and national audit firms regarding the relative importance of twelve attributes of audit practice quality. Seven of the twelve attributes are ranked differently between these two sectors of public accounting.

INTRODUCTION

Both the professional and academic accounting literature indicate that quality of public accounting practice is a current issue of importance to academicians, public accountants, public policy makers, and professional associations such as the American Institute of Certified Public Accountants (AICPA). The United States General Accounting Office (GOA) established and Audit Quality Task Force in 1984. The Task Force's findings were dismal. "One out of every five audits that the [regional inspectors general] quality control reviewed was not accepted until the auditor (1) performed more audit work, (2) clarified work performed, or (3) provided more support for the audit work performed. A few were in fact never accepted" [7, p. 16].

Audit quality was also one of several issues addressed by the National Commission on Fraudulent Reporting. The Commission indicated that the probability of fraud detection would increase with improvement in audit quality [8 p. 43]. Additionally, in recent years, the public accounting profession has received a good deal of Congressional attention. This was notably exhibited by the Metcalf and Moss Committees of the late 1970's. More recently, Representative John Dingell's House Energy and Commerce Subcommittee on Oversight and Investigations has held hearings in regard to public accounting, citing audit failures as evidence of poor audit practice quality control within the profession.

Currently, no definitive criteria exist for assessing the quality of audit practice in public accounting firms. Consequently, no theory exists upon which to build an assessment of quality beyond whether adherence to generally accepted auditing standards was maintained during

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an individual audit. 1

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1 The GAO [7, p. 8] has defined audit quality as "compliance with professional standards set out for the particular type of audit being conducted." This is simply a procedural definition, linking audit practice quality to conformance with accepted standards for a particular audit engagement. Audit practice quality has been and will continue to be of primary importance to public accountants, public policy makers and users of financial statements. Some definitions of audit quality deal with performance evaluation of an audit team on a particular audit engagement. The quality of an audit practice as a whole is difficult to measure. Some researchers have attempted to equate audit quality directly with audit firm size. However, different perspectives on quality exist (i.e., "quality," like "beauty," is in the eye of the beholder).

PRIOR RESEARCH

Several researchers have attempted to link audit quality with audit firm size. Palmrose [11] used litigation activities of large public accounting firms (national and Big 8) as a measure of the quality of services provided. She argued that auditors with higher (lower) litigation activity represented public accounting firms offering lower (higher) quality services. She found higher litigation activity among the non-Big Eight group [11, p. 72]. Hence, she argued the Big Eight accounting firms provided higher quality auditing services.

DeAngelo [5] viewed the relationship between audit quality and public accounting firm size from an economic perspective. Her definition of the quality of audit services was "the market- assessed joint probability that a given auditor will both (a) discover a breach in the client's accounting system, and (b) report these breaches, and have reduced incentives to "cheat" in order to retain any one client since they have a larger client base [pp. 189- 190]. Consequently, larger public accounting firms maintained better audit quality. Further, she argued that since audit quality was costly to evaluate, consumers allowed size to serve as a surrogate for quality measurement.

Ettredge, Shane and Smith [6] studied correlations between earnings forecast errors and abnormal stock returns relative to public accounting firm size. They argued [p. 31] that if a perceived quality differential between Big Eight and non-Big Eight public accounting firms existed in the market, then the correlation between earnings forecast errors and abnormal stock returns should be greater for Big Eight clients than for clients of other public accounting firms. Their results [pp. 37-38] were consistent with their argument in that the signs of their test statistics were in the expected direction, but the significance levels of the statistics were low.

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Conversely, no relationship between public accounting firm size and quality of audit services provided was found by Wyer, White, and Janson [15]. Their study investigated the relationship between quality and smaller public accounting firms. In addition to examining the characteristics of public clients in smaller public accounting firms, the number and types of audit reports issued by smaller public accounting firms were determined. The researchers then used the audit report patterns of smaller public accounting firms as a weak test of DeAngelo's theory, described above. Their results did not support her theory [p. 170].

Imhoff [9] used financial analysts' quality judgements of familiar public companies' accounting quality to determine whether the analysts' perceptions differed among clients of major audit firms. He [p. 187] found no significant difference between the average quality scores for the clients of each of the Big Eight firms and for a ninth category which represented the clients of all other audit firms in the study.

Libby [10] did not address the issue of audit practice quality directly, but found bankers' perceptions of the reliability of audit reports were influenced by whether the auditor was a national firm. "All bankers indicated that the first question that is asked about a report is 'Who signed it?' If the firm is not a national firm, the reliability of the firm is determined by analysis of their own records or through contacts at other banks" [10, p. 104].

The above research results indicate a lack of conformity regarding audit practice quality assessment. As Cartter notes, "[q]uality is an elusive attribute, not easily subjected to measurement" [3, p. 4]. Additionally, perceptions of quality may differ across groups or individuals. Individuals practicing public accounting can be assumed to have more first hand knowledge about the operation of an audit practice. Further it can be argued that those actually practicing public accounting are more knowledgeable about audit practice quality cues than individuals outside the profession. The purpose of this paper is to determine whether consensus exists in the public accounting profession regarding the relative importance of audit practice quality cues or if they differ in their importance across public accounting sectors. Saaty's Analytic Hierarchy Process is used to assess the importance (or weight) of each of twelve public accounting firm attributes to 53 audit partners in public accounting firms. Some differences were found.

RESEARCH DESIGN AND PROCEDURES

The first phase in the research design was to derive attributes that may influence the assessment of audit practice quality. A group comprised of 26 individuals (8 bankers, 2 audit managers, and 16 audit partners) was used to identify public accounting firm attributes that are

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used in audit practice quality assessment. The individuals in the group participated in tape- recorded interviews and were also asked to complete a questionnaire. A literature review (Schultz and Gustavson [14], Danos and Shields [4], Schroeder, Solomon and Vickrey [13], and Libby [10]) preceded the preliminary work in order to obtain public accounting firm attributes that may be used in audit practice quality assessment. Preliminary work resulted in the derivation of twelve public accounting firm attributes which were appropriate for this study. The attributes are listed in Table 1. Each attribute is listed so that it has a positive relationship with audit practice quality.

The second phase of the research design was to incorporate these twelve attributes in a questionnaire so that Saaty's Analytic Hierarchy Process could be used to determine their relative importance to the respondents. The Analytic Hierarchy Process (AHP) was developed by Saaty [12] as an aid to decision making by reducing complex problems into a series of pairwise comparisons. 2 An individual's comparisons corresponding to specific numbers and their reciprocals which are then placed into a matrix. A reciprocal matrix results. The eigenvector corresponding to the largest eigenvalue for the reciprocal matrix represents the cardinal rankings of the pairwise comparisons.

This "eigenvalue approach to pairwise comparisons provides a way for calibrating a numerical scale, particularly in new areas where measurements and quantitative comparisons do not exist" [12, p. 33].

2 See Zahedi [16] for a good overview of the use of the AHP.

TABLE 1 DERIVED ATTRIBUTES OF AUDIT PRACTICE QUALITY

V1: PARTNER ATTENTION: This represents a high level of partner attention given to an audit during the planning and reviewing phases.

V2: INDUSTRY SPECIALIZATION: This represents the conscious act of specialization (concentration) by an auditing firm (or office) in a particular industry or industries.

V3: PARTNER ACCESSIBILITY BY STAFF: This represents the ease with which a member of an audit team may contact the engagement partner to discuss the audit.

V4: PARTNER ACCESSIBILITY BY CLIENT: This represents the ease with which a representative of the client being audited may contact the engagement partner to discuss the audit or related areas.

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V5: TURNOVER RATE: This represents a turnover rate for the auditing firm's professional staff that is lower than the average turnover of public accounting.

V6: CONTINUING PROFESSIONAL EDUCATION (CPE) REQUIREMENTS: This represents audit firm requirements for professional staff's continued professional education that are in excess of minimum state requirements.

V7: SECOND PARTNER WORKPAPER REVIEW: This represents a policy of requiring that a second partner, not directly involved with the audit of a client, perform a general review of the audit workpapers prior to issuance of an opinion.

V8: CLIENTELE: This represents the quality of the clientele that is audited, both in terms of management's integrity and solid financial standing.

V9: QUALITY OF PERSONNEL: This represents the quality (in terms of education, abilities, proficiency, etc.) of the professional personnel hired by the audit firm.

V10: LACK OF TIME BUDGET PRESSURES: This represents audit time budgets that allow the auditor to complete the engagement by working with diligence, but without excessive overtime requirements.

V11: LACK OF AUDIT FEE PRESSURES: This represents audit fees that allow the audit firm (or office) to recover all costs and make an acceptable profit on the audit.

V12: PEER REVIEW: This represents the external peer review system required for membership in the AICPA's Division for Firms.

Additionally, it is a paramorphic modeling technique that "provides a scale, equation, or other analytical representation of human judgement without purporting literally to capture the form of the actual thought processes" [1, p. 302].

The questionnaire was mailed to 812 public accounting firm partners in a large metropolitan area. After a follow-up "reminder" postcard and a second request for non-responding partners, 225 usable questionnaires were returned, which is a 27.7% response rate. Since a large number of questionnaires were never returned, ANOVA tests were performed to determine whether nonrespondents may be significantly different from respondents. The tests performed indicated that nonresponse bias is minimal.

Analysis of respondents is presented in Table 2. As the Table indicates, 33 respondents are

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partners in national public accounting firms, and 192 are partners in non-national public accounting firms. Further, of the 225 respondents, 53 are audit partners 3 and 172 are not audit partners. Twenty-three of the 53 audit partners are partners with national public accounting firms and the remaining 30 are partners with non-national public accounting firms.

3 Average billable time was estimated at 57% using information obtained from the California State Society of Certified Public Accountants [2, p. 15]. In order to be classified as an "audit partner" the respondent had to spend at least half of his or her billable time (28.5%) performing auditing and related services.

TABLE 2 ANALYSIS OF RESPONDENTS

Respondents from: national firms 33 non-national firms 192 Total 225

Respondents who are: audit partners 53 not audit partners 172 Total 225

Audit partners: with national firms 23 with non-national firms 30 Total 53

Public accounting firm partners classified as "audit partners" could be expected to be more familiar with the quality of audit engagements. In the aggregate, individual audit engagements comprise the audit practice of public accounting firms. Hence, audit partners would be expected to hold differing views than non- audit partners regarding the importance of the twelve attributes.

Some small accounting firms do not perform auditing functions at all, but limit their practices to other areas of public accounting services (tax, write-up work, consulting, etc.). However, all public accounting firm partners who are audit partners should be exposed to the same professional practice concerns and problems.

The analysis is limited to the 53 audit partners only. If public accounting firm partners who are audit partners do indeed share the same professional concerns of audit practice in their rankings of each difference in their rankings of each of the twelve attributes. The null hypothesis is therefore:

Ho1: For audit partners, there is no difference in the rankings of each of the twelve attributes between partners in non-national (small) public accounting firms and partners in national (large) public accounting firms.

The responses of each completed questionnaire resulted in a reciprocal matrix of dimension

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12 X 12. The eigenvector corresponding to the largest eigenvalue was determined for each of the 53 matrices associated with responses from audit partners.

RESULTS

The hypothesis was tested using Student's t test 4. The results are shown in Table 3 on the following page. The null hypothesis is rejected at the 5% level for attributes Vl (Partner Attention), V3 (Partner Accessibility by Staff), and V8 (Clientele). For attributes Vi and V8, audit partners with non-national firms rated the attributes lower than for national audit firm partners. The opposite is true for V3. The null hypothesis is rejected at the l% level for tributes V4 (Partner Accessibility by Client), V6 (CPE Requirements) V10 (Lack of Time Budget Pressures), arid VII (Lack of Audit Fee Pressures). Audit firm partners with non-national firms rated attribute V4 significantly lower than partners with national firms and also rated attributes V6, V10 and V11 significantly higher than audit partners with national firms.

Audit partners with non-national firms placed less importance on V1 (Partner Attention) and V4 (Partner Accessibility by Client) than audit partners with national firms. Audit attributes deal primarily with audit partners' focus on audit engagements. These same respondents placed less importance on V8 (Clientele), which deals with management integrity and the financial standing of audit clients. Audit partners with non-national firms may believe that the planning and reviewing phases of the audit are less important than the actual performance of the audit procedures. Management integrity and solid financial standing is also less important to audit partners with non-national firms. Non-national firms usually audit smaller businesses than national firms. Hence, their exposure to litigation may be lower. Audit partners with non- national firms may be less concerned with the threat of litigation associated with business failure and/or management fraud.

Audit partners with non-national firms rated V3 (Partner Accessibility by Staff) higher than audit partners with national firms. Audit partners with non-national firms may have a closer relationship with the audit team and may actually perform some of the audit procedures themselves, rather than being restricted to planning and reviewing stages of the audit process. Hence, audit partners with non-national firms may feel that direct association with audit team members and availability for audit related quest lolls from staff carries more importance when assessing audit practice quality.

4 As a test for normality, the Kolomogorov D statistic was com- puted for each of the twelve attributes. All attributes are approximately normally distributed except V2 (Industry Specializa- tion), V6 (CPE Requirements), V7 (Second Partner Review), and V12 (Peer Review).

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However, Student's t statistic was used in the subsequent analysis. The t statistic is robust and minor deviations from a normal distribution should not adversely affect its usefulness.

TABLE 3 RESULTS OF HYPOTHESIS TESTING

ATTRIBUTE STUDENT'S NUMBER ATTRIBUTE T SCORE V1 Partner Attention 2.105** V2 Industry Specialization 1.544 V3 Partner Accessibility by Staff -2.491** V4 Partner Accessibility by Client 3.023*** V5 Turnover Rate -1.994 V6 CPE Requirements -3.243*** V7 Second Partner Workpaper Review 0.845 V8 Clientele 2.061** V9 Quality of Personnel -0.615 V10 Lack of Time Budget Pressures -2.681** V11 Lack of Audit Fee Pressures -3.264*** V12 Peer Review -0.952

**Significant at the 5% level ***Significant at the 1% level

Audit partners with non-national firms also rated attributes V6 (CPE Requirements), V10 (Lack of Time Budget Pressures), and V11 (Lack of Audit Fee Pressures) higher than audit partners with national firms. Both V10 and V11 deal with work-related pressures that may be encountered by audit team members during the audit process. Audit partners with non-national firms may feel that these pressures are not necessary and even detrimental to the audit process. Further, CPE Requirements (V6) was rated higher by this group of respondents. Since non-national firms may not be able to provide in-house CPE, as many national firms do, CPE may be harder and more expensive for them to obtain. Therefore, they may place a premium on the importance of keeping themselves up to date tech- nically and professionally.

DISCUSSION AND CONCLUSION

Several differences were found in the ranking of the importance of attributes associated with audit practice quality assessment between audit partners in national and in non-national firms. This is indicative of a lack of agreement in the public accounting profession between audit firms in the large firm sector and in the small firm sector regarding the level of importance of these attributes. Audit partners with smaller firms ranked four of the attributes higher than the audit partners with national firms and three of the attributes lower than the audit partners with national firms.

These results indicate that audit partners practicing in the two sectors of public accounting do not share the same professional concerns regarding audit practice quality. It is therefore possible that in practice, smaller audit firms emphasize attributes of audit practice quality that are not emphasized by national firms. The reverse may also by true. However, it does not follow that a difference in quality results. Rather, each sector of public accounting may have a

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different approach as to which components of audit practice quality are emphasized. Smaller firms place more importance on partner accessibility by staff, CPE, lack of time budget and audit fee pressures and less importance on partner attention, clientele, and partner by clients. Differences between sectors results.

REFERENCES

[1] Arrington, E.E., W. Hillison, and R.F,. Jensen. "An Application of Analytic Hierarchy Process to Model Expert Judgments on Analytical Review Procedures," Journal of Accounting Research, (1984), pp. 298-312.

[2] California Society of Certified Public Accountants, Management of an Accounting Practice Survey, 1986.

[3] Cartter, A.M., An Assessment of Quality Graduate Education, American Council on Education, Washington, D.C., 1966.

[4] Danos, P. and D. Shields, "Referrals from Bankers and Attorneys," The CPA Journal., (May 1981), pp. 13-19.

[5] DeAngelo, L.E. "Auditor Size and Audit Quality," Journal of Accounting and Economics, (1981).

[6] Ettredge, M, P.B. Shane and D.B. Smith, "Audit Firm Size and the Association between Reported Earnings and Security Returns," Auditing: A Journal of Practice and Theory, (1988), pp. 29-42.

[7] GAO. (United States General Accounting Office) CPA Audit Quality, Inspectors General Find Significant Problems Report to the Chairman, Legislation and National Security Subcommittee, House Committee on Government Operations GAO/AFMD-86-33.

[8] Fraud Commission Issues Final Report, "Journal of Accountancy", (November 1987), pp. 39-40, 42-44, 46, 48.

[9] Imhoff, E.A., "A Comparison of Analysts' Accounting Quality Judgments Among CPA Firms' Clients," Auditing: A Journal of Practice and Theory, (1988), pp. 182-191.

[10] Libby, R., "Bankers' and Auditors' Perceptions of the Message Communicated by the Audit Report," Journal of Accounting Research, (1979), pp. 99-122.

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[11] Palmrose, Z.V., "An Analysis of Auditor Litigation and Audit Service Quality," Accounting Review, (1988), pp. 55-73.

[12] Saaty, T.L, The Analytic Hierarchy Process, McGraw-Hill, Inc., 1980. [13] Schroeder, M.S., I. Solomon, and D. Vickrey, "Audit Quality: The Perceptions of Audit-Committee Chairpersons and Audit Partners," Auditing: A Journal of Practice and Theory, (1986), pp. 86-94.

[14] Schultz, J.J. and S.G. Gustavson, "Actuaries Perceptions of Variables Affecting the Independent Auditor's Legal Liability," Accounting Review, (1978), pp. 626-641.

[15] Wyer, J.C., G.T. White and E.C. Janson, "Audits of Public Companies by Smaller CPA Firms: Clients, Reports, and Quality." Auditing: A Journal of Practice and Theory, (1988), pp. 164-173.

[16] Zahedi, F., "The Analytic Hierarchy Process-- Interfaces, (1986), pp. 96-198.

Survey of the Method and its Applications,"

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