FAR Practice Note - What Exactly Do We Mean by Audit Quality?
The concept of “audit quality” is of fundamental importance in auditing but there is little agreement on its definition or measurement. I review several approaches to understanding audit quality and argue that the most meaningful measure of audit quality is based on what the auditor is legally required to do, which is to “opine” on the client’s financial statements. This has resulted in a black and white binary (pass/fail) model of the audit report. However, we know there is a continuum of quality in the audited financial statements of clients, and that much of this variation is the result of the client’s accounting policy choices, particularly accrual estimations. Yet most firms receive a standard clean opinion despite the wide variation in financial statement quality. I argue that while it is important for auditors to follow procedural rules (standards) to gather sufficient evidence, it is equally important that auditors carefully monitor and constrain, where necessary, the client’s accounting policy choices and accrual estimates. The logical consequence is that the quality of audited financial statements and the quality of the audit report are both continuums, fifty shades of grey. Thus, audit report quality is better understood as a spectrum rather than a simple binary pass/fail model. Going forward, the challenge is to find ways for an auditor to convey information about the quality of audited earnings that go beyond the binary model of the current audit report.
Authors
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Professor Jere Francis is ranked among the top ten academics to publish in leading scientific journals in the field of accountancy research. He won two awards from the American Accounting Association (AAA) for his substantial contribution to auditing research. He was also named Outstanding Audit Educator in 2013 by the AAA. Professor Francis served on the editorial boards of several leading scientific journals, including Abacus, Accounting Organizations & Society, Accounting & Finance, Auditing: A Journal of Practice & Theory, Contemporary Accounting Research, Journal of Accounting & Economics, Review of Accounting Studies, and The Accounting Review. In addition to being of scientific import, his research has been of practical significance to accountants and regulatory authorities and he has presented his research to leading international accountancy firms, the American Institute of Certified Public Accountants, the World Bank and the Public Company Accounting Oversight Board in the United States. As FAR Research Chair, Professor Francis conducts scientific research on the quality of audits. He will also boost auditing education in the Netherlands with the help of several PhD students as part of this chair position.