This article was first published in the November/December 2016 international edition of Accounting and Business magazine.

High-quality audits are an essential part of business. If shareholders, directors, the public and press see the audit process as less than rigorous, their confidence in the stability of companies – as well as in the audit profession – will sink. Every corporate fraud and failure is a threat to this fragile balance.

The profession has struggled for years to get across the message that audits are not a panacea to cure all ills; even the best ones can fail to detect a problem if those preparing the accounts are intent on deception. So, more recently – in the wake of the financial crisis – regulators and standard setters have focused more closely on audit quality as a way of improving public confidence in the audit process. This culminated in the Framework for Audit Quality released by the International Auditing and Assurance Standards Board in 2014.

The framework set out the factors underpinning a high-quality audit: independence, competence and the interactions between the audit firm and company representatives. Of these, independence is arguably seen as most critical by regulators, resulting in a string of legislation around audit firm rotation and partner tenure. 

A new comprehensive study from the ACCA, though, shines a light on what company directors see as the most important contributors to audit quality. Directors’, CFOs’ and auditors’ perceptions of audit quality attributes: a comparative study, carried out with the International Governance and Performance Research Centre (IGAP) at Macquarie University in New South Wales, Australia, looked at how these three stakeholder groups assessed and understood audit quality – and its findings threw up several surprises. 

Information inequality

The study assessed the perceptions of directors, CFOs and auditors against the relative importance of 10 audit quality attributes:

  • audit firm size
  • the length of the audit partners’ tenure
  • the provision of non-audit services by the audit firm
  • the audit firm’s experience of the client’s industry
  • the audit partner or manager’s attention to the audit
  • communication between the audit team and client management
  • the audit partner’s knowledge of the client industry 
  • the senior managers’ knowledge of the client industry
  • a very knowledgeable audit team
  • the audit quality assurance review. 

The study is particularly interesting because it compares the perceptions about audit quality from the supply side of the equation – auditors – against those that pay for it. As the report points out, those supplying the service have far more information about audit quality than is available to the purchaser. Of the three groups in the study, auditors have the most information available to them about audit quality, directors the least, and CFOs are somewhere in between.

This is important because it means that the purchasers of audit services are essentially doing so on trust; they have only limited ability to determine the quality of an audit, both before they have bought it and after it is completed. The company could well be uncertain that the service they are paying for fully meets their needs and would not know if they were overcharged. 

Even so, the report’s authors were surprised to find a high level of agreement between the three stakeholder groups on what contributes to a high quality audit. ‘We expected the directors to be much more concerned about independence than the auditors, for example,’ says Nonna Martinov-Bennie, director of IGAP and a member of Chartered Accountants Australia and New Zealand, who co-authored the report with Paul Taylor, a researcher at IGAP. ‘Auditing firms know their personnel whereas the directors must, to some extent, put their faith in the audit team. It’s logical to expect that directors would be more concerned about measures that increase independence.’

In fact, all three groups ranked the competence of the firm and its team and the interaction between the company and auditor as more important than independence. Auditors, CFOs and directors ranked audit firm size as the most important attribute as an indicator of audit quality, followed by the level of attention that partners and managers paid to the audit. The level of communication between the audit team and the client was also rated as very important by all three groups. Audit partner tenure, on the other hand, had a relatively low importance.

Bigger is better

So why does size matter so much? As part of their study, the authors included focus group discussions with representatives from each of the groups taking part, and these conversations indicate general agreement that larger firms are seen as being able to offer better services across a wider range of industries. CFOs also argued that Big Four firms carried a level of prestige that was important for investor confidence. Auditors taking part in the discussion were split, of course, depending on whether they worked for a Big Four or second-tier firm.

The importance attached to partner and manager attention is an indication of the level of trust and confidence that is essential in a good auditor-client relationship. It was of particular importance to directors that they had full confidence in the senior members of the audit team who were conducting their audit. One CFO commented in the focus group discussions that a relationship with the audit partner built up over a period of time went to ‘the heart of getting a quality job done’, while a director added that ‘the more complex the company, the longer it takes the partner to be across the job. I don’t think they really get across the stride of it until about year three, and by year five it’s going really well’.

‘The participants at the focus sessions were emphatic that competence was more important than the focus on independence,’ Martinov-Bennie says. ‘The fact that longer tenure enhances the auditor’s knowledge of the client and its industry outweighed, for them, the fact that longer tenure might potentially increase familiarity and reduce independence.’ But, she adds, she was also left with the impression that although the participants felt that independence is important they did not really consider it to be an issue: ‘They appeared to agree with the auditor who said in one of the focus sessions that independence was “a given”.’ 

Company management want to know and trust their auditor – and it is clear that they see audit firm and partner rotation as getting in the way of that essential relationship. The unanswered question is whether shareholders would agree with the other groups; Martinov-Bennie’s view is that because shareholders generally only have access to publicly available information, ‘it is likely that regulatory controls such as limits on audit partner tenure may have much greater appeal for them’.

She adds that auditors may well be surprised that directors and CFOs would also place a relatively low level of importance on regulatory measures such as limits on audit partner tenure and mandatory quality reviews. ‘Perhaps the real lesson, however, is for the regulators,’ she says. ‘The message is that these measures are almost universally not ranked as a high priority, and there’s some concern that the excessive focus on compliance may in fact have a detrimental effect on audit quality.’

Liz Fisher, journalist