What Do We Know About Audit Quality?

13880 Words Mar 27th, 2011 56 Pages
The British Accounting Review 36 (2004) 345–368 www.elsevier.com/locate/bar

What do we know about audit quality?*
Jere R. Francis*
University of Missouri—Columbia, 432 Cornell Hall, Columbia, MO 65211, USA University of Melbourne, Victoria, Australia

Abstract This paper reviews empirical research over the past 25 years, mainly from the United States, in order to assess what we currently know about audit quality with respect to publicly listed companies. The evidence indicates that outright audit failure rates are infrequent, far less than 1% annually, and audit fees are quite small, less than 0.1% of aggregate client sales. This suggests there may be an acceptable level of audit quality at a relatively low cost. There is also evidence of
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1. What are outright audit failure rates? Audit quality can be conceptualized as a theoretical continuum ranging from very low to very high audit quality. Audit failures obviously occur on the lower end of the quality continuum, and so a good starting point in thinking about audit quality is to ask what the rate of outright audit failure is? An audit failure occurs in two circumstances: when generally accepted accounting principles are not enforced by the auditor (GAAP failure); and when an auditor fails to issue a modified or qualified audit report in the appropriate circumstances (audit report failure). In both cases, the audited financial statements are potentially misleading to users. As a first approximation of audit quality, we can think of audits as either meeting or not meeting minimum legal and professional requirements. Audit quality is inversely related to audit failures: the higher the failure rate, the lower the quality of auditing. What do we know about audit failure rates? Outright audit failures are difficult to determine with certainty but can be inferred from several sources including auditor litigation and business
1 The studies cited in this review date to earlier periods when the dominant group was the Big 8 prior to 1989, the Big 6 from 1989–1997, Big 5 from 1998 to 2001, and the Big 4 since the collapse of Arthur Andersen in