1.10 Indicators of Audit Quality

Auditors must be competent in order to perform a high quality audit. Competence includes having an understanding of Generally Accepted Accounting Principles (GAAP) or other established criteria used by their clients in the preparation of their financial statements. Professional certifications, such as the Certified Public Accountant (CPA) certification ensures that a minimum threshold of competence is demonstrated by those seeking to perform audits. However, continued learning and appropriate training are essential for auditors to stay informed of new and updated standards and to understand client transactions in an increasingly complex financial environment. Because of the difficulty of obtaining and maintaining a deep understanding of the very specific challenges faced by many different industries, many auditors choose to specialize in particular industries. Doing so allows them to develop a deeper level of understanding of the various issues clients in a particular industry face. Research has shown that because of the specialized knowledge they bring, auditors who specialize in this way perform higher quality audits and are able to charge greater fees to their clients. Investors who know that the auditor is competent will be more trusting of his audit report, which makes that auditor more valuable to the client.

Audit quality also improves as auditors gain experience in conducting audits. First-year auditors are not expected to know as much about the audit process as the audit partner who has been performing audit engagements for many years. Similarly, valuable client-specific knowledge results from an auditor’s repeated interactions with that client. Thus, an auditor who has worked with a client for several years will generally perform a higher quality audit than an auditor who is auditing the client for the first time. Because repeated interactions with clients can lead to complacency and overconfidence, there is some evidence in research that auditors who perform the audit for the same client for very long periods of time can become less objective and professionally skeptical over time.

The American Institute of Certified Public Accountants (AICPA) defines objectivityA state of mind, a quality that imposes the obligation to be impartial, intellectually honest, and free of conflicts of interest. as, "a state of mind, a quality that…imposes the obligation to be impartial, intellectually honest, and free of conflicts of interest" (ET Section 55-Article IV). An auditor who has a close personal relationship with upper management of a client may be less impartial and less likely to be free of conflicts of interest. Because of the potential impact of familiarity and complacency on auditor objectivity, many countries have limited the length of time an auditor can serve a particular client. While some countries limit the length of time an accounting firm can audit a client, the U.S. has established standards limiting the time an audit partner can be engaged with a single client to a maximum of five years. After five years, the audit firm must rotate a new lead partner onto the engagement team in an effort to maintain objectivity and, as a result, audit quality.

Closely related to objectivity is independence. Whereas objectivity describes the state of mind an auditor has when she performs the audit, independence relates to the presence of economic relationships the auditor has with the client that may cause the auditor’s judgments to be biased. For example, an auditor who owns shares of stock in his audit client’s company may hesitate to issue a negative audit report about the client because of the negative effect the report would have on the auditor’s personal wealth. Thus, auditing regulators have established comprehensive rules relating to the auditor’s independence from his clients. Topic 4 will discuss these rules in greater detail.

A key element in achieving acceptable levels of audit quality is the auditor’s understanding of his or her role in the financial reporting process. The AICPA’s Code of Professional Conduct reminds auditors of their responsibilities to maintain the public confidence and to act in the interest of the general public. Part of the auditor’s responsibility to the public is to exercise professional skepticismAn attitude that includes a questioning mind and critical assessment of audit evidence., which requires the auditor to have a questioning mind – without being accusatory – throughout each stage of the audit. Some people refer to this mindset as one where the auditor “trusts, but verifies.”

Many of the individual characteristics discussed in this topic are influenced by the environment in which auditors operate. For example, the regulations and auditing standards that auditors follow influence the audit. In addition, the degree to which regulations are enforced can have a significant effect on auditor behavior. Other environmental factors that influence audit quality include the litigation environment, the amount of time auditors have to complete specific procedures, quality of the client's corporate governance, and the culture of the audit firm, including internal pressures auditors receive from their superiors.