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    The Joint Effects of Multiple Legal System Characteristics...
    research summary posted June 22, 2017 by Jennifer M Mueller-Phillips, tagged 01.02 Changes in Audit Standards, 15.04 Audit Firm Rotation 
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    Title:
    The Joint Effects of Multiple Legal System Characteristics on Auditing Standards and Auditing Behavior
    Practical Implications:

    Whether or not the ISA should be adopted by the United States is a greatly contested topic. This study is helpful for regulators and standard-setting boards in the United States about the potential effects of the adoption of ISA and mandatory audit rotation for the United States. This information is also applicable for other countries when making these decisions as well.

    Citation:

    Simunic, Dan A., M. Ye, and P. Zhang. 2017. “The Joint Effects of Multiple Legal System Characteristics on Auditing Standards and Auditor Behavior”. Contemporary Accounting Research 34.1 (2017): 7.

    Purpose of the Study:

    This paper examines the impacts of legal characteristics and auditing standards on audit behavior. Then based on this information the authors determine what the optimal auditing standards would be under different legal regimes. The two legal characteristics examined are vagueness in interpreting audit standards by courts and the expected damage award size in lawsuits against auditors for a failed audit. In recent years there has been a large number of countries adopting the International Standards on Auditing (ISA). Specifically, this study addresses whether or not ISA can be applied efficiently for all countries, and whether or not it adds value to the country that adopts the standards. 

    Design/Method/ Approach:

    The authors begin the analysis by determining the audit quality based on auditing standards and the legal system by using a single-period auditing model with risk-neutral players. After that the optimal auditing standards which maximize audit quality for a specific legal system were determined. The effect of auditor rotation on audit quality was found by adding contingent fees into the model.

    Findings:

    Overall, the authors find that audit quality is affected by both auditing standards and characteristics of legal systems. The optimal audit standards for a particular country also change depending on the legal system.

    Specifically, the authors find:

    • In situations where the expected damages are low, the audit standards are not able to increase audit quality. This is also true for a vague interpretation of audit standards by the courts. Simply adopting a set of rules, such as the ISA, does not determine audit quality.
    • Mandatory auditor rotation can improve audit quality and is more beneficial in countries that have tough and vague auditing standards.

    In regards to ISA the authors find:

    • In places that already have similar standards and legal systems, such as Canada, ISA can be effectively implemented.
    • However, in countries that have a weak legal system, such as China, it is not likely the adoption of ISA will affect audit quality.
    • It is hypothesized by the authors that due to the litigious legal environment of the United States the adoption of ISA would decrease audit quality. 
    Category:
    International Matters, Standard Setting
    Sub-category:
    Changes in Audit Standards
    Home:

    http://commons.aaahq.org/groups/e5075f0eec/summary