Previous studies have devoted a great deal of attention to audit quality. The quality of audit work is very important as it has a significant effect not only on the audit firm but also on the public. In auditing, audit quality is the fundamental factor and explains the demand for auditing practice. The auditing profession serves as a “middle-man” to reduce information asymmetry between the preparer (company’s management) and users (for example company’s shareholders and creditors) of financial statements.
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Therefore, in order to retain this role, auditors must maintain the trust and confidence of the public (Pasewark, Shockley, & Wilkerson, 1995) which can only be achieved by providing high standards of audit quality. It could be argued that this stewardship function has been violated in the event of substandard audit quality.
Audit quality is defined from various perspectives. The most prevalent definition of audit quality in the accounting literature is the market-assessed probability that the financial statements contain material errors and that the auditor will both detect and report errors and irregularities in financial statements (DeAngelo, 1981). Other definitions used in the accounting literature are the probability that an auditor will not issue an unqualified report for financial statements containing significant misstatements (C.-W. J. Lee, Liu, & Wang, 1999), the accuracy of the information provided by auditors (R. A. Davidson & Neu, 1993; Krinsky & Rotenberg, 1989; Titman & Trueman, 1986), and the degree to which the auditors comply with applicable auditing standards (J. M. Cook, 1987; Krishnan & Schauer, 2001; McConnell & Banks, 1998; Tie, 1999).
Although there are various definitions given to audit quality, they share similar dimensions: competence and independence. According to Fearnley and Beattie (2004), these audit quality dimensions are necessary to avoid audit failure, thus, they are mutually inclusive (Barnes & Huan, 1993) and not completely separated as suggested by DeAngelo’s definition (Duff, 2004). If the auditor is incompetent, there is the possibility of his/her independence being jeopardised (T. Lee & Stone, 1995). There is a high possibility of the auditor relying on the information given by clients when he/she has insufficient experience and low expertise. Another example exists, in that the auditor may not properly investigate and discover frauds or material misstatements on the items for which they have no intention to report errors (Duff, 2004). T. Lee and Stone (1995) further argue that if the auditor is incompetent, independence is not an audit characteristic to be anticipated. On the other hand, auditors may be highly
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competent in performing their tasks, however, such an ability is useless if the auditors do not report the errors or fraud discovered due to lack of independence.
Auditors’ competency is defined as the ability of the auditor to identify and discover any omission, misstatement or fraud in the client’s financial statements (Fearnley & Beattie, 2004). Accordingly, ISA 200 relates competency to the ability of the auditor to identify any material misstatements in financial statements through proper planning and an attitude of professional scepticism (IFAC, 2006). Indeed, ISA 240 states that auditors should be able to detect any fraud if they conduct proper audit procedures to obtain reasonable assurance that the financial statements are free of material misstatements (IFAC, 2006). As part of the stewardship function, auditors have a responsibility to respond to error or fraud risk by planning and performing the audit to obtain reasonable assurance that any material misstatement, due to error or fraud, is detected. Therefore, auditors are expected by third parties to have adequate knowledge and the necessary technical skills to perform their duties. Thus, auditors must maintain a level of competency when they consider a broad set of information, including fraud risk factors. In order to ensure auditors have the necessary knowledge, and to maintain a high level of competency among auditors, most of the professional and regulatory bodies set a minimum entry level for the profession (see IES 1, IFAC, 2003). It is believed that by having a minimum entry level, auditors have adequate training in accounting and other areas related to their profession and should be able to recognise any irregularities in the financial system. In addition, in light of the constant changes affecting the accountancy profession, the professional and regulatory bodies have made it mandatory for auditors to attend continuous education training throughout their career, to ensure they stay abreast with current developments in accounting and related matters. For example, the Malaysian Institute of Accountants (MIA) introduced and made mandatory a Continuing Professional Education (CPE) requirement on 1 March 1992. Members of the MIA are required to attain a minimum number of CPE credit hours for each CPE cycle (60 CPE hours within 3 years). Auditors’ competency is based on auditor technical skills and knowledge, and is relatively easy to conceptualise (Duff, 2004). Competency can be easily demonstrated by referring to audit work and incompetence is easily detected through any omission on necessary procedures, standards or guidelines.
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This attribute is very important to increase the credibility of the financial statements. As credible financial statements closely reflect a company’s actual economic condition, which would help users of financial statements to make the right decisions, and avoid possible losses in the future.
On the other hand, independence is an important audit attribute since the main demand for auditing is to reduce the conflict between the preparers and users of financial statements. Indeed, Mansouri, Pirayesh and Salehi (2009) argue that audit quality is highly dependent on the independence of the auditor. The term independence embodies two concepts which are “independence in mind” and “independence in appearance”. DeAngelo’s (1981) definition of independence (an auditor’s willingness to report on misstatements as a result of error or fraud in audited financial statements) could be considered as independence in mind. Auditors however, as required by most professional codes must be both, independent in mind and independent in appearance (Houghton & Jubb, 2003). IFAC (2006, section 290.8) defines independence in mind as “the state of mind that permits the expression of a conclusion without being affected by influences that compromise professional judgement, allowing an individual to act with integrity, exercise objectivity and professional scepticism”. Independence in appearance is defined as the avoidance of facts and circumstances that are so significant that a reasonable and informed third party would reasonably conclude that a firm’s, or a member of the audit team’s, integrity, objectivity or professional scepticism had been compromised (IFAC, 2006). Therefore, independence in mind exists when auditors are able to maintain an unbiased attitude throughout the audit, and independence in appearance relates to the public or market perception about independence (Arens, Elder, & Beasley, 2006). Independence in mind is necessary to enhance the credibility of the financial statements (Church & Zhang, 2002). On the other hand, auditors should also be seen to be independent in executing their audit tasks (Stevenson, 2002), and to increase public confidence in the financial statements (Lowe & Pany, 1995; Manzon & Guo, 2009). Indeed, because the nature of independence in mind is unobservable, the public tends to evaluate auditor’s independence based on their perception. Bad perception of independence of appearance is sufficient to undermine confidence in
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financial reports (Fearnley & Beattie, 2004). Explicitly, both independence concepts are necessary to increase public trust in the auditing process and financial reporting.