Auditing Standards, Professional Judgment, and Audit Quality

Abstract

We propose a model to study how auditing standards affect audit quality. We posit that both auditors' incentives and expertise are relevant for audit effectiveness. Auditing standards are useful in mitigating the auditors' possible misalignment of interest with investors. However, auditing standards also restrict auditors' exercise of professional judgment, which, in turn, leads to compliance mentality and reduces auditors' incentives to become competent in the first place. We identify the conditions under which stricter auditing standards increase or decrease audit quality. Moreover, stricter auditing standards always increase audit fees, but can benefit auditors at firms' expense. The model also generates many testable empirical predictions.

How Is the Audit Market Affected by Characteristics of the Nonaudit Services Market?

“…Further, several studies find that PCAOB inspections improve perceived or actual firm‐wide audit quality (see, e.g., DeFond and Lennox [2017], Fung, Raman, and Zhu [2017], Gipper, Leuz, and Maffett [2020], Westermann, Cohen, and Trompeter [2019]). The model of Gao and Zhang [2019] also features ex ante investment by auditors, termed “expertise,” which is one interpretation of our audit quality variable, .…”

Auditor’s Income Taxation and Audit Quality

“…• • We assume vague auditing standards. Hence, the probability that the effort level chosen by the auditor is considered insufficient by a court is always greater than 0 (Gao & Zhang, 2019;Schwartz, 1998). • • Any unit of audit effort causes marginal costs of c.…”

Training for professional judgment in accounting education

“…It is argued that accounting and auditing are seeing a growing demand for more critical and thoughtful analysis, especially in a technology-driven world (Bucaro, 2019;Cloete, 2018;Terblanche and de Clercq, 2019). Some studies indicate that auditors tend to make mechanistic decisions in situations that require their complexity to be assessed, and professional judgment to be applied thereunto more effectively (Gao and Zhang, 2019). Following this train of thought, academic programs implement several educational methodologies and strategies to foster critical thinking.…”

“…Nevertheless, as some studies suggest (Chabrak and Craig, 2013;Kang et al, 2015;Gao and Zhang, 2019), the exercise of professional judgment may be restricted by the rules. Gao and Zhang (2019) studied this phenomenon in auditors and identified an extensive mindset of mere compliance, wherein quality and professional competence are set aside.…”