Are Referred-to Auditors Associated with Lower Audit Quality?

• In Event: Audit Quality

Abstract

The Public Company Accounting Oversight Board (PCAOB) has proposed a new auditing standard, Auditing Standard (AS) 1206, for audits in which the lead auditor divides responsibility with other auditors, and “refers” to the other auditors’ work in its audit report. In response to the Board’s call for data and analyses relating to referred-to auditors, we document trends in the use of referred-to auditors and examine their association with “actual” (discretionary accruals) and perceived (earnings response coefficients) audit quality. Using the Audit Analytics database, we document, consistent with the PCAOB’s observations, that referred-to auditors are used predominantly in two settings: when the lead auditor’s client has equity method investees or consolidated subsidiaries. Further, the use of referred-to auditors has declined over the period 2000-2015. Our audit quality analyses yield mixed results. We find some evidence indicating that referred-to auditors for consolidated subsidiaries are associated with higher perceived audit quality. In contrast, referred-to auditors for equity method investees are associated, in some subsets of our sample, with both lower actual audit quality (higher discretionary accruals) and lower perceived audit quality (lower earnings response coefficients). We conclude that, in addition to its focus on referred-to auditors’ involvement with consolidated subsidiaries, the Board should also consider potential audit quality effects of equity method investees.

Authors

• Jayanthi Krishnan, Temple University

• Mengtian Li, Temple University