Does an Audit Office’s Quality Control System Impact Audit Quality? Evidence from Audit Report Errors

• In Event: Audit Offices

Abstract

Although practitioner literature asserts a link between an auditor’s quality control system and engagement-level audit outcomes, prior archival evidence has struggled to identify observable indicators in support of this claim. We identify an observable failure that is unambiguously attributable to the auditor – an error in the audit report – as an office-level proxy for poor quality controls. Audit report errors suggest a breakdown in the engagement’s quality review process, which we expect to reveal broader quality control problems and lower audit quality in the respective office. Consistent with this hypothesis, we find that clients of a Big Four office with an audit report error display greater abnormal accruals than do clients of offices not cited for errors. We document the pattern in non-adverse restatements and going concern explanatory paragraphs, as well. The findings suggest that audit firms’ internal quality mechanisms impact the quality of their clients’ financial reporting processes. Furthermore, audit report errors may be used as a proxy for an office’s audit quality independent of its clients’ pre-audit inputs.

Authors

• Lawrence J Abbott, University of Wisconsin-Milwaukee

• William L Buslepp, Louisiana State University

• Blair B Marquardt, University of North Texas

• Stephanie Merrell, Nicholls State University