Australia’s capital markets are continuing to grow at a time when other capital markets around the world are in decline, and so continued confidence in financial reporting of both established and emerging firms is crucial to the continued success of the Australian economy.
The credibility of the audit function and perceptions of audit quality are a key component of an effective and efficient capital market. A strong auditing and accounting profession builds confidence and trust in financial reports, which in turn underpins capital market confidence. Market confidence and trust in the credibility of the audit function and reliability of financial statements are closely linked to market’s perceptions of audit quality, and to the technical aspects of audit.
The question of what constitutes an audit of high quality has come under increasing scrutiny in recent years. In the past decade, corporate collapses and audit failures have threatened the credibility of the audit function, for example, HIH Insurance in Australia, Enron and Worldcom in the United States and Parmalat and Royal Ahold in Europe. In particular, the perception of audit quality has come under scrutiny by policy makers and financial media commentators around the world.
More recently in Australia, the corporate scandals and perceived audit failures associated with Centro Property Group and building services company, Hastie Group, have again drawn attention to the quality of the audit process.
The Global Financial Crisis has also motivated policy makers to attempt to identify key drivers of audit quality. Examples include the establishment of the Advisory Committee on the Auditing Profession in the US, the release of The Audit Quality Framework (2008) in the UK, the release of Audit Quality in Australia – A Strategic Review (2010) and the European Commission (EC) Green Paper Audit Policy: Lessons from the Crisis (2010).
Benefits of an effective capital market
There are both public and private benefits to an effective and efficient capital market. The public benefit is the contribution it makes to a more equitable distribution of the gains from investing. Reliable and credible financial statements encourage investment by a broader range of investors. The private benefit is that it contributes to higher investment returns because it helps to reduce a significant component of the risk of investing, namely, financial statement risk.
However, the question remains;
What constitutes a high quality audit?
In an recent innovative project investigating factors that can influence perceptions of audit quality Dr Alan Kilgore established that factors associated with the audit team such as teamwork, regular communication between the audit team and the client and the experience and knowledge of the audit team were more important to audit quality than were factors associated with the audit firm such as the industry experience of the audit firm or audit partner tenure.
The findings of the project are particularly important for regulatory and professional accounting bodies since they have tended to focus on audit firm factors in seeking to improve audit quality.
Further research needed
The IGAP team at Macquarie University, consisting of Dr Alan Kilgore, Professor Nonna Martinov-Bennie and Associate Professor Sue Wright, are conducting a follow up project jointly funded by Macquarie University and the Association of Chartered Certified Accountants (ACCA), one of the largest and fastest-growing global accounting bodies. This project aims to investigate the key drivers of audit quality by investigating audit quality from the perspective of two important groups involved in the audit market; chief financial officers (CFOs) and directors.
The results of the project are likely to have implications for the audit profession, regulators and standards setters and their concerns with improving the effectiveness and integrity of the audit process in their attempts to guide improvements in audit processes, leading to increased audit quality and financial reporting integrity. The project’s outcomes are also likely to provide valuable input into the current policy debate by international regulators.
Written by Professors Nonna Martinov-Bennie and Alan Kilgore from the International Governance and Performance Research Centre at Macquarie University’s Faculty of Business and Economics.
International Governance and Performance Research Centre (IGAP), Faculty of Business and Economics, Macquarie University, Director Nonna Martinov-Bennie and Deputy Head of Department, Alan Kilgore, share their thoughts on audit quality: