Research Summary 15: Differences in Quality Among Audit Firms




Summary #15

Differences in Quality
Among Audit Firms

Size affects compliance with GAAP.


hile accounting regulators maintain audit quality is independent of firm size, others argue that large firms produce a higher quality audit than small firms. Prior research yielded mixed conclusions, perhaps due to the difficulty of measuring audit quality. However, our results indicated that a positive association exists between audit firm size and audit quality. In order to test the association between quality and size, we examined 164 not-for-profit, voluntary health and welfare organizations. Our sample comprised 35 clients of what were then the Big 6 firms, 65 clients of firms with more than 10 professionals and 64 clients of smaller firms with 10 or fewer professionals.

We measured quality as the degree to which the client complied with GAAP disclosure requirements for (1) investments, (2) valuation of fixed assets, (3) depreciation of fixed assets, (4) form of audit report, (5) cash donations and pledges, (6) donated materials and services, (7) presentation of statement of functional expenses and (8) presentation of balance sheet and other statements.

We hypothesized that not complying with GAAP disclosure requirements was likely to be associated directly with poor audit quality, and that compliance with GAAP would increase as the firm’s size increased. Our study used data from audits conducted prior to the issuance of three pronouncements on not-for-profit organizations, which FASB released in response to known inconsistent reporting by these entities.

The results indicated that 83% of the sample treated at least six of the eight GAAP items correctly. Noncompliance was highest for pledges and donated materials. However, noncompliance differed across audit firms of different sizes—compliance increased from the small firms to the firms with more than 10 professionals and from such firms to the Big 6. This positive association between audit firm size and compliance with GAAP disclosure requirements, as a measure of audit quality, holds even after controlling for other factors relating to quality, such as the client’s size, financial health, wealth and participation in peer review. The results of our study indicated that smaller firms might need to strengthen the quality control functions of their audits in order to improve compliance, particularly in audits with industry-specific requirements, such as those for voluntary health and welfare organizations.

For the full text of the research paper, see Auditing: A Journal of Practice & Theory, Fall 2000, vol. 19, no. 2.

JAGAN KRISHNAN, PhD, is a chartered accountant and associate professor of accounting, Temple University, Philadelphia. His e-mail address is . PAUL C. SCHAUER, CPA, PhD, is a certified information systems auditor and assistant professor of accounting, Bowling Green State University, Ohio.


Summary #16

Independence and
Auditor Selection

Independent boards might prefer generic
specialists to brand-name generalists.


n our study, we examined the association between independent boards of directors, measured as the percentage of outside directors on the board, and the type of external auditor selected—an industry specialist from what was then the Big 6, a nonspecialist from the Big 6 or an auditor who was not from the Big 6. We’ve observed that the market has always perceived Big 6 auditors, whether specialists or nonspecialists, as performing higher quality audits than other auditors. We hypothesized that boards with a high percentage of outside directors were more likely to be associated with higher quality auditors than boards with a lower percentage.

We examined 681 property-liability insurers and found that after controlling for insurer size, organizational structure, financial condition and geographic dispersion, as well as other variables, the likelihood an insurer would use a specialist Big 6 auditor increased as the percentage of outsiders on the board of directors increased. However, we did not find an association between a board’s composition and its choice of either a nonspecialist Big 6 or other auditor. This suggests that in a specialized industry, such as insurance, independent boards of directors might find the distinction between specialist and nonspecialist auditors more important than that between Big 6 and other auditors.

For the full text of the research paper, see Auditing: A Journal of Practice & Theory, Spring 2001, vol. 20, no. 1.

MARK S. BEASLEY, CPA, PhD, is associate professor of accounting at North Carolina State University, Raleigh. His e-mail address is . KATHY R. PETRONI, PhD, is associate professor of accounting at Michigan State University, East Lansing.

This series is based on work published in Auditing: A Journal of Practice & Theory. The intent is to bridge the gap between researchers and practitioners by offering concise practice summaries of cutting-edge research in the field of auditing.


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