The auditor’s opinion is derived through a complex process such as establishing an audit plan, due diligence, external inquiry, and on-site audit (Rho 2016). However, existing audit reports disclosed only audit opinions without specific details. For t ...
The auditor’s opinion is derived through a complex process such as establishing an audit plan, due diligence, external inquiry, and on-site audit (Rho 2016). However, existing audit reports disclosed only audit opinions without specific details. For this reason, it is often pointed out that the information is insufficient for investors to evaluate the quality of audit reports. In May 2014, The Korea government amended the Act on External Audit of Stock Companies (hereafter, the “External Audit Act”) to require the auditor to disclose detailed audit execution data in an audit report. In particular, since 2014 the auditor should disclose two types of audit execution data. One is the personnel composition of audit engagement team. The other is the composition of audit procedure. The auditor should disclose detailed audit hour data subdivided by auditor’s rank and audit process.
The Financial Supervisory Service (FSS) expects that the disclosure of detailed audit execution data plays an important role in raising the reliability and usefulness of financial statements. It also plans to use the disclosed information to select the subject of audit review. The above discussion assumes that there is a systematic difference in the audit quality depending on how the audit engagement team is structured and how the auditor allocates audit hours to each audit process. There have been many studies on the impact of the characteristics of accounting firms or engagement partners on audit quality (DeAngelo 1981; Becker et al. 1998; Balsam et al. 2003; Krishnan 2003; Chi and Chin 2011; Zerni 2012; Gul et al. 2014; Bae et al. 2014; Choi et al. 2016), but few studies examined whether audit quality is influenced by the assignment of audit resources. We expect our study to fill this gap.
The year 2014 is especially important in that it is not only the first year to adopt the New International Standards on Auditing (hereafter, “New ISA”) in Korea, but also disclosure of detailed audit execution data became mandatory. One of the key features of New ISA is a top-down risk based approach, which focuses audit resources on the key risk factors identified in the planning phase. If the auditor spend sufficient time on the planning, he or she will be able to better identify key audit risks, which will increase the likelihood of finding accounting frauds or errors on financial statements (New ISA §300 Para. 2; Blokdijk et al. 2006). Furthermore, the New ISA emphasizes the involvement of key engagement team members in the planning phase (New ISA §300 Para. 5). The involvement of the engagement partner and other key members in the audit planning facilitates the transfer of knowledge and experience among team members, thereby enhancing effectiveness and efficiency of the planning process (New ISA §300 Para. A4; Bell et al. 2008). From this point of view, this study deals with two research questions. First, we examine how an appropriate audit planning can affect audit quality based on the disclosure of external audit execution data. Second, we investigate whether the involvement of engagement partner in the planning phase is a useful information to the capital market.
To address these two research questions, we use 1,194 firms listed on Korea Stock Exchange (KSE) and Korea Securities Dealers Automated Quotations (KOSDAQ) in 2014. We use discretionary accruals as a proxy of audit quality (Becker et al. 1998; DeFond and Subramayam 1998; Carey and Simnett 2006). We find that discretionary accruals are negatively associated with abnormal audit planning ratio. It suggests that if the auditor puts sufficient time into the planning phase, audit quality improves. These results are consistent with the policy pursued by the New ISA, which emphasizes an appropriate audit planning in order to increase the likelihood of finding material misstatement (New ISA §300 Para. 2). Meanwhile, the proportion of partner time (as a fraction of total audit hours) dose not significantly affect this positive relation between abnormal audit planning ratio and audit quality.
We make several contributions to prior literature. First, we respond to calls for more research on the audit process (DeFond and Zhang 2014). In Korea, total audit hours have been disclosed since 2001, but detailed audit hours information subdivided by auditor’s rank or audit process was not provided. Due to the data limitations, research in this field has been conducted very limitedly through inside data of one or two accounting firms or experimental settings (Davidson and Gist 1998; Blokdijk et al. 2006; Sohn et al. 2006). Our large-sample archival evidence complements the prior researches that rely on the experimental setting. Second, we focus on the role of audit planning in improving audit quality. The outstanding feature of New ISA is the emphasis on the top-down risk based approach. This approach emphasizes the audit planning phase, at which the auditor identifies key risky items that may contain potential misstatement. However, there is little empirical evidence to examine whether the auditor’s commitment to the planning phase leads to an increase in audit quality, and whether the active involvement of experienced engagement partner is helpful in this process. Our study provides the empirical evidence on the role of audit planning, which has recently been emphasized in auditing standards and practices. Third, our study provides information on which disclosure items may be useful for market participants (including regulators) when assessing a firm’s audit quality.