MBA Thesis Audit Quality

Henley Management College

PERCEPTIONS OF AUDIT QUALITY IN A POST-ENRON WORLD

THE DIMENSIONS OF MALTESE FINANCIAL QUALITY AUDITS

by

- Renzo Farrugia -

Dissertation submitted in partial fulfillment

of the requirements for the degree of Masters of Business Administration

2007

HENLEY MANAGEMET COLLEGE

ABSTRACT

This dissertation reviews and evaluates the theory and practical implications on

financial audit quality with relevance to the Maltese environment.

Following the unheralded collapses of giant corporates like Parmalat, Enron and

World.Com, the focus is on how the auditing profession is organising its activities to

convey trust and credibility to users of financial information. In the midst of this

period of self-examination, various countries are rethinking their audit process with

a heightened zeal to ensure that such intricate plights do not happen in their

communities – and Malta is no exception.

The objective of this dissertation is to take stock of the large body of audit quality

literature and assess the current understanding of this concept from a Maltese

perspective – in particular the view point of audit partners and of audit committees

of companies quoted on Malta Stock Exchange. These views are then compared,

gaps are identified and recommendations are provided.

Consequently, a theoretical framework that treats audit quality as a construct with

multiple and interrelated dimension is built. This constitutes a well-defined space

for locating existing research and future hypothesis formation. Three hypotheses

are also presented to facilitate the construction of research taxonomy. These

hypotheses relate to the nature of audit quality, awareness of this dimension and

how audit quality can be the catalyst to ensure long-term sustainable competitive

advantage.

At the end of this study, a model detailing the different typologies of audit firms in

Malta is presented enabling practitioners to gauge their level of audit quality based

on their competitive focus and posture correlation.

It is hoped that these findings provide evidence for audit firms, not only to meet the

satisfaction level of their client and other stakeholders, but also to improve their

own audit quality.

T a b l e o f C o n t e n t s

1 PART ONE – INTRODUCTION............................................................................. 2

1.1 BACKGROUND..................................................................................................... 2 1.2 SCOPE AND OBJECTIVE....................................................................................... 3 1.3 RESEARCH HYPOTHESIS...................................................................................... 3 1.4 STRUCTURE OF DISSERTATION........................................................................... 4 1.5 ORGANISATIONAL ANALYSIS ............................................................................. 5

2 PART ONE - LITERATURE REVIEW ................................................................. 8

2.1 DEFINING AUDIT QUALITY ................................................................................. 8 2.2 EVOLUTION OF AUDIT QUALITY ......................................................................... 9 2.3 PILLAR I - TECHNICAL APPROACH TO AUDIT QUALITY.................................... 10

2.3.1 Audit Quality and Fees Reliance ................................................................ 10 2.3.2 Audit Quality and Agency Conflicts............................................................ 11 2.3.3 Audit Quality and its relation to Brand Name Auditors............................. 12

2.4 PILLAR II - BEHAVIORAL APPROACH TO AUDIT QUALITY ............................... 14 2.4.1 Audit Quality and Client Satisfaction ......................................................... 15 2.4.2 Audit Quality and Stakeholders’ Perception .............................................. 15 2.4.3 Audit Quality and Service Quality – AuditQual ......................................... 16 2.4.4 Behavioural Theories and its implications in Malta .................................. 17

2.5 PILLAR III - REGULATORY REGIME PERSPECTIVE............................................ 17 2.6 PILLAR IV - QUALITY ASSURANCE AUTHORITIES PERSPECTIVES................... 19

2.6.1 US experience - PCAOB ............................................................................. 20 2.6.2 UK experience - POBA ............................................................................... 21 2.6.3 Maltese experience - QAOC ....................................................................... 21

2.7 PILLAR V - AUDITING STANDARDS PERSPECTIVE............................................ 22 2.8 CONCLUSION – THE ‘AUDIT QUALITY WHEEL MODEL’ ..................................... 23

3 PART TWO – RESEARCH METHODOLOGY ................................................ 27

3.1 RESEARCH THEME ............................................................................................ 27 3.2 AREA OF FOCUS................................................................................................. 27 3.3 CHOICE OF RESEARCH INSTRUMENT................................................................ 28 3.4 DESIGNING THE RESEARCH QUESTIONNAIRE...................................................28

3.4.1 Addressing Questionnaire Risks ................................................................. 30 3.5 TARGET AUDIENCE AND RESPONSE RATE........................................................ 31

3.5.1 Audit Partners ............................................................................................. 32 3.5.2 Audit Committee of Companies listed on MSE........................................... 32

3.6 LIMITATIONS ON RESEARCH METHODOLOGY...................................................33

4 PART TWO – FIELDWORK RESULTS............................................................. 35

4.1 SECTION A, DEMOGRAPHIC ANALYSIS............................................................. 35 4.1.1.1 Summary on Section A..................................................................................36

4.2 SECTION B, LITERATURE REVIEW ANALYSIS...................................................36 4.2.1 Comparison of Respondents Opinions........................................................ 40 4.2.2 Comparison of Respondents Opinions........................................................ 41

4.2.2.1 Audit Firm Culture......................................................................................... 41 4.2.2.2 Partner Involvement....................................................................................... 45

4.2.2.3 Audit Team Involvement............................................................................... 48 4.2.2.4 Quality on the Field ....................................................................................... 50 4.2.2.5 Stakeholders’ Involvement ............................................................................ 53 4.2.2.6 Managing Customers Relationship................................................................ 55 4.2.2.7 Summarizing the Results of Section B.......................................................... 57

4.3 SECTION C, FREE-FORM COMMENTS ANALYSIS .............................................. 59 4.3.1 Audit Fees.................................................................................................... 60 4.3.2 Self-Regulating Profession.......................................................................... 60 4.3.3 Term of Office Duration.............................................................................. 61 4.3.4 Publicity of Defaulters................................................................................. 61 4.3.5 Monitoring by Government......................................................................... 62 4.3.6 Components of Audit Quality...................................................................... 62 4.3.7 Benefits of Audit Quality .............................................................................63 4.3.8 Duration of audit quality.............................................................................63 4.3.9 Summary on Section C ................................................................................ 63

4.4 CONCLUSION..................................................................................................... 64

5 PART THREE - DISCUSSION OF FINDINGS.................................................. 66

5.1 TESTING THE THREE HYPOTHESIS.................................................................... 66 5.1.1 Hypothesis One – Nature of Audit Quality ................................................. 66 5.1.2 Hypothesis Two – Recognition of Audit Quality dimensions ..................... 68 5.1.3 Hypothesis Three – Competitive advantage through Audit Quality .......... 69

5.2 AUDIT QUALITY COMPETITIVE MATRIX .......................................................... 69 5.3 WIDER VALIDITY OF DISSERTATION................................................................ 74

5.3.1 The Five Pillars of Audit Quality – A guideline ......................................... 74 5.3.2 The Audit Quality Wheel Model.................................................................. 74 5.3.3 Audit Firm Competitive Matrix................................................................... 74

6 PART THREE, OVERALL CONCLUSIONS..................................................... 76

6.1 RECOMMENDATIONS......................................................................................... 76 6.1.1 Enhancing the education of auditing practitioners .................................... 76 6.1.2 Educating society about the audit function and the work of the auditor ... 77 6.1.3 Installing a mechanism to receive complaints on the internet ................... 77 6.1.4 Improving the quality control in audit firms............................................... 77 6.1.5 Summary of Implementation measures....................................................... 78

6.2 AVENUES FOR FUTURE RESEARCH.................................................................... 79 6.3 PERSONAL LEARNING AND REFLECTION.......................................................... 80

7 APPENDICES .......................................................................................................... 83

APPENDIX A, SHORT NOTES ON ACCOUNTANCY PROFESSION ACT’S DIRECTIVES........ 83 APPENDIX B, QUESTIONNAIRE......................................................................................... 85 APPENDIX C, LETTER TO CHAIRPERSONS OF AUDIT COMMITTEES................................. 96

8 BIBLIOGRAPHY .................................................................................................... 98

L i s t o f E x h i b i t s

Exhibit Number Page EXHIBIT 1, STRUCTURE OF DISSERTATION............................................................................. 4 EXHIBIT 2, QAOC OBJECTIVES.............................................................................................. 5 EXHIBIT 3, MALTESE ORGANISATIONAL SET-UP IN ENSURING AUDIT QUALITY .................. 6 EXHIBIT 4, FIVE MAJOR APPROACHES TO AUDIT QUALITY ................................................. 10 EXHIBIT 5, RESULTS OF BEHAVIOURAL AUDIT QUALITY RESEARCH.................................. 14 EXHIBIT 6, THE AUDITQUAL MODEL................................................................................... 16 EXHIBIT 7, ILLUSTRATIVE QUALITY CONTROL SYSTEM ADOPTED BY PCAOB .................. 20 EXHIBIT 8, ISQC 1 REQUIREMENTS...................................................................................... 23 EXHIBIT 9, THE AUDIT QUALITY WHEEL MODEL................................................................ 24 EXHIBIT 10, CONTENTS IN MAIN BODY OF THE QUESTIONNAIRE.......................................... 29 EXHIBIT 11, ADDRESSING POTENTIAL QUESTIONNAIRE PITFALLS ...................................... 30 EXHIBIT 12, POPULATION OF AUDIT FIRMS AND MSE COMPANIES.................................... 31 EXHIBIT 13, WORK EXPERIENCE OF AUDIT PARTNERS BY GENDER.................................... 35 EXHIBIT 14, DEMOGRAPHICS OF AUDIT PARTNERS AND CHAIRPERSONS OF COMMITTEES 36 EXHIBIT 15, TEN MOST INFLUENTIAL FACTORS ON AUDIT QUALITY.................................... 37 EXHIBIT 16, TEN LEAST INFLUENTIAL FACTORS ON AUDIT QUALITY................................... 39 EXHIBIT 17 INDEPENDENT SAMPLE TEST (T-TEST) .............................................................. 40 EXHIBIT 18, RESULTS OF AUDIT FIRM CULTURE ................................................................. 42 EXHIBIT 19, RANKINGS FROM AUDIT FIRM CULTURE.......................................................... 44 EXHIBIT 20, RESULTS OF PARTNER INVOLVEMENT.............................................................. 45 EXHIBIT 21, RANKINGS FROM PARTNER INVOLVEMENT ...................................................... 47 EXHIBIT 22, RESULTS OF AUDIT TEAM INVOLVEMENT........................................................ 48 EXHIBIT 23, RANKINGS FROM AUDIT TEAM INVOLVEMENT ................................................ 50 EXHIBIT 24, RESULTS OF QUALITY ON THE FIELD................................................................ 51 EXHIBIT 25, RANKINGS FROM QUALITY ON FIELD ............................................................... 52 EXHIBIT 26, RESULTS OF STAKEHOLDERS’ INVOLVEMENT.................................................. 53 EXHIBIT 27, RANKINGS FROM STAKEHOLDERS’ INVOLVEMENT.......................................... 54 EXHIBIT 28, RESULTS OF STAKEHOLDERS’ INVOLVEMENT.................................................. 55 EXHIBIT 29, RANKINGS FROM CUSTOMERS’ INVOLVEMENT................................................ 56 EXHIBIT 30, MEAN SCORE FOR ATTRIBUTES – AUDIT PARTNERS’ V IEW ............................ 57 EXHIBIT 31, AUDIT QUALITY WHEEL MODEL – ILLUSTRATION OF MALTESE FINDINGS.... 58 EXHIBIT 32, SECTION C RESULTS......................................................................................... 59 EXHIBIT 33, OBLIGATORY ELEMENTS OF AUDIT QUALITY .................................................. 67 EXHIBIT 34, AUDIT COMPETITIVE FOCUS-POSTURE MATRIX .............................................. 69 EXHIBIT 35 CHARACTERISTICS OF A BASIC AUDIT FIRM ..................................................... 70 EXHIBIT 36 CHARACTERISTICS OF A DARING AUDIT FIRM .................................................. 71 EXHIBIT 37 CHARACTERISTICS OF A CUSTODIAN AUDIT FIRM ............................................ 71 EXHIBIT 38 ADDING VALUE ................................................................................................. 72 EXHIBIT 39 CHARACTERISTICS OF AN ENVIED AUDIT FIRM ................................................ 73 EXHIBIT 40 GAANT CHART – IMPLEMENTATION MEASURES............................................... 78

A c k n o w l e d g m e n t s

This dissertation has been completed with the help and support from a

number of people. I would especially like to thank:

Mr. David Murphy at Henley Management College who helped me in the

critical phase of the dissertation with good advice and quick response on

my questions. His expertise in academic and research matters have

provided me with generous and continual support. His proficiency has

taught me a great deal as we worked together to adapt audit quality

thinking to the Maltese scenario.

I am also indebt to Mr. Francis Farrugia who helped me with his

knowledge concerning the subject of audit quality, with the pilot test of the

field research and with the revision of the field research question.

I also want to acknowledge how much I have learned by working with

colleagues at the Quality Assurance Unit, the Accountancy Board, the

Ministry of Finance and the Malta Institute of Accountants. Such talented

people all provided me with their practical experiences related to their

specific roles whilst contributing their expertise in building up this

dissertation.

My overriding debt is to my lovely expectant wife Bernice and my two kids

Brandon and Gabriel, who provided me with the time, support, and

inspiration needed for the dissertation. It is truly our work.

A c r o n y m s

The acronyms are presented in alphabetical order, for ease of reference.

AB Accountancy Board (Malta) AIU Audit Inspection Unit (UK) APA Accountancy Profession Act, CAP 281 EGAOB European Group of Auditors’ Oversight Bodies EU European Union FEE Fédération des Experts Comptables Européens FRC Financial Reporting Council (UK) IAASB International Auditing and Assurance Standards Board IAS International Accounting Standards IFAC International Federation of Accountants ISA International Standards on Auditing ISQC1 International Standard on Quality Control MIA Malta Institute of Accountants PCAOB Public Company Accounting Oversight Board (US) POBA Professional Oversight Board (UK) QA Quality Assurance QAOC Quality Assurance Oversight Committee (Malta) QAU Quality Assurance Unit (Malta) UK United Kingdom US United States

These acronyms are utilised very sparsely in the dissertation to ensure a

holistic understanding of the matter in discussion.

D e c l a r a t i o n

This Dissertation is submitted in partial fulfillment of the Masters in Business Administration

(Henley Management College)

Unless otherwise stated, the findings, research methodology, analysis and results of this dissertation is my work.

The following details the number of words for each Part of the Dissertation.

Abstract 288 words Part One 5,342 words Part One, Introduction (Chpt.1) 872 words Part One, Literature Review (Chpt.2) 4,470 words Part Two 8,827 words Part Two, Research Methodology (Chpt.3) 2,034 words Part Two, Fieldwork Results (Chpt.4) 6,793 words Part Three 3,645 words Part Three, Discussion of Findings (Chpt.5) 2,323 words Part Three, Overall Conclusions (Chpt.6) 1,322 words

Total No of words (excl Abstract and Appendices) are 17,814 words

_______________________________

Mr. Renzo Farrugia CPAA, B.Accty(Hons) Certified Public Accountant and Auditor

Student ID Number: 2059425 (MT)

C h a p t e r 1

PART 0NE - INTRODUCTION

Audits serve a vital economic purpose and play an important role in serving the public interest to strengthen accountability and reinforce trust and confidence in financial reporting. As such, audits help enhance economic prosperity, expanding the variety, number and value of transactions that people are prepared to enter into. However, in recent years, and in the light of corporate scandals, the profession witnessed ongoing global demands for improvements in audit quality. This raises questions about, what really constitutes audit quality and what are its dimensions.

Hussey et al. 2001

Henley Management College Part ONE, Introduction

Renzo Farrugia Page 2 Student Id: 2059425 (MT)

1 PART ONE – INTRODUCTION

This dissertation is submitted in part fulfillment of the requirements for the Henley

Management College degree of Masters of Business Administration and aims to

meet the academic standards required of a rigorous and insightful research

study, culminating in tangible recommendations for management practice.

The subjects investigated in this work are of great interest to the author because

it traverses his career as an auditor and his current position with the Quality

Assurance Unit [QAU]. The objective of this dissertation is to identify the different

perceptions of audit quality within the Maltese1 context.

1.1 Background

Financial audit quality has attracted a great amount of interest from the

accountancy profession on an international basis. Enron's collapse, and the

implications of serious control issues that accompanied it, are having a profound

impact on how the auditing profession view their control environments. Various

countries are rethinking their governance processes with a heightened zeal to

ensure that such intricate plights don't happen in their communities.

On 14th December 2005, the European Union [EU] established the European

Group of Auditors’ Oversight Bodies [EGAOB] to ensure smooth and efficient co-

operation amongst public oversight systems within Member States and with third

countries. Furthermore, the EU Statutory Audit Directive2 issued during March

2006, obligates Member State to establish a regulatory authority with the remit to

ensure effective quality, thereby minimising threats of lack of credibility in the

auditing profession.

1 The Maltese Archipelago consists of Malta, Gozo, Comino and two small uninhabited islands - all over the area of 316 sq km (122 sq miles). Being located south of the Italian island of Sicily the island lies virtually in the centre of the Mediterranean Sea between Europe and North Africa. The Maltese population is 397,000 (UN, 2005) and the GNI is US $13,590 (World Bank, 2006).

2 The EU Statutory Audit Directive is the short name for ‘Directive of the European Parliament and of the Council on statutory audits of annual accounts and consolidated accounts, amending Council Directives 78/660/EEC and 83/349/EEC and repealing Council Directive 84/253/EEC.’

Henley Management College Part ONE, Literature Review


On a Maltese context, Directive 4 of the Accountancy Profession Act [CAP 281],

issued during 2006, established an independent Quality Assurance Oversight

Committee [QAOC] with the remit to assist firms to maintain and improve their

quality of their audit work, whilst co-operating with European counterparts. This

relatively new set-up is expected to undertake on-the-spot reviews of auditors on

a case-by-case basis to enhance public faith in the profession.

1.2 Scope and Objective

The scope of this dissertation is to identify, possible critical antecedents of audit

quality within the Maltese auditing profession.

The objective of this dissertation is to analyse how local practitioners actually

manage their audit quality and to suggest a model that might assist audit firms in

attaining sustainable competitive advantage through the rejuvenation of audit

quality methodologies in their daily operations.

1.3 Research Hypothesis

To focus the research, the author is presenting the following set of hypothesis

that represent current problem areas as will be described in Chapter 3 [pp.26] of

this dissertation.

The prime hypothesis is that the dimensions of audit quality are not something

static or universal. Instead it is a multi-dimension construct that evolves due to

continual changes in the environmental influences effecting the profession.

A priori it is expected that managing audit quality is in an emerging state, leading

to the second hypothesis that; such dimensions, are not fully recognised within

the local auditing profession.

Focusing on audit quality can be the means through which firms gain competitive

advantage. However, history has shown that even large, reputable audit firms

imminently collapsed due to negligent wrong-doing of some minor staff. This

leads to the third hypothesis; audit firms who manage audit quality at all levels of

its organisation, ensure long term sustainable competitive advantage.



The objective is to confront these hypotheses by mirroring literature findings on

antecedents of audit quality against present practices in the auditing profession

derived from a field research. Furthermore it is the objective of the research to

debate literature findings and practical experiences from the field research and

derive conclusions on the Maltese experiences.

1.4 Structure of Dissertation

The framework of the dissertation adheres to the guidelines issued by Henley

Management College [2004]. The general outline of the dissertation is divided into

three parts as illustrated in Exhibit-1.

Exhibit 1, Structure of Dissertation

Introduction

Aim, Hypothesis and

Objectives

Part 1 - Literature Review

Conclusions from

research related to audit quality

Part 2 – Field Work

Evidence identifying antecedents of audit quality within Maltese

context Part 3 - Evaluation

4 – Discussion Findings and

evaluation

5 – Conclusions

Recommendations

Source: Henley, 2004. Study Guide for Undertaking a Research Project, Henley Management College.



Source: Directive 4 of Accountancy Profession Act, 2006

• establish the quality assurance system;

• supervise (planning and control) the quality assurance system;

• evaluate the review results; and

• approve the public reporting of overall results of the running of the

quality assurance system including the results of inspections.

1.5 Organisational Analysis

In Malta, the Accountancy Board owes its origin to the late seventies when the

Accountancy Profession Act [CAP 281] was first enacted. Being an independent

body under the Ministry of Finance, the Board issues Directives to align local

audit firms with best practices, and with EU statutory requirements3. In fact, some

of these EU requirements, have already been implemented by means of the

Directives4 which have been issued by the Accountancy Board as follows:-

• Directive 1, Continued Professional Education;

• Directive 2, Code of Ethics;

• Directive 3, Annual Return; and

• Directive 4, Audit Quality.

The latter Directive introduced during 2006 sets up the Quality Assurance

Oversight Committee [QAOC], as a committee of the Board. The remit of QAOC is

illustrated in Exhibit-2.

Exhibit 2, QAOC Objectives

The QAOC delegates its day-to-day running to a new organisational set-up –

Quality Assurance Unit [QAU]. The work of the QAU is focused to ensure quality

assurance on all audit firms and sole practitioners, by carrying out on-site visits

and writing reports to the QAOC recommending necessary action. The QAOC is

responsible for monitoring practitioners thereby fulfilling their ‘regulator role’ in the

profession.

3 Malta has become a Member State of the European Union in June 2004.

4 Appendix A, pp.83 details a summary of the salient issues of Directives 1,2,3 and 4 of the APA, Cap 281



Source: Author, 2006. Compiled from various sources.

On the other hand, the ‘educator role’ is carried out by an independent

professional institute - the Malta Institute of Accountants [MIA]. It is the remit of

the MIA to provide any technical assistance and support to practitioners to align

their present methodologies with best practices. Exhibit-3 illustrates the interplay

of relationship between these key players.

Exhibit 3, Maltese Organisational Set-up in ensuring Audit Quality

MINISTRY OF FINANCE

Accountancy Board (AB)

Quality Assurance Oversight Committee (QAOC)

Quality Assurance Unit (QAU)

REGULATOR

Performs on-site visits on audit firms.

Audit Firms & Practitioners in public practice

Audit firm solicits support from the MIA.

Malta Institute of Accountants (MIA)

EDUCATOR

C h a p t e r 2

LITERATURE REVIEW

Audit quality can be viewed in its broadest sense as encompassing all those activities that are carried out to assure that audit services meet or exceed expectations of quality. These audit quality activities are cross cutting in any business organization. They are concerned with the inputs, processes and outcomes of the business system, and they must involve, to some extent, every department and every individual auditor.

Lemont et al. 1987



2 PART ONE - LITERATURE REVIEW

This review begins with a brief explanation of the origins of ‘audit quality’

research. This is followed by a detailed analysis of audit quality from the

perspectives of the technical and behavioural schools of thought. Reference is

also made to the present legalistic turmoil and the adaptation of recently

introduced professional auditing standards both of which are impacting the

development of this term into unexplored dimensions.

2.1 Defining Audit Quality

Though there is no one single definition of audit quality, DeAngelo, L. E. [1981]

provides a definition that is cited in much of the subsequent audit quality

literature. She defines audit quality as:

‘the market assessed joint probability that a given auditor will both (a) discover a breach in the client’s accounting system, and (b) report the breach.’

DeAngelo’s seminal work considers quality of an audit to be dependent on two

factors. First, audit quality relates to the auditor’s ability to examine the accounts

and identify errors or anomalies - i.e. their technical competence. Secondly, audit

quality depends on the auditor’s objectivity - i.e. their independence. This

classical dual definition is necessarily a subjective one as it does not fully capture

the potentially conflicting roles of the various audit market participants [Mansi et

al., 2004]. The latter participants (or stakeholders) can be grouped into three

categories: first; external statement users; second, audit clients and third,

auditors [Sutton, 1993]. Consequently various researchers explored other

elements that constitute audit quality such as:

• the probability that an auditor will not issue an unqualified report for

statements containing material errors [e.g., Lee et al., 1999];

• auditors with low litigation services represents high quality suppliers [e.g.,

ZV. Palmrose, 1997]; and

• a measure of the audit's ability to reduce noise and bias and improve

fineness in accounting data [e.g., Wallace, 1980].



2.2 Evolution of Audit Quality

Whilst way back in the 1980s and 1990s academics and researchers were

sending alerts to the business community, provoking the immediate

professional’s attention to the importance of audit quality, it was not until recent

corporate scandals that the profession actually realised the importance of this

term. In fact, following the exodus of these scandals - that were somewhat

grossly amplified by international media, both the United States [US] and the

European Union [EU] developed their own models to thwart industry corruption

and boost their overall business credibility as a country. So in 2002 [for the US]

and in 2005 [for the EU], the business environment of the profession entered a

relatively new area - the period of intensified government enforcement and

regulations.

Thus it is the intention of the author to critically analyse the different literature

sources and practical implications in this turbulent environment, whereby various

Governments are designing their regulatory measures, audit firms are rethinking

their methodologies and the business community is still somewhat confused on

what the fuss is really about.

Exhibit-4 [pp.10] illustrates the major approaches to audit quality that will be

discussed in this literature review. It is believed that the analogy of the Greek

‘Parthenon Temple’ offers valuable insights in this review.

Firstly, audit quality definition is based on five pillars being (i) technical; (ii)

behavioural; (iii) legalistic; (iv)oversight bodies; and (v) professional standards

perspectives. If one ignores any one of these ‘pillars’, the exploration of audit

quality dimensions cannot hold for long and it will eventually collapse.

Secondly, if the builder builds these pillars with unequal height, the temple will

look really crooked and it will not succeed the test of time. It is thus considered

that each of these dimensions carry equal importance.

Finally, though these Greek pillars look the same, they are still different from

each other. In fact, each pillar can stand on its own right. However one cannot

call a pillar – the ‘Parthenon Temple’. It is when the whole construction is

collectively unified when the temple can actually be formed.




Exhibit 4, Five Major Approaches to Audit Quality

2.3 Pillar I - Technical Approach to audit quality

Throughout the past decades, there were various academics and researchers

who focused on the technical dimension of audit quality. Perhaps the most

notable work relates to the relationships found to exist between audit quality and

fees determination [DeAngelo, 1981], brand name auditors [Francis et al.1988] and

stakeholders’ expectations [Davidson et al. 1993].

2.3.1 Audit Quality and Fees Reliance

DeAngelo [1981] provides an economic argument linking higher audit quality to

larger audit firm size. She argues that initial start-up costs are so significant for

incumbent auditors that these eventually quit the market. This is because the

environment of an audit firm is so taxing on its resources that these specific

quasi-rents are subject to loss if it is discovered that the auditor has provided

lower than expected monitoring strength. This serves to deter the auditor from

behaving opportunistically, whilst provides protection to existing audit firms.

AUDIT QUALITY

Technical Approach

Behavioural Approach

Legalistic Perspective

Oversight Bodies View

Prof. Stand. Perspective

ACADEMIC RESEARCH PRACTICAL FIELD



Empirical research carried out by Krishnan G. [2003] have also established that

as larger audit firms have a wider spectrum and volume of clientele, these are

less likely to rely on a particular business for his/her major source of income –

hence questioning the independence of an auditor. All of this leads to the

conclusion that the bigger the audit firm, the more assurance there is in providing

higher audit quality services – a view also supported by empirical work carried

out by Watkins A. in 2004. The only way that remains for the small practitioner is

to fight back in this oligopolistic market is through a reduction in audit fee charged

– often referred to as ‘low balling’ [Wallace, 1980].

Low-balling refers to pricing initial audits significantly below cost to tap in a new

customer. Such a practice could lead to time and budget pressures as well as

making it more difficult for auditors to refuse accounting concessions because of

the threat of termination. This could impair auditor independence and contribute

to lower quality audits [Lee and Gu, 1998]. Although studies presenting theoretical

arguments and analytical models have provided support for the existence of low-

balling, these studies have also demonstrated that such practices do not

necessarily reduce auditor independence, nor do they lower audit quality [Zang,

1999]. Empirical evidence relating to the affects of low-balling on auditor

independence is thus nonexistent. This, coupled with the various theoretical

arguments for its existence, makes it difficult to assess the implications of low-

balling on audit quality [Stice, 1991].

2.3.2 Audit Quality and Agency Conflicts

Francis, J. R. and E. R. Wilson [1988] examined the association between various

agency conflicts and audit quality using both levels and changes in specific

agency conflict proxies. Francis and Wilson proposed that clients with higher

agency conflict are more likely to switch to brand name auditors in order to

reduce uncertainty relating to company value, and thus, increase management

compensation. They have found out two proxies for audit quality being: (1) a

categorical variable, brand name (Big Audit firms/non-Big Audit firms) and, (2) a

continuous size variable, total client sales audited by the audit firm. Two

representations of agency cost were also included in this study being: (1) the

changes in agency proxies over a three-year period preceding the auditor switch

and (2) the levels of agency cost proxies in the year prior to the auditor switch.



These authors posit that auditors should not undertake any work other than audit

for their audit clients as this hefty impairs on their independence. However, this

work fails to highlight the key determinants of such independence infringements

[Ahmed and Hopson, 1990].

Relating Francis et al. findings to the Maltese scenario, it is customary that the

book-keeping processing and the actual performance of an audit are done by one

and the same firm. This may have a direct bearing on the auditor’s ethical values

to express an independent opinion on the financial statements. Yet, audit firms

argue that they have put safeguards to ensure that auditing and accounting work

is done through separate departments - what is often referred to as the ‘Chinese

walls’ concept. However though this set-up was acceptable during the late 1980s,

the new regulatory regime restricts this ‘safeguard’ to the extent that one cannot

accept such client engagements. For instance in Ireland, Section 74 of Company

Law Enforcement Act [2001] puts the onus on the auditor to report any business

entity that has not kept adequate book of accounts to the Registrar of

Companies. If this regulation is enforced in Malta, the auditor may find himself in

a bizarre situation of the need to report himself to our authorities – clearly a

‘conflicts of interest’ case.

2.3.3 Audit Quality and its relation to Brand Name Auditors

Davidson, R. A. and D. Neu. [1993] tested the relation between auditor reputation,

auditor monitoring strength, and a measure of information quality. Davidson and

Neu posit that managers have an incentive to minimize the difference between

forecasted income and reported income and will utilize accruals and other

discretionary accounting practices to manipulate reported income to minimize

that difference. However, managers will be less able to manipulate earnings to

achieve forecasted earnings when they hire brand name auditors as against

other smaller firms. Davidson and Neu caution that while this suggests that larger

auditors may do a better job of minimizing earnings management, it is also

possible that the same factors that drive clients not to engage in earnings

management also drive those clients to seek brand name auditors. These

authors argue that larger auditors have more reputation collateral at risk and are,

therefore, less likely to behave opportunistically. In fact the reputation of a big

audit firm is so significant that if this is shattered, the entire clientele collapse.



This research indicates that in the eyes of a client, audit quality tends to vary with

auditor’s reputation and brand. However it fails in identifying the extent of such

positive correlation and in asserting that high brand name auditors equates

higher quality [Myers et al, 2003].

From the 1990s, to date, we have witnessed the downfall of one of the big audit

firm giants – Arthur Anderson, thereby emphasising the importance of Davidson

and Neu’s emphasis on reputation and the implications it has on the firm as a

whole. On the other hand, in Malta small practitioners and middle-sized firms still

blossom and carry out a substantial proportion of audit work. What still needs to

be attested is whether the quality of a small practitioner is of equal standard to

that of a middle-sized or big audit firm. Perhaps whilst one reckons that due to

economies of scale, larger audit firms perform better quality audits from the

technical point of view, small practitioners are more in proximity with their

clientele. But being in close proximity with constituency is often viewed as a

threat to independence in the auditing business environment [Davis, 2002]. This

shed concern on the debate as to whether the auditor should occupy a term of

office for a fixed duration period of time indicated by law – i.e. auditor rotation

[Husey and Lan, 2001]. The latter concept was well accepted within the European

Union authorities, though the Fédération des Experts Comptables Européens5

exerted pressure to withhold such initiative to safeguard the interests of its

members.

5 Fédération des Experts Comptables Européens is the representative organisation for the accountancy profession in

Europe. FEE's membership consists of 44 professional institutes of accountants from 32 countries. FEE member

bodies are present in all 25 member states of the European Union and three member countries of EFTA. FEE

member bodies represent more than 500,000 accountants in Europe.



2.4 Pillar II - Behavioral Approach to Audit Quality

Despite the academic focus on technical aspects of audit quality, other empirical

research focused on the humane side of the audit engagement – what the author

classifies as ‘behavioural approach’. In fact, academics particularly in the US,

have encouraged auditing firms to cultivate a marketing culture [Ahmed & Hopson

1990], to consider developing a marketing positioning strategy [Ellis & Mosher,

1995], and to extend their portfolio of services [Diamantopouos, O’Donahue, &

Petersen, 1995]. Exhibit-5 summarises the most notable results and

methodologies adopted of such researches as from 1990’s to date.

Exhibit 5, Results of Behavioural Audit Quality Research

Authors Research Method Results Sutton (1993)

Nominal Group technique on experienced auditors to develop and validate a set of audit quality factors and measures

Identified 19 quality factors which could be categorised into three groups: planning, fieldwork and administration.

Behn et al. (1997)

Survey of controllers in the US to evaluate existing auditor using 12-item questionnaire to identify determinants of audit client satisfaction.

Responsiveness to client needs, executive involvement, effective and ongoing interaction with audit committee, industry expertise and prior experience of client all positively associated with client satisfaction.

Waming – Rasmussen and Jensen (2001)

Survey of shareholders, financial journalists, auditors and managing directors’ perceptions of a quality.

External users tend to perceive audit quality attributes as attributes that inspire confidence in the auditor: six main quality dimensions identified; four groups rate quality dimensions differently.

Angus Duff (2006)

UK Survey of auditors, auditees and stakeholders’ perceptions of a quality through the use of the Servqual instrument developed by Zeithaml, et al.

Identified 8 audit gaps and the antecedents of audit quality: nine main quality dimensions identified; three groups rate quality dimensions rather homogeneously.

This section gives an oversight of these studies and concludes by attesting their

applicability to the Maltese scenario.

Source: Adopted from A. Duff, 2006



2.4.1 Audit Quality and Client Satisfaction

In 1997, Behn et al. carried out a research exercise to determine the relationship

between audit quality and client satisfaction. Previous marketing literature

revealed that though these are related, such attributes exhibit unique

characteristics [Cronin & Taylor, 1994]. Working on 12 audit quality attributes found

by Carcello et al. [1992], Behn identified that six of these had a positive

relationship with client satisfaction and with the audit team being:- (i)

responsiveness to client needs; (ii) effective interaction with the audit committee;

(iii) audit firm executives actively involved in the audit, (iv) appropriate conduct of

audit-fieldwork, (v) industry expertise and (vi) team and firm experience with

client. The only audit quality variable that was negatively associated with client

satisfaction was –‘the audit team members maintained a skeptical attitude

throughout the audit engagement’. Perhaps this finding relates to the fact that the

auditor needs to balance out the need of satisfying his customer whilst at the

same time has a legal obligation towards stakeholders’ expectations. Behn et al.

also suggest that there exists some evidence that client satisfaction is higher

during the first few years after a change in auditors. However, though this

research assists in determining the key attributes of audit quality, it focuses only

on the relationship between client satisfaction and the audit team, ignoring other

behavioural dimensions of audit quality [Krishnan, 2003].

2.4.2 Audit Quality and Stakeholders’ Perception

Warming-Rasmussen and Jensen [2001] studied the stakeholders’ perception of

audit quality, with the intention of developing an audit quality scale. Warming-

Rasmussen and Jensen found out that there are 6 major quality dimensions,

focusing largely on moral and ethical issues, which they labeled as: (i) personal

credibility; (ii) auditor’s independence of company management; (iii) openness in

the report ; (iv) knowledge of the industry; (v) loyalty about minority shareholders;

(vi) auditors skeptical attitude to the auditee. These audit quality dimensions tend

to be ranked higher by stakeholders than auditors. Notwithstanding the moral and

ethical focus of this research, Warming-Rasmussen concluded that the

effectiveness of maintaining good relationships with clients is quite often

overlooked by auditors.



2.4.3 Audit Quality and Service Quality – AuditQual

The Servqual questionnaire [Zeithaml, Parasuraman and Berry, 1990] is one of the

preeminent instruments for measuring the quality of services as perceived by the

customer. This questionnaire was adopted by Duff A, [2006] to study the gaps

between auditors’, clients’ and stakeholders’ expectations. The author identified

that the perceptions across the three sampled groups of auditors, auditees and

external users were relatively homogenous, though accounting firm partners

tended to rate technical aspects of audit quality higher than the other two.

Nonetheless, it is worthwhile noting that reputation and credibility received the

highest rating from the three samples. The researcher identified eight gaps

(through Servqual) that could be duly filled in through nine distinct dimensions.

These dimensions relate to both technical quality and service quality, and are

illustrated in Exhibit-6.

Exhibit 6, The AuditQual Model

This study also suggests that audit quality is very much dependent on the audit

firms’ ability to attract, train and develop staff of highest caliber with both

technical and interpersonal quality to provide the best possible service to clients.

However notwithstanding its recent issue, Auditqual may be criticised on the

same basis of Servqual, due to the problems associated with using different

scores. This negatively impinges on the reliability, discriminant validity,

convergent validity and predictive validity of the measure [Van Dyke et al, 1999].

Reputation

Capability

Expertise

Experience

Empathy

Client Service

Status

Independence

Knowledge

Responsiveness

Non-Audit Services

Understanding

TECHNICAL QUALITY

SERVICE QUALITY

Source: Angus Duff, 2006.



2.4.4 Behavioural Theories and its implications in Malta

There has been limited (if any) research on the attributes of audit quality within the

Maltese environment. The communal perception is that the auditing profession is

obligatory by law and very limited value added is delivered to constituency. The

latter exhibit very limited interest in the profession, whilst authorities seem to be

quite hesitant to promote their initiatives. It is thus suggested that few accounting

firms have sufficient understanding of themselves or their clients, to improve the

quality of service they provide to those clients [Ellis et al, 1995].

Furthermore, it is believed that an audit firm is not so market-oriented and instead

it tends to focus more on technical issues rather than positioning strategy [Dopuch

et al, 1982]. Perhaps keeping a low-profile and doing the work ad verbatim, is still

rendering results in Malta. However the gashing winds of change from the

legislative side and international business community, are putting into question

the sustainability of such rudimentary audit firm strategies. These may be

considered to be ill-equipped to meet the taxing requirements of the new

regulatory regime, let alone compete in a constrained market.

2.5 Pillar III - Regulatory Regime Perspective

Way back in the eighties, Simunic et al. identified that as auditing has a direct

bearing on public interest obligations, it should be viewed as an essential part of

the regulatory infrastructure of the economy. It is thus deemed appropriate to

solicit the regulatory regime perspective as such legislation is shaping out the

manner of audit conduct in the real world [Krishnan, G. V. 2003].

Though currently various European countries have their own legislative

frameworks, the enforcement of Directive 2006/43 of The European Parliament

and of the Council on Statutory Audits of Annual Accounts and Consolidated

Accounts issued on 17 May 2006, obligates Member States to harmonise their

legislative frameworks by not later than 29th June 2008. This revamped legislation

sets out various requirements including:-



• The setting up of an online public register detailing the details of

auditors/audit firms (Chapter III);

• The obligation of auditors to observe the fundamental principles of

professional ethics, independence, objectivity, confidentiality and

professional secrecy (Chapter IV);

• Obligation to comply with International Standards on Auditing (ISA)

(Chapter V);

• Obligation that each Member State should have institutions responsible

for the national public oversight system on the audit profession (Chapter

VI);

• Co-operation between Public oversight bodies and regulatory

arrangements between Member States (Chapter VIII); and

• Obligation for auditor to issue ‘transparency report’ for public interest

entities (Chapter X).

All of the above indicate the measures adopted by the EU to ensure sustainable

audit quality within the Community level. However, no one single Member State

has fully adopted all the provisions of this Directive yet. Though perhaps at the

forefront, one will find the United Kingdom and Germany, other Member States

need to literally revamp their legislative framework (eg. Slovenia, and Lithuania).

Turning our focus to the Maltese scenario, the framework regulating the auditing

profession is governed by the Accountancy Profession Act, [Chapter 281];

Accountancy Profession Regulations [Chapter 281.1]; Companies Act, [Chapter

386] and Directives issued by the Accountancy Board. The latter include

regulations for Continued Professional Education (Directive 1), the formulation of a

Code of Ethics for accountants and auditors (Directive 2), formulation of annual

return (Directive 3) and the setting up a system of Quality Assurance (Directive 4).

One can out rightly say that various mandatory Articles defined by European

counterparts are included in Maltese Law. In fact, the fundamental articles like

the setting up of a quality assurance system, that an audit needs to be carried out

in accordance with ISA and that there is a set of rigorous academic and practical

training to attain an auditors warrant are all duly integrated in the Maltese

legislative framework. However more work still needs to be done with respect to

other key areas like cooperation and exchange of information with other EU

countries and transparency reports.



However it is interesting to note that Section 9 of Directive 4 of the Accountancy

Profession Act attempts to hint to a definition of what constitutes audit quality in

the Maltese Context:

‘The Quality Assurance Process is intended to be a means through which the Board provides assurance as to the quality of the professional work of warrant holders in public practice and firms and on the maintenance of appropriate levels of professional standards thereby.’

However, the Directive fails to explicitly indicate the parameters of ‘quality of

professional work’ and ‘appropriate levels of professional standards’.

Taking this definition to European Union level, the scope of quality assurance

reviews have been defined by EU Statutory Audit Directive under Article 29 (1) (f)

to include; (i) compliance with applicable auditing standards; (ii) independence

requirements; (iii) quantity and quality of resources spent; (iv) audit fees charged;

and (iv) internal quality control system of the audit firm. Perhaps this is the first

ever definition that identifies the antecedents of audit quality dimension clearly

entrenched in law.

To conclude, having the necessary legislation in place does not automatically

mean that there is actual enforcement. Thus one may ask: what implementation

measures are being adopted by various countries to ensure audit quality?

2.6 Pillar IV - Quality Assurance Authorities Perspectives

An effective public oversight authority over the audit profession is a vital element

in the maintenance and enhancement of confidence in the audit function. The

current lack of confidence in some countries is partly based on a public

perception that a self-regulating profession runs a serious risk of conflicts of

interests in dealing with its shortcomings [Zang P, 1999]. It is thus worth noting,

the practical experience of authorities who already performed several quality

assurance review visits on practitioners and identify possible antecedents of audit

quality from their practical work. The experience of the United States [US] and

United Kingdom [UK] are discussed together with the Maltese model.

Source: Section 9 of Directive 4 of the APA, Cap281 (2006)



2.6.1 US experience - PCAOB

In the US, the designated public oversight authority is the Public Company

Accounting Oversight Board [PCAOB]. The PCAOB suggests that an effective

audit quality control system should need to have appropriate policies and

procedures to ensure sustainable audit quality. Exhibit-7 illustrates the key

antecedents of audit quality which relates to firm culture, governance,

compensation and rewards, quality control risk assessment, and monitoring

mechanisms.

Exhibit 7, Illustrative Quality Control System adopted by PCAOB

It is also the policy of the PCAOB to publicly disclose all the audit firms in default

(to ensure transparency) and to offer accreditation to those who demonstrate

audit quality in their procedures.

Source: http://www.pcaobus.org/inspections/



2.6.2 UK experience - POBA

A similar arrangement was set-up in the UK, appointing the Professional

Oversight Board [POBA] as the oversight body on the profession. The POBA

place prominence in its procedures by challenging partners’ judgments as well as

critically evaluating audit processes and internal controls adopted by these firms.

In doing so, POBA has developed and implemented an approach to audit

monitoring based on the following characteristics:-

• Wide-ranging reviews of firm wide procedures, including an assessment

of how the culture within firms impacts on audit quality;

• In-depth reviews of major audits, focusing on the quality of the group

audit, including critical assessment of the key audit judgments made and

a detailed review of compliance with UK Auditing Standards; and

• Review of the quality of reporting to the Audit Committee.

It is worth noting, that whilst in the US more emphasis is placed on transparency

and public accountability, the UK’s approach is focused on examining how culture

within audit firms impacts audit quality.

2.6.3 Maltese experience - QAOC

In Malta, the Quality Assurance Oversight Committee [QAOC] within the

Accountancy Board, and its duly appointed agents – the Quality Assurance Unit

[QAU] are the designated authorities responsible for ensuring audit quality.

Notwithstanding, the embryonic phase of the quality assurance system, the

implicit objectives relates:

• To evaluate whether warrant holders engaged in public practice have

established appropriate quality control policies and procedures and that

they are complying with those policies;


complied with relevant professional standards;

• To require warrant holders in public practice to make appropriate

improvements in their quality control policies and procedures; and

• To take appropriate corrective action, including educational or disciplinary

measures, as may be indicated by the circumstances.



It is anticipated that after the first cycle of reviews are conducted, standards will

increase and the business community is deemed to benefit from such reviews. It

is expected that the first reviews will be carried out in the second quarter of 2007.

Presently work is carried out in the preparation of these visits and it is applauded

to note that practitioners are being informed of proceedings to ensure

transparency. On the other hand, one may attest whether such communications

may also be presented to the Maltese business community to make them more

aware of this newly established set-up and their working methodologies. This

complies with the recommendations proposed by Diamantopouos, et al. in 1995

that to be successful auditors need to be more available to all key stakeholders.

2.7 Pillar V - Auditing Standards Perspective

The practitioner literature often defines audit quality relative to the degree to

which the audit conforms to applicable auditing standards [Cook, 1987]. The

leading international standard being also adopted by the EU is the International

Standards on Auditing [ISA]. Nonetheless, given the prominence of audit quality

issues on an international level, a new standard ISQC 1 - International Standard

on Quality Control, came into effect during 2006 establishing five critical

antecedents of audit quality relating to (i) leadership; (ii) human resources; (iii)

ethical policies; (iv) engagement performance and (v) monitoring [Vide Exhibit-8,

pp.23]. It is believed that by complying with this standard, audit firms attain

sufficient audit quality in their methodologies.



Source: http://www.ifac.org/IAASB/

Exhibit 8, ISQC 1 Requirements

2.8 Conclusion – The ‘Audit Quality Wheel Model’

Audit quality research has been prolific over the past two decades [Myers, 2003].

Although these authors and the practical field have created constructs which may

have elements in common, they have been used with little reference to one

another. In sum, the concept of audit quality is not exactly clear in terms of its

definitions, scope and operationalisation [Watkins A., 2004]. The lack of clear

constructs and specific operationalisations complicates interpretations and the

ability to replicate findings [Sekeran U, 2000]. This suggests that there is still much

to learn about relations between the various attributes of audit quality.




However, to summarise literature review and the broad number of issues of

importance and dimensions of audit quality derived, the main areas have been

structured in a model as shown in Exhibit-9. The model does not claim to provide

full justice to all issues on audit quality but offers an indication of the central

themes and a practical context of assessing the results of the field work

presented in the later sections.

Exhibit 9, The Audit Quality Wheel Model



The audit quality wheel model builds on six (6) fundamental spokes resulting from

technical, behavioural, regulatory, oversight bodies and auditing standards

perspectives. These fundamental elements are:-

(i) audit firm culture;

(ii) partner involvement;

(iii) audit team involvement;

(iv) quality on the field;

(v) stakeholders’ interest; and

(vi) customers’ satisfaction.

Furthermore, the author referred to the distinction used by Kotler’s [2002]

between core and augmented attributes. Issues related to audit independence,

competence, integrity and quality and openness of audit report are considered to

be core dimensions of audit quality. On the other hand, the augmented audit

quality contains elements that goes beyond these basic elements and possibly

enhance the audit quality of the firm through recruiting highest caliber of staff,

issues of empowerment, brand name, reputation and transparency of internal

communication process, amongst others. Based on the literature findings, to

become a sustainable audit quality audit firm, the conditions within the core audit

quality should expectedly be fulfilled before working on the augmented part of

audit quality. The rest of the dissertation will attempt to prove the extent of

applicability of this model to the Maltese situation and a discussion of the

findings.


C h a p t e r 3

PART TWO – RESEARCH METHODOLOGY

In general, most of the previous studies undertake research into audit quality from the standpoint of technical and behavioural schools of thought. However there are only a few studies that investigate the perspectives of the stakeholders, who are in the closest contact with the external auditors in the firm, on the issue of audit quality. This study investigates the views of audit firms and companies (audit committees) about what constitutes audit quality and its implications on sustainable competitive advantage.

Author, 2006

Henley Management College Part TWO, Research Methodology


3 PART TWO – RESEARCH METHODOLOGY

From the preceding discussion, this study concluded that there are limited studies

undertaken on the perceptions of audit partners and audit committee on the

factors that may influence the quality of an audit. This section examines ‘…the

procedural framework within which the research is conducted’ [Remenyi et al,

1998] by examining the perception of these stakeholders on audit quality issues in

Malta.

3.1 Research Theme

The objectives of the research are to challenge three initial hypotheses.

1st hypothesis - the dimensions of audit quality are not something static or

universal. Instead it is a multi-dimension construct that evolves due to

continual changes in the environmental influences effecting the profession.

2nd hypothesis - the dimensions of audit quality, are not fully recognized within

the local auditing profession.

3rd hypothesis - audit firms who manage audit quality, ensure long term

sustainable competitive advantage.

3.2 Area of focus

This study is undertaken to examine the potential factors that influence audit

quality from the perception of partners of audit firms (providers) and audit

committees of companies quoted on Malta Stock Exchange (audit clients). This

study investigates how much the audit partners’ perception significantly differs in

relation to audit committees whilst attesting their overall perception of the relevant

dimensions to the Maltese environment. Carcello et al. [1992] stated that:

‘in an increasingly competitive environment, it seems important to understand the perceptions of both users and preparers as they relate to audit quality. Any differences may allow for audit firms to deliver more satisfaction to both groups and simultaneously improve their own audit quality.’



3.3 Choice of Research Instrument

This research work includes the entire views of all accessible partners audit

committees through the use of a questionnaire for both subjects of study. This is

because the quest to identify key issues of audit quality perception is expected to

result from tentative answers to answer questions like ‘How many?’ or ‘How

much?’. The latter is the central premise of positivists research separating it from

the non-positivists research focusing on questions such as ‘what?’ ‘why?’ and

‘how?’ [Remenyi et al., 1998].

The questionnaire was intended to be submitted electronically to all audit firm

partners and audit committees. However from feedback gathered during the pilot

testing stage, it was considered difficult to reach a sufficient high number of

members of audit committees of companies quoted on MSE to provide valid data.

This is because much of the audit committees come into existence as from 2005

following the enactment of European Commission Recommendation of

15 February 2005 on the role of non-executive or supervisory directors of listed

companies and on the committees of the (supervisory) board1. Furthermore,

following comments received, the majority of these members do not hold their

office for more than an established period of time (usually one year), and thus

there exist a substantial level of turnover in this group.

To this effect, it was finally decided that for audit firms, a positivists quantitative

research be adopted so as to generalize the overall perceptions of the audit

partners in Malta. On the other hand, this approach was rejected for audit

committees, and instead an interview-based qualitative approach with the

chairperson of the committee was made. For comparison purposes, the same

questionnaire was used as an interview guide with the latter group.

3.4 Designing the Research Questionnaire

The same set of questions was developed for the purpose of this study for both

audit partners and audit committees. Initial versions of the questionnaire were

sent electronically to five (5) audit partners and to two (2) members of audit

committees. Following comments received, some minor adjustments were made

to the questionnaire. The final version of the questionnaire can be viewed in

1 EU Official Journal L 52, 25.2.2005, p. 51.




Appendix B [pp.85]. This questionnaire contains three (3) sections as follows:-

Section A: obtains basic information about respondents such as number

of employees, years in operation and type of organisation. This section

assist in segregating the information detailed in later sections in

accordance to size and experience in the industry.

Section B: details a series of statements based on the audit quality

attributes as identified in Chapter 2, Literature Review. Respondents were

asked to provide their assessment using a four (4) point Likert Scale

ranging from ‘no impact on audit quality’ to ‘extreme impact on audit

quality’. This scale was used throughout the reminder of this part. At the

end of each part, respondents were requested to rank two of these ten

statements which in their opinion are critical for audit quality, whilst also

giving them the opportunity to include any other attribute which in their

opinion could be included as a determinant of audit quality. The main

areas are shown in the Exhibit 10 together with corresponding literature

sources.

Exhibit 10, Contents in main body of the questionnaire

Areas represented in questionnaire Selected related literature sources 1. Audit Firm Culture Beattie & Fearnely (1995), DeAngelo (1981), ISQC 1,

Carcello et al (1992), A.Duff (2006), Davidson, R. A. and D. Neu. (1993), Francis, J.R. et al, (1988) and Simumic (1984).

2. Partner Involvement Parasuraman et al (1991), DeAngelo, (1981), ISQC 1, Carcello et al, (1992), A. Duff (2006), Lee and Gu, (1998) and Beattie, Farnley & Brant, (2001)

3.Audit Team Involvement Beattie & Feanrley, (1995), Francis, J.R. et al, (1988) and ISQC 1

4.Quality on the Field Behn et al (1997), Parasuraman et al (1991), Duff A (2006), Cook (1987), ISQC 1, Dopuch and Simunic, (1982) and Carcello et al (1992)

5.Stakeholders’ Involvement Beattie & Fearnely (1995), Warming et al (2001), E. Woolf (2005), Warming-Rasmussen et al (2001), Watkins et al (2004), A. Duff (2006) and PCAOB, US

6.Managing Customer Relationships Beattie & Fearnely (1995), ISQC 1, Carcello et al, (1992), Davidson, R. A. and D. Neu. (1993), A. Duff, (2006) and Parasuraman et al, (1991)



Section C: requests respondents to put forward their views about audit

quality and attest their knowledge in this respect. Respondents were

given the opportunity to comment on present hot issues within the

profession impinging on audit quality. The questionnaire concludes by

providing freeform comments.

Structuring the questionnaire in sections based on literature findings simplified

categorisation of information to be used in seeking patterns and themes relevant

to test hypothesis.

3.4.1 Addressing Questionnaire Risks

In designing the questionnaire great care was given to avoid a number of

potential pitfalls usually associated with the administration of a questionnaire.

Such pitfalls include interviewer bias, respondent bias, rigid bias sample bias and

race bias [Henley, 2004]. The latter is not seen as a potential risk in this research.

Exhibit-11 details the necessary safeguards implemented to address these

potential risk factors.

Exhibit 11, Addressing Potential Questionnaire Pitfalls

Type of Bias Potential Risk Safeguards Interviewer Questionnaire include

leading questions Formulating all questions on theory and inspired by international surveys on audit quality

Respondent Questionnaire not

answered or answered from wishful thinking rather than facts

Using closed ended questions through the use of the Likert Scale

Rigid Narrow scope to

provide justice to research

Providing respondents with an opportunity to mark the possible importance of other issues , not defined in the questionnaire

Sample Whether choice of

respondents is appropriate

By targeting the whole audit firms in Malta and companies quoted on MSE in addition to randomly distributing the questionnaire to qualified auditors and other companies.

Source: Adopted from Henley, 2004. Study Guide for Undertaking a Research Project, Henley Management College.



3.5 Target Audience and Response Rate

The questionnaire was electronically distributed to all the audit partners in Malta.

Furthermore, all chairpersons were primarily contacted by phone and a meeting

was arranged to set an appointment in their offices. Exhibit-12 illustrates the

names of the thirty-two (32) audit firms and the list of the twenty-seven (27)

companies quoted on Malta Stock Exchange (MSE), acting as the basis of the

entire population for this research.

Exhibit 12, Population of Audit Firms and MSE Companies

Population of (32)Audit Firms in Malta Abdilla Fenech & Co Alliot Malta Attard Giglio & Co. RSM Malta Baker Tilly Sant BDO Attard, Buttigieg, Psaila & Co. Bryant, Mayl & Co Busuttil & Micallef Carm A Fenech & Co Degiorgio Scerri & Co Deloitte & Touche DFK (Malta) Farrugia, Farrugia & Co DG & Associates Ernst & Young Gatt, Galea & Co MGI Malta Grant Thornton Griffiths & Associates HLB Falzon & Falzon Horwath (Malta) KPMG MSI Craig Sammut & Co Marmara Camilleri & Co PricewaterhouseCoopers R S Attard & Co -Moore Stephens Malta Richard J Attard & Co Robert Cassar & Co Schranz & Co Spiteri Bailey & Co UHY Pace, Galea Musu & Co Vincent Curmi & Associates Victor Schranz & Associates

Population of (27)Companies Quoted on Stock Exchang e Bank of Valletta plc Bay Street Finance plc Big Bon Finance plc CareMalta Finance plc CC Car Parks plc Corinthia Finance plc Datatrak Holdings plc Dolmen Properties plc Eden Finance plc FIMBank plc Gasan Finance plc Global Financial Services Group plc Hotel San Antonio plc HSBC Bank Malta plc International Hotel Investments plc Lombard Bank Malta plc Malta Government Privatisation plc Malta International Airport plc Maltacom plc Mariner Finance plc Middlesea Insurance plc Mizzi Organisation plc Plaza Centres plc Simonds Farsons Cisk plc Suncrest Hotels plc Tumas Investments plc United Finance plc

Source: Adopted from Accountancy Board & Malta Stock Exchange Websites respectively



3.5.1 Audit Partners

The register of audit firms6 published in Malta Government Gazette during March

2006, lists down one-hundred and eight (108) audit firm partners within thirty-two

(32) registered audit firms licensed to practice in Malta. Out of these 108

partners, (5) five individuals indicated that they do not wish to participate due to

lack of management time, another two (2) said that the addressee had retired,

whilst another eleven (11) were not audit firm partners [lawyers or tax partners]

and refused to participate in this study. As a result, the number of accessible

audit partners for this study is ninety (90). Upon receipt of the e-mail, confirmation

was sought that the intended addressee was the actual person who filled in the

questionnaire.

The questionnaire was electronically distributed to all audit firms on 2nd October

2006 requesting their return by 13th October. Sixteen (16) responses had been

received by 13th October. A reminder e-mail was sent on 16th and a further 10

responses were received. In total, 26 completed questionnaires were received, a

response rate of more than 28%. Although the response rate may appear to be

relatively low, considering the questionnaire length and the somewhat unorthodox

nature of the subject, it provides sufficient sample size upon which conclusions

can be drawn and considered acceptable for an e-mail survey of this nature. In

fact, Green, Tull & Albaum, [1998] identified that such related studies usually

achieve a response rate of between 10% and 30%.

3.5.2 Audit Committee of Companies listed on MSE

Being the principal users of auditing information, during 2006, there were twenty-

seven (27) licensed companies quoted on the Malta Stock Exchange (MSE). The

author performed semi-structured interviews with ten (10) companies who were

willing to participate in this study. These respondents come from the banking

industry, manufacturing, hotel industry and other financial services. A short brief

was given in the letter inviting the interviewees to participate [vide Appendix C,

pp.96]. The interviews were conducted in Maltese and have been recorded with

the permission of the interviewees. Since comparison needed to be made

between the audit firm perception and that of the audit committee, the same

questionnaire was adopted to retain consistency whilst allowing more scope for 6 The register of audit firms and of all warrant holders holding a practicing certificate in auditing is published annually

by the Accountancy Board as required by the Accountancy Profession Act, CAP 281.



the respondent to express himself/herself at some length without loosing grip or

direction. This semi-structured interview took on average about one (1) hour and

was carried out in an open and honest dialogue. All interviews were carried out in

the participating companies, and the interviewed person was either the chairman

of the committee or another member appointed by the aforementioned

chairperson. It was recommended that if possible two individual members of the

committee participate to make this analysis as valid as possible and to minimize

individual feelings and opinions on specific statements. Furthermore, Kvale et al.

[1996] identified that the quality of an interview may be evaluated against the

extent to which spontaneous, rich, specific and relevant information is provided –

i.e. the shorter question and the longer the answer the better, and the extent to

which all relevant aspects are pursued and clarified. When evaluated against this

standard some variations appeared as many chairpersons were very enthusiastic

and communicative, while a few provided only the briefest of answers.

3.6 Limitations on research methodology

As the scope and aim of the dissertation in short is a limited study on what audit

firms and auditees consider as antecedents of audit quality, there are limitations

in the research wider validity. The research cannot be taken as representing a

general Maltese survey as it does not allow for a holistic assessment of audit

quality. In fact, the research only focuses on audit partners and audit committees’

view and can therefore not be said to be a full analysis of audit quality, which

should have included as assessment of other relevant present perceptions, like

sole practitioners and other companies. Furthermore, this study focused only on

the largest two segments ignoring other stakeholders involved like auditors

employed within the audit firms and finance managers employed by companies.

Additionally, as it is the first attempt on researching the quality antecedents within

the Maltese industry, the research is limited from conducting a longitudinal

analysis and thereby from capturing differences over time. Despite these

limitations, the findings of this study do provide a platform for future investigation

and diagnosis.


C h a p t e r 4

PART TWO – FIELDWORK RESULTS

There is a perception that audit committees, investors and financial institutions appear, or have appeared, to choose or demand Big 4 auditors for the largest listed companies. This could be for a number of reasons, for example: the ‘deep pockets’ issue; a lack of information about shareholders’ views, a perception that smaller audit firms produce lower quality caused by their not being present in the stock exchange; network issues; or merely being comfortable with well-known brands.

Fetham et al. ,1991

Henley Management College Part TWO, Fieldwork Results


4 PART TWO – FIELDWORK RESULTS

The content of the data analysis and the key findings from the fieldwork is

presented below. Subsection 4.1 relates to Section A of the questionnaire

providing information about the demographic data of respondents. Subsection 4.2

relates to Section B of the questionnaire extrapolating the six dimensions

identified in the attested ‘Audit Quality Wheel Model’, whilst Subsection 4.3

relates to Section C of the questionnaire provoking free-form comments.

4.1 Section A, Demographic Analysis

Analysis of demographic data reveals that from the 26 audit partners who

responded, 16 (62%) respondents were employed by the Big 4 audit firms, 6

(23%) respondents were employed in medium-sized firms (10 to 25 employees)

and another 4 (15%) respondents from smaller sized-firms (less than 10

employees). Meanwhile, 10 interviews representing 37% of the audit committee

listed on Malta Stock Exchange (MSE) were conducted by the author.

The analysis of the audit partners’ experience in the work reveals that 14 (53.8%)

have more than fifteen years experience, 8 (30.8%) have between five to fifteen

and only 4 (15.4%) have less than five in the current position. Exhibit-13 profiles

the work experience of audit partners by gender.

Exhibit 13, Work Experience of Audit Partners by gender

Work Experience Female Male Total Less than 5 years 1 3 4 (15.4%) From 5 to 15 years 2 6 8 (30.8%) More than 15 years 3 11 14 (53.8%) Total 6 20 26 (100%)

This is in stark contrast with the current work experience of the audit committees

all of which hold their office as a chairman for less than five years.



It is also worth noting the age groups of respondents for both groups. In both

cases a similarity was noted that much of the audit partners and members within

audit committees fall within the age of 40 to 49 years having 50% of audit

partners and 40% of audit committees. Exhibit-14 indicates the age group and

sexes of respondents in this study.

Exhibit 14, Demographics of Audit Partners and Chairpersons of Committees

Age Group Female Male Total Female Male Total Audit Partners Audit Committees 30 to 39 years 1 5 6 (23.1%) 2 0 2 (20%) 40 to 49 years 4 9 13 (50%) 0 4 4 (40%) 50 to 59 years 1 4 5 (19.2%) 0 2 2 (20%) Over 60 years 0 2 2 (7.7%) 0 2 2 (20%) Total 6 20 26 (100%) 2 8 10 (100%)

4.1.1.1 Summary on Section A

On an overall basis, most respondents came from the 40 to 49 years age-group

having more than fifteen years of experience practicing as auditors. Given the

embryonic phase of audit committees, chairpersons occupied their office for

about five years. There is also dominance of male participants in this

questionnaire amounting to more than 73% of all respondents.

4.2 Section B, Literature Review Analysis

An analysis was made on the combined responses of all the two groups of

respondents. Exhibit-15 [pp.37] illustrates the ten factors with the highest means,

which indicate a considerable degree of importance in influencing the audit

quality. Each of the ten highest rated factors had an overall mean score of at

least 2.83.



Exhibit 15, Ten most influential factors on audit quality

Overall Audit

Partner Audit

Committee Mean Mean Mean

Question Statement Statistic Rank Statistic Statistic

1.4 Audit firm employs a robust internal procedure compliant with the international standards requirements and regulatory framework regime.

3.00 1 3.00 3.00

2.5 Engagement partner has sufficient knowledge and understands what is happening within the client’s organisation.

3.00 1 3.00 3.00

3.1 Audit team members are independent from the client.

3.00 1 3.00 3.00

3.2 Audit team exercise discretion and professional judgment whilst performing the audit.

3.00 1 3.00 3.00

3.4 Audit team adopts high ethical standards when performing their work.

3.00 1 3.00 3.00

4.4 Audit team performs the audit in accordance with International Standards on Auditing and with appropriate and relevant legislations.

3.00 1 3.00 3.00

4.5 Audit team gathers sufficient and appropriate documented evidence supporting audit opinions.

3.00 1 3.00 3.00

1.5 Audit firm is knowledgeable about the clients’ industry. 2.94 2 2.92 3.00 4.8 Audit team files are reviewed by people with appropriate

experience who will encourage alertness, originality of thought and a thorough investigation of anomalies.

2.93 3 2.86 3.00

2.3 Engagement partner dedicates resources to align the audit firm’s strategy and internal communications with recent developments in the profession.

2.92 4 2.88 3.00

3.3 Audit team keeps abreast of recent developments in the profession.

2.91 5 2.93 2.89

1.6 Audit firm is able to attract, train and develop staff of highest calibre with appropriate skills and qualifications.

2.90 6 3.00 2.50

4.7 Audit team evaluates appropriate judgments made by their clients with rigour and professional scepticism.

2.89 7 2.83 3.00

4.9 Audit team on field works in accordance to the working practices embedded within the audit firm’s internal control procedure.

2.89 7 2.78 3.00

1.7 Audit firm consistently monitors its quality control policies to align with recent best practice in the audit profession.

2.89 7 2.86 3.00

3.9 Audit team is motivated both personally and by their working environment.

2.88 8 2.86 3.00

2.7 Engagement partner allocates more time and effort on those areas that have the highest risk.

2.87 9 2.75 3.00

1.2 Audit firm is independent of the board of directors. 2.83 10 2.80 2.88 2.10 Engagement partner allocates necessary resources for all

its clients, irrespective of the audit fee charged.

2.83 10 2.70 3.00



Seven statements were ranked as the prime contributories of audit quality

attaining the highest mean score of 3.00 each by both groups of respondents.

Out of these seven statements, three relate to audit team involvement, two relate

to quality on the field and the remaining two statements relate to audit firm culture

and partner involvement. This may indicate that the competency, knowledge and

experience of the audit team are more important for audit quality than other

issues.

It is also interesting to note that statements related to stakeholders’ involvement

and managing customers’ relationship did not gain the highest means. Instead

much of these statements are those that are perceived by both group of

respondents as the least factors that may influence audit quality. Exhibit-16

[pp.39] shows the ten factors with the lowest means, hence factors that are

perceived to least influence audit quality.



Exhibit 16, Ten Least influential factors on audit quality

Overall Audit

Partner Audit

Committee Mean Mean Mean Question Statement Statistic Rank Statistic Statistic

3.10 Audit team benefits from competitive reward mechanisms.

2.52 28 2.53 2.50

4.6 Audit team aims for early communication with management when corrective action may be required.

2.52 28 2.72 2.11

5.1 Audit firm delivers consistent messages to all stakeholders.

2.50 29 2.41 3.00

6.6 Audit firm is responsive by giving advice to customers that add value.

2.50 29 2.47 2.67

2.8 Engagement partner performs different types of audits each year to enrich his/her spread of knowledge within various industries.

2.48 30 2.52 2.25

6.10 Audit firm charges appropriate fee to meet all legal, regulatory and professional obligation, without putting unnecessary pressure on audit staff to cut corners.

2.48 30 2.67 2.13

5.9 Having the necessary set-up to lodge a complaint against an auditor from the general public leads to higher levels of audit quality.

2.46 31 2.53 2.33

5.10 Stakeholders will feel more trust, if the list of audit firms clearly indicates, those that are ‘quality certified’ by an independent oversight authority.

2.45 32 2.47 2.33

1.1 Audit firm operates to the highest standards of integrity.

2.40 33 3.00 2.14

5.7 Increase in audit fees implies higher assurance to stakeholders.

2.38 34 2.53 2.11

6.3 Audit firm provides additional services such as accounting/book-keeping, taxation and consultancy services to their audit clients.

2.36 35 2.47 2.13

2.6 Engagement partner puts forward frequent advice to clients.

2.35 36 2.41 2.22

3.7 Audit team provides immediate and professional assistance to clients recommending possible action for improvement.

2.33 37 2.42 2.13

5.6 The interests of shareholders would be best served if audit firms remain in place for a fixed term (eg five years) - without any re- appointment option.

2.29 38 2.50 2.00



4.2.1 Comparison of Respondents Opinions

An independent t-test was conducted to analyse whether the audit committee and

audit partners’ opinion on the factors that may the quality of an audit is

significantly different or not. The results, presented in Exhibit-17 shows that audit

partners and MSE audit committees had significantly different views on nine

factors. Information in the column labeled Sig. (2-tailed) shows the means are

significantly different (<0.05) for assumptions of either equal or unequal

variances.

Exhibit 17 Independent Sample Test (T-test)

Ref Statement t-test for Equality of Means t df Sig.

(2-tailed) Mean

Difference

1.1 Equal variances assumed 3.795 8.00 0.005 0.857

Audit firm operates to the highest standards of integrity. Equal variances not assumed 6.000 6.00 0.001 0.857

1.10 Equal variances assumed -2.360 20.00 0.029 -0.467

Being a big audit firm adds credibility to users of financial statements. Equal variances not assumed -3.500 14.00 0.004 -0.467


Audit team provides the client with individual attention. Equal variances not assumed -3.873 20.00 0.001 -0.429


Audit team creates the minimum disruption to the client so far as practically possible.

Equal variances not assumed -2.658 18.88 0.016 -0.454


Audit team aims for early communication with management when corrective action may be required.

Equal variances not assumed 3.933 21.40 0.001 0.611


The interests of shareholders would be best served if audit firms remain in place for a fixed term (eg five years) - without any re- appointment option.



Increase in audit fees implies higher assurance to stakeholders. Equal variances not assumed 2.504 22.78 0.020 0.418


Audit firm provides assurance about its knowledge, courtesy of employees and ability to convey trust.

Equal variances not assumed -4.359 19.00 0.000 -0.500


Audit firm charges appropriate fee to meet all legal, regulatory and professional obligation, without putting unnecessary pressure on audit staff to cut corners.




Greater importance was given by audit partners on issues related to audit firm

integrity, early communication with management, audit firm rotation and audit

fees computations – all of these factors focusing on the technical side of the

effective conduct of an audit. Meanwhile, MSE audit committee placed higher

importance on audit firm size, individual attention, minimum disruption and the

ability of audit firm to convey trust. The latter factors being more oriented to

ensure customer satisfaction. This is an expected finding, as external users of

accounting information are less likely to be interested in technical quality issues

between the auditor and the client. This finding is similar to the results of

Warming-Rasmussen & Jensen’s [2001] study conducted in Denmark, where

Danish external users (shareholders and financial journalists) rated audit quality

(ie service quality attributes) higher than auditors.

4.2.2 Comparison of Respondents Opinions

Having identified the generic similarities and differences of auditors’ and audit

committees’ perception on audit quality, this section shall investigate into greater

depth each classification of audit quality according to the literature review

findings, and summarised through the ‘Audit Quality Wheel Model’ found on

Exhibit-9 [pp.24].

4.2.2.1 Audit Firm Culture

Exhibit 18 [pp.42] shows the results of the 10 factors grouped under the first

heading of this study – Audit Firm Culture.



Exhibit 18, Results of Audit Firm Culture

Audit Partners'

Perception

MSE Audit Committees'

Perception Overall Question Statement Mean Mean Mean

Statistic Statistic Statistic 1.1 Audit firm operates to the highest standards of

integrity. 3.00 2.14 2.40

1.2 Audit firm is independent of the board of directors.

2.80 2.88 2.83

1.3 Audit firm enjoys good reputation. 2.63 2.33 2.54 1.4 Audit firm employs a robust internal

procedure compliant with the international standards requirements and regulatory framework regime.

3.00 3.00 3.00

1.5 Audit firm is knowledgeable about the clients’ industry.

2.92 3.00 2.94


3.00 2.50 2.90


2.86 3.00 2.89

1.8 Audit firm uses avant-garde technology and knowledge management systems to assist it in retaining knowledge gathered from its audits.

2.71 2.75 2.72

1.9 Audit firm provides other non-audit services to the audited firm, including taxation, consultancy and general advice.

2.75 2.86 2.78

1.10 Being a big audit firm adds credibility to users of financial statements.

2.53 3.00 2.68

Out of these ten statements, the most influential factor on audit quality perceived

by both groups relates to the adaptation of a robust internal procedure compliant

with the international standards requirements and regulatory framework regime.

Attaining a mean score of 3.00 for each group, the perception is that audit quality

is strongly effected by the internal system and procedures adopted by the audit

firm to duly fulfill its obligations. This finding is in line with auditing literature that

very often defines audit quality relative to the degree to which the audit firm

applies necessary procedures to conform to applicable auditing standards and

regulations [Krishnan and Schauer, 2001]. For example, Dopuch and Simunic [1982]

made the argument that audit quality is a function of the number and extent of

audit procedures performed by the auditor. It thus seems that this finding is

replicated to the Maltese auditing industry where emphasis is being placed on the

internal control structure of an audit firm as the medium perceived to drive audit

quality. However this is a continuous endeavor as both group of respondents



identified that to ensure sustainable audit quality, an audit firm should

consistently monitor its quality control policies to align with recent best practice in

the audit profession.

Audit partners also view other aspects of audit firm culture as highly critical in

their work. Issues related to audit firm integrity and retaining key staff, are also

considered to be fundamental elements that influence audit quality – all attaining

a high mean score of 3.00. This view is not so particularly shared by their clients.

In fact, whilst audit firms place particular emphasis on their integrity, perhaps

quite surprisingly, their clients only gave 2.14 to this attribute. This score is not

only the lowest score attributed to this dimension by this group but even one of

the lowest overall score in this study attaining an overall mean of 2.4. The issue

then becomes why audit committees do not perceive integrity as being a vital

component of audit quality. Following recent financial scandals, the downfall of

corporate international giants and the demise of Arthur Anderson, it was

expected that this attribute will be featured in the top ten ranked statements – not

as one of the lowest mean scores. To this effect, more should be done by the

auditor to make constituency aware of the role of an auditor and his responsibility

towards society. Perhaps Government should also partake in raising such

awareness, thereby contributing to an increase in the expectations of audit work.

On the other hand, MSE audit committees identified the fact that being one of the

big audit firms adds credibility to users of financial statements. This compliments

the findings of several demand-side studies that theorized that high-risk clients or

clients with other motivations might attempt to credibly signal company-value

information by selecting brand name auditors [Stice, 1991; Palmrose, 1988; Kellogg,

1984; St. Pierre and Anderson, 1984].This perception is not duly shared by audit

partners whereby a lower mean score of 2.53 was given. Quoting a comment

received by one of the audit partners ‘an audit is always an audit … and should

be carried out in accordance to the rules of the game irrespective of the audit firm

size’.

Furthermore, constituents’ belief that being knowledgeable about the clients’

industry enhances audit quality is also shared by audit partners’ view attributing a

mean score of 2.92. However such industry specialization is a costly endeavor. In

fact this finding relates to Craswell et al. research, who in 1995 identified that

auditors who specialise in a particular industry earns a 34% fee premium over



other auditors who are not industry specialists.

To conclude this analysis of audit firm culture, both groups of respondents

perceive that the adaptation of a sound internal control system within an audit

firm is the underlying engine that drives audit quality from within the firm itself.

However whilst auditors gave higher ranking to technical elements like audit

firms’ integrity and recruiting highest caliber staff, members on audit committees

ranked other factors like brand name and industry specialization, which relate to

a more market or customer-oriented dimensions. This perception was even

shared when respondents were asked to rank two of the most important

statements in order of priority, as can be viewed from Exhibit-19.

Exhibit 19, Rankings from Audit Firm Culture

0.00%5.00%

10.00%15.00%20.00%25.00%30.00%35.00%40.00%

1 2 3 4 5 6 7 8 9 10

Statement Number

Audit Firm MSE Audit Committee



4.2.2.2 Partner Involvement

Exhibit-20 shows the results of the 10 factors grouped under the second

classification of audit quality – Partner Involvement.

Exhibit 20, Results of Partner Involvement

Audit Partners'

Perception


Perception

Overall

Question Statement Mean Mean Mean Statistic Statistic Statistic

2.1 Engagement partner adopts high ethical standards.

2.67 2.50 2.60

2.2 Engagement partner is independent of the board of directors.

2.50 3.00 2.57


2.88 3.00 2.92

2.4 Engagement partner actively involves himself/herself in the engagement beginning from the initial planning throughout the audit process and completion.

2.75 2.86 2.80


3.00 3.00 3.00


2.41 2.22 2.35


2.75 3.00 2.87


2.52 2.25 2.48

2.9 Engagement partner is subject to internal review during the audit by other partners of the audit firm.

2.63 2.25 2.57

2.10 Engagement partner allocates necessary resources for all its clients, irrespective of the audit fee charged.

2.70 3.00 2.83

Statement 2.5 attained the highest mean score of 3.00 by both audit partners and

MSE committees alike whereby it is perceived that the engagement partner’s

knowledge and understanding of the client is considered to be critical

components in audit quality. As previous research identified [Palmrose, 1988 and



Anderson, 1984], each individual business transaction takes place within a broader

context, and the skilled auditor should maintain a view which includes seemingly

insignificant details and their place in relation to the mainstream of the client’s

business activity. Emile Wolf [1997] argued that it could justifiably be said, albeit

loosely, that the auditor should audit the client, not just the financial statements.

Meanwhile whilst both groups reckoned the pivotal role of the audit partner by

staying close to the customer, audit committees identified another four

statements scoring the highest mean score of 3.00. The other perceived

elements of audit quality by MSE committee relate to (St2.2) audit partner

independence from the board of directors, (St2.3) appropriate allocation of

resources, (St2.5) keeping up-to-date with the organization’s pace, (St2.7)

concern towards risk and (St2.10) issues related to audit fee charged.

On the lower spectrum of this classification, the impact of partner rotation on

audit quality was perceived to be one of the least important influences on this

dimension attaining an overall score of 2.48. This finding compliments the

previous finding that audit committee looks for long-term relationships with the

audit partner. This reduces the time and resources needed to start a new

acquaintance from scratch. This raison d'être is also found in contemporary

studies. For instance, Myers et al. [2003] concluded that longer auditor tenure

constraints managerial discretion with accrual accounting, which suggests higher

audit quality. These findings were again accentuated a year later by Mansi et al.

[2004] who found that the cost of debt declines with longer tenure, which suggests

that bondholders perceive audit quality as improving with extended tenure.

Nonetheless, this contrasts with the findings of Davis et al. [2002] who concluded

that audit quality declines with extended tenure because as tenure increases,

client firms have greater reporting flexibility and earnings forecast error decline.

This view is also supported by the EU Directive, which encourages audit partners

rotation. This Law also establishes that where a Member State considers it

appropriate a change of audit firm may also be required to preserve

independence issues. This indicates that it is no longer an option for Malta to

engage in partner rotation, but it is now obligatory that audit partner rotation is

pursued.



To conclude on partner involvement, both groups of respondents perceive that

the knowledge of the audit partner vis-à-vis the organisation being audited is

considered to have undisputed impact on audit quality. Nonetheless, audit

committees place more emphasis on the inter-personal relationship with the

partner as contributing further to this audit quality dimension. Meanwhile such

inter-personal attributes were very modestly ranked by auditors. This perception

was even shared when respondents were asked to rank two of the most

important statements in order of priority, as can be viewed from Exhibit-21.

Exhibit 21, Rankings from Partner Involvement

0.00%5.00%

10.00%15.00%20.00%25.00%30.00%35.00%40.00%

1 2 3 4 5 6 7 8 9 10

Statement Number




4.2.2.3 Audit Team Involvement

Exhibit-22 shows the results of the 10 factors grouped under the third

classification of audit quality – Audit Team Involvement.

Exhibit 22, Results of Audit Team Involvement

Audit Partners'

Perception


Perception

Overall



3.00 3.00 3.00


3.00 3.00 3.00


2.93 2.89 2.91


3.00 3.00 3.00

3.5 Audit team genuinely believe in the public interest purpose of the audit.

2.75 2.67 2.73

3.6 Audit team shares the same values of the audit firm, having a sense of belongingness and stewardship to their organisation.

2.77 2.78 2.77


2.42 2.13 2.33

3.8 Audit team has a clear understanding of roles of partners and staff on audits and that they are properly qualified to perform them.

2.73 2.80 2.76


2.86 3.00 2.88


2.53 2.50 2.52

There is consensus by both groups of respondents on the three most important

attributes of audit team involvement with respect to (St3.1) independence from

the client, (St3.2) discretion and professional judgment and (St3.4) adopting

ethical standards when performing their work. This finding is a replica of the

research done by Lemont et. al. (1987) who identified that audit teams should

stay away from any conflict of interest, avoid any manipulation that may affect

their unbiasedness and acknowledge their views, which they reach as the



consequence of their work, without directly or indirectly considering the benefits

of other parties. In turn, Lemont even sustained the correlation of “auditor

independence” to ethical issues. This supports the findings found in Malta

whereby both groups of respondents reckoned the importance of being both

independent and ethical in performing an audit assignment.

Other than the above mentioned statements, audit committees perceived that

audit quality of the team augments when each individual member is motivated

both personally and by their working environment. This attribute was also

relatively highly ranked by audit partners scoring a mean of 2.86. This finding

confirms the study carried out by Craswell et al. [1995] where he identified a

relationship between the performance of auditors, their competence and their

motivation. He argued that even highly skilled and knowledgeable people will not

achieve audit quality unless they are determined (motivated) to do so. Such

motivation factors broadly fall into three groups – (i) firms’ values, (ii) self-belief &

consultation and (iii) rewarding appropriate behaviour. Unless an audit firm

motivates its staff, its audit quality is deemed to suffer.

Another highly ranked statement by both groups of respondents relates to

continuous professional education (St3.3). Attaining an overall mean of 2.91, both

groups agreed that if an audit firm continually keeps abreast with developments

in the profession, than audit quality should be improved.

Meanwhile, the least perceived influential factor on audit quality relates to (St3.7)

wherein an overall mean score of 2.33 was given. Perhaps quite surprisingly this

statement relates to the provision of immediate and professional assistance by

the audit team. It thus seems that whilst audit committees are willing to receive

feedback and suggestions from their audit partner (vide St2.4), they tend to keep

at a distance from the actual team members performing the audit. The reason

submitted by one of the chairperson was that they want the audit team to critically

evaluate the judgments made by their organisation without any undue influence

from the committee. Audit committee feels that the appropriate timing to settle

any issues, should be done at the closure of the audit by the audit partner.

To summarise the findings of audit team involvement, both groups of

respondents perceive that the audit team independence and having people with

the right aptitude are key elements of audit quality. It was further perceived by



audit committees that motivating staff also enhance such audit quality dimension.

This perception was also supported by auditors considering the ability to have the

people with the appropriate personal values whilst ensuring training and on-the-

job learning to reinforce such values consistently. This perception was even



Exhibit 23, Rankings from Audit Team Involvement

0.00%5.00%

10.00%15.00%20.00%25.00%30.00%35.00%40.00%45.00%

1 2 3 4 5 6 7 8 9 10

Statement Number


4.2.2.4 Quality on the Field

Exhibit-24 [pp.51] shows the results of the 10 factors grouped under the fourth

classification of audit quality – Quality on the Field.



Exhibit 24, Results of Quality on the Field

Audit Partners'

Perception


Perception

Overall


4.1 There is a ‘good fit’ between the audit team, engagement partner and the finance director.

2.83 2.78 2.81

4.2 Audit team provides the client with individual attention.

2.57 3.00 2.70

4.3 Audit team creates the minimum disruption to the client so far as practically possible.

2.42 2.88 2.56


3.00 3.00 3.00


3.00 3.00 3.00


2.72 2.11 2.52

4.7 Audit team evaluates appropriate judgments made by their clients with rigour and professional skepticism.

2.83 3.00 2.89

4.8 Audit team files are reviewed by people with appropriate experience who will encourage alertness, originality of thought and a thorough investigation of anomalies.

2.86 3.00 2.93


2.78 3.00 2.89

4.10 Audit team uses information technology to liaise and obtain second opinions from the lead engagement partner.

2.57 2.90 2.68

The findings of this section echo the previous findings outlined in Statement 1.4

and Statement 3.4 related to the performance of an audit in accordance with

International Standards on Auditing and legislations (St4.4) and the gathering of

sufficient and appropriate documented evidence supporting audit opinions (St4.5)

respectively. One should also note that out of these 10 statements, MSE highest

mean of 3.00 was also given to another four statements related to (St4.2) clients’

individual attention, (St4.7) evaluation of judgments with rigour and professional

skepticism, (St4.8) audit files are reviewed by experienced people and (St4.9)

team works in accordance to the working practices embedded within the audit

firm’s internal control procedure. This section was the highest ranked section by



the audit committees scoring a mean of 3.00 for six statements. It is thus

worthwhile noting the difference in perception of both groups of respondents in

this particular classification of audit quality. Whilst audit committees scored high

mean values, auditors attributed modest means to this dimension. To take an

example, audit partners gave only 2.57 marks for the statement that audit quality

is improved when the audit team provides the client with individual attention.

Similar to this finding, whilst audit committees reckon that audit quality may be

effected if there is disruption to their modus operandi only a low score of 2.42

was actually given by audit partners. This finding compliments the research

carried out by Walker et al. [2001] suggesting that the effectiveness of maintaining

good relationship with clients is often overlooked by auditors, wherein the latter

place more emphasis on the technical component of audit quality.

To conclude, both groups of respondents perceive that quality on the field as

being fundamental. On a general basis, audit committees tend to rate such

classification on a much higher basis then auditors. Nonetheless, partners do

reckon that this requires effective implementation through a combination of

people with motivation, skills and working practices. This perception was even



Exhibit 25, Rankings from Quality on Field

0.00%5.00%

10.00%15.00%20.00%25.00%30.00%35.00%40.00%45.00%

1 2 3 4 5 6 7 8 9 10

Statement Number




4.2.2.5 Stakeholders’ Involvement

Exhibit-26 shows the results of the 10 factors grouped under the fifth

classification of audit quality – Stakeholders’ Involvement.

Exhibit 26, Results of Stakeholders’ Involvement

Audit Partners'

Perception


Perception

Overall



2.41 3.00 2.50

5.2 Audit firm provides the directors and officers constructive observations arising from the audit process.

2.60 2.00 2.57

5.3 Audit firm acts in the interest of shareholders while having regard to the wider public interests.

2.73 2.50 2.69

5.4 Audit firm with a strong reputation may imply higher credibility to users of audited financial statements.

2.76 3.00 2.80

5.5 Audit firms issuing audit reports with matters of interest to creditors and shareholders provide more assurance to stakeholders.

2.65 2.89 2.73


2.50 2.00 2.29


2.53 2.11 2.38

5.8 Employees of the companies are more willing to co-operate with auditors with good inter-personal and intra-personal skills.

2.59 2.00 2.57


2.53 2.33 2.46


2.47 2.33 2.45

There has always been a debate in the auditing profession as to whether the

responsibility of the auditor is solely towards shareholders or to the public at

large. Current standards and regulations establish that the prime responsibility is

towards the shareholders or owners of the company. Even the format of the audit

report supports this approach. Perhaps the idea that the auditors’ remit be

extended to cover other stakeholders is still at a very early stage not only in

Malta, but even within several EU countries. Although all audits have precisely



0.00%5.00%

10.00%15.00%20.00%25.00%30.00%35.00%40.00%

1 2 3 4 5 6 7 8 9 10

Statement Number


the same objective, namely to report to the interested parties on the results of the

audit review undertaken, the remit of an auditor should be extended to cover

wider public interests. It is thus no surprise that this category received the lowest

scores from both groups of respondents.

The highest means score for this dimension comes from St5.4 wherein it is stated

that audit firms with a strong reputation may imply higher credibility to users of

audited financial statements. Upon closer examination, of who these users of

financial statements really are, a relatively high score was put forward by audit

committees. Scoring 2.89 for Statement 5.5, audit firms issuing audit reports with

matters of interest to creditors and shareholders are viewed to provide more

assurance to stakeholders by audit committees.

Moreover, it is interesting to note that whilst audit committees considers it critical

that an audit firm should deliver consistent messages to all stakeholders (St5.1),

only a modest score of 2.41 was given by audit partners. At the bottom end of

this list one will find that the rotation of audit firms is not applauded by both audit

partners and their clients alike. Attaining an overall means score of 2.29, this

statement was the least scored in this study.

To conclude, both groups of respondents perceive that stakeholder involvement

does not have any particular bearing on the audit quality of the firm, though in the

near future, such dimension should attain further importance. This perception

was even shared when respondents were asked to rank two of the most

important statements in order of priority, as can be viewed from Exhibit-27.

Exhibit 27, Rankings from Stakeholders’ Involvement



4.2.2.6 Managing Customers Relationship

Exhibit-28 shows the results of the 10 factors grouped under the sixth

classification of audit quality – Managing Customers’ Relationships.

Exhibit 28, Results of Stakeholders’ Involvement

Audit Partners'

Perception


Perception

Overall


6.1 Audit team communicates regularly and appropriately with executive management and/or audit committee.

2.77 3.00 2.80

6.2 Audit firm communicates regularly and appropriately with client management and directors.

2.73 2.89 2.79


2.47 2.13 2.36

6.4 Audit firm is easily contactable (eg by email, internet, phone).

2.80 2.75 2.79

6.5 Audit firm is reliable in performing the promised service dependably and accurately.

2.77 3.00 2.81


2.47 2.67 2.50

6.7 Audit firm provides assurance about its knowledge, courtesy of employees and ability to convey trust.

2.50 3.00 2.66

6.8 Audit firm provides individual attention to customers.

2.69 3.00 2.72

6.9 Audit firm has a good image and communication material.

2.78 2.33 2.63


2.67 2.13 2.48

On an overall basis, MSE ranked 4 statements as being highly critical in

influencing the audit quality, each attaining a mean score of 3.00. The statements

are (St 6.1) audit team communicates regularly and appropriately with executive

management and/or audit committee, (St6.5) audit firm is reliable in performing

the promised service dependably and accurately, (St6.7) audit firm provides



assurance about its knowledge, courtesy of employees and ability to convey trust

and (St6.8) audit firm provides individual attention to customers.

It is interesting to note that audit partners, did not consider even one of these

statements as being really fundamental in audit quality. Another interesting point

is that whilst audit partners perceived that the provision of additional services

such as accounting/book-keeping, taxation and consultancy services to their

audit clients could enhance audit quality, this view was not equally shared by

audit committees. Instead only a low score of 2.13 was given to such an attribute.

This indicates that audit committees may be concerned that local audit firms

perform an array of financial services to the detriment of the auditor’s

independence. If one had to look at the experience of other countries, various

nations have put forward legislation to augment the independence of auditors.

Audit firms in the UK and Australia have to inform their government about the

amount of their revenues that they receive from non-audit works so that their

independence can be more precisely evaluated [Harma and Sidhu, 2001]. From

this, it can be seen that auditor independence is considered to be a crucial factor

for the efficiency of the capital markets as well – and Malta is no exception.

Juggling with too many services, may be a threat to independence – which can at

any time strike at the grass root of the audit function. This perception was even



Exhibit 29, Rankings from Customers’ Involvement

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

1 2 3 4 5 6 7 8 9 10

Statement Number




4.2.2.7 Summarizing the Results of Section B

After identifying the particular means for each of the statements identified in this

study, an important research question is what categories are perceived to

contribute to enhance audit quality by both groups of respondents. Exhibit-30

summarises the average overall mean scores across these two groups.

Exhibit 30, Mean Score for Attributes – Audit Partners’ View

Attribute Mean Score

Ranking Mean Score

Ranking

Audit Partner’s View Companies’ View Audit firm Culture 3.265 2 3.160 2 Partner Involvement 3.300 1 3.300 1 Audit Team Involvement 3.169 3 3.140 3 Quality on Field 3.131 4 3.160 2 Stakeholder’s involvement 2.577 6 2.900 5 Managing Customer Relationships 2.819 5 2.980 4

In general terms, auditors and audit committees mean scores across the six

dimensions are broadly similar with both groups of respondents putting partner

involvement as the category that received the highest scores followed by audit

firm culture. It is interesting to note that audit committees also gave high scores

to attributes related to quality on the field, sharing the second place audit firm

culture. Meanwhile, auditors placed this category in the fourth place. At the lower

end of the results, Stakeholders’ Involvement and Customer Relationships were

regarded as less important.

One may also attest these findings diagrammatically as can be seen from Exhibit-

31 [pp.58], which relates to the Maltese perception of the ‘Audit Quality Wheel

Model’ presented in Exhibit-9 [pp24]. This model highlights those statements

whose mean score is equal to 3.00.




Exhibit 31, Audit Quality Wheel Model – Illustration of Maltese Findings

Key

Black, refers to issues identified by audit partners Blue, refers to issues identified by Audit Committees Red, refers to issues identified by both parties



4.3 Section C, Free-form Comments Analysis

Exhibit-32 puts forward an overall summary about the perception of audit

partners and audit committees on topical auditing issues. This part addresses the

extent of awareness that both respondents have on topical issues whilst

providing reference to the perception of the Maltese system.

Exhibit 32, Section C Results

Audit Firm

MSE audit committee

Total Respondents

7.1 agree 13 (50%) 2 (20%) 15 (42%)

Higher fees charged reflect higher quality of audit services. disagree 13 (50%) 8 (80%) 21 (58%)

7.2 agree 8(31%) 7 (70%) 15 (42%)

Self-regulating profession runs a serious risk of conflicts of interests. An auditor can never be truly independent of those who have the power to sack you.

disagree 18 (69%) 3 (30%) 21 (58%)

7.3 agree 6 (23%) 8 (80%) 14(39%)

An audit firm should occupy a term of office for a fixed duration period of time indicated by law.

disagree 20(77%) 2 (20%) 22(61%)

7.4 agree 19 (73%) 6 (60%) 25 (69%)

Audit firms who are not performing to the standards of quality are to be publicly disclosed by the relevant authorities.

disagree 7(27%) 4 (40%) 11(31%)

7.5 agree 16(62%) 6 (60%) 22 (61%)

Having an independent unit performing on-the-spot visits on all audit firms and practitioners performing audit work enhance audit quality.

disagree 10(38%) 4 (40%) 14 (39%)

7.6 agree 5(19%) 2 (20%) 7(19%)

The various components constituting audit quality is fully known in Malta disagree 21(81%) 8 (80%) 29(81%)

7.7 agree 11(42%) 3 (30%) 14(39%)

Audit quality yield more costs than benefits for an audit firm to adopt and maintain.

disagree 15(58%) 7 (70%) 22(61%)

7.8 agree 3(12%) 3 (30%) 6(17%)

Audit quality is a one-time effort by the firm to align its internal control procedures with best practices.

disagree 23(88%) 7 (70%) 30(83%)



4.3.1 Audit Fees

One motivation for audit fee studies is the concern that larger audit firms are able

to charge higher audit fees due to market (monopolistic) powers. This has

implications for audit quality because it has been found that auditor monopoly

reduces the quantity demanded of external auditing and results in lower quality,

higher-cost financial reporting systems [Simunic, 1980]. Whilst there are mixed

perceptions between audit partners about whether higher audit fees imply higher

quality of service, 80% of MSE respondents identified that this may not be

necessarily the case. Talking from their own personal experiences they have

argued that at times an audit fee is usually set to a minimum competitive level to

attract other related services like consultancy and tax advise. Generally,

however, a positive relation is assumed to exist between audit quality and audit

fees with audit partners identifying that if larger firms are charging higher fees it

reflects the higher quality of their audit services.

4.3.2 Self-Regulating Profession

Very convergent views were again found from both groups on the second

statement which identified that a self-regulating profession runs a serious risk of

conflicts of interests. 69% of audit partners disagreed with this statement putting

forward arguments that this set-up increase rather than decrease audit quality as

people with inappropriate expertise could be running the regulative aspect of the

profession. Contrary to this perception 70% of MSE audit committee agreed with

this statement. This seems to be sustained by various contemporary audit

researchers who identified the need of having the regulative side of the auditing

profession outside the hands of majority of practitioners. For instance, Husey and

Lan [2001] found in their study that auditing should not be developed and

regulated by the accounting profession. A practical move towards this end has

already been made by the enactment of the EU Statutory Audit Directive which

request that the public oversight system should be governed by non-practitioners

who are knowledgeable in the areas relevant to statutory audit. This Directive

necessitate that these non-practitioners may be specialists who have never been

linked with the audit profession or former practitioners who have left the

profession. Member States may, however, allow a minority of practitioners to be

involved in the governance of the public oversight system. However it seems that



audit firms in Malta are still very much inclined to be in control of what is

happening in the profession.

4.3.3 Term of Office Duration

80% of MSE audit committee identified that they agree that an audit firm should

occupy a term of office for a fixed duration period of time indicated by law. On the

other hand audit partners had different perception on this matter wherein 70%

disagreed with this set-up suggesting that only competitive forces should decide

whether an auditor is to retain his office or not and not legal imposition. In fact,

very few auditors in Malta belief that auditing should be restricted to a fixed

period and subject to a rotation. However, the study of Beattie et al. [2004] shows

that as the relationship between the auditor and their clients becomes less

distant, the belief that there must be a compulsory rotation for the auditors

becomes more apparent. The latter suggested that the law should restrict the

audit service to the same firm to a certain period or by subjecting them to a

rotation on a fixed period between 5 and 12 years.

4.3.4 Publicity of Defaulters

73% of audit partners and 60% of Audit Committees agreed that audit firms who

are not performing to the standards of quality are to be publicly disclosed by the

relevant authorities. In the US this set-up of transparency and accountability was

imminently put into place after the Enron case. It is applauded to note that there

exists consensus amongst the two groups that this measure can be applied to

Malta. Perhaps not going into the peculiar details and making available each

audit firm review report on the internet, but sure enough the enactment of

Directive 4 of the Accountancy Profession Act, ensures that a report summarizing

the findings of audit firms is to be made available to the public on an annual

basis.



4.3.5 Monitoring by Government

Consensus was also reached between the two groups of respondents related to

the setting up of a new unit to perform on-the-spot visits on audit firms to ensure

audit quality. 62% of audit partners and 60% of audit committees identified that

this Unit is expected to increase standards of audit quality. This system is no

longer an option for Malta but is mandatory by virtue of the enactment of the 4th

Directive wherein these reviewers are expected to perform on-the-site

inspections on audit firms to ensure audit quality. For instance in the UK, the

Audit Inspection Unit (AIU) was set up following the Government’s post-Enron

review of the regulation of the UK accountancy profession which reported in

January 2003. The Government’s report recommended enhancing the monitoring

of the audits of listed and other major public interest entities through a new

independent inspection unit (the AIU) reporting to a professional oversight board

within an integrated independent regulator (the FRC). The AIU monitors the

auditors of all listed and other major public interest entities and reports its findings

to the Audit Registration Committee (ARC).

4.3.6 Components of Audit Quality

Only 5 audit partners and 2 chairpersons of audit committees feel that the various

components constituting audit quality are fully known in Malta. Instead the

majority of both groups of respondents identified that there is a lack of knowledge

in this regard. Perhaps this gap may be the result of a rather passive attitude

taken by both auditors themselves and their regulators in ensuring that they align

their knowledge with recent developments in the profession. This further confirms

the educational role that the auditor and the regulator should pursue to ensure

the spread of knowledge of what audit quality is really about and what the

regulator is really after. In fact recently an initiative has been taken by the

Government to launch some educational seminars for auditors to identify how the

proposed system is going to be implemented.



4.3.7 Benefits of Audit Quality

Whilst 70% of audit committee agrees that audit quality yield more benefits than

costs for an audit firm to adopt and maintain, a relatively high percentage of

auditor feel otherwise. In fact, 42% disagree with this assertion and think that

there is a high cost to be recouped in implementing a highly qualitative audit.

Their argument is that the present legislation and professional standards are

imposing very stringent requirements far beyond the audit fee charged. In fact,

the implementation of an audit quality assurance system is expected to raise the

audit fee charged. The auditors’ concern is whether or not their clientele can

actually identify which audit is of a certain standard of quality and thus merit the

increase in price and other non qualitative audit assignments. The fear is that

their clients are unable to make this comparison. Here again, one must underline

the importance of that the educational role of the auditor and regulator. Quoting

one auditors’ response, “we do not have the complete picture from Government

as to what constitutes audit quality, so the implication is that we cannot really

establish the feasibility or otherwise of this initiative”.

4.3.8 Duration of audit quality

The majority of both audit partners and audit committee reckon the importance

that the implementation of an audit quality system is not a one-time effort, but is a

continual endeavor to align the firm with best practices. This idea that one must

keep abreast of recent developments, further sustains the importance of the

supporting and educational role that each audit firm needs to pursue during its

entire lifecycle.

4.3.9 Summary on Section C

Though there is consensus amongst the two groups about issues related to

publicity of defaulters, monitoring by Government, extent, benefits and duration of

audit quality, there are contrasting views about the matters relating to self-

regulating profession and rotation of audit firms. On the other hand, auditors

seem to share their opinions about whether or not a high audit fee reflects higher

audit quality, whereas the majority of audit committee disagrees with this

assertion.



4.4 Conclusion

To conclude this study aims to examine the potential factors that influence the

quality of audit from the perception of two selected parties in auditing: partners of

audit firms and audit committees. The result of the study appeared to suggest

that seven major factors that may influence audit quality. These seven traits of

the audit quality in Malta are:-

1. the sustainability of an audit firm’s internal control system;

2. engagement’s partner knowledge about the clients’ industry;

3. independence of audit team members from client;

4. audit team’s ability to exercise professional discretion and judgment;

5. auditors obligation to follow ethical standards;

6. conduct of audit should be done within the rules of the game; and

7. auditors should be able to document all necessary findings to support

their opinion.


C h a p t e r 5

PART THREE - DISCUSSION OF FINDINGS

Criticism of auditors, and litigation against them may result from auditors failing to meet society ’ s expectations of them. It may be that society ’ s expectations are unreasonable, or that society ’ s expectations are reasonable but that auditors ’ existing legal and professional requirements do not fulfil these expectations. Alternatively, it may be that auditors do not perform their existing responsibilities to a satisfactory standard. Whatever the cause of the gap between society ’ s expectations of auditors and its perception of auditors ’ performance (termed ‘ the audit expectation-performance gap ’ ), the resultant dissatisfaction with auditors’ performance serves to undermine confidence in the auditing profession and the external audit function.

DeFond et al., 2002

Henley Management College Part THREE, Discussion of Findings


5 PART THREE - DISCUSSION OF FINDINGS

Following the presentation of results, this part of the dissertation challenges the

hypothesis by testing them against the research findings. In the second part of

this Section the wider validity of this dissertation is also discussed.

5.1 Testing the Three Hypothesis

5.1.1 Hypothesis One – Nature of Audit Quality

The prime hypothesis of the dissertation is that;

‘the dimensions of audit quality are not something static or universal. Instead it is a multi-dimension construct that evolves due to continual changes in the environmental influences effecting the profession.’

This study revealed that owing to the dynamism of the environment of the

auditing profession, particularly that related with legislative frameworks (both

emanating from European Union and local Maltese variants) and auditing

standards issued by the professional bodies, there exist no such terminology as

being static in the auditor’s modus operandi. For instance, until very recently the

continuation of self-regulation in the profession appeared virtually unassailable.

There have, of course, been rumblings about the profession’s need to ‘get its

house in order’, and similar, but equally glib, expressions of dissatisfaction over

the seeming disparity, in the public perception, between the profession’s

performance and the expectations laid upon it. The government, therefore, seized

the opportunity presented by the EU Directive to enforce a completely new

regulatory regime on the profession, and its novel features, such as formal on-

the-spot reviews of audit firms, which is creating understandable anxiety amongst

practitioners.

All of this leads to further substantiate the recurring finding in this study that audit

quality standards cannot be duly increased through legalistic enforcement unless

appropriate self-development – or what the profession usually refers to CPE

(continuous profession education) fuel this process of continuous alignment. The

key to keep auditors abreast of recent developments is through practical training.

Meanwhile, increasing development and complexity in the economic world forces

firms to be more responsible to society. Therefore, it is a duty for firms to disclose



information about themselves through financial reporting to stakeholders,

creditors and legislative institutions. However, this information can enable these

groups to make accurate decisions as long as they are reliable and unbiased.

Therefore the importance of the independence of auditor is highlighted. In fact

this study also revealed that whilst there are various dynamic forces shaping the

auditing profession, there exist some fundamental factors that are obligatory

‘rules of the game’.

Perception of independence is still viewed to be the critical by both groups of

respondents. New measures are being introduced both by law and even by

International Standards to refine this concept further. Some of the mandatory

safeguards relates to the rotation of the lead engagement audit partner and in

cases whereby the supervisory authority thinks fit, the rotation of the audit firm

itself. E Woolf [1997] identified that the concept of the audit and the concept of

independence are the twin sides of the same coin. The auditor who has lost his

independence, has lost his raison d’ệtre, he becomes ‘dependent’, and a

dependent auditor is a contradiction in terms. Other essential elements of audit

quality highly ranked by both groups of respondents are summarized in the

Exhibit-33.

Exhibit 33, Obligatory Elements of Audit Quality

Audit Firm

Audit Committee


� �

3.1 Audit team members are independent from the client. � �

3.4 Audit team adopts high ethical standards when performing their work. � �

4.4 Audit team performs the audit in accordance with International Standards on Auditing and with appropriate and relevant legislations. � �

4.5 Audit team gathers sufficient and appropriate documented evidence supporting audit opinions. � �

To summarise, whilst it is true that the audit environment is continually changing,

the core rules of the game still remain the same - that of providing an

independent audit opinion on the financial statements. The findings in the study

confirm the first hypothesis that audit quality is a multi-dimension construct that



evolves due to continual changes in the environmental influences effecting the

profession.

5.1.2 Hypothesis Two – Recognition of Audit Quality dimensions

The second hypothesis of the dissertation is that;

‘the dimensions of audit quality, are not fully recognised within the local auditing profession.’

Having a direct question in Section C of the questionnaire, there is consensus

amongst the two groups of respondents that this assertion is also valid in the

Maltese scenario. Furthermore, this finding was further substantiated when

carrying out interviews with audit committees who at times were oblivious to the

queries raised and felt suspicious that there could be some tricky question hidden

somewhere. During the interviews eye brows were raised and comments like, this

is a ‘far-fetched idea’ and ‘oblivious to our organisation’ were also noted. In fact,

this quote from one of the chairpersons seems to summarise the overall

perception and attitude of audit committees,

‘our interest is that of complying with the law and recognised accounting standards… our concern is of engaging competent audit firms that add credibility to our financial statements… we welcome any initiative to augment the quality standard of the audit, though we reckon that we are pleased with the overall work done by our auditors…’

Furthermore and perhaps quite surprisingly even audit partners, have shown

peculiar responses to issues that are within their remit. A typical example relates

to the low ranking of statements related to rotation of audit partners, which is no

longer best practice but is mandatory by EU law! Though one must reckon that

this legislation will be duly enforced in 2008, it is no surprise that auditors do not

exhibit a positive preference to this clause. Even preliminary discussion held

prior to the enactment of this law, this clause was out rightly refused by EU

representatives of audit firms. It is here once again accentuated that there is an

urgent need that interested parties be informed of what this audit quality is all

about, not only in the light of what the law necessitates but tackling the public

interest dimension of an audit.

To summarise the second hypothesis testing, it is ascertained that the

dimensions of audit quality are not fully known in Malta.




5.1.3 Hypothesis Three – Competitive advantage through Audit Quality

The third hypothesis of the dissertation is that;

audit firms who manage audit quality at all levels of its organisation, ensure long term sustainable competitive advantage.

As reported by Bernstein [1978] and Kotler et al [1984], the growing competition

within the profession forces auditing firms to becoming more cognizant of the

need to market their services. The question is how the auditing firm should

differentiate themselves from each other in order to be more competitive.

Carcello et al [1992] suggested that one of the dimensions on which firms have

attempted to differentiate themselves is the quality of services provided. Section

5.2 –Audit Quality Competitive Matrix explores this hypothesis in further depth.

5.2 Audit Quality Competitive Matrix

Having identified what elements of audit quality are considered to be critical in the

eyes of auditors and audit committees, a proposed model is illustrated in Exhibit-

34 classifying the dimensions of audit quality according to their competitive

posture and competitive focus. The audit focus-posture matrix is divided into four

cells, each indicating a different type of audit firm.

Exhibit 34, Audit Competitive Focus-Posture Matrix

Competitive Posture Obligatory Adds Value

Technical issues

BASIC AUDIT FIRM

CUSTODIAN AUDIT FIRM

Com

petit

ive

Foc

us

Service issues

DARING AUDIT FIRM ENVIED AUDIT FIRM



1. Basic Audit Firm: Audit firms who stick to legislation and tick-marks,

focusing exclusively on getting the job done within the parameters of

professional standards. These firms add little value to their constituency

let alone putting the public interest first and foremost. Attaining the most

ranked statements, it transpires that this audit firm style still enjoys quite

some popularity in Malta, vide Exhibit-35.

Exhibit 35 Characteristics of a Basic Audit Firm

Question Statement 1.1 Audit firm operates to the highest standards of integrity. 1.4 Audit firm employs a robust internal procedure compliant with the

international standards requirements and regulatory framework regime.

3.1 Audit team members are independent from the client. 3.4 Audit team adopts high ethical standards when performing their work. 4.4 Audit team performs the audit in accordance with International Standards on

Auditing and with appropriate and relevant legislations. 4.5 Audit team gathers sufficient and appropriate documented evidence

supporting audit opinions. 2.2 Engagement partner is independent of the board of directors. 4.7 Audit team evaluates appropriate judgments made by their clients with rigour

and professional skepticism. 4.8 Audit team files are reviewed by people with appropriate experience who will

encourage alertness, originality of thought and a thorough investigation of anomalies.


However, having this competitive posture is not sustainable in the long-

term as other audit firms are redesigning their procedures and systems to

add value to the public in general. So whilst it is essential that all audit

firms operate within the rules of the game, they need to differentiate their

service to ensure long-term sustainable advantage.

2. Daring Audit Firm: Audit firm methodology is still very much inclined

towards the legalistic regime, yet auditors do try and put some effort to

introduce their constituency in the picture. Exhibit-36 [pp.71] defines some

characteristics of this type of firm. In Malta it seems that this style does

not enjoy a high level of popularity.



Exhibit 36 Characteristics of a Daring Audit Firm




3. Custodian Audit Firm: Audit firm that have strong technical background

but search whilst searching for new ways to add value to constituency.

Exhibit-37 defines some characteristics of this type of firm. In Malta it

seems that this style is perhaps the most popular one.

Exhibit 37 Characteristics of a Custodian Audit Firm




1.5 Audit firm is knowledgeable about the clients’ industry. 1.7 Audit firm consistently monitors its quality control policies to align with recent

best practice in the audit profession. 2.3 Engagement partner dedicates resources to align the audit firm’s strategy

and internal communications with recent developments in the profession.

P.P. Russell [2004] indicated some potential elements how the audit-function

can actually add value to its constituency. These are summarized in Exhibit-

38 [pp.72].



Exhibit 38 Adding Value

4. Envied Audit Firm: Audit firm that seeks to add value and put constituency

as the prime focus of their methodology-vide Exhibit-39 [pp73]. Though

this style can be seen to be more popular with clientele, it may be

dangerous if taken to extreme as independence may be severely

jeopardized. However this style can proof to be the most successful to

sustain competitive advantage.



Exhibit 39 Characteristics of an Envied Audit Firm


3.9 Audit team is motivated both personally and by their working environment. 4.2 Audit team provides the client with individual attention. 5.1 Audit firm delivers consistent messages to all stakeholders. 5.4 Audit firm with a strong reputation may imply higher credibility to users of

audited financial statements. 6.5 Audit firm is reliable in performing the promised service dependably and

accurately. 6.7 Audit firm provides assurance about its knowledge, courtesy of employees

and ability to convey trust. 6.8 Audit firm provides individual attention to customers.

As time passes, successful audit firms change their position in the focus-posture

matrix. Successful audit firms have a lifecycle. These start as a basic firm,

become custodian, then daring and finally envied firm. For this reason audit firms

should examine not only their current positions in this matrix but even their

moving positions throughout their lifecycle.

If the auditing profession were willing to broaden its responsibilities to embrace

these duties that can reasonably be expected of auditors, the overall audit quality

would improve significantly. However as DeFond et al. [2002] noted, it seems

that the willingness of the profession to accept any extended responsibilities is

hampered by concerns about the perceived potential increase in exposure to

legal liability rather than encouraged by the potential benefits to be gained from

better meeting society’ s expectations and be thereby enhancing the value of the

audit function in society.



5.3 Wider Validity of Dissertation

It is hoped that this study developed a conceptual framework to assist academics

and practitioners in understanding what are the dimensions of audit quality, how

discrepancies can arise and how these can be managed. This section contains a

description of the wider validity on the topic of audit quality that can be drawn

from this study.

5.3.1 The Five Pillars of Audit Quality – A guideline

This dissertation adds value to the practical management of audit quality by

establishing a model, presented through a Greek representation of the

‘Parthenon Temple’. By combing the academic research with the practical issues,

it is believed that the dimensions of audit quality are explored into greater

dimensions.

5.3.2 The Audit Quality Wheel Model

Dividing the literature review into six major headings provides a holistic analysis

of the dimensions of audit quality not only from the technical and clients point of

view but even from the view of the public interest and stakeholder analysis.

Though the latter are not considered yet being critical key players in audit quality,

as social responsibility of auditors augments, the latter are gaining more and

more importance. To this effect this six classification approach can assist an audit

firm as a checklist to establish the areas that it needs to address further to ensure

sustainable audit quality when conducting a self-review audit.

5.3.3 Audit Firm Competitive Matrix

Another model proposed by this dissertation relates to the different

characteristics of an audit firm in relation to its competitive focus and posture.

This model can be used by audit firms to identify their extent of focus and

whether this is in line with their own culture and strategy. This model can also be

used to detail the lifecycle of an audit firm proposing the sequence

Basic→Daring→Custodian→Envied as the less risky with highest returns.


C h a p t e r 6

PART THREE-OVERALL CONCLUSIONS

The auditing service emerged from the requirements of stakeholders for the detection of the extent to which managers fulfill their responsibilities. If auditors can not sustain their independence, the parties of the contract will not value the service. Any definition of ethics involves moral tasks and obligations that make out how should the behaviour of a person be. For an auditor to be ethical, it is essential that they should be independent by maintaining their objectivity and stay away from any possible conflicts of interest while fulfilling their responsibilities.

Krishnan et al.,2001

Henley Management College Part THREE, Overall Conclusions


6 PART THREE, OVERALL CONCLUSIONS

6.1 Recommendations

Limperg Instituut [1985] observed that auditors have a dual responsibility: Firstly,

not to arouse ‘in the sensible layman’ greater expectations than can be fulfilled by

the work done, and secondly to carry out the work in a manner that does not

betray the expectations evoked. Limperg’s analysis highlights the fact that, if

auditors fail to identify society’s expectations of them, or to recognise the extent

to which they meet (or, more pertinently, fail to meet) those expectations, then

not only will they be subject to criticism but also, if the failure persists, society’s

confidence in the audit function will be undermined and the audit function, and

the auditing profession, will be perceived to have no value. To this effect a set of

recommendations have been proposed to ensure that the audit quality is duly

understood by the key parties involved and action is taken not to let another

Enron happen in our Maltese community.

6.1.1 Enhancing the education of auditing practitioners

The research findings suggest that the enhanced education of auditors is

required. It was noted that auditors were found to have a ‘knowledge gap’ in

respect of their existing responsibilities. These CPE activities should be

organised on a practical approach rather than merely being informative in their

nature. It is therefore suggested that further practical education be carried out to

inform practitioners about what is expected of them with regards to audit quality,

possibly through compulsory professional development sessions. Obviously

these courses should be mandatory for all the professional people wishing to

maintain their auditors’ warrant.



6.1.2 Educating society about the audit function and the work of the auditor

From the research findings, it is evident that the Maltese business community

needs education about the audit function and what auditors can reasonably be

expected to achieve. One possible means is to use the opportunity afforded by

an infamous fraud and/or unexpected corporate failure that reaches the media

headlines to explain the audit function and the work of auditors. Such occasions

could be used to explain, in a non-technical, easily understandable language, the

auditors’ role in those particular circumstances – and placing those

circumstances in the broader context of the audit function and the role and

responsibilities of auditors in general. An alternative, and perhaps more effective

way to educate such community, is to seek opportunities to educate influential

journalists, formally and informally, about the audit function and the work of

auditors.

6.1.3 Installing a mechanism to receive complaints on the internet

The use of the internet has gained massive popularity in Malta wherein the

majority of business communities and the general public have access to this

medium of communication. To this effect, a mechanism should be implemented

to capture any queries or complaints about the conduct of an auditor to the

relevant authorities, whilst preserving the confidentiality of the individual.

6.1.4 Improving the quality control in audit firms

The monitoring of auditors’ quality is expected to augment standards of auditing

in the local profession. The Quality Assurance Unit is expected to conduct its first

reviews during the second quarter of the year 2007. There is great anxiety

amongst auditors as to what these reviews will really entail. It is recommended

that an educational role be primarily launched to establish the practical remit of

this Unit, to avoid unnecessary misconceptions whilst contributing to enhance the

overall audit quality of audit firms in Malta.




6.1.5 Summary of Implementation measures

A clear understanding of what constitutes audit quality is highly applauded by

both practitioners and auditees alike. It is thus consider of fundamental

importance that awareness campaigns and training initiatives be primarily

targeted to these key stakeholders. Several media can be used to reach this

objective including articles on newspapers, professional magazines and the

interactive use of the Accountancy Baord’s web portal. Having the right

atmosphere and attention to receive audit quality reviews, the first on-the-spot

visits can be conducted, as hopefully people will recognize that this process will

increase the overall quality standards in the local auditing profession. Exhibit 40

provides an overall summary of such implementation measures and time frames

through the use of a Gaant Chart.

Exhibit 40 Gaant Chart – Implementation Measures

Euros (€) Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Analysis of Expected Expenditure for 2007

1. Educating PractitionersDesign practical training course 400Launching practical training two-day seminar 2,000Promote practical training initiative 1,500Deliver training courses once every quarter 6,000Total - Educating the Practitioners 9,900

2. Educating SocietyDesign awareness campaign 500Perform feasibility of what type of media best-fit consituency 200Launching awareness campaign two-day seminar with auditees 2,000Keep in touch with public 1,500(eg. Articles on papers, professional publications & internet)

Total - Educating Society 4,200

3. Install Complaints Mechanism at Ministry of Fina nceDesign feasibility of having a interactive web portal 800Develop a new web portal catering for complaints 7,000Recruit staff providing assistance to consituency through phone-calls 30,000Total - Installing Complaints Mechanism 37,800

4. Perform on-the-spot reviewsRecruit additional staff at Ministry 65,000Launching on-the-spot visits 2,500Obtain feedback from practitioners after each visit 500Total - Perfroming on-the-spot visits 68,000

TOTAL COSTS FORECASTED FOR THE YEAR 2007 (A) 119,900

Analysis of Expected Income for 2007TOTAL REVENUE EXPECTED FROM FEES LEVIED FOR 2007 51,000TOTAL SUBSIDIES RECEIVED FROM GOVERNMENT 70,000TOTAL REVENUE FORECASTED FOR THE YEAR 2007 (B) 121,000

EXPECTED SURPLUS FOR PERIOD (B-A) 1,100



6.2 Avenues for future research

Part of the strength of any research projects lies in the recognition of its

limitations. This will identify potential issues that merit future work.

Primarily this study focused exclusively on audit partners to proxy for auditors

and audit committees as representatives of auditees. Future work that reveals

whether the results could be generalized across other groups of auditors and

external users would be interesting.

Secondly all attributes of audit quality were measured at one point in time, from a

static perspective. Recent corporate accounting scandals which have almost

certainly damaged the auditing profession may have altered the dynamics of

audit quality. It is interesting to note how such perception change over time.

Thirdly, this research project has identified the important role of audit staff and

teams play in delivering audit quality. Future work may wish to conceptualize a

personality profile and subject it to empirical testing. The development of such a

profile might assist audit firms to screen individuals seeking employment as

auditors.



6.3 Personal Learning and Reflection

Reflecting on the last six (6) months has been extremely difficult and tough to get

through this final dissertation. Having two sons and an expectant wife, made it

rather more difficult. But now as the finish line has been crossed, it is extremely

satisfying and a great relief to me and my family.

The process of writing a dissertation is a huge learning process and I have

gained a lot of knowledge in a subject which I do believe that can be used by

audit firms and sole practitioners alike. Being one of the persons performing on-

the-spot visits on audit firms, I am quite pleased with this study as I think that it

met my objectives of identifying a ‘generic’ set of success criteria in examining

financial audit quality. In fact the identification of these audit quality antecedents

will surely assist me when conducting the first reviews expected to be carried out

next year.

There were even some changes in the policy implementation at my place of work

following the exodus of this dissertation. In fact, original plans were that the Unit

performs on-the-spot visits with little regard to the educational aspect. However,

plans were altered to put awareness campaigns and practical development

initiatives as the foundations of audit quality in Malta. On an even more practical

note, this dissertation has also helped me to come into contact with the majority

of audit partners and audit committees, whom I really wish to thank for their kind

collaboration and sincerity expressed in this study.

From a personal point of view, the research has been challenging and rewarding

in so far as it has demonstrated how useful both interviews and questionnaires

are to reach an in-depth understanding of a theme, but also how difficult to

master. The attitude of the interviews was mostly positive and chairpersons were

very helpful in their participation. I had not realised how much time it takes to

handle an interview with subsequent transcribing and analysis and the process

could have been better planned. In hindsight, I would have planned the

interviews at a later stage as I discovered that it can be a problem if these are

carried too early in the process. I felt it as a constraint that the group of audit

committee was relatively small and as they revealed many similarities in their

attitudes to audit quality, it did not provide the rich varied material that I had

hoped for.



From a development perspective this study challenged my ability to apply and

critically appraise the latest theories and concepts to the real live situation, test

and assess their validity for myself and develop my own thinking as a result. On

one hand I am pleased that the hypotheses of this dissertation have been

confirmed, but on the other hand it is disappointing to see that some audit firms

are ill equipped to meet the taxing environment that we are living in.

Sincerely I do hope that such practical training recommendations actually

instigate enthusiasm in Maltese firms to revisit their methodologies and reckon

the importance of this professional cliché –‘audit quality’ that really has become

the nightmare of many. I wish to end this study by inaugurating all audit firms

success in their work and a brighter future in their day-to-day professional

demanding tasks.

- The End -

Henley Management College Appendices


C h a p t e r 7

APPENDICES

For the wise man looks into space and he knows there is no limited dimensions.

Lao-Tse, 1977



7 APPENDICES

Appendix A, Short Notes on Accountancy Profession Act’s Directives

Directive 1 - CPE

The first Directive - Continued Professional Education (CPE), establishes the

minimum thresholds that each and every warrant holder should abide with to keep

abreast of recent developments in the profession.

Directive 2 – Code of Ethics

The subject of the second Directive is the Code of Ethics applicable to all warrant

holders. This code incorporates three important elements namely the IFAC Code, the

EU Eighth Directive and the realities of the Maltese profession. It gives detailed

guidance to the practising accountant but is essentially a principles-based document

that, amongst others, sets out a number of situations that can threaten the integrity of

the accountant and the suggested safeguards that should be in place before

embarking on a course of action or engagement.

Directive 3 – Annual Return and Registration Fee

The Third Directive obliges accountants to send in a yearly return concerning certain

details about their firm or practice. The objective is to:-

• enable the Board to maintain a complete and updated register of warrant

holders including key data and information;

• obtain confirmation that warrant holders are abiding by relevant rules and

regulations;

• enable the Board to obtain information relating to those members engaged

in public practice together with a profile of their activities;

• assist the Board or its representative in the planning of quality assurance

reviews.



Directive 4 – Audit Quality

The Fourth Directive deals with ‘audit quality’. This Directive is aimed at improving

standards and wherever possible the system will be implemented to provide

assistance to practitioners who are found to lack sufficient command of and

adherence to, ethical, regulatory and technical compliance. It will lay particular

emphasis where the practitioner is delivering services to entities of particular interest

to the public such as financial and credit institutions, companies with publicly traded

securities and others that the Board may from time to time consider appropriate to

include in the list of public interest companies. The objectives of the quality

assurance system are listed below:

• To set out the minimum quality control standards to be adopted by warrant

holders engaged in public practice;


established appropriate quality control policies and procedures and that they

are complying with those policies;


complied with relevant professional standards for assurance engagements;

• To require warrant holders in public practice to make appropriate

improvements in their quality control policies and procedures, or in their

compliance with those policies and procedures, when the need for such

improvement is identified;

• Where warrant holders in public practice fail to comply with relevant

professional standards, to take appropriate corrective action, including

educational or disciplinary measures, as may be indicated by the

circumstances.



Appendix B, Questionnaire

Audit Quality (AQ) in Malta

Thank you for spending some of your precious time with this questionnaire.

I am writing my dissertation with Henley Management College, and thus close to the end of my studies, but I need your help to come to the rest of the way.

The dissertation is about the dimension of audit quality within the local Maltese context. This questionnaire will take approximately 15-20 minutes .

Your answers will be treated confidentially and used for the purpose of this study. Please indicate in your reply whether you would like to receive a concentrated version of the results from the survey. Your e-mail and your answers to the questionnaire will not in any way be linked.

I would also like to underline that although the questions are inspired heavily by international audit quality questionnaires and literature, they are my responsibility and any inconvenience related to the questionnaire rests solely on my shoulders.

I am very grateful for your assistance. This same questionnaire has been e-mailed to all other partners within 36 registered audit firms in Malta, and to all audit committees of the 27 companies quoted on the Malta Stock Exchange . Please do not hesitate to contact me if there are any questions on the questionnaire or you need any further clarifications.

Submission of Questionnaire

Please return your completed questionnaire to following e-mail address:

[email protected]

I hope to receive your answers preferably before the 9th November 2006 .

Once again, thank you for spending time on the questionnaire, and wishing you success in your work.

Yours Faithfully,



SECTION A - GENERAL INFORMATION Kindly complete the following table by filling in EITHER

• Column A if you are a partner within an audit firm OR • Column B if you are a member of an audit committee of a company quoted on MSE.

Please DO NOT fill in both columns.

COLUMNA COLUMNB

Type Who is filling this questionnaire?

Audit Partner

Member of an Audit Committee of Company quoted on Malta Stock Exchange (MSE)

Sex Male Female

Male Female

Age Less than 29 years from 30 to 39 years from 40 to 49 years from 50 to 59 years over 60 years

Less than 29 years from 30 to 39 years from 40 to 49 years from 50 to 59 years over 60 years

Industry

Not applicable

(e.g. Consumer product industry, Hotel industry, etc)

Size of your organisation (number of full-time employees)

Less than 10 employees from 10 to 25 employees More than 25 employees

Less than 10 employees from 10 to 25 employees More than 25 employees

Years working for organisation

Less than 5 years from 5 to 15 years More than 15 years

Less than 5 years from 5 to 15 years More than 15 years



SECTION B – AUDIT QUALITY (AQ) This section has been structured into 6 main parts of 10 statements each as follows:-

1. Audit Firm Culture

This relates to factors associated with general culture and values of an audit firm.

2. Partner Involvement

This relates to factors that are directly attributable to the engagement partner involvement and enthusiasm.

3. Audit Team Involvement

This relates to factors that build up the competencies of the individual auditor and the team.

4. Quality on the Field

This relates to factors that are directly attributable to the audit team competence when performing audit work.

5. Stakeholders’ Involvement

This relates to factors of interest to users of audited financial statements.

6. Managing Customer Relationships

This relates to satisfying the need of companies and managing directors.

On the basis of your general views about auditing, please rate the importance of each statement to audit quality, by ticking the number on the scale on the right. • If you think that such statements do not have any impact on audit quality, please tick number 1. • If you feel that a statement is very important for high audit quality, please select number 4. • If your feelings are less strong, please tick one of the numbers in the middle.

At the end of each part, you are requested to indicate which two of these ten statements are critical statements for audit quality in order of importance. Please do not spend too long thinking about each item – give the first nature answer that occurs to you. But at the same time, do not rush your responses or respond without giving due consideration to each item. Be honest and truthful with yourself and do not just say what you think good or acceptable. Do not miss any item, and select only ONE response for each statement given.



1) Audit Firm Culture Ref. Statements No impact

on AQ

(1)

Slight impact on

AQ (2)

Impacts AQ

(3)

Extreme impact on

AQ (4)

1.1 Audit firm operates to the highest standards of integrity.

1.2 Audit firm is independent of the board of directors.

1.3 Audit firm enjoys good reputation.


1.5 Audit firm is knowledgeable about the clients’ industry.



1.8 Audit firm uses avant-garde technology and knowledge management systems to assist it in retaining knowledge gathered from its audits.

1.9 Audit firm provides other non-audit services to the audited firm, including taxation, consultancy and general advice.


Kindly identify which are the (2) two most important statements in order of prior ity that have the largest impact on audit quality from the above.

1st important statement: Select One

1

2

3

4

5

6

7

8

9

10

2nd important statement: Select One

1

2

3

4

5

6

7

8

9

10



2) Partner Involvement Ref. Statements No impact

on AQ

(1)

Slight impact on

AQ (2)

Impacts AQ

(3)

Extreme impact on

AQ (4)

2.1 Engagement partner adopts high ethical standards.

2.2 Engagement partner is independent of the board of directors.


2.4 Engagement partner actively involves himself/herself in the engagement beginning from the initial planning throughout the audit process and completion.





2.9 Engagement partner is subject to internal review during the audit by other partners of the audit firm.




1

2

3

4

5

6

7

8

9

10


1

2

3

4

5

6

7

8

9

10



3) Audit Team Involvement Ref. Statements No impact

on AQ

(1)

Slight impact on

AQ (2)

Impacts AQ

(3)

Extreme impact on

AQ (4)





3.5 Audit team genuinely believe in the public interest purpose of the audit.

3.6 Audit team shares the same values of the audit firm, having a sense of belongingness and stewardship to their organisation.


3.8 Audit team has a clear understanding of roles of partners and staff on audits and that they are properly qualified to perform them.





1

2

3

4

5

6

7

8

9

10


1

2

3

4

5

6

7

8

9

10



4) Quality on the Field Ref. Statements No impact

on AQ

(1)

Slight impact on

AQ (2)

Impacts AQ

(3)

Extreme impact on

AQ (4)

4.1 There is a ‘good fit’ between the audit team, engagement partner and the finance director.

4.2 Audit team provides the client with individual attention.

4.3 Audit team creates the minimum disruption to the client so far as practically possible.




4.7 Audit team evaluates appropriate judgments made by their clients with rigour and professional scepticism.

4.8 Audit team files are reviewed by people with appropriate experience who will encourage alertness, originality of thought and a thorough investigation of anomalies.


4.10 Audit team uses information technology to liaise and obtain second opinions from the lead engagement partner directly on the audit fee.



1

2

3

4

5

6

7

8

9

10


1

2

3

4

5

6

7

8

9

10



5) Stakeholder’s Involvement Ref. Statements No impact

on AQ

(1)

Slight impact on

AQ (2)

Impacts AQ

(3)

Extreme impact on

AQ (4)


5.2 Audit firm provides the directors and officers constructive observations arising from the audit process.

5.3 Audit firm acts in the interest of shareholders while having regard to the wider public interests.

5.4 Audit firm with a strong reputation may imply higher credibility to users of audited financial statements.

5.5 Audit firms issuing audit reports with matters of interest to creditors and shareholders provide more assurance to stakeholders.



5.8 Employees of the companies are more willing to co-operate with auditors with good inter-personal and intra-personal skills.





1

2

3

4

5

6

7

8

9

10


1

2

3

4

5

6

7

8

9

10



6) Managing Customer Relationships Ref. Statements No impact

on AQ

(1)

Slight impact on

AQ (2)

Impacts AQ

(3)

Extreme impact on

AQ (4)


6.2 Audit firm communicates regularly and appropriately with client management and directors.


6.4 Audit firm is easily contactable (eg by email, internet, phone).

6.5 Audit firm is reliable in performing the promised service dependably and accurately.


6.7 Audit firm provides assurance about its knowledge, courtesy of employees and ability to convey trust.

6.8 Audit firm provides individual attention to customers.

6.9 Audit firm has a good image and communication material.




1

2

3

4

5

6

7

8

9

10


1

2

3

4

5

6

7

8

9

10



SECTION C - YOUR OPINION COUNTS This part contains 9 questions relating to your perception of the current context within the auditing profession. On the basis of your general views, please identify whether you agree or not with these statements, providing also your brief comments (if any). Ref. Statements Agree Do Not Agree Comments 1. Higher fees charged reflect higher quality of audit services.

2. Self-regulating profession runs a serious risk of conflicts of interests. An auditor can never be truly independent of those who have the power to sack you.

3. An audit firm should occupy a term of office for a fixed duration period of time indicated by law.

4. Audit firms who are not performing to the standards of quality are to be publicly disclosed by the relevant authorities.

5. Having an independent unit performing on-the-spot visits on all audit firms and practitioners performing audit work enhance audit quality.

6. The various components constituting audit quality is fully known in Malta.

7. Audit quality yield more costs than benefits for an audit firm to adopt and maintain.

8. Audit quality is a one-time effort by the firm to align its internal control procedures with best practices.



9. In the space below, please provide any other comments which you think are relevant to audit quality in the Maltese context.

You have reached the end!

Thank you in assisting me with your answers.

Write ‘Interested’ in the e-mail if you would like to receive a concentrated version of the results from the survey,

clearly indicating your preferred e-mail address.

Renzo Farrugia October 2006



Appendix C, Letter to Chairpersons of Audit Committees

Assistance in Preparation of Dissertation about Audit Quality

Date:

Messrs.,

As I am completing my dissertation on the MBA-Program with Henley Management College, I am in need of assistance from your Audit Committee and I hope for your obligingness and assistance in this study.

My dissertation is based on a qualitative approach using in-depth research interviews and I thus need to have an interview preferably with two members of the Board. I therefore kindly ask you for your participation in an interview of approximately one hour together with another member of the same board. The interview will be subsequently transcribed and used for the sole purpose of this dissertation. In the dissertation it will not be possible to link any statements or results to any audit committee.

To this effect, if you are able to schedule an interview during this month, you are welcome to suggest a time that will suit you. Otherwise, I will contact you on telephone to make an appointment.

Should you have any further queries, please do not hesitate to contact me.

Yours Sincerely,

Renzo Farrugia October 2006

Henley Management College Bibliography


C h a p t e r 8

BIBLIOGRAPHY

Words ought to be a little wild, for they are the assaults of thoughts on the unthinking.

John M. Kaynes, 1992



8 BIBLIOGRAPHY

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MBA Thesis Audit Quality