Does Opinion Shopping Impair Auditor Independence and Audit Quality?

Topics: Financial audit, Audit, Research Pages: 6 (2355 words) Published: April 29, 2014
Audit Theory

Written Essay Assignment

Does Opinion Shopping Impair Auditor Independence and Audit Quality?

by:

Tong Lu

Journal of Accounting Research, Vol. 44, No.3 (Jun., 2006), pp.561-583

Additional articles:

Ghosh, A., Moon, D., (2005). Auditor Tenure and Perceptions of Audit Quality. The Accounting Review, Vol. 80(2), pp.585-612.

Myers, J. N., Myers, L. A., Omer, T. C., (2003). Exploring the Term of the Auditor-Client Relationship and the Quality of Earnings: Case for Mandatory Auditor Rotation? The Accounting Review, Vol. 78(3), pp.779-799.

1. Summary

In accounting as a scientific discipline there are three major specialty areas namely, financial accounting, management accounting and auditing. The article, which I will discuss in this essay, belongs to the auditing and financial accounting discipline and focuses on the independency of auditors and the quality of audit (reports). A lot have been written and there has been a lot of discussion yet about this subject, on which Tong Lu builds further in his article: ‘Does Opinion Shopping Impair Auditor Independence and Audit Quality?’ He tries to find and answer to the question whether the independence of auditors and the quality of audit (reports) are threatened by a certain practice, called opinion shopping. Lu describes this practice as ‘the involvement of the search for an auditor willing to support a proposed accounting treatment designed to help a company achieve its reporting objectives even though that treatment might frustrate reliable reporting’ (SEC (1988)). In approaching the research question he focuses on auditor switching, which in some cases is driven by opinion shopping. According to Lu this focus is because of two issues: audit quality and auditor independence. The former refers to the probability that the auditor will detect misstatements and the latter refers to the probability that the auditor will refuse to support detected misstatements. He builds further on research done by Dye (1991) and Teoh (1992) but stresses two differences between his article and the ones of them. In the model of Lu two opposing forces are introduced that influence the decisions made by auditors: the auditor fee and the legal liability. Whereas audit fees are potential auditor benefits from repeat audit business and non-audit services and legal liabilities are those that may be imposed on auditors when the rosiness of a client’s portrayal turns out to be gloomy. Auditors are to choose the quality of the audit in order to maximize the difference between the audit fee and legal liability minus the audit cost. After presenting the model, Lu continues his article with 4 sections in which he gives his results that lead to certain propositions. He starts with an outline of the firm’s reporting strategy, the auditor’s attestation (quality of the audit), and the capital market’s pricing rule. In this part he gives a formula that expresses the market price as a function of the market belief. He also stresses the tension between auditor fee and legal liability and whether the auditor decides to support the firm’s preferred report. Moreover, Lu makes a distinction from the point of view of the auditor between the practice of conservative accounting and aggressive accounting. He concludes that auditor aggressiveness may lead to overstatements and auditor conservatism to understatements. Because of that a rosy report from aggressive accounting is not as reliable as a rosy report from conservative accounting. And also the other way around, a gloomy report from conservative accounting is not as reliable as a gloomy report from aggressive accounting. In the fourth section about audit quality, two determinants of this variable are relevant: conservative accounting and aggressive accounting. Depending on the type, a larger auditor fee may cause a higher or lower audit quality (so not one way). A larger audit...
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