Study Shows Better Audit Reports Lead to Better Audits

Expanded audit reports and audit committee reports have led to better audits in the United Kingdom, according to emerging academic research, perhaps because expanded reporting has given auditors more leverage over financial statement assertions.

As U.K. regulators began requiring more insightful audit reports and audit committee reports, U.K. companies began reporting fewer abnormal accruals and showed less tendency to just meet or beat analyst forecasts, the study shows, without significant increases in audit costs or time taken to issue audit reports. “Taken together, this study documents that the new auditor and audit committee reporting requirements are associated with a significant improvement in audit quality without detecting a significant incremental cost,” the study concludes.

The study comes from heavy hitters in the U.S. accounting an audit academic community -- Joe Carcello and Terry Neal at the University of Tennessee, and Lauren Reid and Chan Li at the University of Pittsburgh. They sought to find empirical evidence of how U.K. requirements around improving auditor and audit committee reporting have affected the audit, to lend data to the ongoing consideration of similar requirements in the United States. 

In the United Kingdom, the Financial Reporting Council changed the U.K. Corporate Governance Code and Guidance for Audit Committees to require the audit committee report to address significant financial statement issues that were discussed by the audit committee and how they were addressed. FRC also amended auditing standards to require auditors to include in their audit reports discussion of assessed risks of material misstatements, the materiality threshold, and the scope of the audit.

The Securities and Exchange Commission and the Public Company Accounting Oversight Board are considering similar requirements for U.S. companies and auditors. The SEC is taking a comprehensive look at a number of ideas for upgrading audit committee reporting, while the PCAOB is considering requiring auditors to provide narrative on “critical audit matters” that arose in the course of an audit.

The authors of the study said the reporting requirements introduced in the United Kingdom led to better quality audits, as measured by looking at unusual accruals and the tendency to just meet or beat earnings targets, without any real increase to audit costs. Even better, the authors note: “the improvement in audit quality without a corresponding increase in audit costs suggests that the increase in quality may be driven by the reporting requirements’ provision of greater leverage over management to the auditor and audit committee rather than the generation of additional audit work.”