Auditing Teams

Dynamics and Efficiency

Mara Cameran, Angelo Ditillo, Angela Pettinicchio

• Publisher: Routledge
• Year: 2017
• ISBN:
  9781134825608
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

The recent audit failures which have rocked financial markets worldwide have accentuated the need for a better understanding of the link between risk, control and audit quality; as well as emphasising the need to open the "black box" of the ways auditing firms actually function. Reflecting these imperatives, Auditing Teams unravels the organizational and management issues in audit firms that are key to achieving effectiveness in service provision.

Specifically, this key research reflects upon the relevance and dynamics of auditing teams and their impact on auditing quality, and specifically responding to the recent claim from regulators which highlights auditing team characteristics as the source of wide variations in quality.

By leveraging different perspectives – auditing, management accounting, organization and psychology – to investigate auditing teams and basing on evidence collected from the professional world, this book will provide a unique insight into the role of auditing teams on audit quality.

It will be of great interest to scholars and advanced students in auditing, as well as to practitioners and regulators in the field.

1 Introduction

The audit failures that have shocked financial markets worldwide have accentuated the need for opening the “black box” of auditing firms’ functioning. With this premise, this book has the objective to explore the audit firms’ organizational and management issues that are key to achieve effectiveness in auditing service provision. More specifically, starting from acknowledging the knowledge-intensive nature of audit firms and illustrating the relevant characteristics of individual auditors, this work aims to reflect upon the relevance and dynamics of auditing teams and their impact on auditing quality. Our work represents a response to the recent claim from regulators that consider audit team characteristics as particularly important:

Based on more than ten years of oversight, the Board knows that, even within a single firm and notwithstanding firm-wide or network-wide quality control systems, the quality of individual audit engagements varies. PCAOB inspectors have observed a wide variation in the quality of auditing by many engagement teams.

(PCAOB 2013: 6)

An important distinctive element of our contribution is that it leverages on different disciplines (psychology, organization, auditing and management accounting) to investigate audit teams, and we complement our arguments with evidence collected from the professional world.

In our book, we examine the specific features of audit teams as well as their dynamics, which matter in terms of the final performance they are able to achieve. In particular, we analyze the impact of group characteristics, the interaction between individuals, and the corresponding forms of control adopted at the team level on audit quality. In fact, individual auditors do not operate in isolation and their behaviour depends on the dynamics activated within the audit teams in which they work.

These aspects could be of interest for both the academic and professional audiences. Therefore, our work is oriented to not only researchers in the fields of auditing and management accounting but also to practitioners operating in the audit and other professional firms as well as managers of auditees involved in the audit process.

The book is structured in six additional chapters after this one. The objective of the second chapter is to analyze auditing firms as professional service firms and describe their specifics. This type of firm combines a high degree of interaction with the client, together with a high degree of customization. For this reason, professional service firms compete simultaneously in two markets: the “output” market for the services, and the “input” market for the professional workforce. The aim of the chapter is to illustrate how auditing firms find balance between the conflicting demands and constraints of these two markets that constitutes the special challenge for the management of the professional service firms. This equilibrium is maintained through the firm’s economic and organizational structures as well as through the use of suitable management control mechanisms. These would allow, on the one hand, to achieve an appropriate balance between controlling audit costs and maintaining a high level of quality and on the other hand to prevent behaviours that can negatively affect audit quality. A description of these aspects as well as of the major variables that may affect their interaction will be provided and discussed.

The third chapter is focused on individual auditors. Regulators and professional bodies around the world are aware of the importance of auditors’ individual characteristics and set different requirements that people should meet in order to become certified auditors. All the above is in the spirit of serving the public interest by contributing to the ability of the auditing profession to meet the needs of the persons who rely on the opinion expressed in the audit reports. Also auditing firms consider people selection as one of their key processes. From an academic point of view, different contributors have questioned whether there are differences in individual auditor judgements and outcomes and what are the relevant individual characteristics for explaining these differences. A summary of this research is presented in the chapter. The literature implicitly assumes that the quality of the audit being undertaken by a team depends on the sum of the skills and personality of individuals. However, individual auditors do not work in isolation and are affected by the interaction within the audit teams in which they operate.

In Chapter 4 the literature on audit team composition and its effect on audit activity is presented, followed by an analysis of the literature on audit team dynamics, such as brainstorming and consultations within the firms. This chapter is complemented by a focus on professional practice and regulatory standards about audit teams. Reference will be made to audit standards and to professional practice via information disclosed in audit firms’ transparency reports, audit quality reports, and annual reviews.

Chapter 5 concentrates on the forms of control, including auditing quality controls and clan controls, adopted by auditing firms at the team level and the importance of communication in socializing auditing staff, relevant to enhancing the auditing teams’ level of performance. In addition, it illustrates the potential quality threatening behaviours that can be activated within the teams, as well as their potential determinants and consequences.

The aim of Chapter 6 is to report the voice of practitioners involved in the audit process, mainly collected by means of interviews. In particular, the chapter reports evidence from respondents with different roles within the Big 4 in relation to the following aspects: audit team composition and related criteria and policies to select the members of the teams; team dynamics and internal organization and management of the team; finally, team performance measurement and control as well as how team members are rewarded.

The last chapter draws from the arguments presented in the previous chapters, illustrating the main conclusions and providing the main implications of our contribution.

Reference

Public Company Accounting Oversight Board (PCAOB). (2013). Release No. 2013–009. Improving the transparency of audits: proposed amendments to PCAOB auditing standards to provide disclosure in the auditor’s report of certain participants in the audit. Retrieved from http://www.ey.com/publication/vwluassetsdld/pcaobproposal_transparency_4december2013/$file/pcaobproposal_transparency_4december2013.pdf?OpenElement

2 The management of auditing firms

Introduction

Auditing firms are categorized in the management literature as professional and knowledge-intensive firms (Ekstedt 1989; Starbuck 1992; Winch and Schneider 1993; Von Nordenflycht 2010). Therefore, the characteristics assigned to these categories of firms can be extended to the auditing firms, and are useful to understand their functioning. Auditing firms are professional service organizations, because their experts belong to a recognized profession (Von Nordenflycht 2010). A profession possesses at least four characteristics apart from expertise: an ethical code, cohesion, collegial enforcement of standards and autonomy (Schriesheim, Von Glinow, and Kerr 1977). Ethical codes require that professionals operate impersonally. They work as third parties to transactions and act on behalf of the various stakeholders that are interested in company accounts. To play this role they need to be independent and perceived as disinterested subjects. Professionals identify strongly with their professions; they not only follow the professional standards, but also they are convinced that only those that belong to the profession have the right competencies and ethics to enforce those standards (Starbuck 1992; Winch and Schneider 1993; Von Nordenflycht 2010). Auditing firms are also knowledge-intensive organizations. This is because they employ people in areas that require specific expertise. So their capital consists mainly of human capital even if part of the knowledge is institutionalized and localized in the organization as collective frames of reference, systematized methods of work and sophisticated routines (Ekstedt 1989; Starbuck 1992; Winch and Schneider 1993; Ditillo 2004).

The above elements have implications in terms of how auditing firms are organized and managed. First, in the design of these firms, the number of hierarchical levels is limited because coordination and control are achieved directly by professionals. Second, there is a constant tension between professional and organizational norms (Hinings, Brown, and Greenwood 1991). Third, there is a need to manage properly complex interpersonal dynamics inherent in the development and dissemination of knowledge within the firm and to define knowledge management strategies which influence the way in which the professionals operate within the firm (Morris and Empson 1998). Finally, in order to assess where and how value is generated, specific performance metrics are needed and are aimed at highlighting the productivity of people (Barber and Strack 2005). Much attention is focused on the time of professionals. The billed time ratio, which is the ratio of hours billed to total professional hours supplied, is monitored carefully. In addition, if it is necessary to employ idle time or for marketing reasons some engagements are billed at lower rates, the resulting variance is subject to close scrutiny (Anthony and Govindarajan 2007).

The management of auditing firms

Auditing firms operate in two different markets at the same time. On the one hand, they operate in the market of the services they provide. On the other hand, they act in the market for professional workforce. Balancing the tension between these two markets is achieved by means of the firm’s economic and organizational structures (Maister 1982). According to Maister (1982) the management of professional service firms requires the consideration of the various links that connect the two markets and the two structures.

• The market for professional labour. Professional service firms organize career paths along the three levels of partners, managers, and junior staff described previously. New entrants start at the bottom and progress through the organization. Two elements are particularly important in the functioning of this market: the normal amount of time necessary for being promoted and the proportion promoted. Auditors that are not promoted in what is considered a reasonable amount of time will either decide to leave the company or alternatively will be suggested to do so by those who do not think they are promotable (Maister 1982).
• The market for the firm’s services. This market has already been taken into consideration in relation to the link with the firm’s economic structure (by means of the billing rates) and with the organizational structure (by means of the project team structure). One key element that links this market to the market for professionals is represented by the quality of professional labour that the firm would like to hire and attract. Top professionals will be attracted by those firms that show that the projects in which they engage are challenging and those that provide major chances for professional achievements and developments (Maister 1982).
• The organizational structure. The structure’s key feature is that the national office of a firm is governed through a form of representative democracy. At the top there is a partnership body, which elects an executive policy committee. This latter typically represents major functional areas. Other committees are concerned with both major functional areas and managerial functions such as professional development, professional standards and marketing. One important element is that in the national offices there are committees of partners drawn from the field. In addition, employments at the national or international offices are often temporary appointments. National partners and national executive partners usually go back to the local offices after a predefined period of time. Moreover, most professionals aspire to partnership and most partners operate at the local office level. The reference for the activity and commitment is at the local and not the national office (Greenwood, Hinings, and Brown 1990). Normally, these firms are organized in three different levels. At the top are owner-partners who are in charge of managing the relationships with the clients and the policy and strategic orientation of the firm. At an intermediate level are the managers who are in charge of dealing with the day-to-day interaction with the clients and monitor the activities of the junior staff. At the lowest level are the junior staff who carry out the operating activities and some supervisory tasks (Maister 1982, 1993; Hinings, Brown, and Greenwood 1991). Because of their customized nature, the activities of the auditing firms are organized by combining members of the three levels described earlier in teams (Maister 1982; Anthony and Govindarajan 2007). These latter allow to combine the specialist knowledge of many individuals and to achieve effective integration while reducing the need of knowledge transfer through cross-learning by team members (Ditillo 2004). This means that junior staff collaborate with more senior auditors, and also that a rather clear-cut division of labour, both vertically and horizontally, is activated. Teams are organized in a way that allows members to have a clear idea of their own contributions (Kärreman and Alvesson 2004).
• The economic structure. Revenue generation in auditing firms is the result of the relative hours provided to the customers by the different levels of auditors in the hierarchical pyramid as well as of the various billing rates – the hourly charge to clients for the services provided by the different auditors. Cost occurrence is related to the remuneration assigned to the different auditors’ groups. One essential element in explaining the performance of auditing firms is related to the fact that the relative revenue generation levels do not correspond to the relative compensation levels. This imbalance is essential to understand the financial achievements of auditing firms. This means that the compensation of partners derives only partially from the high rates that partners can charge their clients. Partners’ rewards are to a large extent the result of the ability of the firm, by means of its project team structure, to leverage the professional knowledge of the seniors with the contribution of the juniors to satisfy clients’ needs (Maister 1982).

The management of professional service firms requires to achieve a balance between the previously described markets and structures. The firm cannot introduce changes in one of these elements neglecting the implications that these changes have on the other elements. Although many firms concentrate their attention on the design of their organizational and economic structures, these analyses must be carried out by integrating them with the market for the firm’s services and that of professional labour forces (Maister 1982, 1993).

The management control in auditing firms

Auditors have to put a reasonable level of competencies, concentration, and attention in carrying out their work. To this end, auditing standards and guidelines suggest principles and procedures to achieve this level and also require auditors to plan and control their activities effectively. High professional standards alone, however, are not enough to guarantee the outcomes of auditing firms and their durability. Long-term success is also the result of the implementation of effective management controls (Otley and Pierce 1996; Sweeney and Pierce 2004; Pierce and Sweeney 2005; Anthony and Govindarajan 2007).

The management accounting suggests different types of controls that can be implemented in organizations (Merchant 1998; Simons 2014; Drury 2016; Merchant and Van der Stede 2016):

• Action or behavioural controls. These controls are related to the definition, observation and monitoring of the behaviours of individuals during their work. They can take different forms: behavioural constraints, to prevent individuals from performing all or a portion of specific acts in the form of physical constraints (e.g. passwords) or administrative constraints (e.g. restriction of decision-making authority or separation of duties); pre-action reviews, to approve or disapprove the proposed plans, ask for modification, or require a ...