The Importance Of Audit Quality

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Audit quality is often defined as the probability that auditors will detect and report misstatements or unintentional measurement errors in the financial statements (DeAngelo 1981). This stems from an auditor’s competence and independence, in both how they are perceived and in actuality (Watkins et al 2004). This is of vital importance to analysts because financial statements form the basis of forecast inputs. The outcome of a financial analysis model can only be as accurate as the values used to create said model. As such, if input values are inaccurate, the output (forecasts) would no doubt also be erroneous. Dang (2004) argues that by limiting errors in the historical data used to formulate forecasts, high quality audits will improve the …show more content…

Specifically, the Big 4 auditors represent high audit quality and non-Big 4 firms represent low audit quality. This relies upon the assumption that the Big 4 always provide higher quality audits that communicate the reliability of unobservable financial reports. Of course, this does not mean to suggest that non-Big 4 firms intentionally deviate from US GAAP or other relevant reporting standards. Nevertheless, Teoh and Wong (1993) find that the amounts of deviation of the reported numbers from true economic levels are higher for non-Big 4 auditors. DeAngelo (1981) identifies the Big 4 firms as a suitable proxy for high audit quality as the brand name and size carry an assumption of a greater reliability due to technical expertise. According to Sori et al (2006), the Big 4 employees are more skilled and have access to better financial resources, research facilities, and technology. This grants them a competitive advantage to conduct large or specialised audits and greater ability discover errors or misstatements. This argument is supported by the low levels of accounting restatements issued as opposed to that of non-Big 4 auditors (Eshleman and Guo 2014), and by their extensive specialised training programmes (Khurana and Raman

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