Acknowledgment: helpful comments on earlier drafts of this thesis were given by my colleague students in the MSc Accountancy, Anouk Tolsma and Beryl Dekker. The comments of anonymous reviewers are also much appreciated.
Supervisor: prof. dr. D.A. de Waard RA
The Usefulness of the Extended Auditor’s
Report for Small Investors: A Qualitative
Approach
Ruben N. Hoving
University of Groningen
ABSTRACT: In 2014, the NBA, answering a call from society for more transparency, issued a new audit standard which mandates auditors to issue an extended auditor’s report. This thesis contributes to current literature by focusing on the effects of this standard on, technical audit quality, auditor independence, and perceived audit quality, both from an auditor and an investor perspective. This thesis describes the usefulness of the extended auditor’s report for small investors from a qualitative approach using grounded theory by interviewing one member of the NBA, eleven auditors and eight investors. The results suggest, firstly, that the extended auditor’s report informs investors about the audit approach and guides them to important aspects in the annual report. Moreover, results suggest that the extended auditor’s report provides small investors context to the critical aspects of an audit. Secondly, auditors perceive a convergence of the content of the auditor’s report: on the one hand by a changing focus of the independent market conduct authority (AFM) and on the other hand by analyzing content of other auditor’s reports. Convergence of materiality affects the auditor’s substantive analytical procedures and thus technical audit quality. In addition, materiality affects the reporting threshold to the board and indicates a change in auditor independence. Lastly, results suggest that investors perceive an increase in audit quality due to extra regulations and close supervision.
Keywords: Extended auditor’s report; Key Audit Matters; Materiality; Audit quality; Small investors.
TABLE OF CONTENTS
I. INTRODUCTION ... 3
II. INSTITUTIONAL BACKGROUND AND LITERATURE REVIEW ... 6
Audit Reporting Model ... 6
Audit Quality ... 7 III. METHODOLOGY ... 9 Data Collection ... 9 Data Analysis ... 11 IV. RESULTS ... 13 NBA ... 13 Auditors ... 13 Investors ... 18
V. DISCUSSION AND CONCLUSIONS ... 21
REFERENCES ... 24
APPENDICES ... 28
Appendix I: Interview questions NBA ... 28
Appendix II: Interview questions auditor ... 30
Appendix III: Interview questions investor ... 32
Appendix IV: All codes used ... 34
Appendix V: Memos used in grounded theory ... 36
Memo 1 Results auditors 1 ... 36
Memo 2 Results auditors 2 ... 37
I. INTRODUCTION
he auditor’s report has been under discussion by the business press since the late 19th century (Chandler & Edwards, 1996). In recent years, many studies have been published regarding the change of the auditor’s report (Gutierrex, Minutti-Meza, Tatum, & Vulcheva, 2016; Lennox, Schmidt, & Thompson, 2016; Reid, Carcello, Li & Neal, 2016), as introduced by the Financial Reporting Council (FRC) in the United Kingdom and Ireland in 2013 (FRC, 2013). This standard mandates significant changes in the auditor’s report, which requires auditors to describe (1) significant risks of material misstatements, (2) the materiality maintained in the audit, and (3) the scope of the audit. The key reasons for this change are improving auditor’s transparency and audit quality (FRC, 2016a). The Dutch auditors’ association (Nederlandse Beroepsorganisatie van Accountants, hereafter: NBA) adopted this standard for Dutch public interest entities in 2014.
Investors make use of the annual report to determine the fundamental value of a company (Scott, 2015). An audit opinion helps investors to determine the reliability of the annual report (Coram, Mock, Turner, & Gray, 2011). In addition, Menon and Williams (2010) found empirical evidence that investors react to the independent auditor’s opinion modified for going concern. The results suggest that the going concern audit opinion provides information for investors who thereafter negatively value the company. Libby (1979) discussed in his paper that investors value qualified or disclaimed auditor’s reports largely negatively in contrast to a ‘normal’ unqualified report which is hardly values positively. This has also recently been tested for the Italian market and confirmed by Ianniello and Galloppo (2015). However, these studies do not specify if small (private) investors make use of the extended auditor’s report. In addition, according to Ball and Brown (1968) and Foster, Olsen, and Shevlin (1984), financial information is, at the moment of the announcement, already incorporated in the price of the stocks. Subsequently, the question arises, as to the usefulness of the annual report when the information in the annual report is already incorporated in the price of the company at the moment of presentation of the annual report. However, for small investors, this access to additional information is limited, because they do not have the resources that institutional investors have (Mock, Bédard, Coram, Davis, Espahbodi, and Warne, 2012). Besides the abovementioned questionable information on usefulness, auditors nowadays are hesitant to disclose information, because of litigation risks. This results in generic risk descriptions without detailed explanations (FRC, 2016b). Based on Cox, Dayanandan, and Donker (2014) disclosing information about materiality positively impacts the perception of the auditor’s risk of litigation. This is due to the fact that investors and analysts do not understand what (the change in) materiality means for the company and the possible related risks (Cox et al., 2014). Therefore, the main research question is this thesis is:
RQ: How is the extended auditor’s report useful for small investors?
The answer to this research question comes in two parts. The first part is about determining the usefulness of an extended auditor’s report in general and the second part is about the usefulness for small investors.
This research contributes to the existing literature about the audit reporting model. The main focus of current research is quantitative and uses total financial market response (Earnings Response Coefficient, hereafter: ERC) as a variable to investigate investor responses (Bédard, Gonthier-Besacier, & Schatt, 2014; Lennox et al., 2016; Reid et al., 2016). This study provides a qualitative view on the current debate about the extended auditor’s report, which is particularly interesting for the small
T
investors as users of the extended auditor’s report, because this view has not specifically been researched yet.
This research also contributes to the audit quality literature. Reid et al. (2016) suggests that this regulatory change (the extended auditor’s report) affects technical audit quality without significantly incremental costs. The proxy for audit quality in this study was absolute abnormal accruals and the propensity to just meet or beat analyst forecasts. They suggest that audit quality is inclined by changes in audit committee requirements. Higher audit quality can derive from a better conducted audit (technical audit quality) (DeAngelo, 1981a) or from the way auditors are demanding management to make adjustments (auditor independence) (Antle & Nalebuff, 1991; Nelson, Elliott, & Tarpley, 2002; Watts & Zimmerman, 1981). In prior studies, it is hard to distinguish if technical audit quality or auditor independence improves, because of the use of proxies for audit quality (e.g. Carcello & Li, 2013; Carey & Simnett, 2006; Francis & Krishnan, 1999; Heninger, 2001; Jones, 1991; Kinney, Palmrose, & Scholz, 2004; Lennox, 1999; Weber & Willenborg, 2003). An example of this is that Carcello and Li (2013) found evidence that the audit quality increases when the audit engagement partner has to sign the auditor’s report instead of just disclosing his/her name. There was a regulatory change in the UK in 2009, which mandated audit engagement partners to sign the audit report. They used abnormal accruals and the likelihood of meeting an earnings threshold as proxy for audit quality. Using abnormal accruals in this case does not distinguish auditor independence from technical audit quality. Furthermore, literature distinguishes another form of audit quality, namely perceived audit quality. This is the perception of quality of users of the auditor’s report. A common proxy for perceived audit quality is the earnings response coefficient (ERC). Teoh and Wong (1993) found evidence that investors perceive a higher audit quality for audits done by Big N audit firms and therefore have a higher ERC. In addition, Ghosh and Moon (2005) found evidence for auditor tenure as determinant for perceived audit quality by using ERC. In conclusion, this research contributes to a better understanding of the different dimensions of audit quality, since literature is still inconclusive about a definition of audit quality (IAASB, 2011). This research examines the expected increase of audit quality after adoption of the new standard by interviewing standard setters, auditors and investors.
Another academic contribution is the selection of solely Dutch listed firms. Previous studies examined the reaction of investors in the United Kingdom on the new standards (e.g. Gutiettex et al., 2016; Lennox et al., 2016; Reid et al., 2016). It is interesting to compare the results of this study with the United Kingdom market, because of differences in investor protection (La Porta, Lopez-de-Silanes, Shleifer, & Vishny, 2000). La Porta et al. (2000) found evidence that the United Kingdom (common law) and the Netherlands (code law: French law) have different forms of investor protection and accounting standards. The quality of the accounting standards in French law countries (the Netherlands) is the least in comparison with other legal origins (e.g. common law countries). This implies that the information value of Dutch auditor’s reports for investors is less and investors can rely less on this source of information. However, since the adoption of IFRS in 2005 for Dutch listed firms the accounting standards have improved and should have mitigated the differences in accounting quality. Nonetheless, Soderstrom and Sun (2007) reviewed the evidence provided by literature regarding the adoption of the IFRS standards and concluded that the differences in accounting quality maintained, because of the institutional setting and political system of the country where audit firms operate. This thesis provides a current view on reporting quality perceived by Dutch auditors and investors.
Next to contributing solely to academic literature, this study is also relevant in practice. The findings of this study can be of interest to Dutch and international regulators considering changes to the
audit reporting model, because of the change in audit quality, auditor independence and usefulness for small investors as users of the extended auditor’s report.
The next section describes the audit reporting model and related research. Section III describes the methodology. Section IV reports on the findings. Section V discusses possible directions for future research and concludes the thesis.
II. INSTITUTIONAL BACKGROUND AND LITERATURE REVIEW Audit Reporting Model
The current audit reporting model derives from agency theory (Jensen & Meckling, 1976). Due to the separation of ownership and control of companies, shareholders (principles) have an interest in alignment of the managers’ (agents) goals with their own goals. As a result of separation of ownership and control, information asymmetry arises because managers have more inside information than shareholders (Healy & Palepu, 2001). Agency theory outlines the relevance of incentives and information systems. The current auditor’s report is an information system for shareholders to reach a certain level of assurance about the financial statements. Church, Davis, and McCracken (2008) give insight into the development of the auditor’s report, from an unstandardized certified report in the early days of auditing to a standardized opinion of the auditor on the financial statements and on internal control nowadays. This change is initiated by regulators, because of recurring accounting scandals (e.g. stock market crash in 1929 and Enron collapsing in 2001). To gain insight in the usefulness of the audit reporting model, many empirical studies are conducted to assess the market reaction to the auditor’s report (Church et al., 2008). Results indicate that the market reacts negatively to nonstandard auditor’s reports (Cheng, Ho, & Tian, 2006; Taffler, Lu, & Kausar, 2004).
The content of the auditor’s report is shaped by an expectation (gap) of users, as the perception of what users think the role of the auditor is and the perception of the auditor of this role differs (Humphrey, Moizer, & Turley, 1992; Porter, 1993). “Half of the gap (50%) is attributable to deficient standards, 34% results from society holding unreasonable expectations of auditors, and 16% derives from perceived sub-standard performance by auditors.” (Porter, 1993, p. 66). Humphrey et al. (1992) describes two strategies to reduce the gap: (1) education to gain reassurance of the public and/or (2) change audit procedures to meet the public needs. The new standard (FRC, 2013) is an attempt to reduce the current audit expectation gap (hereafter: expectation gap) in changing audit procedures. The changes introduced by the new standard are that the auditor should describe (1) significant risks of material misstatements, (2) the materiality maintained in the audit, and (3) the scope of the audit.
The first change in the extended auditor’s report is the description of risks of material misstatements (Hereafter: Key Audit Matters) (FRC, 2013). The effects of disclosing risks of material misstatements in literature are inconclusive. Firstly, Christensen et al. (2014) studied the reaction of nonprofessional investors to the Key Audit Matter (KAM) in an auditor’s report. They used business school graduates in their experiment to study the initial reaction to a single KAM and their subsequent reaction to multiple KAMs. They found a positive effect when a single KAM was shown, but this effect was reduced when participants read multiple KAM paragraphs. Another recent study, conducted by Lennox et al. (2016) investigated individual investors’ responses to disclosed risks of material misstatements. They found no significant effect in the short-window, neither in the long-window market reaction. They argue that the risks are mitigated by extensive audit procedures on the one hand and that management already disclosed these risks through other channels (e.g. earnings announcements, conference calls) on the other hand. Finally, Köhler, Quick, and Willekens (2016) provide two other explanations. Firstly, auditors do not disclose certain risks, because they want to avoid difficult discussions with the board and/or secondly, because the risks could become a boilerplate and will not contain company specific elements.
The second change is the disclosure of the materiality maintained in the audit. In experimental studies, researchers found a positive relation between materiality disclosure and market efficiency (Davis, 2007; Fisher, 1990). However, they state that it is hard to say if these findings hold in complex
market settings. A recent study conducted by Christensen, Eilifsen, Glover, and Messier (2018) found empirical evidence that investors struggle to understand materiality disclosures.
The third change is disclosure regarding the scope of the audit. Manson and Zaman (2001) surveyed auditors, preparers and different users to investigate the expectation gap. They recommend that the auditor discloses more about the scope of the audit to reduce the expectation gap, because users, in contrast to auditors, strongly agree that such information is helpful for users to give impressions, provide guidance, and enhance audit quality. Users agree that auditors should report findings regarding fraud or illegal acts, the extent to which the auditor relies on internal controls, and the extent of their examination of the Directors’ Report and the Operating and Financial Review.
The FRC (2016b) reviewed the changes that are stated above. In contrast to the abovementioned empirical evidence, they discussed the changes with investors and concluded that investors greatly value the enhanced information the extended auditor’s report provides. They suggest that the information is particularly valuable when assessing companies when there are fewer sources of information (smaller companies). In addition, FRC (2016b) also reported that investors would like to see the explanation of the auditor about the changes from this year in perspective to last year for all above mentioned aspects. Lastly, FRC (2016b) mentioned that the extended auditor’s report enhances audit quality.
Another aspect that effects the content of the extended auditor’s report is institutionalization. DiMaggio & Powel (1983) conducted a study towards three types of institutionalization, namely mimetic, coercive and normative isomorphism. Bolk (2018) and Boven (2018) conducted an empirical study towards the effect of isomorphism on the content of the audit report and concluded that coercive and mimetic isomorphism are in place. This means that according to theory, formal and informal pressures and uncertainties shape the content of the audit report. The results suggest that the content of the extended auditor’s report is converging to each other and lose information value. However, these studies are rather new and further research has to be examined to underpin these findings.
Audit Quality
As stated earlier, research shows that (small) investors make decisions based on the auditor’s report (Scott, 2015). The (perceived) quality of the audit affects the value judgment of the investor. Audit quality is very broadly defined by several authors, but no single definition is widely accepted, however DeAngelo (1981a) is often the starting point of the discussion. She found evidence that audit firm size positively effects audit quality due to quasi-rents and because large audit firms have ‘more to lose’, because of a greater number of clients. She defined 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, 1981a, p. 186). This refers to the technical audit quality (be able to detect a misstatement) and auditor independence (reporting it). DeAngelo (1981a) also highlights the fact that audit quality is hard to evaluate, because of the heterogeneous characteristic. Due to the fact that audit quality is hard to assess, clients want auditors to maintain a certain level of quality (perceived audit quality). Perceived audit quality is often related to as the perception of audit quality of users of the auditor’s report (Ghosh & Moon, 2005; Teoh & Wong, 1993).
Audit quality and earnings quality are often used interchangeably (Chi, Huang, Liao & Xie, 2009; Myers, Myers and Omer 2003). As audit quality is a result of auditor’s work, it is determined by
many variables. Francis (2004) reviewed the empirical evidence of audit quality over the last 25 years. Audit quality is measured in many different ways: the amount of modified auditor’s reports issued in case of a going concern (Carey & Simnett, 2006; Francis & Krishnan, 1999), earnings accuracy (Lennox,
1999; Weber & Willenborg, 2003), auditor litigations (Heninger, 2001), earnings benchmark beating (Carey & Simnett, 2006), and earnings restatements (Kinney, Palmrose, & Scholz, 2004). Most often, audit quality is measured by making use of absolute or signed abnormal accruals (Carcello & Li, 2013; Jones, 1991; Teoh & Wong, 1993). Using abnormal accruals as proxy for earnings quality is widely accepted in literature (Healy & Wahlen, 1999).
Francis (2004) describes that audit quality is different for small audit firms and Big N firms, audit firm industry specialization and audit firm cross office differences (contextual factors). He also describes that other approaches to study audit quality are focused on auditor tenure, audit fees, audit committees, alumni in senior management positions and the effect of legal systems on auditor incentives (psychological factors). Contextual factors and psychological factors affect the professional behavior of the auditor (Gul, Wu, & Yang, 2013). Individual auditor characteristics influence audit quality. Gul et al. (2013) found evidence for education, gender, Big N experience, age, rank in the audit firm and political affiliation affecting audit quality.
Lastly, auditor independence effects audit quality. According to DeAngelo (1981b) audit quality is effected by auditor’s perceived ability to withstand client pressures to disclose information and suggests that the optimal level of independence is less than perfect independence. Auditor independence is defined in literature as the conditional probability of reporting a material misstatement (DeAngelo, 1981b; Watts & Zimmerman, 1981). Ashbaugh, LaFond, and Mayhew (2003) researched certain threats to auditor independence and concluded that no significant threats can be observed (e.g. non audit services and fee ratio) with respect to other research performed by Frankel, Johnson, and Nelson (2002). However, as a result of a number of financial reporting scandals (e.g. Enron and Ahold) and the importance of an independent auditor (Healy & Palepu, 2001), the NBA designed regulations regarding independence (in Dutch: ViO) to secure the independence of auditors towards an audit. This study uses the concept of auditor independence to describe the perceived ability to disclose material misstatements. As FRC (2016a) indicates, the main reason for adopting the new standard was enhancing auditor’s transparency and audit quality. This research distinguished audit quality perceived by investors from audit quality perceived by standard setters and auditors. It is interesting to see whether audit quality improves as result of the new standard and enhances market efficiency as proposed by Francis (1990).
III. METHODOLOGY Data Collection
The main method used in this study is a qualitative research method. To start with, I have critically read a random selection of approximately 20 extended auditor’s reports of Dutch listed companies issued from 2013 to 2016. furthermore, an overview of all issued KAMs per company1 is
drawn up to review its content. Based on this data, a colleague thesis writer and I performed a brief analysis (on percentage of recurring KAMs, number of KAMs, on the content, materiality benchmarks and wording of the scope of the audit). The content of the extended auditor’s report is the basis for explorative research. I will try to find new relationships and discover new facts about the extended auditor’s report. Based on the reports and the theoretical framework, I designed and conducted interviews with concerned parties. The interviews were built up with grounded theory (Parker & Roffey, 1997). Parker and Roffey (1997) reviewed the major accounting and management journals over the past ten years and concluded grounded theory is potentially valuable in a qualitative interpretative field research. Grounded theory develops a theory from the data rather than developing a priori theory. Corbin and Strauss (1990) developed eleven canons and procedures that have to be followed to be able to draw conclusions from grounded theory, an overview is given in Figure 1. The data is collected and analyzed following these guidelines. Each canon/procedure will be indicated with a step, however a preferred sequence of events is not inferred. In the last column of Figure 1 the relation between the canon/procedure and the respective action(s) of the researcher is described.
The data is collected by conducting semi-structured interviews. This means that I asked a series of questions according to the interview guide, which are provided in Appendix I, II, and III. In a semi-structured interview, I was able to ask follow-up questions regarding each concept. Each interview is critically assessed and (re)designed (step 1) based on the analysis of the data. This enabled the research process to capture all potentially relevant aspects (Corbin & Strauss, 1990). In this case, semi-structured interviews are better than structured interviews, because new aspects can come to light during the interview which require relevant follow-up questions. Likewise, an unstructured interview is also not to be preferred, because this method makes it hard to make connections between interviews. Questions from one interview to another changed due to several reasons. In most of the cases the questions had some different wordings, but had the same purport. In a couple of cases, I skipped a question, because the question had already been answered by the interviewee. Furthermore, additional questions were asked occasionally, because some extra information had been provided by the interviewee and I was either interested to follow that line of reasoning or because of my experience of an answer provided by an earlier interview. In a couple of cases the question evolved and became more specific, because in previous interviews the given answers where too broad. Finally, in a couple of cases I was not able to ask all the questions I wanted to ask due to time issues.
Based on incidents or activities that came to light during the interviews and observations from the extended auditor’s reports, concepts are defined (step 2). “Each concept earns its way into the theory by repeatedly being present in interviews, documents, and observations in one form or another” (Corbin & Strauss, 1990, p. 7). Furthermore, the sampling of the interviews was based on theoretical grounds. To assess the usefulness of the extended auditor’s report for small investors, interviews are held with concerned parties of the extended auditor’s report (step 4): standard setters, auditors and a specific group
of users of the report. Interviews are held with the members of the NBA statements committee2, because
they have set the wordings of the extended auditor’s report. The line of reasoning of the NBA is interesting to follow, because this helps to better understand the subject and whether to assess if the small investor was/is a party of interest for the NBA. Furthermore, Dutch chartered auditors (in Dutch: RA) are interviewed. The selection of eleven Dutch chartered auditors is done based on a selection of Dutch listed firms on the AEX-index at Euronext Amsterdam. Firms which received an independent auditor’s report over fiscal year 2016 from Big N audit firms were selected. Eleven auditors are a repetitive group, because most auditors had experience with more than one public listed firm and due to the time constraint of this thesis no more auditors were selected. The Dutch chartered auditor is held accountable for the content of the extended auditor’s report. This makes them a rather interesting party to study, because they have to apply the new standard to maintain high audit quality and meet investor expectations. Their perception on perceived increase of audit quality is the starting point for the last group of interviews. This last group was a set of eight small (individual) randomly selected investors3.
The latter interviews will be used to test propositions that derived from the interviews with auditors.
2 With the NBA committee I refer to the workgroup statements (in Dutch: werkgroep Verklaringen). The
workgroup consists of six members.
3 Small (individual) investors are selected out of the member base of the Dutch Association of
Stockholders (in Dutch: Vereniging van Effectenbezitters). This association advocates the interests of
Step Canon/procedure Link to this research
Step 1:
Step 2: Concepts Are the Basic Units of Analysis Use related theories Step 3: Categories Must Be Developed and Related Use open codes
Step 4: Select the sample
Step 5: Analysis Makes Use of Constant Comparisons Use open codes Step 6: Patterns and Variations Must Be Accounted For Use axial codes Step 7: Process Must Be Built Into the Theory Use axial codes
Step 8: Use memos (see appendix V)
Step 9:
Step 10: A Grounded Theorist Need Not Work Alone Discus findings Step 11: Broader Structural Conditions Must Be Analyzed, Use selective codes
However Microscopic the Research
Use axial codes and redesign interview questions
(Re)design interview questions based on theory and findings
Hypotheses About Relationships among Categories Should Be Developed and Verified as Much as Possible during the Reasearch Process
Writing Theoretical Memos Is an Integral Part of Doing Grounded Theory
Data Collection and Analysis are Interrelated Processes.
Sampling in Grounded Theory Proceeds on Theoretical Grounds
FIGURE 1
An Overview of the Canons and Procedures Followed in Grounded Theory Developed by Corbin and Strauss (1990)
Data Analysis
“The data analysis begins as soon as the first bit of data is collected” (Corbin & Strauss, 1990, p. 6). Each interview is transcribed4 to reflect what is said. After each transcription is made, I have reread
it to improve my understanding of the interview. In grounded theory three types of coding exist: open, axial, and selective coding (Corbin & Strauss, 1990). The different types of coding used to analyze the data will be elaborated respectively to the step it is related with. During the coding process, I tried to use unique codes to specifically describe the content of the data, all codes are set out in Appendix IV: All codes used.
In order to develop theory, concepts drafted from the interviews are grouped and form categories (step 3). Over time, these categories can become related to one another to form a theory. Braun and Clarke (2006) are often cited when laying links between themes during a research process, they described advantages and disadvantages when doing such an analysis. In the end they concluded that thematic analysis is not a complex method and helps answering the research question. Despite the fact that it is not complex, I have discussed the codes with my colleague researcher as described in step 10 to verify my results with her research findings.
Each incident that occurs is compared with other incidents (step 5) (Corbin & Strauss, 1990). An incident is nothing more than an occurrence of a concept. Comparing the incidents bases on similarities and differences helps to define concepts. Open coding helps with this process. Open coding is achieved by grouping similar events/actions/interactions under an “open” code. Once identified, categories and their properties become the basis for sampling on theoretical grounds. Corbin and Strauss (1990) suggest to put an emphasis on these categories in the following interviews. In addition, Corbin and Strauss (1990) point out that the researcher must examine the data for regularity and for an understanding of where that regularity is not apparent (step 6). In other words, be critical in finding patterns and routines. In addition, process analysis (step 7) is needed to get a better understanding of the phenomenon (Corbin & Strauss, 1990). This has been done by examining process (inter)actions and trying to sequence them. In this case there is limited use of processes, so I put an emphasis on examining the interests of the different interview groups. During the coding process, writing theoretical memos (step 8) is necessary to keep track of the analytical process according to Corbin and Strauss (1990). Memos helped me to formulate and revise theory during the research process, and are outlined in Appendix V: Memos used in grounded theory. The format of the memos is free and should be seen as a tool. Nevertheless, the content of the memos should be primarily evidence based. The memos used in this study helped to retain an overview of the axial codes and related open codes.
Based on the concepts, routines, processes and theoretical memos, expectations were hypothesized/proposed (step 9) (Corbin & Strauss, 1990). Relationships among categories were developed and verified as much as possible during the research process. This means that I tested certain the expected relationships during the interviews. This resulted in verified or revised propositions that held true for all phenomena under study. I therefore also consult the extended auditor’s report and verify
approximately 42.000 individual stock investors since 1924. In addition, investors out of the network of prof. dr. D.A. de Waard RA where contacted, to increase the sample.
4 The interviews and transcriptions are in Dutch, because this is the working language of the interviewer
and interviewees. When doing the interviews in Dutch it is more likely to capture all aspects, because no one is restrained by a language barrier.
the hypotheses. Axial coding helps with this process (Corbin & Strauss, 1990). In axial coding, categories were related to their subcategories, and the relationships tested against new data.
To increase theoretical sensitivity, the concept testing is done with a colleague thesis writer (step 10) (Corbin & Strauss, 1990). Before, between and after the interviews, discussions with her have led to new insights and acted as a supportive resource. However, these discussions were not transcribed neither extensively disclosed in this thesis. When analyzing the problem, broader structural conditions (step 11) were analyzed as well (Corbin & Strauss, 1990). This means that certain conditions could affect the phenomenon. Corbin and Strauss (1998) developed a Conditional/Consequential Matrix to help identify these different conditions. The matrix starts with individual conditions to create context, followed by group, family, sub-organizational, organizational, institutional, community, national, regional and, finally global conditions that could affect the main phenomenon. During this phase in the research, selective coding takes place (Corbin & Strauss, 1990). This coding process unifies all categories around a “core” category. This category is the main phenomenon of the study.
IV. RESULTS NBA
An interview is conducted with one high tenured member of the NBA statements committee and the interview is therefore not a representation of official assertions. The main reason for the NBA to adopt the extended audit report was to reduce the expectation gap after the credit crisis in 2008. The expectation gap as projected by the interviewee:
“The audit report for a failing systemic bank or for a small production company were identical and that was very hard to explain to society.”
The NBA wanted to be ahead of international legislations and created its own legislation, based on international initiatives (IFAC, IAASB, United Kingdom). This legislation provided auditors a way of communicating company-specific key audit matters in the audit report and organizations would feel more compelled to disclose information in the annual report and in the management board report. In addition, disclosing materiality and scope of the audit helps to point out (again) that the annual report gives a true and fair view and is not audited up to the last cent, because this was not always clear to society. Introducing new laws and legislations should enhance technical audit quality, auditor independence, and perceived audit quality, because the reporting requirements increase. As argued by the interviewee, small investors are just one group of intended users and the subject is too comprehensive to only focus on that group.
Auditors
I want to present an overall picture of the perception of auditors regarding the extended auditor’s report. The auditors who participated in this study have a broad experience in issuing the extended auditor’s report. This is reflected in the way that some auditors participated in the pilot-year in 2013, other auditors are responsible for different listed companies and almost everyone issued the auditor’s report for a company for different years. Five auditors point out, without bringing up the issue, that costs are involved to draft an extended auditor’s report. The overall conclusion is that significant costs are involved in coming with the appropriate phrasing. This is in contrast with Reid et al. (2016), who stated that no significant incremental costs are incurred when issuing an extended auditor’s report.
Auditor’s report
The extended auditor’s report is part of a larger transition to disclosing information and being more transparent as an auditor. The extended auditor’s report is just a small element in the overall debate about the expectation gap. It is unclear to society what work is performed by auditors. To determine the usefulness for the intended user, all auditors point out that there is not one general user. There are different user groups: shareholders, management, the board, employees, AFM, the VEB, Eumedion and various other stakeholders. The extended auditor’s report helps point out the size of the expectation gap and possibly reduce a part of this gap, but that should be determined by society itself. As auditor 5 points out, it is in the interest of the intended user to sometimes put emphasis on the gap. The content of the extended auditor’s report helps to concretize the overall debate. As auditor 3 indicates:
“The extended auditor’s report points out the work auditor’s performed in the audit and raises questions upon the intended users.”
The content of the extended auditor’s report raises questions from investors at the Annual General Meeting of shareholders (hereafter: AGM), because auditor’s provide investors with information and this information is not always clear to all investors. However, as auditor 7 points out, only 1.5% of total shares of a particular Dutch listed firm is held by Dutch shareholders and as shareholders appoint the members of the board, the board challenges the auditor about the content of the auditor’s report. In addition, the VEB and Eumedion as representatives of investors, also challenge the auditor during an AGM. Several auditor’s point out that the extended auditor’s report serves different purposes. On the one hand, informing the intended users about KAMs, materiality and scope of the audit and try to reduce the expectation gap. On the other hand, KAMs guide intended users to critical issues in the audit and the corresponding account in the annual report, so users do not have to read the integral annual report, but only the parts that have the interest of the auditor.
Content
Among auditors, the opinions about the effects and the usefulness of the “new” content of the extended auditor’s report greatly vary. Figure 2 gives an overview of the opinions of the auditors regarding the added value of particular elements in the extended auditor’s report (positive, neutral, or negative). Overall, auditors raise the issue of boilerplate texts. In drafting an extended auditor’s report, an auditor begins with looking at past year audits and competitor firms’ statements to benchmark its content. They state that this has an overall negative value on information usefulness and as auditor 1 indicates:
“It is rather odd if you have two organizations in the same industry with completely different KAMs, but we should of course maintain a keen eye.”
To start with, the main reason for disclosing KAMs was due to a call from society to auditors to be more transparent. Despite this call for transparency, auditors are divided with regard to disclosing information. They state that the expectation gap exists since more than 100 years and will therefore never disappear. Moreover, the discussion about transparency does not only apply to auditors, but also to medical doctors for example. Five auditors state that the content is shaping towards boilerplate texts and therefore does not reflect the substantive discussion with management and the board about key elements during the audit. This is consistent with Bolk (2018) and Boven (2018). Bolk (2018) and Boven (2018) used institutional theory and found empirical evidence for institutional isomorphism is in place with respect to extended audit reports. This substantive discussion should be of interest to users, because it provides context and will help to better understand the audit and work performed by the auditor. In the beginning of the extended auditor’s report, KAMs where plain texts without an opinion of the auditor, but this has now shifted to a detailed description of the related risks, risk response and partial conclusion. This shift is helpful for users to understand the auditors work as stated by auditor 6, but can create an incorrect view, as stated by auditor 10, because it misrepresents the audit approach where there is one goal and that is to give an overall opinion of the annual report and whether this gives a true and fair view.
In addition, as pointed out by auditor 1, there is a shift from a large number of significant risks a couple of years ago to nowadays a small number of pinpointed significant risks. This affects the number of KAMs disclosed in the auditor’s report, because only significant risks were an auditor had put a lot of effort in will eventually be translated from significant risk to KAM. This results in a mix of a number of company specific risks and a number of industry specific risks, as pointed out by auditor 9.
Eventually, the choice to disclose a KAM is arbitrary, but an auditor should be able to explain it to intended users. There is a discussion with the board and the audit committee about the KAMs, and the KAMs should be familiar to them. It provides intended users of the annual report with information, but this information is holistic and generic. According to auditor 8, in order to disclose more relevant KAMs, auditors can choose to disclose matters related to non-financial information. This could be for example about IT or internal control related issues, but auditors find themselves on thin ice in that area (auditor 3).
Secondly, auditors are just as divided about materiality as to KAMs, but for other reasons. Auditors doubt the extent to which investors understand the concept of materiality. On the one hand, disclosing materiality helps to explain to investors that there could be misstatements in the annual report for as high as the materiality, investors can benchmark the materiality to better understand the work performed by auditors, and investors can discuss about it with auditors during the AGM. On the other hand, because auditors use four different type of terms (materiality, performance materiality, reporting threshold, and component materiality), users and investors misinterpret it which could lead to wrongful conclusions. Because it is a threshold used by auditors in the audit, investors cannot logically base their investment decisions on it. Based on experience, auditors argue that despite the fact that we nowadays disclose materiality, there is a sway by issues of the day. If the headline of a newspaper state that there is a fraud detected of a couple of thousand euros and the materiality is over a million, the auditor still gets blamed for it. According to auditors, investors and society should eventually understand that the annual report can still contain certain misstatements, as long as they are below the materiality threshold. As auditor 8 stated, the best way to do this is to lecture society and investors and that is not possible. In addition, Brouwer (2018) states in his article that materiality is the core of the auditing profession and should not just be calculated with a simple formula, but this discussion should be held with users of the annual report. Disclosing this information in the extended auditor’s report helps to inform the users, but has not initiated a public debate yet.
Auditor KAMs Materiality Scope of the audit
1 +/- + + 2 + +/- +/-3 - - + 4 - - + 5 + + + 6 + + + 7 + + + 8 + +/- + 9 + +/- + 10 - + +/-11 +/- - +
Auditors' opinions about the added value of the different elements of the extended auditor's report.
In addition, as pointed out by auditor 2:
“There is an equalization of the use of materiality.”
Auditors consciously or unconsciously benchmark their materiality with the industry, before determining it for the current audit. According to auditor 5, this results in less use of eccentric benchmarks. It is very easy for auditors now to compare the different benchmarks and to level them to each other. As auditor 8 states:
“You do not want that the one is much higher or lower than the other.”
Auditor 6 also mentions that for all public entities profit before tax is the most appropriate measure, because that is of interest to investors. The change in use of materiality affects audit quality, but I will elaborate on that later on in this thesis.
The third part of the extended auditor’s report is the scope of the audit. There is a generally positive response of all interviewees about disclosing the scope of the audit. According to auditor 1:
“It contributes to the understanding of what an auditor covers in during an audit and not 100% is in scope.”
Despite the fact that not 100% is audited, there is some work performed to gain assurance about those respective components. This could be an overall analytical review or some small analytical procedures and perhaps no substantive audit procedures. An auditor provides context to the disclosed coverage ratio, in this way the investor is able to retrace the work performed by the auditor. Auditor 5 elaborated on this and stated that this section provides informative value and illustrates the complexity of an audit by providing an explanation of the procedures carried out. Furthermore, auditors get asked about the scope of the audit during the AGM. In the AGM auditors provide investors with information so they can better understand the considerations of the auditor.
Audit quality
In the institutional background different forms of audit quality are explained. These forms are technical audit quality, auditor independence, and perceived audit quality. First, technical audit quality will be set forth. Technical audit quality is a difficult concept. The AFM concluded in its report in 2014 and 2017 that the audit quality was below standards, but the cases investigated by the AFM in their sample did not result in changes in the annual report or audit report (auditor 5). To comply with the new standards, Big N audit firms improved their internal quality organizations. For example, as auditor 5 pointed out, the internal dialogue about the coverage ratio resulted in an increase in scoping and extra work is conducted to gather audit evidence and thereby an increase in technical audit quality. However, this is not the case for all auditors. Most auditors argued that no change in technical audit quality can be observed. The main focus of the extended audit report is to be transparent to users about the auditors work and did not change the audit approach. Auditor 6 explained this as a second order effect. Which is explained as by reading audit reports from other auditors, an auditor will maybe reconsider certain aspects and this has therefore an indirect effect on the audit quality.
Furthermore, the extended auditor’s report could be used as leverage for the auditor towards management. The auditor discloses KAMs and in some cases this results in a discussion with management and again puts pressure on certain issues. Management is therefore inclined to disclose more information towards users about these issues to prevent any misunderstandings. As auditor 9 points
out, it has a preventive function, because it assures engagement of management in the reporting process. This does according to auditor 4, not apply to every organization, because some organizations just took good care of it. The “old” audit report had some leverage, because an auditor could give a nonstandard audit opinion. But as auditor 7 argued, because an auditor discloses information about the most relevant aspects it is a more specified tool to lever management to disclose certain elements. It is only possible to sign the extended auditor’s report if the auditor thinks management discloses properly about the KAMs (auditor 6).
Another key element of technical audit quality is the use of the materiality concept. As described above, auditor 2 argued that by clarifying the materiality in the audit report, there is a convergence of the use of materiality. This observation is supported by auditor 5, who argues that eccentric benchmarks are less likely to be adopted. A change in materiality has a direct impact on technical audit quality, because materiality affects the sample size of substantive analytical procedures during the audit and will result in a higher (lower) number of samples, based on the decrease (increase) of materiality.
Second, auditor independence will be set forth. Disclosing KAMs, materiality and scope of the audit is a way of disclosing audit information. In line with this, there is a discussion with the board about certain audit risks. Based on this discussion, the auditor can extend the number of KAMs based on the demand of the board (auditor 7). However, auditors do not think that due to the implementation of the extended auditor’s report, they provided society with different conclusions or remarks concerning the audit. However, as described above, due to the standard having an effect on materiality, the auditor independence does change. A change in materiality affects the threshold to which auditors report misstatements to the board and therefore affect the content of the annual report or the auditor’s opinion. Third, perceived audit quality will be set out. Auditors are hesitant to conclude if the extended auditor’s report affects the perceived audit quality. But as auditor 11 argues and a member of the NBA commented, being transparent is the main goal of the standard. As auditor 9 stated:
“Auditors create the impression that the audit quality improved, whether this is the case or not, is not yet determined.”
Auditor 4 argued that the users will probably think that audit quality is high, because the auditor carefully picked the words. However, as auditor 1 and 11 argue, to determine if perceived audit quality is improved, you should ask this question to investors. Auditor 2 agrees on this and argues that it depends on whether investors read the extended auditor’s report. (S)he thinks that the audit report is too long to read and if someone reads it, the question is if that person understands what it says. In line with this, auditor 3 argues that if investors read the extended audit report, that at best, the extent of the auditor expectation gap comes to light. Auditor 5 argues that the board and management, as users of the audit report, have a general feeling that auditors become more critical. The same goes for the AFM as intended user. In addition, the VEB and Eumedion as users also think that the extended auditor’s report contributed to quality of communication of the auditor according to auditor 5.
Furthermore, deepening the scope of the audit contributes to the perceived audit quality. Auditor 6 stated that he thinks that users get the feeling that the auditor was thorough in the audit when reading this part of the audit report, because it is easier to understand than materiality and contributes to the understanding of the auditors’ work.
The hard part of changing perceived audit quality is that it cannot be changed from one day to another. As auditor 2 described it as the everyday humdrum, auditor 6 described it as incidents. They argue that certain events which get highlighted by the media have a large impact on the perception on
quality. But as auditor 6 argues, the extended auditor’s report decreases the negative impact of such an event. The extended auditor’s report provides users with understanding about the audit process (auditor 10) and should therefore provide context for such an event. You could say that some users indicated that they think that audit quality improved, but as auditor 9 concluded, there is not a single investor that came to the auditor and stated that they are happy with the extended auditor’s report.
Investor needs
To analyze and solve the problem about the usefulness of the extended auditor’s report for small investors 10 out of 11 auditors argue to map the information needs of investors. When these needs are clear and unambiguous, auditors can modify the auditor’s report to meet investors’ expectation. As auditor you get questioned by investors during the AGM. These questions are twofold according to auditor 3. On the one hand questions are asked concerning the content of the auditor’s report and on the other hand questions are asked regarding the quality of management. This latter part is rather hard to do because auditors do not have an assessment framework yet. Auditor 2, 4 and 5 therefore plead for Dutch or EU SOX regulations. Dutch SOX could contribute to the awareness of management about quality of reporting: because, as pointed out by auditor 10, the client argues that the extended auditor’s report costs too much and is not of any added value. Dutch SOX causes the ball to end up at the organizations, when they have to improve their internal control and report about that, not all fingers will be pointed at the auditor. Some other aspects that could be disclosed in the auditor’s report could be:
- Auditor 5: disclosing audit fee and corresponding hours. This helps to gain insight into the audit process and the trade-off to use audit software or man-hours. It contributes to the debate around audit quality.
- Auditor 6: disclosing the content of the management letter. The content of de management letter is often not disclosed by management, but can help investors to better place the financial figures in context.
- Auditor 7: disclosing audit differences, to be more transparent about the audit process. - Auditor 8: design a new platform to disclose information instead of using the old-fashioned
annual report.
- Auditor 11: disclosing more regarding fraud detection, because auditors get challenged a lot about this subject.
This debate about the extended auditor’s report is not over and it is good to keep experimenting with such laws and regulations, as mentioned by auditor 10 and pointed out by auditor 5:
“I imagine that other aspects will become part of the extended auditor’s report and will constantly develop and I therefore plead for scientific research.”
Investors
Interviews with eight small non-professional investors are conducted to determine the usefulness of the extended auditor’s report for this group. It is hard to determine if the investors we spoke to, are a representative sample of the population, but it is used to sketch a general image of investor behavior. We tried to divide investors based on their investment strategy. Based on the strategy they use information to invest/divest in certain stocks.
In the interviews, the investors argue that they use information based on their own investment strategy. They argue that the strategy can be traced based on the number of trades. For example,
investor 2, 7 and 8 argue that they are long-term investors, because they hardly do any trades. As investor 2 quotes:
“I have the feeling that when stocks plummet, you just have to hold them, without panicking and devesting. I am long term focused and not short term focused.”
Information used for this investment strategy are monthly stock magazines, financial newspapers and specific information about dividend payout policies. Investor 3 and 6 have invested their capital at banks who invest in plan assets. These banks trade for them and obtain a certain yield, they argue that they are not active investors and do not obtain specific information about specific companies. Investor 5 argued that he copies this strategy and follows the banks activities. In addition, investor 1 and 4 are both independent investors with their own made up strategy. Investor 1 speculates on certain pharmaceutical stocks and investor 4 invests in high-dividend United States stocks. They have their own sources of information for this and do not use the annual report neither the independent auditor’s report. Based on the interviews, not a single investor used these information sources to invest in certain stocks. Figure 3 gives an overview of the investor’s opinions about the sources of information provided by the company and the auditor. They argue that they do not read the annual report, because they consider it to be irrelevant, outdated and/or biased towards the organization. In fact, only investor 2 mentioned (s)he has opened such a document, but the analysis was done by others. Apart from the annual report, they also do not read the auditor’s report, because the information provided by the auditor is not relevant, because as investor 6 states: 99 out of the 100 audit reports are the same, which is an unqualified opinion. So for listed firms, according to investor 7, it is probably just fine. If a qualified auditor’s report is issued, you will probably hear from it elsewhere and act on that information. This is consistent with the results of Cheng et al. (2006) and Taffler et al. (2004) who concluded that investors react different to nonstandard audit opinions. The reason why investors did not read an extended auditor’s report is hard to tell. This could be, according to investor 5, because investors do not have the time to analyze all information or as investor 8 mentions, that there is a lack of specific knowledge to take into account this information.
In addition, they argue that they question the usefulness of the information provided by the auditor, they do not expect that the auditor provides investors with information regarding investment decisions. Investors know that the auditor just focusses on the past year and for other information they use other sources of information. Investor 1, 2, 3, 6, 7 and 8 argue that they actually do not know of an existing expectation gap. However, investor 4 and 5 do see a gap, but do not experience a gap and argue that the gap is getting smaller by extra regulations.
Despite the fact that nobody read the extended auditor’s report, investors think that disclosing information could be useful. With regard to the KAMs, investor 2 and 7 do not think it is of any value, because the conclusion of the auditor is indifferent. Investor 3 and 4 argue that it is possible that it is useful, if some specific information comes to light which would not be the case if this was not part of the auditor’s report. Investor 5 argues that all information provided by an auditor can be useful for investors, each individual investor can weigh out this information for their investments. Information about materiality and scope of the audit is useful according to investor 3, 4, 5, and 7. They argue that this information gives insights in the audit procedures and can help to better outweigh the value of the auditor’s report. Investor 8 does not think the extended auditor’s report is useful for him/her, as investor 8 states:
“This information is relevant, but not for my investment decisions.”
To analyze the audit quality perceived by investors, questions are asked whether the investor trusted the auditor more than before. The results vary, some investors argued that they lost trust, because of the scandals that where undiscovered by auditors and they observe no improvements. It is however hard to say if they outweighed the new standard in this, because they did not read the annual report neither the extended auditor’s report. They do not argue that the new standard is of negative value. Furthermore, some investors gained trust, because as investor 4 cites:
“The depth of the audit is clearly improved, because the auditor has to comply to more laws and regulations.”
The improvement of trust is according to investor 2 also powered independent market conduct authorities who have sanctioned auditors in the past years. So despite the fact that they did not read the auditor’s report they gained trust, because they have the feeling that the auditor is under close supervision and the extended auditor’s report can be seen as one of the effects of that. In addition, there are three investors who argue that they sense no change in trust. They are aware of the changes in laws and regulations; but are, however, critical about the results. As investor 5 argues:
“I do not read the reports, but through newspapers and analysts I guess I do use them for making investment decisions.”
Investor 1 2 3 4 5 6 7 8 Have you read the following documents before deciding to invest/devest in a certain stock?
- Annual report No Sometimes No No No No No No
- Audit report No No No No No No No No
- Extended AR No No No No No No No No
Do you think the following sections of the extended auditor's report can be usuful for investors?
- KAMs N/A No Possibly Possibly Yes N/A No Yes
- Materiality N/A N/A Yes Yes Yes N/A Yes Yes
- Scope N/A N/A Yes Yes Yes N/A Yes Yes
Do you trust the auditor in general?
- Trust +/- + + + +/- N/A -
-FIGURE 3
V. DISCUSSION AND CONCLUSIONS
In order to conclude if the extended auditor’s report is useful for investors, interviews with a member of the NBA statements committee, auditors and investors were held. This qualitative approach using grounded theory (Corbin & Strauss, 1990) helps to build theory, this can later be tested by future research as described later. Using axial coding during the research process made it possible to test propositions that derived from the interviews. Testing propositions during the research process enhances the generalizability of data (Corbin & Strauss, 1990). The extended auditor’s report is useful for small investors in several ways.
First of all, the extended auditor’s report was initiated in the United Kingdom and after that implemented in The Netherlands by the NBA. The main goal was that auditor’s would be more transparent about the audit process and thereby reduce the expectation gap. The extended auditor’s report can be used to inform and guide intended users of the annual report. It is a misconception that 100% of a certain organization is audited, but auditors identify KAMs, determine materiality and describe the scope of the audit. Disclosing this information helps placing the auditor’s opinion in context, but the current disclosures are to some extend too technical and therefore hard to understand by society. Christensen et al. (2018) found the same results and concluded that investors struggle to understand materiality. Köhler et al. (2016) argued that auditors are hesitant in disclosing certain risks, because they want to avoid difficult discussions with the board. But as stated in the interviews, auditors embrace the discussion with the board and want to enhance reporting quality. They argue that the reason why the number of KAMs is reducing, is because of the narrow focus of the AFM on a single or a small number of large risks and not because they avoid discussions. However, auditors argue that there is convergence of the content of the extended auditor’s report, which has a negative effect on information value. Furthermore, information about risks, materiality and scope of the audit is welcomed by investors. Investors that participated in this research responded positively towards disclosures that can be of help to make better investment decisions, despite the fact that not a single investor has read the auditor’s report.
Secondly, most auditors argued that no change in technical audit quality can be observed, however by disclosing key elements of the audit strategy, namely materiality and scope of the audit, it is easy for auditors to copy this information. Bolk (2018) and Boven (2018) found evidence that mimetic isomorphism is in place. Copying information regarding materiality could have an effect on audit quality. A change in materiality has an effect on technical audit quality and auditor independence (DeAngelo, 1981a). By changing the materiality, the number of samples drafted for substantive analytical procedures changes, which results in a change in detection risk (technical audit quality). Changing the materiality also affects the reporting threshold which is maintained to report misstatements to the board (auditor independence). By giving the right to auditors to disclose any information in the extended auditor’s report, auditors argue to have some leverage or can exercise pressure towards management to disclose more information about certain critical aspects. This can be on purpose of the auditor or just because of the external pressure perceived by management. A change in audit quality can be useful (negative) if audit quality increases (decreases) and reporting quality increases (decreases) (Chen, Chen, Lobo, & Wang, 2011).
Thirdly, the usefulness of the extended auditor’s report is the direct effect on perceived audit quality according to auditors. Auditors argue that investors probably perceives higher audit quality by this new standard, because an oversight board monitors the work of auditors. Furthermore, auditors argue that there is a direct effect of an “incident” (reported in the media) on perceived audit quality. The
extended auditors report can be of a negative moderator effect on this relationship as argued by auditors, because the extended auditor’s report provides a context for such an incident. This proposition of auditors is confirmed by investors. The interview question regarding trust in the auditor concluded that the extended auditor’s report doesn’t negatively affect perception towards auditors, but remains unchanged or increased, which affects the perception of quality. This new standard is according to NBA, auditors and investors part of a larger transition to be more transparent about the audit process and enhance audit quality. this is consistent with the results of the FRC (2016b), who concluded that investors greatly value the extended auditors report.
This study is not without limitations. The first limitation is the number of interviews held. According to Thomson (2011) a minimum of 25 to 30 interviews should be held to properly link different concepts. In this thesis 11 interviews with auditors and 8 interviews with investors have led to the conclusions, but the validity can be questioned here. In the study that starts in September 2018, a questionnaire will be set out towards the investors to test propositions published in this thesis. Furthermore, I only describe the usefulness for small investors as intended user of the auditor’s report, but the extended auditor’s report could also be useful, according to the auditors, for large (institutional) investors, analysts and/or other parties. The questions put to auditors about audit quality could be enhanced. At first, not a single auditor was inclined to say a change in audit quality was a result of the new standard, but based on the answers about the convergence of the content of the auditor’s report, auditors were inclined to say that audit quality has changed. Another limitation is the narrow focus on audit quality. The extended auditor’s report is a drop in the ocean. As the NBA and the auditors argue, it is just one small aspect and cannot be seen as a stand-alone object and research cannot cover all aspects that play a role in this process. Finally, literature describes a third form of audit quality, namely service quality (Ismail, Haron, Nasir Ibrahim, & Mohd Isa, 2006). Service quality can be defined as the quality of the services provided by the auditor, for example timeliness or budget overrun. This thesis does not elaborate on service quality, because this concept came to light of the researcher after each interview was conducted. The impact of the extended auditors report on service quality of auditors should be further examined.
This thesis provides avenues of future research. Firstly, implications for future research derive from the proposed conclusions which are formulated above as this thesis has a focus on theory building and lacks theory testing. Based on this thesis, I call for an empirical study towards the use of materiality by auditors. Some auditors stated that this standard affected the use of materiality in a way that it affected audit quality. A time series study towards the development of the materiality concept, could provide evidence for that. Messier Jr, Martinov-Bennie and Eilifsen (2005) reviewed the materiality literature and also call for future research towards the use of materiality in large (complex) audits, because this has not been researched yet. Secondly, another implication for future research could be to verify the results by interviewing the AFM and organizations that received an extended auditor’s report in the past years. This can give insights in audit quality and reporting quality. Thirdly, Another question that can be asked is the positive or negative impact of Dutch SOX on audit quality, because auditors seem to think there might be some impact. Knechel, Krishnan, Pevzner, Shefchik, & Velury (2012) reviewed the literature about audit quality and concluded that the effect of United States SOX on audit quality has hardly been researched yet, but that a couple of studies found that SOX had a positive impact on audit quality. Finally, another avenue of future research to enhance the quality of the extended auditor’s report, auditors suggest, is to study the information needs of investors. Based on questions asked in an AGM, auditors argue that investors would like to receive information regarding the quality of
management and level of internal control. Without directly drawing conclusions from those subjects, I would like to see further research on the relationship between the coverage ratio disclosed by the auditor and level of internal control of organizations. I expect that a low coverage ratio could be an indication of a high level of internal control.
