Reform of auditor supervision and stability of the financial market
Project funded by the OeNB Anniversary Fund (Project No. 17783)

Against the background described above, the activities of the Austrian and German auditor supervisory authorities were analyzed for an initial sub-project. The structure and tasks of the supervisory authorities were analyzed. As part of their activities, a number of violations were punished with (sometimes expensive) sanctions in both countries. In principle, such transparent imposition of sanctions for the various breaches by audit firms is welcome and thus increases the publicly available information on the audit. However, as no specific auditors or audit firms are named, the question arises as to what extent this anonymous publication of information can actually contribute in advance to a decision for or against the engagement of an audit firm.

However, information can be requested from the engaging party in this regard; i.e. in the engagement process it will be advisable to ask to what extent there have been complaints in quality assurance reviews or inspections and whether an investigation (DE: event-driven professional oversight) has been carried out by the audit oversight authorities. As part of this investigation, it was also established that no list of PIE firms is freely/publicly available for Austria, which makes it difficult to analyze the market of particularly important, generally capital market-oriented companies in detail.

See here:

Graschitz, Sabine; Holzknecht, Simona (2020): Wie agiert die Abschlussprüferaufsicht in Österreich und Deutschland?, in: Die Wirtschaftsprüfung (73) 22/2020, S. 1341 - 1348.

Following on from the previous article on the activities of the authorities in Austria and Germany, the identified deficiencies were analyzed by the supervisory authorities. It was found that after five years of action by the new audit oversight authorities, many deficiencies in the audit processes could be identified. In Austria, this relates in particular to the standards on the general organization of audit operations, but the authorities also found fault with issues such as the regulations on engagement processing, acceptance and continuation as well as the premature termination of engagements. In Germany, on the other hand, the deficiencies identified mainly relate to quality assurance during the engagement and the implementation of the risk-oriented audit approach when auditing revenue and trade receivables.

For this article, an analysis of activity reports, annual reports, website information and information on sanctions imposed by the authorities was carried out. The analysis focuses in particular on public interest entities (PIEs) and the inspections carried out by their auditors (and, in Austria, related quality assurance reviews). The focus of the article is on these companies as they are of particular importance for the financial market and its stability.

See here:

Graschitz, Sabine; Holzknecht, Simona (2023): Reform der Abschlussprüferaufsicht in Österreich und Deutschland – Wo liegen die festgestellten Mängel in der Abschlussprüfung? Rückblick und Analyse der Jahre 2016 – 2021, in: Die Wirtschaftsprüfung (76) 13/2023, S 722 – 732.

Derived from the above contributions, in which the research team was often faced with incomplete and contradictory information on the Austrian audit market, a structured analysis was carried out under the title “What were the effects of the EU audit reform in Austria? An empirical analysis of the Austrian audit market", the Austrian audit market was analyzed in a structured manner.

The reform of the European audit market, which came into force in 2016, brought with it a series of measures designed to boost competition in the market, reduce market concentration and strengthen independence, among other things. Against this background, a detailed archive data analysis of the Austrian audit market was carried out. The work of Willekens et al. (2019) and the reports of the European Commission (2021, 2022) on the implementation and effects of the statutory audit reform at EU level were used as a starting point. However, these studies are highly relevant for the EU as a whole and provide few details about the individual countries and, in the context of this research project, about the situation in Austria.

The study therefore analyzes the years 2010 to 2020 and focuses on market shares and concentration, auditor changes and fee composition and development during this period. Differences in the effects of the EU reform are to be expected, as implementation was carried out differently despite the uniform requirements of EU Regulation 537/2014. Differences are possible, for example, from Art. 4 (2) with regard to the fee cap, from Art. 5 (2) with regard to additional prohibited non-audit services, from Art. 17 with regard to the term of the audit mandate or to the organization of the auditor oversight authorities as defined in Art. 20 of the Regulation. Additional divergences between different countries could also be caused by differences in the implementation of EU Directives 2006/43/EC in conjunction with 2014/56/EU.

This part of the research project therefore provides detailed insights into the Austrian market for PIE audits. This is essentially based on the work of Willekens et al. (2019) The analysis shows that the audit reform has certainly had an impact in some areas. This would be the case, for example, in the context of fee caps and external rotation. The extent to which external rotation leads to positive or negative effects remains to be seen. However, there are massive negative effects for the Austrian market in the context of market concentration and market competition. A significantly smaller number of providers can be observed on the audit market. This may well have a negative impact on the stability of the financial market in the longer term. Even if market concentration is falling, it is still at an extremely high level. This will be particularly challenging due to the upcoming changes resulting from the CSRD (EU Directive 2022/2464/EU).

See here:

Graschitz, Sabine; Holzknecht, Simona; Steller, Marcel (2023): What were the effects of the EU audit reform in Austria? An empirical analysis of the Austrian audit market.

The scope of activities of the Austrian APAB also includes the analysis of audit opinions. Particular attention is paid to the normative and formal accuracy of the audit opinions. However, in light of recent accounting scandals such as Wirecard in Germany and Commerzialbank Mattersburg, the question also arises as to the extent to which reporting, the type of error and the auditor's work input influence the decisions of the recipients of the financial statements and the extent to which dealing with or the occurrence of such cases influences the perception of the auditor's work.

The quality of the audit is the subject of numerous studies. As audit quality is not directly observable for parties interested in the annual financial statements, various factors have been used as surrogates. Numerous studies analyze the influence of work input on audit quality. Permanent extensions to the activities involved in the audit process, growing responsibilities and continuous reforms mean that the audit workload must increase in order to cover the new tasks and ensure high audit quality. The reforms resulting from the recent accounting scandals primarily affect the auditor's report, in particular the additional obligation to disclose “key audit matters” (KAMs).

The paper “How Do Audit Effort and KAM Disclosure Affect an Auditor's Perceived Responsibility?” deals with the liability of the auditor depending on various influencing factors and serves to answer the third research question. In addition, the influence of the audit effort (expressed in audit hours and auditor's fees) on the auditor's perceived liability in the event of corporate insolvency is examined according to the opinion of “mock jurors”.  Categorical misstatements or measurement uncertainty were taken into account as additional possible influencing factors. A 2x2x2 between-subjects experiment was conducted via the Econlab of the University of Innsbruck with 332 participants who were used as “jurors”. The participants in the study were randomly assigned to the respective situations. The following table shows the distribution of the experiment participants to the different groups and some demographic information about the experiment participants.

Results

The results of this part of the project show that more work does not always protect. In addition, the project revealed that the presence of external quality assurance authorities has a significant positive influence on perceived audit quality. This basically indicates that auditor oversight or external quality assurance is suitable for positively influencing (perceived) audit quality. This in turn implies that the audit fulfills its purpose and is suitable for positively influencing financial market stability.

See here:

Graschitz, Sabine; Holzknecht, Simona; Steller, Marcel (2023): The Effect of Audit Effort, Type of Misstatement and Key Audit Matter Disclosure on the Assessment of Auditor`s responsibility, available on SSRN: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4460052.

This article returns to the topic of auditor communication in the auditor's report; specifically, it addresses the various reporting obligations on the topic of “other information”. As can be seen in the analysis for Austria, this reporting obligation is regularly breached.  This can sometimes be due to doubts about the communication value of the section on “other information”, which could lead to the expectation gap being widened, as users of the financial statements could assume from a statement by the auditor that the information has also been audited. 

The paper aims to inform standard setters and regulators about the specific effect of ISA 720 (Revised) and provides a basis for argumentation for the regulator with regard to the effect of the adopted auditing standards. In the course of this part of the research project, research question four was addressed.

As the second experiment-based work, this article deals with the question of how reporting with regard to other information is perceived by non-professional investors. According to ISA 720 (Revised), other information is information that is published together with the annual financial statements. This means that large parts of the management report, the corporate governance report and integrated sustainability reports are usually part of the other information. Following the introduction of ISA 720 (Revised), if the ISAs are applied, the auditor's duties in this context must be reported in the auditor's report. Essentially, the auditor's duties follow the so-called “read and consider approach”. This means that the auditor must read the other information and critically assess whether it conflicts with the information in the audited annual financial statements. In any case, the auditor is obliged to report briefly on his duties. It is also noted that the auditor does not perform any audit procedures in this context and does not provide any assurance on the other information.

Prior to the introduction of ISA 720 (Revised), there was an intensive discussion about how the new auditor's reporting obligation would be perceived.  Essentially, the fear remained that the new reporting requirement would result in increased liability. At the same time as the IAASB, the US PCAOB also considered changing the reporting requirements in the context of other information. In contrast to ISA 720 (Revised), however, no changes were made to AS 2710, partly due to significant concerns about the effect of the standard.

Against this background, a 4x2 between participants experiment design is used to analyze how different types of reports are perceived in connection with “other information”. The results lead to the conclusion that greater involvement of the auditor generally leads to more reliable information. This shows that the auditor's work is perceived better in the context of financial information than in the context of non-financial information.

See here:

Graschitz, Sabine; Hamilton, Erin; Messier, William, Pietsch, Christian (2023): Auditor Reporting on Other Information Outside of the Financial Statements: available on SSRN: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4486378.

Project 4 showed that the existence of an authority for external quality assurance is seen as relevant for high-quality audit performance. Following on from this, this part of the research project focuses on the communication of the audit oversight authority. In principle, there are a wide variety of communication strategies of the audit oversight authority regarding the inspection procedures to the outside world - while in Austria only anonymous reporting of identified misstatements takes place due to data protection regulations, the PCAOB, for example, uses a much more specific reporting practice, so that audit firm-specific inspection reports - including the presentation of any identified deficiencies and weaknesses - are published.

In an experimental setting, it is analyzed how the reporting practice can influence the addressees of the annual financial statements. To this end, the level of reporting detail and the presence or absence of errors will be manipulated.

Project 6 is classified as a work-in-progress and is currently being developed in more detail.

Graschitz, Sabine; Schenkenfelder, Christoph: Investor's reaction to the auditor oversight's reports - do different reporting approaches matter?; Work in Progress.