INDEPENDENSI DAN KUALITAS AUDIT Audit Kontemporer Rudy Suryanto

Key Issues Rotation of audit partners Audit Quality The basis is there is a reduction in audit quality associated with long periods of tenure. Using Australia data Three measures of audit quality

Glossary Lead Audit Partner? Second Review Audit Partner? Audit Team and Job distribution? Big 4?

Organizational Structure of Public Accounting Firm

Big 4 PriceWaterhouse Coopers Ernst & Young KPMG Deloitte Touché

Audit Quality Propensity to issue a going-concern audit opinion for distressed comapanies Abnormal working capital accruals Just beating (missing) earning benchmarks

DATA Australian companies Year of 1995

Result There is a lower propensity to issue a going-concern opinion for long audit partner tenure observation. There is no evidence of an association of long partner tenure with either the signed or absolute amount of abnormal working capital accruals There is some evidence of just beating (missing) earnings benchmarks for long partner tenure observations Sensitivity analyses demonstrate that identified deteriotion in audit quality is specifically associated with non-Big 6 audit firms.

Policy Initiatives U.S 1970 AICPA Practice Section mandated periodic partner rotation after seven years of tenure Sarbannes-Oxley Act of 2002 requires that lead audit partner and review partner be rotated every five years on public company engagements. U.K, the Cadbury Committee followed the U.S approach of requiring rotation of the audit partner. International Federation for Accountants (IFAC)  “familiarity thread” Indonesia?

Literature Review Chi and Huang (2005) examined the relationship of audit tenure and audit quality in the Taiwanese audit market. They found evidence consistent with lower earnings quality in the early years of audit tenure (either firm or partner) and the later years of tenure (firm), where earnings quality is measured as the level of abnormal accruals. However their results are contingent on the method used to calculate the level of abnormal return. Why???

Literature Review De Angelo (1981) identifies a ‘learning curve’ that gives incumbent auditor a comparative quality advantage. Ryan Commission Report (1992), AICPA (Cohen Commission Report, 1978) said continuity is to reduce audit risk due to a familiarity with client system and an understanding of risks associated with the client’s business/industry environment.

Literature Review There is some empirical evidence of a heightened risk of reduced audit quality during the first years of an audit firm’s tenure (AICPA 1992, Johnson et al, 2002, St. Pierre and Anderson 1984) There is some empirical evidence also of higher audit quality with longer audit firm (Myers et al, 2003) But how these relationships translate to audit partner tenure is not clear!

Mitigate Risk of Audit Rotation How to mitigate risk of New partner’s lack of familiarity (e.g. second partner review and standard new engagement familiarization procedures for incoming partner) The maintenance of knowledge and expertise within the firm (e.g. continuity of field staff, the carrying forward of working papers, partner familiarity with existing audit methodology and client databases)

Association between long audit partner tenure and Audit Quality The arguments supporting a negative association between long audit partner tenure and audit quality are: Erosion of independence that may arise with the developmenet of personal relationships between an auditor and their client Deterioration in the audit partner’s capacity to effect critical appraisal (familiarity threat)

Association between long audit partner tenure and Audit Quality The arguments supporting a positive association between long audit partner tenure and audit quality are: Higher audit cost associated with early periods of auditor tenure The increase in client and industry knowledge gained over repeated audits (Myers et al, 2003)

So Why mandatory partner rotation? The increase prevalence of mandatory partner rotation policies shows that the regulators believe that the potential costs associated with long periods of partner tenure outweigh the potential benefit.

Empirical Test H1: There is a negative association between audit quality and long audit partner tenure Research Model Opinion = PBank + Size + Age + LEV + CLEV + RETURN + LLOSS + INVESTMENTS + AUDFIRM + FEERATIO + CFFO + MINING + TENURE < 2 + TENURE > 7

RESULT Significant at 5%: Significant at 10% : Tenure > 7 Age Audit Firm Significant at 5%: Tenure > 7 Age Leverage LLoss Investments