Auditing Research Lectures
Lecture 1; The Purpose and Value(s) of Auditing in Society and
Capital Markets:
What is an Audit for?
An audit provides assurance through an independent and objective assessment of financial
statements, internal controls, or compliance with regulations. This assurance helps stakeholders
gain trust that the information presented is accurate, reliable, and free from material
misstatements or fraud. Auditors can give three levels of assurance; reasonable assurance, limited
assurance, or no assurance.
There is still a misconception between auditors and the public. The public, for example, thinks
that auditors should detect all fraud. As long as these misconceptions about audits exist,
confrontations with angry investors and lawmakers are likely to continue.
What is the Primary Purpose of Auditing in Society and Capital Markets?
The primary purpose of auditing in society and capital markets is to enhance trust,
transparency, and accountability by providing independent assurance on financial statements.
Other purposes of auditing are:
- Audits also protect stakeholders by promoting integrity and confidence in the financial
system.
- While not designed to detect all fraud, audits can help identify material misstatements and
weaknesses in internal controls, therefore maybe detecting fraud and errors.
How does the Nature of Assurance provided by Auditing Services distinguish them from Other
Professional Services?
The nature of assurance provided by auditing services distinguishes them from other professional
services in several key ways:
- Independence and objectivity: auditors provide an independent evaluation of financial
statements. Other services often also give advice such as helping the management make
decisions.
- Reasonable assurance vs. advisory guidance: auditors offer reasonable assurance that
financial statements are free from material misstatements. In contrast, services like tax
planning or business consulting focus on providing strategic advice without an assurance
component.
- Focus on public interest: auditing serves a public and investor protection role, ensuring
financial transparency and accountability. Other professional services typically serve the
interest of the client.
Humphrey, C., Sonnerfeldt, A., Komori, N., & Curtis, E. (2021). Audit and the Pursuit of Dynamic
Repair:
According to the paper from Humphrey et al. (2001) audit is in fundamental need of a dynamic
repair. The paper calls for us to rethink the role of auditing in society by shifting the focus from
simply fulfilling the profession’s current public interest duties to a broader question: “What kind of
society do we want to create?” Instead of just ensuring financial compliance and accuracy, we
should reimagine auditing in ways that make a more meaningful and direct contribution to society.
This could involve expanding the scope of audits to address issues like environmental impact
and social responsibility, ensuring that audits serve not just investors, but the public as a whole.
The role and relevance of auditing are being reconsidered, with increasing discussions around
whether “an audit is just an audit”. Traditionally, auditing has been seen as a standardized and
transactional process with limited value-added, leading to little differentiation between audit firms.
1
,The article introduces the notion that auditing should evolve into an assurance service that goes
beyond financial reporting to address broader societal issues like environmental impact, social
responsibility, risk management, sustainability, and governance. This shift challenges the
profession to reconsider whether auditing should remain narrowly defined or expand into a broader,
value-driven function that serves the public good and societal needs.
According to the IAASB: “Audit is an activity of ‘significant public interest’”. The value of audit is:
- Assuring that the quality and credibility of financial information is good, and boosting public
confidence in financial reporting and disclosure.
- Auditing primarily serves capital markets, focusing on decision-usefulness and the
alignment toward a global set of principles-based auditing standards.
Audit is a social construct that influences how financial transparency affects economic and social
outcomes. More transparent financial reports lead to a reduction in corporate costs of capital, which
in turn increases the NPV of future revenue streams. This, in turn, boosts corporate wealth, allowing
for higher dividends, greater private and public investments, and broader economic growth. Over
time, these effects help reduce poverty, address social inequalities, and improve overall social
well-being.
In short, the article suggests four major re-conceptualizations aimed at strengthening the value
and flexibility of auditing:
1. Audit as a primary function: rather than being a secondary check on financial
statements, auditing should be recognized as an essential institution that fosters trust and
accountability in society.
2. Reframing audit and assurance: audit should be recognized as an essential institution
that fosters trust and accountability in society.
3. Encouraging innovation in standards: audit regulations should allow for more
innovation rather than focusing solely on compliance. A flexible approach would help
auditors address emerging risks and technological changes.
4. Rethinking the public interest: the assumption that audits inherently serve the public
good should be reconsidered. Auditors must actively shape their role in society to align with
evolving societal needs.
By adopting a dynamic repair approach, the audit profession can shift from a reactive stance—
focused on compliance and damage control—to a proactive and constructive function that
continuously adapts to meet new challenges.
The article challenges the traditional view of auditor independence as a uniform solution for
ensuring audit quality. Instead, it suggests that the Business Risk Audit (BRA) model could be
tailored to address the unique risks and requirements of each organization. Aligning business
objectives with broader social goals and values through the BRA model could create a more
socially impactful audit, extending its purpose beyond just financial assurance to contribute
positively to the public good.
In conclusion, the article calls for a rethinking of the audit profession. By embracing a more
dynamic and flexible approach, auditors can play a greater role in addressing not only financial
transparency but also broader societal issues like sustainability, social responsibility, and
governance.
Knechel, W. R. (2021). The Future of Assurance in Capital Markets: Reclaiming the
Economic Imperative of the Auditing Profession:
Knechel (2021) explores the evolving role of auditing in capital markets, highlighting that the
traditional model primarily focuses on providing assurance about the accuracy of financial
statements. Over time, improvements in accounting standards, technology, and regulation have
enhanced financial reporting. However, the audit model has not kept up with the changing needs of
capital markets.
2
,Knechel argues that for the auditing profession to remain relevant, it must expand its role beyond
traditional financial reporting. Auditors should provide assurance on new and critical areas such as
non-GAAP earnings, ESG reporting, and cybersecurity risk disclosures. This shift is necessary as
capital markets increasingly rely on timely, trustworthy information to make informed decisions.
During the 1990s and early 2000s, auditors attempted to expand assurance services by
highlighting their economic value, but several challenges hindered progress:
- High-profile audit failures weakened public trust in auditors.
- Lack of advanced information systems prevented auditors from efficiently supporting
broader assurance services.
- Unclear understanding of market participants' information needs limited the
relevance of new assurance services.
- Minimal pressure on companies to expand disclosures or seek additional assurance
services.
During this period, the concept of Business Risk Auditing (BRA) emerged, reflecting a shift in
focus toward identifying and assessing various business risks in both the supply and demand of
audits. This approach recognized that third-party assurance is most valuable when it addresses
economically significant risks that affect a large group of stakeholders.
Knechel argues that to uphold its economic relevance, the auditing profession must move beyond
traditional financial statement assurance and actively participate in verifying other critical
types of information that influence capital markets. This shift requires auditors to listen carefully to
users and understand who they are, what information they use, and how they use it.
The article identifies three critical areas where auditors can improve information quality:
- Non-GAAP earnings: providing assurance on earnings measures not defined by GAAP to
ensure their reliability—like EBITDA.
- ESG Reporting: assuring ESG disclosures to meet the growing demand for transparent and
credible sustainability information.
- Cybersecurity risk disclosures: evaluating and assuring disclosures related to
cybersecurity risks to boost stakeholder confidence.
For auditors to provide effective assurance in these new domains, they must:
- Clearly identify which information or processes require assurance.
- Develop specialized knowledge and skills in these areas.
- Create robust methodologies for verifying accuracy and reliability.
- Ensure organizational support, including resources and infrastructure, to sustain assurance
activities.
Auditor independence = a core principle of auditing is independence, which ensures that
auditors provide unbiased and objective opinions. However, Knechel points out that auditors are
regularly interacting with internal process owners, management, internal auditors, and audit
committees. This close coordination raises concerns about maintaining independence while
effectively engaging with these corporate actors.
A key theme of the article is that auditing should not be seen as just a secondary function that
derives its legitimacy from financial reporting. Instead, it should be recognized as a primary
function that plays a critical role in promoting trust and accountability in society.
Furthermore, Knechel questions whether statutory (mandatory) financial audits inherently
serve the public interest. He argues that auditors must actively shape their role in society rather
than assume their work automatically benefits the public.
To maintain its economic relevance, Knechel calls for several changes within the auditing
profession:
- Innovation in audit practices: auditors should embrace innovation in auditing practices
and standard-setting to address emerging risks and technological changes.
- Broader assurance role: the profession must expand its scope to include assurance
services beyond traditional financial reporting.
3
, - Engagement with stakeholders: auditors should engage in continuous dialogue with
stakeholders to better understand their evolving information needs.
- Reinforcing public trust: auditing should focus on reinforcing its commitment to public
trust and contributing to the integrity of capital markets.
To conclude, Knechel (2021) presents a compelling case for redefining the role of auditors in capital
markets. As financial reporting becomes more complex and investor demands evolve, the auditing
profession must adapt to remain economically relevant. This means shifting beyond traditional
financial statement assurance to new areas of assurance, such as non-GAAP earnings, ESG
disclosures, and cybersecurity risks. It also requires rethinking the audit function itself, recognizing
it as a fundamental institution that enhances trust and accountability across multiple dimensions of
economic activity.
How does Market Concentration among Auditing Firms impact Competition and Choice for Clients?
Market concentration = a small number of large firms dominate the industry.
Market concentration among auditing firms has a significant effect on competition and client choice.
This issue is especially prominent in the audit of large public companies, where the Big4 controls
the majority of the market. This market concentration impacts the audit landscape in the following
ways:
- Limited choice: fewer large firms means clients have fewer options, especially for
complex audits.
- Higher costs: less competition allows major firms to charge higher fees.
- Conflicts of interest: offering both audit and consulting services raises independence
concerns.
- Systematic risk: if a major firm fails, it could disrupt the audit market and reduce public
trust.
- Barriers to entry: smaller firms struggle to compete due to resource and reputation
challenges.
- Reduced innovation: less competition may lead to slower improvements in audit quality
and practices.
Dekeyser, S., Gaeremynck, A., Knechel, W. R., & Willekens, M. (2021). Multimarket Contact and
Mutual Forbearance in Audit Markets:
The paper explores how audit firms interact with each other in competitive markets where they
operate across multiple segments or regions.
Over the past decade, regulators have expressed concerns about the level of competition in the
audit market. One major worry is that dominant accounting firms may engage in coordinated
behavior, which could reduce competition and limit client choice. This behavior, known as mutual
forbearance, occurs when firms deliberately avoid aggressive competition to maintain stability in
the market, potentially leading to higher audit fees.
The study aims to explore how audit firms behave when faced with competition from other firms
across various industry segments in local markets. The research seeks to determine whether
increased competition results in lower audit fees, improved audit quality, or whether dominant firms
continue to control pricing and practice despite the presence of competitors.
Mutual forbearance = a concept in competitive strategy where rival firms avoid aggressive
competition to maintain market stability and higher profits. In the audit market, this means that if
two large audit firms operate in many industry sectors or geographic regions, they may avoid
lowering their audit fees or competing too aggressively in any one location. This behavior leads to
higher prices and less competition, as both firms prefer stability over potential conflict.
The more overlap audit firms have across different markets, referred to as multi-industry
contact, the less likely they are to aggressively compete in those markets. This overlap fosters
mutual forbearance, leading to higher fees and reduced market competition.
While previous research has suggested that the audit market is highly competitive, the authors
challenge this assumption. The audit market is not perfectly competitive; instead, it can be best
4
Lecture 1; The Purpose and Value(s) of Auditing in Society and
Capital Markets:
What is an Audit for?
An audit provides assurance through an independent and objective assessment of financial
statements, internal controls, or compliance with regulations. This assurance helps stakeholders
gain trust that the information presented is accurate, reliable, and free from material
misstatements or fraud. Auditors can give three levels of assurance; reasonable assurance, limited
assurance, or no assurance.
There is still a misconception between auditors and the public. The public, for example, thinks
that auditors should detect all fraud. As long as these misconceptions about audits exist,
confrontations with angry investors and lawmakers are likely to continue.
What is the Primary Purpose of Auditing in Society and Capital Markets?
The primary purpose of auditing in society and capital markets is to enhance trust,
transparency, and accountability by providing independent assurance on financial statements.
Other purposes of auditing are:
- Audits also protect stakeholders by promoting integrity and confidence in the financial
system.
- While not designed to detect all fraud, audits can help identify material misstatements and
weaknesses in internal controls, therefore maybe detecting fraud and errors.
How does the Nature of Assurance provided by Auditing Services distinguish them from Other
Professional Services?
The nature of assurance provided by auditing services distinguishes them from other professional
services in several key ways:
- Independence and objectivity: auditors provide an independent evaluation of financial
statements. Other services often also give advice such as helping the management make
decisions.
- Reasonable assurance vs. advisory guidance: auditors offer reasonable assurance that
financial statements are free from material misstatements. In contrast, services like tax
planning or business consulting focus on providing strategic advice without an assurance
component.
- Focus on public interest: auditing serves a public and investor protection role, ensuring
financial transparency and accountability. Other professional services typically serve the
interest of the client.
Humphrey, C., Sonnerfeldt, A., Komori, N., & Curtis, E. (2021). Audit and the Pursuit of Dynamic
Repair:
According to the paper from Humphrey et al. (2001) audit is in fundamental need of a dynamic
repair. The paper calls for us to rethink the role of auditing in society by shifting the focus from
simply fulfilling the profession’s current public interest duties to a broader question: “What kind of
society do we want to create?” Instead of just ensuring financial compliance and accuracy, we
should reimagine auditing in ways that make a more meaningful and direct contribution to society.
This could involve expanding the scope of audits to address issues like environmental impact
and social responsibility, ensuring that audits serve not just investors, but the public as a whole.
The role and relevance of auditing are being reconsidered, with increasing discussions around
whether “an audit is just an audit”. Traditionally, auditing has been seen as a standardized and
transactional process with limited value-added, leading to little differentiation between audit firms.
1
,The article introduces the notion that auditing should evolve into an assurance service that goes
beyond financial reporting to address broader societal issues like environmental impact, social
responsibility, risk management, sustainability, and governance. This shift challenges the
profession to reconsider whether auditing should remain narrowly defined or expand into a broader,
value-driven function that serves the public good and societal needs.
According to the IAASB: “Audit is an activity of ‘significant public interest’”. The value of audit is:
- Assuring that the quality and credibility of financial information is good, and boosting public
confidence in financial reporting and disclosure.
- Auditing primarily serves capital markets, focusing on decision-usefulness and the
alignment toward a global set of principles-based auditing standards.
Audit is a social construct that influences how financial transparency affects economic and social
outcomes. More transparent financial reports lead to a reduction in corporate costs of capital, which
in turn increases the NPV of future revenue streams. This, in turn, boosts corporate wealth, allowing
for higher dividends, greater private and public investments, and broader economic growth. Over
time, these effects help reduce poverty, address social inequalities, and improve overall social
well-being.
In short, the article suggests four major re-conceptualizations aimed at strengthening the value
and flexibility of auditing:
1. Audit as a primary function: rather than being a secondary check on financial
statements, auditing should be recognized as an essential institution that fosters trust and
accountability in society.
2. Reframing audit and assurance: audit should be recognized as an essential institution
that fosters trust and accountability in society.
3. Encouraging innovation in standards: audit regulations should allow for more
innovation rather than focusing solely on compliance. A flexible approach would help
auditors address emerging risks and technological changes.
4. Rethinking the public interest: the assumption that audits inherently serve the public
good should be reconsidered. Auditors must actively shape their role in society to align with
evolving societal needs.
By adopting a dynamic repair approach, the audit profession can shift from a reactive stance—
focused on compliance and damage control—to a proactive and constructive function that
continuously adapts to meet new challenges.
The article challenges the traditional view of auditor independence as a uniform solution for
ensuring audit quality. Instead, it suggests that the Business Risk Audit (BRA) model could be
tailored to address the unique risks and requirements of each organization. Aligning business
objectives with broader social goals and values through the BRA model could create a more
socially impactful audit, extending its purpose beyond just financial assurance to contribute
positively to the public good.
In conclusion, the article calls for a rethinking of the audit profession. By embracing a more
dynamic and flexible approach, auditors can play a greater role in addressing not only financial
transparency but also broader societal issues like sustainability, social responsibility, and
governance.
Knechel, W. R. (2021). The Future of Assurance in Capital Markets: Reclaiming the
Economic Imperative of the Auditing Profession:
Knechel (2021) explores the evolving role of auditing in capital markets, highlighting that the
traditional model primarily focuses on providing assurance about the accuracy of financial
statements. Over time, improvements in accounting standards, technology, and regulation have
enhanced financial reporting. However, the audit model has not kept up with the changing needs of
capital markets.
2
,Knechel argues that for the auditing profession to remain relevant, it must expand its role beyond
traditional financial reporting. Auditors should provide assurance on new and critical areas such as
non-GAAP earnings, ESG reporting, and cybersecurity risk disclosures. This shift is necessary as
capital markets increasingly rely on timely, trustworthy information to make informed decisions.
During the 1990s and early 2000s, auditors attempted to expand assurance services by
highlighting their economic value, but several challenges hindered progress:
- High-profile audit failures weakened public trust in auditors.
- Lack of advanced information systems prevented auditors from efficiently supporting
broader assurance services.
- Unclear understanding of market participants' information needs limited the
relevance of new assurance services.
- Minimal pressure on companies to expand disclosures or seek additional assurance
services.
During this period, the concept of Business Risk Auditing (BRA) emerged, reflecting a shift in
focus toward identifying and assessing various business risks in both the supply and demand of
audits. This approach recognized that third-party assurance is most valuable when it addresses
economically significant risks that affect a large group of stakeholders.
Knechel argues that to uphold its economic relevance, the auditing profession must move beyond
traditional financial statement assurance and actively participate in verifying other critical
types of information that influence capital markets. This shift requires auditors to listen carefully to
users and understand who they are, what information they use, and how they use it.
The article identifies three critical areas where auditors can improve information quality:
- Non-GAAP earnings: providing assurance on earnings measures not defined by GAAP to
ensure their reliability—like EBITDA.
- ESG Reporting: assuring ESG disclosures to meet the growing demand for transparent and
credible sustainability information.
- Cybersecurity risk disclosures: evaluating and assuring disclosures related to
cybersecurity risks to boost stakeholder confidence.
For auditors to provide effective assurance in these new domains, they must:
- Clearly identify which information or processes require assurance.
- Develop specialized knowledge and skills in these areas.
- Create robust methodologies for verifying accuracy and reliability.
- Ensure organizational support, including resources and infrastructure, to sustain assurance
activities.
Auditor independence = a core principle of auditing is independence, which ensures that
auditors provide unbiased and objective opinions. However, Knechel points out that auditors are
regularly interacting with internal process owners, management, internal auditors, and audit
committees. This close coordination raises concerns about maintaining independence while
effectively engaging with these corporate actors.
A key theme of the article is that auditing should not be seen as just a secondary function that
derives its legitimacy from financial reporting. Instead, it should be recognized as a primary
function that plays a critical role in promoting trust and accountability in society.
Furthermore, Knechel questions whether statutory (mandatory) financial audits inherently
serve the public interest. He argues that auditors must actively shape their role in society rather
than assume their work automatically benefits the public.
To maintain its economic relevance, Knechel calls for several changes within the auditing
profession:
- Innovation in audit practices: auditors should embrace innovation in auditing practices
and standard-setting to address emerging risks and technological changes.
- Broader assurance role: the profession must expand its scope to include assurance
services beyond traditional financial reporting.
3
, - Engagement with stakeholders: auditors should engage in continuous dialogue with
stakeholders to better understand their evolving information needs.
- Reinforcing public trust: auditing should focus on reinforcing its commitment to public
trust and contributing to the integrity of capital markets.
To conclude, Knechel (2021) presents a compelling case for redefining the role of auditors in capital
markets. As financial reporting becomes more complex and investor demands evolve, the auditing
profession must adapt to remain economically relevant. This means shifting beyond traditional
financial statement assurance to new areas of assurance, such as non-GAAP earnings, ESG
disclosures, and cybersecurity risks. It also requires rethinking the audit function itself, recognizing
it as a fundamental institution that enhances trust and accountability across multiple dimensions of
economic activity.
How does Market Concentration among Auditing Firms impact Competition and Choice for Clients?
Market concentration = a small number of large firms dominate the industry.
Market concentration among auditing firms has a significant effect on competition and client choice.
This issue is especially prominent in the audit of large public companies, where the Big4 controls
the majority of the market. This market concentration impacts the audit landscape in the following
ways:
- Limited choice: fewer large firms means clients have fewer options, especially for
complex audits.
- Higher costs: less competition allows major firms to charge higher fees.
- Conflicts of interest: offering both audit and consulting services raises independence
concerns.
- Systematic risk: if a major firm fails, it could disrupt the audit market and reduce public
trust.
- Barriers to entry: smaller firms struggle to compete due to resource and reputation
challenges.
- Reduced innovation: less competition may lead to slower improvements in audit quality
and practices.
Dekeyser, S., Gaeremynck, A., Knechel, W. R., & Willekens, M. (2021). Multimarket Contact and
Mutual Forbearance in Audit Markets:
The paper explores how audit firms interact with each other in competitive markets where they
operate across multiple segments or regions.
Over the past decade, regulators have expressed concerns about the level of competition in the
audit market. One major worry is that dominant accounting firms may engage in coordinated
behavior, which could reduce competition and limit client choice. This behavior, known as mutual
forbearance, occurs when firms deliberately avoid aggressive competition to maintain stability in
the market, potentially leading to higher audit fees.
The study aims to explore how audit firms behave when faced with competition from other firms
across various industry segments in local markets. The research seeks to determine whether
increased competition results in lower audit fees, improved audit quality, or whether dominant firms
continue to control pricing and practice despite the presence of competitors.
Mutual forbearance = a concept in competitive strategy where rival firms avoid aggressive
competition to maintain market stability and higher profits. In the audit market, this means that if
two large audit firms operate in many industry sectors or geographic regions, they may avoid
lowering their audit fees or competing too aggressively in any one location. This behavior leads to
higher prices and less competition, as both firms prefer stability over potential conflict.
The more overlap audit firms have across different markets, referred to as multi-industry
contact, the less likely they are to aggressively compete in those markets. This overlap fosters
mutual forbearance, leading to higher fees and reduced market competition.
While previous research has suggested that the audit market is highly competitive, the authors
challenge this assumption. The audit market is not perfectly competitive; instead, it can be best
4
