In an era of uncertain economic landscapes, the reliability of audited financial reports gains crucial support from the growing adoption of international standards. Recent findings spearheaded by a scholar from the University of Toronto’s Rotman School of Management have shed light on the significant improvements in financial auditing across nations that have embraced the International Standards on Auditing (ISA). These standards, promulgated by the International Federation of Accountants—the global umbrella organization for the accounting profession—have proven instrumental in elevating the trustworthiness of financial disclosures.

The research, conducted by Ole-Kristian Hope, who holds the Deloitte Professorship of Accounting at the Rotman School, indicates a general enhancement in audit quality following the adoption of ISA. However, Hope points out that the impact of these standards is also contingent on the robustness of local enforcement mechanisms. This dual dependency highlights the complexities of implementing international norms within diverse regulatory frameworks.

ISA was initially formulated from global best practices and oriented towards principles rather than rigid regulations, ISA was officially established as a standard in 1991. In the subsequent decades, paralleling the trend towards economic globalization, over 160 countries and jurisdictions have adopted ISA to varying extents within their regulatory and practice frameworks. Countries like Canada have fully integrated these standards into their domestic auditing practices, while the U.S. has adopted them partially. Despite widespread adoption, comprehensive research into the actual efficacy of ISA in enhancing audit quality has been sparse, leaving a gap in understanding their exact impact on financial transparency and reliability.

Prof. Hope and a team of three other researchers embarked on an exhaustive study involving manual data analysis from 41 countries that had assimilated ISA into their auditing standards between 2001 and 2018. The staggered adoption timeline across these nations provided a fertile ground for comparative analysis. The findings were particularly striking for domestic and smaller auditing firms, which benefited most from adopting ISA. These entities, generally less equipped than their larger global counterparts, found a valuable framework to elevate their auditing standards in ISA, often surpassing those of more prominent firms that already maintain stringent audit practices due to their extensive resources and international reach.

Furthermore, the impact of ISA was more pronounced in countries where the enforcement of auditing standards was more vigorous and where ISA had been more comprehensively integrated into local practices, for example, through mandatory application. The research team assessed audit quality primarily by examining the levels of discretionary accruals—adjustments in financial statements that, while legitimate for reflecting estimated earnings not yet received, can also be manipulated to obscure proper financial health. Lower levels of these accruals were indicative of higher audit quality. The study corroborated these findings with alternative measures of audit quality. It explored further through machine learning techniques, suggesting that the benefits of ISA are mainly due to their emphasis on critical areas such as a company’s viability, legal compliance, fraud risk, internal controls, and transactions with related parties.

This research underscores the vital role of international standards in fostering more reliable financial reporting. It highlights the importance of enforcement and local adaptation in realizing the full benefits of such global frameworks. The findings serve as a call to action for countries still insisting on fully integrating ISA into their auditing standards. Doing so could significantly bolster the trustworthiness and accuracy of financial reporting, ultimately benefiting investors and other stakeholders in the economic ecosystem.

More information: Ole-Kristian Hope et al, Does Convergence with International Standards on Auditing Improve Audit Quality? The Accounting Review. DOI: 10.2308/TAR-2022-0610

Journal information: The Accounting Review Provided by University of Toronto, Rotman School of Management