Reviewed by Roland L. Madison John Carroll University
The author has provided an interesting description of the nature and frequency of change in audit qualifications that have occurred in Australia over a period of thirty years. In the study, Craswell examined over 33,500 annual reports, of which 2,740 were identified as being “qualified.” The study was based upon the following hypothesis:
Auditors respond to changes in their legal and profes¬sional obligations and to the extent that those changes impinge upon reporting obligtaions, changes in the frequency of qualifications can be expected to result [p. 16].
In order to investigate this hypothesis, the author developed an extensive taxonomy for audit qualificationis. Craswell clas-sified the changes in audit qualifications as a reaction to changes in three distinct areas. These changes were: reactions to changes in the Companies Act (statutory qualifications), to changes in the auditor’s legal obligations (judicial case influ¬ence), and to changes in professional standards (technical pro¬nouncements from the accounting profession). The author analyzed the frequency and type of qualifications separately for industrial and mining companies. As previously noted, the study covered a period of 30 years, during which time a number of significant changes occurred in technical accounting standards, the Companies Act, and legal decisions rendered. This gave the author an opportunity to measure the frequency of changes in audit qualifications and evaluate the perceived responsiveness of auditors to changes in their obligations.
A major premise used to develop the hypothesis is that the “auditor’s prime motivation for qualifying their opinions is assumed to be the avoidance of sanctions and not to the provision of information” [p. 16]. In a similar fashion, Craswell implies that managers also view the acceptability of audit qualification from a position of economic impact upon the entity as well as upon themselves. He says “If managers are assumed to adopt least-cost alternatives, avoidable qualifica-tions may be expected to arise where managers assess the expected cost of publishing financial statements containing a qualified opinion to be less than the expected costs of complying with the auditors’ request for change to the accounts” [p. 9]. Cost of compliance would include, but would not be limited to, loss in share market value, or adverse effects upon manager compensation.
Given the above premise, the author proposes that the increase in the number of audit qualifications is a surrogate measure of the auditors’ responsiveness to changes in their professional and statutory reporting obligations, with the au-ditors’ responsiveness being tempered by an economic evalua-tion of sanctions that might be endured if audit qualifications were not rendered.
Several potential problems should be considered before an evaluation is made of this research to the accounting literature.
One potentially significant problem is that the term “qual-ification” did not even exist in the professional literature throughout the major portion of the research period (1950-1966) until ICA Statement C2 was issued in 1967. Furthermore, this Statement did not define what constituted an audit qualification and the profession had no established format or language to identify qualifying terminology in an audit report [p. 18]. The author acknowledges this limitation. He says: “Ultimately it is for the users of the financial statement to interpret auditors’ reports” [p. 28]. That is exactly what the author has done in the book. He has subjectively determined which audit reports are qualified and which are not qualified. In the text, audit qualifi¬cations are defined in the “broad view” as:
Statements in audit reports referring to non-compliance with accounting standards (whether or not auditors express agreement with the non-compliance), to problems in the valuation or meas¬urement of financial statement items (whether or not the effect of the qualification is quantified), and to non-compliance with provisions of the Companies Act [p. 28].
The preceding discussion and quotation raises questions concerning potential omissions and commissions of audit qual-ifications from the study and the impact this may have upon any conclusions developed in the study.
The second major problem relates to the research process and the results of the study relative to the author’s hypothesis. The author did not find a significant change in the frequency in audit qualifications during twenty years covered by the study (circa 1950-1970) even though events occurred that should have affected the frequency of qualifications. During the discussion of this time period, explanations are frequently given for the inconsistency of the results that should occur if the stated hypothesis is accurate. One should note, however, that a number of the explanations given do seem quite plausible. Unfortu¬nately, the Hedley Byrne case [1964] and the changes to the Companies Act [1961] produced results that were quite contrary to expectations consistent with the hypothesis of the study. These results do significant harm to many of the otherwise plausible explanations offered elsewhere by the author (see Chapter 5; specifically pp. 59, 67; and pp. 71, 80).
The author did not find a significant increase in the fre-quency of audit qualifications until 1971 and subsequent years. One problem with these findings is that, within a very short period of time, three events occurred that affected auditors’ obligations. These events were: the Pacific Acceptance Corpora¬tion case decision [1970], the Companies Act Amendment of 1971, and the ICA issuance of the first version of Statement K1 [1971]. Although the latter professional pronouncement seems to be credited as the most influential stimulus for the change in frequency of audit qualifications, the author does not provide statistical analysis (tests) of significance to help identify the specific casual factors to the exclusion of other possible explanatory factors. In defense of the author, it would be quite difficult to construct tests to differentiate among the three events given the brief time span in which they occurred. How¬ever, this shortcoming makes the research methodology and the results of the study very difficult to evaluate in a positive manner.
The above problems may have been avoided if the author had used the methodology he identified early in the text [p. 2]. This would be to interview numerous audit partners and corpo-rate managers to determine the reasons why audit qualifica¬tions did or did not occur in the financial reports. While this would theoretically seem to develop the most accurate results, it would obviously involve a great deal of time and cost for the researcher and also involve a potential risk for the various participants to disclose sensitive information.
In conclusion, the text is a very interesting and well-written piece of historical accounting literature. However, due to the critical points and potential problems discussed herein, the reviewer cannot suggest that a replication of this research project, using the NAARS data bank, would have value to the accounting profession in the United States. Audit partners from two national firms agreed with this assessment of the study.
