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The Effect of Auditors Industry Specialization and Auditors Independence on Audit Procedure to Detect Fraud Risk in a Financial Statement Audit, and Their Implications on Audit Quality

Autor:   •  September 14, 2017  •  8,889 Words (36 Pages)  •  195 Views

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According to the GAO (2003), audit quality is defined as one audit which is performed in accordance with generally accepted auditing standards (GAAS) to provide reasonable assurance that the audited financial statements and related disclosures are (1) presented in accordance with generally accepted accounting principles (GAAP) and (2) are not materially misstated whether due to errors or fraud. So, material deviation from the standards is presumed to reflect poor audit quality. Prior research also documented that auditors with industry specialization and auditor independence have significant effect to audit quality. Since these two factors are remarkable by the public and by the auditing profession in Indonesia it will be interesting if we can examine the inter relationship between these 3 factors influence to audit quality. Prior research suggest that for detecting fraud, an industry specialist auditor can perform an audit procedures for detecting fraud much better than non-specialist auditor, and that no matter how good the availability of auditing procedures it solely depend with the level of auditors independence from the individual auditor during the audit process (Balsam et.al 2000) and (Deis and Giroux, 1992).

Cases of financial scandals by public companies in Indonesia which could not be detected by the auditors as described above, added with the revelations by PPAJP infringement cases by public accountants in the application of auditing standards, can eventually lead to the decline of public confidence, especially investors in the capital market, on audit quality generated by a public accountant who provide an opinion about the fairness of the financial statements. The position of the public accountant profession as the holder of public confidence is also began to be questioned by the users of financial statements, as more and more found 'audit failure' resulting restatement to the financial statements which have been audited and has been presented in a general meeting of shareholders (Pakenko, 2003).

Inconsistencies between situational aspects and conditional aspects as described above are detrimental to society, as a result of financial engineering (fraudulent financial reporting) that could not be detected by a public accountant in the general audit framework, and disclosure of the infringement case of public accountant on auditing standards by the PPAJP, can be regarded as an audit failure (audit failure) which can endanger the public accountant profession if it is not be handled properly.

Based on the background described above, the problem formulation which can be taken in this research is to determine how much the influence of auditor industry specialization and auditor independence in Indonesia on application of audit procedures to detect material fraud in a financial statement audit, as well as how much influence of auditor industry specialization , auditor independence and audit procedures to detect material fraud in a financial statement on audit quality in Indonesia, partially and simultaneously.

PRIOR RESEARCH AND HYPOTHESES DEVELOPMENT

Auditor Industry Specialization

According to Arens et.al (2011:237) definition of auditor specialization or auditors with specific industry specialization is as follows, “Auditor specialization is auditor as having deep understanding (knowledge) and long experiences of the client’s specific business and industry, having knowledge about the company’s operations, and specific accounting and auditing guidance which are essensial for doing a high quality audit. The nature of the client’s business and industry affects clients’ business risk and the risk of material misstatements in the financial statements”.

Furthermore Tuanakotta (2011:213) defines auditor specialization as follows, "Auditor specialization is an auditor who specializes in a particular industry and has particular additional experience and knowledge, so that it becomes an expert in a particular industry." Owhoso et.al (2002) defines auditor specialization as follows, “Auditors specialization are a team of auditors who aquired special training and specific task experiences in specialized areas, and are likely to exhibit superior performance in those specific areas”. Cohan et.al (2010) defines auditor specialization as follows: “Industry Specialist Auditor is auditor as having long experiences and deep understandings of how general and specific accounting guidance applies to the specific client’s industry, and includes understanding of operational challances and nuances of such industry. Furthermore, specialization skills by such auditors are not limited only to general industry accounting knowledge, but also extended to specific accounting areas such as valuation, acquisition, cost of capital, pensions, etc. as well as in other complex areas such as financial instruments and tax provisioning.”

There are studies that developed about auditor specialization, Rittenberg et.al (2010:21-22) argues that accounting firm that engage the auditor specialization in the audit process of its client in particular industry, will be able to select and implement audit procedures that are more precise and effective than the non-auditor specialization. Furthermore, according to Balsam et.al (2003) audit process requires competence, expertise and high professionalism. The competence and expertness are not be obtained from formal education only but also from many other factors such as from experience on repetition of the same audit procedures in certain industries for many years.

Libby and Frederick (1990) states that a public accountant job is a job that involves expertness as the result of experience and deep understanding. The more experienced a public accountant in a certain industry, the more certain he is able to produce a better performance in the professional complex duties. Wright and Wright (1997) states that the more experience an auditor in a clients particular industry, it will enhance the ability of the auditor to suspect the existence of errors and fraud in financial statements audits by doing the analytical audit procedure. The study results by Balsam et.al (2003) showed that the auditor industry specialization in the audit process will provide higher confidence on audit quality produced compared to the non- auditors specialization. This is caused by the length of experience and a deeper understanding of the business processes and accounting processes of its clients. The study results by Lin et.al (2010) showed that assigning an auditor industry specialization in a particular client industry, will positively benefit the client because they can keep the quality of company earning better, which

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