What do you know about audit failure so far?

Abstract

This article presents a comprehensive review of academic research pertaining to audit failure. This literature review is based on auditing-related articles published in leading journals during the 1976-2019 period. We organize our review around three main groups, namely (a) proxy measures of audit failure, (b) causes of audit failure, and (c) effects of audit failure. We observe that the literature uses a variety of proxies to capture audit failure, such as auditors’ going concern opinions (GCOs), material misstatements, auditor communication, financial reporting quality, and perceptions. We find that there are three signals of audit failure: non-issuance of a GCO prior to a business failure, material misstatements in the last audited financial statements, and violation of the code issued by regulators. We find that audit failures reduce clients’ market value and the auditor’s ability to retain clients. There is also evidence that larger penalties for audit failure result in higher audit fees and overinvestment in audit effort and that increased liability decreases audit failure and reduces auditor shirking. A related objective of this paper is to shed light on audit failure by Big N and non-Big N auditors separately. We observe that the audit failure rate is lower for Big N auditors than for non-Big N auditors. Our findings have implications for government policies, regulators, auditors, investors, and academics.