Study Finds At Least Some Auditing Expertise Applies Across Industry Sectors

A new study finds the expert skills developed by auditing offices that specialize in working with specific industries are actually applicable across industry sectors, improving the quality of their audits regardless of the industry sector they are auditing.

“It’s well established that when auditing offices do lots of audits in one industry, they develop expert skills in auditing companies in that industry,” says Nathan Goldman, co-author of the study and an assistant professor of accounting in the Poole College of Management at North Carolina State University.

“We wanted to know whether those skills are actually limited to the specific industry. In other words, are auditing offices developing forms of expertise through the types of tasks that they perform, regardless of which industry they are auditing?”

For this work, the researchers focused solely on the auditing of corporate income taxes as reported in financial statements, because this aspect of auditing is fairly uniform across all industry sectors.

“If we were going to find task-specific expertise, rather than industry-specific expertise, this would be where we’d find it,” Goldman says. “That made it a good focal point for this proof-of-concept study.”

For this study, the researchers looked at publicly available data on 2,047 publicly traded companies from 2003 to 2015, all of which were audited by large accounting firms.

Companies have auditors review their financial statements before the statements are finalized. The higher the quality of the audit, the less likely that a final financial statement will contain an error and need to be amended. One way of assessing the quality of an audit office’s work is to look at the percentage of financial statements they audited that required these amended “restatements.”

Therefore, the researchers looked at the likelihood that each of the audit offices in the dataset had to make restatements due to errors in audits of income tax accounts in financial statements.

In addition to this quantitative assessment, the researchers conducted interviews with 15 partners or senior managers at large accounting firms to get a more in-depth understanding of how knowledge was transferred within an auditing office. Specifically, the interviews focused on how offices shared knowledge about how to do a good job of auditing income tax financial statement accounts.

“We found that audit offices with greater exposure to complex tax issues were less likely to make tax-related errors in their financial statements,” Goldman says. “That tells us they have higher audit quality when it comes to income tax accounts, regardless of which industry sector they were auditing.

“This is relevant for the public accounting sector, because it tells managers that people who are developing task-specific skills will likely be able to apply those skills in any sector,” Goldman says. “That’s valuable information for both cultivating and recruiting talent in the auditing sector.”

And while this study focused on tax auditing, researchers say it raises interesting questions about how broadly the findings may apply to other tasks.

“Additional work will be required to explore that, but it’s certainly possible that a variety of auditing tasks could be applied with equal proficiency across industry sectors,” Goldman says. “For example, I’m curious as to whether expertise in auditing tasks related to environmental, social and governmental issues could be applied across industries.”

The paper, “Does Task-Specific Knowledge Improve Audit Quality: Evidence from Audits of Income Tax Accounts,” appears in the journal Accounting, Organizations & Society. The paper is co-authored by Kat Harris of Washington State University and Thomas Omer of the University of Nebraska-Lincoln.

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Note to Editors: The study abstract follows.

“Does Task-Specific Knowledge Improve Audit Quality: Evidence from Audits of Income Tax Accounts”

Authors: Nathan Goldman, North Carolina State University; Kat Harris, Washington State University; and Thomas Omer, University of Nebraska-Lincoln

Published: Nov. 26, Accounting, Organizations & Society

DOI: 10.1016/j.aos.2021.101320

Abstract: Two forms of expertise can influence audit quality: industry and task-specific expertise. Anecdotal evidence suggests that tax knowledge is task-specific, rather than industry-specific and audit offices with increased exposure to complex tax issues develop this task-specific expertise. Using outcomes related to audits of the income tax accounts, we examine whether tax task-specific knowledge (TSK) affects the audit quality of the income tax accounts and find that tax TSK increases the audit quality of the income tax accounts. We also find evidence of an improved response to misstatements among audit offices with tax TSK, demonstrated by a decreased likelihood of future tax misstatements following the disclosure of a tax restatement. Finally, we observe the effect of tax TSK among audit offices with lower levels of auditor-provided tax services (APTS). This result suggests that audit offices without the benefit of knowledge spillover from APTS rely more on the tax TSK.

This post was originally published in NC State News.