The Use and Characteristics of Foreign Component Auditors in U.S. Multinational Audits: Insights from Form AP Disclosures*

Abstract

This paper investigates the common, yet previously opaque, practice of using foreign audit firms (component auditors) to conduct portions of audit work for U.S. public companies. U.S. regulators have expressed concern for the transparency and quality of audits using component auditors. Employing data disclosed in the newly mandated PCAOB Form AP, we find that component auditor use is largely structural, determined by the size and complexity of clients' multinational operations. We do not find that the mere use of component auditors is detrimental to audit outcomes, but rather the amount of work conducted by component auditors is associated with lower audit quality (i.e., higher likelihood of misstatement), higher likelihood of nontimely reporting, and higher audit fees, which collectively suggest that component auditor engagements are associated with adverse outcomes. Furthermore, we find that only the work performed by less competent component auditors and those facing geographic and cultural/language barriers, including significant geographic and cultural distance, weak rule of law, and low English language proficiency, is associated with adverse audit outcomes. Overall, these findings provide initial archival evidence that the use of certain component auditors on U.S. multinational audits is associated with audit coordination issues, which suggests that PCAOB Form AP disclosures provide relevant information.

Does The Implementation Of SA 600 Cause Shifting Of Audit Clients And Reducing Audit Quality? Evidence From Indonesia

“…The results show that investors perceive that audit quality is very low when the group auditor uses the work of other auditors. These results are consistent with the findings of Burke et al (2020) which not only found that the use of component auditors would only be detrimental to the audit results, but would also lead to lower audit quality due to higher likelihood of misstatement and higher audit costs. find that the quality of MNE group audits involving other auditors from the same network was lower, this did not appear to be affected by the revision of ISA 600.…”

Challenging Global Group Audits: The Perspective of US Group Audit Leads*

“…Specifically, an MNC will engage a member firm to lead (i.e., coordinate and perform) the financial statement audit. However, if the company's international operations are significant to the consolidated financial statements (e.g., material in terms of size or risk), other auditors in each applicable jurisdiction will typically be engaged to perform work over the respective components of the business (e.g., Burke et al 2020). GGAs reflect the work of numerous national or regional partnerships who are typically members of the same global firm, providing a unique setting to consider member firm interactions and issues arising in day‐to‐day audit practice within the global firm.…”

Context matters

“…Prompted by the increased regulatory attention, a number of recent concurrent working papers use the disclosure requirement of PCAOB Form AP on leading and participating auditors in the audit of SEC issuers. Burke et al [2019] find, for a sample of 881 U.S public issuers with Form AP and an audit report due date between June 2017 and June 2018, that the total percentage of audit hours conducted by component auditors is associated with lower audit quality in the form of higher likelihood of quarterly restatement, longer audit delay, and higher audit fees. Further, they document that the mere use of a component auditor and the total number of component auditors in an engagement are associated with higher audit fees but not with restatement likelihood and audit delay.…”

“…These results appear to contrast with those of Dee et al [2018], who document that audit quality is lower (measured by discretionary accruals) when a component auditor is involved and that the use of more than one component auditor leads to lower audit quality and higher fees. Dee et al find (Sunderland and Trompeter [2017], Downey and Bedard [2019a], Burke et al [2019]), we examine the factors that influence the decision to involve a component auditor. With regard to client characteristics, group auditors of MNEs with extensive, diverse international operations might face a greater need to involve component auditors, due to resource and time constraints or legal, language, and cultural barriers.…”

“…Internationally, IFIAR's 2017 inspection findings reveal that group audits have frequent adverse findings at the engagement level (IFIAR [2018]). 6 PCAOB Rule 3211 on Form AP, Auditor reporting of certain audit participants, effective for audit reports issued on or after June 30, 2017.7 The evidence based on first-time disclosures of component auditors in the United States appears mixed Burke et al [2019]. report that the total percentage of audit hours conducted by component auditors harms audit quality (i.e., higher likelihood of restatement) while the mere use of a component auditor and the total number of component auditors that participated in the engagement do not affect audit quality.…”