Auditing Transformation: Regulation, Digitalisation and Sustainability 1000926974, 9781000926972

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Auditing Transformation

This book identifies and discusses drivers of auditing transformation, including regulation, digitalisation, sustainability, and individual auditor characteristics. It provides a holistic perspective, discussing these current and highly relevant themes in depth and ‘one by one’ and also stresses the importance of the temporal dimension, i.e. offering a historical and a present-day perspective. The book covers several different theoretical perspectives when analysing and discussing how the various drivers affect auditors, the audit process, accounting firms, stakeholders, and so on. Sweden is used as a setting to study the effects of these drivers of transition. The Swedish experience is generalisable to other European countries, with a Germanic origin currently influenced by Anglo-American ideas of auditing. In addition, Sweden provides a research setting with unique access to empirical data. The book is unique in its broad coverage of drivers of transformation, combined with its clear focus on financial auditing. It is informed by a wide range of research approaches, from qualitative interview studies to recently developed machine learning methods. Readers, therefore, benefit from a comprehensive understanding of current changes in the audit industry. The book will be a useful reference work for students of accounting and auditing, as well as for audit practitioners, including both auditors and regulators, and for researchers. Jan Marton is an Associate Professor in Business Administration at the School of Business, Economics and Law, University of Gothenburg, Sweden. Fredrik Nilsson is a Professor of Business Studies, specialising in Accounting at Uppsala University, Sweden. Peter Öhman is a Professor of Business Administration and Director of Centre for Research on Economic Relations, Mid Sweden University, Sundsvall, Sweden.

Routledge Studies in Accounting

43. Quality Management and Accounting in Service Industries A New Model of Quality Cost Calculation Wojciech Sadkowski and Piotr Jedynak 44. Artificial Intelligence in Accounting Organisational and Ethical Implications Othmar Lehner and Carina Knoll 45. The Financial Reporting Quality of Public Companies The Cultural Dimension Katarzyna Mokrzycka-Kogut 46. Strategic Pricing and Management Accounting David Dugdale 47. Statutory Audits in Europe Latest Reforms and Future Challenges Michael Kend, Giulia Leoni, Cristina Florio and Silvia Gaia 48. The Privatisation of British Rail How Not to Run a Railway Sean McCartney and John Stittle 49. The UK Accounting Standards Board, 1990-2000 Restoring Honesty and Trust in Accounting David Tweedie, Allan Cook and Geoffrey Whittington 50. Auditing Transformation Regulation, Digitalisation and Sustainability Edited by Jan Marton, Fredrik Nilsson and Peter Öhman For more information about this series, please visit www.routledge.com/ Routledge-Studies-in-Accounting/book-series/SE0715

Auditing Transformation Regulation, Digitalisation and Sustainability

Edited by

Jan Marton, Fredrik Nilsson, and Peter Öhman

First published 2024 by Routledge 4 Park Square, Milton Park, Abingdon, Oxon OX14 4RN and by Routledge 605 Third Avenue, New York, NY 10158 Routledge is an imprint of the Taylor & Francis Group, an informa business © 2024 selection and editorial matter, Jan Marton, Fredrik Nilsson and Peter Öhman; individual chapters, the contributors The right of Jan Marton, Fredrik Nilsson and Peter Öhman to be identified as the authors of the editorial material, and of the authors for their individual chapters, has been asserted in accordance with sections 77 and 78 of the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Trademark notice: Product or corporate names may be trademarks or registered trademarks and are used only for identification and explanation without intent to infringe. British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library ISBN: 978-1-032-53303-2 (hbk) ISBN: 978-1-032-53305-6 (pbk) ISBN: 978-1-003-41139-0 (ebk) DOI: 10.4324/9781003411390 Typeset in Sabon by KnowledgeWorks Global Ltd.

Contents

List of figures and tables List of contributors Foreword Preface List of acronyms and abbreviations 1 Auditing in transformation: An introduction

ix xii xxi xxiii xxv 1

JAN MARTON, FREDRIK NILSSON, AND PETER ÖHMAN

PART I

Regulation

17

2 In pursuit of a more socially relevant audit in the context of international standardisation

19

AMANDA SONNERFELDT AND GUNILLA EKLÖV ALANDER

3 The construction of status in the auditor–audit committee relationship

46

GUNILLA EKLÖV ALANDER, KARIN JONNERGÅRD, AND ULF LARSSON OLAISON

4 Audit reporting transformation: Increasing the relevance of the audit through key audit matters?

69

KATHARINA RAHNERT

5 The adoption of professional audit standards in the public sector: The role of the audit profession and other actors PERNILLA BROBERG AND TORBJÖRN TAGESSON

90

vi Contents PART II

Digitalisation111 6 On the structures of judgement in auditing

113

THOMAS CARRINGTON AND BINO CATASÚS

7 Digitalisation and professional scepticism of Swedish auditors

136

ANDREAS JANSSON, TIMUR UMAN, EMILIA FLORIN-SAMUELSSON, ALEXANDRA KANTONENKO, AND THERÉSE KARLSTRÖM

8 Being an audit professional in the digital age

157

AMANDA SONNERFELDT AND KARIN JONNERGÅRD

9 Advanced digital technologies and sustainability assurance: Evidence from Sweden

180

JASON CRAWFORD, TIM KASTRUP, AND AYNAZ MONAZZAM

PART III

Sustainability

203

10 Assessment of double materiality: The development of predictively valid materiality assessments with artificial intelligence

205

PETER ÖHMAN, JAN SVANBERG, AND ISAK SAMSTEN

11 Organising for quality in sustainability assurance: A literature review

228

KATARZYNA CIESLAK, CECILIA GULLBERG, SHRUTI KASHYAP, AND JOACHIM LANDSTRÖM

12 Challenges of sustainability-assurance practices: Insights from the Big 4 accounting firms

250

DANIELA ARGENTO, MASHAL IQBAL, AND FATOU SONKO

PART IV

Auditor Characteristics

273

13 The average professional: On the selection and socialisation of auditors

275

THOMAS CARRINGTON, TOBIAS JOHANSSON-BERG, GUSTAV JOHED, AND PETER ÖHMAN

Contents vii 14 The importance of the engagement partner

294

JAN MARTON AND SAVVAS PAPADOPOULOS

15 Transformation in audit teams: Implications for team competence

314

ALICE ANNELIN AND TOBIAS SVANSTRÖM

16 Expertise in financial auditing

338

JENNY BACKMAN, MICHAEL GRANT, AND FREDRIK NILSSON

17 Auditing transformation: Practitioners’ views

360

RAKEL LENNARTSSON

18 Concluding remarks

379

JAN MARTON, FREDRIK NILSSON, AND PETER ÖHMAN

Index

386

Figures and tables

Figures 2.1 2.2 2.3 2.4 5.1 5.2 7.1 10.1 10.2 13.1 13.2 13.3 13.4 15.1

Framework for analysing the audit innovation context. 25 Summary of the constraints and capacity of NPA pertaining to the development of SASE. 30 The most significant changes in the development of RevR6 from 2004 to 2018. 31 Summary of the constraints and capacities for the development of RevR6. 35 Theoretical model based on Hussein (1981, p. 29) and Greenwood et al. (2002, p. 54). 95 Empirically adjusted model of institutional change. 105 Interaction effect. 146 Evaluation of predictive performance. 214 SHAP force plot for Delta Electronics Inc. 219 2019 respondents’ alma maters. 281 Perceived employers focus on hard and soft skills when hiring audit assistants. 283 Confidence placed in formal institutions of society. 285 Value commitments of audit assistants and senior auditors. 286 Conceptual framework of transitioning audit teams. 331

Tables 3.1 4.1 4.2 4.3

Details on our interviews with lead engagement auditors and audit committee members. Range of the number of KAMs in auditor’s reports, means, and standard deviations per company category, and in total. Qualitative specificity in KAM headings per company category, and in total. Average number of KAMs per audit firm (and audit partner).

67 76 77 78

x  Figures and tables 4.4

Comparisons of KAMs to previous year with regard to percentage of number of KAMs, KAM heading wordings and content per company category, and in total. 80 4.5 Comparisons of KAMs to previous year with regard to KAM heading wordings and content for (a) same audit partner and (b) audit partner rotation conditions per company category, and in total. 81 4.6 Comparisons of KAMs to previous year with regard to KAM heading wordings and content for (a) same audit firm and (b) audit firm rotation conditions per company 83 category, and in total. 5.1 Timeline – Important and decisive events throughout the development of a standard for municipal auditing of financial reporting. 93 5.2 Interviewees. 109 5.3 Interview guide. 109 6.1 Purpose and expected effect on auditor judgement of different forms of structure. 128 7.1 Descriptive statistics. 144 7.2 Correlation matrix. 145 7.3 Regression models. 146 7.4 Dependent variable. 154 7.5 Independent variable. 155 7.6 Moderating variable. 155 8.1 List of interviewees. 179 9.1 List of respondents, by organisation and role. 200 9.2 Examples of interview themes and theme-related questions. 201 10.1 Descriptive statistics by industry, number of controversies, and total assets. 212 10.2 Measures of random forest predictive performance. 213 10.3 Most important (i.e. material) indicators based on the random forest environmental controversy prediction model. 217 10.4 Measures of performance. 226 10.5 The 112 environmental performance indicators used in the investigation. 226 11.1 Reviewed articles. 249 12.1 Overview of interviews. 270 12.2 Simplified interview guide. 271 13.1 Background characteristics of respondents from the 2019 survey. 282 14.1 Overview of studies on engagement-partner characteristics. 299 14.2 Proxies for audit quality in the literature on engagement-partner characteristics. 300

Figures and tables xi 14.3 Personal characteristics in the literature on engagement-partner characteristics. 14.4 Mechanisms to link personal engagement partner characteristics with audit quality. 14.5 Specific availability of data in Sweden for quantitative research on audit-partner characteristics. 15.1 Literature review papers and classification of the research. 16.1 Description of interviewees.

303 304 306 318 359

Contributors

Alice Annelin, PhD, is an Associate Professor of Business Administration (Accounting) at Umeå School of Business, Economics and Statistics, Umeå University, Sweden. Her research focuses on audit teams, and her research interests include audit teams’ competence, audit quality threatening behaviour, and audit technology, as well as education for sustainability. She has published in the International Journal of Auditing, Managerial Auditing Journal, and International Journal of Sustainability in Higher Education and has a work experience across Europe and South-East Asia. Daniela Argento, PhD, is an Associate Professor of Business Administration (Accounting) at Kristianstad University, Sweden. Her research focuses on accounting and organisational change, governance, control, and performance of public service organisations, smart city strategies and performance, sustainability reporting and assurance, the impact of digitalisation on accounting and management control, as well as identity threats in academia due to the increased importance of journal rankings. She has published in scientific journals, including Accounting, Auditing & Accountability Journal, Critical Perspectives on Accounting, Journal of Management Control, Journal of Public Budgeting Accounting & Financial Management, and Qualitative Research in Accounting & Management. Jenny Backman, PhD, is a Lecturer and Researcher in Business Studies (Accounting) at Uppsala University, Sweden. Her research focuses on judgement and decision-making in various accounting information contexts with an emphasis on the effects of human psychological factors in accounting information processing. In her recently published thesis, she examined if, and how, the presentation format of accounting information impacts evaluative judgements of corporate performance, focusing particularly on the judgemental effects of visuals in accounting communications, including annual reports and social accounting reports. She has also a research interest in accounting education.

Contributors xiii Pernilla Broberg, PhD, is a Senior Associate Professor of Business Administration (Accounting and Auditing) and Head of the Business Administration Division at Linköping University, Sweden. Her research focuses on auditing, audit quality, auditors and audit practice and her studies often explore issues and phenomena related to auditor’s day-to-day work, auditor qualifications, the audit profession and audit firms. She has published in scientific journals such as Accounting, Auditing & Accountability Journal, Journal of International Accounting, Auditing and Taxation, Managerial Auditing Journal, and Scandinavian Journal of Educational Research as well as articles in popular science journals. She is the vice Chair of the Swedish Academy of Auditing. Thomas Carrington, PhD, is a Professor of Business Administration (Accounting and Auditing) at Åbo Akademi University, Finland. His research focuses on the role of financial accounting and auditing in organisations and society, both in the private and public sectors. He has published in scientific journals such as Accounting, Auditing & Accountability Journal, Behavioral Research in Accounting, Contemporary Accounting Research, Critical Perspectives on Accounting, European Accounting Review, and Qualitative Research in Accounting & Management. Before entering academia, he worked for a big audit firm and has continued to engage with the audit profession by publishing books on financial accounting and auditing, articles in professional publications, and through the Swedish Academy of Auditing, where he served as the executive member for five years. Bino Catasús, PhD, is a Professor in Business Administration (Accounting and Auditing) at Stockholm University, Sweden. The Chair is partly funded by FAR (the institute for the accountancy profession in Sweden). He has conducted research on management control, environmental accounting, auditing, governance, public sector accounting, and intellectual capital. He has published in scientific journals, including Accounting, Auditing & Accountability Journal, Contemporary Accounting Research, Critical Perspectives on Accounting, and European Accounting Review, and has written books (Edward Elgar) and book chapters. In terms of other engagements, he has been involved in collaborations with practitioners and has been a member of several boards inside and outside of academia, including the Swedish Academy of Auditing. Katarzyna Cieslak, PhD, is an Assistant Professor of Business Studies (Accounting) at Uppsala University, Sweden. Her current research focuses on capital market consequences of corporate governance as well as financial and sustainability reporting. She has published in scientific journals such as Journal of Management and Governance and Journal of International Accounting, Auditing and Taxation. She has also published book chapters and presented her research at international conferences. Before joining

xiv Contributors academia, she worked for a big audit firm, and she has affiliate status with the Association of Chartered Certified Accountants in Great Britain. Jason Crawford, PhD, is an Assistant Professor in Business Studies (Accounting) at Uppsala University, Sweden. His research focuses on regulation, strategy, enterprise risk management, and management control systems in financial and other industries. He is a member of ERRN (European Risk Research Network), was recently awarded the Wallander scholarship, and is currently engaged in research projects generously financed by Swedish research foundations. His recent work focuses on the cognitive aspects of risk management. He has published book chapters and presented his research at various European accounting conferences. Gunilla Eklöv Alander, PhD, is an Assistant Professor of Business Administration (Accounting and Auditing) at Stockholm Business School, Stockholm University, Sweden. Her research focuses on regulatory changes in auditing, accounting, and corporate governance. She has published in scientific journals, including Accounting, Auditing & Accountability Journal, International Journal of Auditing, and Qualitative Research in Accounting & Management, book chapters, and articles in popular science journals. She has work experience from a big audit firm, has been a member of FAR (the institute for the accountancy profession in Sweden) and worked for the Swedish Inspectorate of Auditors. She is a board member of the Swedish Academy of Auditing. Emilia Florin-Samuelsson, PhD, is an Assistant Professor of Business Administration (Management Accounting and Control) and the Associate Dean of Faculty at Jönköping International Business School, Jönköping University, Sweden. Her research is focused on management accounting and, in particular, control practices in different organisational contexts. She is also engaged in research projects related to the internationalisation of higher education. She has published in scientific journals like Accounting, Auditing & Accountability Journal as well as book chapters. Michael Grant, PhD, is an Assistant Professor of Business Studies (Accounting) at Uppsala University, Sweden. His research focuses on expertise and experts’ use of intuition in complex tasks, such as strategic decisionmaking, and he has a broad research interest in mergers and acquisitions. He has published in scientific journals like British Accounting Review and European Management Journal, as well as books (Routledge) and book chapters. He has more than 20 years of experience working internationally with mergers and acquisitions and is a board member of the Swedish Academy of Auditing. Cecilia Gullberg, PhD, is an Assistant Professor of Business Administration (Accounting) at Södertörn University, Sweden. Her research revolves around issues of transparency and accountability, often related to the

Contributors xv characteristics of accounting information. She currently explores these questions in the context of sustainability reporting and also related to increased digitalisation. She has published in scientific journals such as Accounting, Auditing & Accountability Journal and Qualitative Research in Accounting & Management as well as book chapters. Mashal Iqbal, MSc, is a graduate of the master’s programme in Business Administration (Auditing and Control) at Kristianstad University, Sweden. In 2021, she completed her master’s with a thesis on sustainability assurance, and her research focuses on sustainability reporting and assurance. She currently works as an audit associate at one of the Big 4 accounting firms. Andreas Jansson, PhD, is an Associate Professor of Business Administration (Accounting and Corporate Governance) at Jönköping International Business School, Jönköping University, Sweden. His research interests cover accounting and corporate governance in a broad sense, and his studies are focused on the effects of digitalisation on accounting practices, ownership and control, and institutional change in accounting and corporate governance. He has published in scientific journals, including Accounting, Economics, and Law: A Convivium, Competition & Change, Corporate Governance: An International Review, Culture and Organization, and Ephemera. He is also the author of book chapters. Tobias Johansson-Berg, PhD, is a Professor of Business Administration (Accounting and Control) at Mälardalen University, Sweden. His research focuses mainly on management control systems in the public and private sectors, the audit profession and occupation, and government contracting. He has published a significant number of articles in scientific journals such as Accounting, Organizations and Society, Contemporary Accounting Research, Journal of Public Administration Research and Theory, Management Accounting Research, and Public Management Review and he is the author of book chapters and articles in popular science journals. He is currently associate editor of Scandinavian Journal of Management and a member of two editorial boards. Gustav Johed, PhD, is an Associate Professor of Business Administration (Accounting and Auditing) at the University of Stockholm, Sweden. His research focuses on the role of financial accounting and auditing in organisations and society, and he is involved in studies on the audit profession and occupation. He has published in scientific journals such as Accounting, Auditing & Accountability Journal, Accounting, Organizations and Society, Behavioral Research in Accounting, Contemporary Accounting Research, Critical Perspectives on Accounting, and Qualitative Research in Accounting & Management. He is a former board member of the Swedish Academy of Auditing.

xvi Contributors Karin Jonnergård, PhD, is a Professor of Business Administration (Accounting and Corporate Finance) at School of Economics and Management, Lund University, Sweden. Her research interests are corporate governance, professions, and regulation. Her latest research project deals with the digitalisation of bookkeeping and the governance of two-sided platforms. She has published in scientific journals such as Accounting, Economics, and Law: A Convivium, Corporate Governance: An International Review, European Accounting Review, and Law & Policy. She has been active in the formation of the Nordic Network for research on professions and the Nordic Corporate Governance Network and is a former board member of the Swedish Academy of Auditing. Alexandra Kantonenko, MSc, is a graduate of the master’s programme in Accounting at Jönköping International Business School, Jönköping University, Sweden. She is currently employed as an auditor at a small audit firm. Therése Karlström, MSc, is a graduate of the master’s programme in Accounting at Jönköping International Business School, Jönköping University, Sweden. She is currently employed as an audit associate at a large audit firm. Shruti Kashyap, JD, PhD, is an Assistant Professor of Business Administration (Accounting) at Örebro University School of Business, Örebro University, Sweden. She is also a postdoctoral research fellow at the Royal Swedish Academy of Sciences and the Sustainable Finance Lab in Stockholm, Sweden. Her research currently focuses on technology, risk, and resilience in the context of sustainability-focused accounting regulation and practice. She has published in scientific journals, including European Company Law and Journal of Management and Governance, and book chapters. Before entering academia, she worked as a derivatives analyst with Morgan Stanley, and as an international trade economist and legal expert with the United Nations and World Trade Organization. Tim Kastrup, MSc, is a PhD candidate in Business Studies at Uppsala University, Sweden. His research sits at the intersection of accounting, data analytics, and decision-making. Empirically, he focuses on due diligence in mergers and acquisitions. He has work experience in auditing and assurance, including the application of International Standard on Assurance Engagements 3000. He is a member of the Swedish Research School of Management and Information Technology and the Research School in Accounting. Joachim Landström, PhD, is an Assistant Professor of Business Studies (Accounting) at Uppsala University, Sweden. His research focuses on capital market consequences of financial and sustainability reporting and investment research. He has published reports and previously worked for Lancaster University, researching financial accounting and financial

Contributors xvii economics. He has been an expert in two Swedish official government investigations and an expert witness in Swedish courts. He is currently a member of the board of a Swedish hedge fund. Ulf Larsson Olaison, PhD, is an Assistant Professor of Business Administration (Accounting) at Jönköping International Business School, Jönköping University, Sweden. His specialisation and main research interest are in accounting and corporate governance, and the latest research projects deal with foundations controlling corporations. He has published in scientific journals such as Accounting, Economics, and Law: A Convivium, Corporate Governance: An International Review, and Ephemera. Rakel Lennartsson is a Swedish journalist who has been covering the audit profession for 15 years. She is a graduate of Uppsala University and Sorbonne Paris I with degrees in political science and journalism. She started her career as editorialist at regional newspapers before becoming a reporter covering politics and economics, as well as culture and religion. In 2009, she became part of the small editorial team at FAR’s magazine Balans, the journal for the audit profession in Sweden, a position that she held until 2017. During that period, she gained deep knowledge about the audit industry in Sweden and the national and international regulations that structure it. She continues to contribute to Balans as a freelancer. Jan Marton, PhD, is an Associate Professor of Business Administration (Financial Accounting) and Assistant Head of the Department of Business Administration at the School of Business, Economics and Law, University of Gothenburg, Sweden. His research focuses on the effects of regulatory changes in accounting, the relationship between financial reporting and capital markets, and effects of personal characteristics of the audit engagement partner. He has published in scientific journals, including Accounting and Business Research, Accounting in Europe, British Accounting Review, and European Accounting Review, in book chapters and in popular science and professional journals. He has worked for big accounting firms (also in the US) and been involved in the accounting standard-setting process on the European and Swedish levels. He is the Chairman of the Swedish Academy of Auditing. Aynaz Monazzam, MSc, is a PhD candidate in Business Studies at Uppsala University, Sweden. Her research interests are in accounting information systems, organisational behaviour, and corporate strategy. Empirically, she focuses mainly on the relationship between enterprise risk management, management control, and sustainability reporting systems, investigating how the integration of these systems influences resilience capabilities of a firm undergoing transformative change. She is a member of the Swedish Research School of Management and Information Technology and the Research School in Accounting.

xviii Contributors Fredrik Nilsson, PhD, is a Professor of Business Studies (Accounting) at Uppsala University, Sweden. His research focuses on how information systems, for example related to financial accounting, management control, and enterprise risk management, are designed and used in formulating and implementing strategies. He has published in scientific journals such as Accounting & Finance, British Accounting Review, British Journal of Management, European Management Journal, Management Accounting Research, and Scandinavian Journal of Management, as well as books (e.g. Routledge and Springer) and book chapters. He is a member of the Examination Council at the Swedish Inspectorate of Auditors, Chairman of the Swedish Research School of Management and Information Technology, and former Chairman of the Swedish Academy of Auditing. Peter Öhman, PhD, is a Professor of Business Administration (Accounting and Auditing) at Mid Sweden University in Sundsvall, Sweden, and director of the Centre for research on Economic Relations. His research focuses on behavioural issues, primarily in accounting and auditing, but also in the banking and property industries. He has published a significant number of articles in journals such as Accounting History, Behavioural Research in Accounting, Contemporary Accounting Research, and European Accounting Review. He has published books (Springer), book chapters, and articles in popular science journals, and received international research awards. He is a member of editorial boards, the Scientific Council of the Swedish National Audit Office, the Disciplinary Board of Public Accountants at the Swedish Inspectorate of Auditors, and the Swedish Academy of Auditing. Savvas Papadopoulos, PhD, is a Postdoc Business Administration researcher at the School of Business, Economics and Law, University of Gothenburg, Sweden. His research focuses on the examination of the individual characteristics and social networks of market participants, in particular firm executives, directors, and audit partners, in order to understand the choices they make, as well as the consequences of these choices. He has presented his research at international accounting conferences, including the European Accounting Association annual congress and the American Accounting Association annual meeting. Katharina Rahnert, PhD, is an Assistant Professor of Business Administration (Accounting and Auditing) at Karlstad Business School, Karlstad University, Sweden. Her research interests are related to accounting history and accounting education. Other research areas addressed are the auditor’s report, the Swedish auditing profession’s marketisation, the development of professional conduct and generally accepted auditing standards, and the development of audit regulation in relation to socio-economic matters. She has published book chapters and articles in scientific and popular science journals. She has previously worked as an auditor at a Big 4 firm and is affiliated with the Centre for Organizational Research at Stockholm University, Sweden.

Contributors xix Isak Samsten, PhD, is an Assistant Professor of Computer Science at Stockholm University, Sweden. His area of expertise is algorithmic data mining and machine learning with applications in interpretable and explainable learning systems for temporal and complex data. He has published in scientific journals, including Journal of Cleaner Production, Journal of Data Mining and Knowledge Discovery, and Knowledge and Information Systems Journal, and presented his research at international conferences. He is a member of the editorial board of Journal of Data Mining and Knowledge Discovery. Fatou Sonko, MSc, is a graduate of the master’s programme in Business Administration (Auditing and Control) at Kristianstad University, Sweden. In 2021, she completed her master’s with a thesis on sustainability assurance, and her research focuses on sustainability assurance. She has worked all her career as an auditor at the National Audit Office in Gambia. Amanda Sonnerfeldt, PhD, is an Assistant Professor of Business Administration (Accounting and Finance) at School of Economics and Management, Lund University, Sweden. Her research focuses on regulatory issues related to emerging corporate reporting, auditing and assurance, and ethics of the audit profession. She has published in scientific journals, including Accounting and Business Research, Accounting Forum, Accounting History, Economics Letters, and European Accounting Review, book chapters and articles in popular science journals. She has work experience as an accountant in the US and Ireland, is a member of the Intergovernmental Working Group of Experts on International Standards of Accounting and Reporting (ISAR) Academic Research Network, and is a board member of the Swedish Academy of Auditing. Jan Svanberg, PhD, is an Associate Professor of Business Administration (Accounting) at University of Gävle and the Centre for Research on Economic Relations. He also holds degrees in engineering, physics, and law. He has conducted audit research and interdisciplinary research in transcontinental research teams with a focus on using artificial intelligence to solve fundamental business problems in cooperation with financial institutions. His research is mainly focused on socially responsible investments. He has published in scientific journals, including Accounting, Auditing & Accountability Journal, British Accounting Review, and Journal of Cleaner Production, as well as books (Springer). He has received an international research award. Tobias Svanström, PhD, is a Professor of Business Administration (Accounting) at Umeå School of Business, Economics and Statistics, Umeå University, Sweden, and an Adjunct Professor at BI Norwegian Business School, Norway. His area of interest is audit quality, auditor reporting, audit effort, audit partner characteristics, audit team attributes, non-audit services, and public oversight of auditors. He has published in scientific journals such as Accounting and Business Research, Auditing: A Journal of Practice & Theory, Contemporary Accounting Research, European

xx Contributors Accounting Review, Journal of Accounting and Public Policy, and Managerial Auditing Journal. He has also published book chapters, including the Routledge Companion to Auditing. He is a board member of the Swedish Academy of Auditing. Torbjörn Tagesson, PhD, is a Professor of Business Administration (Accounting) at Linköping University, Sweden. His research focuses on accounting and audit regulation in public and private sectors, and he has a particular interest in accounting choice, and accounting and audit quality. He has published in scientific journals, including Critical Perspectives on Accounting, Financial Accountability and Management, International Review of Administrative Sciences, and Journal of Public Budgeting, Accounting & Financial Management. He has written books (Routledge) and book chapters. Since 2008, he works part time as the Executive Director of the Swedish Council for Municipal Accounting (the standard-setting body for accounting in municipalities and regions in Sweden). He is a board member of the Swedish Academy of Auditing. Timur Uman, PhD, is a Professor of Business Administration (Accounting) at Jönköping International Business School, Jönköping University, Sweden. His research is focused on accounting and control, and his research interests cover commercialisation of audit practices, management accounting and control in hybrid organisations, and corporate governance of entrepreneurial firms. He has published in scientific journals such as Accounting, Auditing & Accountability Journal, Corporate Governance: An International Review, International Journal of Accounting, Auditing and Taxation, Journal of World Business, Long Range Planning, and Public Management Review. He is an associate editor at Baltic Journal of Management and serves on the editorial board of Journal of Public Budgeting, Accounting & Financial Management.

Foreword

A century has passed since FAR, the institute for the accountancy profession in Sweden, was founded. A great deal has happened in that time, both in the accountancy profession and in the world around us. Auditing was initially introduced to provide owners with insight into companies over which they did not have direct control, and laws were progressively introduced to regulate the area. Over the years, auditing gradually came to also fulfil a more general need as a control mechanism to maintain the efficiency of the financial system and confidence that it serves the public interest. Developments in this field continue to this day – and at an even faster pace, given that the needs of the business community and of society in general are changing. One example is the area of sustainability, where auditors have a key role as assurers of sustainability reporting. Another example is greater demands on regulation following corporate failures. For the accountancy profession to prepare for the changes that are taking place and to make the most of the opportunities that are arising, familiarity with the forces driving developments is essential. The areas that this book focuses on are: audit regulation, digitalisation of auditing, sustainability audit, and auditor characteristics. Together – and separately – all these areas have a significant impact on the audit industry. In summary, the different sections and chapters present a clear, thorough description of the changes that are taking place and the drivers behind them – from the effects of digitalisation on auditing to the significance of personal values for entrants to the accountancy profession. The final section discusses the drivers from a holistic perspective. Preliminary conclusions suggest that the effect of drivers is often not what might be expected. It has been valuable to participate in the process of developing this comprehensive publication. We enjoyed the workshop organised at Uppsala University in early 2022, and we have followed the creation of the book, chapter by chapter with great interest. It is with pleasure that we at FAR have contributed a chapter where we present our views on the future development from the perspective of the practitioners. I would like to thank all the researchers for their sincere involvement and for sharing their insightful knowledge, thus making this book a reality. It

xxii Foreword forms a basis for further research, and it will also be of interest to students as well as practitioners. How the accountancy profession will look a hundred years from now is something we can only speculate about. But the contents of this book are intended to help us understand how we reached the current situation and prepare for the future, so that the accountancy profession can continue to contribute to confidence and efficiency in both the business community and in society at large. I would like to express my warmest thanks to the editors, Jan Marton, Fredrik Nilsson, and Peter Öhman for taking the initiative on this project and bringing it forward. Last, but not least, I would like to thank Rakel Lennartsson, the writer of FAR’s chapter (Chapter 17). Karin Apelman Secretary General and CEO at FAR Stockholm, Sweden, February 2023

Preface

Auditing is in transformation. Practitioners and scholars bear witness to many, sometimes fundamental, changes in auditing. Looking back at our own careers, as researchers and practitioners, we make similar observations. A long view helps us to put more recent changes into perspective. For example, in the early 1990s, digitalisation was in an immature phase. The volume and complexity of regulations were still manageable and had, to a large extent, a national origin. Sustainability was not considered to be an area of much interest for the audit industry. Thirty years later, it is not an exaggeration to argue that much has changed, and there is no doubt that auditing must continue to transform and adapt to remain relevant to the stakeholders, the companies being audited, and society as a whole. This edited volume is an overview of the developments outlined above. It presents important drivers of audit transformation and its consequences in detail while also applying a holistic perspective. By using relevant theories and perspectives, the reader is provided with a novel analysis. The book also demonstrates that audit research has expanded and developed substantially since Hopwood (1996) made a call for more audit research. At that point in time, audit research was not well developed, and rather few researchers were pursuing studies that could contribute to our knowledge of auditing practices and what affects them (Power, 1997). This book shows that today’s situation is quite different, and we believe that academia has transformed as well. The idea of publishing a book about auditing in transformation originated in run-up to the forthcoming celebration of the 100th anniversary of FAR (the institute for the accountancy profession in Sweden) in 2023. To consolidate present knowledge in the area and reflect upon recent changes and possible future developments seemed fitting considering the upcoming jubilee. During the whole process, FAR, and especially its Secretary General, Karin Apelman, have been strong supporters of the project. We would therefore like to express our sincere gratitude for their enduring interest in the development of the book, intellectually stimulating discussions, and generous financial support that have facilitated the realisation of the project. We hope and believe that the book will contribute to many

xxiv Preface discussions between practitioners and scholars about the role of auditing in society today and in the future – especially regarding possible challenges and opportunities. An ambitious book project like this involves many people who have contributed their expert knowledge and time. We would, therefore, like to thank all co-authors for a most professional and enjoyable collaboration. One example is the friendly, vibrant, and stimulating two-day workshop that was held in Uppsala in March 2022. Another example is the positive response to all comments and suggestions provided by co-authors and editors. We hope that you are as happy with the final product as we are. A successful book project needs strong support from a reputable international publishing house. Our publisher, Routledge, and their team have provided that and given us all the support we have asked for and often more than that. We would especially like to thank senior editor Kristina Abbotts for her enthusiastic support from start to finish. It has been a pleasure working with her and the team at Routledge. Finally, we would like to thank Dr. Donald MacQueen for help with the language editing and the Centre for research on Economic Relations (CER) at Mid Sweden University for financial support on this matter. Jan Marton, Fredrik Nilsson, and Peter Öhman Gothenburg, Uppsala, and Sundsvall, Sweden, February 2023 References Hopwood, A.G. (1996). Introduction. Accounting, Organizations and Society, 21(2/3), 217–218. Power, M. (1997). The audit society: Rituals of verification. Oxford: Oxford University Press.

Acronyms and abbreviations

CSRD ESRS FAR

Corporate Sustainability Reporting Directive European Sustainability Reporting Standards The institute for the accountancy profession in Sweden (not an acronym) GAAS Generally Accepted Auditing Standards GRI Global Reporting Initiative IAASB International Auditing and Assurance Standards Board IASB International Accounting Standards Board ICAEW Institute of Chartered Accountants in England and Wales IFAC International Federation of Accountants IFRS International Financial Reporting Standards ISA International Standards on Auditing ISSB International Sustainability Standards Board KAM Key Audit Matters NFRD Non-Financial Reporting Directive PCAOB Public Company Accounting Oversight Board SEC Securities and Exchange Commission SIA The Swedish Inspectorate of Auditors SOX Sarbanes-Oxley Act

1

Auditing in transformation An introduction Jan Marton, Fredrik Nilsson, and Peter Öhman

The emergence and current state of auditing In a speech at the Inter-Scandinavian Congress of Accountants in Helsinki, Finland, in 1954, the honorary chairman of FAR (the institute for the accountancy profession in Sweden), Oskar Sillén, reflected on audit activities by comparing them with what characterised auditing shortly after the turn of the century. He began by quoting an elderly Danish accountant (Rahnert & Öhman, 2023, p. 466): ‘Our equipment then consisted of 1:0 a pencil, 2:0 a bit of confidence and 3:0 a lot of mistrust.’ Since that time, an extraordinarily strong development has taken place. (Our translation.) In retrospect, one has to agree with the honorary chairman of FAR that the working methods have improved significantly in relation to how things were in the infancy of auditing as we know it. Although there is evidence of regular voluntary auditing of companies several hundred years ago, modern financial auditing began to take shape in Scotland and England in the mid-nineteenth century. The driver was industrialisation. Limited companies started to grow and became increasingly dependent on external suppliers of capital, which in turn, provided a stimulus for control (Chandler & Edwards, 1996). At that time, there were no stipulations as to the qualifications needed to be an auditor, no uniform understanding of how to perform an audit, and the laypeople that audited companies were regarded with scepticism (Öhman & Wallerstedt, 2012). According to Jones (1995, p. 10), there were many complaints against the ‘ignorant set of men called auditors’. However, the requirements for professional auditing gradually increased in the industrialised part of the world. Audit work became increasingly structured, auditing methods were refined (Matthews, 2006), and the characteristics of a profession (according to Abbott, 1988 and Wilensky, 1964) were gradually met. The core of any profession – relating to particularly important tasks for society such as priests, lawyers, and medical doctors – consists of signs DOI: 10.4324/9781003411390-1

2  Jan Marton, Fredrik Nilsson, and Peter Öhman of professionalism that symbolise its domain: full-time occupation, adequate training (including university education), professional associations, legislated protection for the professional title, and a code of ethics. Professions also develop abstract, formal knowledge systems, and a characteristic feature of a profession is the successive structuring of such a cognitive domain. Another characteristic of professions is that regulation and supervision gradually tend to increase, partly as a result of the profession’s efforts to develop and partly because of external drivers, e.g. events like audit failures. Regulation of professions might in part include self-regulation, and professions given the right to self-regulate their activities achieve a particularly strong position in society (Adams, 2017). Of particular importance for the development of the audit profession in Sweden was the fact that the Companies Act of 1975 recognised FAR as a standard-setting body. It was left to the professionals to interpret the law and express in recommendations and standards what would be considered generally accepted audit work (Öhman & Wallerstedt, 2012). Due to globalisation, auditors are nowadays members of an internationally established profession, applying structured and cost-effective audit methods. Auditing is also said to be of utmost importance for well-functioning capital markets through maintenance of trust in company financial statements. It further affects almost all areas related to economic activity, from combating economic crime to sustainability reporting. Particularly interesting are the different views of how auditing has developed since it began to take shape in the UK, and the value of the current ‘audit society’. Power (1997) has criticised the development, arguing that auditing is not contributing to increased transparency or accountability. It is more like a ritual, fulfilling its own needs. This can be related to claims that the audit industry is unable to prevent accounting scandals such as the Kreuger crash in the 1930s or the Enron case in the 2000s. Meanwhile, other researchers and many practitioners argue that auditing is important for maintaining and fostering sustainable economic development in society. For example, articles and letters in Financial Times discuss not only the importance of auditing in modern society but also why it needs to change (e.g. McFarlane, 2018; Mooney, 2020). Irrespective of the position taken in this still ongoing debate, there seems to be general agreement that auditing has not been quick to adapt to changes in society. Some researchers and practitioners would probably even consider it to be slow and conservative. Adams (2017), for example, argues that selfregulated professions, like the audit profession, tend to put their own interests above the public’s interests and oppose changes (unless they are beneficial to the profession). However, even if we apply a rather short-time perspective, there are signs that auditing is actually in a phase of transformation. Presumably, the audit industry will encounter future changes that are more pervasive than ever before, and of a different magnitude than the changes honorary chairman of FAR, Oskar Sillén, considered as ‘an extraordinarily strong development’. One example is the tsunami of new regulations affecting auditing directly and indirectly (e.g. through regulations of accounting, auditing, and corporate

An introduction 3 governance); another is how new digital solutions (e.g. big data and artificial intelligence) are affecting auditing practices; and a third is how the increased importance of environment, social, and governance (ESG) reporting is transforming auditing (e.g. auditing of sustainability information). The last example gives the accounting firms new business opportunities, while concerns are expressed regarding the difficulty of making reliable materiality assessments in sustainability audits. We also note that audit research has developed significantly since the 1990s, when editors of international journals called for research that could open the ‘black box’ of auditing (Hopwood, 1996). Since then, our knowledge has increased regarding, for example, auditor independence (e.g. Quick & Warming-Rasmussen, 2015) and audit quality (e.g. Francis, 2004; Knechel et al., 2013). Among the issues highlighted regarding auditor independence and audit quality are pressure faced by auditors (e.g. Umar & Anandarajan, 2004), and how client identification by Big 4 auditors (e.g. Bamber & Iyer, 2007) and non-Big 4 auditors (e.g. Svanberg & Öhman, 2015) can influence their objectivity and thereby audit quality. Important and somewhat more comprehensive research reviews have been conducted (e.g. Humphrey, 2008) and research syntheses have been published in well-researched audit fields such as going concern reporting (e.g. Carson et al., 2013). The drivers of particular interest in this book – i.e. regulation, digitalisation, and sustainability – have also received increased research attention, not least in relation to the long-term questions regarding auditor independence and audit quality. For example, Humphrey et al. (2011) ask whether the impact of regulation on audit quality is, at best, presumed. Another question is how the audit profession, the accounting firms, and the auditors can handle the opportunities relating to new digital solutions. Digitalisation in most professions, the audit profession included, has arguably gone from being a question of the future to a question of the present, and from being an option to being an obligation (Pemer, 2021). An example of research addressing negative aspects of the ongoing transformation in sustainability reporting is Puroila and Mäkelä (2019), who argue that materiality assessments in such reporting involve value-laden judgements to the extent that it is best described as a sociopolitical process. Although our knowledge of auditing has increased in many ways, there is still much to study, discover, and learn from. This is especially true when auditing, and the audit industry, is in a phase of transformation. The content of the book Structure of the book

As noted, the book presents research on three general drivers (regulation, digitalisation, and sustainability) that affect many aspects of society. The fourth driver discussed in the book is more specific to the audit industry: auditor

4  Jan Marton, Fredrik Nilsson, and Peter Öhman characteristics. This last driver may both facilitate and impede change. There is a separate section in the book for each of the four drivers. Even though several chapters relate to more than one driver, the classification of chapters into sections is based on the primary driver in each chapter. The book contains 18 chapters that represent a variety of research approaches, including qualitative and quantitative empirical studies, and literature reviews. The objective of the book is to provide comprehensive insights into current drivers of auditing transformation and not to focus on any particular theoretical framework or empirical method. The book also complements previous books with a more general focus on financial auditing (e.g. Hay et al., 2014). There is a standardised structure applied to most of the chapters, including introduction, motivation, literature review, results, and conclusions and implications. Each chapter also has an appendix with information about the method. However, chapters based on a literature review instead of an empirical study combine the literature review and results sections. Chapter 17 (on practitioners’ views) and the concluding chapter (Chapter 18) also follow unique structures. Swedish data generalisable to other Western countries

Most of the empirical research presented relates to auditing in Sweden. In relation to the size of the country, a disproportionate share of audit research over the last ten years is based on Swedish data. Publicly available data on individuals allow for behavioural studies on individual audit partner characteristics, and the Swedish branches of Big 4 accounting firms and FAR are open to in-depth interaction with researchers, allowing for the collection of rich data through interviews and observational studies. Response rates to questionnaires are also substantially higher than those commonly achieved in other countries. While the access to unique data allows for studies on Swedish conditions, the question is to what extent the results are generalisable to settings outside Sweden. We argue that such a generalisation to at least other Western countries is possible, as there are similarities in terms of regulation and market structure of auditing. There are several contextual factors in Sweden, which are of interest to readers in other countries.

• There is a historical German legal origin, with substantial Anglo-American

influence in the last few decades (Aisbitt, 2008). Sweden shares the tension between traditional legal systems and recent international regulations with many European countries. • An audit is legally required for many unlisted companies. Therefore, the increasing complexity of audits in listed companies is followed by attempts at partial simplification in audits of SMEs, creating a system of two levels of audit requirements. This situation resembles the situation in other European countries.

An introduction 5

• The recruiting challenges found in Swedish accounting firms are a largely global phenomenon.

A factor that contributed to writing the book is that FAR has its centennial jubilee in 2023, leading to an increased interest from the profession to use research to reflect on current and future changes. Part of the interest is evidenced through the above-mentioned Chapter 17, written by a journalist on behalf of FAR and based on interviews with practitioners heavily involved in the professional work of the association. The following five subsections describe the chapters of the book. The first three sections are related to external drivers of auditing transformation. The fourth section includes chapters discussing auditor characteristics. Finally, there is a concluding section with two chapters – one presenting the view of practitioners and the other presenting overall conclusions and implications from the editors. Regulation

Like any profession assigned important societal tasks, the audit profession is highly regulated. Regulation is, and has been, an important driver of how auditing develops, but it most often comes into play either because of the profession’s efforts to improve its operations or because of external triggers, i.e. critical events. In other words, laws and additional rules have, on the one hand, codified auditing practice and, on the other, responded to audit failures. Regardless of the underlying cause, regulation has paved the way for a strengthening of the profession’s position in society (Allen & McDermott, 1993; Öhman & Wallerstedt, 2012). Throughout history, legislation has gradually increased, making the audit profession strongly dependent on regulation – and self-regulation – to consolidate the achieved position (because regulation signals that an activity is considered important). Today, however, researchers as well as practitioners use expressions like ‘a tsunami of new international regulations’ when discussing the direct and/or indirect effects on auditing. This indicates that the recent development is not only beneficial and that the effects of regulations are not always as anticipated. Examples of international regulation that affects auditors are the 2002 Sarbanes-Oxley Act (SOX) in the US, and the 2014 EU directive on auditing (2014/56/EU). Even though SOX is only applicable in the US, it affected the Big 4 accounting firms worldwide through their global networks. The 2014 EU directive substantially strengthened regulation of auditing in the EU, and were directly applicable to audits conducted in Sweden through the adoption of the directive in Swedish legislation. This section includes chapters discussing how regulations are affecting auditing and audit work, starting with Chapter 2 (In pursuit of a more socially relevant audit in the context of international standardisation), written by Amanda Sonnerfeldt and Gunilla Eklöv Alander. The chapter aims to

6  Jan Marton, Fredrik Nilsson, and Peter Öhman enhance our knowledge of the implications that international standardisation might have on audit innovation at the national level. It reports on the ways in which transnational regulation effectuates institutional constraints as a setting to discuss capacities for the audit profession to make audits more socially relevant. The chapter reviews two initiatives for increased social relevance by the professional organisation FAR: (i) standards for audits of small entities and (ii) a standard on assurance of sustainability reports. While auditing is conceived to be in transformation to meet contemporary societal challenges, the analysis reveals that the development, role, and conceptual foundations of audit have been increasingly constrained by normative, cognitive, and regulative forces. The main message is the importance of critically reflecting on the conditions under which national professional associations work to develop the audit. Policymakers, regulators, the audit profession, and academia are encouraged to contribute to developing auditing to better serve society’s changing needs. Chapter 3 (The construction of status in the auditor–audit committee relationship) is written by Gunilla Eklöv Alander, Karin Jonnergård, and Ulf Larsson Olaison. This chapter describes the effects of another regulative initiative, the audit committee, which works as a driver for changing the relationship between the auditor and the client’s board. The study is informed by interviews with audit committee members and external auditors in large, listed companies. The effects on the role of the auditor after introducing audit committees are discussed, and a main finding is that a result of the regulatory changes is a weakened position for the auditor, reducing his or her status in relation to board members, becoming a supplier, among other suppliers, of trust and comfort to the directors. Due to the fact that regulation emphasises the importance of audit committees to increase audit quality, this finding can be seen as rather paradoxical since the audit committee actually appears to weaken the auditor. It also serves as an example that a regulation with good intentions, in this case to address corporate failures, does not always lead to the anticipated effects. Chapter 4 (Audit reporting transformation: Increasing the relevance of the audit through key audit matters?), written by Katharina Rahnert, focuses on the ‘new’ auditor’s report. Although users of financial statements have long expressed demands for informative auditor’s reports including entity-specific information, they have received nothing but standardised information. Ultimately, this led to a regulatory change that mandated key audit matter (KAM) disclosures. The chapter provides an analysis of how regulation has affected KAM disclosures, i.e. entity-specific information, in auditor’s reports of Swedish listed companies (covering the 2016–2021 period). The results show, contrary to expectations, that the information has not become less standardised. Auditors primarily change KAMs when conducting initial audit engagements. Otherwise, they tend to reuse previously provided information, not contributing to any increased information value for the users of financial statements. However, the increased regulation on

An introduction 7 auditor rotation might facilitate a fresh view of the entity-specific information disclosed in the auditor’s report. The chapter, thereby, provides valuable insights into the relationship between changed regulation concerning the information in the auditor’s report and auditor rotation. Chapter 5 (The adoption of professional audit standards in the public sector: The role of the audit profession and other actors) is written by Pernilla Broberg and Torbjörn Tagesson. This chapter emphasises that private accounting firms must consider different institutional conditions and operate in parallel within different organisational fields. Thus, these firms, and their auditors, could be highly involved and influence auditing throughout processes where international regulation is a key driver for adopting new auditing standards, in this case auditing standards for municipal financial auditing in Sweden. By interviewing various actors and analysing documents from the standard development process, the chapter aims to increase our knowledge of how change within auditing is initiated and formed through collaboration and negotiation between several actors within the organisational field. The first main contribution is the empirical description and explanation of the process by which a standard for municipal auditing of accounts was developed. The second main contribution is theoretical additions to models that explain institutional change. Digitalisation

The chapters in this section examine in detail the digitalisation of auditing, i.e. a driver that has attracted substantial attention among scholars and practitioners (e.g. Appelbaum et al., 2017). The development and introduction of new digital solutions, using technologies such as big data and artificial intelligence, mainly affect the audit industry in two different ways. It is not only about the new digital solutions to be implemented in auditors’ own work but also about what the audit covers (where the objects of audit increasingly need to be understood in the light of digital transformation). Some scholars and practitioners are of the opinion that we have only seen the beginning of this transformation and that the long-term effects on the audit industry will be significant. Others are a bit more sceptical and argue that this process will probably take much longer than anticipated. This section contains four chapters that will provide the reader with a discussion of the fundamental question about how structures, like digital solutions, affect auditors’ judgement. It also discusses how far digitalisation of auditing has come, problems experienced during the transformation, and why digitalisation in the audit profession can still be considered to be in a rather immature state. Chapter 6 (On the structures of judgement in auditing) is written by Thomas Carrington and Bino Catasús. The main focus of the chapter is how structure affects judgement in auditing and vice versa. By showing that structures exist in different forms, the authors are able to nuance a long-standing

8  Jan Marton, Fredrik Nilsson, and Peter Öhman debate about how structures, like checklists and new digital solutions, affect judgement and ultimately audit quality. This debate has to a large extent divided researchers into those who believe that structures will decrease the need for judgement and those who believe structures will improve audit quality. The authors take their departure from these different standpoints and argue, based on the literature and their own interview material, that drivers of transformation – such as digitalisation of auditing – affect the outcome through different forms of structures (i.e. procedural, analytical, controlling, and mnemonic). By introducing these forms of structures, the authors are able to increase our understanding of the auditing transformation process and what effects can be expected from it. The chapter also contributes to our understanding of why these effects can deviate from expectations as a result of how auditors perceive structures. Chapter 7 (Digitalisation and professional scepticism of Swedish auditors), written by Andreas Jansson, Timur Uman, Emilia Florin-Samuelsson, Alexandra Kantonenko, and Therése Karlström, takes its departure from the type of research used by Carrington and Catasús, i.e. the influential stream of literature discussing the relationship between structure and judgement. Being interested in how digital solutions, so-called computer-assisted audit techniques (CAAT), affect professional scepticism and audit quality, the authors of this chapter conducted a survey among Swedish authorised auditors. The results from the survey show that the use of CAAT has a positive effect on professional scepticism. The effect, however, depends on the degree of scepticism shown by the individual auditor. More specifically, if the auditor is sufficiently sceptical, CAAT can be used to free up time to increase audit quality through the use of professional judgement. Hence, these results question the old standpoint that more structure will lead to less judgement. It is thus a contribution to a more nuanced debate about the effects of auditing in general and digital solutions in particular on structures. Chapter 8 (Being an audit professional in the digital age) is written by Amanda Sonnerfeldt and Karin Jonnergård. In discussions about how digital solutions affect auditing, there is rarely a critical analysis of how the individual auditor’s professional identity is affected. This chapter helps to fill this void in the literature and, by doing so, increases our understanding of what it means to be an audit professional in the digital age. An interview study with auditors in various positions shows that some of them experience professional insecurities as well as concerns about the future development of the profession as a whole. Examples of such insecurities and concerns are a lack of trust in their systems of expertise, the deskilling of the next generation due to inadequate foundational knowledge of their core competence, and lack of skills in the field of digital technology. The authors call for educators in higher education institutions, FAR, and accounting firms to be aware of how digital transformation affects what is considered auditing expertise and to accommodate that in their curricula to advance the competence and future readiness of auditors.

An introduction 9 Chapter 9 (Advanced digital technologies and sustainability assurance: Evidence from Sweden) is written by Jason Crawford, Tim Kastrup, and Aynaz Monazzam. The main focus of this chapter is to identify and discuss drivers that influence the use of advanced digital technologies (ADT) in a particular type of auditing, i.e. sustainability assurance. A rich empirical material – consisting of interviews with FAR, the Swedish Inspectorate of Auditors (SIA), Big 4 firms, and two large investors, as well as industry reports – shows how technology use in sustainability assurance is affected by the interplay of institutional demands, an evolving audit profession, and competitive pressures. Currently, ADT plays a minor to non-existent role in sustainability assurance engagements conducted by large accounting firms in Sweden. The authors identify ongoing regulatory and standard-setting uncertainty, low-quality ESG data, a lack of mature internal controls, and tensions between auditors and digital technologies as central barriers to the use of ADT. The future role of ADT in sustainability assurance will arguably depend on the ability of regulatory and standard-setting bodies, accounting firms, and auditees to deal with these barriers. Sustainability

Over time, the issue of sustainability has received increasing interest in business and in society in general. Consequently, there has been a strong growth in sustainability reporting by companies and other organisations (Christensen et al., 2021). Originally, sustainability had three pillars: economic, environmental, and social. Currently, most people only refer to the last two, as economic sustainability is already captured in traditional financial accounting. There are additional related concepts. ESG includes – as the term suggests – governance in addition to two of the sustainability pillars, while corporate social responsibility (CSR) is about how companies have a broader responsibility beyond giving a return to their shareholders. This book focuses on the term sustainability. Until recently, sustainability reporting was largely developed through companies voluntarily providing information. The most commonly used framework is reporting standards developed by Global Reporting Initiative (GRI). In 2014, the EU issued the Non-Financial Reporting Directive (NFRD), which became mandatory a few years after it was issued. It contains some general requirements for sustainability reporting but gives no detail. Therefore, many companies that implement NFRD use GRI standards for detailed guidance. Late in 2022, the EU adopted the Corporate Sustainability Reporting Directive (CSRD), with much more comprehensive requirements than NFRD. Connected to the CSRD, there will be detailed European Sustainability Reporting Standards (ESRS). CSRD, including ESRS, will become mandatory starting in 2024 for the largest companies. For accounting firms, sustainability reporting is important to the extent that it is audited or creates opportunities for consulting services. The CSRD is highly relevant, as

10  Jan Marton, Fredrik Nilsson, and Peter Öhman it requires that sustainability reporting be audited. However, the audit does not have to be done by authorised auditors, so there is potential competition from outside the audit industry. The area of sustainability reporting, and the audit of such reporting, is currently in a phase of tremendous development. Such is the setting for the chapters that relate to this driver of auditing transformation. Chapter 10 (Assessment of double materiality: The development of predictively valid materiality assessments with artificial intelligence), written by Peter Öhman, Jan Svanberg, and Isak Samsten, suggests a method to determine ‘double materiality’ in sustainability reporting. The background is that some sustainability reporting standards, e.g. GRI and ESRS, require a broader definition of materiality than traditionally used in financial reporting. Material information is traditionally defined as information that has the potential to affect decisions made by capital providers, such as investors and creditors. Double materiality expands this concept to also include information about companies’ environmental and social impact that is relevant to society at large. A problem for reporting companies and auditors is that the assessment of double materiality is currently uncertain. The chapter utilises machine learning methods to study what type of information can predict environmental issues resulting from companies’ operations. It represents a proposal to use a structured and quantitative approach to determine double materiality, thereby potentially facilitating sustainability reporting in accordance with current GRI standards and future ESRS. Chapter 11 (Organising for quality in sustainability assurance: A literature review) is written by Katarzyna Cieslak, Cecilia Gullberg, Shruti Kashyap, and Joachim Landström. The chapter focuses on auditing of sustainability reporting, including reporting and audit quality. It is based on a literature review that provides an overview of existing knowledge in the area. To date, audits of sustainability reporting have not been mandatory, and there seems to be variation in audit quality. Overall, however, audited sustainability reporting has higher quality than unaudited reporting. The literature suggests that the current situation, where auditing is not mandatory, results in a lack of reliability, such as frequent occurrences of greenwashing. There are arguments for both accounting firms and other entities performing the audit. For example, accounting firms are good at finding errors in reported information, but in sustainability reports, it may be equally important to identify missing information. It is, therefore, currently not clear whether audits by accounting firms or other entities will lead to higher quality in sustainability reporting. Chapter 12 (Challenges of sustainability-assurance practices: Insights from Big 4 accounting firms) is written by Daniela Argento, Mashal Iqbal, and Fatou Sonko. The chapter discusses a similar issue as Chapter 11, i.e. the quality of current auditing of sustainability reporting. It is based on interviews with auditors involved in sustainability reporting audits, thereby providing a practice-oriented view in addition to the literature review in Chapter 11. The

An introduction 11 findings confirm that there is currently substantial variation in how audits of sustainability reports are carried out, even within accounting firms. It is not clear to what extent auditors should ideally be specialised in auditing or sustainability reporting. Probably, the creation of teams with diverse competencies is a way forward. The chapter shows that audits of sustainability reports is an immature field, where a consistent practice has yet to develop, even within individual accounting firms. In addition, arguments are possible for such audits being performed by both authorised auditors and other parties, so the final conclusion to this issue is currently unclear. Auditor characteristics

The drivers of transformation discussed so far are generally recognised as being of significant importance in many industries and even considered to affect globalisation (e.g. Blomkvist et al., 2021). They can thus be characterised as global drivers coming from the ‘outside’ affecting the audit industry and the accounting firms. However, both the cohesive industry and the individual Big 4 firms are trying to affect the drivers. One example is lobbying activities to affect new regulations. They are also applying strategies to respond to the drivers and take advantage of new business opportunities. Ultimately, the outcome of these activities by the audit profession is to a large extent dependent on individual auditor characteristics. The four chapters in this area show that these types of characteristics can be an impediment or a facilitator for the drivers of change identified and discussed in the preceding sections. These insights are important, since accounting firms decide who they employ. The recruitments affect how audit work will be performed and, therefore, the functioning of the firm and ultimately the entire industry. The insights provided are also important for educators as well as authorities (e.g. SIA), who decide what knowledge and skills an authorised auditor should have. Chapter 13 (The average professional: On the selection and socialisation of auditors) is written by Thomas Carrington, Tobias Johansson-Berg, Gustav Johed, and Peter Öhman. The chapter presents an empirical study of newly employed auditors at the seven largest accounting firms in Sweden. The study is a detailed and unique analysis of the characteristics of this category of auditors and to what extent their opinions coincide with the opinions of other citizens with higher education. It also provides the reader with insights into the value commitments of the new recruits and to what extent they coincide with those of senior auditors. The results show that those recruited today are more diverse than earlier in regard to their educational, socio-economic, and geographical background. While sharing a high level of confidence in the universities, the legal system, and the police, the newly recruited audit assistants’ opinions (i.e. trust in societal institutions like the media) deviate from the average, well-educated, citizen in that the newly recruited audit assistants have significantly lower trust in the media.

12  Jan Marton, Fredrik Nilsson, and Peter Öhman Regarding opinions directly related to auditing (e.g. professional and client commitments), the newly recruited auditors do not deviate from senior auditors, indicating that the former group seems to already closely reflect the identity of authorised auditors at recruitment. They also believe that the reason for them being hired is more related to ‘soft skills’ (e.g. being communicative) than to ‘hard skills’ (e.g. having advanced accounting and auditing knowledge). This is a surprising finding considering the increasing complexity of accounting and reporting practices. Chapter 14 (The importance of the engagement partner) is written by Jan Marton and Savvas Papadopoulos. The theoretical starting point for this chapter is that the lead auditor characteristics are more important for audit quality than internal control in accounting firms or the characteristics of other members of the audit team. Furthermore, to the extent that auditors’ personal characteristics are stable over time, these characteristics introduce inertia in the effect of drivers of transition. Departing from this line of argumentation, the authors have conducted a literature review about the importance of the engagement partner (EP), specifically about the effect of EP characteristics on audit quality. One conclusion from the review is that the research conducted so far does not focus on the exact interaction effects on audit quality of external changes with individual EP characteristics. However, the literature suggests that EP reactions to different types of incentives can be explained by individual EP characteristics (e.g. in terms of risk preferences and professional scepticism). How this important finding can be expected to interact with the drivers of regulation, digitalisation, and sustainability is discussed in the chapter along with some of the practical implications for accounting firms, clients, investors, and regulators. Chapter 15 (Transformation in audit teams: Implications for team competence), written by Alice Annelin and Tobias Svanström, reviews and discusses literature of relevance for audit team competence (i.e. team composition, team expertise, and team dynamics). These competencies are related to regulation, digitalisation, and sustainability. For each identified area of audit competence, hypotheses are developed regarding their future development and impact on audit work and quality. Based on their review and analysis of the literature, the authors present a conceptual framework. It illustrates possible ways in which audit teams may choose to address future demands on audits emanating from the identified drivers. One example of an important decision is whether audit teams should increase intra-team specialisation or if they should instead aim for a full integration of expertise across all team members. Irrespective of how accounting firms approach this type of question, it will impact how auditing competencies are developed and nurtured as well as which services can be delivered at a high-quality level. It will possibly also affect how universities design courses and programmes. Chapter 16 (Expertise in financial auditing) is written by Jenny Backman, Michael Grant, and Fredrik Nilsson. This chapter reports on an explorative study that seeks to understand how expertise is expressed in what auditors

An introduction 13 do and what factors affect the expertise needed. The study builds on interviews with senior auditing professionals from a large accounting firm. Findings show that the interviewees’ perceptions of audit expertise, and how it is expressed in judgements, can be categorised into the following areas: judging how accounting (and other) regulations should be applied; making risk judgements; judging materiality; judging people; and base judgements on a holistic understanding of the issue at hand. Furthermore, the chapter highlights that increased regulation and digitalisation are perceived as important drivers affecting audit expertise. The findings highlight the importance of considering drivers for change when developing both a theoretical and practical understanding of what expertise is, and how it can be developed and fostered, in the field of auditing. This knowledge is valuable for accounting researchers, accounting firm representatives, regulators, and the accounting educational system. Concluding discussion on drivers and their effects

Chapter 17 (Audit transformation: Practitioners’ views) is written by Rakel Lennartsson on assignment of FAR. The chapter presents practitioners’ views on important drivers of auditing transformation and their effects. It is based on interviews with prominent representatives of the Swedish audit industry. The interviews confirm the importance of the drivers and their effects discussed in the book, with only minor differences in emphasis (see Chapter 18). The chapter starts with an account of how globalisation has affected the organisation of Big 4 firms, and perhaps even more importantly, how regulation of reporting and auditing has been affected. The regulation of how public interest entities should be audited is an example of this development. In the years to come, the practitioners predict particularly strong effects of digitalisation and sustainability, and they believe that these drivers have the potential to lead to growth in the audit industry. Digitalisation has already affected auditing significantly even though it has not been as dramatic as expected. Sustainability reporting is considered an opportunity to expand auditing to new areas. Meanwhile, competition from other actors than accounting firms is likely to increase. In sum, it seems likely that competition for ‘talent’ will intensify further. Chapter 18 (Concluding remarks) is written by Jan Marton, Fredrik Nilsson, and Peter Öhman. The chapter summarises the conclusions from the preceding seventeen chapters and relates them to the drivers of transformation. An overall conclusion is that the effect of the drivers identified is often both unexpected and unintended. Another overall conclusion is that ongoing developments are not linear and unidirectional. Finally, the competencies of the individual auditor, as well as other characteristics, are affecting the transformation process and the effects of the drivers in focus of this book. In addition to a discussion of these conclusions, the chapter outlines some possible avenues for future research.

14  Jan Marton, Fredrik Nilsson, and Peter Öhman References Abbott, A. (1988). The systems of professions. An essay on the division of expert labour. Chicago, IL: University of Chicago Press. Adams, T.L. (2017). Self-regulating professions: Past, present, future. Journal of Professions and Organization, 4(1), 70–87. Aisbitt, S. (2008). Implementation of supra-national policies: Lessons from the Nordic countries’ experiences of European directives. Accounting History, 13(1), 75–99. Allen, D.G., & McDermott, K. (1993). Accounting for success: A history of Price Waterhouse in America, 1980–1990. Boston, MA: Harvard Business School Press. Appelbaum, D., Kogan, A., & Vasarhelyi, M.A. (2017). Big data and analytics in the modern audit engagement: Research needs. Auditing: A Journal of Practice & Theory, 36(4), 1–27. Bamber, E.M., & Iyer, V.M. (2007). Auditors’ identification with their clients and its effect on auditors’ objectivity. Auditing: A Journal of Practice and Theory, 26(2), 1–24. Blomkvist, K., Schmuck, A., & Arora-Jonsson, S. (2021). Trumpism, Brexit, Industry 4.0, and COVID-19: What is happening to globalization? A Review of the literature on economic globalization. Report, Department of Business Studies, Uppsala University. Carson, E., Fargher, N.L., Geiger, M.A., Lennox, C.S., Raghunandan, K., & Willekens, M. (2013). Audit reporting for going-concern uncertainty: A research synthesis. Auditing: A Journal of Practice & Theory, 32(S1), 353–384. Chandler, R.A., & Edwards, J.R. (1996). Recurring issues in auditing: Back to the future? Accounting, Auditing and Accountability Journal, 9(2), 4–29. Christensen, H.B., Hail, L., & Leuz, C. (2021). Mandatory CSR and sustainability reporting: Economic analysis and literature review. Review of Accounting Studies, 26(3), 1176–1248. Francis, J.R. (2004). What do we know about audit quality? British Accounting Review, 36(4), 345–368. Hay, D., Knechel, W.R., & Willekens, M. (Eds.). (2014). The Routledge companion to auditing. London: Routledge. Hopwood, A.G. (1996). Introduction. Accounting, Organizations and Society, 21(2/3), 217–218. Humphrey, C. (2008). Auditing research: A review across the disciplinary divide. Accounting, Auditing & Accountability Journal, 21(2), 170–203. Humphrey, C., Kausar, A., Loft, A., & Woods, M. (2011). Regulating audit beyond the crisis: A critical discussion of the EU Green Paper. European Accounting Review, 20(3), 431–457. Jones, E. (1995). True and fair. A history of Price Waterhouse. London: Hamish Hamilton. Knechel, W.R., Krishnan, G.V., Pevzner, M., Shefchik, L.B., & Velury, U.K. (2013). Audit quality: Insights from the academic literature. Auditing: A Journal of Practice & Theory, 32(Supplement 1), 385–421. Matthews, D. (2006). From ticking to clicking: Changes in auditing techniques in Britain from the 19th century to the present. The Accounting Historians Journal, 33(2), 63–102. McFarlane, J. (2018). Audit has essential role in the wider economy. Financial Times, December 21.

An introduction 15 Mooney, A. (2020). Is audit fit for purpose? Financial Times, September 12. Öhman, P., & Wallerstedt, E. (2012). Audit regulation and the development of the auditing profession: The case of Sweden. Accounting History, 17(2), 241–257. Pemer, F. (2021). Enacting professional service work in times of digitalization and potential disruption. Journal of Service Research, 24(2), 249–268. Power, M. (1997). The audit society: Rituals of verification. Oxford: Oxford University Press. Puroila, J., & Mäkelä, H. (2019). Matter of opinion: Exploring the socio-political nature of materiality disclosures in sustainability reporting. Accounting, Auditing and Accountability Journal, 32(4), 1043–1072. Quick, R., & Warming-Rasmussen, B. (2015). An experimental analysis of the effects of non-audit services on auditor independence in appearance in the European Union: Evidence from Germany. Journal of International Financial Management & Accounting, 26(2), 150–187. Rahnert, K., & Öhman, P. (2023). Avslutande tankar om revision i går, i dag och i morgon. In Swedish (Final thoughts on auditing yesterday, today and tomorrow). In Rahnert, K., & Öhman, P. (Eds), Revision: I går, i dag, i morgon. In Swedish (Auditing: Yesterday, today, tomorrow). Stockholm: Ekerlids förlag, 466–471. Svanberg, J., & Öhman, P. (2015). Auditors’ identification with their clients: Effects on audit quality. British Accounting Review, 47(4), 395–408. Umar, A., & Anandarajan, A. (2004). Dimensions of pressures faced by auditors and its impact on auditors’ independence: A comparative study of the USA and Australia. Managerial Auditing Journal, 19(1), 99–116. Wilensky, H.L. (1964). The professionalization of everyone? The American Journal of Sociology, 70(2), 137–158.

Part I

Regulation

2

In pursuit of a more socially relevant audit in the context of international standardisation Amanda Sonnerfeldt and Gunilla Eklöv Alander

Introduction Globalisation has significantly reshaped the regulatory landscape and the organisational field of auditing, shifting the key structural boundaries and power from the state-profession nexus to the transnational level (Gillis et al., 2014). The last three decades saw the rise of international standards defining best-practice rules for national regulators and market participants. Within the transnational regulatory arena, the International Audit and Assurance Standards Board (IAASB) emerged as the globally recognised institution that sets International Standards on Auditing (ISAs), which is now adopted by more than 120 jurisdictions (IFAC, 2019), and is supported by international regulators and global audit firms (Humphrey et al., 2009). Transnational regulation, particularly international standardisation, has been a significant force driving the development of audit. Today, audit performed according to ISAs is regarded as part of the international financial architecture and is seen as essential for financial stability. For the audit profession, it has also come to be a central part of audit professionalism and is its quality mark. According to ISA 200 the overall objectives of the auditor are: (a) To obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, thereby enabling the auditor to express an opinion on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework; and (b) To report on the financial statements, and communicate as required by the ISAs, in accordance with the auditor’s findings. (IAASB, 2022, p. 52) The aforementioned purpose and scope of audit are not unchallenged, however. Various stakeholders, including financial report users and national accountancy professional associations (henceforth NPA), are calling for a more socially relevant audit, i.e. one with a direct intent of enhancing societal contribution (Humphrey et al., 2021). In this chapter, we define a socially DOI: 10.4324/9781003411390-3

20  Amanda Sonnerfeldt and Gunilla Eklöv Alander relevant audit as one aligned with and responsive to significant issues and evolving with the changing needs of contemporary society. There have been calls by stakeholders for a more holistic audit, greater transparency into firm operations, more value-relevant audits for small entities, greater responsiveness to sustainability, and more informative auditor’s report (see Accountancy Europe, 2018a; Forbes, 2014; Humphrey et al., 2021; Malmström, 2021; Rahnert, in this volume). Interestingly, studies have shown that international standardisation, the very driving force that has set the path for audit development in the last three decades, is paradoxically constraining its development (Durocher et al., 2016; Humphrey et al., 2021). For this reason, the capacity of the profession to innovate should not be presumed; auditing transformation has to be understood within the context of transnational regulation and international standardisation of the audit. The aim of this chapter is to enhance our understanding of the implications of transnational regulation, particularly international standardisation, on audit innovation at the national level. The focus on audit innovation allows our analysis to go beyond the ways by which international standardisation eliminates local differences. Instead, it draws our attention to process and product innovations where NPAs have engaged to develop the audit. Process innovation refers to new or improved ways of performing audit services (e.g. more efficient testing methods), whereas product innovation refers to improvements to the functionality of audits (e.g. widening the scope of the audit to further sustainable development goals). We have chosen Sweden as a site of study because the Swedish NPA – FAR – had for many years, since its establishment in 1923, enjoyed relative autonomy to develop the audit within the discretion granted by Swedish legislation, and often preceding it (Öhman & Wallerstedt, 2012). As an effect of globalisation, the audit profession’s autonomy has been significantly shaped by regulatory developments and the interplay of global, regional, and local events (Samsonova & Humphrey, 2014), resulting in regulatory structures in different jurisdictions becoming more similar over time (Baker et al., 2014). Transnational audit regulation has had a significant effect on audit in Sweden due to Sweden’s accession to the EU in 1995; followed in 2002 by firstly tailored, then in 2011 full adoption of ISAs. The adoption of ISAs has reinforced the transnational audit model as one for maintaining trust in financial statements in Sweden. While the effects of standardisation of the audit are widely discussed, its implications for audit innovation by an NPA are less known. This chapter presents our analysis of the ways in which transnational regulation effectuates institutional constraints on audit innovation as a setting to discuss the capacity of the audit profession to drive innovation and make audit more socially relevant. Based on our analysis, we offer ways forward to encourage policymakers, regulators, the audit profession, and academia to move beyond the current financial audit model and to rethink and reconceptualise audit differently, to allow its transformation to better serve society’s changing needs.

Socially relevant audit of international standardisation 21 Motivation This chapter is prompted by our concern about the ways transnational regulation constrains audit innovation by NPAs, especially where conceptual development is needed for audit to become more relevant to meet contemporary societal challenges. Audit is a social phenomenon (Flint, 1988; Mautz & Sharaf, 1961); its existence is contingent upon its economic and social relevance. Throughout history, the dynamic and fluid nature of audit has been observed, where changes in the socio-economic environment and changes in audit objectives and technologies are closely linked (Andon et al., 2015), thereby maintaining its raisons d’être. The notion and definitional fuzziness of the idea of audit have allowed the percolation of the body of audit knowledge into a variety of contexts where ‘audits’ serve to institutionalise different forms of accountability (Power, 1997). Although international standardisation of the financial audit has benefitted the profession and its stakeholders by enabling higher quality and more consistent audits, it is not without unintended consequences. For example, the increasing support for convergence of audit practices has made it difficult for auditors to depart from ISAs and move beyond the presumptions of the current audit model. This development is particularly concerning given that innovation has been lacking, less in the way in which audit is made more efficient (process innovation) but more in terms of the profession challenging the conceptual foundations of auditing and its purpose (Humphrey et al., 2021). While audit is conceived to be transforming in light of various driving forces such as digitalisation and sustainability (Marton et al., the first chapter in this volume), we argue that it is important to critically reflect on the nature of such innovations and the conditions transnational regulation poses to NPAs in their attempts to engage in audit innovation. This study contributes to our understanding of the institutional forces constraining and enabling NPAs to engage in audit innovation. Further, it unveils some of the ideas that had surfaced to develop the audit but failed to materialise due to the commitment to international standardisation in the regulatory arena. To realise the aim of this chapter, we review two audit innovations which FAR was involved in:

• Standard for audits of small entities (SASE); and • Standard for assurance of sustainability reports (RevR6) These empirical domains were chosen, firstly, for their contemporary nature and prominence on the global and national audit profession’s agenda,1 and secondly, for the potential of such services to improve the social relevance of the audit. These two initiatives were driven by the need to increase the efficiency and value relevance of the audit for small entities and develop sustainability reporting and assurance practices, respectively. Our analyses focus on how international standardisation has contributed to the constraints and the

22  Amanda Sonnerfeldt and Gunilla Eklöv Alander capacity of FAR to develop the financial audit in the former, and assurance – an area adjacent to the audit – in the latter. We adopt a qualitative research approach combining an extensive review of documents (see Appendix), supported by extant literature and observations of several standard-setting and practitioner events organised by the accounting profession.2 Our findings are presented through the lens of transnational governance and institutional theory, exemplifying the ways by which attempts to challenge the existing audit model have been subjugated and discouraged under the existing transnational audit regime. The concluding section mobilises the concept of dynamic repair put forth by Humphrey et al. (2021), in order to discuss the possibility of rethinking the conceptual underpinnings of the audit, given the capacity of Swedish institutions to make audits socially relevant. Literature review In this section, we first review the literature on transnational and national regulation and then identify forces constraining audit innovation at the international and national levels. Thereafter, we draw on the literature review and institutional theory to develop a framework to analyse our findings. Transnational audit regulation

Transnational audit regulation was given shape and content during the aftermath of the Asian financial crisis in 1997 when the G7 instituted the ‘standards-surveillance-compliance system’ to strengthen the international financial architecture (Humphrey et al., 2009). It is a coordinated governance system reflecting regulatory arrangements binding together international regulators and the international accounting profession. The setting of ISAs is overseen by the Public Interest Oversight Board (PIOB) and monitored by international regulators committed to advancing the public interest (Humphrey et al., 2009). In 2000, ISAs were recommended by the Financial Stability Forum (now the Financial Stability Board) as one of the 12 core standards to strengthen institutional and market infrastructure to promote international financial stability. Based on the notion that audit, performed in accordance with high-quality international standards, is vital for the reliability and transparency of financial statements, the audit carried out in accordance with ISAs gained legitimacy in the financial reporting supply chain. This conception of audit has been reinforced with subsequent reforms, including the Post-Enron and Post2007 Global Financial Crisis, directed towards achieving a more consistent audit globally (Humphrey et al., 2021). In the transnational regulatory arena, the purpose of audit is limited to providing assurance on financial reports and serving the interests of primarily the capital market (Humphrey et al., 2009). While transnational regulation may seem remote when reviewing initiatives by national standard-setters, the proliferation of both state and

Socially relevant audit of international standardisation 23 non-state actors’ involvement in the international financial architecture has had significant effects on the development of audit policy, regulation, and practice. It sets the stage where standards and practices of auditing are developed and implemented at the national level. Here, NPAs play a pivotal role as intermediaries operating between local and transnational regulatory arenas to institutionalise international standards at the local level. At the same time, they engage with transnational actor networks and institutions to extend their position and influence in the audit regulatory arena (Samsonova & Humphrey, 2014). With more than 120 jurisdictions adopting ISAs (IFAC, 2019), the shifts in the capacity and expertise of standard-setting from NPAs to the transnational level have made it more difficult for audit innovations to originate locally (Löhlein & Müßig, 2020). It is therefore hardly possible to discuss the conditions within which FAR engages in audit innovation without considering the complexity existing between these transnational institutions that affect the legitimacy of standards and practices (Cooper & Robson, 2006). Audit regulation in Sweden

Audit regulation today can be described as multileveled, whereby the processes of standard-setting, implementation, monitoring, and enforcement are dispersed across more than one level amongst public and private actors (Humphrey & Loft, 2011). Auditing in Sweden is regulated by interplay of the EU, national legislation, and professional norms. According to the Lisbon Treaty, European institutions share competence with their member states to adopt legislative acts to regulate auditing to safeguard the internal market. Directive 2006/43/EC (amended by Directive 2014/56/EU) delegates authority to the European Commission to mandate the adoption of ISAs and International Standards on Quality Control (ISQC) in the EU. However, pending the exercise of that authority, national law applies. In Sweden, the statutory audit of limited liability companies is legislated by the Companies Act (SFS, 2005) that stipulate that an auditor shall examine the company’s annual report and financial statements, the management of the company by the board of directors and the managing director, and that the audit shall be as detailed and extensive as required by generally accepted auditing standards (GAAS) (Chapter 9, §3 of the Companies Act). Due to the developments in the transnational, regional regulatory arena, and FAR’s membership obligation to IFAC, the Swedish profession made a tailored adoption of ISAs in the form of RS (Revisionsstandard i Sverige) in 2002, followed by full adoption in 2011. ISAs have since been reinforced by the Swedish Inspectorate of Auditors (SIA) as GAAS, though the Swedish Courts remain the final interpreters of GAAS. With the implementation of ISAs occurring at sites of audit practice, global audit firms play a significant role in determining interpretation and compliance with ISAs. Although audit

24  Amanda Sonnerfeldt and Gunilla Eklöv Alander enforcement takes place at the national level, SIA is part of the International Forum of Independent Audit Regulators (IFIAR) that works with the Global Public Policy Committee (GPPC), which brings together senior representatives from the international accounting networks, to improve audit quality with regards to compliance with ISAs. Hence, the successful diffusion and implementation of audit innovation rest on its acceptance by key actors in the regulatory arena. Innovation in the context of transnational audit regulation

Research has shown that the role and conceptual foundations of the financial audit have been increasingly confined to an ‘iron cage’. This condition results from the commitment by international regulators and global audit firms to international audit standardisation, reinforced by a complex of rules in the audit regulatory arena (Humphrey et al., 2021). This has led to concerns about the nature of ISAs, the cultivation of a standards-compliance mindset and the lack of healthy competition in standard setting to encourage audit innovation. Research on the development of audit primarily features audit process innovation due to technological advancements (Salijeni et al., 2021). Studies on product and conceptual innovation are less common. One notable exception is research on Business Risk Auditing (BRA). BRA changed audit methodology from an assessment of the risks of material misstatement to a consideration of risks of an entity not meeting its objectives. Curtis et al. (2016) illustrate that the acceptance of such innovation in audit practice is contingent on the interplay between ‘a shifting mix of professional and regulatory interests and preferences’ (Curtis et al., 2016, p. 75). For audit innovation to be put into operation, it has to be the type that regulators are prepared to accept. Knechel et al. (2020) propose how audit can be conceived differently by adopting a service perspective (compared with the present manufacturing), giving consideration to the idiosyncrasies of each audit, to allow contemplating different stakeholder needs and alternative ways to improve accountability structures and the distribution of knowledge in society. Although these studies do not cover innovation by NPAs, they show constraints on product and process innovation in the audit field. The process-oriented nature of ISAs takes the purpose and conceptual underpinnings of the audit for granted, which tends to constrain audit innovation to improvements in audit processes rather than audit itself (Humphrey et al., 2021). This circumstance limits the capacity of audit to respond to societal demands for a more socially relevant audit, for instance, to answer to societal needs for sustainability assurance or a different type of audit of small and less complex entities. Drawing from Sennett’s (2008; 2012) notions of repair, Humphrey et al. (2021) contend that previous initiatives to improve the financial audit are essentially static repairs, i.e. either restorative or remediating. The former refers to bringing audit back to its former state; the latter refers to substituting

Socially relevant audit of international standardisation 25 better parts or materials to improve its operation. Both these forms of repair are limited to the quality and efficiency of audit as a second-order function in the financial reporting supply chain. In comparison, dynamic repair reframes the audit’s relationship with the social, facilitating a change in purpose as well as function of the audit to better serve the changing needs of society. We propose that a more socially relevant audit could entail not only process innovation but also product innovation, to challenge the presumption of audit as a second-order function where its main task of assuring there are no material misstatements in financial statements. This also resonates with Öhman et al. (2006), where such a development will shift the focus of auditors to do the right thing, not just do things right. Analytical framework

The literature review shows that the audit operates in a highly institutionalised arena and adheres to the pressures from regulation and different stakeholders. It is regulated by the state and a myriad of non-state actors operating at the transnational, regional, national, and firm levels engaged in the process of standard setting, adoption, implementation, oversight, and enforcement. Baker et al. (2014, p. 374) argue: A highly institutionalised field exerts pressures on regulatory structures and regulatory bodies due to the power of the state and other external forces which influence the regulatory structures into adopting practices consistent with expectations. To better understand the conditions for audit innovation, attending to the institutional elements that shape the audit profession’s innovation context is needed. We draw on the above literature and institutional theory to develop a framework for analysing the dynamics in an audit innovation context. Figure 2.1 exemplifies the conceptual relationships among the institutional elements.

Figure 2.1 Framework for analysing the audit innovation context.

26  Amanda Sonnerfeldt and Gunilla Eklöv Alander According to Scott (1995), institutions consist of regulative, normative, and cognitive elements. The regulative element can be described as ‘institutionalised understandings of government policy, infrastructural constraints, bureaucratic requirements’ that work to effectuate action in certain ways (Munir, 2002, p. 1411). It is more formalised, precise, and indicative of what actors have to do. The analysis of the regulative element and how it affects the innovation context requires a revisit of the fundamental questions of regulation, such as the body regulating, the character of rules/ standards, and their interplay in the regulatory process. The normative element refers to professional norms. It includes values pertaining to preferred ways, hence specifying how work ought to be done or how actors ought to act (Scott, 1995). Such pressures ‘introduce a prescriptive, evaluative and obligatory dimension’ (Munir, 2002, p. 1411). Particular to this chapter, it refers to the role audits should play and the standards by which they should be performed. The cognitive element refers to the conceptual beliefs, mental models, and frames held by actors that have been internalised and culturally supported by them. It ‘determines the extent to which wider belief systems and cultural frames are imposed on or adopted by individual actors and organisations’ (Munir, 2002, p. 1411), which are instrumental in shaping the audit innovation context. Hence, forming the basis of how actors want to act. This analytical framework provides a basis to analyse how the three institutional elements act in mutually reinforcing ways to shape the audit innovation context that determines the profession’s ability to innovate. It also serves to reveal myths and actual rules that actors have to, ought to, and want to comply with. It guides our analysis of the innovation conditions, i.e. the constraints and capacity for NPAs to engage in audit innovation in the context of international standardisation. Results In this section, we present our results on the two initiatives, the development of SASE and RevR6. The analysis focuses on the nature of audit innovation and the innovation context. The latter entails the interaction of regulative, normative, and cognitive elements at the transnational, regional (i.e. European), and national (i.e. Swedish) levels, which reveal the constraints and capacity of FAR to innovate to make audits more socially relevant. Initiative 1: A standard for audits of small entities – SASE The development of SASE

FAR is a member of the Nordic Federation of Public Accountants (NRF), and since the implementation of ISAs in the Nordic countries, there has been a growing concern in NRF on the lack of fit of ISAs for small entity audits. In Sweden, the legislation on the mandatory audit exemption in combination

Socially relevant audit of international standardisation 27 with the increasing complexity of ISAs placed extensive requirements on small entity audits, which led to pressure for auditors to deliver more efficient audits (Malmström, 2021). In 2015, the NRF launched a proposal for SASE with the aim of maintaining the value relevance of small entity audits (NRF, 2015a). The core tenet of the SASE initiative was to develop a principlesbased standard emphasising the auditor’s professional judgement to consider the idiosyncrasies of each audit rather than having to perform specific predefined procedures (NRF, 2015b). SASE is, according to the NRF, not ISA compliant but ISA compatible. The standard is claimed to be based on GAAS and adopts a risk-based audit approach providing guidance to auditors to conduct an engagement to obtain a reasonable level of assurance, based on sufficient and appropriate audit evidence to opine whether the financial statements of the entity are free from material misstatements. SASE is a form of process innovation; it does not challenge the conceptual underpinnings of audit but introduces a different way to perform audits more efficiently. Constraints on innovation

SASE was released for comments in 2015 and received mixed reviews from transnational and local stakeholders. The standard proposed to be equal in quality to an audit performed in compliance with ISA, but was met with forceful resistance from transnational actors, particularly the IAASB and the global audit firms. The IAASB voiced concerns about the quality and fragmentation of the audit, emphasising that without guidance similar to that of ISAs, there would be a risk for deterioration of audit quality if less experienced auditors were to perform audits applying SASE. Audit complexities may be overlooked, and an insufficient amount of audit evidence may be obtained to support the auditor’s opinion. IAASB also drew attention to crossreferences to ISAs and the language used to draft SASE, expressing concerns that it could create confusion for readers of auditors’ reports and put the public interest at stake (IAASB, 2015). The basis of IAASB’s response is premised on IFAC’s policy position 2 (IFAC, 2012a) which normatively espouses global audit standardisation. According to the statement, ISAs apply to the audits of entities of all sizes. IFAC believes that ISAs enable a consistent level of assurance to be associated with the word ‘audit’ and allow users to make decisions based on a common understanding of the reliability of audited financial statements (IFAC, 2012a). This policy position guides the work of the IAASB and stipulates: The audit approach itself may differ, the auditing standards on which it is based and the level of assurance the auditor is required to obtain, should not. It is in this sense that ‘an audit is an audit’. (IFAC, 2012a, p. 2) The policy statement guides the interpretation of the phrase ‘an audit is an audit’ and what constitutes a quality audit (Humphrey et al., 2021). ‘An

28  Amanda Sonnerfeldt and Gunilla Eklöv Alander audit is an audit’ was reiterated then when IAASB affirmed that better guidance on scalability and proportionality in the drafting of ISAs to guide small entity audits was the way forward rather than a separate standard. This illustrated IAASB’s ‘scale down’ rather than ‘think-small-first’ approach when making pronouncements to guide audits on small entities (Accountancy Europe, 2018b). IAASB’s position was reinforced through the transnational accountancy firms’ membership obligation to the Forum of Firms (FoF) (FoF, 2021). Part 2 of the FoF constitution requires its members to demonstrate their commitment to adhere to and promote the consistent application of high-quality audit practices worldwide and to support the convergence of national audit standards with ISAs. This entails firms to have policies and methodologies for the conduct of transnational audits that are based, ‘to the extent practicable’, on the ISAs to support the convergence of auditing standards (FoF, 2021, part 2, p. 5b-c). Firms are required to report annually to the FoF that their membership obligations are met. While global audit firms are granted the discretion to the extent practicable, their existing audit technologies that were developed in compliance with the ISAs and the belief in ‘an audit is an audit’ serve as normative and cognitive constraints discouraging the firms from supporting SASE. This has been evident in their comment letters on SASE stating their preference for a global solution proposed or endorsed by IAASB. In Sweden, according to the responses to the exposure draft, the reception to SASE was mixed (Malmström, 2021). SASE garnered the support of the Confederation of Swedish Enterprise (Svenskt Näringsliv) and a number of small audit practitioners, but was met with doubts from the regulator and the national factions of the global accounting firms concerning the quality, fragmentation of audits, and standing in relation to ISAs and GAAS. In the regulatory context, the Swedish Accountant’s Act (2001:883) stipulates that SIA is the supervising authority and ensures that GAAS is appropriately developed. In its comment letter, SIA stated that in the absence of clear application guidance in SASE or any supplementary document, it would use ISAs as the basis for its inspections for audits performed in accordance with GAAS (SIA, 2015). This interpretation constrains innovation on the processes required to be performed for an audit engagement. Hence, on both transnational and national levels, regulative, normative, and cognitive elements interact in mutually reinforcing ways to reinforce the use of ISAs, imposing a constraint on audit innovation at the national level. Capacity for innovation

At the regional level, the development of small entity audits is faced with less resistance. Historically, the EU has expressed little interest in regulating or standardising small entity audits. The Accounting Directive 2013/34/EU exempts small entities from audits but allows member states to impose an audit on small entities. According to EU legislation on statutory audits, member

Socially relevant audit of international standardisation 29 states may apply national auditing standards, procedures, or requirements, given that the Commission has not exercised the authority to adopt legislation that would require the member states to mandate the adoption of ISAs. Thus, we conceive that the legislative framework at the regional level does not constrain the development of national auditing standards but leaves this to the discretion of individual member states. Granted Sweden’s EU membership, Sweden has the obligation to transpose EU Directives into national legislation. When transposing the Accounting Directive 2013/34/EU, Swedish legislators set significantly lower thresholds than the EU when requiring mandatory audits for small entities. The Swedish Companies Act does not mandate the use of ISAs; instead, it stipulates statutory audits are to be conducted according to GAAS. Doctrinal writings characterise such standards as legal concepts where material content is not provided by statutes but will be specified and evolved through standards and practices outside the legal system (Sonnerfeldt, 2011). This legislative approach awards flexibility for GAAS to continually adapt to the dynamic conditions in practice (Swedish government, 1971). According to the government bill 1997/98:99, standards of the profession lack legal status but can be used as guidance to determine GAAS (Swedish government, 1998). The government bill also makes explicit that the final interpretation of GAAS lies with the courts and not with the standard-setting organisations of the audit profession. The inherent nature of the Swedish GAAS together with the EU Directive 2014/56/EU creates conditions providing capacity for FAR to develop audits for small entities. The above analysis exemplifies that it is not the wording in the legal text but rather professional norms and the interpretation made by SIA that pose the strongest constraints on the development of SASE. In this process, ‘an audit is an audit’ is persistent and the capacity of SASE to achieve the same level of assurance as ISA is resisted. Figure 2.2 presents a summary of the findings. Initiative 2: A standard for sustainability assurance – RevR6 The development of RevR6

In February 2004, FAR published the pronouncement, ‘Proposed recommendation: Independent review of voluntary separate sustainability report’ (RevR6, 2004), developed in light of the global increase in sustainability reporting practices (Larsson, 2009). Though not broadly known worldwide, it was the first subject-specific standard for assurance of sustainability reports. Although assurance on sustainability practice was not widespread in Sweden then (Sonnerfeldt, 2011, 2014), FAR engaged proactively in innovation to provide practitioners with guidance in this field. The initial pronouncement RevR6 (2004) provided guidance in the form of an extended review. In addition to evidence-gathering procedures normally performed in a review, such as interviews and analytical procedures, RevR6

30  Amanda Sonnerfeldt and Gunilla Eklöv Alander

Figure 2.2  Summary of the constraints and capacity of NPA pertaining to the development of SASE.

Socially relevant audit of international standardisation 31 also required the practitioner to perform procedures on the entity’s internal control system and stipulated a list of non-exhaustive procedures (e.g. site visits, observation of stakeholder dialogue, etc.) that guided the work effort needed for practitioners to reduce risk to an acceptable level to provide limited assurance (RevR6, 2004). Besides an assurance report that could be published with the reporting organisation’s sustainability report, the practitioner was required to prepare an internal report with recommendations to be discussed with the entity’s management. The requirements were thus quite farreaching and more demanding on the work effort to perform in a sustainability engagement compared with the ‘normal’ review standards ISRE 2400/2410 on engagements to review historical financial information. The extended review entails both product as well as process innovation designed to improve the quality and consistency of sustainability assurance practices in Sweden. Still in effect today, RevR6 has undergone several revisions between 2004 and 2018 (see Figure 2.3). The significant revisions include the alignment to ISAE3000 in 2007; expanding its scope and guidance on audit-level assurance practices drawing on the Dutch NPA Royal NiVRA standard 3410N in 2009, applications of ISAs in 2014; and most recently, redrafting it to be a complement to ISAE3000 in 2018. The subsections below present an analysis of the constraints and capacity faced by FAR in the development of RevR6 within the context of international standardisation.

Figure 2.3 The most significant changes in the development of RevR6 from 2004 to 2018.

32  Amanda Sonnerfeldt and Gunilla Eklöv Alander Constraints on innovation

RevR6 (2004) was introduced during the period when IAASB was finalising ISAE3000, a generic assurance standard that does not provide subject-specific guidance (Sonnerfeldt, 2011). Due to the diversity of assurance practices performed on other subject matters than financial information, IAASB sought greater consistency and quality of assurance practices. ISAE3000 entailed lifting the elements of financial auditing to a more generic level, which could be applied to different subject matters (Sonnerfeldt & Pontoppidan, 2020). In the process, the difference between a financial audit and the concept of assurance was debated, which led IAASB to decide to classify the financial audit as a special form of assurance (IAASB, 2002). This decision set the normative basis for delineating the financial audit as different from other forms of assurance. This new order was reinforced by the International Framework for Assurance Engagements (IAF) which gives two separate sets of standards: financial audit and review standards guiding assurance of historical financial information (ISAs and ISREs), and assurance on subject matters other than historical financial information (ISAEs). The development at the transnational level posed normative and cognitive constraints on the development of RevR6. Firstly, ISAE3000 sets boundaries in terms of its form and content (e.g. procedural and reporting guidance). An extended review of sustainability reports, being in-between audit and review, did not fit this frame of reference. Secondly, it created a division between audit of historical financial information and other information making it difficult to broaden the scope of the financial audit to expand to the entity as a whole (Sonnerfeldt, 2011), also including sustainability. For this reason, the development of sustainability assurance and accountancy practitioner’s role is limited to assuring that the sustainability report is prepared according to established or developed criteria, hence, constraining innovation by limiting its potential value to entities and society.3 IFAC established the Compliance Committee to strengthen the compliance of its standards in 2004. In lieu of FAR’s membership obligation to IFAC, FAR revised RevR6 in 2006 to align its concepts, terminology, and components with ISAE3000, which was effective in 2005. While retaining the elements of the extended review in RevR6, the terms assurance engagement (bestyrkandeuppdrag) replaced the limited review engagement (översiktligt granskningsuppdrag). Furthermore, guidance regarding terms of agreement on changes in engagement scope, work of an expert, and quality control was added to align RevR6 with ISAE3000. Another event that influenced the innovative capacity of NPAs followed in 2005. This occurred when IAASB considered using NiVRA’s sustainability assurance exposure draft (ED3410) as a point of departure to develop an international assurance standard on sustainability reports. Several underlying assurance concepts, such as materiality, the practitioner’s role, and procedures to distinguish audit and review levels of assurance, were discussed and

Socially relevant audit of international standardisation 33 interpreted by the IAASB. The response to ED3410 by the IAASB task force has had an influence on the development of NiVRA’s standard Assurance Engagements Relating to Sustainability Reports (3410N) and its alignment with ISAE3000 in terms of the elements of assurance and drafting conventions. This event importantly defined the scope within which NPAs were granted discretion to define the boundaries of the various engagements and the interpretation of the elements of assurance (Sonnerfeldt, 2011). Over time, globalisation and developments in transnational regulation led to a greater commitment to international standards by transnational regulators and global audit firms. Sweden’s multinational entities recently indicated their preference for ISAE3000 as the standard for quality assurance in their sustainability reports (Lennartsson, 2016). In 2017, FAR initiated a significant revision of RevR6 to remove provisions that overlapped with ISAE3000, and in the process, relegating the standalone standard RevR6 to one that provides complementary guidance to the application of ISAE3000. This is clearly illustrated in its objective: …that auditors with the help of explanations and illustrating examples (in RevR6) shall get a deeper understanding of the application of ISAE3000 when examining sustainability information. (RevR6(2018):1.3, our translation) RevR6(2018) includes provisions on planning, materiality, understanding of the reporting entity, and examples of evidence-gathering procedures pertaining to the particular circumstances of sustainability matters and reporting. Even though it could have been anticipated that the terminology would also be aligned with ISAE3000, the terminologies ‘audit’ for reasonable assurance and ‘review’ for limited assurance are still used. The reporting examples provide for combined engagements, with clear delineation of review and audit, or only review engagements. In the examples, no reference is made to RevR6 in the assurance report, only to ISAE3000. This final stage underscores the trajectory the standard has undergone from a stand-alone giving extensive guidance, and even being an ISA-compliant standard, to a short complement to ISAE3000, adapted to the normative elements constraining innovation. Capacity for innovation

In 2004, FAR had the capacity to take on a leadership role to pioneer the development of sustainability assurance standards due to the knowledge and active participation of several of its members in international efforts to harmonise this new area. The first Swedish assurance report was issued in 1995 in Stora Kopparberg’s environmental report (Larsson, 2009). Given that the development of assurance standards lies outside the financial auditing context, the development of RevR6 was met with few legal constraints

34  Amanda Sonnerfeldt and Gunilla Eklöv Alander at the regional or national level. Even subsequent legislation that encouraged sustainability reports to be quality assured left assurance standards to the market. We have shown above that the development of transnational regulation has imposed constraints on product innovation pertaining to the development of assurance services at the national level. However, the lack of a global standard for assurance on sustainability reporting and weak enforcement mechanisms of IFAC, being a non-state standard-setter, have allowed FAR the capacity to develop subject-specific assurance standards for sustainability reporting, and in certain respects depart from ISAE3000. This has been evident since 2005 when FAR aligned RevR6 with ISAE3000 but managed to preserve the extended review model which then was essential to improve the quality of engagements. The development of sustainability reporting practices in Swedish entities in the late 2000s led to demands in the Swedish profession to provide auditlevel assurance engagements, in addition to reviews of sustainability reports. Within the innovative space, FAR was able to draw on NIVRA’s N3410 to extend the scope of RevR6 to include audit engagements, as well as a combined approach allowing different parts of the report to be assured at the audit or review levels. Although the preamble of RevR6 describes this work as a ‘translation’ of 3410N, records from that time show that FAR retained the capacity to include more work, exclude elements of 3410N, and in 2014, discontinued its connection to 3410N. For instance, FAR was of the opinion that it was too early in the practice development to set delimitations on the magnitude of depth that a review would imply, which led them to decide to maintain that the practitioner should decide on testing the effectiveness of internal controls when performing reviews (cf. Eklöv Alander, 2009). RevR6 further required ‘verification’ in review work compared to ‘confirmation’ which is less thorough in scope (Eklöv Alander, 2009). FAR further adapted its guidance to the needs of the Swedish market in light of companies’ developments of sustainability reporting. The 2015 revision proclaimed that RevR6 is a Swedish application of ISAE3000 and in occurring cases applicable parts of ISA, and RevR6 made references to financial auditing standards including ISA 230, ISA 300–330, ISA 560–580, ISA 610–620, and ISQC1. This development was short-lived, however, due to FAR’s decision in 2018 to reposition RevR6 as complementary guidance to ISAE3000 due to the constraints arising primarily from developments in transnational regulation as discussed above. Figure 2.4 presents a summary of the findings. Discussion This chapter considers the implications of transnational regulation, particularly international standardisation, on audit innovation at the national level. Our analyses reveal that the development, role and conceptual foundations

Socially relevant audit of international standardisation 35

Figure 2.4  Summary of the constraints and capacities for the development of RevR6.

36  Amanda Sonnerfeldt and Gunilla Eklöv Alander of audit have been increasingly constrained by normative, cognitive and regulative forces interacting to reinforce international standardisation, making innovation at the national level difficult. Most prominently, innovation has been constrained by the commitment of actors in the regulatory arena to international standards, the agreements between IFAC and its member bodies, and the global accounting firms. In this section, we critically reflect on our findings to explore ways forward and the possibility to rethink and reconceptualise audit differently to better serve society’s changing needs. Rethinking audits of small entities

The SASE case exemplifies how the audit has been constrained by professional norms and enforcement structures reinforcing the current conceptions of the audit and specifically, ‘an audit is an audit’ notion. Even though this is changing, as IAASB now advocates that an audit can be an audit solely regarding the level of assurance rather than depending on a specific standard (Malmström, 2021), it has been difficult for standard-setters, including the IAASB, to depart from the current audit model. This is owing to the institutionalised notion that good quality audits are audits performed according to ISAs. Hence, audits performed according to other standards risk being perceived of inferior quality. This has been a widely discussed issue in the current IAASB initiative to set a stand-alone standard for audits of less complex entities (IAASB, 2020). From our analysis above, neither the text of the Swedish Companies Act nor the court’s interpretation of GAAS constrains the development of small entity audits. While debates have focused on the thresholds for statutory audits, we call to mind that Sweden as an EU member state has the discretion to decide on the type of audit/assurance required for small entities. This has been evident with the French and Belgian NPAs’ standards for audits of small entities and the German NPA working towards a separate standard for audits of less complex entities other than public-interest entities (IAASB, 2020). Furthermore, unlike many jurisdictions, the 2§ p. 7 of the Swedish Auditor’s Act (revisorslagen) provides that auditors should give advice that relates to their audit findings, thus granting a space for the profession to play a role not only in assurance but also channelling time and resources towards a ‘repairing’ role to improve the quality of reporting practices so as to facilitate efficient operations and sustainability of small entities. In the interpretation of GAAS, Swedish audit regulators may reconsider if having one global consistent audit provides better-quality audits than an audit that may be conceptually different. While consistency is one quality measure, it has to be traded off with other quality measures. In contrast with today’s audit, which strives towards producing a homogeneous output and where appropriate quality is achieved by meeting the demands of auditing standards, regulation, and the quality performance indicators of the firm, Knechel et al. (2020) introduce a service perspective to conceptualise

Socially relevant audit of international standardisation 37 auditing. This approach allows us to consider the idiosyncratic nature of the client-auditor relationship, the heterogeneous audit outputs produced by this relationship, and the possibility of co-constructing value. This would benefit society in several ways. First, such a development opens the possibility for auditors to utilise their expertise to advise and support small entities. Second, value-relevant audits customed to specific companies can open the market for more small entity audits which may increase transparency and reliability of information, and reduce transaction costs. It may also reduce the risk of economic crime such as money laundering and tax evasion (cf. Riksrevisionen, 2017). This is particularly important because small entities constitute an engine of economic growth and employment essential for the Swedish economy. There is a need to reconsider the value proposition of small-entity audits, more specifically, to rethink the purpose of audits and what societal goals audits can help to achieve (ends) rather than maintaining a near-sighted focus on compliance to standards (means) and losing the bigger picture. An audit with a different purpose may entail revisiting the socially constructed boundaries between audit and assurance, on the one hand, and consulting and independence on the other, to make audits more relevant. Focus can be placed on more relevant procedures improving the value of audit to the company and its stakeholders rather than strict compliance with ISA, such as documenting why certain irrelevant procedures are not performed. While thoughts of having a different audit may seem far-reaching, we can look to financial reporting in Sweden with its different GAAPs (K2 and K3), the Danish case where small undertakings are given the option of an extended review, and the latest EU audit reform, which has made a distinction between the audit of entities in general and of public-interest entities in particular. This opens the agenda to further research on audit quality of small-entity audits and how they may differ from audits of large, complex, or public-interest entities. Not valuing how audits can be socially relevant in areas other than large company audits, would be myopic, leading to lost opportunities to improve accountability structures and knowledge distribution for a better functioning business ecosystem and society as a whole. Rethinking sustainability assurance

The RevR6 initiative reveals that even in an adjacent domain (sustainability assurance, being less regulated than the financial audit) international standardisation has constrained innovation by FAR in three ways. Firstly, IAASB pronouncements have defined the space within which FAR can innovate in terms of the type of engagement (e.g. audit, review, assurance) and the interpretation of the elements of assurance when developing sustainabilityassurance standards. Secondly, because the assurance framework is built on the audit model, assurance, like audit, is constrained to be a second-order function in the reporting supply chain, limiting the assurance role to provide

38  Amanda Sonnerfeldt and Gunilla Eklöv Alander assurance on reports. Thirdly, the delineations between the assurance of financial and non-financial information pose significant constraints on widening the scope of both sustainability assurance and the statutory financial audit. We have shown FAR’s capacity to develop sustainability assurance within the space granted due to the lack of a global standard for assurance on sustainability reporting and weak transnational enforcement mechanisms. However, normative pressures towards international standardisation have led to a preference of international over national standards. Sustainability reporting is an area where regulation (e.g. the EU taxonomy and the EU Corporate Social Reporting Directive), standards, and practices are rapidly developing. As a consequence, companies are challenged with building capacity, internal control and information systems to produce relevant and reliable environmental, social, and governance information. Further, leading reporting companies are gradually integrating sustainability information in their financial statements. Given such development, the nature of the assurance function, the division of audit and assurance based on the subject matter and the role of auditors and assurance providers need to be reconsidered. Humphrey et al. (2021) put forward the possibility of reversing the presumed relationship between audit and assurance, more specifically, to treat assurance as a subset of audit (instead of audit as a subset of assurance) in order to create a space to conceptualise both audit and assurance differently. This perspective removes the delineation in standard-setting and audit practice between assurance of historical financial information and other information which allows the scope of audit to extend beyond financial information. This enables corporate reports consisting of financial, sustainability, and integrated information to be audited as a whole. While such developments are not likely to be viable at the national level in today’s context, it is important to preserve the ideas to develop sustainability assurance that have failed to materialise due to the normative pressure to commit to international standardisation. The innovative work by the Swedish profession to develop RevR6 has allowed for better technical guidance on the performance of sustainability assurance. Although not all innovations within RevR6 have stood the test of time, its guidance has shown how to perform audit procedures and extended review procedures on such information drawing on the ISAs, ISRE, and assurance practice that has evolved over three decades. This stands in contrast with IAASB guidance constraining audits to historical financial information and assurance to other kinds of information. Despite the limitations of sustainability assurance (cf. Sonnerfeldt & Pontoppidan, 2020), companies at different stages of maturation in their reporting systems and society have benefitted from the output of these services via the recommendations on streamlining and developing sustainability reporting, internal control processes and better-quality information for decision-making. Similarly, NiVRA had developed different ways to think

Socially relevant audit of international standardisation 39 about minimum criteria and materiality taking into consideration stakeholders’ views, requiring assurance providers to play a different role than the one interpreted by IAASB. IAASB is currently undertaking information gathering and research activities to develop a ‘stand-alone’ standard consistent with ISAE3000 for assurance on sustainability reporting. The standard intends to draw on material in the existing IAASB standards and guidance with enhancements and specificity to address both limited and reasonable assurance of sustainability information. It is essential that knowledge gained through national innovations in this area be considered in IAASB’s work, so as not to reinvent the wheel, and for such innovations to increase the social relevance of sustainability assurance. Conclusions and implications Regulation as a driver of audit transformation has been discussed in several chapters in this volume, e.g. Broberg and Tagesson, Eklöv Alander et al., and Rahnert. In analysing the implications of international standardisation in this chapter, we note, however, the constraining nature of transnational regulation, particularly to how audit innovation at the national level has been constrained. The mission of IFAC is to serve the public interest by ‘contributing to and supporting high-quality international standards, helping to build and encourage strong professional accountancy organisations, accounting firms, and high-quality practices by professional accountants, and speaking out on public interest issues’ (IFAC, 2022:5). To do so, it is also important to support the profession with the guidance it needs in order to stay relevant in society. We propose that to achieve a more socially relevant audit, firstly, the IAASB and regulators can encourage innovation at a national level by downplaying compliance and convergence to one standard but allowing standardsetting to centre on innovation. This applies particularly to developing areas of practice. Opening up the innovative space would allow practitioners to be more responsive to market needs and encourage both product and process innovation to develop the audit. Such a change could produce an array of novel solutions that IAASB can draw from to develop international standards. Secondly, the IAASB, regulators, and global firms can move audit innovation forward by rethinking what role audit and assurance can play in contemporary society (e.g. in achieving the UN sustainable development goals). A broader and clearer purpose enables standards to be set in society’s interests. This, however, would entail a shift from the static conceptualisation of the financial audit as an information-verification function to one that may dynamically reconfigure audit practice. This chapter presents a study based on an extensive analysis of documents on transnational regulation in the audit field and on the developments of

40  Amanda Sonnerfeldt and Gunilla Eklöv Alander national audit standards. As such, it poses limitations as to the depth of understanding of circumstances pertaining to the innovation process among key individuals involved. In order to further understand innovation and the constraints and capacities for each initiative, we propose studies based on interviews or observations of work by the IAASB, on the one hand, and NPAs, on the other, to understand how the innovation context and the interaction of regulative, normative, and cognitive elements at play in the activities undertaken by an NPA in its work with innovations can be applied in the pursuit of a more socially relevant audit. Acknowledgements We express our gratitude to Elina Malmström and Chris Humphrey for the constructive discussions we have had during the work on this book chapter. We also want to thank Daniela Argento for her constructive comments and suggestions on the earlier drafts. We gratefully acknowledge the financial support from Jan Wallander and Tom Hedelius Foundation (grant numbers P16-0249 and P18-0095). Notes 1 Setting standards for audits of less-complex entities and assurance of sustainability are on IAASB’s strategic work plan 2022–2023. 2 In this chapter, the term accounting profession is used when a wider constituency of accountants including auditors, accountants in business, education, and public sector are organised as a profession. This stands in contrast with the audit profession. Historically, only auditors were organised as a profession in Sweden. 3 We recognise that process innovation and innovation in areas that are not regulated by international standards on assurance feature in assurance practice (Andon et al., 2015; Crawford et al., in this volume).

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42  Amanda Sonnerfeldt and Gunilla Eklöv Alander Samsonova-Taddei, A., & Humphrey, C. (2014). Transnationalism and the transforming roles of professional accountancy bodies: Towards a research agenda. Accounting, Auditing & Accountability Journal, 27(6), 903–932. Scott, R. (1995). Institutions and organisations. Thousand Oaks, CA: Sage Publications. Sennett, R. (2008). The craftsman. New Haven, CT: Yale University Press. Sennett, R. (2012). Together: The rituals, pleasures and politics of cooperation. New Haven, CT: Yale University Press. SFS (2005). Swedish Code of Statutes (SFS 2005:551) Companies Act. Stockholm, Sweden: Regeringen. Sonnerfeldt, A. (2011). The development and use of standards by non-state actors: A study of the dynamics of regulating sustainability assurance,Doctoral Dissertation. Lund: Lund University. Sonnerfeldt, A. (2014). Regulating third party assurance engagements on sustainability reports: Insights from the Swedish case. European Company Law, 11(2), 137–140. Sonnerfeldt, A., & Pontoppidan, C.A. (2020). The challenges of assurance on nonfinancial reporting. Accounting, Economics, and Law: A Convivium, 10(2), 1–23.

Appendix: Research design We adopted a qualitative research approach to combine an extensive review of private and public archival documents, supported by literature and observations of several standard-setting and practitioner events organised by the profession. These events include conferences, stakeholder engagements, and seminars organised by Accountancy Europe and the IAASB.1 The documents we analysed were categorised according to the initiative, the source of origin, date, actor, and keywords to map out the chronology of events and regulatory structure related to each initiative. Thereafter, based on our analytical framework, we identified the regulative, normative, and cognitive elements shaping the innovation context from which the constraints on innovation and capacity for FAR to innovate are drawn. Initiative 1

Accountancy Europe (2018a). Simplifying auditing standards for small or non-complex entities – Exploring possible solutions. Brussels. Accountancy Europe (2018b). Simplifying auditing standards for small or non-complex entities, meeting, 30 May 2018. Available at https://www. youtube.com/watch?v=0etyuX-Xun0&t=10810s (Accessed 8 February 2023.) European Union: Treaty of Lisbon Directive 2006/43/EC. Directive 2013/34/EU. Directive 2014/56/EU.

Socially relevant audit of international standardisation 43 FoF (2021). Forum of Firms’ Constitution. IAASB. New York: IAASB. IAASB (2015). Comment letter: IAASB comments on Nordic Federation of Public Accountants proposed standards on audits of small entities. IAASB (2019a). Discussion paper: Audits of less complex entities. IAASB (2019b). Feedback statement and way forward: Audits of small and less complex entities. IAASB. (2020). Audit of less complex entities: Separate standards issues. IAASB Board Meeting December 2020, Main agenda item 2. IAASB (2016–2021). Minutes of the meetings of IAASB. IAASB (2016–2021). Minutes of the meetings of the Consultative Advisory Group. IFAC. New York: IFAC. IFAC (2008). Policy position 2: IFAC’s support for a single set of auditing standards: Implications for audits of small- and medium-sized entities. IFAC (2012a). Policy position 2: IFAC’s support for a single set of auditing standards: Audits of small- and medium-sized entities. IFAC (2004). Statements of Membership Obligations. IFAC (2014). Constitution of the International Federation of Accountants. IFAC (2019). International standards: 2019 Global Status Report. NRF (2015a). Consultation paper: The Nordic standard for audits of small entities. Available at https://www.revisorforeningen.no/globalassets/fag/ revisjon/sase/NSASE-eng (Accessed 8 February 2023). NRF (2015b). Comment letters to SASE. Riksrevisionen (2017). Avskaffandet av revisionsplikten för små aktiebolag – en reform som kostar mer än den smakar (RiR 2017:35). In Swedish (Abolition of audit obligation for small limited companies – a reform where costs outweigh benefits). Stockholm: National audit office. SIA (2015). Yttrande över Nordiska Revisorsförbundets förslag till nordisk standard för revision i mindre företag (2015:773), 2015-10-16. In Swedish (Opinion on the Nordic Association of Auditors’ proposal for a Nordic standard for auditing in smaller companies). Stockholm: Revisorsnämnden (Swedish Inspectorate of Auditors (SIA)). Swedish Government (1971) SOU 1971:15. Förslag till aktiebolagslag m.m. In Swedish (Proposal for the Companies Act). Stockholm: Regeringen. Swedish Government (1998) Proposition 1997/98:99. Aktiebolagets organisation. In Swedish (Organisation of the company). Stockholm: Regeringen. Initiative 2

Eklöv Alander, G. (2009). Möjligt med revision av hållbarhetsredovisningar. Revision och översiktlig granskning med nytt förslag till RevR6. In

44  Amanda Sonnerfeldt and Gunilla Eklöv Alander Swedish (Auditing sustainability reports is attainable: Audit and review with a new proposal for RevR6). Balans, 6/7, 28–30. European Sustainability Reporting Association (2006–2008) Report for Sweden. ESRA. FAR. Stockholm: FAR Förlag. FAR English dictionary. RevR6 (2004). Förslag till rekommendation: RevR6 Oberoende översiktlig granskning av frivillig separat hållbarhetsredovisning. In Swedish (Independent review of voluntary separate sustainability report). RevR6 (2006). Förslag till rekommendation: Oberoende översiktlig granskning av frivillig separat hållbarhetsredovisning. In Swedish (Independent review of voluntary separate sustainability report). RevR6 (2007). Förslag till rekommendation: Oberoende översiktlig granskning av frivillig separat hållbarhetsredovisning. In Swedish (Independent review of voluntary separate sustainability report). RevR6 (2008). Oberoende granskning av frivillig separat hållbarhetsredovisning. In Swedish (Independent review of voluntary separate sustainability report). RevR6 (2009). Bestyrkande av hållbarhetsredovisning. In Swedish (Assurance of sustainability reports). RevR6 (2013). Bestyrkande av hållbarhetsredovisning. In Swedish (Assurance of sustainability reports). RevR6 (2014). Bestyrkande av hållbarhetsredovisning. In Swedish (Assurance of sustainability reports). RevR6 (2015). Bestyrkande av hållbarhetsredovisning. In Swedish (Assurance of sustainability reports). RevR6 (2018). Bestyrkande av hållbarhetsredovisning. In Swedish (Assurance of sustainability reports). IAASB. New York: IAASB IAASB (2002–2005). Minutes of the meeting of the IAASB. IAASB (2003). International Framework for Assurance Engagements. IAASB (2022). Handbook of International Standards on Auditing and Quality Control. IFAC. New York: IFAC IAPC (1999). Exposure draft: Assurance Engagements. IFAC (2004). Statements of Membership Obligations. IFAC (2007). Policy position 1: IFAC’s position on professional regulation. IFAC (2012b). Policy position 5: A definition of the public interest. Lennartsson, R. (2016). Revision av hållbarhet – vilka standarder finns för bestyrkande? In Swedish (Audit of sustainability – what standards exist for assurance?). Balans, 42(3), 30–31. Ministry of Enterprise, Energy and Communications (2007). Guidelines for external reporting by state-owned companies. Stockholm: Regeringen. Royal NiVRA. Amsterdam: NiVRA

Socially relevant audit of international standardisation 45 Royal NiVRA(2005). ED 3410 Assurance Engagements relating to sustainability reports. Royal NiVRA(2007). 3410N Assurance Engagements relating to sustainability reports. English version. Swedish Government (2006). Genomlysning av de statligt ägda företagens hållbarhetsredovisning 2006. In Swedish (Review of the state-owned companies’ sustainability report 2006). Stockholm: Regeringen. Note 1 The documents are organised by each initiative we reviewed and arranged in alphabetical order.

3

The construction of status in the auditor–audit committee relationship Gunilla Eklöv Alander, Karin Jonnergård, and Ulf Larsson Olaison

Introduction A common way to solve societal problems is through regulatory innovations (Black, 2005). In corporate governance regulation, a recurring pattern is that corporate failures lead to regulatory change, which entails changes in the role and status of the external auditor. These changes are often pursued by global networks such as the International Federation of Accountants (IFAC), or supranational organisations such as the European Union (EU). Solutions, often modelled on successful regulatory innovations in the US or UK, are pursued either on the transnational or national level and implemented in national contexts. The legal traditions differ across countries (La Porta et al., 1999) sometimes leading to a misfit between the original regulatory solution and its implemented context. This chapter describes the effects of a regulative innovation: the audit committee, which works as a driver for changing the relationship between the auditor and the corporate board. Following corporate failures, the statutory audit tends to be at the centre of regulative innovations, even though ‘the impact on audit quality is at best presumed’ (Humphrey et al., 2011, p. 442). In this light, the promotion of audit committees for oversight over the audit should be understood (Beasley et al., 2009; Spira, 1999). There are important differences in the meanings of ‘oversight’ in different jurisdictions. In the UK, the audit committee should have oversight over the audit even at the planning stage (Beattie et al., 2013) in contrast to Sweden, where the Companies Act stipulates an independent audit. Despite the intentions of the law, Swedish corporate governance practice tends to follow Anglo-Saxon logic, and in certain companies to the detriment of auditor independence (Eklöv Alander, 2019). The literature on audit committees has so far largely been focused on audit committee efficiency (Beasley et al., 2009; Cohen et al., 2004; DeZoort et al., 2002; Gendron & Bédard, 2006; Turley & Zaman, 2007), particularly regarding the external auditor (Beattie et al., 2013; Carcello et al., 2011; Dobija, 2015). A smaller portion of the literature focuses on the audit committee’s role in the negotiations between management and auditor (BrownLiburd & Wright, 2011; Pomeroy, 2010; Salleh & Stewart, 2012). This DOI: 10.4324/9781003411390-4

Construction of status in the auditor–audit committee relationship 47 literature shows that the strength and competence of the audit committee, as well as the information it is given, influence the committee’s role as a counterpart (Pomeroy, 2010), or mediating party (Salleh & Stewart, 2012), in the negotiation between the auditor and management. What this literature has not yet sufficiently investigated is how the implementation of the audit committee has influenced the position of the auditors and the relationship between the auditor and the audit committee in these processes of negotiation. The more general negotiation literature stresses two perceptions as important for relations between negotiating parties, i.e. the perception of power and the perception of status (see Brett & Thompson, 2016; Greer & Bendersky, 2013). In this chapter, we focus on how the audit committee practice in Sweden can be understood from its implication for the distribution of status (Faunce, 1989; Prato et al., 2019) between the auditor and the audit committee. According to Greer and Bendersky (2013, p. 239): Status is defined as the extent to which one is respected and admired by others, and power is defined as control over socially valued resources […]. Differences in power and status can alter negotiations and conflict processes […], and differences in power and status can themselves be points of contention and negotiation […]. This implies the perception of status is distinct from the concept of power and therefore an important input in negotiations, and that status is essential for how relationships are developed and evaluated. Regarding the implementation of the audit committee, one may assume status is important both in negotiations between the auditor and the committee members and for the auditors to gain acceptance for the audit process and be considered independent. This may be especially important in the Swedish context as the regulatory reform of the audit committee has emerged as a part of the international harmonisation of the corporate governance system rather than as a solution to national problems. Based on this, we raise two research questions in this chapter: (i) how do auditors and members of audit committees perceive each other’s status; and (ii) can we discern any influence of this perception on the relationship between the auditors and the audit committees? By applying a status perspective, we contribute novel insights to the understanding of how a regulatory innovation, the audit committee, drives the transition of auditing due to the changes in the status of the auditor and the audit committee that the innovation implies. As we will see below, the introduction of audit committees is the result of an EU development, not necessarily relevant in a Swedish setting but with implications for audit practice in Sweden. This study is informed by semi-structured interviews with ten audit committee members (they have several board engagements, and in 2010– 2011 represented 32 large Nasdaq listed companies) and six lead external auditors (with multiple engagements in 2010–2011 auditing 23 large Nasdaq

48  Gunilla Eklöv Alander, Karin Jonnergård, and Ulf Larsson Olaison listed companies). Our method is described in the Appendix. We document a rather paradoxical development where the auditors increase their status through direct access to the board of directors while decreasing their status by being reduced to a supplier, among other suppliers, of trust and comfort to the directors. Motivation As mentioned, corporate failures are often the driver for changes in audit regulation (e.g. Humphrey et al., 2011). Audit committees in Sweden have a different origin and should be understood in light of the international search for corporate governance best practices, starting in the UK in the early 1990s with the Cadbury report. The New York Stock Exchange demanded the introduction of audit committees as early as 1978, but the Swedish discussion followed post-Cadbury. Identifying UK problems in the 1990s, the Cadbury report addressed problems associated with dispersed ownership and managerial control of corporate boards. Directors, either serving as managers or dependent on management, would have a conflict of interest with the external auditor. Audit committees were formed on corporate boards, to be an arena for independent directors to strengthen auditor independence (e.g. Spira, 1999). The Cadbury suggestion of audit committees sparked a discussion in the Swedish corporate governance system, where proponents for and against audit committees surfaced. Skandia, for instance, was in favour of such committees: The assignment of the audit committee is to be informed by the auditor as well as give input to the auditor regarding how the audit should be performed and what priorities should be done. Performed in a specific committee this assignment could be done with greater detail than is possible if the whole board should participate. (Skandia, annual report, 2000) Skandia was at the time one of the few major Swedish listed corporations with dispersed ownership (Fristedt & Sundqvist, 2000) and the stock traded at the London Stock Exchange. In terms of Swedish regulation, the introduction of audit committees is first discussed in the new corporate act to harmonise Swedish corporate law with EC directives when Sweden was joining the EU in 1995. Audit committees were favoured by Aktiespararna (organising small private shareholders) but rejected by the government and all other stakeholders, the argument being that it was a solution to non-existing problems (prop. 1997/98:99, p. 137). The situation in the US, where management, due to the dispersion of ownership, could control auditor’s appointments and independence, was not considered a problem in Sweden, as most of the listed corporations had a controlling shareholder that limited the managerial influence on the audit

Construction of status in the auditor–audit committee relationship 49 function. In corporate practice audit committees were becoming increasingly popular. By 2004, in the annual reports of the ten largest listed Swedish corporations, nine stated that they had an audit committee. Within this group, there were differences about who should sit on the committee in terms of numbers (from two to five) and how many should be independent of major shareholders (from zero to 100 per cent). There were even examples of labour-elected directors serving on the committees. By 2005, audit committees were regulated for the largest listed corporations following the introduction of the Swedish corporate–governance code. The code followed a ‘comply or explain’ approach. Audit committees were discussed intensively, and in general the auditors were critical of how the committees were to be introduced (Jonnergård & Larsson, 2007). For example, the reply by the professional organisation of auditors, FAR, to the first proposal: FARs’ major concern is the audit committee should ‘evaluate the audit’. Doing so would imply some of the board members will have a supervisory role for those appointed to, among other things, monitor that the board fulfils their control function. That, according to FAR, is contrary to the Companies Act on accountability and auditor independence. (SOU 2004:46, p.3) Similar opinions were voiced by the Swedish Inspectorate of Auditors (Revisorsinspektionen). Nevertheless, audit committees were introduced in the Swedish corporate governance code, and the specific writing on ‘evaluating the audit’ was kept in rule 3.8.3. The introduction of audit committees was argued to be proactive to avoid the inclusion of such committees in the Swedish Companies Act, as part of work with the EU’s upcoming audit directive (Larsson Olaison, 2014). In 2006, the EU audit directive was implemented in Swedish law (SOU 2007:56; Prop. 2008/09:135) and made effective in mid-2009. The audit committee regulation was moved from the Code to the Companies Act. In the relatively short period from 1995 to 2009, the committee transformed from a corporate–governance device applied in a few cases (such as Skandia) into corporate law applicable to all listed corporations. The committee was not developed out of regulatory concerns with a lax audit practice; it was a development in board practice, mostly connected to globalisation, and finally transformed into law manifested by an EU directive. This happened despite the auditors’ concerns pointing out that the committee was a solution to a problem not manifested in Sweden. In the corporate governance reports of Swedish corporations, different practices are described concerning audit committee cooperation with the auditors, in distinct cases jeopardising the auditor’s independence with a hegemonic logic where audit committees exert undue influence on the auditor’s planning (Eklöv Alander, 2019). An investigation into how the committees are perceived and have changed the

50  Gunilla Eklöv Alander, Karin Jonnergård, and Ulf Larsson Olaison interactions between the auditors and the board from a status perspective is thereby called for. Literature on status implies that new continuous interactions between actors, here the auditor and audit committee, entail that a hierarchy of status develops between the actors that influence the way the actors are valued and their capacity to ‘master events’ (Ridgeway, 1991, p. 375). One important aspect is thereby how the status of the auditor and/or the committee developed and whether this development has had implications on the work of the auditor. This will be dealt with in the rest of the chapter. Literature review As indicated above, we focus on the concept of status for describing the impact of the auditor and the audit committee interactions. We assume the committee will be important in the auditor’s negotiations with the auditee regarding its accounting and auditing process. In line with the literature, we assume the perceived status of the groups involved in the negotiations is important for their outcome (Faunce, 1989; Prato et al., 2019; Ridgeway, 1991). Status is often defined as a concept separated from the concept of power but can influence the outcome of the negotiations, according to Greer and Bendersky (2013, p. 240): Those who attain high positions in the status hierarchies are given more opportunities to influence and contribute to groups and their contribution are evaluated more positively. In organisation theory, a distinction is made between the organisation’s status in the environment and the individual’s status within the organisation. This research tradition departs from the sociological theories of status (e.g. Ridgeway, 1991). Washington and Zajac (2005, p. 284) define status as: A socially constructed, intersubjectively agreed-upon and accepted ordering or ranking of individuals, groups, organisations, or activities in a social system. If an actor belongs to or interacts with more than one organisation, this implies belonging to more than one status hierarchy. There may also be a difference between the status actors are ascribed as being part of a special social group, for example, the audit profession, and the status actors achieve through their actions. This indicates status is a complex concept, and actors may perceive differences in the status they have achieved by their performance compared with the status assigned by others in different situations. The perceived inconsistencies may lead actors to feel anxiety and initiate actions of conformity or deviation (Prato et al., 2019). We focus on the status concept as an element in relationships that may influence negotiations, but we do not study the negotiation process as such.

Construction of status in the auditor–audit committee relationship 51 It is reasonable to expect that the implementation of audit committees has changed the perception of the status of the actors involved, both regarding their own status and that of others. Initiating new forms of interactions and collective problem-solving, the committee infuses a new or changed status hierarchy that values the members of the committee as well as the status of those interacting with the committee. For a status hierarchy to emerge, two conditions are necessary: (i) a nominal characteristic, i.e. a socially recognised attribute on which a social worth is attached, and the members of the interaction are perceived to differ (e.g. education), and (ii) continuous interactions that can shape and stabilise the status hierarchy (Ridgeway, 1991; Ridgeway et al., 1998). According to Ridgeway (1991), nominal characteristics are connected to perceived competence and are the basis for social worth, implying higher perceived competence, the worthier an actor is regarded to be in the eyes of society. Ridgeway (1991, pp. 368–369) defines competence as ‘beliefs about an individual’s general capacity to achieve a desired end’. Regarding audit committees, the nominal characteristic can be differences in the function and legal responsibilities between its members and auditors, and new perceptions of status hierarchies will emerge as an effect of the continuous interactions at the committee’s meetings and their assessments of each other’s capacity. When entering a new status position, an actor brings the status allotted earlier (Bunderson et al., 2014; Washington & Zajac, 2005). This implies that the auditor, when entering interactions with the audit committee, is already ascribed status as an auditor. The perception of this ‘original’ status may or may not change due to the interactions with the audit committee. In addition, each member of the committee forms a status hierarchy in this group. They establish the status of the committee in relation to other entities that control the company, such as the board at large or the top management. This may lead to beliefs about the committee’s role and functions that trespass its legally allotted role, leading to a diffused border between it and other corporate governance actors such as the auditors, and implying status anxiety, or changed self-esteem for those exposed to the diffused border (Faunce, 1989). The interactions between the board committee and the auditor may lead to a perceived higher status for the auditor, who now has a direct link to the board of directors. In other words, the status of auditors in their own eyes, as well as in the eyes of actors in the auditee, may change. The discussion above implies that the effects of the interactions between the auditor and audit committee may vary according to how they define their status positions. In general, the literature indicates actors with a middle status are more likely to search for conformity in interactions (Durand & Kremp, 2016). In asymmetric relations, the lower-status actor is likely to enhance the status of the higher-status actors (Mark, 2018), while the higherstatus actor is more likely to engage in deviant behaviour (Prato et al., 2019). If auditors perceive themselves as middle status, they will consequently search for conformity in their relation to the audit committee by contending,

52  Gunilla Eklöv Alander, Karin Jonnergård, and Ulf Larsson Olaison compromising, and conceding actions, whereas if they perceive themselves as having high status they will pursue integrative tactics by expanding the agenda and engaging in problem-solving, and vice versa for the counterpart (Hollindale et al., 2011), the audit committee. These assumptions are partly confirmed by Brown-Liburd and Wright (2011), i.e. auditors apply contenting strategies when the committee is perceived as strong. The literature on audit committee status has foremost focused on the relationship between the status and competence of the committee and earnings management (Baldolato et al., 2014; Dewi & Mita, 2019; Shepardson, 2019; Suprianto et al., 2017). Baldolato et al. (2014) found committees with high financial competence and status being related negatively to earning management, but none of the other studies found such a relationship. The articles operationalised status differently and studied other contexts in comparison with Hayes (2014). Regarding the relationship between the auditor and audit committee, status was not in focus; instead, other aspects were discussed. Rummell et al. (2019) found the audit committee tends to support the auditor in disagreements with management more if the accounting firm has a long tenure. Cohen et al. (2017) investigated the approaches of auditors, Chief Financial Officers (CFO), and audit committee members to enterprise risk management and found auditors focus on control while the CFO and committee members focus on control and strategy. Pomeroy (2010) studied audit committee oversight over accounting decisions and concluded that committee members make investigations to reduce discomfort by asking probing questions. Salleh and Stewart (2012) found that audit committees play a mediating role when the conflict between management and auditor is material, but otherwise do not take sides. We expect the auditor and the audit committee to have partly different interests, and their relationship is built up over time. In summary, perceptions of status hierarchies and the actors’ position within them affect perceptions of roles and legitimate actions. In the implementation of the audit committee, the emerging status hierarchies will affect those who are assumed to oversee and decide on the auditor’s work. We assume the auditor and the audit committee start by perceiving themselves as having high-status positions. This makes the outcome of the interactions between them more unpredictable than in interactions where a visible status difference exists, and the interaction may be perceived as a negotiation of status in which the role and functions of the parts are sharpened. In the following, we investigate how the roles and functions are sharpened and how this impacts the status of the auditor and the audit committee. Results From the literature review, we can deduce that status is a two-sided concept based on self-assessment and the status one holds in the eyes of others (Bitektine, 2011). We view status as formed on the perceived abilities of actors

Construction of status in the auditor–audit committee relationship 53 to control or master events (Ridgeway, 1991). We structure our findings of the status of auditors and audit committees from this two-sidedness, i.e. we describe both the actors’ status in their own eyes and in the eyes of others. Audit committee’s status in their own eyes

The importance of the audit committee has developed since its introduction in Sweden, and having a seat is often connected with its growing purport: ‘In my view, the role of the audit committee has increased significantly the last 5–10 years’ (AC19-02-07b). It seems like the committee has a certain status position in the governance of Swedish companies. As presented in the literature review, Baldolato et al. (2014) argue that the audit committee has a lower status in relation to management because of changes in the market for boards due to regulations requiring financial expertise. In the Swedish environment, these results do not seem likely, because the audit committee can command the Chief Executive Officer (CEO) to participate in committee work. A CEO’s absence is not tolerated: ‘because it is too important, it can be due to a prestige or status [of the audit committee]’ (AC19-02-07b). Our question of whether the work in an audit committee confers status receives an affirmative answer, the role as such provides status through the influence at the board that it brings: I and several others think it is much more fun to work on a board when chairing a committee; this gives you a distinct role. […] Also, it gives status as you report [to the board] your voice is always heard, you sometimes have special discussions with the board’s chairperson, yes it gives a sort of status; you are among the important people. (AC19-02-07a) It is not only the role as such that brings status but it also gives a natural position for participation in board meetings. Chairing the audit committee allows for meeting with the board’s chairperson. This aspect of status is akin to the professional role of such a board member. Yet another aspect of the increased status of the committee, relating to technology, is in this case digitalisation: Processes in a company are often pretty administrative and get more and more dependent on IT and are the subject of internal control, and thereby the IT ends up at the audit committee as a tail. So, the role of the committee in corporate governance and boards has, I would say, increased significantly. (AC19-02-07b) As the board members are collectively responsible through the solidarity principle, it is key for each one of them to keep informed of the reporting matters and risks in the company. To be able to carry out this responsibility,

54  Gunilla Eklöv Alander, Karin Jonnergård, and Ulf Larsson Olaison we find that audit committee members receive status even though the committee is merely preparatory, as decisions must be taken by the board: Practically, if a lot, really a lot, of work is being carried out in a committee and you don’t sit in that committee, how will you be able to question its work when it comes up at the board meeting? Here is a skewness, causing an imbalance in the board members’ insights and possibilities to keep up with issues, whilst they are collectively responsible. I must say this is why I enjoy sitting on the audit committee because then I feel I have a bit of control. (AC19-02-07b) Such influence as the audit committee performs seems to stem from the fact that the board members are dependent upon the committee to execute their responsibilities. Being knowledgeable is key for them to accept a seat on the board. This circumstance gives the audit committee members status (cf. Ridgeway, 1991). There is also a certain gap between the board and the committee that causes friction: … I can feel that sometimes, which I think is a kind of inefficiency in the system, there is insecurity among those [board members] not sitting on the audit committee. Then the matter must be discussed yet another round, first, you have prepared the matter at length in the committee, and then you must do the same turn again in the board room… it happens when someone does not feel entirely comfortable not having all the knowledge. (AC19-02-07b) The situation described indicates the audit committee’s preparation does not entirely have the status that can make up for the risk the board members take when they find decisions risky, even though the knowledge the audit committee brings to the board’s work is appreciated and gives status in the committee’s own eyes. Also, an important task of the audit committee is to be in charge of contacts with the auditor. On the question of whether it is good that the committee monitors the auditor in a Swedish context, one audit committee member answered: ‘But who else should monitor the auditor?’ (AC18-11-22b). This audit committee chairperson argues that the only reasonable unit that can have the duty of monitoring the auditor is the committee. The statement is based on the following argument: I mean, there is not a chance a Swedish nomination committee which consists of good people from our institutions, of whom no one has ever worked in a company, would have the ability to make an audit tender. That is utterly impossible, it does not work that way in real life, there is quite a flaw in the thinking there, certainly. (AC18-11-22b)

Construction of status in the auditor–audit committee relationship 55 This statement positions the audit committee higher in the status hierarchy than the nomination committee, due to its members’ expertise in leading large companies (cf. Ridgeway, 1991). The committee members’ status also depends on the importance of the matters they deal with, and their need for information: … I have never experienced I would not get enough time [in the Boardroom] or there would not be any interest. Instead, it is self-preserving for everyone to know about these things. (AC19-02-07a) The description here concerns the division of responsibilities between the audit committee, from the viewpoint of the committee chairperson, and the board, as well as other important information providers, such as compliance and risk, and internal audit functions. The position of the audit committee chairperson is so important that s/he can instruct the chairperson of the board and the remuneration committee. This is interesting, as it says how pivotal this position is: …it has happened several times when we have an audit committee [meeting] and I realise this matters…in some cases, I call the board chairperson to say this is something you must take to the upcoming meeting because we have a matter of such dignity that I think you should inform the full board. […] The other day a matter appeared during our meeting that concerned the remuneration committee, I left the room during the break and called its chairperson and said: ‘I suggest you call an additional meeting tonight before the board meeting tomorrow because this matter must be sorted out. (AC19-02-07a) How this audit committee chairperson acts to draw the strings, helping everyone on the board to get important information for them to act, is noteworthy, because it indicates the status of the committee as an enabler and provider of strategically decisive information. Through the exercise of knowledge and expertise of what is important and what counts in the daily agenda of the board, the audit committee chairperson enacts their own status belief to further consensual beliefs of the status dimension the committee possesses in their own eyes (cf. Ridgeway, 1991). The increased emphasis on functions within the domain of the audit committee enhances its status within the board. On the downside, the attractiveness of a seat on the committee is less for other board committees. It is tough work and perceived as gendered. Even though the committee’s members perceive an increase in their status, this implies that the relative status of the committee in the eyes of the rest of the board members is less than for other board committees.

56  Gunilla Eklöv Alander, Karin Jonnergård, and Ulf Larsson Olaison Audit committee’s status in the eyes of the auditors

In the eyes of the auditors, the status hierarchy between the auditor and the board is sustained despite the introduction of the audit committee in the Swedish environment: You may say the auditor’s and the board’s assignments mirror each other in such a way that we meet at least once a year and then have common issues to discuss. It was only a movement of that responsibility to the audit committee and the work of the auditor. (EA18-11-19b) The committee as such gains its status through the division of work of the board, and no larger changes in status are apparent. The salient status effect for the auditors is the increased status of the tasks within the domain of the audit committee: I am in favour of the addition of an audit committee. I believe you get a forum where you can discuss a bit more detail and get some more time to discuss external auditing issues, but also other concerns. I believe more time is devoted to these tasks in the committee than were previously given in the board. (EA18-11-19a) The auditors perceive the audit committee’s status as lower than that of the board of directors but appreciate the committee because it has increased its leverage on the issues important to the auditor. Before the introduction of audit committees in Swedish corporate governance, the auditor was given only a few minutes to present the findings from the audit to the board. The auditors perceived the members of the board only wanted the auditor to confirm all matters were safely dealt with, and all figures were in order: Things could easily get misunderstood, and one is a little bit nervous … some [board members] find this boring and others interesting so it was not an optimal situation. It could be good, certainly. But the audit committee was a great improvement. (EA22-05-17) Before the introduction of audit committees, limited place was given to make board members understand the complexity or risk in the judgements involved in measurement issues. All this changed with the introduction of audit committees. Also, auditors appreciate the committee members because the task to sit on the committee is both signalling professionality and accountability, its members have often chosen to sit there while they get precious knowledge of the company that would otherwise be out of reach. The members of the audit committee form an A-team in the eyes of auditors.

Construction of status in the auditor–audit committee relationship 57 Auditors’ status in their own eyes

As audit committee practices developed, questions such as who should participate, when, and under what items were settled. Certainly, this development implied a new and more important position for the auditors. While previously having worked through the CFO and only rarely meeting the directors, the auditor got a recurring meeting with the committee, along with the management. Several of the audit committee members describe the situation of having the auditors at the committee meeting as something that provides them comfort. Practices were also developed for giving the auditor access to the audit committee without managerial presence. These practices, giving the auditors access to the board’s ‘A-team’, translate to higher status for auditors. So, it was positive, more time for important issues and it implied we gained a higher status within the organisation because we reported more directly, and we got a better continuous dialogue. (EA18-11-06) The perceived status implies the auditors to see themselves in the same position in the status hierarchy as the committee, especially as the auditor tends to have more assignments than directors have board seats. This meant that auditors came to be seen as knowledge providers also for strategic board work. The opportunity to discuss judgements at the committee meetings meant better anchoring of the understanding of how financial reporting works, and their effects on volatile asset and liability measurements: We sit for half days and more sometimes, several times a year, and discuss our matters at length. This means there is space to discuss until we feel they have understood this complexity. Accounting is often based on judgments, requiring you exchange ideas around the issues and show them if we change estimates in a certain measurement then the value may change rather much. To discuss this, how the standards are set, and to show the effects of pursuing a different action and testing together. One might comment it is not given the future becomes as in our main scenario. The whole board gets a better understanding of this through the intermediation of committee members. That is good for us. (EA18-11-19b) The opportunity to get time on the audit committee is valuable and helps auditors to manage the expectations of the audit and the meaning of the financial reports. Most auditors perceived the interactions with the committee to increase their self-assessed status, especially in relation to the rest of the organisation. We find audit committees partly attempt to control or master the auditor’s planning phase (Ridgeway, 1991). Audit planning is a vulnerable

58  Gunilla Eklöv Alander, Karin Jonnergård, and Ulf Larsson Olaison phase of the audit work and is a part of the inscribed status of the auditor in different regulatory frameworks. The auditors must manage committee chairpersons who believe it is their capacity to authorise the audit planning: ‘We do authorise it and we have a discussion, but to develop it is more a task for the management and auditors.’ (AC19-02-07a). The auditor has to deal with the expectations of audit committee members to have far-reaching mandates on the audit planning process: The audit committee is involved and draws up and approves the [audit] plan. It starts with the CEO and the auditors and then with the committee. It is more than just approval. They also have opinions on the plan and may correct things too. (AC19-06-11b) These expectations go against the intentions of both Swedish GAAS and ISA, stipulating the audit should be performed without being ‘too predictable’ (IFAC, 2009a, p. A16; IFAC, 2009b, p. A3) and auditors should be cautious about communicating not only with the CEO and CFO but also with the audit committee about the planned scope and timing of the audit. Previous research indicates such practice occurs among large listed companies in Sweden (Eklöv Alander, 2019). There are also indications in the Swedish environment that the CFO dictates the audit plan (Hellman, 2011). Caution regarding the audit plan is inherent in several influential audit standards on the global level (cf. IFAC, 2009a; IFAC, 2009b; PCAOB, 2012, AS 16, p. 9). At the same time as audit committee members experienced they were in the position to decide upon the audit plan, auditors themselves do not fully agree with their planning phase that is directed to this extent by the committee: It was rather like they wanted us to do more than what we did, it was seldom someone said you can skip this or that. (EA22-05-06) Some of the auditors clarified to the audit committee members the division of tasks and functions between themselves and the committee: Sometimes it appears a bit sloppily on the agenda in some committees: ‘now we shall endorse the auditor’s plan’. I reply ‘it is not you to endorse it, instead it is I who formally take responsibility for my plan, I who decide how much and what I shall audit. But I do want to anchor it with them; I must find out why they have another viewpoint because I must understand their outlook on the company’s risks. (EA22-05-19) This process, where the audit committee has one perception of its role and the auditor has another, is an example of the way perceptions of status

Construction of status in the auditor–audit committee relationship 59 hierarchies emerge in this forum for discussions of audit matters, and how the parties assess each other’s capacity (Ridgeway, 1991; Ridgeway et al., 1998). The quotes above imply a discrepancy between the achieved status the auditors perceive and the ascribed status the auditors perceive they possess. Auditors’ status in the eyes of the audit committee

To present our results about the auditors’ status in the eyes of the audit committee, we need to begin by comparing the role of the external auditor in regulation, based on the notion of the auditor as the principals’ guard against opportunistic behaviour of agents using their discretion to misstate financial information (Jensen & Meckling, 1976). The principals here are the shareholders, who, following the Companies Act, appoint the auditors at the annual general meeting, and the auditors provide them with assurance on the financial statements prepared by the CEO and presented and endorsed by the board and its audit committee. In Sweden, the board members, as well as the CEO, must sign the financial statements, in this way they indicate their responsibility for the fairness of these reports, which the auditor thereafter audits. We find the audit committee needs the auditor to have integrity and not let themselves be persuaded to take a position against their convictions. The status of the auditor in the eyes of the committee largely depends on the expertise of the auditors and the knowledge possessed by their firms: And it comes with great experience and competence. They have specialists on their backs, the teams we see and these specialists, they certainly work in many companies… They come here with independence…and then that they are strong in themselves, not tagging along to make buddies, for us to elect them yet again. (AC19-02-07a) A weak auditor who is eager to please the client is a risk for the audit committee; such an auditor would not help bring to light risks that could backfire in the future: They give us important inputs in case we would be moving in the wrong direction. So instead of letting us fall and report it, they help us, and we thank them and accordingly make changes. This is much more productive than if they were pointing from far away what we have done wrong. (AC19-02-07a) To uphold the consensual belief of the audit committee as mastering the information flow to the board, the committee needs the auditor to enable this continuous knowledge feed to the board (Ridgeway, 1991). Despite this important function, the impression is that the audit committee perceives the status of the auditor on the level of just any other service provider among

60  Gunilla Eklöv Alander, Karin Jonnergård, and Ulf Larsson Olaison others. One interviewee mentions the contacts they have with their auditor: ‘…an external accounting firm that does external audits for us’ (AC1902-07a). Another indication of the overall apprehension by audit committee members of the audit being a supplier: ‘Certainly, one should not be prodigal about the audit, but it should be done properly’ (AC18-11-22b). On the other hand, the status of the auditor is maintained by further procedures akin to respect on the part of the committee chairperson, in that the auditor is also asked for information used to evaluate the organisation: I also usually ask the auditors for feedback regarding how the organisation works, do you get the information, do you get good answers, does it escalate to a proper level, it is sort of mutual feedback. (AC19-02-07a) We also find indications of the relationship between the auditor and audit committee that has increased the status of the auditor in relation to management, here exemplified through the committee as a sort of safety valve for auditors who are pressured by management to decrease their scoping: Management has often a cost responsibility and wants to keep the auditing hours on a reasonable level while auditors look at us a bit as a ventilator, if management screws too hard then an audit committee that can say ‘no, it is probably important we do this as well’. (AC18-11-22b) This openness between the auditor and the audit committee is important to the auditor because it provides insights into the committee’s knowledge of the company and their concerns. It is also important for the committee; otherwise, the audit would not be helpful: I procure some accounting firms every year and proactivity is one of the important things. They must have integrity, but they must also be proactive. That is important because you get much higher quality in the financial reporting, which is better for the owners. (AC19-02-07a) A particular issue shakes the perception of auditor status; the annual audit assessment, and how the auditors are evaluated in the organisation: ‘We often survey to evaluate the auditors’ (AC19-02-07a). This evaluation serves to establish how the auditors have functioned within the organisation during the audit: It is sent out kind of like an employee survey meaning a graded scale of how one experiences the auditors in different places, and comments can be provided. (AC19-02-07a)

Construction of status in the auditor–audit committee relationship 61 Such an evaluation is pervasive, probing into how the auditors throughout the organisation have gathered evidence. One common discontent with the auditors is that they are requesting overly detailed information, not being sufficiently proactive, and coming in after events instead of helping out in novel situations. The critique can also be that they do not sufficiently cooperate with the internal audit, causing unnecessary work. There can also be issues around their ability to cooperate with employees, communication skills, and coordination of audit teams worldwide. The auditors are expected to respond to this critique, first in a meeting with the CFO, and then for outstanding issues, with the audit committee. The auditors are expected to reply with measures on how to remedy the critique. One audit committee chair remarks: Issues are most often addressed and rectified, but if not rectified one has to consider changing them. (AC19-02-07a) The tone here is quite harsh and does not square well with the auditor being the independent vindicator elected by the shareholders at the company’s Annual General Meeting. The auditor is treated just like any other supplier or employee that can be exchanged. From a public-interest viewpoint, this is worrying, because the auditor should audit the work of the CFO and audit committee, and to perform this task the auditor needs to maintain independence. The auditor’s status in relation to the audit committee could be a pressing issue, as the committee member sees the auditor as a possible subject of such surveys that employees go through. The survey procedure causes strains on the relationship between the auditor and the organisation, particularly the CFO and the audit committee members, and is an example of the argument of Prato et al. (2019) that status differences may stem from, in our case, auditors’ perception of their status and the status achieved in the eyes of the committee. The question here is how auditors accommodate the anxiety in their status ascription to either conform with or deviate from the expectations of the audit committee (cf. Prato et al., 2019). In sum, it is clear that the audit committee perceives the importance of such auditor characteristics as independence; on the other hand, the committees tend to describe the auditor as yet another supplier, and also instil certain organisational practices that threaten to weaken their independence. Nonetheless, the auditors are perceived as having a certain status due to their expertise. Conclusions and implications In the literature, status is defined as ‘the extent to which one is respected and admired by others’ (Greer & Bendersky, 2013, p. 239) and a distinction is made between achieved and ascribed status (Prato et al., 2019) that may or may not be in concurrence with each other. Our results indicate that several different status hierarchies are at play in the interactions between the auditors, the audit committee, and the board of directors: First, the ascribed

62  Gunilla Eklöv Alander, Karin Jonnergård, and Ulf Larsson Olaison status of the auditors in relation to the board, i.e. the auditors’ inherited status based on the nominal characteristics of the audit profession and its legal functions; second, the achieved status, i.e. the status the auditors receive due to their accomplishments, in interactions with the committee; third, the status hierarchy within the board and among the various committees of the board; and fourth, the status of the individual board members engaged in the committee. Our results indicate that a concurrence of achieved and ascribed status is apparent in the auditors’ perception of their status in relation to the board. The auditors view themselves in the same position in the governance system as the board of directors. We also note that the ascribed status of the auditors is important in the interactions between the audit committee for both the auditors and the committee. The knowledge of the auditors (and their firms) is highlighted by both the auditors and the audit committee members as important for their status interactions. The achieved status does not always seem to agree with the ascribed one. In some instances, it appears the auditors, rather than possessing the status the law ascribes to them as the independent gatekeeper of the companies’ accounts, are allotted the status of ‘one contractor amongst others’. Several of our interviewees describe situations where the audit committee crosses the line into territory that must be understood as naturally belonging to the auditor’s expertise, such as planning and choosing entities in their engagement scoping, in the end also requesting the auditors to deliver their opinion before the directors have signed off themselves. This is in line with the results of Eklöv Alander’s (2019) study which found some of the investigated audit committees narrated their reports in a way that indicated control over the audit planning process, which contradicts the intention of audit regulation for shareholder protection. The introduction of audit committees alters not only the auditors’ achieved status but the directors themselves are also affected. In the internal status hierarchy of the board, we find the achieved status of the committee as a board committee agrees with the ascribed status. The audit committee has a status as a preparatory and information-diffusing organ, not as a decision-making one, and its achieved status is not higher but rather lower than that of other board committees. The perception of the status of the individual board member engaged in the audit committee seems to increase as the member gains a function and a responsibility adding to the general one as a board member. In the perception of the auditor, the committee seems to achieve high status, which is important for the auditors’ interactions with the company. The literature indicated the auditor and the audit committee would have differing perspectives, where the auditor would have a control focus, (Christopher, 2010; Watts & Zimmerman, 1983), and the committee would focus on both control and strategy (Cohen et al., 2017). We find the auditor is not wanted primarily in the role of a statutory provider of audit services, but for their capability to provide proactive advice to different managerial levels regarding financial reporting and internal control matters. Hence, the study

Construction of status in the auditor–audit committee relationship 63 does not support the proposition that it is the audit as such that is in demand (Power, 1997), rather, other services of accounting firms are gaining ground. The above results imply that if the status hierarchy has an impact on the possibility of acting in a non-conformal way, as the literature indicates, it is important to find a balance where the auditor and audit committee assign each other at least the same level of status, to assure that the auditors can perform their legal responsibility properly. When equalising the auditor with, e.g. the CFO or the internal auditor, the impact of different opinions also tends to be equalised, even though the legal status and consequences differ. The implication may have substantial practical effects, as our study indicates that the audit committee has emerged as an arena where the negotiation about the form and content of the auditing is, if not decided, at least significantly influenced. Cohen et al. (2002) noted there were no specific auditing standards relating to the effect of corporate governance upon the audit. Ever since, the IAASB has developed the international standards on auditing ISA 260, and 265, as well as ISA 300 (IFAC 2009a, 2009b, 2009c). These standards guide the auditor to see that the audit is not too predictable or that the auditee interferes in the audit process, particularly in the audit planning and scoping. The literature points to the transgression by the auditee, both the management and the audit committee, of such stipulations (Eklöv Alander, 2019; Guénin-Paracini et al., 2014), and our findings here align with these previous findings. We argue that the drivers for harmonising the transnational regulation of corporate governance and the introduction of audit committees in the Swedish jurisdiction make such breaches of auditor independence possible. Our study adds to these studies by indicating the audit of large listed entities is not always sufficiently independent from the auditee, including the audit committee, and this may become problematic under certain circumstances. As long as these large companies are solid and prosperous, the professional and ethical standards are protected, but we are concerned about the public interest in cases of harsher economic cycles when there may arise incentives to follow another agenda than one publicly shared. In the Swedish regulative environment, following the Swedish Companies Act, in which the auditor is independent of the board and audit committee and elected by and reports to the AGM, the auditor is given a status higher than the audit committee and the company’s board of directors. It is interesting to find that the status is occasionally reversed, where the auditor has a lower achieved status than the audit committee, in turn with a lower status than the board. Generally, this implies the regulatory transition has been a driver in changing the legal status order and in separating auditors’ ascribed and achieved status to a weakened state. This chapter aligns with particularly two other chapters in this volume in that the intended effects of regulation may not be achieved. Where Rahnert discusses the regulation on key audit matters and Sonnerfeldt & Eklöv Alander discuss the effects of regulation on audit innovation, we find that the audit committee regulation leaves much to be desired before being able to strengthen the status of the auditor.

64  Gunilla Eklöv Alander, Karin Jonnergård, and Ulf Larsson Olaison The study has several limitations, starting with its scale. The limited number of interviewed auditors prescribes caution when discussing the auditors’ perceptions. There may be other aspects not revealed in our interviews. For those aspects discussed here, a consensus between the auditors is found. Connected to this is the fact the interviews were restricted to one hour (see the Appendix), a constraint necessitated by audit committees’ chairpersons being extremely busy and defining a time limit helped us gain access. On the other hand, we did not experience being left with any unanswered questions. Another limitation of the study is the focus on large companies. The auditors mentioned that the audit committee acts differently in large versus small companies. This indicates a road for future research would be to focus on committees and their auditors in small listed companies. References Baldolato, P.G., Donelson, D.C., & Ege, M. (2014). Audit committee financial expertise and earning management: The role of status. Journal of Accounting and Economics, 58, 208–230. Beasley, M.S., Carcello, J.V., Hermanson, D.R., & Neal, T.L. (2009). The audit committee oversight process. Contemporary Accounting Research, 26(1), 65–122. Beattie, V., Fearnley, S., & Hines, T. (2013). Perceptions of factors affecting audit quality in the post-SOX UK regulatory environment. Accounting and Business Research, 43(1), 56–81. Bitektine, A. (2011). Toward a theory of social judgements of organizations: The case of legitimacy, reputation, and status. Academy of Management Review, 36(1), 151–179. Black, J. (2005). What is regulatory innovation? In Black, J., Lodge, M., & Thatcher, M. (Eds.), Regulatory innovation: A comparative analysis. Cheltenham: Edward Elgar. Brett, J., & Thompson, L. (2016). Negotiation. Organizational Behavior and Human Decision Processes, 136, 68–79. Brown-Liburd, H.L., & Wright, A.M. (2011). The effect of past client relationship and strength of the audit committee on auditor negotiations. Auditing: A Journal of Practice and Theory, 30(4), 51–69. Bunderson, J.S., Olin, J.M., & Van der Vegt, G.S. (2014). Status inertia and member replacement in role-differentiated teams. Organization Science, 25(1), 57–72. Carcello, J.V., Hermanson, D.R., & Ye, Z. (2011). Corporate governance research in accounting and auditing: Insights, practice implications, and future research directions. Auditing: A Journal of Practice and Theory, 30(3), 1–31. Christopher, J. (2010). Corporate governance—A multi-theoretical approach to recognizing the wider influencing forces impacting on organizations. Critical Perspectives on Accounting, 21, 683–695. Cohen, J., Krishnamoorthy, G., & Wright, A. (2002). Corporate governance and the audit process. Contemporary Accounting Research, 19(4), 573–594. Cohen, J., Krishnamoorthy, G., & Wright, A. (2004). The corporate governance mosaic and financial reporting quality. Journal of Accounting Literature, 23, 87–152. Cohen, J., Krishnamoorthy, G., & Wright, A. (2017). Enterprise risk management and the financial reporting process: The experiences of audit committee members, CFOs and external auditors. Comparative Accounting Research, 34(2), 1178–1209.

Construction of status in the auditor–audit committee relationship 65 Dewi, R.F., & Mita, A.F. (2019). The impact of audit committee’s financial expertise and status on accrual earnings management. Jurnal Akuntansi dan Keuangan, 21(2), 2–89. DeZoort, F.T., Hermanson, D.R., Archambeault, D.S., & Reed, S.A. (2002). Audit committee effectiveness: A synthesis of the empirical audit committee literature. Journal of Accounting Literature, 21, 38–75. Dobija, D. (2015). Exploring audit committee practices: Oversight of financial reporting and external auditors in Poland. Journal of Management and Governance, 19, 113–143. Durand, R., & Kremp, P.-A. (2016). Classical deviation: Organizational and individual status as antecedents of conformity. Academy of Management Journal, 59(1), 65–89. Eklöv Alander, G. (2019). Clash of corporate governance logics obscuring auditor independence. International Journal of Auditing, 23(2), 336–351. Faunce, W.A. (1989). Occupational status-assignment systems: The effect of status on self esteem. American Journal of Sociology, 95(2), 378–400. Fristedt, D., & Sundqvist, S.-I. (2000). Ägarna och makten i sveriges börsföretag 2000. In Swedish (Owners and power in Sweden’s listed Companies 2000). Halmstad: SIS Ägarservice. Gendron, Y., & Bédard, J. (2006). On the constitution of audit committee effectiveness. Accounting, Organizations and Society, 31(3), 211–239. Greer, L., & Bendersky, C. (2013). Power and status in conflict and negotiation research: Introduction to the special issue. Negotiation and Conflict Management Research, 6(4), 239–252. Guénin-Paracini, H., Malsch, B., & Marché Paillé, A. (2014). Fear and risk in the audit process. Accounting, Organizations and Society, 39, 264–288. Hayes, R.M. (2014). Discussion of “Audit committee financial expertise and earning management: The role of status” by Baldolato, Donelson and Ege (2014). Journal of Accounting and Economics, 58, 231–239. Hellman, N. (2011). Chief financial officer influence on audit planning. International Journal of Auditing, 15, 247–274. Hollindale, J., Kent, P., & McNamara, R. (2011). Auditor tactics in negotiations: A research note. International Journal of Auditing, 15, 288–300. Humphrey, C., Kausar, A., Loft, A., & Woods, M. (2011). Regulating audit beyond the crisis: A critical discussion of the EU Green Paper. European Accounting Review, 20(3), 431–457. IFAC (2009a). International standard on auditing (ISA) 260: Communication with those charged with governance. New York, NY: International Federation of Accountants. IFAC (2009b). International standard on auditing (ISA) 265: Communicating deficiencies in internal control to those charged with governance and management. New York, NY: International Federation of Accountants. IFAC (2009c). International standard on auditing (ISA) 300: Planning an audit of financial statements. New York, NY: International Federation of Accountants. Jensen, M.C., & Meckling, W.H. (1976). Theory of the firm: Managerial behaviour, agency costs and ownership structure. Journal of Financial Economics, 3(4), 305–360. Jonnergård, K., & Larsson, U. (2007). Developing codes of conduct: Regulatory conversations as means for detecting institutional change. Law and Policy, 29(4), 460–492.

66  Gunilla Eklöv Alander, Karin Jonnergård, and Ulf Larsson Olaison La Porta, R., Lopez-de-Silanes, F., & Shleifer, A. (1999). Corporate ownership around the world. The Journal of Finance, 54(2), 471–517. Larsson Olaison, U. (2014). Convergence of national corporate governance systems: Localizing and fitting the transplants. Doctoral dissertation, Linnaeus University Press. Mark, N.P. (2018). Status organizes cooperation: An evolutionary theory of status and social order (2018). American Journal of Sociology, 123(6), 1601–1634. Pomeroy, B. (2010). Audit committee member investigation of significant accounting decision. Auditing: A Journal of Practice and Theory, 29(1), 173–205. Power, M. (1997). The audit society: Rituals of verification. Oxford: Oxford University Press. Prato, M., Kypraios, M., Ertug, G., & Lee, Y.G. (2019). Middle-status conformity revisited: The interplay between achieved and ascribed status. Academy of Management Journal, 62(4), 1003–1027. PCAOB (2012). Auditing standard no. 16—Communications with audit committees. PCAOB Release No. 2012-004. Washington, DC: Public Company Accounting Oversight Board. Ridgeway, C.L. (1991). The social construction of status value: Gender and other nominal characteristics. Social Forces, 70, 367–386. Ridgeway, C.L., Heger Boyle, E., Kuipers, K.J., & Robinson, D.T. (1998). How do status beliefs develop? The role of resources and interactional experience. American Sociological Review, 63(3), 331–350. Rummell, J.-E., DeZoort, F.T., & Hermanson, D.R. (2019). Does audit firm tenure matter to audit committee members? Evidence from an accounting dispute. Accounting Horizons, 33(2), 25–41. Salleh, Z., & Stewart, J. (2012). The role of the audit committee in resolving auditorclient disagreements: A Malaysian study. Accounting, Auditing and Accountability Journal, 25(8), 1340–1372. Shepardson, M.L. (2019). Effect of individual task-specific experience in audit committee oversight of financial reporting outcomes. Accounting, Organization and Society, 74, 56–74. Spira, L. (1999). Independence in corporate governance: The audit committee role. Business Ethics: A European Review, 8(4), 262–273. Suprianto, E., Suwarno, S., Murini, H., Rahmawati, R., & Sawitri, D. (2017). Audit committee accounting expert and earnings management with “status” audit committee as moderating variable. Indonesian Journal of Sustainability Accounting and Management, 1(2), 49–58. Turley, S., & Zaman, M. (2007). Audit committee effectiveness: Informal processes and behavioural effects. Accounting, Auditing and Accountability Journal, 20(5), 765–788. Washington, M., & Zajac, E.J. (2005). Status evolution and competition: Theory and evidence. Academy of Management Journal, 48(2), 282–296. Watts, R.L., & Zimmerman, J.L. (1983). Agency problems, auditing, and the theory of the firm: Some evidence. The Journal of Law & Economics, 26(3), 613–633.

Appendix: Research design This study draws upon semi-structured interviews performed during 2018– 2019. Three external auditors with experience from audits of large listed clients in Sweden, and ten Swedish audit committee members serving in 18

Construction of status in the auditor–audit committee relationship 67 Nasdaq-listed companies were interviewed. Three additional interviews with external auditors were conducted in 2022. The interview guide covered four areas: (i) the relationship between the audit committee and the auditor, (ii) the involvement of the audit committee in planning and performing the audit, (iii) changes in the audit process and the relations over time, and (iv) perceptions of the Swedish corporate governance systems in relation to other governance systems. All but two interviews were recorded, and the total recording time was 17 hours and 41 minutes. The remaining interviews were instead carefully written down. Ten interviews were performed with two of the researchers participating, four with only one, and two with all three researchers. All but one were face-to-face; the exception was done by telephone. The interviewees have been anonymised at their request (see Table 3.1). The interviews were coded using NVivo, rendering 518 unique codes, through the perspective of the audit committee and analysed using the theory of status and control. The outcome of the coding was structured in the second-level-concept perceived status of the audit committee from the Table 3.1  D  etails on our interviews with lead engagement auditors and audit committee members. No.

Position

Duration

Remark

1 2 3 4

Auditor 1 18-11-06 Auditor 2 18-11-19a Auditor 3 18-11-19b Audit committee member 1 18-12-06 Audit committee member 2 19-01-24 Audit committee member 3 19-02-07a Audit committee member 4 18-11-22a Audit committee member 5 19-02-07b Audit committee member 6 18-11-22b Audit committee member 7 19-06-12 Audit committee member 8 19-06-11a Audit committee member 9 19-06-11b Audit committee member 10 18-11-20 Auditor 4 22-05-06 Auditor 5 22-05-17 Auditor 6 22-05-19 Recording time in total

1:39:06 1:05:06 1:06:30 1:00:00

Face-to-face, one interviewer Face-to-face, two interviewers Face-to-face, two interviewers Face-to-face, not recorded, two interviewers taking notes Face-to-face, two interviewers

5 6 7 8 9 10 11 12 13 14 15 16

1:01:06 1:17:33

1:07:51

Face-to-face, two interviewers, notes Telephone interview, three interviewers Face-to-face, two interviewers

1:03:20

Face-to-face, three interviewers

1:02:15

Face-to-face, two interviewers

00:59:10

Face-to-face, two interviewers

1:10:03

Face-to-face, two interviewers

1:00:00

Face-to-face, not recorded, one interviewer taking notes Face-to-face, two interviewers Face-to face, one interviewer Face-to-face, one interviewer

1:09:50

00:55:13 00:52:48 1:11:28 17:41:19

68  Gunilla Eklöv Alander, Karin Jonnergård, and Ulf Larsson Olaison chairperson of the committee (i) and the auditor (ii); perceived status of the auditor from the chairperson of the committee (iii) and the auditor (iv). In addition, we used the audit process (planning, implementation, report, and evaluation) as an object of analysis, and particularly the planning and evaluation parts are discussed in the chapter. As research on status hierarchies involving parties around the audit committee is in an early stage, the study should be viewed as explorative.

4

Audit reporting transformation Increasing the relevance of the audit through key audit matters? Katharina Rahnert

Introduction This chapter sheds light on the transformation of one of the most important audit outputs, the auditor’s report. The driver for change in focus relates to regulatory changes in the early twenty-first century that stem from financial statement users’ prolonged expectations that were in conflict with previous audit regulation. Recurrently, users of financial statements have expressed demands for informative auditor’s reports including entity-specific information but received in principle nothing but standardised or – as some suggested – even boilerplate information from the auditor for many decades (Church et al., 2008). The auditor’s report has changed considerably throughout history (King & Case, 2003). There is evidence of extremely short auditor’s reports issued in Britain in the late nineteenth century (Monkhouse, 1890). In contrast, Swedish auditor’s reports issued before the twentieth century were relatively long and contained entity-specific information on the auditors’ observations, including figures and frank evaluative statements (Påhlgren, 1938). With the introduction of mandatory auditing for all limited companies and liability for damages if the auditor reported incorrectly in the late nineteenth century, auditor’s reports started to contain less entity-specific information (Rahnert, 2017). The development towards general formulations increased during the following century and resulted in standardised reports basically without any entity-specific information in the second half of the twentieth century. The Cohen Commission (AICPA, 1978) addressed growing dissatisfactions with auditing and identified the existence of an audit expectations gap that was also related to the auditor’s report. The development that followed internationally was characterised by successively longer, but standardised reports explaining auditor responsibilities vis-à-vis corporate management (Church et al., 2008; Rahnert, 2017). However, financial statement users continued to demand ‘valuable’ information that is entity-specific information from the auditor. In the aftermath of the financial crisis in the late 2000s, auditors’ professional organisations and regulators showed a willingness to meet users’ needs and to narrow audit-reporting-related gaps. According to adjusted regulation DOI: 10.4324/9781003411390-5

70  Katharina Rahnert (ISA 700 (revised); ISA 701), auditors of public interest entities are to provide entity-specific information in the otherwise still-standardised auditor’s report on so-called key audit matters (KAMs). KAMs are defined as those matters that, in the auditor’s professional judgement, were of most significance in the audit of the financial statements and are collected from matters communicated with corporate management. Determining KAMs includes a consideration of whether a matter is exposed to high assessed risk of material misstatement, requires significant judgement from the auditor and from corporate management, and is affected by the audit. To enhance the usability of a KAM, the regulation clarifies that a generic or standardised language should be avoided. Instead, the auditor is recommended to relate the KAM directly to the specific circumstances of the audited entity. Another regulation change introduced in the early twenty-first century relates to auditor tenure and its implication for auditor independence (Regulation No 537/2014 of the European Parliament and of the Council of 16 April 2014 on specific requirements regarding statutory audit of public-interest entities and repealing Commission Decision 2005/909/EC. L 158/77). The reason behind mandatory auditor rotation was that situations, where a company appointed the same audit firm or the same audit partner for decades, seemed incompatible with desirable standards of independence due to a threat of familiarity (EC, 2010). Regulators also suggested that mandatory rotation might operate as a catalyst to introduce more dynamism into the audit market. Given the copy-paste audit reporting behaviour in the past, a crucial means to achieve such dynamism for informative auditor’s reports might relate to audit partner and audit firm rotation. Auditor rotation might increase the value of the audit because of the fresh views brought by new auditors and a potentially different reporting behaviour (Lin & Yen, 2022). In the European Union, audit firm rotation is required every ten years, although national regulation can extend the period to 20 years in case of tendering or 24 years in case of a joint audit. These requirements also apply to Swedish audit firms of public interest entities (EtikU 13). Audit partners of public interest entities are to rotate after seven years. The chapter focuses on KAM disclosures in auditor’s reports of Swedish public interest entities. It is assumed that a time series study comprising the years 2016–2021 may indicate whether or not the adjusted reporting regulation effectively breaks the historical trend of the uniform audit reporting model. In addition, KAM disclosures are related to auditor rotation in order to evaluate whether KAMs might be impacted by the fresh views brought by new auditors. Thus, the aim is to investigate whether and under what conditions KAM disclosures have the intended potential to enhance the informative value of the auditor’s report and thereby increase the relevance of the audit. Motivation The introduction of KAMs was implemented after practitioners (IOSCO, 2009) and researchers (e.g. Gold et al., 2009) highlighted the limited value of the standardised text format of the former auditor’s report. Both parties

Audit reporting transformation 71 questioned whether the report was an appropriate tool for financial statement users’ decision-making process. In 2011, the IAASB released the consultation paper Enhancing the Value of Auditor Reporting: Exploring Options for Change (IAASB, 2011). The purpose was to determine whether there were common views among international key financial statement users about the usefulness of audit reporting and to explore possible options to enhance the quality, relevance, and value of the auditor’s report. Feedback from 82 stakeholders revealed ‘a singular point: the status quo is not an option’ (IAASB, 2012, p. 3). This led IAASB to issue a further consultation document in 2012 and an exposure draft in 2013. In the latter document, IAASB recognised a need to reinvest in the audit profession’s legitimacy. Based on the responses from 165 stakeholders to the consultation paper from 2012, IAASB (2013, p. 19) concluded: ‘Many were of the view that enhancements to auditor reporting, such as commentary, would add further value to the pass/fail opinion and help to reinvigorate the public’s trust and confidence in the independent auditor and increase the relevance of the audit.’ In 2015, a new International Standard on Auditing (ISA 701, Communicating Key Audit Matters in the Independent Auditor’s Report) and a revised standard (ISA 700) were published. A number of changes, such as a different order of sections included and additional (standardised) information on the responsibilities of the auditor, were introduced in the auditor’s report. The most important change for audits of public interest entities was the inclusion of a section on KAMs in the standardised auditor’s report. In fact, users’ expressed interests in entity-specific information are highlighted on several occasions in the ISA 701. Even though researchers have outlined far more suggestions for improvement (for an overview, see Rahnert, 2017), it is this section on KAMs that I will focus on in the remainder of this chapter. The new and revised standards imply a change to the prior reporting practice that is likely to cause major challenges for auditors and users. A question that is asked in the emerging literature on KAMs is whether the new regulation enables the intended change, i.e. do KAMs matter? Literature reviews on KAMs have identified three areas that might be impacted by the new audit reporting regulation. There are studies evaluating the process that leads auditors to choose which KAMs to include in their reports, studies on how disclosures by the auditor impact financial reporting behaviour, and studies on users’ changed behaviour due to KAMs (Svanström et al., 2020; Velte & Issa, 2019). Thus, the intention has been to measure the effects of reporting KAMs on auditors themselves (e.g. Rautiainen et al., 2021; Zeng et al., 2021), on financial statement preparers (e.g. Gold et al., 2020), and on financial statement users (e.g. Moroney et al., 2021; Seebeck & Kaya, 2022). So far, existing studies from diverse countries draw a rather inconclusive picture of the potential effect of KAMs. There are currently only a few studies published in international scientific journals that explicitly relate KAMs to auditor rotation. Lin and Yen (2022) examined auditor’s reports for public firms in Taiwan between the years 2016

72  Katharina Rahnert and 2018. Their analysis, however, is restricted to the correlation between KAMs and audit partner rotation – audit firm rotation is not considered. However, mandatory audit firm rotation (in addition to audit partner rotation) is a crucial means to combat threats to independence in the audit market and should be taken into consideration in the context of KAM disclosures. Duboisée de Ricquebourg and Maroun (2022), in a study on KAM disclosures issued in South Africa between the years 2018 and 2020, consider both audit partner and audit firm rotation as possible KAM determinants. The authors conclude that only audit firm rotation (not audit partner rotation) appears to have a significant impact on the KAMs added to or removed from an auditor’s report. Their study, however, is limited to the number of KAMs, thereby omitting more precise measures such as KAM wording and content. Contributions from the Nordic countries are still relatively rare (see Rahnert, 2017; Rautiainen et al., 2021) and in addition to limited insights into the relation between KAMs and auditor rotation, one aspect is generally scarce in the international literature: How KAMs change over time. By exploratively analysing KAMs included in auditor’s reports for Swedish public limited companies between 2016 and 2021, and by relating these to audit partner and audit firm rotation, I will address these shortcomings. Analysing changes over time is assumed to be crucial in order to evaluate whether auditors provide nuanced information that has potential to increase the usefulness of auditor’s reports and thereby the relevance of the audit. A snapshot of KAM disclosures – as often provided in previous research – is not enough, as KAMs can be reused from year to year and thus do probably not add much value in the long run. The KAMs analysed in this chapter stem from auditor’s reports for Swedish public limited companies listed on the Stockholm Stock Exchange and included in the database Retriever as of 1 June 2022. A description of these 351 companies, their auditor’s reports and KAMs is provided in the Appendix. The companies are divided into the following three categories: Large Cap, Mid Cap, and Small Cap. The focus is on KAM headings. Although KAM headings do not reveal ‘the whole story’, they are important because they draw attention to what financial statement users might find worth taking into consideration (Moroney et al., 2021). Also, it can be assumed that KAM headings show the central aspects of KAMs. Literature review The driver of the recent audit reporting regulation change relates mainly to financial statement users’ dissatisfaction with existing audit reporting (IAASB, 2011). Given the insights that auditors gain during their work, for many years, users expected auditors to report on entity-specific information and abstain from standardised reports (Church et al., 2008). In recent years, the audit information gap has been defined as ‘the divide between what users believe is necessary to make informed decisions, and what is available to them through the entity’s audited financial statements, the auditor’s report or other

Audit reporting transformation 73 publicly available information’ (IAASB, 2011, p. 4; Vanstraelen et al., 2012). In its consultation paper, IAASB (2011) clarified that the information gap has implications for the efficiency of capital markets and therefore is an important gap to take into consideration. One of the reasons for the existence of the gap is an increased complexity in the business and reporting environment. While multiple potential means to narrow the information gap have been identified (Rahnert, 2017), to increase the informative value of auditor’s reports through the inclusion of KAMs can only contribute to a part of the solution to the information gap. A growing number of research studies report positive effects of the inclusion of KAMs in auditor’s reports. Gold et al. (2020), for instance, find that managers’ tendency to make an aggressive financial reporting decision is reduced when KAMs are included in the auditor’s report even when the informational precision is low. However, previous research has also identified potential problems, which might negatively affect the possibility of narrowing the audit information gap. Thus, drivers for further change may persist. Sirois et al. (2018) experimentally examined whether and how KAMs affect financial statement users’ information acquisition by using eye-tracking technology. IAASB previously outlined a potential risk that KAM disclosures might substitute for reading the financial statements. The researchers find that when exposed to an auditor’s report including several KAMs, users devote less attention to the remaining parts of the financial statements. Acknowledging the fact that KAMs have an attention-directing role, it is concluded that the number of KAMs is decisive. Possible explanations relate to increasingly complex financial statements and an overload of financial disclosures as well as limited cognitive processing capabilities among users. In a similar vein, Moroney et al. (2021) conclude that the inclusion of KAMs draws investors’ attention to new and expanded messages, directing their attention away from the core messages of the auditor’s report. Under these circumstances, potential benefits on financial reporting, as outlined by Gold et al. (2020), may have limited value for users. Studies have also addressed audit firm characteristics in relation to KAMs. Based on evidence that audit firm size affects investors’ perceptions across a range of measures, Moroney et al. (2021) examined whether the inclusion of KAMs in the auditor’s report has an effect on investors’ perceptions of the value of the audit as well as the credibility of the auditor. The researchers find that the inclusion of KAMs improves perceived value and credibility only when a non-Big 4 firm conducts the audit. For Big 4 firms, value and credibility are high whether KAMs are included or not. According to the research, a ceiling effect may explain the results – Big 4 firms are perceived as providing valuable audits and being credible. A crucial follow-up question from this experimental study is whether Big 4 audit firms also have a larger margin of error or imprecision when reporting KAMs compared to non-Big 4 firms. Related to the informative value of the auditor’s report is also the question to what extent auditors include specific information in KAMs.

74  Katharina Rahnert According to ISA 701 (A47), a KAM should be formulated in a way that ‘relates the matter directly to the specific circumstances of the entity, while avoiding generic or standardized language.’ The premise is that disclosures that are more specific imply greater informative content and thus greater informative value. Specificity is defined as a higher level of detail provided in the descriptions of KAMs and includes qualitative information such as names of persons, names of locations, and names of organisations, as well as quantitative categories expressed in percentages, money values, times, and dates (Seebeck & Kaya, 2022). In a recent study of auditor’s reports of companies listed on the London and Irish stock exchanges, Seebeck and Kaya (2022) found evidence that a higher specificity of KAMs leads to greater short-window investor attention and positive market reactions due to more precise information. In other words, specificity in KAMs appears to improve financial statement users’ decision-making process. In a study based on Chinese data of KAMs, specificity is also measured and related to audit quality, which is improved compared to auditor’s reports prior to mandatory KAM disclosure (Zeng et al., 2021). A further potential problem to date mainly addressed by standard-setters (e.g. IAASB, 2011) is the development of KAMs over time and the risk that auditors will use boilerplate language in the long run. There are several reasons for why one might assume that what appears as entity-specific information expressed in the KAM section of an auditor’s report in a particular year will be repeated in the following year. Historically, auditors have proven to be ‘copypaste experts’ when it comes to audit reporting – not least due to potential litigation risks (Rahnert, 2017). Furthermore, the influence of user groups on audit reporting behaviour has not been particularly strong, and the introduction of KAMs has not been treated positively; Swedish auditors, for instance, asked for back-to-basics auditor’s reports (Rahnert, 2017). Also, Rautiainen et al. (2021) report that auditors themselves do not regard KAMs as improving audit quality. Related to this is the ongoing discussion on structures of judgement in auditing (see Carrington & Catasús in this volume). However, there are researchers who see potential improvements of KAMs over time. Seebeck and Kaya (2022) refer to a potential auditor learning curve when discussing improvements of the value of KAMs during a three-year period. Literature on auditor rotation has outlined the pros and cons of long-term auditor-client relationships (Jenkins & Vermeer, 2013). Following rotation, new auditors experience a learning curve, which might have a negative effect on audit quality. Also, a lack of familiarity might increase the probability of initial engagement auditors overlooking financial misreporting. On the other hand, new auditors can make different professional judgements concerning risk assessments and employ different audit strategies, which might lead to different evaluations of clients’ financial statements due to this new perspective. Singer and Zhang (2018) highlight the importance of this new perspective or fresh view in initial audit engagements and suggest that long auditor tenure tends to impair audit quality. In light of these latter findings, it

Audit reporting transformation 75 can be expected that different KAMs are identified by auditors in the year of auditor rotation compared to the previous year. The study conducted by Lin and Yen (2022) indicates that different KAMs are more likely to be disclosed in the first auditor’s report after audit partner rotation. The authors suggest that this finding is consistent with expectations that KAM disclosures can change due to the fresh perspective from the successor engagement partner. However, the results indicate that different views from audit partners are more likely to be observed in a non-mandatory rotation than in a mandatory rotation. Duboisée de Ricquebourg and Maroun (2022) provide a somewhat different picture. They conclude that whereas audit partner rotation shows an insignificant effect on KAM disclosures, audit firm rotation is associated with significantly different KAMs being identified and reported. A possible explanation relates to different internal policies and best practices in audit firms that complement ISA 701 and serve to coordinate, monitor, and control how the requirement to disclose KAMs is operationalised. Although there is initial evidence of positive effects of the new audit reporting regulation, a review of the literature shows that many problems have been identified and multiple questions remain unanswered. By describing and analysing KAM disclosures in Swedish auditor’s reports and relating them to auditor rotation, this chapter contributes to the emerging audit reporting literature focusing on KAMs. Covering a six-year period, it specifically addresses the development of KAM disclosures over time. It highlights potential problems and indicates possible future developments that have implications for practitioners in the field. Due to the explorative nature of the study, a number of relevant future research questions are also outlined. Results Because the International Standards on Auditing 700 (revised) and 701 apply to Swedish auditors, the KAM regulation in Sweden has been effective for audits of financial statements for periods ending on or after 15 December 2016 and applies to the audit of listed entities and public interest entities. In addition to these standards, the Swedish professional organisation FAR has provided the recommendations RevR 700 and RevR 701. Due to the mandatory management audit in Sweden, the Swedish auditor’s report includes a report on the financial statements and a report on other legal and regulatory requirements. This latter report concerns the management audit. KAM characteristics

Although financial statement users have asked for comprehensive and detailed information from the auditor, according to ISA 701, auditors’ decisionmaking process in determining KAMs is designed to select a smaller number of those matters communicated with corporate management. Concerning a relevant number of KAMs, the standard also clarifies that lengthy lists of

76  Katharina Rahnert Table 4.1  Range of the number of KAMs in auditor’s reports, means, and standard deviations per company category, and in total.

Large Cap Mid Cap Small Cap Total

KAMs

2016

2017

2018

2019

2020

2021

Total

Range Mean SD Range Mean SD Range Mean SD Range Mean SD

1–7 2.78 1.37 1–4 2.20 0.85 1–4 2.08 0.75 1–7 2.39 1.10

1–7 2.33 1.21 1–4 2.02 0.83 1–4 1.92 0.80 1–7 2.11 1.00

0–7 2.25 1.14 0–4 1.84 0.84 1–4 1.94 0.77 0–7 2.02 0.96

0–6 2.22 1.10 0–4 1.80 0.84 0–3 1.78 0,79 0–6 1.95 0.95

0–6 2.08 1.01 0–4 1.68 0.79 1–3 1.73 0.73 0–6 1.84 0.88

1–5 2.05 0.90 0–4 1.70 0.72 1–3 1.74 0,70 0–5 1.83 0.80

0–7 2.27 1.14 0–4 1.85 0.82 0–4 1.85 0.76 0–7 2.00 0.96

KAMs may be contrary to the notion of such matters being those of most significance. Standard-setters assumed that auditors of listed companies would be able to determine at least one KAM. Table 4.1 shows the range of the number of KAMs disclosed in the sample of this study for the years 2016–2021 per company category, and in total. The number of KAMs disclosed ranges from 0 to 7 in total. Zero KAMs means that there are auditor’s reports that include a KAM section, but no KAMs. In these cases, auditors considered no matter to be of significance in the audit. Further, the total mean number decreased from 2.39 KAMs in 2016 to 1.83 in 2021, and the standard deviation also decreased. However, the patterns in the Large Cap category and the other two categories (Mid Cap and Small Cap) are different. Auditor’s reports for Large Cap companies include a higher range of KAMs, a higher mean number, and a higher distribution compared to auditor’s reports for Mid Cap and Small Cap companies. KAMs in the Mid Cap and Small Cap categories have similarities in terms of range, mean number, and distribution. Because of these differences and similarities, it seems valuable to report KAM characteristics per company category in the further analyses of this chapter. All KAMs were included in the report on the financial statements indicating that Swedish auditors do not find it appropriate to report KAMs related to the management audit and included in the report on other legal and regulatory requirements. The way KAMs were disclosed in the auditor’s reports generally followed the requirements given in ISA 701. Auditors described each KAM using a subheading in a separate section of the auditor’s report under the heading Key Audit Matters. Auditors also referred to the related disclosure in the audited financial statements and outlined why the matter was considered one of the most significant and how the matter was addressed in the audit. In line with ISA 701, Sirois et al. (2018) and Moroney et al. (2021) indicate potential problems with the inclusion of too many KAMs. Financial

Audit reporting transformation 77 statement users tend to devote less attention to the remaining parts of the auditor’s report and the financial statements when too many KAMs are disclosed. In the experiment Sirois et al. (2018) conducted, already three KAMs indicated problems for users’ processing capabilities. Thus, the number of KAMs especially in auditor’s reports in the Large Cap category and in the beginning of the six-year period might have decreased the informative value of the reports. In terms of specificity, ISA 701 requires auditors to consider the relevance of the information in KAMs for intended financial statement users. Furthermore, the standard clarifies that a matter that relates directly to the specific circumstances of the audited company may help to minimise the potential that KAMs become standardised and less useful over time. For instance, the auditor may highlight aspects specific to the audited company such as circumstances that affected the underlying judgements made in the financial statements. In order to measure specificity, KAM headings were coded following Seebeck and Kaya (2022). Specificity thus is defined based on qualitative categories such as names of persons, locations, and organisations, as well as quantitative categories expressed in percentages, money values, times, and dates. In Table 4.2, the proportion of qualitative-specific KAM headings in the different years is shown per company category, and in total. None of the quantitative specificity measures were identified. During the six-year period, no names of persons were disclosed in the KAM headings. Names of locations and organisations could be identified, Table 4.2  Q  ualitative specificity in KAM headings per company category, and in total. Qualitative specificity in KAM headings Large Cap Mid Cap Small Cap Total

2016

2017

2018

2019

2020

2021

Total

Names of persons 0 0 0 0 0 0 0 Names of locations 9 5 6 2 2 2 26 Names of 14 13 12 5 4 7 55 organisations Names of persons 0 0 0 0 0 0 0 Names of locations 1 0 2 1 1 3 8 Names of 8 8 6 8 4 5 39 organisations Names of persons 0 0 0 0 0 0 0 Names of locations 1 1 0 0 0 0 2 Names of 4 2 5 4 5 9 29 organisations Names of persons 0 0 0 0 0 0 0 Names of locations 11 6 8 3 3 5 36 Names of 26 23 23 17 13 21 123 organisations Proportion of total 6.48% 4.99% 5.32% 3.41% 2.79% 4.28% 4.55% KAMs

78  Katharina Rahnert the latter often related to acquisitions. Even though it is meaningless to compare the number of specific KAM headings in Swedish auditor’s reports to KAMs that include specific information in auditor’s report issued in other countries (e.g. Seebeck & Kaya, 2022), it can be asserted that the overall number of specific KAM headings is relatively low, 4.55 per cent in total. Also, the proportion of qualitative specificity in KAM headings out of all KAM headings decreased from 6.48 per cent in 2016 to 2.79 per cent in 2020 (before increasing again in 2021). Overall, these observations indicate that KAM headings in auditor’s reports of public interest entities are not particularly helpful for users. Due to the low percentage of specific KAM headings, no further analyses of specific KAM headings will be conducted. Auditors reporting on KAMs

Previous research has shown that audit firm characteristics matter when evaluating financial statement users’ perceptions of KAMs and how KAMs are formulated. Audit firms are also analysed in this study. In total, PwC signed most auditor’s reports, followed by EY, KPMG, and Deloitte. Some auditor’s reports were signed by non-Big 4 audit firms, such as BDO, Grant Thornton, and Mazars, and some companies did not elect an audit firm as its auditor, but audit partners (from Big 4 and non-Big 4 audit firms). The total percentage of auditor’s reports signed by non-Big 4 audit firms and partners was relatively low, 6.8 per cent. As shown in Table 4.3, the number of KAMs disclosed by audit firms is relatively evenly distributed among audit firms. According to Kruskal-Wallis tests, there are no statistically significant differences between the number of KAMs disclosed by the different audit firms during the six-year period, except for 2016. The difference in 2016 is likely caused by Deloitte, who reported a higher number of KAMs compared to all other audit firms. Due to the observation of a relatively evenly distributed number of KAMs among audit firms, no further analyses of potential differences among audit firms will be conducted. Previous research findings suggest that KAMs provided by Big 4 audit firms affect neither investors’ perceptions of the value of the audit nor the Table 4.3  Average number of KAMs per audit firm (and audit partner). No.

Audit firm (and audit partner)

2016

2017

2018

2019

2020

2021

1 2 3 4 5

PwC EY KPMG Deloitte Non-Big 4/ Audit partners p-value (Kruskal-Wallis tests)

2.24 2.37 2.14 3.21 2.56

2.25 2.16 1.86 2.13 1.87

2.17 2.03 1.88 1.84 2.07

1.93 2.00 1.93 1.79 2.25

1.90 1.81 1.65 1.86 2.00

1.88 1.85 1.63 1.92 1.82

Total

(.009) (.306) (.425) (.761) (.431) (.291) 2.39 2.11 2.02 1.95 1.84 1.83

Audit reporting transformation 79 credibility of the auditor due to a ceiling effect (Moroney et al., 2021). Big 4 firms are already perceived as providing valuable audits and to be credible due to the ‘big Four is Best’ bias (EC, 2010, p. 16). This indicates that KAMs reported by Big 4 firms are not as important for users’ decision-making process as those reported by non-Big 4 firms. Also, Big 4 firms are likely to gain less from reporting KAMs than do non-Big 4 firms. Whether this is true also in the Swedish context, especially in the Small Cap category where almost equally many auditor’s reports were signed by non-Big 4 audit firms and partners as were by one of the Big 4 audit firms, is yet to be evaluated. KAMs and auditor rotation

A central question for practitioners and researchers is how the formulation of KAMs will develop over time. Specifically, will KAMs become standardised or will auditors be able to provide relevant, entity-specific information in the long run? Several aspects, such as audit reporting behaviour in the past (Rahnert, 2017), and the fact that auditors do not regard KAMs as improving audit quality (Rautiainen et al., 2021), give us reasons to believe that the informative value of KAMs will decrease with time. As mentioned above, according to ISA 701, auditors are to formulate KAMs in a way that helps to minimise the potential that descriptions become overly standardised and less useful over time. Notwithstanding, ISA 701 also states that it may be useful for the auditor to consider whether a matter that was a KAM in the audit of the prior period continues to be a KAM in the audit of the current period. It is reasonable to assume that, even though a new auditor may reconsider which matters actually should be classified as KAMs, there are matters identified as KAMs in one year that will also be identified as KAMs in the following year. In other words, new auditors may not form views different from their predecessors when there is no significant change in the clients’ financial statements, organisational structure, or business environment. In order to evaluate if KAMs change over time, and how changes relate to auditor rotation, a number of analyses have been conducted. Table 4.4 shows the proportion of auditor’s reports that contained the same number of KAMs compared to the respective previous year. Comparisons of KAM headings to the respective previous year with regard to their wording and content are also presented. For instance, compared to 2016, the number of auditor’s reports with the same number of KAMs in 2017 was 64.85 per cent. During the six-year period, in total 73.89 per cent of all auditor’s reports included the same number of KAMs compared to the respective previous year. In terms of wordings, the proportion of KAMs that reused KAM headings from the respective previous year during the six-year period was in total 81.54 per cent. A closer look at the KAM headings reveals that – even though KAM headings were altered and thus no longer had exactly the same wording as in the previous year – in 90.5 per cent of all KAMs the content was the same compared to KAMs in the respective previous year.

80  Katharina Rahnert Table 4.4  Comparisons of KAMs to previous year with regard to percentage of number of KAMs, KAM heading wordings and content per company category, and in total.

Large Cap

Mid Cap

Small Cap

Total

Same number of KAMs Same wording in KAM headings Same content in KAM headings Same number of KAMs Same wording in KAM headings Same content in KAM headings Same number of KAMs Same wording in KAM headings Same content in KAM headings Same number of KAMs Same wording in KAM headings Same content in KAM headings

2017

2018

2019

2020

2021

Total

57.14 81.69

77.67 81.12

70.75 80.93

70.65 86.28

81.08 74.92

69.80 80.95

91.94

90.74

89.36

92.58

90.08

90.92

66.28 77.71

71.43 82.82

80.95 84.91

76.15 86.44

81.42 83.19

75.73 83.25

89.83

94.13

90.72

92.05

88.50

91.02

74.19 71.91

74.65 79.23

71.43 88.10

83.75 81.67

80.25 77.57

77.09 80.01

88.04

88.26

92.42

88.75

88.27

89.20

64.85 77.72

74.63 81.24

74.65 84.30

76.17 85.11

77.38 78.70

73.89 81.54

90.17

91.32

90.67

91.36

89.01

90.50

The pattern that becomes visible for KAMs in all company categories together resembles that for each company category. The proportion of auditor’s reports that contained the same number of KAMs compared to the respective previous year is generally lower than the proportion of auditor’s reports that contained the same wording in the KAM heading. The proportion of auditor’s reports that contained the same KAM heading content was the highest measure during the whole six-year period. Developments over the six-year period show no major differences in these patterns. In sum, the analyses indicate a relatively high degree of copy-paste work during the six-year period. There can be several reasons for this. As outlined in ISA 701, an obvious reason might be that auditors determine matters that required significant auditor attention in performing audits one year to be the same compared to the previous year. An intrusive question is then how auditors’ disclosing of the same KAM headings, or similar KAM content, year after year affects the informative value of the auditor’s report. Do financial statement users find such headings inspiring enough to continue reading the whole KAM section? Further analyses were conducted to achieve a more nuanced picture of KAM change over time related to auditor rotation. It was considered that the wording and content were most crucial in relation to the informative value of the auditor’s report. Therefore, further analyses of the number of KAMs were not conducted. Table 4.5 reveals what happens to KAMs when another

Audit reporting transformation 81 Table 4.5  Comparisons of KAMs to previous year with regard to KAM heading wordings and content for (a) same audit partner and (b) audit partner rotation conditions per company category, and in total.

Large Same wording in KAM headings Cap (a) Same auditor (b) Audit partner rotation p-value (Mann-Whitney tests) Same content in KAM headings (a) Same auditor (b) Audit partner rotation p-value (Mann-Whitney tests) Mid Same wording in KAM headings Cap (a) Same auditor (b) Audit partner rotation p-value (Mann-Whitney tests) Same content in KAM headings (a) Same auditor (b) Audit partner rotation p-value (Mann-Whitney tests) Small Same wording in KAM headings Cap (a) Same auditor (b) Audit partner rotation p-value (Mann-Whitney tests) Same content in KAM headings (a) Same auditor (b) Audit partner rotation p-value (Mann-Whitney tests) Total Same wording in KAM headings (a) Same auditor (b) Audit partner rotation p-value (Mann-Whitney tests) Same content in KAM headings (a) Same auditor (b) Audit partner rotation p-value (Mann-Whitney tests)

2017

2018

2019

2020

2021

86.76% 61.11% (.013)

85.64% 52.38% (.004)

85.85% 62.12% (.028)

90.79% 73.85% (.007)

82.52% 52.68% (.001)

94.98% 79.63% (.008)

93.41% 73.81% (.007)

91.01% 80.0% (.012)

96.04% 83.05% (.001)

91.16% 86.91% (0.250)

81.5% 58.36% (.038)

89.24% 66.04% (.008)

89.6% 59.82% (.001)

89.22% 78.72% (.285)

85.13% 74.15% (.175)

90.18% 88.14% (.583)

93.82% 95.07% (.652)

93.39% 76.53% (.009)

93.74% 87.35% (.219)

88.18% 90.0% (.690)

80.19% 50.0% (.014)

81.83% 63.33% (.324)

91.28% 70.83% (.106)

83.07% 76.04% (.554)

89.18% 50.0% (.001)

91.67% 78.43% (.349)

91.53% 68.33% (.081)

92.56% 91.67% (.595)

89.06% 87.5% (.958)

93.86% 75.00% (.001)

82.21% 56.47% (.001)

85.74% 61.76% (.001)

88.73% 63.41% (.001)

88.03% 76.23% (.009)

85.2% 57.75% (.001)

92.38% 81.65% (.015)

93.02% 83.99% (.072)

92.6% 81.59% (.002)

92.23% 85.7% (.008)

90.63% 83.8% (.014)

audit partner (employed by the same or another audit firm compared to the previous year) signs the auditor’s report.1 Again, the analyses are provided per company category and year. Comparisons of KAM headings to the respective previous year are made with regard to their wording and content (a) when the same audit partner signed the auditor’s report and (b) when another audit partner signed the report (audit partner rotation). In terms of wordings of KAM headings, 82.21 per cent of KAM headings in auditor’s reports signed by the same auditor in 2017 and 2016 included exactly the same wording as in 2016. In contrast, only 56.47 per cent of KAM headings in auditor’s reports signed by another audit partner (audit partner rotation) in 2017 compared to 2016 included exactly the same wording as in 2016. In all company categories, this pattern became visible. When

82  Katharina Rahnert the same auditor compared to the previous year signed the auditor’s report, the proportion of equal KAM headings was higher compared to when there was an audit partner rotation. According to Mann-Whitney tests, there are statistically significant differences between the proportion of KAM headings with the same wording compared to the respective previous year when the same audit partner signed the report or when there was an audit partner rotation in the Large Cap category in all years. Statistically significant differences were observed between 2017 and 2019 in the Mid Cap category, as well as 2017 and 2021 in the Small Cap category. Thus, there are indications that an audit partner rotation affects the wording of KAM headings in a majority of auditor’s reports, especially in the Large Cap category. The proportion of KAM headings that were altered (and no longer had exactly the same heading as in the previous year), but referred to the same content, differed also depending on whether the same or another audit partner signed the report compared to the previous year. According to Mann-Whitney tests, there are statistically significant differences between the proportion of KAM headings with the same content compared to the respective previous year when the same audit partner signed the report or when there was an audit partner rotation in the Large Cap category, except for 2021. In the Mid Cap and Small Cap categories, statistically significant differences could only be observed for one year each. This indicates that an audit partner rotation affects the content of KAMs in a majority of auditor’s reports for Large Cap companies. An equal effect of an audit partner rotation on the content of KAMs could not be observed in the other two categories. Table 4.6 reveals how KAMs are affected by an audit firm rotation. It shows comparisons of KAM headings to the respective previous year with regard to their wording and content (a) when the same audit firm was assigned and (b) when another audit firm was assigned (audit firm rotation).2 The analyses are provided per company category and year. In terms of wordings of KAM headings, 82.3 per cent of KAM headings in auditor’s reports where the same audit firm was assigned in 2017 and in 2016 included exactly the same wording in 2017 as in 2016. In contrast, only 31.82 per cent of KAM headings in auditor’s reports where another audit firm was assigned (audit firm rotation) in 2017 compared to 2016 included exactly the same wording in 2017 as in 2016. The distribution of percentages in the three company categories followed similar patterns per year and across the six-year period. There are statistically significant differences between the proportion of KAM headings with the same wording compared to the respective previous year when the same audit firm was assigned or when there was an audit firm rotation in all years and company categories except for 2018 and 2020 in the Small Cap category. Thus, there are relatively strong indications that audit firm rotation affects the wording of KAM headings. The proportion of KAM headings that were altered (and no longer had exactly the same heading as in the previous year), but referred to the same content, differed also dependent on whether the same or another audit firm

Audit reporting transformation 83 Table 4.6  Comparisons of KAMs to previous year with regard to KAM heading wordings and content for (a) same audit firm and (b) audit firm rotation conditions per company category, and in total.

Large Same wording in KAM headings Cap (a) Same audit firm (b) Audit firm rotation p-value (Mann-Whitney tests) Same content in KAM headings (a) Same audit firm (b) Audit firm rotation p-value (Mann-Whitney tests) Mid Same wording in KAM headings Cap (a) Same audit firm (b) Audit firm rotation p-value (Mann-Whitney tests) Same content in KAM headings (a) Same audit firm (b) Audit firm rotation p-value (Mann-Whitney tests) Small Same wording in KAM headings Cap (a) Same audit firm (b) Audit firm rotation p-value (Mann-Whitney tests) Same content in KAM headings (a) Same audit firm (b) Audit firm rotation p-value (Mann-Whitney tests) Total Same wording in KAM headings (a) Same audit firm (b) Audit firm rotation p-value (Mann-Whitney tests) Same content in KAM headings (a) Same audit firm (b) Audit firm rotation p-value (Mann-Whitney tests)

2017

2018

2019

2020

2021

87.15% 25.0% (.001)

85.05% 19.05% (.001)

86.37% 28.67% (.001)

89.08% 51.04% (.002)

81.38% 36.98% (.001)

94.98% 60.42% (.001)

93.19% 57.14% (.001)

92.1% 63.0% (.001)

94.55% 67.71% (.005)

90.06% 80.39% (.261)

81.06% 20.0% (.003)

86.17% 43.75% (.006)

87.89% 20.0% (.001)

89.27% 46.6% (.016)

85.21% 36.6% (.002)

90.34% 80.0% (.264)

94.13% 93.75% (.949)

92.62% 50.0% (.005)

92.24% 86.6% (.655)

88.79% 80.0% (.820)

76.57% 44.44% (.032)

81.25% 33.3% (.082)

92.13% 30.0% (.001)

83.33% 50.0% (.161)

87.01% 28.2% (.001)

87.26% 92.59% (.579)

89.95% 50% (.034)

93.29% 80.0% (.598)

89.04% 83.33% (.673)

90.93% 74.36% (.018)

82.3% 31.82% (.001)

84.65% 32.41% (.001)

88.45% 26.83% (.001)

87.21% 49.5% (.001)

84.33% 33.57% (.001)

91.37% 78.03% (.005)

92.65% 72.22% (.001)

92.61% 64.0% (.001)

92.21% 76.94% (.019)

89.97% 80.39% (.019)

was assigned compared to the previous year. The results show statistically significant differences between the proportion of KAMs with the same content compared to the respective previous year when the same audit firm was assigned or when there was an audit firm rotation in the Large Cap category in all years, except for 2021. In the Mid Cap and Small Cap categories, statistically significant differences could only be observed in 2018 (Small Cap), 2019 (Mid Cap), and 2021 (Small Cap). This indicates that an audit firm rotation affects the content of KAMs for Large Cap companies. However, no equal effect of an audit firm rotation on the content of KAMs could be observed for the other two company categories. In sum, there are indications that the proportion of KAMs that include the same heading, and (to a lesser extent) the same content differs compared to

84  Katharina Rahnert the previous year depending on whether the same or another audit partner signed the report of a Large Cap company, and whether the same or another audit firm was assigned by a Large Cap company. For Large Cap companies, the following can be observed. The tendency to change a KAM heading is relatively high when – compared to the previous year – another auditor (employed by the same or another audit firm compared to the previous year) signed the report. The tendency to change a KAM heading is even higher when – compared to the previous year – another audit firm is assigned. The findings might indicate that different auditors make different judgements on the financial reporting conditions of the client company due to the implementation of another audit plan, other procedures, and other evaluations of the audit. Thus, auditor rotation might have a beneficial effect on the informative value of the auditor’s report. However, as indicated by Lin and Yen (2022), there might be differences between the impact of mandatory and non-mandatory auditor rotation on changed KAMs in initial audit engagements. This complicates decisions for regulators to shorten mandatory auditor rotation. For auditor’s reports for Mid Cap and Small Cap companies the abovedescribed differences are not as obvious. In some cases, even a higher proportion of copy-paste KAM headings content can be observed after audit partner and audit firm rotation. The differences between KAM reporting for Large Cap companies on the one hand, and KAM reporting for Mid Cap and Small Cap companies on the other, might be attributed to the fact that auditors of the largest listed companies are those most exposed to media scrutiny, pressure from within their organisations, and threats of litigation (see Carrington et al., 2013). Conclusions and implications This chapter aimed to investigate whether and under what conditions KAM disclosures have the intended potential to enhance the informative value of the auditor’s report and thereby increase the relevance of the audit. KAM disclosures in auditor’s reports of Swedish public interest entities for the years 2016–2021 were studied and related to auditor rotation, another area recently addressed in enforced regulative change. The findings show that auditors of Swedish public interest entities provide a varying number of KAMs which are relatively evenly distributed among (mainly Big 4) audit firms. At first glance, this indicates a development away from the criticised uniform audit reporting model. However, the study identified a number of potential problems relating to KAM disclosures that have both practical and theoretical implications. A high number of KAMs disclosed might have a negative effect on financial statement users’ cognitive processing capabilities and thus decrease the informative value of the auditor’s report as a whole. Financial statement users tend to devote less attention to the auditor’s report when too many KAMs are disclosed (Moroney et al., 2021; Sirois et al., 2018). Even though

Audit reporting transformation 85 the average number of KAMs disclosed in auditor’s reports in this study was 2.00 and the average number of KAMs per auditor’s report decreased during the six-year period, in some cases – especially in the Large Cap category – Swedish auditors might have disclosed too many KAMs. Also, a majority of auditor’s reports included in the sample were signed by auditors from Big 4 audit firms. Due to a ceiling effect, disclosed KAMs might not have any effect on financial statement users’ perceptions of the value of the audit or the credibility of the auditor (Moroney et al., 2021). Big 4 firm auditors are generally perceived as providing valuable audits and to be credible – whether KAMs are included in their reports or not. Therefore, users might accept larger margins of error or imprecision in KAM reporting. A means for auditors to increase the value of KAMs is to include specific information. Specificity seems to matter to financial statement users’ decision-making process (Seebeck & Kaya, 2022). However, the auditor’s reports under study included a relatively low proportion of specific KAM headings. Thus, to disclose only a limited number of specific KAM headings may have detrimental effects for the informative value of the auditor’s report. Even though the degree of specificity might be higher in the text following the heading, the absence of specificity in KAM headings can fail to draw attention to what financial statement users find worth taking into consideration. A further central problem indicated in the analyses is the development of KAMs related to auditor rotation in the Large Cap category. The findings indicate a tendency that these auditors change KAMs primarily when conducting initial audit engagements. Otherwise, these auditors show a higher tendency to reuse KAMs. The change of wordings and content of KAM headings is related to audit partner rotation and – to an even higher degree – to audit firm rotation. Auditor rotation seems to facilitate a fresh view to the audit probably due to a changed audit strategy by individual audit partners (see Lin & Yen, 2022) or due to differences in internal policies and best practices developed by audit firms (see Duboisée de Ricquebourg & Maroun, 2022). These observations indicate that auditor rotation is positively correlated with the informative value of the auditor’s report for Large Cap companies. The current audit partner and audit firm tenures allowed for these companies might be too long in terms of their implications on the informative value of the auditor’s report. The analyses of KAMs in relation to auditor rotation in the Mid Cap and Small Cap categories are different. The change of wordings and content of KAM headings is not equally related to audit partner or audit firm rotation. Many auditors conducting initial audit engagements reuse KAM heading wordings and content, and many auditors that continue to conduct audits for the same company change the wording and content of KAM headings. Based on these findings, a shift in auditor tenure for these company categories might not impact the informative value of the auditor’s report. In sum, there are indications that the way KAMs were formulated in auditor’s reports for Swedish public interest entities between 2016 and 2021 – irrespective of the assigned audit firm – have insufficient capacity to enhance

86  Katharina Rahnert the value of the auditor’s report in the long run. Rather, the low number of specific KAM headings and the copy-paste work related to KAMs in cases when the same auditor signed the auditor’s report compared to the previous year, seem to have limited potential to halt drivers for further change. The problems identified thus may trigger further audit reporting transformations. In order to avoid financial statement user dissatisfaction with and misperception of KAMs in the future, a number of potential improvements are suggested. For instance, it is proposed that auditors increase the use of specific information in KAM headings such as names of persons, locations, and organisations as well as percentages, money values, times, and dates (see Seebeck & Kaya, 2022). This potentially increases the informative value of KAMs. To ensure a uniform level of audit reporting quality, an obligation for auditors to provide specific KAM headings could be introduced. To increase the informative value over time, it seems also relevant to introduce more frequent auditor rotations – at least for Large Cap companies. Notwithstanding potential increases in costs for audits, audit partner and audit firm rotation seem to provide financial statement users with dynamism in auditor’s reports over time – novel information is provided in initial audit engagements. The copy-paste audit reporting behaviour as evidenced in the past could be avoided by more frequent audit partner and audit firm rotations. As with all research studies, the results of the analyses in this chapter should be viewed in light of their limitations. The study focused on KAM headings. Acknowledging the fact that analyses of KAMs (not only KAM headings) provide a more nuanced picture, KAM headings are considered important. In times of information overflow, they are attention-directing and might determine whether financial statement users will invest time in actually reading the following text. Also, headings can be assumed to indicate the central aspects of the KAMs. A further limitation of this study relates to its explorative nature. While the analyses of KAMs provide valuable insights, no effects of KAM disclosures on auditors, financial statement preparers, or financial statement users have been examined. These limitations provide fruitful avenues for future research. In terms of effect, an examination of KAM disclosure over time, and in relation to auditor rotation, is considered to be of particular importance. In addition, there are a number of questions relating to the practical and theoretical implications of KAMs. Future research may evaluate whether a high number of KAMs as observed in some of the auditor’s reports in this study have detrimental effects on financial statement users’ perceptions of the value of the report. A relevant question is also whether more specific KAM headings have the potential to direct financial statement users’ attention to the KAMs and thus increase the informative value of auditor’s reports. Further questions for future research relate to KAMs and auditor rotation in Large Cap companies. This research might explain the background to the observed behaviour such as whether KAM changes in times of audit

Audit reporting transformation 87 partner or audit firm rotations are related to changes in the audited company. Whether different auditors’ assessments of KAMs or auditors’ knowledge relating to matters of most significance in the audit differ to such a degree that auditors report different KAMs should also be evaluated. In terms of credibility, scholars might investigate whether KAM changes in relation to audit partner and audit firm rotations relate to prestige, i.e. a way of indicating to corporate management and financial statement users that the new auditor performed an audit that resulted in better (or at least different) assessments. Users’ reactions when auditors tend to reuse KAMs they themselves disclosed in previous periods in auditor’s reports of a certain company and – at the same time – disclose other KAMs compared to the previous year in initial audit engagements should also be taken into consideration, as well as whether more frequent auditor rotation can eliminate the identified reporting behaviour. In addition, the observed differences of KAM reporting behaviour between Large Cap companies, on the one hand, and Mid and Small Cap companies, on the other, prompt further investigations concerning preconditions for auditors’ work in these companies and the effect of the diverging reporting patterns on financial statement users. Answering these questions might help identify and evaluate means to increase the overall value of the auditor’s report and the relevance of the audit. Notes 1 Only first-signing auditors were taken into consideration in the analyses. Also, I did not control whether audit partner rotations can be attributed to mandatory audit partner rotations or not. 2 There are no cases where the same auditor signed a report but another audit firm was assigned. I did not control whether audit firm rotations can be attributed to mandatory audit firm rotations or not.

References AICPA (1978). Report. Conclusions and recommendations of the commission on auditors’ responsibilities. New York: American Institute of Certified Public Accountants. Carrington, T., Johansson, T., Johed, G., & Öhman, P. (2013). An empirical test of the hierarchical construct of professionalism and managerialism in the accounting profession. Behavioral Research in Accounting, 25(2), 1–20. Church, B.K., Davis, S.M., & McCracken, S.A. (2008). The auditor’s reporting model: A literature overview and research synthesis. Accounting Horizons, 22(1), 69–90. Duboisée de Ricquebourg, A., & Maroun, W. (2022). How do auditor rotations affect key audit matters? Archival evidence from South African audits. The British Accounting Review, 55(2), 101099. https://doi.org/10.1016/j.bar.2022.101099 EC (2010). Green paper. Audit policy: Lessons from the crisis. Brussels: European Commission. Gold, A., Gronewold, U., & Pott, C. (2009). Financial statement users’ perceptions of the IAASB’s ISA 700 unqualified auditor’s report in Germany and the Netherlands. Report prepared for the AICPA’s ASB and the IAASB.

88  Katharina Rahnert Gold, A., Heilmann, M., Pott, C., & Rematzki, J. (2020). Do key audit matters impact financial reporting behavior? International Journal of Auditing, 24(2), 232–244. IAASB (2011). Enhancing the value of auditor reporting: Exploring options for change. New York: International Auditing and Assurance Standards Board. IAASB (2012). Invitation to comment: Improving the auditor’s report. New York: International Auditing and Assurance Standards Board. IAASB (2013). Exposure draft: Reporting on audited financial statements: Proposed new and revised International Standards on Auditing (ISAs). New York: International Auditing and Assurance Standards Board. IOSCO (2009). Auditor communications. Consultation Report. Technical Committee of the International Organization of Securities Commissions. Jenkins, D.S., & Vermeer, T.E. (2013). Audit firm rotation and audit quality: Evidence from academic research. Accounting Research Journal, 26(1), 75–84. King, D.L., & Case, C.J. (2003). The evolution of the United States audit report. Academy of Accounting and Financial Studies Journal, 7(1), 1–16. Lin, H.-L., & Yen, A.-R. (2022). Auditor rotation, key audit matter disclosures, and financial reporting quality. Advances in Accounting, 57, 100594. https://doi. org/10.1016/j.adiac.2022.100594 Monkhouse, G.B. (1890). Certificates. The Accountant, 17(October), 538–543. Moroney, R., Phang, S.-Y., & Xiao, X. (2021). When do investors value key audit matters? European Accounting Review, 30(1), 63–82. Påhlgren, S. (1938). Något om gamla svenska revisionsberättelser. In Swedish (Some things about old auditor’s reports). Affärsekonomi, 5, 253–268. Rahnert, K. (2017). The evolution of the Swedish auditor’s report. Doctoral Thesis, Karlstads universitet. Rautiainen, A., Saastamoinen, J., & Pajunen, K. (2021). Do key audit matters (KAMs) matter? Auditors’ perceptions of KAMs and audit quality in Finland. Managerial Auditing Journal, 36(3), 386–404. Seebeck, A., & Kaya, D. (2022). The power of words: An empirical analysis of the communicative value of extended auditor reports. European Accounting Review, DOI: 10.1080/09638180.2021.2021097 Singer, Z., & Zhang, J. (2018). Auditor tenure and the timeliness of misstatement discovery. The Accounting Review, 93(2), 315–338. Sirois, L.-P., Bédard, J., & Bera, P. (2018). The informational value of key audit matters in the auditor’s report: Evidence from an eye-tracking study. Accounting Horizons, 32(2), 141–162. Svanström, T., Stenheim, T., & Kulset, E.M. (2020). KAM disclosure in the auditor’s report: A literature review. In Stenheim, T., & Birkeland, K. (Eds), Finansiell og ikke-finansiell rapportering - trender og utvikling. Oslo: Gyldendal Akademisk, 357–400. Vanstraelen, A., Schelleman, C., Meuwissen, R., & Hofmann, I. (2012). The audit reporting debate: Seemingly intractable problems and feasible solutions. European Accounting Review, 21(2), 193–215. Velte, P., & Issa, J. (2019). The impact of key audit matter (KAM) disclosure in audit reports on stakeholders’ reactions: A literature review. Problems and Perspectives in Management, 17(3), 323–341. Zeng, Y., Zhang, J.H., Zhang, J., & Zhang, M. (2021). Key audit matters reports in China: Their descriptions and implications of audit quality. Accounting Horizons, 35(2), 167–192.

Audit reporting transformation 89 Appendix: Research design The research design is based on the analysis of hand-collected KAMs disclosed in auditor’s reports for three categories of Swedish public limited companies listed on the Stockholm Stock Exchange and included in the database Retriever as of 1 June 2022:

• Large Cap (companies with a market capitalisation over one billion euros) • Mid Cap (companies with a market capitalisation between 150 million euros and one billion euros)

• Small Cap (companies with a market capitalisation below 150 million euros)

In total, 351 companies were included in the study: 123 Large Cap, 137 Mid Cap, and 91 Small Cap companies. The auditor’s reports were issued between 2016 and 2021, including 2,021 available auditor’s reports, 1,747 including a KAM section, and a total of 3,501 KAMs (1,452 for Large Cap, 1,196 for Mid Cap, and 853 for Small Cap companies). Companies that were listed during some year(s) during the six-year period but not reported as listed on the Stockholm Stock Exchange in the database Retriever as of 1 June 2022 were not included in the study. Guided by previous research, key characteristics of KAMs (with a focus on KAM headings) were extracted and analysed using the statistical analysis software SPSS. In some cases, companies were not listed during the whole six-year period. Thus, KAM sections were not included in the auditor’s reports during the year(s) that the companies were not listed. In other cases, companies did not exist during the whole period or were inactive for some year(s). In these cases, neither financial statements nor auditor’s reports were available. Auditor’s reports for these years were excluded, i.e. not coded as including zero KAMs. When comparisons to previous years were made, auditor’s reports without a KAM section were excluded. In other words, KAMs of a certain auditor’s report were not compared to a report not including any KAM section. When judgement was needed, the coding was discussed with a colleague familiar with KAM reporting and in some few instances adjusted accordingly. This was the case when I needed to evaluate whether a certain KAM heading describes the same or a similar content as another KAM heading with a different wording (see Subsection: KAMs and auditor rotation). Descriptive statistics and correlations were reported as well as statistically significant differences between variables. Depending on the characteristics of the variables, Kruskal-Wallis tests and Mann-Whitney tests were conducted (all two-tailed) and the p-value 0.05 was used as an indicator of significance in all analyses.

5

The adoption of professional audit standards in the public sector The role of the audit profession and other actors Pernilla Broberg and Torbjörn Tagesson

Introduction Accounting firms and auditors are active both on a national and international level as well as in several different sectors, including public companies, private companies, non-profit organisations, and public sector organisations. This implies that accounting firms and auditors must consider and manage different institutional conditions and operate in parallel within different organisational fields. In this chapter, we focus on the role of the audit profession and other actors in the development of Generally Accepted Auditing Standards (GAAS) for municipal financial auditing in Sweden. The institutional arrangements of the municipal audit in Sweden are a constant subject of debate and criticism (Tagesson & Brunström, 2022). Recurring criticism concerns the role of the politically appointed auditors (Cassel, 2000; Haglund, 2021), insufficient resources for audit (Tagesson et al., 2015), and lack of accountability and liability (Donatella et al., 2019; Eriksson & Tagesson, 2018; Lundin, 2010; Nyman et al., 2007). Despite repeated criticism, the unique audit regime with politically appointed auditors, who are formally responsible for the audit and the issuing of the audit report, is maintained (Donatella et al., 2022). However, in practice, experts, i.e. professional auditors, assist the politically appointed auditors in their work. The municipal council and political auditors can either create an internal audit office or hire professional auditors from an external accounting firm (Collin et al., 2017). For the financial audit, most municipalities hire professional auditors from the Big 4 accounting firms (Tagesson et al., 2015). During the last decade, there has also been a debate regarding the competence, role, and responsibility of these professional auditors (Haglund, 2021; Lundin, 2010; Tagesson & Eriksson, 2011). Although several amendments have been made to the Local Government Act, in order to regulate the role, competence, and reporting of professional auditors (Lundin, 2010), their authority and professional responsibilities have been unclear. In a recent thematic inspection of the accounting firms’ engagement in the municipal audit, the Swedish Inspectorate of Auditors (SIA) concludes that an assignment to assist politically appointed auditors in the audit DOI: 10.4324/9781003411390-6

Adoption of professional audit standards in the public sector 91 of financial reports is considered to be audit work (SIA, 2020). However, the lack of standards for professional municipal auditing entails ambiguities regarding professional ethics for auditors and GAAS (ibid.). Furthermore, the lack of such a standard also implies insufficient assessment criteria as a basis for SIA’s inspection and control of audit quality in the municipal sector. SIA concludes that there is an explicit need for a framework and a standard for auditing financial reporting within the municipal sector. Even though the Swedish Association of Local Authorities (SALAR) claims that the municipal audit is not under the supervision of SIA (Pettersson, 2020), a project was initiated by SALAR, FAR, and SKYREV (The Swedish Association of Professional Local Government Auditors), in order to develop a set of standards for auditing financial reporting in the local government sector. A first exposure draft of the proposed Swedish standard for municipal auditing of financial reporting was presented and circulated for consultation in the autumn of 2021. The municipalities as well as the private accounting firms actively responded to the exposure draft with comments, criticism, questions, and suggestions. The answers concerned everything from matters related to general positions and assumptions to detailed suggestions for changes in the content and form of the proposed standard. While the municipalities largely seem to take a more sceptical and passive stance towards the proposed standard for auditing financial reporting in the local government sector and the changes it entails, the private accounting firms appear to take a more positive and proactive stance. These firms are also, to some extent, represented in the organisations involved in initiating and developing the exposure draft of the new standard, and they possess the knowledge and competence needed to develop and work according to the new standards. Thus, the private accounting firms, and their professional auditors, are highly involved actors throughout the process where auditing within the municipal sector is undergoing a transition. In this chapter, we analyse documents and interview individuals (representing different perspectives and interests) involved in the process. By analysing the course of events as well as opinions, comments, and arguments that have emerged throughout the process, we explore the process of developing a standard for municipal auditing of financial reporting and how private sector actors and regulations influence the municipal sector. The overall purpose is to contribute to the understanding of how change within auditing is initiated and formed through collaboration and negotiation between FAR and other actors within the organisational field. Motivation The audit industry is under constant change as global developments influence audit practice through changes in, for example, audit standards, audit programmes, and quality control. Accounting firms are striving to provide

92  Pernilla Broberg and Torbjörn Tagesson higher-quality audits, meet quality requirements, enhance efficiency and effectiveness, and so on. Professional auditors must meet requirements from the audit profession and the accounting firms. Thus, ‘general’ audit-industry developments provide conditions and can set the direction for and accelerate or slow down change processes in specific contexts, such as the municipal sector. The understanding gained from this chapter emphasises how the International Federation of Accountants’ (IFAC) mantra, ‘an audit is an audit’, (to the extent that it is still used) serves as a starting point rather than a goal. Even though auditing, as a theoretical concept, ought to be considered as ‘one’ phenomenon, in practice auditing starts from the circumstances of the audit engagement and, hence, auditing could differ from one context to another. To be relevant, the audit must, to some extent, be adapted to the main circumstances of the entity being audited. In this chapter, we focus on how international regulation can be a driver of change regarding municipal auditing of financial reporting through the development of a standard for the latter context. We gain understanding of how the municipal specificity not only affects the output, i.e. how the audit is organised, performed, and reported but also how it influences the process of change per se. The organisation, regulation, and context of the public sector in Sweden set boundaries and provide preconditions for the development and determine what actors need to participate and where anchoring must take place. The private accounting firms must, as actors in the municipal auditing arena, adhere to municipal sector regulations at the same time as they also must apply auditing and auditor-related legislation, comply with rules and recommendations set by the audit profession, and meet accounting-firm-specific quality standards. This entails adaptation and compromising, and the process of transition entails finding an agreement regarding the content and form of an audit that all actors involved can accept. For professional auditors and private accounting firms, one important challenge is dealing with the question of ‘how different can an audit be and still be an audit?’. Throughout the process of change, different interests, circumstances, and requirements are emphasised by different actors, at different times, and in different contexts and situations. By interviewing actors and analysing documents from the standard-development process, we gain a better understanding of how auditing transition is driven by change in regulation that causes different actors to act, manage events, and make choices. An important part of the analysis will, therefore, be to sort these events chronologically in order to be able to describe and understand the course of events and their mutual relationship and impact. These events, which have influenced the development of a standard for municipal auditing of financial reporting in Sweden, have taken place before and during the period in which this book has been written. Table 5.1 shows how the events that form the basis for the analysis have been identified and mapped. We have followed the process of change – through the information that is publicly available but also by interviewing actors who are directly involved

Adoption of professional audit standards in the public sector 93 Table 5.1  T  imeline – Important and decisive events throughout the development of a standard for municipal auditing of financial reporting. Year

Event

1996

PwC acquires KOMREV

1998

Municipal Accounting Act [Lag om kommunal redovisning (KRL)]

2000

SKYREV is formed

2005

RS [Revisionsstandard i Sverige] is implemented for corporate auditing

2009

ISQC 1

2011 2012

ISA replaces RS SKYREV starts projects with ISA-based regulations

2014

SKYREV’s draft guidance for municipal auditing of financial reporting

2017

The accounting firms are beginning to demand ‘written representations from management and, where appropriate, those charged with governance in an audit of financial statements’ (cf. ISA 580) Round table discussions with SALAR, FAR, and SKYREV on standards for municipal auditing of financial reporting FAR replaces its secretary general The Municipal Bookkeeping and Accounting Act (LKBR) enters into force (replaces KRL) SIA conducts thematic supervision SIA’s report from the thematic supervision is published SIA gives a reminder to an expert assistant Draft common standard for municipal auditing of financial reporting is presented The work with the standard continues based on the consultation responses received The common standard for municipal auditing of financial reporting is planned to become effective

2018 2019 2020 2021 2022 2023

in the process – while it has been ongoing. Although a new standard will not be fully implemented by the time this book is published, to follow and study the process itself contributes in terms of: (i) a time document of the course of events, (ii) an understanding of the content and form of the coming standard, (iii) an understanding of how professional auditors and private accounting firms are affected by and able to influence auditing within the municipal (public) sector, and (iv) insights about the role of and interactions between

94  Pernilla Broberg and Torbjörn Tagesson different actors within the field of auditing in Sweden. For a description of the empirical method used in this chapter, see Appendix. Theoretical framework Change in accounting and auditing standards has been described as a social and innovative process influenced by actors in the social system within which change is effected (Greenwood et al., 2002; Hussein, 1981). In line with Malmström (2021), who studied the institutional process of change that led to the proposed International Standard for Audits of Less Complex Entities, the analysis of this study will be structured based on institutional theory (DiMaggio & Powell, 1983). Hence, the change is assumed to be influenced by the actors that constitute the organisational field, i.e. ‘… key suppliers, resource and product consumers, regulatory agencies, and other organisations that produce similar services or products’ (ibid. 1983:148). An organisational field must be defined based on empirical investigation but is characterised by the existence of both connectedness and structural equivalence, i.e. existence of transactions tying organisations to one another (including both formal contractual relationships and informal organisationlevel ties) and ties of the same kind to the same set of other organisations (ibid.). To understand institutional isomorphic change and how organisations adapt to their environment and other organisations within their organisational field[s], DiMaggio and Powell (1983, p. 150) suggest the use of three mechanisms; ‘… 1) coercive isomorphism that stems from political influence and the problem of legitimacy; 2) mimetic isomorphism resulting from standard responses to uncertainty; and 3) normative isomorphism, associated with professionalisation’. Both Hussein (1981) and Greenwood et al. (2002) emphasise how change in the area of accounting (and auditing) is often the result of a process and how there are elements of ‘innovation’ within this process – ‘[i]t would appear that change in the accounting area is subject to a process of innovation rather than instantaneous adjustment’ (Hussein, 1981, p. 27). They both develop models for studying such change processes. The model developed by Hussein describes the innovative process of financial standard-setting. Empirically, Hussein explores the process of adopting GAAS and how accounting innovation can have a material impact on both the content and form of financial statements. Furthermore, the model emphasises how the process of change entails conflicts of interest due to the extent and nature of impact the suggested ‘innovation(s)’ have on different actors involved. Greenwood et al. (2002) outline a model for institutional change that is used to study the role of professional associations in the transformation of institutionalised fields. They studied jurisdictional migration of accounting firms, with an expanded range of services provided and with redefinition of the role of professional auditors (to ‘business advisers’) as well as

Adoption of professional audit standards in the public sector 95 endorsement of a new organisational form (the multidisciplinary practice firm, providing services not only by authorised auditors). The change process as well as the context we are studying are, at least to some extent, similar to the empirical cases in Hussein (1981) and Greenwood et al. (2002). Therefore, based on the empirical case in this chapter, we develop a framework that combines their empirically tested models, and we identify five different stages of the innovation process that leads to institutional change. The five stages are presented below (see Figure 5.1) and are also used in the section ‘Understanding actors and actions throughout the process’ to analyse the process with its course of events as well as the opinions, comments, and arguments that have emerged throughout the process and/or that were expressed by the interviewees in this chapter. I – Precipitating jolt as a trigger of an experienced performance gap

‘From time to time, organisational environments undergo cataclysmic upheavals – changes so sudden and extensive that they alter the trajectories of entire industries, overwhelm the adaptive capacities of resilient organisations ….’ (Meyer et al., 1990, p. 93). These kinds of events, sometimes referred to as environmental jolts, are, according to Meyer (1982, p. 515), ‘… found to be ambiguous events that offer propitious opportunities for organisational learning, administrative drama, and introducing unrelated changes’. However, according to Greenwood et al. (2002), jolts do not have to be the results of unforeseen environmental exogenous shocks or social upheaval but can also be precipitating events such as technological disruptions, competitive discontinuities, or regulatory change. A jolt may very well be a second-order change, and an incremental change at firm level may influence the incidence or intensity at the industry level (Meyer et al., 1990) and, by extension, a whole organisational field. Hence, one consequence of a jolt may be that a performance gap is experienced, and innovation and institutional change are initiated (e.g. Hussein, 1981). I. Precipitating jolt as a trigger of an experienced performance gap

II. Deinstitutionalisation and the process of knowledge and awareness

III. Preinstitutionalisation: Formation of attitudes

V. Diffusion: Outcome

IV. Theorisation: Implicit bargaining (legitimation)

Figure 5.1 Theoretical model based on Hussein (1981, p. 29) and Greenwood et al. (2002, p. 54).

96  Pernilla Broberg and Torbjörn Tagesson II – Deinstitutionalisation and the process of knowledge and awareness

In the next stage, new and old actors in the organisational field will question and debate presuppositions. The socially constructed field-level consensus will be disturbed, and new ideas will be proposed and thus the possibility of change will be debated (Greenwood et al., 2002). This is in line with what Hussein (1981) calls the subprocess of knowledge and awareness. In this stage, change agents play an important role. These change agents can be external as well as internal (cf. institutional entrepreneurs). According to Hussein (ibid.), the main communication channels used at this stage will be mass media channels, since people will be searching through the literature for details about the innovation (cf. new ideas). III – Preinstitutionalisation: Formation of attitudes

In the third stage, organisations will, according to Greenwood et al. (2002), independently innovate and seek technically viable solutions to locally perceived problems. In Hussein’s model, the basic need for change and innovation is known at this stage. However, experiments by early adopters and experiences with similar methods will take place and influence the position and attitudes formed towards further innovation. The main communication channels used in this stage are, according to Hussein (1981), interpersonal ones, where networks of opinion and relations are utilised to clarify matters and persuade others to support one’s position. IV – Theorisation: Implicit bargaining (legitimation)

Greenwood et al. (2002) describe the next stage as theorisation. Theorisation implies a specification of the problem of the prevailing situation and justification of the innovation as a solution to the problem (ibid.). According to Hussein (1981), this part of the process is a collective decision-making process where the different groups engage in an implicit bargaining exchange to reach a compromise solution. Both interpersonal communication and mass media are used as channels in this part of the process (ibid.). Hussein points out that interpersonal relationships between the leaders of the different groups may be important at this stage of institutional change. ‘When the leaders of the different groups share the same attitudes and have developed good personal relations, it reduces the grounds for conflict and increase the likelihood of reaching a compromise’ (ibid., 1982, p. 31). However, the theorisation can be expected to vary according to the heterogeneity among the groups involved in the process. According to Malmström (2021), previous studies show that theorising in the organisational field of auditing is a complicated process where several actors must be considered when new ideas are justified to get moral, pragmatic, and finally cognitive legitimacy. As pointed out by Curtis et al. (2016, p. 94) ‘… for any innovation to be successful it has to secure an alignment across practice, standard-setting, and regulatory domains’.

Adoption of professional audit standards in the public sector 97 V – Diffusion: Outcome

In the model by Greenwood et al. (2002), a successful theorisation is followed by a diffusion of the innovation in terms of objectification. If the innovation gains pragmatic legitimacy, it will stand a chance to be reinstitutionalised, gain cognitive legitimacy, and be accepted as the natural and appropriate arrangement. Otherwise, it will eventually fall into oblivion as other fads and fashions (ibid.). The outcome is the final subprocess in Hussein’s model, where the innovation is adopted as a standard, rejected, or pre-empted (Hussein, 1981). Pre-emption means that some actor actively opposes the proposal and tries to undermine the whole process. Results Course of events

There is a long tradition of using specialists in assisting the politically appointed auditors in their work. Municipalities and regions started to procure audit services from the market during the 1990s (Donatella et al., 2019). At the time, PwC, which in 1996 acquired Komrev (an accounting firm that specialised in municipal audit) from SALAR (Tagesson et al., 2015), was the dominant actor, but gradually the other Big 4 accounting firms have increased their market share (Donatella et al., 2019). Today, the Big 4 firms provide auditing services to just over 95% of municipalities (Donatella et al., 2022). In some municipalities and regions, the politically appointed auditors are assisted by personnel from an internal audit office or by a mix of experts from their own internal audit office and a contracted accounting firm (Collin et al., 2017). Even though Sweden has kept the system of politically appointed auditors, the role and position of professional auditors have gradually been clarified in the legislation. In 2000, an official requirement was introduced in the Local Government Act that the [political] auditors shall be assisted by experts [professional auditors] in their inspection and that these experts shall have the insight and experience of local government activities required to be able to carry out their assignment (Prop. 1998/99:66) (see also Backman et al., in this volume). Thus, the practice of these auditors assisting politically appointed auditors was now confirmed in the legislation, but no formal training or certification requirement was introduced. However, the same year SKYREV was formed, a professional body organising and certifying professional local government auditors. The purpose of the certification programme was, of course, to create legitimacy for the members and signal sufficient insight and experience to be hired as experts [professional auditors] by politically appointed auditors in municipalities and regions. Today, there are several kinds of auditors, both authorised auditors and auditors certified by SKYREV.

98  Pernilla Broberg and Torbjörn Tagesson Another novelty at this time, which went beyond what had previously been in line with practice, was that the legislation now also stipulated that the report of the professional auditors should be attached to the formal audit report of the politically elected auditors (Prop. 1998/99:66). A further review of the municipal audit led to a clarification in the Local Government Act (1990:900) that the professional auditors should assist the politically elected auditors to carry out the audit in accordance with GAAS (Prop. 2005/06:55). In this review, the issue of formal requirements for training or certification of professional auditors was discussed, although without any such requirement being introduced (Prop. 2005/06:55). The above-mentioned changes were retained in the new Local Government Act (2017:725) that came into force in 2018. With the new law, the position of the professional auditors was further strengthened, as they were given the right to attend and speak when the auditor’s report is presented to the Municipal council. A further review of the municipal audit led to a clarification in the Local Government Act (1990:900) that the professional auditors should assist the politically elected auditors to carry out the audit in accordance with GAAS (Prop. 2005/06:55). This requirement to follow GAAS took place during the same period as a new auditing standard, Revisionsstandard i Sverige (RS), was introduced for auditing in the private sector. However, at the time, there was no corresponding standard for auditing municipalities and regions. The existing standard was published by SALAR and addressed the politically appointed auditors. As of December 2009, the International Standard on Quality Control (ISQC) 1 was effective. This standard dealt with quality control for firms that perform audits and reviews of financial statements, and other assurance and related service engagements. When the quality controls in accounting firms were carried out in accordance with this standard, accounting firms began to internally question the assignments in municipalities and regions. When Swedish accounting firms began to fully apply ISA in 2012, proposals were made that these standards, in general, could also be applied in the local government sector (Pettersson, 2012). According to Anders Haglund (member of SKYREV’s fair practices committee), ISA would in some respects imply a tightening compared to previous practice but overall, a codification and a clarification of how the accounting firms already worked (ibid.). SKYREV undertook the task of producing a guide for how ISA would be applied in the municipal sector. In 2014, a draft was presented and published (SKYREV, 2014). However, no final version of the standard has been published. In 2017, the Big 4 accounting firms started to apply ISA 580 in the audit assignments for municipalities and regions, but several CFOs protested and refused to sign (see Ömossa & Gustavsson, 2017). Several representatives of the municipalities and regions turned to SALAR to complain and get advice. Later that year, SALAR, FAR, and SKYREV called for a roundtable meeting to discuss the conditions and need for a standard for financial

Adoption of professional audit standards in the public sector 99 audits in the local government sector. A joint working group was formed with the task of developing a standard. Brännström (2018, p. 85) describes this event as ‘really being a positive breakthrough’ towards a clarified good auditing practice. While the work is in progress, SIA conducts a thematic inspection regarding the accounting firm’s role in the local governments audit. SIA concludes, among other things, that in situations when the accounting firms are hired as expert assistants [professional auditors], the assignments constitute auditing activities (SIA, 2020). In 2021, SIA for the first time gave an auditor a warning about shortcomings in connection with auditing activities in a municipality. That year, the working group presented a first draft of a standard for financial audits in the local government sector. The draft was circulated for consultation. About 17 consultation opinions were received within the framework of the consultation period, which ended by 15 October 2021. The course of events is summarised in Table 5.1, where important and decisive events throughout the process of developing a standard for municipal auditing of financial reporting standards are presented chronologically in a timeline. Understanding actors and actions throughout the process

In the section Course of events, we focus on the different events – what happened, when did it happen, and what actors were involved? In this section, we focus on gaining further understanding of the key actors and their actions throughout the process. Here we use the theoretical model based on Hussein (1981, p. 29) and Greenwood et al. (2002, p. 54) as a starting point. I – Triggers and partial precipitating jolts

It was not an individual jolt that triggered the change, but rather a series of different jolts that together led to the change. The various jolts had different impacts on the organisations involved in the change process. However, the jolt that laid the foundation for the interdependence between FAR and SALAR, was SALAR’s sale of KOMREV to PWC in 1996. Subsequent changes in the legislation created incentives for professional auditors, who were not authorised auditors, to form SKYREV. As several authorised auditors also chose to certify themselves via SKYREV, a dependency was also created between these two organisations. Further changes in the legislation as well as stricter quality and monitoring requirements for authorised auditors and accounting firms created institutional pressure on both FAR and SKYREV to change their approach to the members’ assignments as professional auditors in municipalities. Some interviewees reported that the quality of the municipal audit of financial reporting has been very low, and the main reason for this is that the allocated budgets for these engagements are

100  Pernilla Broberg and Torbjörn Tagesson much too small, the prices are too low, and the competition is not strong enough. … of course, the quality is affected […] you started to feel uncomfortable regarding this … that we cannot continue with this … [the quality] must be raised […] the alternative is to step out [of these engagements] … (Interviewee A) … what we do [in terms of municipal auditing] generally maintains an acceptable level […] but the quality systems have not included this municipal stuff … there it has slipped a bit … there it has been a step down from the usual ISA audit that is set under [the supervision of] SIA. (Interviewee B) The interviewees explained that the increased interest and attention from SIA – manifested in the thematic supervision – as well as the quality-assurance systems at the (large) private accounting firms have probably triggered and accelerated the process of developing a standard for municipal auditing of financial reporting. The increased interest by SIA as well as the thought requirements of ISQC1 (now: ISQM1) is also highlighted as a reason why some interviewees believe that the new standard will have, at least some, explicit effect – ‘because SIA has woken up, we’re starting it in full now’ (interviewee B). II – Deinstitutionalisation and the process of knowledge and awareness

[The municipal auditing of financial reporting] has left a lot to be desired … it has been a bit so and so with how it works … in many places it works really well … in some places it does not work at all … the big problem is that major inaccuracies are let through in some places … … we have let elephants through the system … year after year … without anyone reacting or acting … so as not to annoy political managers and incumbents … there we have the big problems … (Interviewee A) Around the turn of the millennium, an intense debate about the municipal audit began – ‘… there has been general criticism of municipal auditing from various quarters’ (Interviewee D). Criticism of the current system came from both academia (e.g. Lundin, 1999) and representatives of the Swedish National Audit Office (Cassel, 2000). This debate has continued (Brännström, 2018; Eriksson & Tagesson, 2015, 2018; Lundin, 2010; Nyman et al., 2007; Pettersson, 2012; Thomasson, 2016, 2018) in parallel with the occurrence of various partial jolts. The interviewees represent different points of view in the debate. Some interviewees strongly suggest that the politically appointed auditors should be removed from the auditing of financial reporting; that their involvement in this part of the audit is not credible and it does not contribute to building trust. Rather it is ‘an outdated system that we cling to’ using

Adoption of professional audit standards in the public sector 101 historical arguments that are no longer valid (e.g. Interviewee A). Among the reasons for low accounting and auditing quality and for continuing to let ‘elephants through the system … year after year … without anyone reacting or acting …’ (Interviewee A), the interviewees mention a reluctance to annoy political managers and incumbents, lack of knowledge and understanding of accounting and how municipalities differ from companies, as well as a lack of consequences for wrongdoing – ‘if there are no consequences then there is no motivation to do right […] in the absence of consequences, one can allow oneself to have ignorance and reluctance’ (interviewee G). Other interviewees are not as critical of how the accounting and auditing work, and they do not consider quality issues as the primary driving force for change. Still, they recognise how the increasingly widespread criticism and attention directed towards the quality of municipal financial reporting and auditing causes concerns. The main worry is that one may eventually end up in an undesirable situation with a lack of professional auditors available to assist the politically appointed auditors – both due to an unwillingness to engage in audit work that does not meet the quality control requirements set by the audit profession and due to a lack of competence: [T]here must be an available experience-based [expertise] who knows this sector. (Interviewee E) … already today it is the case that when we hire accounting firms … it is important to find firms with staff who have experience and knowledge of municipal auditing … otherwise you won’t get as good an audit at all. even today there is a difference between an auditor and an audiI … (Interviewee F) An implemented standard is seen as a way of creating legitimacy and making the assignment to assist politically appointed auditors attractive enough to ensure expertise in the future. III – Preinstitutionalisation: Formation of attitudes

An important partial jolt that triggered different forms of institutional pressure on the organisations involved was that the accounting firms in Sweden began to apply ISA in 2012. Based on ISA, SKYREV began to develop standards adapted to the Swedish municipal sector. This resulted in a proposal published in 2014. Our interpretation is that SKYREV acted mimetically to create legitimacy for its members. The auditors who worked in Big 4 accounting firms felt normative pressure to apply the international auditing standards to assignments in the municipal sector. However, the change took place gradually, and it was only in 2017 when ISA 580 began to be applied as the issue really came up on SALAR’s agenda. When most of the professional auditors came from the Big 4 accounting firms, the municipal sector

102  Pernilla Broberg and Torbjörn Tagesson and SALAR experienced coercive pressure to consider requirements and conditions set by the authorised auditors. In a potential situation where the big accounting firms would not accept assignments in the municipal sector, an acute shortage of professional auditors, who assist the politically elected auditors, would arise: [We] noticed that there was uncertainty among the accounting firms … can be exposed to this … how do I know that I am doing an audit that is sufficient … that was also input factor … we want our elected representatives to have good experts and they can be found at these firms. […] We want a professional audit … saw a risk of them [the professional auditors] leaving this industry… (Interviewee H) … a flag that was raised … if it continues like this from now on we don’t want to take this risk … doesn’t matter what the price is … if the reputation is at stake … (Interviewee C) For all parties involved, an insight had emerged that ISA was not directly applicable to the Swedish municipal sector. What the professional auditors recognise and are used to was considered an important starting point and ‘strength for the profession’ (Interviewee D), but at the same time this was not enough: … a lot of ISA works … why then create something completely new when there is already an established and good standard … [we need to] look through all the ISAs and see where the problems are … there are some things that need to be adjusted … (Interviewee H) This insight, the interdependence between different types of audits, and the fact that staff exchanges took place in certain key positions, facilitated the possibility of taking the step to a theorisation process and a collective decision-making based on implicit bargaining and exchange in order to reach a compromise solution. In the debate between the predecessors, that took place in the deinstitutionalisation process, the positions were far apart. By now, many actors agreed to discuss and debate, to have a dialogue and in this dialogue, it seems as if ‘FAR, SKRYEV and SALAR found each other in some way’ and that the actors started ‘speaking the same language–’ (Interviewee I). IV – Theorisation: Implicit bargaining (legitimation)

The preceding phases led to a first specification of the problem – a standard is lacking, and a standard is needed. The following phase had this problem as its point of departure and the round table discussions with SALAR, FAR,

Adoption of professional audit standards in the public sector 103 and SKYREV in 2017 – aimed at leading to a standard for auditing financial reporting – initiated a theorisation process. … what was agreed upon then was that a standard should be drawn up to avoid criticism. (Interviewee D) The initiative for the discussions was taken jointly by several actors – ‘it felt a lot like it was in consensus’ (Interviewee C). Representatives of these actors formed a working group with those they considered as being most affected by the issue(s) that was up for discussion: It is important to have the right people … we tried to gather the most competent auditors at the accounting firms … who know both ISA and what is specific about municipalities … (Interviewee H) The working group aimed at being sufficiently wide but still not too large. To have a chance to succeed and bring about change, the members of the group were aware of the importance of taking input from actors not represented in the group. In the interviews, they also mention that it was important with a process characterised by ‘acceptance, understanding, anchoring’ and ‘ongoing reconciliations with different parties [other actors]’ (Interviewee C) were needed. Thus, in the theorisation phase we identify elements of justification, a collective decision-making process and communication. The working group proceeded to develop a draft of a common standard for municipal auditing of financial reporting. SIA’s thematic inspection, decisive stance regarding auditing activities, and warning for shortcomings in connection with auditing activities in a municipality during the years that followed (2019–2021) accelerated and emphasised the importance of a common standard and thus could be seen as partial jolts that took place relatively late in the process. These jolts did not trigger change in direction or new elements in the process but rather functioned as increased pressure that accelerated the already ongoing process. As part of the process, in 2021, the working group presented a draft for a standard for financial audits in the local government sector that was circulated for consultation. They received 17 consultation opinions from different actors – e.g. accounting firms, various stakeholder organisations, SIA, and different municipalities and regions The opinions received were analysed by the working group, and some adjustments were made. Such adjustments could both be seen as improving the standard and as part of justifying the standard (the ‘innovation’) as a solution. Some opinions received showed a situation where different interests are at odds. Thus, the working group had to find a solution through compromise in those parts of the standard where different interests stand against each other.

104  Pernilla Broberg and Torbjörn Tagesson The innovation, e.g. a standard for municipal auditing of financial reporting, was adopted in the summer of 2022 (e.g. Hadjipetri Glantz, 2022). The final subprocess, diffusion (i.e. step V according to the theoretical model), is planned and expected to take place in 2023, when the standard takes effect. Conclusions and implications The main contribution of this chapter is (1) an empirical description and explanation of a process where general auditing standards were tailored for a specific setting (municipal auditing in Sweden), and (2) theoretical additions to models that explain institutional change – including both parallel partial jolts and their respective impacts as well as the different ‘timing’ in the initial stages for different actors. These contributions are further discussed below. Our theoretical framework, based on Hussein (1981) and Greenwood et al. (2002), assumes a single event, due to an identified performance gap or precipitating jolt, as a driver for transition. Furthermore, the model assumed that the different stages of institutional change follow a sequential order where one stage leads to another. However, theories are simplifying abstractions of reality, and the process of developing a standard for municipal auditing of financial reporting is a much more complex process than in theory. For example, in the case discussed and analysed in this chapter, it is not possible to derive an individual precipitating event that triggered the change, but rather a series of partial jolts (events) that together led to the innovation process, which in turn led to the proposed standard for financial audits in the local government sector. Some of the partial jolts were interrelated, whereas others were more disconnected from each other. Some of the partial jolts were important in the initiation of the process while others played a crucial role in the later stages of the innovation process. Hence, a series of seemingly more or less unrelated partial jolts may together constitute an innovation process that involves the whole organisational field and leads to change in regulation and practice (cf. DiMaggio & Powell, 1983). The partial jolts that enter late in the process seem to influence the speed rather than the direction of the innovation and the process can continue in the direction it is already going, just at a higher speed. Partial jolts that to a greater extent entail changed conditions, or a changed current direction ought to lead to a process that at least partially must be redone from previous steps. Furthermore, our analysis shows that for the actors involved, the initial stages of the innovation process differed in time and pace. However, only when all the actors had gone through the de- and preinstitutionalisation stages could theorisation take off. Crucial for the various actors to finally reach this common phase was that all actors, albeit in different ways, experienced institutional pressure during their respective preinstitutionalisation stages. Hence, based on the empirical findings in this chapter, we suggest an adjusted theoretical model (Figure 5.2) where the first stage of the innovation

Adoption of professional audit standards in the public sector 105

I. Partial jolts

I. Partial jolts

I. Partial jolts

II. Deinstitutionalisation and the process of knowledge and awareness III. Preinstitutionalisation: Formation of attitudes

V. Diffusion: Outcome

IV. Theorisation: Implicit bargaining (legitimation)

I. Partial jolts

Figure 5.2  Empirically adjusted model of institutional change.

process in the theoretical model, (i) Precipitating jolt, as a trigger of an experienced performance gap, is replaced by several, sometimes interrelated, partial jolts. These partial jolts do not necessarily affect the initiation of the innovation process but can also have decisive meanings in later stages of the institutional change. The second and third stages of the model – (ii) Deinstitutionalisation and the process of knowledge and awareness, and (iii) Preinstitutionalisation – formation of attitudes – are not sequential but overlapping. However, in line with the initial theoretical framework, the fourth stage, (iv) Theorisation, starts at the same time for all actors involved in the innovation process leading to institutional change. Although the process of institutional change began much earlier, SKYREV initially played an important role in the Deinstitutionalisation stage as institutional entrepreneurs. However, it was only when more powerful actors, in the form of FAR and SALAR, both chose to seriously engage in the innovation process that the Theorisation stage could begin. It was in part different partial jolts that made the various actors feel institutional pressure to get involved in the change process. These partial jolts also occurred at different times, which meant that the stages up to the Theorisation stage were partially overlapping and not completely parallel for the

106  Pernilla Broberg and Torbjörn Tagesson different actors. Besides, the nature of the institutional pressure also varied across actors – while the pressures experienced by SALAR can be considered cohesive due to resource dependency (the need to ensure that there are a sufficient number of professional auditors experienced enough to be able to assist the politically appointed auditors), the pressure experienced by SKYREV was more mimetic in nature, as it was based on maintaining legitimacy. The institutional pressure experienced by the private accounting firms was initially normative but later became cohesive, after the involvement of and attention from SIA. In addition to the fact that interpersonal relations contributed to the achievement of a compromise and a common position during the theorisation, additional partial jolts initiated by SIA, possibly facilitated and accelerated the process as it reinforced the understanding of interdependence between the actors involved. However, the theorisation is not the end of the institutional change process. Ultimately, legitimacy and acceptance must be achieved in a wider circle of stakeholders for change to take place. Previous research shows that organisations and their agents may respond in a variety of ways to normative and regulatory standards – ranging from passive conformity, compromise, and avoidance to defiance and proactive manipulation (Falkman & Tagesson, 2008; Oliver, 1991). The diffusion and outcome of this process are, however, too early to study, but are something that future studies may describe and analyse. This chapter is limited to descriptions, explanations, and experiences of the interviewees. In the chapter, they represent the organisations that are the main (actual) actors throughout the change process; some interviewees also represent more than one actor. Thus, there could be aspects that we do not capture as well as aspects that we amplify (and perhaps even exaggerate). However, the consistency in the interviewees’ answers and in other empirical evidence means that we see this risk as minimal. This chapter is also limited to a time period where the studied innovation (the standards developed) has not yet started to be applied (at least not officially). The implementation phase remains to be studied and therefore, we cannot know if, for example, any additional jolts will emerge later in the process. References Brännström, D. (2018). Mitt liv som FAR [My life as FAR]. Göteborg: Bokförlaget BAS. Cassel, F. (2000). Behovet av Kommunal Externrevision [The need for external municipal audit]. Stockholm: SNS. Collin, S.-O., Haraldsson, M., Tagesson, T., & Blank, V. (2017). Explaining municipal audit cost in Sweden: Reconsidering the political environment, the municipal organization and the audit market. Financial Accountability & Management, 33(4), 391–405. Curtis, E., Humphrey, C., & Turley, S. (2016). Standards of innovation in auditing. Auditing: A Journal of Practice and Theory, 35(3), 75–98.

Adoption of professional audit standards in the public sector 107 DiMaggio, P.J., & Powell, W.W. (1983). The iron cage revisited: Institutional isomorphism and collective rationality in organizational fields. American Sociological Review, 48, 147–160. Donatella, P., Haraldsson, M., & Tagesson, T. (2019). Do audit firm and audit costs/ fees influence earnings management in Swedish municipalities? International Review of Administrative Sciences, 85(49), 673–691. Donatella, P., Haraldsson, M., & Tagesson, T. (2022). Reporting on COVID-19—or not? Annual report disclosure of the pandemic as a subsequent event. Journal of Public Budgeting, Accounting & Financial Management, 34(6), 117–136. Eriksson, O., & Tagesson, T. (2015). Kan man lita på den kommunala redovisningen? [Can the municipal reporting be trusted?]. Kommunal Ekonomi, (2), 8. Eriksson, O., & Tagesson, T. (2018). Partierna ser inte problemen med kommunala revisionen [The Political Parties Cannot See the Problem with the Municipal Audit]. Replik DN Debatt. https://www.dn.se/debatt/repliker/partierna-ser-inte-problemenmed-kommunala-revisionen/ [10/02/2021] Falkman, P., & Tagesson, T. (2008). Accrual accounting does not necessarily mean accrual accounting: Factors that counteract compliance with accounting standards in Swedish municipal accounting. Scandinavian Journal of Management, 24(3), 271–283. Greenwood, R., Suddaby, R., & Hinings, C.R. (2002). Theorizing change: The role of professional associations in the transformation of institutional fields. The Academy of Management Journal, 4(1), 58–80. Hadjipetri Glantz, S. (2022). Ny Standard en milstolpe [A new standard, a milestone]. Balans, (4), 8. Haglund, A. (2021). Förtroendevalda revisorer ska hålla sig borta från finansiell revision [Political auditors must stay away from financial auditing]. Dagens Samhälle, (6), 10. Hussein, M.E. (1981). The innovative process in financial accounting standard setting. Accounting, Organizations and Society, 6(1), 27–37. Lundin, O. (1999). Kommunal revision: En rättslig analys [Municipal Audit: A Legal Analysis]. Uppsala: Uppsala University. (PhD thesis). Lundin, O. (2010). Revisionen reviderad: en rapport om en kommunal angelägenhet [The Audit Revised: A Report on a Municipal Matter], Rapport 2010:6. Stockholm: Regeringskansliet. Malmström, E. (2021). An Audit is an Audit, Stockholm: Stockholm University. (PhD thesis). Meyer, A.D. (1982). Adapting to environmental jolts. Administrative Science Quarterly, 27, 515–537. Meyer, A.D., Brooks, G.R., & Goes, J.B. (1990). Environmental jolts and industry revolutions: Organizational responses to discontinuous change. Strategic Management Journal, 11, 93–110. Nyman, C., Nilsson, F., & Rapp, B. (2007). Ansvarsprövning med förhinder [Liability assessment with obstacles]. Kommunal Ekonomi Och Politik, 11(2), 29–46. Oliver, C. (1991). Strategic response to institutional processes. Academy of Management Review, 16(1), 145–179. Ömossa, A., & Gustavsson, N.-E. (2017). Vem har ansvaret för årsredovisningen? [Who is responsible for the annual report?]. Kommunal Ekonomi, (2), 8. Pettersson, T. (2012). ISA lyfter revisionen [ISA makes the audit better]. Kommunal Ekonomi, (2), 8.

108  Pernilla Broberg and Torbjörn Tagesson Pettersson, T. (2020). Revisorsinspektionen granskar sakkunniga revisorer [SIA examines expert auditors]. Kommunal Ekonomi, (6), 4. Prop. 1998/99:66 En stärkt kommunal revision [A Strengthened Municipal Audit]. Prop. 2005/06:55 Stärkt revision och ansvarsprövning i kommuner och landsting [Strengthened audit and Liability Assessment in Municipalities and Regions] SIA [Revisorsinspektionen] (2020). Tematillsyn: Revisionsbolagens medverkan i den kommunala revisionen [Theme Supervision: Audit firms’ Participation in the Municipal Audit]. Dnr 2020-50. https://www.revisorsinspektionen.se/globalassets/ webbplatsen/publicerat/rapport-tematillsyn-kommunal-revision_2020-01-10.pdf [10/02/2021]. SKYREV (2014). Vägledning för räkenskapsrevison i kommuner och landsting [Guidelines for Financial Audits in Municipalities and Regions]. Tagesson, T., & Brunström, P.-Å. (2022), Local government auditing in Sweden. In Ferry, L. and Ruggiero, P. (Eds.), Auditing practices in local governments: An international comparison (Emerald Studies in Public Service Accounting and Accountability). Bingley: Emerald Publishing Limited, 131–137. https://doi. org/10.1108/978-1-80117-085-720221014 Tagesson, T., & Eriksson, O. (2011). What do auditors do?—Obviously, they do not scrutinize the accounting and reporting. Financial Accountability & Management, 27(3), 272–285. Tagesson, T., Glinatsi, N.A., & Prahl, M. (2015). Procurement of audit services in the municipal sector: The impact of competition. Public Money & Management, 35(4), 273–280. The Local Government Act no. 1990:900 [Kommunallag (1990:900)]. The Local Government Act no. 2017:725 [Kommunallag (2017:725)]. Thomasson, A. (2016). Vänskapskorruption ett problem också i kommuner [Friendship Corruption is Also a Problem in Municipalities], DN Debatt [2016-08-27]. Thomasson, A. (2018). Politicisation of the audit process: The case of politically affiliated auditors in Swedish local governments. Financial Accountability & Management, 34(4), 380–391.

Appendix: Research design To gain an understanding of how change within auditing is initiated and formed through collaboration and negotiation among actors within and outside the audit profession, we used empirical data based on documents and interviews; we interviewed eight individuals within and outside the profession. The documents consist of texts written at different stages of the development of the municipal auditing standard. This includes early and current drafts of the standard, reports related to municipal auditing issued by SIA, consultation responses (17 documents), and topical debate articles from Balans (a professional journal for auditors and other members of FAR) and Kommunal Ekonomi (the main Swedish journal about local government economy). The documents were analysed before we conducted the interviews in order to identify important actors to interview and also to understand the level of commitment, the attitude, and the stance of the various actors regarding a standard for municipal auditing of financial reporting in general and regarding the proposed standard specifically.

Adoption of professional audit standards in the public sector 109 Table 5.2  Interviewees. Interviewee

Role, background, affiliation

A

Politically appointed auditor (certified), former professional auditor (authorised auditor) Big 4 Professional auditor (authorised auditor, certified) Big 4, FAR Professional auditor (authorised auditor) Big 4, FAR Professional auditor (certified), Big 4, SKYREV Professional auditor (certified), audit office, SKYREV Politically appointed auditor, SKR Former professional auditor Big 4, former representative of a professional association Professional representative employer organisation, SALAR Representative audit oversight

B C D E F G H I

The interviewees (see Table 5.2) included auditors with experience in municipal auditing as well as representatives of the different organisations (SALAR, FAR, and SKYREV) involved in developing the Swedish standard for municipal auditing of financial reporting. Besides these Interviewees, we interviewed representatives of the entities being audited and one representative of SIA. We conducted semi-structured interviews based on the questions presented in Table 5.3. The interviews lasted between 60 and 90 minutes. We conducted a content analysis of all the accumulated empirical data. The framework (stages 1–4) was used as an analysis model based on which we could plot, sort, and begin to understand different events and the involvement and actions of actors (at the time of the study, there was no completely finished or implemented standard and therefore we have no empirical data regarding stage 5, which therefore could not be included in the analysis). Throughout the analysis, we mainly focused on (i) producing a timeline of Table 5.3  Interview guide. Questions What is your experience with municipal auditing? How does the municipal financial audit work today? What (if any) changes would you like to see regarding auditing within the municipal sector? Why do you think the development of a proposal for a standard has started now? What and who initiated the development and were there any specific triggers or events that were particularly important? Was it self-evident to base the standard on ISA? Are there any particular strengths/weaknesses in the current draft that you want to highlight? What were the biggest challenges in creating the draft? What are the biggest challenges identified after the consultation round? What will the challenges be in implementing the standard?

110  Pernilla Broberg and Torbjörn Tagesson important and decisive events (what happened and when did it happen?), (ii) understanding who the key actors are (who were involved?), and (iii) the actors’ backgrounds and starting points, as well as their actions throughout the process (how and why did it happen?). In the analysis, we also gained an understanding of how the process and different actors have affected the content and formulations of the new standard (but this is more secondary and uncertain, as no final version of the standard yet exists).

Part II

Digitalisation

6

On the structures of judgement in auditing Thomas Carrington and Bino Catasús

Introduction Currently, the auditing industry is facing issues related to four types of change drivers that deeply affect the relationship between structure and judgement in the profession.1 One of these drivers is the effect of the audit explosion (Power, 1997). The audit explosion and audit society argument (initiated by Michael Power some 25 years ago) holds that, in the interplay between the regulatory expansion and the age of measurability, auditing became the answer and the problem to handle an expansion of risks. This ‘riskification’ of organisations (Power, 2022) worked as a way to expand the audit realm to include issues such as social audits, environmental audits, quality audits, and the like. In addition, when financial accounting standards (further) mobilised theories of financial economics, auditing practices became more enmeshed in market valuations. Today, when we see increased regulatory interest in climate change and ‘taxonomy regulation’ (EU 2020/852) demands a more fine-grained report on environmental performance, auditing has yet again to move into uncharted territories and handle new complexities. The other main type of driver affecting the profession is a bundle of demands all coming together in a processualisation of the audit profession. Processualisation is the increasing push on the profession to follow particular processes to achieve an audit. Although, again, processualisation is not a new aspect of the audit industry, it seems as if the demands of instigating and following a due process are increasing. Typically, these demands emanate from both external stakeholders, such as international standard setters and parliaments, as well as from within the firm, in firm-specific controls and imperatives of the auditor handling particular issues (checklists) in a particular way (work programmes). The imperative guiding this driver is the societal ambition to mitigate the risk of making mistakes (which may increase with digitalisation) and could be considered an effect of the risk management of everything (Power, 2022). Concurrent with technological innovation and the processualisation in audit practice, some researchers point to a regulatory juridification [Verrechtlichung] of auditing (Kohler et al., 2021). These drivers of transition are DOI: 10.4324/9781003411390-8

114  Thomas Carrington and Bino Catasús also fuelled by litigation risks in terms of the financial and reputational risks that are part of juridical attention (Church et al., 2020). Critics argue that lawsuits, legislation, and increased public oversight and governance by bodies such as the PCAOB have made the audit more defensive. These trends, as critics describe them, amplify the way regulatory advances drive audit change: Judgement has to give way to increased structure. As Francis (1994, p. 261) puts it: The drift towards increasing formal structure reflects the need to produce a discourse that can stand up to the court’s gaze. In this respect, all the institutional incentives are on the side of structure and audits may even become more focused on the production of working papers than on the ‘doing’ of an audit. The fourth driver is digitalisation through IT-technology. Although technology as such has been a key driver for the profession since the advent of auditing practices, and IT-technology for well over half a century, it is probably fair to suggest that the potentialities of big data analysis (BDA) and artificial intelligence (AI) are digital technologies that may be considered as paradigmatic change drivers. In recent years, digitalisation has pushed auditing, like many other industries, towards automatisation by digitalisation (and its offspring, like Enterprise Resource Planning, BDA, and AI). Many argue that digitalisation has and will affect the auditing profession through a change in audit practice. In 2016, Deloitte Chief Executive Officer Cathy Engelbert argued that: ‘[i]n the next five or six years I think that the accounting and auditing profession will change more than it has in the last 30 [years]’ (Cohen, 2016). In 2017, Hood (2017) reported that the accounting profession invested up to $5 billion a year in new technologies. The argument for these investments can be summed up by the claims made by a provider of digital solutions in a journal for practitioners: ‘The real solution is to start using technology more to assist auditors and to conduct auditing in real time, not after the event.’2 Certainly, these drivers of transition interact, and we can imagine that increased regulatory pressure leads to increased processualisation, which in turn leads to digitalisation and automatisation which enable the expanding realms of auditing, bringing with it a need for new ways to understand enterprise risk in an increasingly litigious setting. An obvious critique of such a linear view is that we can imagine another, yet equal, narrative. However, this chapter does not attend to which of these drivers is the ‘earth mother’ affecting the audit profession. Instead, our argument is that these drivers affect the perception of an ever-increasing move towards structure in the audit profession. Although the audit profession and industry have been deemed to have been late in terms of investing in technology, researchers seem to contend that auditing has been and will be affected by technological change (Carpenter & Dirsmith, 1993; Power, 1992; Salijeni et al., 2019, 2021). Technology,

On the structures of judgement in auditing 115 here, is seen as the structures by which auditors form their practices. Again, structures have been ever-present (Dewey, 1900; Will, 1974), complementing audit judgement. Not least as computers became affordances in calculation technology, they became obligatory points of passage in, for example, practising statistical methods for sampling in audit practice (Power, 1992). Later advances in computer technology streamlined documentation and the ability to analyse large data sets (Salijeni et al., 2021), and checklists becoming the preferred way to handle the increasing number and effects of risks arguably makes the audit profession more dependent on technologies as solutions. The dream to let structures solve these challenges taps into one of the recurring debates in auditing, namely the relationship between structure and professional judgement in auditing practice. Consequently, the aim of this chapter is to contribute to this debate by analysing the effect of the drivers of transition on what in audit research is often discussed as audit structure. The ambition is to nuance the dichotomy between structure and judgement and to formulate expectations on how different forms of structure can affect audit judgement. In this sense, this is a text on the structures of judgement in auditing. Motivation Today you can train a monkey to be an auditor There is ample evidence of increasing dependency on structures (of all sorts) in audit practice. However, the literature has taken these empirical findings as an ostensive link, suggesting that the only possible effect of increased structure is the de-professionalisation of practice. Following this line of thought, critics have argued that, in order to ‘make auditing great again’, the profession needs to invest in innovations, or else there is a risk that structure will dominate over judgement and, as a result, maybe eliminate the profession (e.g. Catasús et al., 2013). However, a counterargument to this approach can be formulated: Is it possible to imagine auditing totally relying on professional judgement? That is, at the proverbial dawn of auditing, can we think of an audit engagement where no standards, no external regulation, and no technology affected the practice? Maybe so, and therefore, arguably, ‘in the beginning of time’ there was only judgement and no structure. Even if this is a valid, albeit naïve, starting point, it still begs the question of whether the ‘first audit’ was the ideal audit? The success of auditing (in terms of its volume and centrality in society) rests on an increased interest in structure, and maybe the audit explosion started as a formalised audit model that first appeared at the beginning of the 1980s (e.g. the standard on audit sampling that was published by American Institute of Certified Public Accountants [AICPA] in 1981)? Although it is probably impossible (and surely meaningless) to empirically speak of a ‘birthday’ of structure in audit practice, it is nevertheless not without empirical support to suggest that structures (such as standards, checklists, legal

116  Thomas Carrington and Bino Catasús frameworks, and the like) have become more central for auditing practice over the last few decades. The question following this empirical proposition is whether the trend is solely problematic? One answer to the question would be yes, as exemplified by one of the main observations in Power’s (1997) influential book on the audit society, which is that failed auditing never seems to lead to less auditing, always more. And here, ‘more’ implies added structures such as protocols, checklists, models, standards, controls, etc. This processualisation of audit may be seen as a way to decrease the possibility of professional judgement, thereby both dullifying practice and lowering the ambition. In fact, this argument rests on the idea that an increased level of structures leads to less need for judgement, which builds on a proposition that the sum of all audit activities is equal, that is, that increased structure automatically leads to less judgement and vice versa. On the other hand, a contrary analysis is also possible: Structure is the effect of a profession that is learning to achieve better audits through less judgement. It is also quite possible that structure could free up resources and provide the foundation for more judgement and ‘more auditing’ in total. The arguments for the structuration of the industry through automatisation are that there will be more availability for the auditors to carry out high-quality audits, in real time with better quality. In addition, firms can lower the headcount and save costs, not least on junior resources. To mitigate the curse of this success, commercial pressure promises that auditors may take on more important roles with corresponding compensation (Wang, 2019). Hence, to understand the effect of the drivers introduced in the previous section on the transition of auditing from a less- to a more-structured practice, we are justified in looking broadly at how the transition has changed audit structure, to look for nuance and differences in form in variations of structure in auditing and investigate what effect this structure(s) has on audit judgement. With this endeavour in mind, we first review literature by focusing on the interplay between structure and judgement. We then present the different forms of audit structure we have observed when interviewing auditors, by means of examples drawn from a large pool of interviews. These examples are meant to be neither exhaustive nor necessarily representative of anything other than nuances in what often is discussed as mere structure (singular). Although this chapter primarily has a theoretical ambition, the ways in which we can nuance the idea of structure are illustrated by two sources of empirics: (i) from earlier literature, and (ii) from interviews with auditors. We end the chapter with a discussion of what conclusions can be drawn from our findings and what their implications might be. Literature review If auditing is something like ‘a systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions

On the structures of judgement in auditing 117 and established criteria and communicating the results to interested users’ (Silvoso, 1972, p. 18), then auditing is, just like any research activity (Power, 1994), built around pre-established structures guiding the methods of auditing. Although the understanding of auditing as a practice relying on alreadyestablished structures has deep roots, the academic debate did not start before it was highlighted that the pros of structures may indeed have adverse effects on audit quality. The underpinning argument was that audit quality may be negatively affected by: (i) poor structures, and (ii) the amount of judgement that the professional auditor can exert. A reasonable starting point for a literature review is, therefore, the academic debate during the 1980s. With the advent of information technology (now framed as digitalisation), the (potential) effects of structuring were discussed at length (Cushing & Loebbecke, 1986; Dirsmith & McAllister, 1982; Kinney, 1986; Morris & Nichols, 1988). Early studies gathered empirical evidence showing that audit structure can influence audit judgement (e.g. Morris & Nichols, 1988) but also that while ‘[g]reater structure has the advantage of producing visible, consistent, and verifiable evidence, yet it reduces room for individual judgement and autonomy’ (Kohler et al., 2021, p. 1; cf. also Power, 2003). One of the advantages of a more structured audit is that it leads to a more consistent treatment of exceptions to compliance with accounting principles (Morris & Nichols, 1988). Williams and Dirsmith (1988) also show that structure can lead to audit firms being timely in their release of client financial statement disclosures. Structure is hence defined in terms of the degree to which auditor judgement is replaced by structured quantitative algorithms (Sullivan, 1984). In research, this is operationalised by studying the guidance provided by audit practitioners by their firms (Cushing & Loebbecke, 1986) or by the structure of audit methodologies as perceived by auditors in practice (Kinney, 1986; Smith et al., 2001). While much of the early literature focused on efficiency, it was also suggested early on that the structure–judgement distinction could be viewed as an expression of a more fundamental distinction between ‘root metaphors’ of the audit process (Dirsmith & Haskins, 1991). These metaphors are ‘Mechanism’ which ‘names an aspiration for an integrative formal approach to audit that holds out the promise of an algorithmic knowledge base’ (Power, 2003, p. 381) and ‘Organism’ which ‘assumes that the whole is always greater than the parts, and that the specificity of knowledge places limits on the mechanistic world view’ (ibid.). Thus, structure in an auditing setting is the ‘frozen knowledge’ that supports the auditors to solve specific problems according to a specific process. In contrast, judgement is based on knowledge in the making, and the key resource is the skill to pose (other) questions. For Power (2003) this implies that ‘[i]n short, structure is about legitimacy and control, which is not necessarily consistent with better or more efficient auditing’ (Power, 2003, p. 381). With the historical example of statistical sampling, Power (1992) and Carpenter and Dirsmith (1993) demonstrate how the structure introduced in this case aligned audit practice with ideals

118  Thomas Carrington and Bino Catasús of science, sometimes by re-contextualizing already-existing practices (Carpenter & Dirsmith, 1993; Power, 1992, 2003). The introduction of structure, such as statistical sampling, thus modifies the audit profession’s abstract system of knowledge affecting the process of making things auditable (Power, 1997, 2003). ‘Accordingly, statistical sampling in particular, and formal structure in general, are more than simply technical features of audit practice. They are social phenomena’ (Power, 2003, p. 382). For Power (2022), the calculative technologies are not primarily (if at all) vehicles for increased efficiency (in terms of, for example, the relationship between cost and quality). Instead, the structures in auditing should be analysed as the ways in which particular ambitions (formulated elsewhere) penetrate the audit engagement; structures are technologies for power. Other critics also caution against moves towards more structured approaches but mobilise a different argument. Francis (1994) argues that such moves would abandon ‘seasoned judgement’ in the name of efficiency and litigation protection for an algorithmic approach to auditing, i.e. a system of rules, which according to Francis cannot really inform the auditor on what to do. For example, Francis (1994) describes the audit risk model as an empty abstraction and a corruption of the audit judgement process, claiming that it represents a loss of practical reasoning. Francis goes as far as to argue that supplanting judgement with structure leads to a ‘deformity of practical reasoning’ (ibid., cf. also Power, 2003). Thus, clearly, critics such as Francis (1994) see structure and judgement as two sides of a zero-sum game in which increasing structure automatically leads to less judgement. This is seen as a problematic tendency in some parts of the literature. For example, Humphrey et al. (2013) present the current audit practice as a monotonous and an unstimulating practice, and they draw the conclusion that the auditing profession is getting closer to the heat death in which auditing will be alienated from all professional judgement. For Humphrey et al. (2013), such an analysis leads to an imperative: The need for auditing innovation! We label this common idea as the ‘Audit Borg’. The ‘Audit Borg’ builds on the assumption that – in the (far, far) future – we can expect a situation where there is no need for auditors in auditing, i.e. structure is 100% and judgement is nil. Earlier literature implicitly claims that more structure leads to less judgement in the sense that the work that currently is seen as having the character of judgement is being replaced by machines and boxticking (human machines in the terminology of Pentland, 1993). But, as argued in the previous section of this chapter, it is possible and even reasonable to question the hypothesis of an ‘Audit Borg’. Recent empirical studies

Although technologies (as systemised crafts) are not new to auditing practice, the advancement of digital technology and its effects is an issue that has been essential during the last decade and, not long after Francis voiced the fear of

On the structures of judgement in auditing 119 increased structure in the audit process, information and communications technology (ICT) was hailed as the future of auditing. For example, Omoteso et al. (2010) show that investments in ICT and increased structures lead to increased cost-efficiency because auditors would no longer be involved in the mundane part of auditing practice. As a result, Omoteso et al. (2010) argue, ‘ICT adoption is a dominant force in shaping auditors’ roles and outputs’ (p. 147). This, in turn, has affected the ‘shape’ of audit firms in the sense that the traditional pyramid-shaped hierarchy has been given a smaller base (fewer assistants), a fatter waist (more middle management), and a lower overall height (‘flatter’) (ibid.). That is, viewed in 2D space, the change is squashing the triangle-shaped employee seniority distribution into a pentagon. In this pentagon, more senior auditors are expected to rely on automatically generated information (Francis, 1994). Thus, as the role of digital technologies increases, the often hailed ‘experienced eye’ (Carrington & Catasús, 2007) is not backed by the assistant’s ‘learning eye’. Furthermore, moving from the pyramid to the pentagon risks obstructing the move from a ‘learning eye’ to an ‘experienced eye’. Salijeni et al. (2021) show how technology can assist communication of judgement and suggest that visualisation dashboards ‘have properties that afford auditors new opportunities for understanding client operations as well as constructing, justifying and communicating to the client their inferences and recommendations’ (Salijeni et al., 2021, p. 533). And whereas the literature on auditor judgement has largely seen new technologies as decision aids, they suggest that ‘BDA visualisation dashboards [structure] constitute the very arenas where judgements are performed. They carry within them the “mechanisms of reactivity” (Pollock & D’Adderio, 2012, p. 565), as in visually representing clients’ operational realities; they uncover inefficiencies that auditors feel compelled to react to. Further, these visualisation dashboards also provide means to enhance the visibility of audit workflow, thereby making it easier for auditors to convey the narrative of audit quality’ (Salijeni et al., 2021, p. 533). Hence, visualisation dashboards that form part of BDA do not simply visualise or represent, they perform, by shaping both the client reality and audit practice. The ‘mechanisms of reactivity’ (Pollock & D’Adderio, 2012, p. 565) oblige auditors to attend to any visible shortcomings (Salijeni et al., 2021). For many (cf. Krieger et al., 2021; Salijeni et al., 2021), digital technology is structured, but it is structure that supports judgement. Such an approach suggests that the zero-sum game is not relevant. In fact, it resonates with the findings of, for example, Janvrin et al. (2008, p. 3) who suggest that ‘IT use could reduce the time auditors spend performing computational and/ or clerical tasks and improve the quality of audit judgements by structuring audit decision processes.’ Thus, the argument is that increased structure increases the quality of judgement (see also Uman et al., in this volume). Structure, however, is more than digital technology. Or, formulated differently, audit structures existed before BDA and visualisation software. For

120  Thomas Carrington and Bino Catasús example, in order to bolster quality and prevent possible future lawsuits due to faulty or excessively radical interpretation of audit standards, large accounting firms have established a new function that takes on the role of a kind of expert-based control device, the Professional Practice Function (PPF) often from pre-existing internal consulting units (Kohler et al., 2021; Salterio, 1996). The guidance issued by these internal control units in interpretive matters is, if not obligatory, at least strongly encouraged (Kohler et al., 2021). Moreover, the members of these PPFs engaged in so-called ‘centers of IFRS expertise’ are ‘dedicated to mutualizing [i.e. share equally] the treatment of complex interpretive issues’ (Kohler et al., 2021, p. 2). Yet another reason for increased structure is indicated by Kohler et al. (2021). They have interviewed auditors and rely on the structure vs. judgement dichotomy to make sense of the tensions they observe and relay how interviewees describe how normative ambiguity came to increase in step with constant increases in transaction complexity, thus creating a demand for professional judgement (ibid.). They note that ‘[t]he extent of ambiguity may be a source of discomfort for a number of field auditors. In principle, involving the PPF could be an appropriate way for some auditors to increase their level of comfort regarding the acceptability of a given accounting position’ (Kohler et al., 2021, p. 8). Interestingly, they (ibid., p. 19) find that [i]n revisiting the structure-judgement tension in contemporary, increasingly global accounting firms, we found that this tension has changed character over time. While in the 1980s it had to do with the perceived mechanisation of the audit process (Power, 2003), in our data, it is about the locus of IFRS interpretation for audit purposes The tension with regards to structure-judgement found in Kohler et al.’s interviewees is about where in the hierarchy judgement should be allowed to reside, what matters are suitable for general practising auditors to exercise their judgement over, and what matters should be dealt with by specialists at different levels (Kohler et al., 2021). Results Inspired by recent studies that illustrate different forms of structure in auditing, we (non-exhaustively) identify four forms of structure in our interview material, drawing on interviews done with this specific purpose but also drawing from previous interviews where this was not the explicit focus. Procedural structure – e.g. standards and audit guidance

To argue that more audit standards and audit guidance lead to more structure is virtually a self-evident statement. Authoritative statements about procedure do not increase the scope for judgement but rather, ceteris paribus, restrict it.

On the structures of judgement in auditing 121 Mandatory and voluntary standards and other guidance exist to ensure an orderly audit process, not to encourage rough judgement. The question then becomes whether audit standards and guidance have become more prevalent and/or existing standards and guidance have become stricter, i.e. if regulation has moved towards being more rule-based (as opposed to principle-based). The audit research literature seems to point to more and stricter standards (Carcello et al., 2009; Durocher et al., 2016; Power, 1997,). This is exemplified by the Nordic initiative, which later turned into the IAASB project as a standard for the audit of less complex entities (Malmström, 2021). This initiative started after complaints that auditing had become too complex and too highly regulated through the International Standards on Auditing (ISA), a standard that may suit many purposes but not all (ibid.). Another example is found in a study of going-concern opinions in Belgium (Carcello et al., 2009) which found that this was an example of how audit standards are trending in the direction of becoming more rule-based (ibid.). In our interview material, we see the same trends. This includes the accounting firm’s own internal standards and guidance. As one of our respondents phrased it: They try to control more and more by rules and the fact is that I think a lot has happened just in the years I have worked. It was more professional judgement in the beginning. (I) Having an increasing load of standards may be frustrating enough for an auditor who perceives this to be circumscribing their professional judgement. Finding that these global standards and guidelines are difficult to understand can be extra frustrating. I, as signing auditor, who has lived in English-speaking countries for four years in total, I do not understand what it is I should do here. How the hell is my co-worker, who has not worked half as long as I [and does not know English as well as I], going to understand this? (D) While guidance is not universally lamented, some interviewees had difficulty seeing the value in the standards for them. Instead, some saw these internal standards and guidance as having very little to do with audit quality and everything to do with risk management, echoing the observations of Power (1997, 2004) it’s for risk management, it’s not for anything else. (D) In sum, we expect procedural forms of audit structure, ceteris paribus, to have a negative effect on the quantity (but not necessarily quality) of professional judgement. While procedural audit structure may seem similar to mnemonic audit structure (see below), its relationship with auditor judgement is, almost by definition, negative, as every piece of procedural audit

122  Thomas Carrington and Bino Catasús structure that is taken away must be replaced with the auditors’ professional judgement. Analytical structure – e.g. auditing software and BDA

It is rarely contested that audit technology has changed considerably in recent years. This quote, from a senior auditor, who until recently was a partner at a big audit firm and started their career in the late 1990s, is illustrative of how things have changed: When you started at an auditing firm, you did not just work with auditing. You worked a lot with various forms of corporate transactions, buying and selling companies, for clients (D) Not only was there less technology in auditing 20+ years ago but there was also less auditing. Not least because auditors did more consulting work in addition to auditing. Today, auditing is very different, this auditor reflects, and muses on how strange it is that the educational requirements, given this change, have not changed since when they started.3 … the training requirements today look exactly the same as when I became an auditor, but my role as an auditor looks completely different. … I mean network knowledge, data processing, system knowledge, applications and interfaces between these. … given the digitalisation [and price pressure], we try to automate everything in the audit that does not require human involvement. And that does not really lead to us spending less time, but these systems do help us choose the right things to look at. (D) An auditor with about four years of experience from another (large) firm indicated as much when responding to a question about whether there are challenges to using auditing software. This respondent interrupted the question. Exclaiming: ‘yes, YES!’ but they continued, We are far behind … I don’t know how they do it at [the other big accounting firms] and so on, but I think we are far behind. […] But when I started [at the firm], it was right when they [the firm] had started doing … sort of …digital audits, we documented in Excel and when we run [name of accounting software] then we have templates and cut out these accounts and paste them in templates (G) In a highly standardised industry, this is an interesting observation, especially as it has been suggested that auditors should be flexible and employ structured approaches more selectively (Schroeder et al., 1996). Poorly performing firms (auditees) may need less-structured approaches, whereas more structured approaches are a better fit for companies with strong and consistent earnings

On the structures of judgement in auditing 123 (ibid.). Accordingly, the trend is clearly towards more technology, i.e. more structure, in the audit. When we went over to auditing with our new system two years ago – and it was [to no surprise] late with all the bugs a new system has… […] This program exports an income statement and a balance sheet to Excel. And then there also is a tab [in Excel] for each annual report line item. You enter a materiality number, and the certain items can become completely immaterial, and some items becomes material. And there you have to decide – what is the risk? (G) Here, the structure craves judgement because the auditor has to decide on materiality. Thus, one tentative finding is that structure can increase the demand for judgement. Still, it is a particular form of judgement: The system requires me to answer certain questions and I do. But then I can think that some questions are damn strange, that I have better questions that capture it. And, again, auditing is basically about judgement so if I put ten authorised public auditors in a room and ask a question, you will get ten different answers. It is basically a professional judgement. (G) In this auditor’s view, auditing is about professional judgement, and if you do not agree with the system (structure), then you have to do additional work. As such structure does not replace judgement. Instead, it complements judgement: Yes, but of course we will work based on the system. But then we can have better questions. (G) This quote underlines the previous point that, to this auditor, structure is an addition to the audit, which, as mentioned above, does not mean that it is always unproblematic, especially in the cases when the questions are perceived to be ‘damn strange’. If you don’t understand the questions or do not think the added structure adds anything apart from more work to what you are doing, then what is the point? From an audit-quality perspective, this is only truly a problem if these audit steps that are perceived to be irrelevant crowd-out audit procedures that would make the auditor more confident in and comfortable with their judgement. Although this auditor may have been frustrated with the system, they found time to do an audit they were comfortable with. Having said that, there were moments where the auditor saw certain parts of the structure as a complete waste of time: In the old [archiving] system you would put the risks and so on. The system then generated a long list of things to do but … *I had no idea how to put those things in* [Whispering]. It was really just a clicking exercise so you could close the file. (G)

124  Thomas Carrington and Bino Catasús This begs the question of how the auditors use their analytical structure (software, etc.). Asked a direct question of whether they use their software to form an opinion – given that they state that while they use the system, they ‘can have better questions’ – the auditor answered: Yes, to some extent, but it is often slow and has bugs (G) This is an issue that came up during the interviews (and that we recognise from our own experience), namely that digital technologies often promise a solution to a professional problem that turns into a technical problem (e.g. bugs, being slow, ‘can’t reach the system’). Although the auditor perceives that, in theory, the processualisation of audit can support the auditor, G keeps his own vernacular audit technology: H: Yes, absolutely, because in this Excel sheet [which I use besides the firm sanctioned system] I can much more easily write comments, because I also send it to my assistants… [I communicate to them that] this is my analysis and this is what you have to follow up. Then if you have other external [expenses which you are auditing] … in this way they can sort of also understand what you should look at in these records. The digital platforms offered by the firm are perceived as being a good aid, but the structure is also limiting. In this case, it is the reviewing and commenting function that is found lacking: Reporting is much harder to do in this nice system where it comes out in different nice colours. It’s great visually, but ‘it’s useless if I sit up late at night and have to write comments… And I want to do that. (G) Maintaining a parallel structure like this may not always be possible, especially if the system imposed by the firm is perceived to be overwhelming. These very real issues notwithstanding, we, ceteris paribus, expect analytical forms of audit structure to increase the level and/or quality of audit judgement, if they work as intended. Analytical forms of audit structure are supposed to save the auditor time, which can be allocated to making professional judgement calls or even presenting information to the auditor that they otherwise would not see, enabling the auditor to turn their professional judgement to new issues. Controlling structure – e.g. professional practice functions (PPFs)

Another way audit structure may be perceived as overwhelming is when it takes the form of overly ambitious quality requirements. These quality requirements can, in a litigious environment with increasingly strict oversight,

On the structures of judgement in auditing 125 lead to an excessively defensive and preventive structure as the firm considers this a necessary strategy to survive. As one auditor put it: we have [quality] so high on the agenda, so we say then that, no, we should exercise an internal monitoring that is stricter than that of the PCAOB. Because it is the only way to ensure that when they come, they will not find any problems, or we will be able to reduce the number of problems. (D) The problem for this auditor is that when the firm must exercise this control outside of the US, it changes the tonality of the internal quality control, which this auditor previously perceived as helpful: the tonality of that monitoring has become very different. Instead of, like this, John, here we have found six things that you should do better, here you have a good, sort of, description, guidelines for how to do this, so next year we expect you to work with these things and, then we’ll come back and look at them … so it kind of helps. (D) When asked whether this is how it used to work, D replied: Yes, definitely. Now it’s like, the tonality is more like this: we will find the mistakes! We assume you did wrong. Not assume you did right. So, the starting point is something completely different. So, when they come, they are even worse than the Swedish Inspectorate of Auditors! And a huge amount of time is spent on it. (D) What this former audit partner describes is how the engagement partner previously was the one with the final say about the auditor’s report, with support from the firm in the form of national and international internal reviews. Formally, very little – if anything – has changed, but the tonality (the auditor’s word) is now very different. The partner did not perceive discretion (as before) to independently exercise their judgement on the audit, and what was previously perceived as a support function now had turned into more structure that needs to be followed and more hoops to jump through before an audit could be completed. While the auditor still formally has the final word on the auditor’s report, they perceived this to be a judgement call with limitations, as judgement, with Kohler et al. (2021) can be described as, at least partly, having moved up the ladder. Professional judgement could be seen to be less about an individual’s professional judgement and more about group judgement. The auditor mentions that the audit firm’s quality control and standards are tough, which means that you can follow Swedish law, and international standards of auditing and still be non-compliant. But, while critical of the changes in tonality of the internal control, they see a logic in the development which they partly blame on the Swedish Inspectorate of Auditors (SIA),

126  Thomas Carrington and Bino Catasús which in their view, shies away from exercising their judgement within the space allowed by law and international standards of auditing. The Swedish Inspectorate of Auditors, in some way, the last three to four years has sort of sat down in the back seat of the PCAOB Express, sort of, and … and it feels like we do not have real control over this, so we go on their train, and so we start like to monitor in the same way as PCAOB does. So, in my world, sort of, the FBI agents wear auditors’ hats. (D) What this auditor experienced was thus an internal control very much in the spirit of the PPF described by Kohler et al. (2021). This form of controlling forms of audit structure, we, ceteris paribus, expect to have a negative effect on the quantity (but not necessarily quality) of professional judgement. Like procedural forms of audit structure, controlling audit structure may be good for audit quality. However, from the perspective of the engagement partner, it never adds judgement but may, depending on the budget and incentive structure of the audit firm, crowd out professional judgement. (From a firm-level perspective, controlling forms of audit structure may, however, add judgement.) Mnemonic structure – e.g. checklists

The checklist is a trusted tool that has been used for a long time in audit practice (Boritz & Timoshenko, 2014). So-called box-ticking, i.e. the presumed unreflective use of checklists, is, however, an often-criticised part of the same practice (e.g. Power, 2019). Checklists are utilised to assist auditors in completing a variety of tasks, including inherent-risk assessments (Bédard & Graham, 2002; Boritz & Wensley, 1991), internal-control evaluations (Ashton, 1974; Boritz, 1985), substantive test planning (Blocher et al., 1983; Bonner et al., 1996), and fraud-risk assessments (Pincus, 1989). Checklists are also a part of audit standards. Boritz and Timoshenko (2014), for example, point to how the AICPA (2002, pp. 193–197) ‘provides lists of red flags related to misstatements arising from fraudulent financial reporting, as well as misappropriation of assets’ (Boritz and Timoshenko 2014, p. C2). Hence, while in widespread use, when checklists are discussed in the context of auditing, their use is most often portrayed in a negative light (Hogan et al., 2008; Jamal, 2008; Seow, 2011). This sentiment we also find in our interview material. My opinion is probably that most people find the new checklists burdensome […] And some people probably see them as a questioning of their judgement. (I) The auditor also added that: you get annoyed if you have to waste time on something that does not yield anything… all checklists are not so easy to explain to the customer, to explain why they should pay for [us following] them (I)

On the structures of judgement in auditing 127 One of those annoyed with checklists was the auditor complaining about his firm’s internal control function and the SIA. Yes … and that is a problem in itself when the document is 96 pages long. And that every box like this that you have to tick in, in itself, just to click in it … we have done such exercises, where you measure how much time it takes to click in … and now I don’t remember the exactly results, but there are such results. And it takes time because it is like four clicks. You should right-click, set the mouse, you should click, click ok, and then … [sighing] (D). However, not all auditors we talked to saw checklists as something bad. Instead, the argument was made that checklists can be put to good use as mnemonic devices, helping auditors to remember what to look for and what to think about. we have probably umpteen new checklists since I started. And there is nothing wrong with checklists, in the sense that they are great because they allow you to know that you’re also capturing all the questions (G) Asked about how many checklists they have, G’s answer was: I do not know everyone, but it’s a hell of a lot […] and the ones we already have, they’ve gotten longer. The management audit checklist has grown twice as long since I started (G) While this respondent clearly found the number of checklists and the length of the checklists excessive, this, however, did not mean that they found them all bad. Checklist for the annual report … it is insanely long. But it can be good to know … that, ‘these things should be included’. It is easy to see what is wrong but harder to see what is lacking and what should be included. (G) The value of this form of structure is described as functioning as a mnemonic device, helping the auditor look for what they cannot see. As expressed in the quote, errors in the included material (the accounts) are perceived to be relatively easy for the auditor to spot, or, at least, what is included will be audited. It is the items that are not included, the omissions, that are perceived as particularly difficult to audit, not because the audit steps per se are difficult but because absence is more difficult to deal with than presence (Catasús, 2008). The structure provided by the checklist helps the auditor to look for items that should be present but are not. It is not only in auditing that checklists are becoming more commonplace. Here, however, checklists are often proposed as a simple yet effective solution to the challenges of complex projects (such as auditing). As the virtues

128  Thomas Carrington and Bino Catasús of checklists have been extolled to a wider general public through popularscience books (e.g. Gawande, 2009; Kahneman, 2011), it does not seem farfetched to speculate that checklists will stay in auditing for the foreseeable future. The reason for this is that, while they can be perceived as burdensome, ceteris paribus, we expect mnemonic forms of audit structure, similar to analytical forms of audit structure, to increase the level and/or quality of audit judgement, if they work as intended. Mnemonic forms of audit structure are supposed to remind the auditor of the most crucial steps in the audit, which, as is the case with the analytical forms of audit structure, allows the auditor to focus on what is important, i.e. making decisions based on their professional judgement. Four forms of structure

The results of our inquiry into how the four drivers of change affect audit structure and how we expect the different forms of audit structure we identify to affect auditor judgement are summarised in Table 6.1. Whereas the effects of the different forms of structure cannot be guaranteed, we believe that our chapter motivates a more nuanced view of how structures affect judgement. In the next section, we further discuss what conclusions can be drawn from the findings and what the implications of them are. Conclusions and implications In this chapter, we explore the relationship between structure and judgement in audit practice. We do so against a background of two strands of the literature. On the one hand, there are the critics that lament an ever-increasing number of various forms of structure in auditing, at the loss of judgement and thus, they argue, audit quality (e.g. Francis, 1994). On the other hand, there are those who could be labelled as optimists. These optimists see the Table 6.1  P  urpose and expected effect on auditor judgement of different forms of structure. Form of structure

Generalised purpose

Procedural

Ensure an orderly audit process

Analytical

Decision aid (time-saving device)

Controlling

Catch mistakes, quality control

Mnemonic

Help auditors remember

Possible effect on auditor judgement

On the structures of judgement in auditing 129 solution to the problems in a doubling down on structure, in the form of, for example, new technology, better regulation and structures as the guardian against mistakes. Here, structure does not impede audit quality because structure is a formalised best practice. The structure vs. judgement debate has deep roots in audit research (Dirsmith et al., 1985, 1991; Humphrey et al., 2011; Salijeni et al., 2019; Smith et al., 2001) but seldom branches out from its basic form: Are audits best served by structured audit approaches or is it better if auditors rely more on their professional judgement? However, a closer analysis of the forty years of audit structure vs. judgement research paints a more nuanced picture: Structure can come from many places and take many forms. In an attempt to bring both detail and order to this literature, we suggest that the audit standards, regulations, internal-practice guidelines, PPFs, audit analytics, documentation and other software, and checklists of various forms, all referred to as ‘structure’ in the previous literature, can be categorised into one (or more) analytically distinct forms of structure. In our reading of the literature, earlier empirics, and our own interviews, we find that there are at least four forms of structure:

• • • •

procedural, e.g. standards, audit guidance analytical, e.g. Big Data Analysis (BDA) controlling, e.g. Professional Practice Functions (PPFs) mnemonic, e.g. checklists

Procedural audit structures are all forms of normative guidance that tell the auditor what to do. Instead of relying on their own professional judgement, auditors can or must follow these pre-determined structures for how to do a (good) audit. Analytical audit structures are all forms of automated processes that, to varying degrees, serve the auditor by selecting, ordering, and processing data (i.e. analyses data) and presenting this data in a form that the auditor (if, necessary, can further analyse and then) can make decisions upon, decisions that require their professional judgement. Controlling audit structures are those organisational and other solutions that assure the auditor (firm) that the undertaken audit procedures and assessments made follow procedural structure and relevant quality criteria. Mnemonic audit structures are all forms of checklists and other audit devices that make sure the auditor does not forget crucial steps in the audit, regardless of whether these steps are in the form of procedural audit structure or purely judgemental. Albeit the forms of structures are not mutually exclusive or exhaustive, we believe that this study shows the value of nuancing forms of structure. Ceteris paribus, we expect analytical and mnemonic forms of audit structure to increase the level and/or quality of audit judgement, if they work as intended. Analytical forms of audit structure are supposed to save the auditor time, which can be allocated to making professional judgement calls or even presenting information to the auditor that they otherwise would not

130  Thomas Carrington and Bino Catasús see, enabling the auditor to direct their professional judgement to new things. Mnemonic forms of audit structure are supposed to remind the auditor of the most crucial steps in the audit, which, as with the case of the analytical forms of audit structure, allows the auditor to focus on what is important, i.e. making decisions based on their professional judgement. Whether or not we see the expected effects on judgements, however, depends on two things in particular: The implementation of the intended structural element and how the affected auditor perceives the structural element. In the case of procedural audit structure, we expect that the more complex the procedure, the less time there will be for professional judgement and hence procedural forms of structure that are less complex may start to take on traits similar to those of the mnemonic form of auditing. Also, the less experienced the auditor, the more the procedural forms of structure will help the auditor, which enables them to exercise their professional judgement. For analytical forms of audit structure, we expect that when the algorithms become better at spotting old and new relevant issues, the auditor will have to exercise judgement on more issues. Of course, if we, in contrast, believe that judgement is a temporary aspect of the ways in which audit will develop and the future holds a fully automated audit, then the auditor as a profession is rather superfluous. If, conversely, the auditor thinks the analytical audit structure ‘spits out’ uninteresting things, the more the auditor will have to rely on their own analytical work, which then crowds out time for professional judgement. In the case of the controlling form of audit structure, we expect that the more cooperative and future-oriented a control process is (e.g. the interaction with the PPF) the less stifling it may be perceived, and vice versa. With regards to mnemonic audit structures, we expect a short checklist (or similar structural element) that is perceived to be relevant may help auditors avoid forgetting crucial steps in the audit and as such help auditors make good and timely use of their professional judgement. As illustrated above, checklists may also be perceived as burdensome and irrelevant, and, in those cases, we expect them to crowd out auditors’ professional judgement. We stress the importance of personal preferences as mnemonic (and procedural) forms of audit structure may also play a heuristic role. To address the additional question of which instantiations of audit structure are good and which are bad, we must step out of the conceptual laboratory and accept that less (more) judgement is, a priori, neither good nor bad. For some, however, professional judgement is what auditing is about (Francis, 1994, p. 236) and judgement is under siege. And yet, from studies of professionals in aeroplane cockpits, to operating rooms, to complex construction sites, simple structures like checklists have made otherwise impossible things possible and saved thousands of lives in the process (Gawande, 2009; Kahneman, 2011), while at present machine learning has arrived and quickly gone from buzz word to almost ubiquitous (Jordan & Mitchell 2015). Is auditing so different?

On the structures of judgement in auditing 131 Common to many of the studies on both sides of this divide (although not all: See e.g. Salijeni et al., 2021) is that they tend to see judgement as a zero-sum game where Structure (S) + Judgement (J) = Auditing Output (A0), where A is constant. As such judgement is treated as a residual of a fixed output: A0 − S = J A0 is the audit engagement and is considered a constant S is the volume of structural inputs included in the audit engagement J is the residual. But, as we have seen, investments in structure may increase the room for judgement (as in the sales pitch for audit software), through more efficient audits. In other cases, increases in (e.g. controlling) structure may move judgement away to another organisational level or duplicate it, effectively increasing J in step with S. However, what ought to matter is whether A0 increases or decreases in quantity and quality. This deceptively simple question is, however, difficult to answer definitively as its answer is inherently dependent upon what we understand as auditing and audit quality, especially in times of technological and organisational innovation. Is an automated audit still an audit? In other words, can auditing exist without auditors exercising their professional judgement – which currently underlies state-sponsored legal protection almost everywhere? Notes 1 This chapter is focused on the interaction of judgement and structure. The four drivers identified here affect this interaction. They only partially coincide with the four drivers of auditing transformation in overall focus in the book: Regulation, digitalisation, sustainability, and auditor characteristics. 2 https://www.accountancyage.com/2021/01/07/investment-in-technology-willhelp-firms-improve-audit-process retrieved 8 Feb 2023. 3 This is, of course, not strictly true but does not change their main point: While recent changes may have allowed for larger freedom in the educational backgrounds of auditors, an auditor does not have to study much about information systems (beyond accounting and financial reporting as such), programming or computational thinking to be allowed to take the authorisation exam.

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Appendix: Research design This chapter is, at the outset, a theoretical endeavour. That is, the chapter builds on the proposition that it is a worthwhile effort to challenge the dichotomy of the theoretical constructs of structure and judgement. This division into two has had a major impact on (not least) qualitative research in auditing because it highlights the key professional trait of judgement. Still, as our literature review shows, the dichotomy is underdeveloped, especially considering the backdrop of drivers for change. Our research design is, therefore, driven by juxtaposing earlier literature to these drivers and to form an argument that it is possible to nuance an over-optimistic and over-pessimistic approach to structure.

On the structures of judgement in auditing 135 Still, in order to situate this argument, we have an empirical corpus emanating from two sources. The first source is the empirical part of the papers discussing the relationship between structure and judgement. The benefit of using ‘old’ empirics is that these empirics are mobilised to offer a particular argument in the debate on judgement and structure. Still, in order to further situate the discussion, we carried out ten additional interviews with auditors, specifically targeting the question(s) addressed in this chapter. In the chapter, we return to a debate that has been going on for decades, i.e. the relationship between structure and judgement. Thus, the quotes in the chapter are not, primarily, in the text to empirically generalise the auditing profession. Instead, the empirical material is used as illustrations of a theoretical development of how we can nuance what structure can be. Consequently, we made no effort to focus on any strata of the auditing professions (e.g. juniors, seniors, partners, women, men, experienced, public sector auditors, and private sector auditors). Instead, our interviews were carried out by speaking to all sorts of auditors. We recorded the interviews but did not transcribe them word-by-word. Instead, we made notes and re-listened to the interviews to make sense of the notes and our arguments. As the drivers of change (digitalisation, processualisation, juridification, and the audit explosion) are intertwined, we believe that these drivers work together leading the audit profession, at first sight, away from judgement towards (full?) structure. As both authors of this chapter are continuously in contact with the audit profession, we had the intuition that this is not how we see the development of the profession. Meanwhile, one of the researchers had a conversation with an audit partner (long before this project) who stated ‘you can train a monkey to become an auditor’, thereby indicating that judgement is a non-essential capacity.

7

Digitalisation and professional scepticism of Swedish auditors Andreas Jansson, Timur Uman, Emilia Florin-Samuelsson, Alexandra Kantonenko, and Therése Karlström

Introduction Auditing, like most societal sectors, is currently deeply affected by the forces of digitalisation (Fotoh & Lorentzon, 2021). One relatively recent addition to the toolbox of auditors that has received considerable attention in research and practice is digital tools and IT systems, in particular computer-assisted audit techniques (CAAT) (Pedrosa et al., 2020). According to a survey by the Swedish Inspectorate of Auditors (SIA, 2021) automated tools and techniques are widely used among Swedish audit firms as an aid in substantive testing (e.g. for finding deviating entries, or reconciling accounts receivable with the sales revenue account), especially among the larger audit firms. The integration of such tools in the audit process can potentially have great effects on how audits are performed. Since digital technology implies some degree of standardisation (Braun & Davis, 2003), the emergence of such tools has given rise to discussions among both practitioners and researchers about whether these tools may affect audit quality. The backdrop to these considerations is often the long-standing discussion about whether more structure in the audit process means less room for professional judgement and, if so, whether less use of professional judgement leads to lower-quality audits (e.g. Bierstaker et al., 2001; Cushing & Loebbecke, 1986; Kosmala MacLullich, 2001). In the academic world, the discussion about structure and judgement in auditing has been going on for decades, yet there is still no consensus view on the relationship between the two. While some studies put forward both negative and positive impacts of structure on professional judgement (e.g. Bierstaker et al., 2001; Kosmala MacLullich, 2001), most of the literature suggests that structure has a negative impact on judgement (e.g. Cushing & Loebbecke, 1986; Kosmala MacLullich, 2001). The argument made is that structure limits auditors’ ability to engage in exercise of their professional duty – judgement (Kosmala MacLullich, 2001), which makes audits more mechanical and potentially of lower quality. Moreover, the relationship between exercise of professional judgement and audit quality is not necessarily clear either. On the one hand, professional judgement is a cornerstone and DOI: 10.4324/9781003411390-9

Digitalisation and professional scepticism of Swedish auditors 137 might be the most essential element of the auditing profession, but, on the other hand, so is the structure. As ISA 200 paragraph 16 puts it, ‘The auditor shall exercise professional judgement in planning and performing an audit of financial statements’. Maintenance of professional judgement is both an expectation from the client that purchases the service and what the general public expects from the auditor (Cowperthwaite, 2012). However, what is often loosely termed structure represents ‘a systematic approach to auditing characterised by a prescribed, logical sequence of procedures, decisions and documentation steps, and by a comprehensive and integrated set of audit policies’ (Cushing & Loebbecke, 1986) and refers to activities that are rulebased and require some kind of routine (Power, 2003). These aspects are also typically considered integral and essential to the audit process (Broberg, 2013). The emergence of CAAT gives rise to new and additional questions, such as what effect the specific kind of structure introduced by these tools has on audit quality (cf. Curtis & Payne, 2008). CAATs are not merely a structured protocol or a checklist to be applied in the audit process; they are also effective tools that can perform certain tasks faster than a human being. On the one hand, if used properly, digital tools such as CAATs might therefore increase auditors’ productivity through automation of audit tasks (Curtis & Payne, 2008; Mahzan & Lymer, 2014) and allow the auditors more time for reflection and scrutiny of the accounts they audit.1 On the other hand, by making the audit process more automated (Siew et al., 2020), it adds elements of structure and could make the auditors less reflective in the audit process (Gilbert et al., 1990) and more mechanical in their way of thinking (Broberg, 2013). In this chapter, we explore the effect of the use of digital tools in audits in the form of CAATs on a specific aspect of auditing: Professional scepticism, i.e. the auditor’s critical attitude towards audit evidence (Brazel et al., 2016). The purpose of the chapter is to determine how increasing reliance on CAATs relates to auditors’ exercise of professional scepticism. Professional scepticism, as we maintain in the next section, is considered an important aspect of professional judgement with a clear link to audit quality. Motivation The theme of the chapter is the overall issue of how audit quality is affected by digitalisation, a vast topic that arguably is of substantial general interest. However, audit quality is a multifaceted concept that in the practitioner literature is often linked to compliance with auditing standards, but in the scientific literature broadly is understood as the ‘monitoring strength’ of the auditor (Watkins et al., 2004), which thus affects the risk that financial reports contain material errors. Emanating from the latter view, professional judgement has been understood as being promoted by a reasonable mix of professional judgement and systematic process, while maintaining the ability

138  Andreas Jansson et al. to adapt to the idiosyncrasy of each client (Knechel et al., 2013). Professional scepticism has been used as one of the key indicators of professional judgement (Nelson, 2009) and connotes an attitude that requires an auditor to maintain a questioning mind and a critical assessment of the audit evidence (Brazel et al., 2016). As such, professional scepticism can be understood as auditors’ ability to exercise professional judgement, which logically links to the idea of audit quality as monitoring strength (Hurtt, 2010). Empirically, our study investigates how and to what extent reliance on CAAT in audits is related to professional scepticism. In performing this investigation, we remain agnostic as to whether the use of digital tools like CAAT enables more or less professional scepticism. One can argue for both outcomes. On the one hand, the use of CAAT could enable auditors to spend more time on professional judgement (see also Carrington & Catasús, in this volume; Curtis & Payne, 2008; Mahzan & Lymer, 2014) and thus exercise more professional scepticism. On the other hand, the use of CAAT could crowd out professional judgement and thus introduce the possibility of professional scepticism (cf. Broberg, 2013; Gilbert et al., 1990; Siew et al., 2020). We thus propose that either of these scenarios could hold but might depend on the specific characteristics of the auditors who use CAAT in the audit process. More specifically, we suggest that making more room for judgement in the audit process may lead to either more or less professional scepticism exercised in the audit and that this may depend on whether the auditor as an individual possesses the individual trait of being sceptical. If a highly sceptical auditor is given more time for reflection and scrutiny, it will lead to an audit more characterised by professional scepticism, while this additional time to spend on judgement may not produce much in terms of professional scepticism of the audit for an auditor who is less sceptical by nature. According to Hurtt (2010), the concept of professional scepticism consists of two parts, state scepticism and trait scepticism, which Robinson et al. (2018) suggest are two separate constructs, rather than components of a single construct, as it is often conceptualised to be in the literature (e.g. Anderson et al., 2004; Gramling, 1999; Hurtt, 2010; Robertson, 2010). State scepticism is at the core of professional scepticism (Shaub, 1996) and is more closely related to the higher-level construct of professional judgement, given that it relates to the response to the exercise of professional duties in relation to the client (cf. Shaub & Lawrence, 1996). Trait scepticism, on the other hand, is related to the individual characteristics of a person, which this person might apply both in their professional and other contexts (Hurtt et al., 2013; Robinson et al., 2018). From this perspective, the model we test in this chapter suggests that the relationship between reliance on CAAT and state scepticism is moderated by trait scepticism. Or, in less technical terms: the way in which reliance on CAAT in the audit process affects the degree to which the audit is characterised by professional scepticism (i.e. state scepticism) depends on whether the auditor is sceptical by nature (i.e. trait scepticism). By evaluating the validity of this model, we can thus contribute to the

Digitalisation and professional scepticism of Swedish auditors 139 discussion of how digitalisation, in the form of CAAT, contributes to audit quality. Our research design is based on a 2020 survey of Swedish-certified auditors who were FAR (the institute for the accountancy profession in Sweden) members. We received 435 complete answers. We adopted measures of professional scepticism from Hurtt (2010) and Robinson et al. (2018) and trait scepticism from Robinson et al.’s (2018) modification of the Hurtt’s scale (2010). Furthermore, we used a measure of reliance on CAAT inspired by Janvrin et al. (2009). We used linear regression analysis with professional (state) scepticism as dependent variable, reliance on CAAT as independent variable, trait scepticism as moderating variable, and a number of control variables common to the literature to analyse our model. Further information about the methods employed is provided in the Appendix to the chapter. Literature review The application of CAAT is intensively discussed among practitioners, regulators, and researchers (Salijeni et al., 2021). However, in relation to the significant investments made in CAAT by leading auditing firms (Alexander, 2021; SIA, 2021), there are relatively few research studies published. A possible explanation is the ambiguity in relation to the relevance the increased reliance on CAAT has for theory development within the field. In this study, we approach CAAT as, e.g. entailing more (or possibly a specific kind of) structure and connect it to audit quality by investigating its relation to professional scepticism. Therefore, the literature review is reported in three parts: CAAT and audit quality, CAAT as a representation of structure and its relation to judgement, and professional scepticism. CAAT and audit quality

The concept of CAAT is relatively broadly used in the auditing literature, but there are also several related and partly overlapping alternative concepts. Braun and Davis (2003) use the concept ‘computer-assisted audit tools and techniques’ (CAATTs). They argue that, broadly defined, this includes ‘any use of technology to assist in the completion of an audit’ but acknowledge that most often the definition is limited to ‘tools and techniques employed to audit computer applications and to tools and techniques used to extract and analyse data’ (ibid., p. 726). Other authors use the concept to refer to the usage of specific software that can be applied by the auditor to perform audits (Curtis & Payne, 2008; Janvrin et al., 2009; Siew et al., 2020). Examples of the tools studied include software developed for the audit industry as well as software developed for general purposes such as Excel (Widuri et al., 2016). A form of technology-enabled tools, which has become a major topic for discussions among regulators as well as representatives of large audit firms, are Big Data and analytics tools (Salijeni et al., 2021). While these could

140  Andreas Jansson et al. be seen as a particular form of CAAT, we include studies taking this focus since it is relevant also in relation to the general discussion about CAAT. Another common and related concept is ‘digitalisation’ (Fotoh & Lorentzon, 2021; SIA, 2021). This concept is most often used for referring to an even broader set of phenomena, which means that studies employing this concept are also relevant to our discussion below. Sonnerfeldt and Jonnergård (in this volume), for example, discuss how digitalisation of the audit process has influenced the professional identity of auditors. Fotoh and Lorentzon (2021), for example, review a broad set of empirical studies related to the impact of digitalisation on auditors’ professional profile, audit procedures, audit regulation, as well as the auditor–client relationship. Based on the review, they predict that digitalisation is likely to transform the auditing profession and that audit firms will need to consider new business models, new metrics, different capabilities, and new skills in order to remain competitive. As discussed above and demonstrated in several chapters of this book (e.g. Carrington & Catasús, in this volume; Sonnerfeldt & Jonnergård, in this volume), audit quality is another multifaceted concept. Several different definitions of the concept exist as a result of perceived quality to some extent existing in the eyes of the beholder (Knechel et al., 2013). Traditionally, however, the notion of audit quality revolves around the auditors’ competence (effort and ability to discover serious misstatements in audited financial reports) and integrity (whether misstatements will be acted upon) (Knechel et al., 2013). Reviewing academic literature, Watkins et al. (2004) synthesise the many aspects of how the concept is used into meaning the ‘monitoring strength’ of the auditor. Several factors that affect audit quality have been suggested in empirical research, both in terms of input to the auditing process (e.g. incentives, knowledge, and professionalism of the auditor; see e.g. Marton & Papadopoulos, in this volume) and in terms of the audit process itself (e.g. the design of the process and the auditor’s use of judgement and relation to the client) (Knechel et al., 2013). Thus, trait scepticism can be understood as an input factor in the audit process and state scepticism as a characteristic of the process, both with presumed positive impact on audit quality. CAATs affect the audit process itself. In general, the implementation of CAATs is understood as supported by auditing standards (ISA 330) because it improves the effectiveness and efficiency of auditors’ work (Bierstaker et al., 2014). For example, CAATs have automated manual audit tests, which reduce hours spent on an audit and permit auditors to increase the amount of evidence to be tested, which leads to higher-quality audit evidence (Bierstaker et al., 2014; Curtis & Payne, 2008). CAATs are also considered to improve the audit quality and efficiency of the audit process, since they allow auditors to directly investigate evidence that is saved in electronic form (Janvrin et al., 2009; Pedrosa et al., 2020). These advantages are especially important during a time when audit firms feel they are facing increased expectations from their clients (Al-Hiyari et al., 2019; Fotoh & Lorentzon, 2021). Consequently, it is frequently argued that auditors should take advantage of CAATs to remain

Digitalisation and professional scepticism of Swedish auditors 141 relevant and competitive in the market (Bierstaker et al., 2001; Braun & Davis, 2003; Siew et al., 2020). Besides expanding the scope and depth of audit work, recent research has also pinpointed how certain functions of CAAT, such as visualisation dashboards, have had positive effects on the communication between auditors and clients (Salijeni et al., 2021). By enhancing auditors’ ability to communicate and justify their judgements, CAATs could be important tools for responding to calls for ‘greater visibility and transparency’ in auditing (Williams, 2013, p. 556). In line with the above, when investigating the relationship between CAAT and audit quality, it can be argued that researchers most often conclude that CAAT has a positive impact on audit quality. Our empirical study investigates the relationship between the same concepts but does so by approaching CAAT as entailing a specific kind of structure. Next, therefore, we turn our attention to CAAT as a representation of structure, which not necessarily only strengthens audit quality but also has consequences for auditors’ professional judgement. CAAT as a representation of structure and its relation to professional judgement

In line with many other researchers in the field, we follow Cushing and Loebbecke’s (1986) reasoning and define structure as a systematic approach to auditing characterised by a prescribed and logical sequence of procedures, decisions and documentation steps, guided by a comprehensive and integrated set of audit policies. This includes formal decision aids, checklists, and mandated procedures that are usually computer-based (Knechel, 2007). As discussed by Carrington and Catasús (in this volume), checklists are not only a way to standardise the audit process and ensure that all relevant steps have been performed but can also be understood as a heuristic device. As they point out, it could therefore be argued that when auditing is increasingly dependent on CAAT, structure is triumphing. This is supported by research that describes auditing processes as more structured over time, with the increased use of technology and IT tools as a factor driving this development (Sutton, 2010). As mentioned in the introduction, the interest in ‘structure’ in this study is prompted by the conflicting views among audit researchers on what consequences structure has for professional judgement. Both structure and professional judgement are considered central to high audit quality (Broberg, 2013; Kosmala MacLullich, 2001; Öhman et al., 2006). Furthermore, it could be argued that auditors make structured judgements, or, put differently: auditors must be structured in their way of performing judgements (Broberg, 2013). The dilemma is that structure also has been shown to have a negative impact on professional judgement, as it makes audit processes more mechanical and limits auditors’ ability to engage in the free exercise of professional judgement (e.g. Cushing & Loebbecke, 1986; Kosmala MacLullich, 2001).

142  Andreas Jansson et al. The increased use of CAAT complicates this relationship further (Agevall et al., 2018; Curtis & Payne, 2008). While increasing the standardisation and structure of auditing processes, if used properly, CAATs also increase auditors’ productivity through automation of audit tasks (Mahzan & Lymer, 2014). This would allow auditors to spend more time on reflection and professional judgements in relation to each individual client (Bierstaker et al., 2001). As professional scepticism has been identified as one of the key indicators of professional judgement (Nelson, 2009), the concept of scepticism is the focus of our literature review in the next section. Professional scepticism

Professional scepticism is an important concept in auditing research and, according to the IAASB (2015), is necessary to achieve a high-quality audit. In relation to recent audit failures and fraud cases, regulators have repeatedly concluded that the lack of professional scepticism is an important factor. The antecedents and consequences as well as operationalisation of professional scepticism are therefore discussed among regulators and researchers (Broberg, 2013; Hurtt, 2010; Khan & Oczkowski, 2021; Nelson, 2009; Robinson et al., 2018). According to ISA 200 paragraph 13, professional scepticism is ‘an attitude that includes a questioning mind, being alert to conditions which may indicate possible misstatement due to error or fraud and a critical assessment of audit evidence’. Sceptical behaviour should thus be adjusted by the nature of the situation during the auditing process. For example, professional scepticism is expected to be high in situations when the client is new, when the communication is poor, when the client experiences financial distress or when inaccuracies appear in the client’s inventory (Shaub & Lawrence, 1996). These examples of conditions are relevant in relation to what researchers in the field refer to as state scepticism, i.e. a temporary condition that emerges from situational factors (Hurtt et al., 2013). State scepticism relates to the response to the exercise of professional duties in relation to the client (cf. Shaub & Lawrence, 1996) and is therefore considered the core of professional scepticism (Shaub, 1996) in the literature. Auditors’ scepticism and behaviour are also explained by individual traits. Traits are understood as individual and over time relatively stable differences in thoughts, feelings, and behaviour (see also Marton & Papadopoulos, in this volume). Researchers have shown that auditors with higher levels of trait scepticism are more suspicious in nature (Rose, 2007), and are therefore more likely to exercise sceptical behaviour (Hurtt et al., 2008). Since individual traits affect judgement and decisions (Humphrey & Moizer, 1990; Power, 2003), auditors with higher levels of trait scepticism would require more evidence to be convinced compared to auditors with lower levels of trait scepticism in a similar situation (Quadackers et al., 2014). The separation between state and trait scepticism draws on extensive research within psychology. As stated by Robinson et al.

Digitalisation and professional scepticism of Swedish auditors 143 (2018), research in the field of psychology generally assumes behaviour can be explained by dispositional (traits) factors and situational (state) factors. While agreeing that understanding professional scepticism is a key to improving audit quality, researchers debate the definition and operationalisation of scepticism. The use of the two concepts of state scepticism and trait scepticism is relatively well established. A difference is that while some researchers consider state scepticism and trait scepticism to be two parts of professional scepticism (Hurtt, 2010; Nelson, 2009), there are also arguments for viewing them as separate constructs. Robinson et al. (2018) argue that the former view often entails a focus on trait scepticism among researchers while practical efforts to improve audit quality necessitate a focus on state scepticism as well. In order to overcome this problem, Robinson et al. (2018) disentangle the trait and state components and test them as separate constructs. In their approach, state scepticism is measured in terms of the characteristics Questioning Mind, Suspension of Judgement and Search for Knowledge, while, trait scepticism is measured in terms of Interpersonal Understanding, SelfDetermining, and Self-Confidence (Robinson et al., 2018). Based on the discussion above, it could be argued that trait scepticism functions in terms of transition steps between the situational factors and the sceptical behaviour of the auditor. Linking to previous research on CAAT, this means that since auditors with higher levels of trait scepticism show more sceptical behaviour across different situations, the relationship between CAAT and professional scepticism should be moderated by trait scepticism, irrespective of whether CAAT in general enables more or less professional scepticism. Results The research question addressed in this chapter is whether reliance on CAAT by auditors affects professional scepticism and whether this effect depends on the auditor’s innate scepticism (trait scepticism). We rely on data collected in March 2020. An electronic survey was administered to 2800 authorised and approved auditors who were members of FAR. We received 522 responses, 435 of which could be used for the analysis (87 responses were incomplete). Descriptive statistics

Thirty-five per cent of the respondents were women, and the average age of our respondents was 48 years (see Table 7.1). Partners represented 59% of our sample and 68% of responding auditors worked in Big 7 accounting firms. The average reliance on CAAT by auditors in our sample was 4.87 on a 10-point Likert-scale, meaning that the respondents on average lie in the middle between totally disagreeing and totally agreeing to rely on CAAT for tasks such as assessing inventory existence and completeness, identifying entries to be

144  Andreas Jansson et al. Table 7.1  Descriptive statistics.

1 2 3 4 5 6 7 8

Variables

N

Min

Max

Mean

StD

Gender Age Partner Org. tenure Big7 Reliance on CAATs Trait scepticism Professional scepticism

435 425 424 425 435 410 426 426

0 23 0 0 0 1 4.78 4.7

1 82 1 46 1 10 10 10

.35 47.68 .59 14.47 .68 4.87 7.71 8.42

.48 11.76 .49 9.83 .47 2.54 .92 1.12

tested and controlling for fraud. The standard deviation is substantial, suggesting that there is considerable variation in the degree to which Swedish auditors rely on CAAT. Our respondents were relatively high on both trait (mean = 7.71) and professional (mean = 8.42) scepticism (see Table 7.1). As professional scepticism, capturing the auditors’ assessment of their most complex case during the last 12 months comprises aspects that auditors generally wish to strive for and can affect, such as not simply accepting the client’s statements at face value but independently and critically forming one’s own opinion, this result may not be surprising. The measure of trait scepticism is more about characteristics of the auditor and is perhaps more reflective of certain individuals becoming auditors. However, there is variation surrounding the means in both trait and professional scepticisms. This indicates that our measures successfully capture variation in the degree to which professional scepticism characterises the work of sampled auditors and the degree to which they are sceptical as individuals. Pearson correlations

Table 7.2 shows a number of highly significant correlations. It indicates that females perceive themselves to have a higher level of professional scepticism (.136**). Moreover, the age of our respondents positively correlates with their perception of their trait (.120*) and professional (.101*) scepticisms. Hence, with age, the sampled auditors tend to perceive themselves to be both more professionally and more innately sceptical. Being a partner also has a positive correlation with professional scepticism (.096*), suggesting that partners perceive themselves as exercising more professional scepticism. Longer organisational tenure of our respondents appears to have a positive relationship with their reliance on CAATs (.157**) as well as a positive relationship with perceived trait scepticism (.126**). This means that, in general, the longer an auditor has worked at an audit firm, the more reliant the auditor becomes on CAAT and the more innately sceptical the auditor becomes. The former result is somewhat surprising considering the stereotype

Digitalisation and professional scepticism of Swedish auditors 145 Table 7.2  Correlation matrix.

1 2 3 4 5 6 7 8

Variables

1

2

3

4

5

6

7

Gender Age Partner Org. tenure Big7 Reliance on CAATs Trait scepticism Professional scepticism

–.227** –.191** .460** –.160** .578** .251** –.080 .245** .471** –.154** .010 –.022 –.163** .157** –.322** .009 .120* .074 .126** –.019 .148** .136** .101* .096* .057 .070 .096 .444**

* p < .05, ** p < .01

that younger auditors would be more prone to use new technology, but it might possibly be explained by more senior auditors being responsible for larger and more complex clients, for which CAATs are more productively used. Being employed in the Big 7, however, has a negative correlation with reliance on CAATs (–.322**), suggesting somewhat unexpectedly that the smaller firms use CAAT more. Reliance on CAATs has a positive correlation with trait scepticism (.148**) but not with professional scepticism, suggesting that auditors who are more innately sceptical use CAAT more (or, alternatively, that the use of CAAT makes an individual more sceptical). We also observe the positive correlation between trait and professional scepticism (.444**). Regression analysis

We perform hierarchical multiple regression analysis, which is reported in Table 7.3. Model 1 tests whether reliance on CAAT affects professional scepticism, while Model 2 adds a test of whether the relationship between CAAT and professional scepticism is moderated by the trait scepticism of the auditor. In performing these tests, the control variables were entered into the analysis first, followed by the main effect variable – reliance on CAAT (Models 1 and 2). The interaction variable Reliance on CAATs × Trait scepticism (both standardised prior to multiplication to reduce multicollinearity) was entered (Models 2 only). All models had some indications of limited multicollinearity which were within the acceptable range, between 1.968 and 1.972 (cf. Pallant, 2004). The results of the regression analysis – Model 1 – indicate that Reliance on CAATs has a positive relationship with professional scepticism. This would suggest that the more an auditor relies on CAAT, the more professional scepticism is exercised in the audit. Model 1 further suggests that gender (female) has a positive correlation with professional scepticism, i.e. that female auditors exercise more professional scepticism.

146  Andreas Jansson et al. Table 7.3  Regression models. Variables

Constanta Gender Age Partner Organisational tenure Big 4 Reliance on CAATs Trait scepticism Reliance on CAATs × Trait scepticism Adj R² F VIF value, highest

Model 1

Model 2

Std. B

Std. Error

7.354** .170** .090 .092 .001 .051 .129*

.290 .118 .007 .140 .008 .149 .023

.044 4.075** 1.968

Std. B

Std. Error

3.703** .162 .062 .076 –.030 .042 .051 .425** 0.88*

N = 405

.471 .107 .006 .127 .007 .135 .021 .055 .050

.222 15.271** 1.972

Notes a Un-standardised coefficient * p < .05, ** p < .01

This basic interpretation is modified, however, when we introduce the interaction variable in Model 2. The general effect of reliance on CAAT on professional scepticism disappears, but trait scepticism has a positive moderation effect on the relationship between Reliance on CAATs and professional scepticism. The discovered moderation was plotted to explore and visually represent the effect (see Figure 7.1). The plotting of the moderation effect (the representation is based on Dawson [2014]) suggests that correlation between

Figure 7.1  Interaction effect.

Digitalisation and professional scepticism of Swedish auditors 147 Reliance on CAATs and professional scepticism is more pronounced for the respondents with high trait scepticism and less pronounced for the respondents with low trait scepticism. This means that CAAT can have a positive influence on professional scepticism, but only if the individual scepticism of the auditor (measured by trait scepticism) is sufficiently high.2 If the auditor is less sceptical as person, reliance on CAAT will have a negligible or no effect on professional scepticism. Model 2 further indicates that trait scepticism has a positive correlation with professional scepticism, i.e. auditors who are more innately sceptical perform audits more characterised by professional scepticism. The gender effect disappears when trait scepticism is introduced as a factor, suggesting that individual traits of the auditor in terms of trait scepticism is a better predictor for the perception of professional scepticism exercised than gender is. Conclusions and implications We document that CAAT has a positive effect on professional scepticism, but this effect is positively moderated on the degree of trait scepticism of the individual auditor, such that the effect is stronger for auditors who possess high degrees of trait scepticism. Our results tap into ongoing discussions about the effects of digitalisation on auditing (see e.g. Fotoh & Lorentzon, 2021), especially the quality of auditing. Drawing primarily on the intuition that increases in the degrees of structure of the auditing process will crowd out the exercise of professional judgement and thus the room for professional scepticism, supported by the mainstream literature (e.g. Cushing & Loebbecke, 1986; Kosmala MacLullich, 2001; Smith et al., 2001), one conjecture would be that the use of CAAT would decrease professional scepticism and therefore audit quality. In line with Bierstaker et al. (2001) and Kosmala MacLullich (2001), our results rather suggest that the opposite is the case. This result may appear counterintuitive, based on the mainstream literature; however, while CAAT introduces increasing degrees of structure into the auditing process, it also automates the procedure and makes these structural aspects less time-consuming to perform (Al-Hiyari et al., 2019). One interpretation of this result is that reliance on CAAT allows the auditor to have more time to spend on the non-routine and non-repetitive aspects of the audit, and more on advanced tasks requiring professional scepticism in the exercise of judgement (cf. Kosmala MacLullich, 2001; Pedrosa et al., 2020). Another interpretation, as argued by Carrington and Catasús (in this volume), some forms of structure (e.g. CAAT) may actually support the exercise of judgement. However, as documented by Sonnerfeldt and Jonnergård (in this volume), digital technology might give rise to professional insecurity among auditors who display a lack of trust in machines, suggesting that the mechanism behind our result may be more complex. One possibility could be, for example, that auditors hyper-compensate for such professional insecurity by applying more professional scepticism to the audit process.

148  Andreas Jansson et al. Our findings further show that it is only if the auditor is innately sceptical that we see a positive effect on professional scepticism from reliance on CAAT. This suggests that individual-level variability in auditor personality plays a part in understanding the mechanism linking reliance on CAAT and professional scepticism. Since there is some degree of discretion both with regards to if digital tools are used in auditing (as suggested by the 4.87 average on a 1–10 scale on our measure of reliance on CAAT in the sample), but also how they are used, it is reasonable to assume that an auditor possessing more sceptical traits can also use the economising benefits of the CAAT to create more room for the exercise of professional scepticism, and may, for example, primarily use CAAT as an analytical decision aid that increases the room for professional judgement (see also Carrington & Catasús, in this volume). Since trait scepticism affects professional scepticism (Hurtt, 2010; Nelson, 2009), and since use of CAAT can create more space for the exercise of professional scepticism, use of CAAT can act as a lever for sceptically inclined auditors to increase the level of professional scepticism in their audit assignments. It may also be unusually sceptically inclined auditors who are incentivised to exercise additional professional scepticism in the audit process as a response to professional insecurity evoked by reliance on CAAT (i.e. there is a potential endogeneity effect). If we apply a definition of audit quality that emphasises the ‘monitoring strength’ of the auditor (Watkins et al., 2004), however, this would imply either way that reliance on CAAT may either be relatively neutral to, or increase, audit quality depending on whether the auditor is innately sceptical. Based on our results, we conclude that the effect of CAAT on professional scepticism depends on whether the auditor is innately sceptical. The results are in line with the interpretation that the use of CAAT in the audit will free up time for the auditor that, if the auditor is sufficiently sceptical, will be used to increase the level of professional scepticism characterising the audit. It is also consistent with the idea that the professional insecurity among auditors created by the use of CAAT (see also Sonnerfeldt & Jonnergård, in this volume) leads auditors to hyper-compensate and exercise additional professional scepticism. The more sceptical the auditor is, the bigger the effect of the use of CAAT. The study has several implications of theoretical, empirical, and practical nature. First, it challenges the theoretical notion that structure in general is unequivocally negative for the exercise of professional judgement in a professionally sceptic manner (e.g. Cushing & Loebbecke, 1986; Kosmala MacLullich, 2001; Smith et al., 2001). Rather, the results suggest that while some forms of increasing degrees of structure in auditing crowd out professional judgement, some forms of structure may be either consistent with or supportive of professional judgement. This highlights the need for more future research that can identify the boundary conditions for the proposition that structure is inversely related to judgement. While we can only speculate about the precise mechanism based on our data, one interpretation is that, notwithstanding that CAATs necessarily increase standardisation in the

Digitalisation and professional scepticism of Swedish auditors 149 auditing processes for which they are used (Braun & Davis, 2003), these tools may also allow auditors to perform various tasks more efficiently. This, in turn, might allow freeing up valuable time for the auditor, who can use it at their professional discretion, with positive effects on professional scepticism and ultimately audit quality. Second, an empirical implication of the study is that it shows that the (selfreported) constructs of state scepticism and trait scepticism are empirically distinct in the sample. The study furthermore has implications for how to theoretically understand the relationship between them. While some previous literature suggests that these two constructs jointly form a representation of professional scepticism (e.g. Anderson et al., 2004; Gramling, 1999; Hurtt, 2010; Robertson, 2010), and other literature suggests that they are at best weakly correlated (Khan & Oczkowski, 2021), our results rather support the notion that they are two separate constructs, consistent with Robinson et al. (2018). The results also shed some light on how they relate to each other. Since trait scepticism captures individual characteristics of the auditor and state scepticism relates to the exercise of professional tasks (Hurtt et al., 2013; Robinson et al., 2018), it may be reasonable to assume that trait scepticism affects state scepticism, which our study also confirms. However, it is also reasonable to assume that individual auditors with different inclinations to scepticism will respond differently to different aspects related to structure with the potential to affect professional scepticism. In our study, CAAT represented one such aspect related to structure, but in future research it may be of interest to explore whether the same moderating effect exists when, for example, regulation or professional guidelines designed to increase the level of professional scepticism are introduced. From a practical perspective, the study addresses concerns about whether increasing use of digital tools in auditing, by increasing structure and standardisation, may make auditing more mechanical and of poorer quality. The results of this study rather show that increasing the use of CAAT leads to an increase in professional scepticism (at least provided the auditor is innately sceptical), most likely as an effect of making repetitive and less qualified tasks less time-consuming. It is nevertheless reasonable to finish the chapter with a few cautionary notes regarding that proposition. First, we may be watching the early to middle stage of a full-scale implementation of CAAT in the auditing process, and as this implementation continues and more auditing firms enjoy the economising benefits of CAAT, price competition in the industry may increase, which risks decreasing the space for the exercise of judgement and professional scepticism once more. Second, the traditional path for new entrants into the profession has been to start by performing relatively simple and repetitive tasks in combination with more theoretical training, before moving on to more qualified tasks. With the first step of practical learning removed, the profession will need to find other ways to school new recruits or may risk having senior professionals with little understanding of the tasks that CAATs are performing for them, which may make the exercise of

150  Andreas Jansson et al. professional scepticism in relation to computer-generated audits increasingly difficult (see also Sonnerfeldt & Jonnergård, in this volume). The study, of course, has a number of limitations, a few of which are raised here. First, we study professional scepticism as an outcome of reliance on CAAT, assuming (based on theory) that professional scepticism will have a positive influence on audit quality (Knechel et al., 2013). While there are powerful arguments supporting this, scepticism is no end in itself, and future research may attempt to link the use of CAAT to a more direct measure of audit quality. Second, we rely on self-reported perception of professional and state scepticism. While these are standard measures from the literature, for natural reasons, this procedure introduces the risk that respondents based on prestige bias or limited self-knowledge may overestimate their sceptic nature or the degree to which professional scepticism characterises their auditing work. We do not know whether such overestimation is at hand and whether it is uniform across respondents or varies cross-sectionally based on our study design. Third, our data concerns authorised auditors who thus have reached some degree of seniority. However, especially for audits of larger organisations, it is likely the case that it is junior auditors who are new to the profession who perform most of the repetitive tasks that are most obviously possible to automate. Hence, while CAAT may free up time for the senior auditors (perhaps more so for auditors with smaller clients that to a higher extent do the full audit themselves), it is likely to free up even more time for junior auditors who perhaps may not have as developed a sense of professional scepticism. This might mean that different mechanisms linking reliance on CAAT with professional scepticism are at hand, and our study design and measures are unable to distinguish between these. Future research may, therefore, find it of interest to develop measures to capture the effect of reliance on CAAT on the work of less senior auditors, i.e. audit assistants. Moreover, future studies could further explore the relative importance of different mechanisms linking reliance on CAAT and professional scepticism. Acknowledgements Andreas Jansson has benefitted from funding by Jan Wallander och Tom Hedelius Foundation (grant number P18-0095). Notes 1 The argument is contingent on the competitive situation in the audit market. It assumes that efficiency gains and cost savings fall to the auditor and do not lead to a reduction in the price of the audit. 2 Simple slope analysis revealed that Reliance on CAATs has a stronger positive (albeit only on the 10% significance level) relationship with professional scepticism at high trait scepticism values (δ = 1.003, t = 1.831, p < 0.1) compared to the presence of low trait scepticism (δ = 0.491, t = 1.877, p < 0.1). (The trait scepticism is treated as a binary variable for visualisation purposes only.)

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Digitalisation and professional scepticism of Swedish auditors 153 Quadackers, L., Groot, T., & Wright, A. (2014). Auditors’ professional skepticism: Neutrality versus presumptive doubt. Contemporary Accounting Research, 31(3), 639–657. Robertson, J.C. (2010). The effects of ingratiation and client incentive on auditor judgment. Behavioral Research in Accounting, 22(2), 69–86. Robinson, S., Curtis, M.B., & Robertson, J.C. (2018). Disentangling the trait and state components of professional skepticism: Specifying a process for state scale development. Auditing: A Journal of Practice & Theory, 37(1), 215–235. Rose, J.M. (2007). Attention to evidence of aggressive financial reporting and intentional misstatement judgments: Effects of experience and trust. Behavioral Research in Accounting, 19(1): 215–229. Salijeni, G., Samsonova-Taddei, A., & Turley, S. (2021). Understanding how big data technologies reconfigure the nature and organization of financial statement audits: A sociomaterial analysis. European Accounting Review, 30(3), 531–555. Shaub, M.K. (1996). Trust and suspicion: The effects of situational and dispositional factors on auditors’ trust of clients. Behavioral Research in Accounting, 8, 154–174. Shaub, M.K., & Lawrence, J.E. (1996). Ethics, experience and professional skepticism: A situational analysis. Behavioral Research in Accounting, 8(Supplement), 124–157. SIA. (2021). Tematillsyn – Digitalisering och använding av automatiserad verktyg och tekniker (Theme inspection – Digitalisation and use automated tools and technologies). Revisorsinspektionen (Swedish Inspectorate of Auditors). Siew, E.-G., Rosli, K., & Yeow, P.H.P. (2020). Organizational and environmental influences in the adoption of computer-assisted audit tools and techniques (CAATTs) by audit firms in Malaysia. International Journal of Accounting Information Systems, 36, 100–445. Smith, M., Fiedler, B., Brown, B., & Kestell, J. (2001). Structure versus judgement in the audit process: A test of Kinney’s classification. Managerial Auditing Journal, 16(1), 40–49. Sutton, S.G. (2010). The fundamental role of technology in accounting: Researching reality. Advances in Accounting Behavioral Research, 13, 1–11. Swedish Inspectorate of Auditors (2018). Yearly Report. DNR 2019-0474. Available at https://www.revisorsinspektionen.se/globalassets/webbplatsen/publicerat/arligrapport/2019-0474-arlig-rapport-2018.pdf Watkins, A.L., Hillison, W., & Morecroft, S.E. (2004). Audit quality: A synthesis of theory and empirical evidence. Journal of Accounting Literature, 23, 153–193. Widuri, R., O’Connell, B., & Yapa, P.W.S. (2016). Adopting generalized audit software: An Indonesian perspective. Managerial Auditing Journal, 31(8/9), 821–847. Williams, J.W. (2013). Regulatory technologies, risky subjects, and financial boundaries: Governing “fraud” in the financial markets. Accounting, Organizations and Society, 38(6–7), 544–558.

Appendix: Research design We rely on an electronic survey that in 2020 was administered to 2800 authorised and approved auditors who were members of FAR. We received 522 responses of which 435 could be used for the analysis (87 responses were incomplete). The drop-out analysis indicated that the sample did not

154  Andreas Jansson et al. significantly differ from the population in terms of gender and audit firm affiliation (Swedish Inspectorate of Auditors, 2018). We used Harman’s singlefactor test to check for common method bias (Podsakoff et al., 2003). All independent and dependent variables were included in one unrelated factoranalysis procedure. The results indicated the data had a multiple-factor structure and limited common bias. Measures

The measures of our dependent variable Professional scepticism were adopted from Robinson et al. (2018), who equate state scepticism with professional scepticism and measure it along three specific dimensions: Questioning Mind, Suspension of Judgement, and Search for Knowledge. In adopting the scales, we reduced the original 14 items to 10 items (see Table 7.4). The Likert scale was used, where scale 1 = Strongly disagree and 10 = Strongly agree). This adaptation was made after pretesting the scales on a smaller group of authorised auditors. To provide a context to the questions, the respondents were asked to think of their most complex audit during the past 12 months. Professional scepticism had a Cronbach’s alpha value of α = 0.895, which was above the normally acceptable Cronbach’s alpha value of 0.6 (Nunnally, 1967). Thus, we used the mean value of the answers to the ten questions as a measure of the dependent variable. Table 7.4  Dependent variable. Scale: 1 = strongly disagree and 10 = strongly agree Questioning mind (QM)

QM1 QM2 QM3

Suspension of Judgement

SJ1 SJ2 SJ3 SJ4

Search for Knowledge

SK1 SK2 SK3

While working on that case, I tended to question the statements that I received from the company While working on that case, I frequently questioned the things that I saw or read While working on that case, I tended to reject statements unless I had proof that they were true During the case, I did not like to take decisions until I had a chance to look at all the available information While working on that case, I did not like having to make decisions quickly While working on that case, I liked to ensure that I considered most available information While working on this case, I waited to make decisions until I could get more information While completing that case, I actively sought out all the information that I could While working on that case, I searched for more evidence to improve my chances of getting the correct answers for the case While working on that case, I used all resources available to me to get all the information that I could

Digitalisation and professional scepticism of Swedish auditors 155 Table 7.5  Independent variable. Please rank to which extent you agree with the following statements 1 = Not at all, 10 = Very much CA1 CA2 CA3 CA4 CA5

While working on that case, how much did you rely on CAATs when testing samples? While working on that case, how much did you rely on CAATs in the evaluation of inventory existence and completeness? While working on that case, how much did you rely on CAATs when identifying journal entries and other adjustments to be tested? While working on that case, how much did you rely on CAATs in the aspect of internal controls? While working on that case, how much did you rely on CAATs when evaluating fraud risk?

In measuring the independent variable Reliance on CAATs, we were inspired by a study by Janvrin et al. (2009). In total, five items were used to observe the variable (see Table 7.5). The questions were based on a ten-point Likert scale where 1 = Not at all and 10 = Very much. As with the dependent variable, we asked respondents to refer to the same audit of a complex nature that they have had in the last 12 months. The instrument was also pretested on a small number of auditors prior to its adjustments and use in the larger survey. Reliance on CAATs had a Cronbach’s alpha value of α = 0.906, which was above the normally acceptable Cronbach’s alpha value of 0.6 (Nunnally, 1967). Thus, we used the mean value of the answers to the five questions as a measure of the independent variable. We measured the moderating variable Trait scepticism relying on the Robinson et al. (2018) modification of the Hurtt’s scale (2010) and used nine items (see Table 7.6). The questions were measured by means of a tenpoint Likert scale (1 = Strongly disagree, 10 = Strongly agree). The three Table 7.6  Moderating variable. Scale: 1 = strongly disagree and 10 = strongly agree Interpersonal Understanding (IU) Self-Determining (SD) Self-Confidence (SC)

IU1 IU2 IU3 SD1 SD2 SD3 SC1 SC2 SC3

I like to understand the reason for other people’s behaviour The actions people take and the reasons for those actions are fascinating I seldom consider why people behave in a certain way I usually question things I see, read, or hear at face value It is not easy for other people to convince me I usually notice inconsistencies in explanations I have confidence in myself I am self-assured I am confident of my abilities

156  Andreas Jansson et al. dimensions of the measure were Self-Determining, Interpersonal Understanding, and Self-Confidence. As with the independent and dependent variables, we adjusted the scales after pretesting from 16 to 9 items. In contrast with the request for independent and dependent variables, the respondents were asked to think of themselves in general when answering the questions. Trait scepticism had a Cronbach’s alpha value of α = 0.773, which was above the normally acceptable Cronbach’s alpha value of 0.6 (Nunnally, 1967). Thus, we used the mean value of the answers to the nine questions as a measure of the independent variable. We used a number of control variables that have previously been shown to reflect professional scepticism of auditors: Big 7, Partner, Organisational tenure (cf. Bazerman et al., 2002; Carpenter & Reimers, 2013; Quadackers et al., 2014), and demographic variables such as Gender and Age (cf. Niskanen et al., 2011). Data analysis

Descriptive statistics, Pearson correlation, multiple linear regression analysis, and multiple linear moderating regression analyses were performed. To perform the latter, the independent variable (Reliance on CAATs) was standardised and multiplied by the moderator variable (Trait scepticism). Plots were then used to visualise and interpret the results (cf. Murphy & Aguinis, 2022). A simple slope analysis was performed to assess whether there were significant differences between the slopes. In order to assess the robustness of the model, we have reversed the independent and dependent variables, and explored whether professional (state) scepticism impacts reliance on the CAATs and whether this relationship is moderated by trait scepticism. This robustness analysis suggests that the alternative model tested does not provide results that are as robust as the initial model explored in this chapter. Methodological limitations

While the survey as a method has been instrumental in exploring the interrelation between different constructs of relevance for the auditing profession (e.g. Broberg et al., 2018) it has a number of limitations, such as simplification of complex concepts, use of demographic proxies for observation of behaviour as well as response biases. Moreover, we acknowledge that our study could suffer from endogeneity effects driving the results. While collection of the data at different points of time could have been one of the possible remedies, the anonymous nature of the survey did not allow for this. Given the limitations of this method, the findings of the study need to be taken with caution and understood as indicative rather than definite.

8

Being an audit professional in the digital age Amanda Sonnerfeldt and Karin Jonnergård

Introduction What does it mean to be an audit professional in the digital age? How do auditors feel about their professional selves coping with audit in transition? Digital technology is not a new phenomenon, but over the last four decades, it has changed and will continue to change the way we think, live, work, and learn (Schwab, 2016). Today, discussions on technology disruption are high on the agenda of the audit profession in the wake of the widespread diffusion of digital technologies and their evolution at an exponential pace, leading to the inexorable integration of technology in financial and business ecosystems. On the brink of a technological revolution, it is important to the profession that audit professionals be ‘future-fit’. That is, prepared with the skills, capabilities, and ethical orientation to perform the audit required for this dynamic business environment. In recent years, the large accounting firms have made unprecedented investments (billions of US dollars) in technology with the aim of assuming digital leadership and of developing and harnessing proprietary technologies to improve the quality and efficiency of the audit process.1 With new technology come promises on the delivery of high-quality, insightful audits that serve the public interest by enhancing trust, value, and confidence to meet contemporary societal challenges.2 Accordingly, the Big 4 firms have moved beyond basic data analytics and automating auditing work; their current set of available tools encompasses advanced and big data analytics and cognitive technologies.3 For example, PricewaterhouseCoopers (PwC) has developed Halo, an analytics platform that serves as a pipeline to AI and augmented-reality products. These technologies have the potential to further transform or even transmogrify the way in which auditors work. While some of these tools are widely used in practice (e.g., data analytics), many of them, particularly big data analytics and cognitive technologies, are still undergoing testing and are perhaps considered too radical for regulators to trust or lack the business case to implement. The digitalisation of auditing can therefore be described as both a reality and something imminent or ‘on the horizon’. DOI: 10.4324/9781003411390-10

158  Amanda Sonnerfeldt and Karin Jonnergård The enactment of new technologies in auditing has led to discussions on the reorientation of auditor expertise and the potential threat to audit as a distinct field of practice (Susskind & Susskind, 2015). For this reason, extant literature has centred on the collective identity reconstruction of auditors (e.g. Goto, 2021), institutional challenges, and the affordances of new technology (e.g., Salijeni et al., 2019, 2021), as well as the potential of such technology on the capacity of audit (e.g., Humphrey et al., 2021; Issa et al., 2016; Salijeni et al., 2021). Deterministic and socio-materiality perspectives are often adopted in accounting research, focusing on how technology leverages human action and the interaction between the social and material aspects of technology use, respectively (cf. Orlikowski, 2007). The human-centred perspective, however, has often been overlooked. Hence, the aim of this chapter is to address how auditors feel about their identity as audit professionals in the digital age. Drawing on a human-centred perspective, it is important to emphasise that technology is not black-boxed but rather understood to be different contingent upon the different meanings assigned to it and the different ways in which auditors engage with it. The chapter therefore stands in contrast with studies that assume technology to be largely exogenous and performing as intended. Motivation Entering the fourth industrial revolution, the maturity of cognitive technologies, such as visual recognition, textual analysis, and natural language processing, is providing opportunities for their application to auditing as well as to other assurance services (Crawford, et al., in this volume; Öhman et al., in this volume). New audit technologies are emerging, for example, big data analytics in risk assessment; continuous control monitoring systems, AIenabled reviewing, and extracting of relevant information from contracts to reduce laborious human efforts, among others (Issa & Kogan, 2014; Issa et al., 2016). While these developments provide dispositional and relational affordances (Salijeni et al., 2021), and the capacity to transform the audit (Humphrey et al., 2021), practising auditors are often expected or presumed to have adapted to the epistemic changes, as well as acquired new skills and competence to work with new technologies to maintain their legitimate standing as professionals in society. What is often forgotten is that auditors using these tools are usually not the people who have chosen to introduce the technology into the sites of practice. Given the objective, technocratic nature of the audit, and the organisation of audit work particularly in transnational accounting firms, the individual auditor tends to be sidelined as a professional. This chapter fills this void by attending to how auditors feel about their professional identity during this transition. Professional identity can be defined as an auditor’s self-definition as a member of a profession associated with an enactment of the individual’s role in the context of his or her work (Chreim et al., 2007; Ibarra, 1999).

Being an audit professional in the digital age 159 Research on professional identity involves studying the professional’s selfin-role, including the ‘goals, values, beliefs, norms, interaction styles and time horizon that are typically associated with the role’ (Ashforth, 2001, p. 6). In accounting research, studies have focused on the individual’s subjective interpretations of what it means to be a professional or member of the accounting profession. Extant literature draws attention to traits and attitudes, most importantly independence, knowledge, expertise, and how an auditor presents oneself (e.g. Anderson-Gough et al., 2002; Gendron & Suddaby, 2004). Research on professional identity has highlighted the strong connection between the work professionals do and the way they view their professional selves (Chen & Reay, 2021; Pratt et al., 2006). An auditor’s feeling of security about his or her professional identity is in essence based on the trust auditors have in the underlying knowledge, principles, and values that underlie their system of expertise. In the context of the modern audit, expertise embodied within the professional, the firm, and different commodities act together in mutually reinforcing ways when the audit is performed (Abbott, 1991). Hence, when faced with significant changes that have the potential of transforming the way audit is organised and performed, auditors may feel insecure and ambivalent about the trust relationships, assumptions that underlie their system of expertise, and their professional selves. This phenomenon of auditors’ feeling uneasy about the basic characteristics of their professional identities is termed professional insecurity in the accounting literature. To delve into this phenomenon, we designed a qualitative exploratory study based primarily on interviews and supported by presentations by the accounting firms, documents, and Internet sources. These firms were chosen due to their heavy investment in technology, thus constituting sites where the impact of technology is significant. The interview responses were collated and analysed using a thematic analysis (see Appendix). Adopting a human-centred perspective, we allude to the view that new technologies do not enter an occupational field fully defined but are constituted within the context (Leonardi & Barley, 2010). For this reason, we envisage that each interviewee would experience technological changes in the audit differently. Hence, we do not define a specific technology that is driving audit change but instead allow interviewees the voice to convey the audit technologies they encounter, and experience as having shaped their daily work. Using theory and literature as a means to sensitise us to, and enhance our understanding of, this phenomenon, we shift iteratively between the themes initially generated from the data and potential theoretical concepts. Through this process, we identified professional insecurities (Gendron & Suddaby, 2004) as a relevant theoretical concept to analyse and present our findings. It is important to note at this juncture that while the term insecurity may carry negative connotations in colloquial use, we adopt professional insecurity as a means to better understand this phenomenon and bring to light issues that inform research and policy when audit is in transition.

160  Amanda Sonnerfeldt and Karin Jonnergård Literature review To frame our analysis on how auditors feel about their professional selves, this section explains the concept of professional insecurities and presents a review of literature on the influence of disruptive technology on audit work and its implications for the professional role and identity of auditors. Professional insecurities

The concept ‘professional insecurity’ was introduced by Gendron and Suddaby (2004) to capture the effect that changes in the accounting profession had on Canadian chartered accountants’ professional identity shortly before the debacles of Enron and Andersen. The authors defined professional identity as a set of traits that are seen as the core of being a member of a given profession. This included expert knowledge, presentationism, attitudes, and points of view on professional matters. Through their interviews with 15 experienced chartered accountants in Canada, the authors established that the accounting profession was then experiencing professional insecurities. The insecurity was related to three core issues, namely: auditor independence, the capacity of the profession to attract and retain members, and the increasing work diversity as accountants become involved in domains far from their core discipline. Drawing on Anthony Gidden’s theorisation on the importance of ontological security and the role of trust and systems of expertise in modern society (Giddens, 1990), Gendron and Suddaby (2004) introduced and elaborated on ‘professional insecurities’. Professional insecurities refer to auditors’ feeling of uneasiness about the basic characteristics of their professional identities, which may be related to ‘ambiguity, confusion, lack of confidence, or discomfort4 about one’s professional identity’ (Gendron & Suddaby, 2004, p. 86). While the aforementioned study concerns professional insecurities at a collective level, the concept has been further elaborated to apply at the individual level. In the context of change, individuals tend to assess the significance an experience has on his or her identity and determine how to respond to it (Smith, 1991). Previous studies have shown that professional identity is relatively stable due to the esoteric knowledge and skills acquired and held through a long education and socialisation process (Abbott, 1991). However, individuals respond to changes, particularly if they perceive that a change would devalue an identity in the future or make the association between identities and their meaning unsustainable, thereby limiting an identity’s future enactment (Petriglieri, 2011). In a study set in the context of the merger of professional associations in Canada, Guo (2018) established that it is through the lens of professional security or insecurity that accountants develop a subjective understanding of their position and experience in their professional lives. Extending the work of Gendron and Suddaby (2004) on professional insecurity relating to a profession’s jurisdiction and systems of expertise, Guo (2018) identified professional insecurities with respect to accountants’ social footing

Being an audit professional in the digital age 161 in the professional world and competitiveness in the job market. His work highlights their feelings of uneasiness of their professional selves pertaining to their inability to differentiate themselves from other accountant groups, their future professional lives and the cognitive and emotional investment they have expended in the past that did not yield definite returns. The aforementioned studies sensitise us to the importance of the understanding of context within which change takes place and the way by which the professional perceives and appraises the changes. It also highlights that professional insecurities can be analysed at a collective as well as an individual level. Understanding audit work in the context of disruptive technology

Understanding audit work in the context of disruptive technology calls for consideration of the way modern audit is organised and performed. According to Abbott (1991), expertise can be embodied in three forms: commodities, organisations, and professionals. With the rise of global accountancy firms and technological development in the last few decades, audit expertise traditionally embodied in ‘human professionals’ is shifting towards accounting firms (organisations) and commodities. Expertise in organisation refers to the division of work within the accounting firm, such as multidisciplinary teams for auditing, allowing for the capitalisation of economies of scope to assemble audit teams suitable to the idiosyncrasies of each audit engagement. The expertise embedded in commodities includes expert systems where algorithms and routines are written into software; robots that are programmed to perform routine rules; or process-based audit activities according to auditing standards implemented via firm methodology; etc. The three forms of expertise interact as a system that constitutes the foundation for performing the audit. This system of expertise importantly includes substantive forms of know-how, rules pertaining to performing the audit (auditing standards), norms, and routines for reproducing expertise, which together play a fundamental role in allowing society to trust the audit, and, for the professional, it serves as a foundation for professional security. Accountancy firms are therefore not only employers but over the years have given meaning to work and conferred identities to individuals (Broberg, 2013). In recent years, investment in technology has been a strategic focus of transnational accounting firms, driven by external factors (e.g., competition, technological advancements) as well as the firms themselves (to improve global audit methodology, consistent and high-quality audit, strategic partnerships to improve services). These forces have an impact on organisational practices and audit technologies which are changing the role of auditors and their daily work. Research on disruptive technology in auditing is not lacking. Many articles are conceptual or normative in nature, putting forward the capacity of new technology to potentially shape auditing to improve its efficiency and quality (Issa et al., 2016; Kokina & Davenport, 2017; Öhman et al., in this volume). Studies on the actual use of these technologies – the way in which

162  Amanda Sonnerfeldt and Karin Jonnergård audit work is affected as a result – are few, however, as it is a relatively new focus (Eilifsen et al., 2020). One exception is the exploratory study on the application of new technology by Salijeni et al. (2019). Interviewing 20 individuals who have been actively involved in Big data and Data Analytics (BDA) including auditors from large and mid-tier firms mainly from the UK and audit regulatory bodies in Europe, the article provides empirical insights into BDA from the perspective of auditors. Salijeni et al. (2019) found that BDA has provided a basis for widening the scope of services offered to clients, including those that are more advisory in nature within the limits of regulation. Importantly, BDA use is changing audit methodology, affecting the processes of planning, evidence collection, testing, and reporting. In addition, the increased data availability and mobility enabled repetitive tasks to be delegated and performed at shared service centres. In another exploratory study, Eilifsen et al. (2020) performed a questionnaire involving 216 engagement partners and managers in Norway about their perceptions of data analytics and their use in 109 audit engagements. They found that the use of data analytics is relatively limited; more advanced data analytics are used possibly for clients with integrated ERP/IT systems and are therefore rare. The authors elaborated on its use in the planning, substantive testing, and the completion phases of auditing (Eilifsen et al., 2020). The above studies highlight that audit is transforming and that auditors are to varying degrees starting to feel the impact of technology, particularly data analytics, on audit work. Extant literature has raised concerns in three areas: namely, competence, ethics, and independence, all of which are core to the profession’s system of expertise. Firstly, due to rapid technological advancement, the types of competence needed for auditors to remain experts in the auditing field have been questioned (Backman et al., in this volume), in particular, when there is a lack of guidance in International Standards on Auditing (ISAs) pertaining to the use of such tools, and when growing tensions between auditors and data specialists are present (Salijeni et al., 2019). Secondly, owing to BDA’s potential to reconfigure audit and client relationships, concerns have been expressed as to how this development would test the boundaries between auditing and consultancy (Salijeni et al., 2019). Thirdly, there are ethical concerns connected to AI-enabled audits, which, if left unresolved, could negate the anticipated benefits (Munoko et al., 2020). The limits of technology have also been widely discussed by both the profession and academia, stressing that auditing demands professional scepticism and judgement, cognitive abilities of humans that are believed to be irreplaceable by machines at least in the foreseeable future (Tiron-Tudor & Deliu, 2021). Professional identity of auditors in the new digital era

Literature on the relationship between professional identity and technology has shown that the way in which professionals experience and interpret technology changes plays an essential role in how they reconfigure their

Being an audit professional in the digital age 163 professional identity, where new identities emerge through new practices and boundary negotiations (Barrett et al., 2012; Goto, 2021; Nelson & Irwin, 2014). Most relevant to this study, Goto (2021) found that, notwithstanding the potential threat of artificial intelligence, auditors framed their professional transformation as a manageable ongoing process by developing their collective-level professional role identity to include aspects of the technological changes and thereby protect their profession. Based on textual analysis from professional publications and 42 interviews with auditors from Japan and the large accounting firms, Goto (2021) established that technology, as interpreted by audit professionals, forms an integral part of their multidimensional identity themes. The themes that emerged include: the auditor as a productivity maximiser and collaborative facilitator (enhancing managerialism); the auditor as data-empowered advisor and analytics user (enhancing professionalism); and the auditor as continuous self-disruptor and guardian of capital markets (sustaining professional legitimacy). These identity themes enacted a new constellation of managerial and professional logic that framed the audit profession’s future positively. With the focus on professional identity reconfiguration, Goto (2021) illuminates the new roles and identities auditors perceive as emerging from disruptive technology at work and how they reconstitute their professional identity as a collective. Less attention is paid, however, to the individual auditor and how they feel about their professional selves, which is essential to understand the basis behind their identity work (why). This chapter makes three potential contributions to the above literature. First, it answers the call for more qualitative interview-based research to explore and understand how auditors are experiencing audit transformation and sustaining a coherent sense of self-identity in their day-to-day work-life. In contrast to the above studies that have interviewed auditors leading the change, we interviewed both auditors leading the change and ‘ordinary’ auditors. Second, this study draws on the concept of professional insecurities to analyse how audit professionals as individuals feel about their professional selves both as a collective and as individuals during this transition. Third, we complement studies on identity work by taking a step back to provide a foundation regarding how and why auditors are renegotiating their expertise and reconstituting their professional role identities in this digital age. Results This section is structured in two parts. The first part presents the auditors’ perception of a change in the identity and role of auditors resulting from technological change, or envisioned change in the way in which audit is performed. The second part utilises the concept of professional insecurities to analyse how auditors feel about their identity as professionals at the collective and individual levels.

164  Amanda Sonnerfeldt and Karin Jonnergård Audit-in-transition – Professional role and identity of auditors

What does it mean to be an audit professional in this digital age? Most interviewees explicitly state their professional role as being, at its core, to deliver trust in financial statements and the importance of maintaining independence. Interviewees maintain that the fundamental audit and their role in this regard have not changed but rather, in the digital age, the way in which audits are performed is transforming. When asked how they saw themselves as a ‘X (firm name) professional’ in the digital age, the quotes below capture the sentiment of many interviewees. Honestly speaking, I don’t think that is a significant difference between auditors from the Big 4…we have a breadth of knowledge, we work with both large and small companies. (Interviewee B) In the last 10 years however, within the firm, we had let go a group … if one does not want to be part of the development, one cannot stay…, our job is ever-changing, we need co-workers that are ready to take up new challenges, those that seek security and stability doing mundane jobs should not be here. (Interviewee B) With standardisation of audit to prepare for future changes, …we cannot have those that decide, ‘for my clients, I will do it differently’; this does not fit in with the new way audits are organised. (Interviewee C) While preserving the traditional role of the auditor, the above quotes illustrate that auditors identified themselves as a ‘Big 4 firm auditor’ and ‘a dynamic auditor’ in the context of changing technology. Interviewees did not identify strongly with their individual firms per se but rather identified themselves and accentuated their positions through two pecking orders: Big 4 firms versus Non-Big 4 firms; dynamic versus non-dynamic auditor. The former is illustrated by the quote from interviewee B that the Big 4 firm has a system of expertise (cf. Abbott, 1991). This system enabled economies of scope in training where auditors could leverage knowledge from performing audits of large companies to apply to audits of smaller companies. In addition, it allowed for greater exposure and work with specialists from other divisions (particularly in this case, the risk and advisory with information technology (IT) and information systems (IS) expertise) compared to midsize or smaller accounting firms. The latter indicates that auditors identify themselves, as dynamic and continuous self-disruptors (Goto, 2021), to have a legitimate place in the Big 4 firm.

Being an audit professional in the digital age 165 To better understand the professional’s self-in-role from a human-centred perspective, we asked the interviewees to describe how they have experienced alterations in their work and role resulting from technological changes. It is beyond the scope of this chapter to present the detailed changes experienced by each interviewee. We highlight below important changes experienced by auditors which can be classified into changes pertaining to organisation, performance, and communication (including presentationism) of the audit which have implications on their professional role. When describing the changes individual auditors experienced in the way audit engagements are organised, interviewees from a few accounting firms mentioned the beginning of the standardisation of the audit process and the establishment of delivery centres, which perform the mundane and repetitive audit tasks that used to be performed by audit associates. We had an organisation looking like a pyramid with a lot of juniors doing all these repetitive tasks. I would say that we are changing – shifting the pyramid upwards because we will have robotic automations doing these basic tasks. We need more people that could help us to analyse and apply…we will look more into skills in the teams – more people engaged in a team, more specialists being very, very good in their area of expertise. (Interviewee N) The quotes resonate with Abbott (1991) on the rise of organisational expertise and the commodification of auditing. This is further supported by other interviewees stressing the shift to more focus on the skill in interdisciplinary teams with the appropriate knowledge, with more specialists engaged across borders and areas of expertise given the affordances provided by communication and network technologies. Auditors perceive that they play an important role in assembling the right toolkit. Our internal methodology changed a lot, about 6 years back, we had 2 or 3 tools we could use for data analytics but now we have an amazing toolbox with a lot of digital tools, …. we need to decide on the appropriate tools to use. (Interviewee I) While there is an array of tools developed at the corporate level in the Big 4 firms, there are also tools developed in the Nordic region to better suit local businesses. The mid-tier firm we interviewed has developed digital tools suited for the type of clientele they have. Auditors are accustomed to orchestrating or acting as ‘project leaders’ of multidisciplinary team. In the digital age, the auditors’ role as infrastructure bricoleurs – e.g. putting together specialists, teams, digital tools, and work from delivery centres – is perceived to be ever important. Interviewees at the

166  Amanda Sonnerfeldt and Karin Jonnergård manager and partner levels also emphasised the importance of their role as a human or social being essential to building relationships of trust and confidence with their clients and service orientation towards co-constructing value of the audit. In general, when sharing their insights on how they have experienced changes in auditing, most of our interviewees refer to communication platforms and their work with data-analytics tools. Only the partners and two managers we interviewed mentioned BDA and artificial intelligence. Hence, like Eilifsen et al. (2020), we found that advanced data analytics are rare, and most interviewees do not anticipate disruptive changes in the very near future as systems are still undergoing testing. A few of our interviewees from the Big 4 firms estimate that they are using 20–30 per cent5 of the technological capacity of the firm at the global level, where usage has been contingent upon: the teams learning to use the tools, compliance with regulation and IT development on the end of the clients. So even though the perceived identity was a dynamic and continuous self-disruptor, the traditional auditing practice is not expected to change in the near future. In the course of conducting the audit, most interviewees explain that technology has enabled transfer of data and the client companies’ transaction history digitally but qualify that it does not diminish the importance of their social/human role via face-to-face meetings with the clients essential to building trust and relationships. Most of the changes were felt during the evidence collection and testing phases of the audit. Interviewees for the most part stress the functional use of algorithmic tools that systematically extract and analyse large and diverse data sets to facilitate the identification and visualisation of patterns and connections that might otherwise not be visible but that may provide valuable insights when conducting the audit. While recognising these affordances, interviewees continually stress the importance of understanding the business, experience, professional scepticism, and judgement, which they perceive to be embodied in human expertise (Abbott, 1991) and central to their professional role. It allows time to focus on what matters and where it is necessary. I am not saying that the tools are doing our thinking, but they get us to do the thinking rather than doing a lot of data – not letting data kill the story. (Interviewee A) Professional judgement is something you need to learn. Analytics, artificial intelligence, or a robot is never going to help you with that. You need to make your judgement based on your understanding of the client, the risks, who are the stakeholders, etc. Ten years ago, it took me like eight hours to get the materiality calculation I needed to make my judgement. Today, you get that presented directly. So that you can spend more time focusing on what matters when making a judgement. (Interviewee A)

Being an audit professional in the digital age 167 In the context of the ongoing reconfiguration of the audit process, interviewees stress their role as quality controllers ensuring that the data to be used in the audit process is reliable and that technological tools are used to provide input to aid but not replace professional judgement. One interviewee further highlighted the way in which auditors feed into the learning of machines. Describing the modern audit, interviewees mention the transformation of the workspace and image of the firm creating a modern tech-savvy appeal. Capturing the sentiment of how auditors see themselves at work (in a general sense) in a digital era are the following quotes: ‘we did the renovation of our office; we basically removed all our kind of paper-based archives; we don’t have any physical files. Everything is digital.’; ‘no more paper binders, papers and taxis to clients’; ‘partners, seniors, and associates – we don’t have our own rooms but sit and communicate in an open space, what we need are in the cloud or in our laptops’; ‘we didn’t have wifi the same way, so we brought some kind of router to the clients. I mean, it’s only seven years ago so it sounds odd now. Technology-wise, it has actually changed, even if it doesn’t feel like it.’ Through our interviews, we obtain insights into how auditors understand their role as project managers facilitating communication between members of the engagement team (auditors and specialists), and with their clients, capitalising on relational affordances via communication platforms in the course of the audit. Auditors at the manager level described their role in line with two of the roles defined by Goto (2021). First, as collaborative facilitators, e.g. communicating between delivery centres to set up the audit file, requesting documentation from clients via shared communication platforms, and, second, as empowered advisors, e.g. being in a position to convince clients about significant issues given the capacity that technology has enabled regarding testing of greater scope and depth and visualisations enabled by descriptive, diagnostic, and predictive analytics. A couple years ago, it would perhaps be enough just to show a printscreen of a tool to our clients that we have looked at these many transactions and we have done these kinds of analysis to your bookkeeping. I would say already today and definitely in the future meetings will be more interactive. We will bring the tool to the meeting…the client will challenge us and say, ‘Oh, if we look at that account in that period and that date, what will you see then?’ It will be more interactive in the future than a one-way presentation. (Interviewee N) Professional insecurities in the digital age

The above findings show that auditors identify with their traditional role, which most perceive will withstand technological changes in the near future due to audit regulation and other constraints affecting the pace of diffusion.

168  Amanda Sonnerfeldt and Karin Jonnergård However, not all auditors are at ease with the transformation of audit through leveraging digital technologies and their emerging roles in the digital era. In particular, auditors are experiencing the growing importance of their roles as collaborative facilitators, quality controllers, infrastructure bricoleurs, and as human beings having the social and affective skills, expertise to make judgement over machine, and to provide input to machine learning. Notwithstanding the affordances of digital technology providing the capacity to harness the power of data to deliver potentially better-quality audits, audit professionals are experiencing professional insecurities at both the collective and individual levels. This is predominant when the emerging roles are perceived to be incoherent with their systems of expertise, which has implications on how they feel about themselves as a professional. Professional insecurities at a collective level

At the collective level, interviewees depicted uneasiness in trusting their own systems of expertise and about the future-readiness of the audit profession. To recapitulate, in the domain of auditing, systems of expertise refer to the essential expertise embodied in humans (the professional and norms), organisation (firm and multidisciplinary teams), and commodities (audit technologies), which together provide a foundation for professional security (Abbott, 1991). The partners and managers we interviewed expressed trust in their firms’ strategic direction (e.g. ‘X(firm name) Sweden is one of the leading countries in the area of digitalisation’; ‘X(firm name) is leading transformation aspiring confidence and trust’ etc.), methodology, and training programs. However, we find cues suggesting uneasiness in trusting the new and developing digital tools. Sentiments are captured by the following interview quote in the context of providing an audit opinion: I need to have trust that the digital tool gives what it supposed to deliver. We are a global firm, these tools developed at the global level are well tested …I need to dare to trust and buy in on what the corporate office says – that these systems are trustable. I do not have sufficient knowledge to evaluate them but have to accept them. (Interviewee B) The interviewee continued to talk about how insecurities caused by rationale distancing are handled through experience, accounting technical competence, and knowledge about the industry and clients. S/he further stressed the importance of critical thinking being the core of auditing, whether audit tasks are done manually or through digital tools. While such sentiments are shared by other interviewees, three interviewees expressed concerns about keeping up with their clients’ new assets (e.g. crypto currencies), new risks and challenges in terms of new business models, information-technology infrastructure upgrades, developments in accounting processes, internal control

Being an audit professional in the digital age 169 systems and regulation in order to be ‘digitally-fit’ (Interviewee J), thus undermining the confidence to engage in critical thinking, making informed judgements and the auditor’s role as a quality controller. We asked auditors at the manager level about their experience with new digital tools introduced by corporate office, one interviewee responded: It sounds very promising talking about diagnostic, predictive analytics, and data lakes. I guess, I’m a bit divided, because it’s a lot of talk about analytics and artificial intelligence and seeing patterns that neither we nor the client knew existed. All of that is great, but I have had other engagements where we tried more analytics but it’s actually hard. (Interviewee O) We more or less have to use them…We’re struggling right now. I guess nobody in our office would use it if we weren’t forced, …we have this other tool, we know how it works. It’s not perfect but we are always cautious in using it. But when we compare it to this new system that nobody understands, the old one feels safe. (Interviewee E) The interviewee further reflected relying on his or her own resilience, knowledge of rules, and understanding of the concept of the audit to ease the ‘unsafe’ feeling. I guess I’m comfortable. I just have to understand it. I’m confident that when I understand it, I will manage to use it. A lot of it is – what happens if I click here or there? In the audit, nothing should change because we still follow ISAs. I am no longer in my thirties, so I’m comfortable and I believe in myself, that I will manage to understand it somehow. (Interviewee E) From the above, we see indications of professional insecurities where professionals doubt their systems of expertise within not only themselves but their colleagues and technologies undermining their capacity to perform their traditional professional and emerging roles. This, however, does not indicate that the professionals are insecure about themselves, shown by the manner in which they draw on individual experiences to handle changes. Interviewees were also concerned about how digitalisation is affecting the trust relations and tensions within multidisciplinary teams: To trust that everything works as it should, most importantly, I have to have confidence in my colleagues that deal with the IT side and data experts. They do not always understand accounting, that’s probably one of the problems. (Interviewee H)

170  Amanda Sonnerfeldt and Karin Jonnergård A risk is that teams can become too large, too many specialists working in their respective areas. Connections between the work of various specialist and implications for other parts of the audit might be lost. I need to have confidence in specialist colleagues; pertaining to this, I am nervous that we might lose the holistic perspective. (Interviewee C) Apart from concerns about the specialists’ lack of understanding of accounting and the growing size of teams and the fragmentation of analysis, interviewees also voiced concerns about the quality of work of shared service centres, as well as the knowledge, skills, and experience of new hires and gaps in training. Digitalisation and the transformation of audit work have enabled new hires (in audit and assurance) to pursue an expedited career path: the opportunity to be involved in more complex work involving professional judgement earlier in their careers. There is a presumption that through the firms’ training programmes, audit associates can reap economies of scope in learning and move up the experience curve. Reconciling the general ledger to the accounts receivable ledger, nine out of ten times it matches. I would say that you won’t learn anything more from doing that a third time. So, if it could be done by a robot or some other automation solution, you could instead focus on why it doesn’t match…We are moving more into the more complex analytics analysis quickly, with all this technology, hopefully we are making the job more interesting, challenging, and worthwhile. (Interviewee N) Audit associates of the firms we interviewed spent at least 70 per cent of their time training on the job and the remaining time in classrooms or e-learning modules. The training programme covers the basic core accounting subjects and more advanced areas of specialisation. Despite the intensive and rigorous training program, our interviewees expressed concerns on the knowledge foundation and the future-readiness of new hires. We have taken away some of the more routine jobs via delivery centres and automations. Basically, the first year has been taken out; it is an opportunity of a lifetime to come in and do the challenging and fun jobs earlier in their career. There is a risk or gap that they might be unable to take a step back and see things from a holistic perspective. (Interviewee C) I see it as a risk. If they don’t have the foundation, it’s hard to come in directly at this level; a number of our new hires are unable to see the relationship between the income statement and balance sheet, … this

Being an audit professional in the digital age 171 is when universities need to come in to help them with this experience that they may not be able to get from us as in the past. (Interviewee B) Several interviewees expressed apprehensions that, while trusting training programme within the firm, the trade-offs between training and efficiency could undermine the future-readiness of audit professionals. We are trying to achieve efficiency always, when we utilise data analytics – we know who in the engagement team knows the tools. He or she will be assigned those parts. In the next year – the same person will do it again. For example, if I do it, it will go very fast but that is not the idea. Now I have the opportunity to teach my colleagues to be as good… giving them a chance to try and support them – that is the cornerstone in training, especially in data analytics. (Interviewee I) Some interviewees, particularly more junior auditors with a specialisation in data analytics, expressed concern and disappointment with the uneven level of knowledge throughout the firm or the lack of competence by some partners or managers, which could undermine the future-readiness of the profession. We picked up cues such as ‘They struggle with these tools’, ‘you need to have a bit of interest, otherwise it is hard to learn’, ‘their knowledge could be better’. Interviewees L and M indicated that implementation of new digital tools is dependent on the interest of the leadership in the various offices. Interviewee J, who works in a smaller office, indicated a similar situation in the Big 4 firm. In contrast, other interviewees expressed frustration with the constraining nature of regulation and requirements provided by ISAs which has hindered the implementation of digital tools and caused duplication of work and redundancy. Many interviewees mentioned that even though data analytics allow audit testing to be performed on the population of data, sampling is still carried out in order to comply with ISAs. Interestingly, interviewees did not have a common vision as to what it means to be future-ready. This has been dependent on how the individual perceives his or her professional role and the necessary skills and knowledge needed to perform that role. Some interviewees mentioned that the audit profession will be more heterogeneous – auditors specialised in financial accounting, and auditors specialised in digital tools and information: Today we are both auditors but also advisors, analysing and interpreting data. We need diversity – those that are knowledgeable in IT s and those that engage in client-facing time. Both can be auditors – ‘back and front’ – who are different. In audits of large companies, we need more specialists. Auditors do not know everything. (Interviewee B)

172  Amanda Sonnerfeldt and Karin Jonnergård Another interviewee envisioned that the future auditor would need to be ‘an expert in both areas’ (Interviewee A). Standing in contrast is another interviewee who mentioned: I strongly believe that whatever skills we have that makes us uniquely human are the ones that will matter most and are the ones that will increase in importance as we move along. (Interviewee J) The lack of a common vision creates uncertainty and confusion and could undermine the development of the profession and present difficulties for individuals to identify with or feel part of the profession. Profession insecurities on an individual level

Findings from our interviews indicate that, individually, the auditors were at ease with the physical transformations in the office and the tech-savvy image they project enabled by computer technology. However, interviewees experienced professional insecurities owing to their weak foundation in IT/IS knowledge, and the decoupling between claims and audit practice. For an auditor, possessing certain knowledge and skills (university degree, on-the-job and off-the-job training, professional exams) is regarded as essential and necessary in constituting his or her professional identity. Our findings reveal that auditors who are actively involved in digital transformation or have had education or training in information systems and data analytics were more at ease with their professional selves when enacting their role in an audit engagement. Interviews with managers and audit associates have indicated uneasiness with domains that are conceptually distant from financial accounting and auditing. As reporting organisations’ IT infrastructure and information systems increase in complexity, and internal controls become a more important part of auditing, interviewees indicated growing uneasiness with their lack of fundamental skills to understand IT systems, IT general controls, application controls, and GDPR rules albeit the support of the risk advisory departments of the firm. We have to understand clients’ IT systems and how information flows through the systems, where it comes from, where it can be manipulated, etc. To be honest, it’s very hard to understand for a person who just has a business background…I think it’s central, we as auditors should understand it in a better way than we do. It feels still like it’s a section of the audit file that just has to be filled in. (Interviewee E) Risk advisory performs the IT audit. I think they are trying to push some parts down to the audit teams, but I don’t have that knowledge.

Being an audit professional in the digital age 173 So, I’m trying to push it back… sometimes we get the IT deficiencies from the group if it is an international client, we need to find mitigating controls to bridge these IT deficiencies and that’s really hard for us because I need to read the deficiency report like five times before I even understand it. (Interviewee F) The lack of knowledge in areas related to digital accounting has also led to associates being doubtful of their education and career choices, and professional insecurity as to their current and future roles. Captured by this quote from an audit associate: I’m interested in data analytics, but the thing is, I don’t have that knowledge. The first question they (referring to the associate’s mentor) ask is – what do you know about it? …So now, they recommended a course that I should take in Visual Basic, which is step one. … but it will take quite a lot of time to finish the course since I’m working at the same time. The thing is, I cannot help without it. (Interviewee H) In the transition process, auditors further expressed uneasiness about their professional selves due to the decoupling between claims (e.g. on the firms’ websites, social media, during the tender process) and the routine day-to-day practice of auditing. Happening in conjunction with efforts to modernise the audit is the implementation of new EU regulation on mandatory audit-firm rotation, where firms have to engage more intensively in the tendering process. A few interviewees expressed doubts if such messages depicted actual practice and felt an ethical dilemma and obligation to walk the talk. Reflecting on the presentations on the digital tools during the tender process, interviewee E noted: … I am a bit at odds… I think that if it (audit technology presented) would work the way we said, that would be great. I just haven’t used it like that. I mean, we have data analytics, but we still handle them manually, maybe there is a lot of computer stuff going on but at the end of the day, what I get is just an excel file with the result and I filter it myself and I draw conclusions from it by myself. Another interviewee reflected on the firm’s website expressing uneasiness about actual usage of digital tools and the difficult trade-off between efficiency and following regulations: When I listen to (firm name) marketing and when we talk to clients, to a large extent, we are saying – with data analytics we achieve greater efficiency. Perhaps it is not efficiency but rather a better-quality audit that should be emphasised. Our internal methodology has changed to

174  Amanda Sonnerfeldt and Karin Jonnergård be adapted to data analytics tools, but it is not that big of a change. It is sometimes contradictory. We say that we are going to use data analytics and analyse the whole population in order to be more efficient and move away from sampling, but still, we do a lot of sampling. As the regulations say, we need to sample. (Interviewee I) Audit associates have also experienced professional insecurities due to uncertainty and confusion as to the perception of auditor’s role and the associate’s lived day-to-day experience fulfilling that role. While it has been mentioned that associates have a faster career path and actually do a lot of qualified audit work earlier in their careers, not every associate shares the same experience. It’s nothing quite implemented yet as much as I would have imagined it to be. Yes, they were like working on robotics and all of that. … but you need the business case. Also, for smaller clients, you cannot use it at all… You have to have like a big client with very standardised process. (Interviewee H) Conclusion and implications In the digital age, audit professionals are living their role and experiencing the technological transition very differently. Despite the affordances of digital technology providing potentially better-quality audits, some auditors are experiencing professional insecurities – uneasiness about their professional selves and the future-readiness of audit professionals. Notwithstanding the discourses surrounding the auditors’ confidence in the firms’ methodology and processes, and the pertinence of professional judgement when performing the audit, many interviewees expressed concerns both in terms of the development of the audit profession as a collective as well as audit professionals individually. With regard to the former, professional insecurities manifest in the lack of trust in systems of expertise particularly uneasiness in trusting machines and scepticism on the limits of new technology. There are also concerns regarding that deskilling of the next generation due to inadequate foundational knowledge and the commodification of expertise, and the drawbacks of specialisations will lead to auditors losing the holistic perspective in understanding the business. Nevertheless, professional security is sought through current practice routines (e.g. testing and professional judgement), experience, and knowledge of ISAs. At the individual level, audit managers and associates in particular reveal insecurities about their own foundational skills in information technology. This, in turn, has led to frustration and inefficiencies when working with and understanding clients’ IT systems, despite the presence of IT specialists in the accounting firms. Audit associates further express uncertainty about their

Being an audit professional in the digital age 175 professional life trajectories including their careers, education, and training. Auditors further expressed uneasiness about the decoupling between the claims from the audit company and actual practices. This has put individuals in an ethical dilemma and created self-imposed obligation to walk the talk. We recognise that this is an exploratory study with limitations regarding the number of interviews we conducted. In the interviews, it was also difficult to isolate the effects of digitalisation on the audit, as the transformation of audits is driven in conjunction with other forces. Nevertheless, understanding professional insecurities as audits transform offers important insights and points of reflection pivotal for both the audit and auditors to move forward. Findings have research, policy, and practical implications. First, focused on the audit professional, it opens the agenda for more research, for example:

• How are auditors working in different contexts experiencing the digital • • • •

transformation, e.g., auditors in small firms, auditors performing assurance on sustainability information? How do different actors (e.g., professional associations, accounting firms, regulators) envision the role and expertise of a future-ready audit profession? How has digital transformation affected trust between auditors and their stakeholders? How and why are auditors renegotiating their expertise and reconstituting their professional role identity in the digital age? Do auditors possess the knowledge and expertise required in the digital age? Are the learning outcomes developed by the former International Accounting Education Standards Board (IAESB) relevant? What competencies and training are needed for auditors, particularly mid-career auditors? What role can universities play to advance digital competencies of future auditors?

It also provides a basis for research using other theoretical perspectives, including comfort theory (to develop an understanding of the processes by which audit produces comfort in the context of technological change), institutional theory (drivers and constraints of technological diffusion), sense-making theory (how professionals make sense of their identity in the digital age). Second, it subtly reminds accounting educators to proactively respond to the shift in the ways that expertise is and will be embodied and institutionalised. In this study, interviewees have alluded to the need for the next generation of auditors to have:

• knowledge of data analytics, Excel, statistics to work with large sets of structured and unstructured data;

• understanding of risk related to information systems and internal controls; and

• social competence to build trust relationships in order to lead and coordinate engagement teams in the digital age.

176  Amanda Sonnerfeldt and Karin Jonnergård Accounting educators, both in academia and in firms, have an essential role in rethinking and developing a more comprehensive and integrated competency framework. Such a framework is crucial to develop the present and potential audit professionals in their skills, capabilities, and the ethical behaviour required in the digital age. Third, this study cautions us against complacency and to step up efforts to develop a future-ready profession to help society tackle contemporary challenges. Recognising professional insecurities can be viewed positively as a call for action. Understanding reasons underlying professional insecurities during this transition period provides a basis for the profession to engage with stakeholders to develop a common vision of a future-ready profession and to institute changes to build capacity to harness technological developments to improve the quality of audits. A common vision also enables more fitting recruitment and training policies, which would guard against the wrong people leaving the profession. This, however, warrants reflection on current compliant mindset of auditors to ISAs, and the way knowledge of the profession is defined and coded, which currently constrains innovations in audit technology (Sonnerfeldt & Eklöv-Alander, in this volume). Lastly, it stresses the importance for accounting firms to work for greater alignment between their recruitment and marketing discourses and to create a culture appropriate to this digital era. Acknowledgements This work was supported by Jan Wallanders och Tom Hedelius Stiftelse samt Tore Browaldhs Stiftelse [grant number P18-0095]. The authors would like to thank the interviewees for sharing their insights on audit practice, and colleagues who have commented on previous versions of this chapter. Notes 1 For more information, see Bloomberg tax (2020) ‘Big Four Invest Billions in Tech, Reshaping Their Identities’ January. https://news.bloombergtax.com/financialaccounting/big-four-invest-billions-in-tech-reshaping-their-identities) 2 For more information, see Deloitte, EY, KPMG, PwC websites. 3 Cognitive technologies in auditing refer to a broad category of ‘thinking technologies’ such as machine learning, natural language processing, and natural language generation, reaching into the realm of artificial intelligence. 4 The use of the term discomfort in this paper refers to the uneasiness an auditor feels about his or her professional identity. This is distinguished from works on Comfort theory where the focus is on the notion of audit as a comfort-producing activity, works that have sought to develop an understanding of the processes by which audit produces comfort (e.g. Broberg, 2013; Carrington & Catasús, 2007). 5 The mid-tier firms developing digital tools at the local level indicated a higher level of usage.

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Appendix: Research design In this qualitative exploratory study, we conducted semi-structured interviews with open-ended questions with fifteen auditors holding different positions. Our interviewees include partners, managers, audit seniors, and audit associates from transnational accounting firms (see Table 8.1). The interviews were conducted between 2019 and 2021, lasting between 40 and 90 minutes, and focused on four themes:

• • • •

the professional role and identity of auditors in the digital age; experience with technological change pertaining to the audit; vision on the future of auditing and auditors; and the expertise required to be future-ready.

The interview transcripts, observation notes, and web material were analysed by drawing on a thematic analysis (Braun & Clarke, 2006), entailing reading and re-reading the data collected in an interpretative and contextual manner prior to their being coded to capture the meaning within the data. We coded the data manually in Excel to generate initial themes that were used to

Being an audit professional in the digital age 179 Table 8.1  List of interviewees. Interviewee

Firm

Position

Date / duration

Mode

A B C D E F G H I J K L M N O

1 2 2 2 3 1 1 4 4 2 5 5 3 2 2

Partner Partner Manager Manager Manager Manager Manager Audit Associate Manager Manager Audit Associate Manager Manager Partner Audit Associate

1.5 hours 1.5 hours 1.5 hours 1.5 hours 1.1 hours 1.5 hours 1.5 hours 40 minutes 1 hour 1 hour 1 hour 1 hour 50 minutes 1.5 hours 45 minutes

Skype (I) Face-to-face interview (G) Face-to-face interview (G) Face-to-face interview (G) Zoom (I) Face-to-face interview (I) Face-to-face interview (I) Zoom (I) Zoom (I) Face-to-face Teams (G) Teams (G) Zoom (I) Face-to-face (I) Face-to-face (I)

Note G – Group interview; I – Individual interview

identify potential theoretical concepts. Using theory and literature as a means to sensitise us to, and enhance our understanding of, this phenomenon, we shifted iteratively between the themes initially generated from the data and potential theoretical concepts. The findings were collated, synthesized, and presented in the chapter.

9

Advanced digital technologies and sustainability assurance Evidence from Sweden Jason Crawford, Tim Kastrup, and Aynaz Monazzam

Introduction This chapter investigates what occurs at the intersection of institutional demands (i.e. sustainability reporting and assurance regulation), an evolving audit profession (i.e. auditor-client dynamics, embedding advanced digital technologies (ADTs) in assurance work), and competitive pressures (i.e. ESG solution providers) by exploring the relationship between ADTs as the primary driver of change and sustainability assurance practices in Sweden currently and how they are anticipated to evolve in the future. As digital technologies are increasingly used in financial auditing, it is time to consider the implications of extending their application to sustainability assurance, a market that is expected to grow rapidly in coming years. On the one hand, this relates to the introduction of new reporting standards; on the other hand, it relates to the changing information needs of stakeholders (European Commission, 20211). The changes to sustainability reporting regulations include a requirement for companies to digitally tag reported data ‘in order to capitalise on the opportunities presented by digital technologies’, a requirement that already exists for financial data (European Commission, 2021, p. 7). Together with European and national commitments to digital strategies, these changes imply a more central role for digital technologies in future production, audit, and use of Environmental, Social and Governance (ESG) information,2 by companies, auditors, and investors (Macpherson et al., 2021). There is a growing consensus that the audit industry is undergoing a revolution because of the influx of new digital technologies, which promise to automate traditional time-consuming, process-intensive, and routine tasks previously performed manually by accountants and auditors (Bakarich & O’Brien, 2021; Raschke et al., 2018; Tiron-Tudor & Deliu, 2021). Digital technologies, such as big data analytics (BDA), artificial intelligence (AI), machine learning (ML), and blockchain, hold the promise of redefining audit work away from manual data collection, validation, and processing, towards activities that leverage auditors’ unique cognitive capabilities, such as professional judgement, reasoning, and scepticism, to ensure that financial statements remain thoroughly and fairly judged in all material respects and that DOI: 10.4324/9781003411390-11

Advanced digital technologies and sustainability assurance 181 the risk of misstatements is minimised (Burke et al., 2019). With the ambition to improve sustainability reporting so that it is on par with financial reporting, auditees will be required to report metrics in a more standardised way that reflects critical ESG factors that drive the financial performance of firms (Cort & Esty, 2020). Therefore, the opportunities for auditors to use digital technologies in audit and assurance engagements are expected to increase. Moreover, as auditees continue to invest in digital technologies to gather, store, and analyse sustainability-related data, their expectations of audit engagements and the role of technology therein, may also change (Kend & Nguyen, 2020). As the volume and type of internal and external data on clients’ ESG activities increases and becomes more widely available, accounting firms must assess the options available to them to avoid the growing risk of material misstatements. While this has not been a significant issue up to this point, it has become increasingly accepted that sustainability information has financial relevance, and climate-related financial risks are just one example of the close relationship between financial and sustainability information. While some accounting firms may choose to resign or increase fees, it is more likely that firms with sufficient resources will invest in new technologies to detect misstatements (Burke et al., 2019). They may even apply those technologies to auditee-provided sustainability information or use them in the analysis of auditee-related ESG data provided by third parties. Öhman et al. (in this volume), for instance, show how ML can be used for materiality assessment in sustainability auditing. The Big 4 firms continue to invest substantially in digital technologies globally, and increased investments in digital technologies by accounting firms are also evident in Sweden (SIA, 2021). The reasons for investing vary. Extant research suggests that investments are made by accounting firms to fend off future competition from industry outsiders such as Google or other ‘BigTech’ firms that may enter the audit and assurance market (Richins et al., 2017). In Sweden, accounting firms seem less concerned with this kind of competitive pressure and invest in digital technologies to become more efficient, improve financial audit quality, and make the audit profession more attractive to new entrants and new clients (SIA, 2021). However, little is known about how and to what extent these technologies are used in the assurance of sustainability reports. While ‘BigTech’ promotes the promise of AI-driven developmental progress in relation to the UN Sustainable Development Goals (SDGs), some argue that these efforts may harm ESG development, citing significant trust issues in these firms, lack of AI maturity and sophistication, and the absence of proper pre-emptive regulation (Truby, 2020). However, based on preliminary insights gathered in order to write this chapter, it appears as if indirect competition is more likely to come from ‘FinTech’ companies that provide ESG solutions to investors, such as ESG research, indexes, analytic and reporting solutions, as a means of overcoming inadequate reporting by

182  Jason Crawford, Tim Kastrup, and Aynaz Monazzam companies. Indeed, companies such as Sustainalytics already provide such services to investors in Sweden, and Workiva, a US-based company, provides end-to-end ESG cloud software solutions to businesses, assisting them in transforming their internal sustainability data and control environments with the goal of making businesses audit ready (Macpherson et al., 2021). Collectively, these developments are an outcome of growing institutional demands from regulators and investors, changes within the audit industry, and competitive pressures as ESG information becomes a highly sought-after public good, which is attracting new entrants leveraging ADTs into the ESG data provision and analysis market. Therefore, the purpose of this study is to broaden our understanding of what occurs at the intersection of institutional demands, an evolving audit profession, and competitive pressures in the sustainability assurance market space by exploring the relationship between ADTs and sustainability assurance. Doing so opens the way for an exploration of the future of auditing in Sweden and provides a foundation to answer the following research question that guides this chapter: What aspects influence the use of ADTs in sustainability assurance and how can this be expected to evolve in the future? Given its infancy, the body of literature on digital transformation and the use of digital technologies in accounting and audit activity is still exploratory (Bakarich & O’Brien, 2021). There is also a lack of empirically drawn insights (Kend & Nguyen, 2020). In order to help fill this gap in the literature and provide practitioner-relevant insights, we conduct an exploratory and empirically driven study that focuses on the Swedish context. Motivation As stated in this book’s objectives, ‘Auditing is […] said to be of utmost importance for well-functioning capital markets through maintenance of trust in company financial statements’. Because sustainability information has become material to capital markets (Macpherson et al., 2021), companies will have to restructure their reporting practices, improve their internal control environments, and make investments in technologies to gather, store, and analyse sustainability-related data. Additionally, sustainability audit and assurance activities are expected to increase now that the Corporate Sustainability Reporting Directive (CSRD) has recently been adopted by the European Parliament in November 2022, is expected to enter into force in December 2022, and will lead to increased auditing of sustainability disclosures when it becomes mandatory in the member states in 2024. Ensuring the reliability and validity of reported information for ESG-related risks will pose new challenges for auditors. Some of those challenges may be overcome through the use of digital technologies, as some technologies are increasingly employed in new tasks that audit engagements evolve and expand in

Advanced digital technologies and sustainability assurance 183 response to regulatory and stakeholder demands for more extensive, higher quality, investment-grade information in disclosures. However, some other challenges for auditors may not be supported by the new digital technologies. Therefore, it is more likely that digital technologies will augment rather than automate audit and assurance activities in this area, given the complexity surrounding sustainability information and the need to carefully interpret audit results (Kokina & Davenport, 2017). Furthermore, non-automated tasks are likely to become more cognitively demanding in the future and rely on auditors further developing and leveraging their professional judgement, reasoning, and scepticism. The digital transformation journey for accounting firms is not just about preparing for technological change, it is about preparing for cognitive change, i.e. perceptions of ADT usefulness, the latter having the potential to be even more challenging. More specifically, adopting new digital technologies may create a risk to auditors’ professional reputations because the liability for assuring the reported information still rests with the auditors and not the technology they use. While there is considerable speculation about the potential impact of digital transformation and sustainable development on the audit industry, there is limited empirical evidence. To help fill this knowledge gap, we conduct an explorative study to determine how increasing demands from regulators, investors, and stakeholders for corporate sustainability affect the audit and assurance industry and its ability to innovate through digital transformation in sustainability assurance. Primary data is gathered from interviews with experts representing three main perspectives: those regulating the auditing industry in Sweden, The Swedish Inspectorate of Auditors (SIA), The Institute for the Accountancy Profession in Sweden (FAR); accounting firms engaged in sustainability audit and assurance (Deloitte, EY, Grant Thornton, KPMG, PwC); and two institutional investors (Första AP-fonden, Investor AB). Secondary data is gathered from industry and other reports. In Appendix, we describe the research design in more detail. In the next section, we turn to the extant literature to identify key themes and critical issues that will serve as a starting point for our engagement with audit practitioners, the outcome of which is reported thereafter in the results section. Literature review The literature review is divided into two parts. In the first section, we present the relevant regulation on sustainability reporting in the EU and highlight how this regulation links to sustainability assurance. Furthermore, we review the extant sustainability assurance literature, focusing on supply and demand as well as differences with financial auditing (see Cieslak et al., in this volume, for an in-depth review of literature on sustainability assurance). In the second section, we provide an overview of how ADTs are used in two adjacent fields, namely the ESG data space and financial auditing, and point out potential applications for ADTs in sustainability assurance.

184  Jason Crawford, Tim Kastrup, and Aynaz Monazzam Sustainability reporting, regulation, and assurance

In 2014, the European Parliament issued the EU Non-Financial Reporting Directive (NFRD) which required large European firms to provide sustainability reports to have transparent communication with their stakeholders and potential investors, especially about the firms’ ESG performance. In addition to regulatory enforcement, the increasing awareness of investors and the endeavour to reduce threats and enhance opportunities through sustainable investment have led many companies to place greater emphasis on sustainability reporting (Cort & Esty, 2020). As a result, close to 80% of companies deliver their sustainability reports to the public (KPMG, 2020). However, recent studies (Alsahali & Malagueño, 2022; Simnett et al., 2021) show increasing demands for accountability, transparency, and disclosures from society, and, together with governmental regulations on corporate sustainability, have raised concerns about the credibility and validity of the nonfinancial information provided by companies. In the European Commission’s guidelines on the methodology for reporting non-financial information (2017),3 the benefits of third-party expertise and independent external assurance have been recommended as an example of how non-financial information can be made ‘fairer and more accurate’. Based on this statement, the credibility of non-financial reporting can be enhanced when it is verified by an external assurance expert (Simnett et al., 2021; Sonnerfeldt & Pontoppidan, 2020). Due to recent changes in the EU sustainability reporting directive, the assurance of sustainability information will be a mandatory requirement for companies (European Commission, 2021 2021/0104 [COD, p.5]). Therefore, third-party assurance of sustainability reports as a standard practice has grown considerably during the past decade because companies aim to improve the reliability of their sustainability reports by having them assured (Alsahali & Malagueño, 2022). In this regard, KPMG’s survey of sustainability reporting (2020) shows that 71% of the world’s 250 largest companies assure their sustainability information. From a demand-side perspective, scholars have identified some major drivers of sustainability assurance. The macro-level drivers include regulatory enforcement (Venter & van Eck, 2021), country of origin (Simnett et al., 2009), and media pressure in encouraging firms to demand sustainability assurance (Gillet-Monjarret, 2015). At the meso-level, the drivers include firm size, firms’ industry membership (Zorio et al., 2013), and the considerable impact of sustainability assurance on capital providers and investors’ decision-making (Krasodomska et al., 2021). Finally, at the micro level, stakeholders’ perceptions of the sustainability report, the firm’s reputation (Huang & Watson, 2015), and the perceived value added by the sustainability assurance engagement (O’Dwyer et al., 2011) all have a significant impact on demand for sustainability assurance. From a supply-side perspective, studies signal high competition in the market among assurance providers that offer assurance services with different scopes and objectives (e.g. limited,

Advanced digital technologies and sustainability assurance 185 combined, reasonable assurance) and use various tools and procedures to verify the credibility of sustainability information. According to Alsahali and Malagueño (2022), there are two types of sustainability report assurance providers, namely accounting and non-accounting firms. While nonaccounting firms, such as engineering and consulting firms, attempt to place greater emphasis on subject matter expertise (Alsahali & Malagueño, 2022), accounting firms focus on the ‘assurance’ side of sustainability assurance and try to create value for their clients by providing guidance on how to improve systems and processes supporting sustainability reporting (Gray, 2000). Compared to financial auditing, sustainability assurance, which is voluntary for many firms, is much less mature and standardised. Due to the high variation in sustainability reporting practices, most assurers adopt broad, principle-based assurance frameworks, such as the International Auditing and Assurance Standard Board’s ISAE3000 or AccountAbility’s AA1000 AS (Sonnerfeldt & Pontoppidan, 2020). According to both frameworks, the subject matter (e.g. firm’s activities on aspects of ESG, internal control system) of the assurance engagement can be negotiated between the assurer and client (Krasodomska et al., 2021). Due to this flexibility, the complexity of sustainability information, and the aforementioned variation in sustainability reporting practices, sustainability assurance engagements can vary considerably in terms of scope, level (of assurance), and methods used (Cohen & Simnett, 2015). However, there are reasons to believe that sustainability assurance might soon become more similar to financial auditing. Currently, the European Financial Reporting Advisory Group (EFRAG) is drafting the European sustainability reporting standards (ESRS) and the International Sustainability Standards Board (ISSB) is developing a framework for sustainability-related disclosures, the common ambition being that sustainability and financial reporting may be regulated and enforced in a similar way. If this ambition materialises, the difference between sustainability assurance and financial auditing will likely lessen. Advanced digital technologies use in adjacent fields

When the European Commission’s CSRD is adopted in full (European Commission, 2021) and the European Financial Reporting Advisory Group’s (EFRAG) sustainability reporting standards have come into effect (June 2023), European companies’ sustainability reporting will become more detailed and will require significantly greater assurance efforts, particularly when reasonable assurance is sought. Ultimately, assurers may need to turn to ADTs to shoulder this task. In fact, elsewhere in the ESG data market, this is already happening. FinTechs, like TrueValue Labs or RepRisk, leverage AI and readily accessible external data to identify and assess material ESG risks. More specifically, they use ML and natural language processing (NLP) to screen vast quantities of text sources (e.g. print, online and social media,

186  Jason Crawford, Tim Kastrup, and Aynaz Monazzam newsletters and blog posts, government and NGO reports, etc.) to detect leading indicators of future ESG risks (Antoncic, 2020). According to its proponents, the AI-based ‘outside-in approach’ is less prone to greenwashing and produces higher quality ESG data for investment decision-making (Antoncic, 2020). Hughes et al. (2021) even suggest that the algorithmic approach is more transparent and democratic than the traditional human-centric ‘inside out’ approach. However, as of today, there is little robust evidence based on which these performance claims could be confirmed (or rejected). Moreover, the assertion that ‘outside-in’ algorithms are more transparent and democratic is contested and might not find much support elsewhere (Truby, 2020). Importantly, what happens in the ESG data market matters to the sustainability assurance market too (Knechel, 2021). If capital providers were to base their investment decisions on outside-in ESG risk indicators, assurance on ESG disclosures would lose much of its relevance if investment decisions were not based on reported sustainability information. Furthermore, if FinTech algorithms were to detect material ESG risks that sustainability assurers failed to detect, investors could lose trust in their assurance, and their legitimacy could be threatened. Whilst accounting firms should be aware of this risk, they should also be aware of the many opportunities ADTs could afford to their sustainability assurance practices. Recent developments in financial statement auditing, where accounting firms have begun integrating ADTs into their methodologies (Eilifsen et al., 2020), give an indication of what these opportunities could look like. Even today, ML allows auditors to do away with random sampling and to analyse entire populations of transactions instead; an affordance that has begun to revolutionise journal entry testing (Dickey et al., 2019). By screening entire populations (for anomalies), predictive algorithms can help auditors identify risky and suspicious transactions, i.e. transactions that warrant further testing (Kokina & Davenport, 2017). Furthermore, when fed with event logs, process mining can be used to assess the effectiveness of clients’ internal control systems (Jans et al., 2014). Since assessing the internal control environment is no less important when assuring ESG disclosures (Simnett et al., 2021), process mining will likely play an important role in future sustainability assurance practices. Importantly, ADTs affordances are not confined to the analysis of numerical data. Indeed, deep learning, a subcategory of ML that automates not only learning but also feature extraction, excels at the analysis of text, audio, and image and video data (Sun & Vasarhelyi, 2017). Recognising that sustainability reporting involves significant quantities of non-numerical data, deep learning might be a particularly suitable technique to enhance the quality of sustainability assurance. For instance, assurers could deploy the aforementioned outside-in methodologies and NLP-based ML algorithms to identify material ESG risks that the company fails to disclose. Used in this way, ML algorithms could help assurers identify risk areas that warrant special scrutiny during the assurance engagement. Today’s uses of deep learning in auditing primarily concern mundane

Advanced digital technologies and sustainability assurance 187 tasks like contract reviews (Dickey et al., 2019). In the future, however, uses are expected to become more varied and complex. Raschke et al. (2018) even go as far as to suggest that when intelligently combining text understanding, speech and visual recognition, intelligent bots could, at some point, perform interview-based audit inquiries (see also Dickey et al., 2019). In summary, incorporating the latest technologies from the ESG data market and financial auditing into sustainability assurance methodologies could not only shield against the aforementioned threats, it could also make the assurance work more efficient and effective. Despite these promising opportunities, there are two major caveats. First, the uptake of ADTs among financial auditors has been much slower than expected (Eilifsen et al., 2020). In practice, auditors face a long list of issues that obstruct and/or disincentivise the use of ADTs (see also Sonnerfeldt & Jonnergård, in this volume). Examples include regulatory uncertainty, legal repercussions, unfit pricing models, sceptical clients, data availability, insufficient technical expertise, duplicate work and over-auditing, unresolved ethical questions, low trust in ADTs, and antiquated ways of thinking (Bakarich & O’Brien, 2021; Eilifsen et al., 2020; Kend & Nguyen, 2020; SIA, 2021). Second, financial accounting and sustainability accounting often follow different logics and goals (Sonnerfeldt & Pontoppidan, 2020). Because of this, many scholars hold that traditional audit methodologies, which evolved in the context of financial auditing, might be ill-suited to give assurance on sustainability reports and ESG disclosures (Knechel, 2021; Sonnerfeldt & Pontoppidan, 2020). Sustainability reports are complex and involve a lot of qualitative and future-oriented information. As such, sustainability reporting might require not only new databases, new quality controls, and new support systems, but also new assurance methodologies (Simnett et al., 2021). Recognising the differences between the financial and the sustainability domain, both in terms of reporting and assurance, ADTs use cases might not be easily transferable. Unfortunately, so far, the auditing literature on ADTs has not addressed applications in adjacent assurance fields, and the sustainability assurance literature has not addressed how ADTs could enhance sustainability assurance practices (for a notable exception, see Öhman et al., in this volume). Because of this mutual disregard, the role and use of ADTs in sustainability assurance, in the present and the future, constitute scholarly blind spots that are in dire need of empirical inquiry. Results In this section, we present the results of our study, which is a synthesis of the empirical data acquired in the interviews with national representative bodies, auditors, including sustainability experts, investors, and from industry and other reports in Sweden (see Appendix). While this is not an exhaustive sample, it enables us to fulfil the purpose of this study, which is to broaden our

188  Jason Crawford, Tim Kastrup, and Aynaz Monazzam understanding of what occurs at the intersection of institutional demands, an evolving auditing profession, and competitive pressures by exploring the relationship between ADTs as the primary driver of change, and sustainability assurance practices in Sweden currently and how they are anticipated to evolve in the future. This intersection captures the tensions between the inside-out approach to sustainability assurance, which is predominately human-centric (i.e. based on the judgements and activities of humans), and the outside-in approach, which is predominately algorithmic (i.e. based on autonomous task carried out by ADTs). In accordance with the purpose of the study, the results are organised and presented as a discussion of the aforementioned demand- and supply-side aspects that influence the use of ADTs in sustainability assurance. Sustainability reporting and assurance regulation

Sustainability reporting is regulated by the Annual Accounts Act [1995:1554] (ÅRL). In the mid-1990s, there was a change in ÅRL in response to the issuance of the EU Directive, which preceded the Non-Financial Reporting Directive (NFRD). At the time, Sweden had quite a progressive approach to sustainability reporting compared to many other EU countries. The majority of companies were required to include sustainability information in their management reports, which were covered by the auditor’s opinion, but until NFRD was revised in 2014, there was no requirement for a separate opinion on sustainability information. FARs revision of RevR6 in the mid-1990s reflected many of the requirements that would later become part of NFRD. However, the market for sustainability assurance was not yet mature, and the number of assurance engagements was limited. In 2007, Sweden implemented guidelines for external reporting for state-owned companies, replacing previous guidelines issued in 2002. The guidelines were designed to complement existing accounting legislation and accepted accounting principles, which required all state-owned companies to report under GRI and have their sustainability information assured. Given that assurance was not a legal requirement for non-state-owned companies, the sustainability assurance market has grown slowly since, from an estimated 60 companies in 2007 to 114 companies in 2021. Taking state-owned companies out of the equation, very few Swedish companies are assuring their sustainability reports, despite the huge attention on sustainability issues at European and national levels. The implementation of CSRD will result in a number of significant amendments to ÅRL (covered in Chapter 6), and the consensus amongst those interviewed is that it is expected to expand the market for assurance significantly. CSRD builds on NFRD, which was broad in scope and gave companies considerable leeway in terms of what they reported and how they reported it. CSRD is more stringent and detailed as it is supplemented with a delegated act specifying reporting requirements, for example, in terms of the large

Advanced digital technologies and sustainability assurance 189 number of key performance indicators (KPI) that must be reported, rather than a few high-quality KPIs that are important to investors. Some auditors have expressed concern about the associated costs and the need to prioritise what should be reported, despite their belief that it will likely make sustainability reporting more comparable across companies. Together with the introduction of the standards currently being developed by EFRAG, sustainability reporting will become more standardised, and quality is expected to improve, a first step towards the convergence of financial reporting and sustainability reporting. However, the ability of companies to report, the costs that will be incurred, and the potential value of this information to investors all remain in question. While the investors we interviewed are optimistic about the anticipated improvements in ESG data quality with the implementation of CSRD, especially those that are required to report under the Sustainable Financial Disclosure Regulation (SFDR), they have historically not relied on sustainability reports for investment decisions or stewardship activities. For investors, sustainability reports are only one of several data points considered when making investment decisions, and despite EU regulatory ambitions, it is unlikely, according to investors, that CSRD will eliminate the need for ESG solution providers. This is because sustainability is such a broad subject, and investors, who frequently manage global portfolios, require compiled and packaged data sets for a large number of companies that are matched to their unique investment strategies. This is something a single standardised report, driven by a European-centric approach to regulation and standard setting, may not be able to provide as investors may require data that falls outside standardised reporting requirements. Furthermore, it should be noted that ongoing regulatory and standardsetting uncertainty is a significant issue, especially for auditors, because CSRD has only recently been adopted by the European Parliament (10 November 2022), and EFRAG continues to submit interim drafts to the EU Commission on a rolling basis, with the first set of standards expected to be formally adopted in June 2023. Therefore, it is difficult for individual accounting firms to make certain investment decisions (e.g. hiring new specialists, upskilling financial auditors) when there is a lack of regulatory certainty about what will happen in the future. An example of a lack of regulatory certainty that will affect market opportunities quite significantly is whether or not the financial auditor will be allowed to perform the sustainability assurance. While this is a contentious issue currently under debate, regulatory and standard-setting uncertainty is not currently considered by the auditors interviewed to be a direct obstacle to the use of digital technologies in sustainability assurance, but it has not helped advance digital innovation up to this point either. The audit industry has a critical role to play in bridging the gap between how and what companies report, and the type and quality of information investors require. Impending regulations, along with increasing investor pressure, provide an important catalyst that can be leveraged by the auditing

190  Jason Crawford, Tim Kastrup, and Aynaz Monazzam industry to educate c-suite executives on the importance of investing in proper information systems and internal controls in order to improve sustainability reporting. While Sweden has an ambitious digital strategy and the SIA concludes that further investments in digital technologies will be required by the audit industry due to technology development in society, regulation, i.e. ÅRL, is largely neutral in promoting the use of digital technologies. This is left to the industry itself and is managed as an internal policy matter in individual accounting firms. This neutrality is also reflected in the approach of global standard setters such as IAASB, which remains technology neutral.4 Auditor-client dynamics and embedding ADTs

In Sweden, sustainability assurance is primarily carried out by the financial statement auditor, and the market is divided amongst the Big 4 firms (Deloitte, EY, KPMG, PwC), which adhere to ISAE 3000. The role of digital technologies in sustainability assurance is not something that has attracted much attention at the industry level as yet. While the SIA and the Institute for the Accountancy Profession in Sweden both provide an important platform and input into discussions about the future of auditing, including the increased use of ADTs in financial statement audit, that discussion has not yet crossed over into the debate about the future of sustainability reporting and assurance, and the use of ADTs therein. This omission reflects the current gap between financial reporting and sustainability reporting in general, a divide that must be bridged if sustainability reporting is to be on par with financial reporting in the future. Immature internal control environments and data quality are significant barriers to using digital technologies in sustainability assurance, barriers that, according to those interviewed, do not apply to financial statement audit to the same extent. For the large accounting firms in particular, it is not that they lack ADTs to handle structured (e.g. data from ERP systems) and unstructured data (e.g. text and pictures) that is the issue. The issue is that client sustainability/ESG data quality are below the threshold where ADTs can be applied and that the internal control environment of many companies is not mature. The feasibility of applying ADTs is determined by the volume, format, structure, and quality of the data. While ADTs such as NLP tools are increasingly used by large accounting firms in financial audits (e.g. reading and extracting specific information from standardised contracts), they are not universally applicable to all tasks, as the effort required and the data needed to train AI tools to execute tasks reliably are too great. In other words, there must be alignment between the intended task and the digital tool intended to carry out that task. Auditors play a critical role in expediting the process to the point where companies cross that threshold, but they are dependent on companies making sustainability reporting a strategic priority and enacting a number of changes, such as investing in IT systems and improving the internal control

Advanced digital technologies and sustainability assurance 191 environment, increasing sustainability knowledge and skills (e.g. hiring sustainability controllers), and reorienting the sustainability department’s collaboration away from the communications department and towards the accounting department. Additionally, auditees require assistance in addressing difficult questions such as: Do we have the necessary data and where? Is the data of sufficient quality to be used for reporting purposes? How can we move from estimating certain ESG risks to calculating specific risks in line with emerging sustainability accounting and reporting standards (e.g. scope 3 CO2 emissions)? As sustainability information becomes increasingly important for strategic decision-making, auditors expect that this will lead to the necessary changes mentioned earlier. In fact, auditors can already see emergent change as more companies request pre-assurance services and boards take on more responsibility for sustainability information. Industry affiliation, company size, resource availability, and familiarity with building and working with large datasets all influence the pace of that change. From the client’s perspective, there are also cost-value trade-off issues. Building a data and internal control infrastructure to improve sustainability reporting is a significant investment. For some companies, it may be a question of whether we want to make these types of investments or if we want to direct those resources towards the realisation of our strategic objectives. The eventual answer, at this stage, is company specific, given that mandatory reporting has not yet come into force, and factors such as level of capital market dependency, ownership structure, and exposures to certain ESG risks that dictate the pace of business-model transformation, all come into play. However, improving reporting quality and assuring sustainability reports (or parts thereof) has a powerful signalling effect on investors in terms of company commitment to ESG. As mandatory reporting becomes a requirement, and companies seek reasonable (instead of limited) assurance to differentiate themselves competitively and financially, costs will increase. However, these costs may be offset and value realised by developments in financial markets. New financial instruments are emerging, such as green bonds and green loans, which require companies to get their sustainability report assured in order to avail of financing options or receive more attractive rates. Therefore, the value proposition of sustainability assurance is no longer just about the value generated during the actual assurance engagement (e.g. knowledge transfer between auditor and auditee), although this is very important. Sustainability assurance is becoming an important prerequisite for access to products and services emerging under the umbrella of sustainable finance and is an important illustrative example of the expanding role of the audit industry as a mediator for change in the relationship between companies and capital markets. In addition to the dynamics between auditors and their clients, tensions exist between auditors and digital technologies that can influence the use of ADTs in sustainability assurance. The position of auditors is that digital technologies are not equipped to make decisions that require professional judgement on specific issues, such as the materiality of specific ESG risks. Of

192  Jason Crawford, Tim Kastrup, and Aynaz Monazzam course, it is widely accepted amongst the auditors interviewed that digital technologies have brought efficiencies and improved quality in some areas of financial statement audit, especially with the shift from sample testing to full population testing. However, in the absence of dedicated systems to collect and store ESG data, auditors need to go and look for supporting ESG data in a wide variety of different systems (e.g. health and safety information), which, in contrast to structured financial data, can be very difficult to verify and ultimately assure. This tension is also a manifestation of auditors’ high levels of cognitive engagement with certain audit and assurance tasks that they feel cannot be compromised by digital tools because they create a risk to their professional reputation, a reputation that is built on the highest standards for responsible and ethical behaviour. Adopting new and unproven digital technologies can increase perceived professional and reputational vulnerabilities. It is auditors that need to sign off; therefore, the liability rests with them and not the technologies used. It is clear from our conversations with members of the profession that they are unwilling to accept cognitive gaps5 – whether they are caused by incomplete data or the application of ADTs that black box certain parts of the process – that would impede them from forming a comprehensive understanding of what underlies the conclusion. That understanding is compromised when auditors are not involved in the design of the technology, something that would provide a more nuanced understanding of what specific digital technologies are predisposed to do when applied to specific tasks. There is also a certain element of comfort in doing things the way they have always been done, and some auditors, by their own admission, are quite risk-averse, although age can be a factor that impedes a more curious attitude towards the use of ADTs. While the digital toolkit available to auditors is expanding and new ADTs application possibilities are beginning to emerge in the sustainability assurance space, professional judgement – an important cognitive ability – is still the key tool that the auditor has and uses. ADTs can help get auditors to the areas where judgements are required faster, but they will not replace professional judgement, at least not in the foreseeable future, as analysing sustainability issues requires a thorough understanding of the industry or sector, the ability to ask pertinent questions, evaluate data quality and completeness, and make materiality assessments based on plans and activities. Compare this discussion to Carrington and Catasús’ analysis of structure and judgement in auditing, Backman et al.’s study of expertise in auditing, and Sonnerfeldt and Jonnergård’s exploration into auditors’ professional (in-)securities in the digital age (all in this volume). The emergence of alternative solution providers

Alternative ESG data solution providers using AI-based outside-in approaches to identify and assess material ESG risk are emerging. They are relatively new entrants to the ESG data market and are commonly used by

Advanced digital technologies and sustainability assurance 193 institutional investors, as they are unable to rely solely on assessments that are based purely on company-provided information. Data from ESG solution providers are not used by auditors. However, large accounting firms employ more fundamental digital technologies to scan external data sources (e.g. media data) for issues such as environmental degradation, corruption, or human rights violations that can be brought to the client’s attention early in the assurance engagement. This is one area where ADTs can be used more in the future. In neighbouring Denmark and Norway, auditors now have access to tax and bank data, and while Sweden has not yet taken this step, national and international data-sharing policies would provide auditors with access to high-quality third-party data that is easily verifiable and is outside the auditor-auditee relationship. This could be an effective strategy in combating outside-in competition, but taking such a step would raise significant legal, ethical, and privacy issues that are related to the potential misuse of ADTs. Some auditors are concerned that the growth of ESG indices providers, in particular, will result in sustainability reporting being manipulated in order to achieve a higher ESG score (e.g. in Dow Jones Sustainability Index). This concern stems from the emergence of some consultancy services that advise companies on how to structure their reports in order to achieve higher ESG scores without contributing to improving transparency policies and processes, diminishing the value of sustainability reporting as a means for companies to learn how to transition to a more sustainable business model. Alternative solution providers have an important role in driving progress and filling the gap between information needs and what is currently being disclosed. They do so by harnessing the opportunities that ADTs provide. However, according to one interviewee, there is a risk that less serious ESG solution providers lack the transparency required to enable investors and other stakeholders to make informed decisions about whether to use their services or not because there is a lack of transparency about their methodologies, the data they use, and the underlying assumptions in their models. As more and more varied types of ESG data become available, data quality, verification, and assurance are becoming increasingly important issues for all parties, companies, auditors, and investors. Conclusions and implications This chapter investigates what occurs at the intersection of institutional demands (i.e. sustainability reporting and assurance regulation), an evolving audit profession, and competitive pressures by exploring the relationship between ADTs as the primary driver of change and sustainability assurance practices in Sweden currently and how they are anticipated to evolve in the future. The main contribution of this chapter is that it identifies and discusses the tensions that exist at the intersection of the inside-out and outside-in approaches to ESG information provision to capital markets and how ADTs are implicated in these tensions. In this final section, we provide the reader

194  Jason Crawford, Tim Kastrup, and Aynaz Monazzam with key takeaways that build on the results, thereby answering the research question that has guided this chapter. The future regulation of the European sustainability assurance market has garnered considerable attention, as it, alongside CSRD, the EU Taxonomy, SFRD, and efforts to develop standards for sustainability reporting, is a critical component of the EU’s sustainable finance strategy and the possibility of achieving the European Green Deal’s objectives (European Commission, 2021). Consequently, Sweden’s audit industry, which has pioneered a progressive approach to sustainability assurance since the 1990s (Simnett et al., 2021), is currently considering the implications of an impending significant change to the EU’s sustainability assurance market. In the literature review, we identified several drivers of the sustainability assurance market, both on the demand side and on the supply side. On the demand side, regulatory enforcement (Venter & van Eck, 2021), found to be a strong driver of sustainability assurance in other contexts, has not been used to drive the Swedish market for assurance forward to any significant degree since 2007. Moreover, sustainability assurance, found to have a considerable impact on investors’ decision-making in other contexts (Krasodomska et al., 2021), seems to be less important to investors with interests in Sweden than it is elsewhere. On first assessment, one could conclude that regulatory demands and stakeholder expectations are rather low. But this conclusion would ignore important country-specific factors (Simnett et al., 2009), such as a tradition of soft regulation, in which companies are expected to follow ‘softer materials’, such as codes and guidelines (including those on sustainability reporting and assurance), rather than forced to comply with ‘hard law’. It would also ignore that the characteristics of capital market dependency and the ownership structures of large non-state-owned Swedish companies,6 many of which are owned by a few large active Swedish institutional investors, differ significantly from ownership structures found in Anglo-American and continental European contexts. Hence, in the Swedish context, there can be regulation without enforcement, as large active investors may ‘enforce’ changes in companies’ (sustainability) control and reporting practices through collaboration, in which investors support companies to make improvements, e.g. in calculating CO2 emissions. On the supply side, the Big 4 accounting firms dominate the assurance services market in Sweden. The majority of engagements only require limited assurance – the confirmation that a sustainability report exists. Voluntary assurance engagements account for a small portion of accounting firm’s business as they are currently classified as advisory services. While some auditors by their own admission could be better at marketing their assurance services, the market is constrained by rules that limit the sale of advisory services by statutory auditors. Market rules, together with assurance engagements that are limited in scope, do little to create opportunities for accounting firms to create demonstrable value-added opportunities for their clients (Gray, 2000) that from a supply-side perspective encourage auditees to improve their

Advanced digital technologies and sustainability assurance 195 information systems and internal control environments, making it easier to apply ADTs. In our opinion, value-added opportunities are more likely to emerge as companies move or are driven towards reasonable assurance as a floor for engagement activities if new incentives like those emerging in corporate banking are made available to offset the costs. ADTs currently play a minor to non-existent role in sustainability assurance engagements conducted by the large accounting firms in Sweden. Issues such as low-quality ESG data; insufficiently developed reporting processes and systems; a lack of mature internal controls; and a lack of standardisation in data reporting formats and structures, all inhibit the potential to use ADTs in sustainability assurance engagements. So too does the fact that the majority of assurance engagements currently conducted by accounting firms in Sweden are limited assurance engagements. Auditors are not required to analyse the data provided to identify material risks or to conduct sample or other types of testing during limited engagements, areas where certain tasks may be suitable for applying ADTs. There is also an issue for auditors in terms of understanding what ADTs are, how they work, what kinds of tasks they are suitable for, and not. This is an area where accounting firms can do more to transfer knowledge from the IT specialists out to the audit teams, and for audit teams in turn to explain the benefits of using these new tools in assurance engagements to their clients so that clients better understand their potential value-adding capabilities and not just see the costs. The future role of ADTs in sustainability audit and assurance will depend on the ability of regulatory and standard-setting bodies, audit industry actors, and auditees to deal with a long list of obstacles that are currently disincentivising the use of ADTs in sustainability assurance engagements, many of which are highlighted above and discussed in the chapter’s results section. Given the volatile and continually evolving nature of ESG risks, resolving these issues (if possible) may take many years. While there is some support among auditors for the argument that the methodologies and technologies used in financial auditing can eventually be transferred and used in sustainability assurance engagements, this is contingent upon the resolution of numerous regulatory, technical, and cognitive issues. Nonetheless, this argument diverts attention away from the different logics and objectives (Sonnerfeldt & Pontoppidan, 2020) in the complex and fragmented regulatory landscape underpinning corporate reporting that impedes transitional ADT-led innovation in the sustainability assurance market in the meantime. Capital market participants (e.g. investors) are already looking for alternative sources of ESG information to fill the information gap, and a market of outside-in ESG solution providers adept at applying ADTs to imperfect ESG data is growing quickly as data becomes increasingly available, and analysis technologies, methodologies, and models evolve. Furthermore, there is also a trend towards the production of forward-looking data by using AI technologies. As companies begin their transition to a new relationship with the environment and society, and where data-driven decision-making and

196  Jason Crawford, Tim Kastrup, and Aynaz Monazzam investing, are/will be an increasingly important part of the solution in realising a greener European economy, the audit industry cannot afford to wait for regulatory certainty before it deploys ADTs innovations in the ESG audit and assurance space if it wants to maintain its position as an important mediator between companies and capital markets. The Swedish audit industry is at a pivotal point, where it must carefully consider the opportunities to apply ADTs to sustainability reporting and assurance in order to fend off competition from alternative ESG solution providers. In addition to the aforementioned implications outlined for the audit industry, there are also implications for regulators. In a context that is being redefined technologically, economically, and socially, regulators need to understand that the transformation towards a sustainable future relies on improvements in ESG data management, quality, and sharing. Many companies have a long way to go in this regard. For the transformation processes to bring about meaningful change, regulation needs to create incentives that strengthen the audit industry’s position in relation to its clients, so that it can push them to meet future demands for reasonable assurance and pass the threshold where ADTs can be applied in sustainability assurance engagements. The study has several limitations. First, it is explorative, which means its results should be interpreted with some caution. Our ambition was to piece together the most important elements of a current, complex, and dynamic phenomenon, an endeavour that makes it difficult to offer definite conclusions. On the 10th of November, CSRD was adopted by the European Parliament, just days before the submission of the final version of the chapter and EFRAG’s sustainability reporting standards are still at the interim draft stage, with the first set of standards expected to be formally adopted in June 2023. This inevitably means that the results of this study reflect actors’ perceptions at a particular point in time. Furthermore, it is important to acknowledge the peculiarities of the Swedish context. For instance, in Sweden, the financial auditor must attest that the sustainability report has been prepared. For this reason, engaging anyone but the financial auditor would result in double work, which means there is a high-entry barrier for non-audit competitors in the Swedish sustainability assurance market. In other countries, where this requirement does not exist, competitive pressures may differ. In summary, whilst many of our findings appear to be more general, some relate to a particular time and place. Despite these limitations, the study provides important insights into how the interaction of institutional demands, an evolving auditing profession, and competitive pressures impact the audit industry’s ability to innovate through the use of ADTs. While this chapter serves as a departure point for further debate and exploration, the auditing literature on ADTs application and use, needs to do more to address the current scholarly blind spots regarding the role and use of ADTs in sustainability assurance in the present and the future.

Advanced digital technologies and sustainability assurance 197 Acknowledgements We would like to thank all those who contributed their time to be interviewed. The corresponding author would also like to acknowledge the support of the Jan Wallander and Tom Hedelius Foundation and the Tore Browaldh Foundation, project number P18-0224, and Svenska Revisionsakademin (SRA) [The Swedish Audit Academy]. Notes 1 The CSRD proposal, including an explanatory memorandum text motivating the reasons and objectives for revising NFRD, is available at: https://eur-lex.europa. eu/legal-content/EN/TXT/?uri=CELEX:52021PC0189 2 Although the terms ESG and sustainability are often used interchangeably, the former typically concerns specific criteria and measures (of sustainability performance), whereas the latter refers to the larger objective of ‘meeting today’s needs without compromising the ability of future generations to meet their own needs’ (see Brundtland Report, WCED, 1987). Furthermore, finance/investing discourses tend to refer to ESG (information), whereas accounting/reporting discourses tend to refer to sustainability (information). 3 Communication from the commission – Guidelines on non-financial reporting (methodology for reporting non-financial information) C/2017/4234, OJ C 215, 5.7.2017, p. 7. 4 Technology neutrality is discussed as part of a larger discussion on global standard setting in the Swedish Inspectorate of Auditors’ Report ‘digitalization and use of automated tools and techniques’ (Dnr. 2021-0145). 5 By cognitive gap, we mean a limitation to the ability of the auditor/assurer to be fully aware and understand what has happened at each stage of the assurance process, even parts of the process where ADTs have been used. 6 The increasing importance of ESG is also a result of a business strategy reorientation pursued by several important Swedish companies (see Blomkvist et al., 2021).

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Advanced digital technologies and sustainability assurance 199 Richins, G., Stapleton, A., Stratopoulos, T.C., & Wong, C. (2017). Big data analytics: Opportunity or threat for the accounting profession? Journal of Information Systems, 31(3), 63–79. Simnett, R., Vanstraelen, A., & Chua, W. F. (2009). Assurance on sustainability reports: an international comparison. The Accounting Review, 84(3), 937–967. Simnett, R., Zhou, S., & Hoang, H. (2021). The history and future of sustainability assurance. In C. Adams (Ed.), Handbook of accounting and sustainability (pp. 241–259). Cheltenham, London: Edward Elgar Publishing Ltd. Sonnerfeldt, A.L.L., & Pontoppidan, C.A. (2020). The challenges of assurance on non-financial reporting. Accounting, Economics, and Law: A Convivium, 10(2), 1–23. Sun, T., & Vasarhelyi, M.A. (2017). Deep learning and the future of auditing: How an evolving technology could transform analysis and improve judgment. The CPA Journal, 87(6), 24–29. The Swedish Inspectorate of Auditors (SIA) (2021) Tematillsyn–digitalisering och användning av automatiserade verktyg och tekniker. In Swedish (Theme supervision–digitalisation and use of automised tools and techniques). (Accessed on 7 January, 2022). Retrieved from https://www.revisorsinspektionen.se/globalassets/ webbplatsen/publicerat/rapporter-fran-tematillsyn/tematillsyn--digitalisering-ochanvandning-av-automatiserade-verktyg-och-tekniker.pdf Tiron-Tudor, A., & Deliu, D. (2021). Reflections on the human-algorithm complex duality perspectives in the auditing process. Qualitative Research in Accounting & Management, 19(3), 255–285. Truby, J. (2020). Governing artificial intelligence to benefit the UN sustainable development goals. Sustainable Development, 28(4), 946–959. Venter, E.R., & van Eck, L. (2021). Research on extended external reporting assurance: Trends, themes, and opportunities. Journal of International Financial Management & Accounting, 32(1), 63–103. Zorio, A., García-Benau, M.A., & Sierra, L. (2013). Sustainability development and the quality of assurance reports: Empirical evidence. Business Strategy and the Environment, 22(7), 484–500.

Appendix: Research design The purpose of this study is to broaden our understanding of what occurs at the intersection of institutional demands, an evolving auditing profession, and competitive pressures, by exploring the relationship between ADTs as the primary driver of change and sustainability assurance practices in Sweden currently and how they are anticipated to evolve in the future. Even though the literature on sustainability assurance and ADTs in financial auditing is continuously expanding, little is known about their interface. To help fill this gap in the literature, we carry out an explorative and empirically driven study, which focuses on the Swedish context. Data is gathered from semistructured expert interviews and from industry and other reports. The interviewed experts represent three important perspectives: those regulating the auditing industry in Sweden (The Swedish Inspectorate of Auditors, The Institute for the Accountancy Profession in Sweden), accounting firms engaged

200  Jason Crawford, Tim Kastrup, and Aynaz Monazzam Table 9.1  List of respondents, by organisation and role. Organisation

Interviewees and roles

The Swedish Inspectorate of Auditors The Institute for the Accountancy Profession in Sweden Deloitte

1. Senior authorised auditor 2. Senior authorised auditor 3. Authorised auditing consultant 4. Authorised auditor 5. Senior authorised auditor 6. Partner, audit, and assurance 7. Partner, risk advisory, and sustainability 8. Sustainability expert, business advisory 9. Authorised auditor, assurance, and sustainability 10. Partner, assurance 11. Senior manager, sustainability 12. Director, authorised auditor 13. Authorised auditor and sustainability expert 14. Senior ESG expert, responsible for sustainable valuation creation 15. Chief operating officer (COO), financial reporting expert

Grant Thornton EY KPMG PwC Första AP-fonden [First AP-Fund] Investor AB

in sustainability audit and assurance engagements (Deloitte, EY, Grant Thornton, KPMG, PwC), and two institutional investors (Första AP-fonden, Investor AB). In total, we interviewed 15 experts from nine different organisations (see Table 9.1). The interviews were conducted online (via Microsoft Teams and Zoom), attended by all three authors, and lasted approximately one hour each. The interviews were recorded and later transcribed. In the first step of the analysis, each author independently reviewed the transcripts. Given that the interview guides followed a common structure of investigation around themes such as sustainability reporting and regulatory changes, sustainability reporting and assurance, digital technologies, and future outlook (see Table 9.2), we each separately extracted the data that seemed most relevant to the purpose and the research question from the themes into which the interview questions were categorised. This information was compiled into separate documents, which were then shared amongst the authors and thoroughly discussed at several meetings. As a result of those discussions, we were able to identify issues that we felt were most relevant to the study’s purpose and research question. In the second step, we compared our identified issues, and after several iterations where we wove the identified issues from each of the perspectives (regulators, accounting firms, institutional investors) into a draught text, we decided on the structure of how these should be presented to the reader. Initially, we had intended to carry out a detailed mapping of each of the identified issues across the three main perspectives. This proved difficult, as it created a rather rigid framework that privileged some issues and excluded others. This idea was abandoned as it risked omitting important insights that explorative studies such as this one seek to identify. Instead, we decided to

Advanced digital technologies and sustainability assurance 201 Table 9.2  Examples of interview themes and theme-related questions. Example interview themes

Example theme-related questions

Sustainability Reporting and Regulatory Changes

What do you see as the strengths and weaknesses of sustainability reporting today in terms of the quantity and quality of information disclosed? Does that differ for different stakeholder groups? To what extent are companies meeting stakeholders’ demands for sustainability information – is the gap widening here as the evidence seems to suggest is the case elsewhere? Who or what is driving the demand for sustainability assurance? Is it the companies themselves, their investors, politics, or the wider public? Or does it relate to other factors? With the intention to move from limited to reasonable assurance in the future, what are the most important areas (knowledge development, IT skills, etc.) the profession needs to focus on to meet the expectations of the regulators, the clients, and the users of sustainability reports? Looking forward, (where) do you see more opportunities to use digital technologies, such as AI, data analytics, RPA, etc., in sustainability assurance engagements? Digital technologies, especially NLP and machine learning, offer new means to analyse non-numerical data (e.g. text). Is that something you are looking into or intend to explore in the future? What trends, both technological and nontechnological, do you expect to see in sustainability reporting and assurance in the near to mid future?

Sustainability Reporting and Assurance

Digital Technologies

Future Outlook

present the results using three broad, yet encompassing, themes: (1) sustainability reporting and assurance regulation; (2) auditor-client dynamics and embedding ADTs; and (3) the emergence of alternative solution providers. A draft of the chapter was presented at an internal workshop, where valuable feedback was received. In addition, we distributed the draft chapter to the interviewees and solicited their feedback. This was done to ensure that the chapter accurately reflected the current situation in Sweden at the time of writing and to obtain permission to use the organisations’ names. The editors and contributors’ comments were then incorporated into the final version.

Part III

Sustainability

10 Assessment of double materiality The development of predictively valid materiality assessments with artificial intelligence Peter Öhman, Jan Svanberg, and Isak Samsten Introduction Many claim that the audit profession is transforming as a result of the introduction of autonomous support systems taking over routine tasks. However, most claims are based on little or no practical experience of the technology, and academic writing on this topic is rather speculative. Most audit research on Artificial Intelligence (AI) assumes that AI is useful mostly for automation of structured tasks such as information collection, while more complex and unstructured tasks are believed to be best conducted by humans based on their professional judgement (Kokina & Davenport, 2017). However, this does not mean that AI is limited to more structured information and financial auditing. It might also have potential to be a decision-support tool for sustainability assurance. As suggested by Simnett et al. (2022), sustainability reporting might require not only new databases and new support systems but also new assurance methodologies. In a recent research project, we examined how AI could assist materiality assessments in sustainability audits (MASA). This has all the features of a task suited for professional judgement because it is unstructured, analytical, multidimensional, and future-oriented. It also involves qualitative and quantitative data. The aim of this chapter is to discuss a decision-support tool, i.e. a simple prototype of a machine learning (ML) application developed to assess materiality consistent with sustainability reporting according to the Global Reporting Initiative (GRI).1 Although the MASA methodology could be developed for environmental, social, and governance (ESG) performance, we limit the scope of the task to environmental performance. According to Trumpp et al. (2015), environmental performance is a highly multidimensional and aggregate construct. The background to the project is the difficulties auditors face when they are to assess whether company reporting is consistent with the materiality definition according to the GRI standards. Roughly speaking, sustainability reporting standards require either of two types of MASA. One type places the emphasis on financial materiality and is referred to as single materiality because it limits materiality to those issues that impact the financial profit of the DOI: 10.4324/9781003411390-13

206  Peter Öhman, Jan Svanberg, and Isak Samsten reporting company and its owners. The other type is a broader assessment and is referred to as double materiality, including the materiality of topics relating to financial impacts on the reporting company and the materiality of topics relating to impacts of any kind of environmental, social, or governance performance. According to Adams et al. (2020), there is currently a push towards double materiality in sustainability reporting. The connection between the GRI standards and the double materiality principle is of interest for two reasons. Firstly, double materiality does not reduce the issue of whether a company is (un)sustainable to matters that only affect the financial profit of the company and its owners but rather emphasises the broader issue of the externalities. GRI has defined material sustainability information as topics that have a direct or indirect impact on an organisation’s ability to create, preserve, or erode financial, environmental, and social value for itself, its stakeholders and society at large. However, GRI revised its view in an exposure draft (GRI, 2021, p. 8) as follows: ‘the organization prioritizes reporting on those topics that reflect its most significant impacts on the economy, environment, and people, including impacts on human rights’. It appears that this is in tune with the societal debate on the climate crisis because this debate refers to sustainability largely as impacts that do not currently incur costs for the companies responsible for causing them. Secondly, at the time of the study, 73 per cent of the world’s 250 largest companies reported sustainability performance according to GRI.2 When reviewing the accounting and auditing literature on MASA, we find that the amount of uncertainty about how material sustainability items can or should be determined among reporting companies and auditors is considerable. The movement, particularly in Europe, towards the double materiality perspective increases the assessment uncertainties. This is because assessments of the significance of a large number of disparate topics from the point of view of society might be a highly subjective process in which it is likely that personal opinions, experiences, and expectations impact the assessment outcome (Puroila & Mäkelä, 2019). Auditors’ experiences of MASA reflect the uncertainty of the task. Case study research reports that auditors find it difficult to determine evidence to support the adequacy of the reporting company’s MASA because sustainability reports contain little, if any, information about the company’s internal MASA process (Canning et al., 2019). For example, the auditor is supposed to be able to verify whether the reporting company has adequately mediated potential conflicts and divergences among stakeholder opinions, which is difficult if the auditor does not know the stakeholder opinions (Bellantuono et al., 2016). Motivation The United Nations’ summits in Rio de Janeiro 1992 and Johannesburg 2002 emphasise that companies must contribute to environmental concerns. Institutional investors try to do this through socially responsible investments and by using ESG ratings (Drempetic et al., 2020). The financial aspects of

Assessment of double materiality 207 sustainable business are the tip of the iceberg because businesses are considered to cause externalities for which they, per definition, are not (yet) held responsible and for which there is no financial relevance. It is therefore suggested that sustainability assurance providers, as well as the reporting companies, need to develop methods that ensure accurate and adequate assessments according to the double materiality principle. However, research finds little evidence that single materiality would be possible to estimate (Christensen et al., 2021), and we find no evidence in the literature of a valid method for estimating double materiality. Nevertheless, MASA is a prerequisite for sustainability reporting consistent with reporting standards, and this chapter shows the potential usefulness of digitalisation and new ML methods on this matter. By screening entire populations, predictive algorithms can help auditors to identify transactions that warrant further testing (Kokina & Davenport, 2017). In addition, the development of methodologies based on the ability of ESG disclosures to predict environmental controversies could be a first step towards a quantitative estimate of double materiality, providing useful guidance to sustainability auditors. The materiality problem has been systematically researched regarding institutional investors’ use of ESG ratings (e.g. Beske et al., 2020; Calabrese et al., 2016; Canning et al., 2019; Guix et al., 2019; Machado et al., 2021; Moroney & Trotman, 2016; Puroila & Mäkelä, 2019). Institutional investors and sustainability auditors deal with the same basic problem. While the institutional investor needs to assign importance weights to the reported items to aggregate them into a holistic sustainability metric, the auditor needs to assess whether the reported items are the most material ones. A significant problem is the assumption that all selected aspects of ESG are equally important for the overall sustainability performance (Chen & Delmas, 2011). Research also finds that ESG ratings are substantially inconsistent across raters (Chatterji et al., 2016), with differences between leading raters over 30 per cent of the rating number when assessing the same company’s ESG (Christensen et al., 2022). One of the main reasons for the low validity of these metrics is differences between how competing ESG raters emphasise topics and indicators as they compute the ratings (Berg et al., 2022). The differences mean that some of the largest financial data companies in the world (e.g. Bloomberg, MSCI, and Refinitiv) have substantially diverging opinions on how material various sustainability topics should be (Chatterji et al., 2016). These observations are relevant, because an ESG rating and a MASA are closely related tasks, and we find no evidence in the literature that sustainability auditors would access tools that outperform those of the ESG raters. Literature review Although sustainability reporting now has a relatively long history, the frequency and amount of disclosed information have grown substantially in recent years. Because sustainability reports have been criticised for low

208  Peter Öhman, Jan Svanberg, and Isak Samsten credibility, concerns have been raised about the increased need for thirdparty assurance. Although companies show considerable variation in sustainability reporting practices, most of them aim to improve the reliability of their reports by having them assured. Accounting firms invest resources in establishing themselves as reliable service providers within this area where various assurance providers, accounting firms as well as non-accounting firms, offer services with different scopes and objectives using various tools and procedures (Alsahali & Malagueño, 2022; Channuntapipat et al., 2020). It follows from this that sustainability assurance engagements can vary significantly in several respects. The importance of sustainability assurance is further emphasised by the gap between how materiality is understood and applied among reporting companies (Guix et al., 2019). A complicating factor is that, for various reasons, companies vary in how they apply the concept of materiality. Stakeholder engagement can be used by some companies to deliberately reduce materiality of selected topics, while other companies could lack adequate knowledge to assess materiality or favour short-term financial interests at the expense of long-term externalities. It is claimed that materiality assessments are the basis for the sustainability audit and the point of departure for auditor-client negotiations with implications for the sustainability report and possibly for the financial report (Eilifsen & Messier, 2015). Although traditional audit methodologies evolved in the context of financial audit might be ill-suited to give assurance on sustainability reports and ESG disclosures (Knechel, 2021), researchers have argued that MASA can be viewed as a translation of the idea of materiality assessment in financial audits (Eilifsen & Messier, 2015; Messier et al., 2005; Moroney & Trotman, 2016). Materiality in financial reporting is the threshold at which disclosures begin to matter for a stakeholder’s decisions, but a MASA results in the identification of a number of sustainability reporting items that are termed ‘material’. The purpose of a MASA is, therefore, to verify that the reporting company has disclosed an adequate set of sustainability items. The differences between a financial and a sustainability audit illustrate the challenges auditors face with MASA. First, the double materiality requires that auditors identify external stakeholders other than investors, i.e. broad stakeholder groups, while the financial audit assesses materiality for a much more limited group of stakeholders. The broader stakeholder groups are difficult to identify, and their often conflicting needs are not clearly defined (Moroney & Trotman, 2016; Moser & Martin, 2012; Puroila & Mäkelä, 2019). Second, while a financial audit could use a precise materiality threshold – a percentage is often used as a benchmark – the MASA according to GRI standards has no such benchmark.3 Instead, standards refer to the magnitude and likelihood of effects that might be relevant to stakeholders, which are factors that auditors would have difficulty estimating with high precision. The level of agreement between auditors regarding what might be relevant to stakeholders in sustainability audits is, therefore,

Assessment of double materiality 209 generally low (Libby & Brown, 2013). Third, while the financial audit materiality assessment is largely a quantitative exercise, the MASA relies much more on qualitative estimates (Canning et al., 2019; Moroney & Trotman, 2016). These main differences univocally suggest that a double materiality assessment might result in difficult estimates and considerable uncertainty in the subsequent assurance process. In addition to the inherent uncertainties in the MASA observed by Moroney and Trotman (2016) and Canning et al. (2019), the credibility of sustainability reports has been questioned due to the inadequacies of a MASA (Guix et al., 2019; Machado et al., 2021). Consequences of inadequate materiality assessments can be that companies disclose good performance while withholding poor, and thus use sustainability reports to legitimise their actions through misleading stakeholders (Adams, 2004; Beske et al., 2020). Puroila and Mäkelä (2019) argue that materiality in sustainability reporting is best described as a sociopolitical process because stakeholder engagements are not achievable for most companies and therefore function as an alibi for subjectivity that favours financial issues. However, materiality assessments according to GRI standards tend to play a limited role in sustainability audits, and in the current state of affairs, such audits are mostly focused on narrow scoped data-checking principles from financial audits, such as completeness and data accuracy (Boiral & HerasSaizarbitoria, 2020; Boiral et al., 2019; Farooq & de Villiers, 2020). A possible cause of such an approach is that auditors lack the tools for conducting MASA in a manner that supplements the assessments of the reporting company. Auditors can question the outcome of a company’s materiality assessment only if they can demonstrate a discrepancy between company disclosures and a more valid or accurate MASA. A key challenge for such a methodology would be to tackle the subjectivity of the assessment. The available methods for doing so have been described as lacking in structure, and Calabrese et al. (2016) proposed a formalised procedure to assist in the MASA, However, the proposed methodology does not provide any evidence of validity or accuracy of the assessments accomplished by their procedure. In fact, the literature does not describe any such method with which the MASA could be initiated and thus provide the auditor with a reference point other than that provided by the reporting company’s proposed assessment. We find no approach that might assist in the early phase of a sustainability audit by providing the auditor with materiality assessments that can be verified in terms of accuracy. The lack of such methods in the literature might be because they are viewed as irrelevant at the current state of sustainability assurance. However, research seems contradictory, because some researchers indicate that auditors do not engage themselves with MASA beyond fact checking (Boiral et al., 2019), while other researchers describe the complexity that auditors face regarding MASA in actual audits (Canning et al., 2019). Based on this literature review, it seems to be of interest to develop a MASA methodology consistent with sustainability reporting standards. In

210  Peter Öhman, Jan Svanberg, and Isak Samsten contrast to Calabrese et al. (2016), we find it relevant to provide auditors with more than procedural support when performing MASA, including a reference point in line with the rule-of-thumb percentage used in financial audits. The main issue with double materiality is that society’s point of view is in focus. Society is a broad concept, for which a definition is not provided in the reporting standards. We identify those aspects of society that matter in a system of communication and argue that society’s oversight of companies takes place in several ways, for example, through court processes, licensing and media coverage. Of particular interest is that companies are publicly scrutinised by the media. Media critique is a component of most ESG ratings and is also considered a main source of information for assessing individual company track records for the extent to which companies are compliant with sustainability norms (Faulkner, 2011; Fiaschi et al., 2020). We suggest that controversies described in the media could be seen as labels of non-compliance with ESG responsibilities. In the results section below, we explain how we use the compliance labels in ML experiments for the purpose of developing a model to assess companies’ sustainability performance based on how they are likely to be criticised for non-compliance with environmental responsibilities placed on them by society. We then demonstrate how the relative importance, i.e. materiality, of individual sustainability reporting items can be estimated from the model and discuss interpretations of the model output. Results Based on the ML experiments, we explore the possibility of predicting environmental controversies (i.e. non-compliance with environmental responsibilities described in the media) and the relative importance (i.e. materiality) of environmental indicators for the prediction among companies for which there are sustainability reports available. The prediction model developed in this study uses information that companies voluntarily disclose in their annual reports. Such information about a company would be available to a sustainability auditor for the MASA before and during a sustainability audit. Once the prediction model is developed, non-disclosed environmental information can also be provided to the model. This means that the actual considerations that the reporting company might have had prior to deciding about material items can be reconsidered by the auditor with support from the model. However, the main question at this point is whether prediction of instances where companies are non-compliant with environmental controversies is possible and, in particular, what the prediction model’s output means in relation to the MASA. The estimation of materiality with the proposed methodology means that the items that contribute most to the likelihood that a company is compliant or non-compliant with environmental responsibilities will be rated as

Assessment of double materiality 211 the most material, while other items will follow in a falling order of materiality. In other words, the model output is an estimate of environmental risk in terms of the likelihood that a company could be criticised for noncompliance with environmental responsibilities. The risk estimate is derived by the associations the ML model has learned through the experiments between patterns of substantial outcomes (e.g. energy use, greenhouse gas (GHG), pollution, and water use), company sustainability policies, and the likelihood of environmental controversies. Through this process, the various harmful effects can all be gauged on the same wrongdoing scale. The scale might be referred to as environmental non-compliance risk. We exemplify our MASA methodology by investigating the predictive performance of a random forest algorithm that is regarded in the ML literature as a state-of-the-art model in many areas of prediction tasks (for some additional information about random forest, see the Appendix). Our experiments use real environmental sustainability data and real environmental controversy data in a ten-year window for each company in our sample. The predictive ability of the model is evaluated according to five conventional performance measures (cf. Alpaydin, 2010): precision, recall, F-measure, area under receiver operating characteristic (ROC) curve, and precision recall curve (PRC). The basic measures for precision, recall, and F-measure can be found in the Appendix. We acquired data from the Refinitiv Eikon database, previously Thomson Reuters, which is one of the most commonly used databases for sustainability research. For the prediction model not to exclude potential material items ex-ante. Instead, we use as many as 112 environmental performance indicators as model input (the complete list of these indicators is provided in the Appendix). In addition to those, and to aid in our assessment of how environmental controversies are predicted by the model, we included total assets, net assets, return on assets, market value, industry classification (i.e. Global Industry Classification Standard (GICS) sector), and country of headquarters. The dataset contains 2517 companies, approximately 13 per cent of which have been involved in at least one environmental controversy over the 10-year window. Table 10.1 provides an overview of the companies and GICS sectors in the sample. We first examine the ability of random forest to predict environmental controversies according to the five conventional performance measures. The output of the algorithm after training is the prediction of the likelihood that a company complies with environmental responsibilities.4 The predictions are then interpreted using a post hoc interpretation method called SHapley Additive exPlanations, SHAP, (Lundberg & Lee, 2017) which, for example, produces diagrams with the contribution to the prediction of each environmental performance indicator and identification of the most important ones for the model’s estimate of compliance likelihood. Notably, prediction in this study does not mean that the model is forward-looking because the model’s

Controversies, when n > 0

GICS sector

1.47 1.83 1.53 1.09

1.19 3.2 1.37 0.4

4581 2703 3494 4153

0.07 0.04 0.13 0.11

291 96 259 331

25 9 28 13

51 15 36 35

3 3 3 6

12 14 15 46

420 156 141 398 201

19 16 7 5 2

18 12 6 5 2

1 1 1 1 1

2 2 2 1 1

1.06 1.33 1.17 1 1

0.24 0.49 0.41 0 0

4.24 0.81 2.45 0 0

18 −1.65 6 0 0

5770 2377 2257 79534 2387

0.25 0.29 0.05 0.24 0.16

457 160 144 2509 182

13 15 16 199 11

35 23 24 393 24

10 3 2 3 4

122 15 7 11 24

161

1

1

1

1

1

0

0

0

3415

0.06

284

21

40

3

14

155

1

1

1

1

1

0

0

0

1667

0.42

78

10

12

2

7

Max

Kurtosis

1.69 1.43 0.89 0.9

Skewness

Skewness

2.2 2 1.55 1.71

Standard deviation

Standard deviation

7 7 4 4

Mean

Mean

1 1 1 1

Min

Max

59 48 38 21

Assets in USD billions

Min

130 96 59 36

Kurtosis

Companies with controversies, n

Controversies, n

183 277 124 297

Companies, n Energy Materials Utilities Consumer discretionary Industrials Consumer staples Health care Financials Information technology Communication services Real estate

Assets in USD billions per company

212  Peter Öhman, Jan Svanberg, and Isak Samsten

Table 10.1  Descriptive statistics by industry, number of controversies, and total assets.

Assessment of double materiality 213 purpose is to characterise companies as more or less environmentally compliant based on typical patterns in their environmental indicators. The model shows a characterisation, or an assessment, of each company, not a prediction of a future state based on past performance. We divide companies into two categories and denote companies with a controversy described in the media as positive cases and companies that have not been involved in a controversy as negative cases. The longitudinal aspect of data is captured by an average if numerical (e.g. CO2 emission) or encoding using dummy variables if binary (e.g. one per year). We compute SHAP values, and the SHAP diagrams used are illustrations through which the materiality distribution is easily comprehended. To evaluate the random forest algorithm,5 we first calculate precision and recall. Precision is the fraction of true positives in relation to the total number of positive case predictions, while recall is the fraction of true positive predictions in relation to the true positive and false negative cases in the data. Precision can be said to represent the number of times a darts player’s arrow hits the target in relation to the number of attempts and recall represents the ability of the predictor to identify the largest possible fraction of all the controversy companies in a data set. In addition, we use the F-measure which is the trade-off between precision and recall (see Appendix). Furthermore, the measure Area under the ROC curve estimates the probability of a classifier ranking a true positive instance ahead of a false positive instance and is thus a measure of its so-called ranking performance. Similarly, the PRC estimates the mean precision for multiple thresholds of recall. The main benefit of the area under the ROC curve and PRC is that they are insensitive to the class distribution of the training and testing data, as opposed to the static accuracy measures. Table 10.2 summarises our findings regarding the ML model’s ability to predict environmental controversies. The MASA methodology requires predictive validity of its underlying model, i.e. a model that can predict our operationalisation of environmental performance for individual companies. As shown, random forest does well on the task of predicting environmental controversies with a high precision of 0.70 but a more moderate recall of 0.19. Broadly speaking, this means that the model’s current settings make it good at correctly identifying a small sample of non-compliant companies. Figure 10.1 (a) and (b) enables evaluation of the ranking and predictive performance of the model and interpretations are briefly explained under each part of the figure. The graphs reveal that the results in Table 10.2 and Figure 10.1 are consistent, i.e. random forest learns the indicator patterns Table 10.2  Measures of random forest predictive performance.

Random forest

Precision

Recall

F-measure

ROC

PRC

0.6994

0.1942

0.2990

0.8849

0.5090

214  Peter Öhman, Jan Svanberg, and Isak Samsten

Figure 10.1  Evaluation of predictive performance. ( a) Area under the ROC curve, where the black line represents the results for predicting non-controversy and the grey line represents the results for predicting controversy. Note that classifiers that produce ROC curves that lie above the dashed line provide predictions that are better than random guessing. ( b) Precision Recall Curve (PRC), where the black line represents the results for predicting non-controversy and the grey line represents the results for predicting controversy. The PRC shows the precision of a classifier as the recall increases. The top region (defined by the dashed grey line) shows the region for which a classifier performs better than random guessing for the non-controversy cases, and the region between the bottom and top regions shows where a classifier performs better for the controversy cases. ( c) Correlation between the random forest corporate environmental performance (CEP) ratings and the number of years a company has had a controversy. The figure clearly shows that our CEP ratings penalise firms with more controversies and assign lower scores, i.e. the lower the CEP rating, the more controversies. (Continued)

Assessment of double materiality 215

Figure 10.1 (Continued)

typical of controversy companies and performs well as a controversy company predictor. The performance according to the area under the ROC in Figure 10.1 (a) is good for both non-controversies (black curve) and controversies (grey curve). Figure 10.1 (c) presents negative correlations between likelihood estimations and the number of controversies. The x-axis is the number of controversies per company, and the y-axis is the estimated likelihood based on corporate environmental performance (CEP) ratings. The slope in the graph is downwards, as expected, because the more controversies a company has had, the higher the estimated likelihood of controversy. Our estimates of materiality in terms of the SHAP values are numerical between 0 and 1 and, which is common in the ML literature, presented graphically. Notably, SHAP can be generated for any aggregation level within an industry classification such as GICS, i.e. from MASA for the individual company to MASA for the sub-industry, the industry, or all companies of interest. The SHAP is most accurate for the individual company, but if the auditor were to believe that the MASA should be identical for a group of companies,

216  Peter Öhman, Jan Svanberg, and Isak Samsten

Figure 10.1 (Continued)

our methodology allows the computation of MASA for any sample of companies. A decision-support tool that calculates MASA could be particularly useful when comparing the audited company with other companies in the same industry. Derived from a summary plot, i.e. a global SHAP diagram, Table 10.3 shows the 14 most important indicators in materiality order based on the sample and the random forest environmental controversy prediction model. Each vertical position represents a SHAP value for an environmental performance item. In addition to these items, other items added to the prediction model might appear in the diagram. For example, firm size (i.e. Net asset value and Total assets) might be associated with an increased risk of environmental controversy, but the size of the firm is irrelevant to the reporting of material environmental issues and does not affect the MASA. In a coloured SHAP diagram, each company is represented by one dot on each indicator line. The position on the vertical axis signals the average contribution to the prediction of controversy, i.e. to be criticised by the society,

Assessment of double materiality 217 Table 10.3  M  ost important (i.e. material) indicators based on the random forest environmental controversy prediction model. Estimated CO2 emission equivalents total CO2 equivalent emissions direct Biodiversity impact reduction Net asset value CO2 equivalent emissions total Total CO2 equivalent emissions to revenues Land environmental impact reduction Total assets Water withdrawal total NOX and SOX emissions reduction Climate change commercial risks opportunities Environmental expenditures investments Environmental restoration initiatives CO2 equivalent emissions indirect

from a particular indicator for all companies in the sample. In other words, it is the total amount of conditional probability normalised to a number between 0 and 1. The horizontal axis shows the SHAP value for each individual company, which indicates the strength of the indicator’s impact on the likelihood of controversy for a particular company. The colour of each company-dot on each line represents the indicator values from low (e.g. blue) to high (e.g. red). For example, if a company has a high amount of estimated CO2 emission – which is the most material issue for the whole sample of companies in this research project – it has a red dot on the line for this indicator. Overlapping points are jittered with a thicker horizontal line where there are many indicator values (i.e. observations), so we obtain a sense of the distribution of the SHAP values. It follows from a SHAP summary plot that the frequencies of indicator values and their contribution to the predictions can be explained in detail in a single visual inspection. A red dot represents a high indicator value, and if it is located far to the right on the SHAP value scale, it contributes significantly towards classifying a company as controversial. Consequently, if a blue dot is located far to the left it contributes a lot to predicting the company as not having a controversy. The models’ ability to predict environmental issues signals the degree of materiality to the auditor. Some emissions might occur only in some classes of companies, suggesting that the predictive ability of an indicator in Table 10.3 (from top to bottom) is less relevant for the MASA of a particular company. Nitrogen oxides (NOX) are a family of poisonous, highly reactive gases that form when fuel is burned at high temperatures. NOX pollution is emitted by automobiles, trucks, and various non-road vehicles (e.g. construction equipment and boats) as well as industrial products such as power plants,

218  Peter Öhman, Jan Svanberg, and Isak Samsten industrial boilers, cement kilns, and turbines. The materiality of NOX varies substantially across industries and thus pushes the global importance down, although these gases are likely of great concern for companies emitting them. It is, therefore, possible to have serious issues of low frequency on a global MASA, while an indicator can be of the highest materiality when the model focuses on a sub-industry or an individual company. The variation between industries or companies is even greater for sulphur oxides (SOX), which is one of the main causes of acid rain but emitted essentially only from engines of large ships. This is an example of an industry-specific issue so important to society that it is ranked among the most material issues on the global assessment scale even though it does not affect most industries at all. Appearing at the top of the global materiality rating are indicators of what, in the sustainability literature, is referred to as substantial outcomes (Wood, 2010) or environmental risks (Delmas et al., 2013). Such indicators have a concrete and indisputable impact on the environment, e.g. CO2 emission, NOX and SOX emissions reduction, water withdrawal, and climate change commercial risks and opportunities. Several of these types of indicators are just below the most important ones (not displayed in Table 10.3), e.g. waste total, energy purchased, energy used total, waste recycled total, and hazardous waste. In addition to substantial outcomes, policy-type indicators that describe self-reported efforts to reduce a company’s environmental impact, e.g. biodiversity impact reduction, land environmental impact reduction, environmental expenditures investments, and environmental restoration initiatives, are predicted as material by our MASA model. As noted by Delmas et al. (2013, p. 263), ‘Companies may excel at reporting, governance, and the utilization of environmental performance systems but still emit substantial amounts of pollution’, i.e. companies can use policies symbolically without pursuing substantial outcomes. The MASA model interprets the use of policy-type indicators with caution because its estimation of materiality is based on the predictively valid classification of companies’ compliance with environmental responsibilities. Not displayed in Table 10.3 are indicators relevant only for a small group of companies. Such indicators are assessed as more material by the rating model when it predicts controversies for a company in a particular industry. Regarding the interpretation of individual controversy predictions, SHAP force plots for an individual company can offer an overview of environmental feature materiality. Figure 10.2 exemplifies how sustainability auditors could be helped to develop an understanding of MASA from conditional probabilities. The model’s MASA for Delta Electronics Inc., an information technology company based in Taiwan, is shown in the figure. The company takes pride in environmental responsibility and has been in the Dow Jones Sustainability Indices for the past five years. The light grey arrows with the forces pushing the rating to be high totally dominate the dark grey, suggesting that there are very few doubts from our compliance-based model that Delta

Assessment of double materiality 219

Figure 10.2  SHAP force plot for Delta Electronics Inc.

220  Peter Öhman, Jan Svanberg, and Isak Samsten Electronics is a company highly likely to comprehensively comply with environmental responsibilities and therefore having a low risk of environmental controversies. Figure 10.2 demonstrates that the most material items are light grey, i.e. environmental performance strengths or risk-reducers, rather than showing red flags. Even the absence of land environmental impact reduction is discounted by the model as an indication that the company is not involved in environmentally risky activities, and low CO2 emission confirms the image of a company exposed to low risks of being non-compliant with environmental responsibilities. In summary, the developed model might have the potential to be used as a reference point, or a materiality threshold, in a sustainability audit in a manner similar to the rule-of-thumb percentage reference mark when a financial audit is initiated. While the methodology remains to be improved, it is a first illustration of how one of the most complex and difficult audit tasks can be supported by the use of AI and ML. Conclusions and implications This chapter addresses the difficulties with sustainability reporting materiality assessment noted in the literature. The difficulties are expected to be particularly great when assessing double materiality according to the GRI standards because such assessments presuppose that the auditor can determine which ESG aspects of a company’s operations have the greatest impact on the environment and society if viewed from the perspective of the broadest possible stakeholder group, i.e. the surrounding society. The reviewed literature univocally describes MASA, whether single or double materiality, as subjective, uncertain, or imprecise, without a clear reference point such as the rule-of-thumb percentage often used by financial auditors as a materiality threshold to start from (Moroney & Trotman, 2016). The literature provides descriptions of the difficulties, and MASA is the target of critique in research. However, we find no proposed solution to the problem of assessing the non-financial and societal-perspective aspects of double materiality. These kinds of assessments are examples of tasks suited to audit analytics (e.g. Simnett et al., 2022). For example, auditors are projected to use AIbased, autonomous analytics that provides a full examination of the entire ledgers of larger companies instead of the manual, risk-based sampling auditors currently use. The advantage of the proposed methodology compared to manual assessments is that the ML-based MASA is data-driven, derived from a specifiable and verifiable set of data. A potential gain is to anchor the MASA in its initial planning phase on a metric that does not derive itself from claims by the reporting company or the possibly biased views about the broad and multifaceted stakeholder groups’ opinions the auditor might hold prior to a sustainability audit. Even a rough estimate serving as a starting point for further audit work would be of use

Assessment of double materiality 221 because previous research has emphasised the difficulty of knowing the views of the broad stakeholder groups that are relevant to the MASA (Moroney & Trotman, 2016; Moser & Martin, 2012). Our proposed methodology might reduce uncertainty in the planning phase of the sustainability audit and assist with initiating the auditor’s manual MASA. A second possible benefit is related to the fact that the materiality principle is much less precise for sustainability assurance engagements than in financial audits (Canning et al., 2019; Machado et al., 2021). Auditors, therefore, could benefit from a structured starting point for the MASA. Such structure can be provided by future refinements of standards. However, as long as the reporting standards are vague regarding MASA, the auditor could benefit from the cognitive structure provided by the preliminary ML-based model. A third potential benefit of using the ML-based MASA is related to the qualitative elements that are more difficult to compare than the quantitative elements in the financial audit (Canning et al., 2019; Moroney & Trotman, 2016). The ML-based model might assist the auditor with initially reducing the complexity of the MASA, and it offers good predictive performance, even when there are many dimensions. The usefulness of an automated assessment tool should be judged on how well it performs on the assessment compared to alternative methods. The only realistic alternative appears to be the way MASA is presently performed by auditors. Unfortunately, we find no evidence of the validity and accuracy of any presently practised MASA method. On the contrary, our literature review shows that materiality is considered a serious problem both when the reporting company and the external auditor perform it. There are examples of high disagreement among auditors about MASA and indications that they are uncertain of how MASA should be adequately performed. Some research even shows that MASA is ignored by auditors or is performed only as a factchecking procedure (Boiral & Heras-Saizarbitoria, 2020; Farooq & de Villiers, 2020). In summary, there is no evidence that the manual procedures to conduct MASA represent any conceptualisations of CEP, corporate social responsibility (CSR) or sustainable performance as described in the literature. In contrast to these descriptions, the validity of the ML-based MASA as a predictor of the reporting company’s compliance with, in this case, environmental responsibilities seems to be relatively high. The proposed solution to the double materiality problem is to define sustainable performance according to the original drafts of the concept by Carroll (1979) and Wood (2010) as companies’ compliance with CSR. The relatively high predictive performance of the random forest algorithm indicates that the ML-based MASA represents important information pertaining to the reporting company’s compliance with responsibilities, which, for environmental sustainability, translates into, for example, low water and energy use, low pollution, adequate policies, and goals to improve the company’s environmental performance because such behaviours are typical for environmental responsibilities (Svanberg et al., 2022).

222  Peter Öhman, Jan Svanberg, and Isak Samsten The development of a double materiality-based MASA decision-support tool seems feasible with ML, and recent developments in interpretation methods in ML enable a thorough calculation of the contributions to a holistic environmental performance metric. The environmental performance metric can be estimated with predictive validity, which is promising compared to other metrics known to the literature (e.g. Berg et al., 2022; Chatterji et al., 2016). The predictive validity of the environmental performance metric and the thorough calculation of the contribution to environmental performance enabled by the SHAP method for feature importance assessment suggest that the MASA model output is an accurate estimate of double materiality. The suggested approach is not without limitations. A first limitation is that we did not adjust the model for the unequal media attention paid to companies, which likely leads to different companies having different likelihoods of having a controversy, not corresponding to differences in their non-compliance with environmental responsibilities. Media reporting might also differ across countries. What is perceived as alarming in one part of the world may be more or less ignored in another. Furthermore, we did not intend to develop an operational MASA method but rather to explore aspects of the construction of a MASA methodology, which meant that we included several indicators that should not be adopted in an actual decision-support tool. Another limitation is that we have not fine-tuned the parameters in the ML algorithm, which would enable higher predictive performance. The controversies database might also be replaced by a database that offers a higher coverage of companies and geographical settings. Future development of the methodology could also attempt to make the predictions unbiased regarding firm size and profitability, i.e. two biases that according to Drempetic et al. (2020) have seriously troubled the use of ESG ratings. Notes 1 The regulation in this field has been weak, leaving room for various initiatives. However, the Corporate Sustainability Reporting Directive (CSRD) has recently, December 2022, been adopted by the European Parliament. It entered into force at the beginning of 2023, and becomes mandatory in the member states in 2024 (see Argento et al., Cieslak et al., Crawford et al. and the introductory and concluding chapters by Marton et al. in this volume). 2 https://assets.kpmg/content/dam/kpmg/be/pdf/2020/12/The_Time_Has_Come_ KPMG_Survey_of_Sustainability_Reporting_2020.pdf 3 Notably, materiality of disclosures in the notes does not have such benchmarks, even though it relates to financial reporting. 4 See Svanberg et al. (2022) for technical and methodological details of the model for predicting the controversies. 5 The technical aspects of these measures are complicated, but a basic understanding of interpretations of the measures for the good performance of a predictor is not that difficult to develop, so we omit the details but provide some overall information. Some additional information about the random forest algorithm is provided in the Appendix.

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Appendix: Research design Random forest, created by Breiman (2001), is one of the most widely applied machine learning algorithms and is often considered the current state of the art in many domains. The algorithm constructs an ensemble model by creating decision trees trained using (random) samples of training data (e.g. companies). We construct each tree by sampling a limited number of CEP indicators at each node to increase the variability and predictive performance. The final controversial prediction of the model is a majority vote among the trees. Random forest works well with outliers and noise in the training set (Yeh et al., 2014), which are good features of a prediction model for environmental controversies, which can be expected to be noisy due to greenwashing and the lack of internationally binding reporting standards. Another benefit of random forest is that it calculates the importance of each indicator for the classification results. Using the majority of votes among the trees avoids data overfitting and provides precise forecasts (Breiman, 2001). Under the hood, the random forest is essentially a classification and regression trees (CART) algorithm. However, it creates an ensemble of many trees instead of just one. CART is an algorithm that predicts the target variable. It is a decision tree where each fork is split into a predictor variable and each node has a prediction for the target variable at the end. In the tree, the nodes are split into sub-nodes on the basis of a threshold value of an attribute. A root node is taken as the training set. It is split into two by considering the best attribute and threshold value. Then, the subsets are split using the same manner. This continues until the last subset is found in the tree or the maximum number of leaves possible in that growing tree is reached. Details can be found in Hastie et al. (2009). The basic measures of performance are presented in Table 10.4 and the environmental performance indicators used are presented in Table 10.5.

226  Peter Öhman, Jan Svanberg, and Isak Samsten Table 10.4  Measures of performance. Precision =

Recall =

Truepositive Truepositive + Falsepositive

Truepositive Truepositive + Falsenegative

F − measure =

2 × Precision × Recall Precision + Recall

Truepositive =

Truepositive Truepositive + Falsenegative

Falsepositive =

Falsepositive Falsepositive + Truenegative

Table 10.5  The 112 environmental performance indicators used in the investigation. No. Variable name

No. Variable name

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29

30 31

Resource reduction policy Policy water efficiency Policy energy efficiency Policy sustainable packaging Policy environmental supply chain Resource reduction targets Targets water efficiency Targets energy efficiency Environment management team Environment management training Environmental materials sourcing Toxic chemicals reduction Total energy use to revenues Renewable energy use ratio Renewable energy supply Energy use total Energy purchased direct Energy produced direct Indirect energy use Electricity purchased Electricity produced Cement energy use Renewable energy purchased Renewable energy produced Renewable energy used Green buildings Water use to revenues Water withdrawal total Freshwater withdrawal

32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52

Water recycled Environmental supply chain management Environmental supply chain monitoring Environmental supply chain partnership termination Land environmental impact reduction Total renewable energy Policy emissions Targets emissions Biodiversity impact reduction Total CO2 equivalent emissions to revenues CO2 equivalent emissions total CO2 equivalent emissions direct CO2 equivalent emissions indirect Carbon offsets/credits Estimated CO2 emission equivalents total CO2 estimation method Emissions trading Cements CO2 equivalents emission Climate change commercial risks opportunities Flaring gases Ozone-depleting substances NOX and SOX emissions reduction NOX emissions (Continued)

Assessment of double materiality 227 Table 10.5  (Continued) No. Variable name 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81

SOX emissions VOC or particulate matter emissions reduction VOC emissions reduction Particulate matter emissions reduction VOC emissions Total waste to revenues Waste recycled to total waste Total hazardous waste to revenues Waste total Non-hazardous waste Waste recycled total Waste recycling ratio Hazardous waste Waste reduction initiatives e-Waste reduction Water pollutant emissions to revenues Water discharged Water pollutant emissions ISO 14000 or EMS EMS certified per cent Environmental restoration initiatives Staff transportation impact reduction Accidental spills Environmental expenditures investments Self-reported environmental fines Environmental partnerships Internal carbon pricing Internal carbon price per tonne Emission reduction target percentage

No. Variable name 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 100 101 102 103 104 105 106 107 108 109 110 111 112

Emission reduction target year Environmental products Eco-design products Environmental R&D expenditures to revenues Environmental R&D expenditures Noise reduction Fleet fuel consumption Hybrid vehicles Fleet CO2 emissions Environmental assets under management Equator principles Equator principles or environmental project financing Environmental project financing Nuclear Nuclear production Labelled wood production Labelled wood Organic products initiatives Product impact minimisation Take-back and recycling initiatives Product environmental responsible use GMO products Agrochemical products Agrochemical 5 per cent revenue Animal testing Animal testing cosmetics Animal testing reduction Renewable/clean energy products Water technologies Sustainable building products Real estate sustainability certifications

11 Organising for quality in sustainability assurance A literature review Katarzyna Cieslak, Cecilia Gullberg, Shruti Kashyap, and Joachim Landström Introduction This chapter recognises the rise of sustainability reporting, the development of sustainability reporting standards, and the emerging need for assurance of sustainability reports as comprising a significant driver for audit transition. We investigate this driver by engaging in a literature review of 40 articles published in 27 top-ranked accounting and audit journals. The corpus, narrowed down from an initial identification of 219 articles, recognises important facets of quality as related to sustainability reporting and assurance. Our analysis identifies four emergent themes within the literature: first, how sustainability assurance is currently understood; second, what drives assurance quality; third, how assurance and the quality of sustainability reports are related; and fourth, how sustainability assurance may impact investors’ reactions to the reported information. Collectively, this chapter provides insights into how sustainability assurance quality is approached today, and what some meaningful future directions might be. The regulation and practice of sustainability reporting and assurance are undergoing changes in line with evolving social norms and societal expectations of firms. Under the current Swedish reporting framework, the only mandated requirement for external audit reports is the disclosure of whether the audited firm has issued a sustainability report,1 although some firms choose to voluntarily perform limited assurance of their sustainability reports. This stands to change under the recently adopted EU Corporate Sustainability Reporting Directive (CSRD), which introduces limited assurance and the future possibility of mandated reasonable assurance of sustainability reports. In parallel, the recent creation of the International Sustainability Standards Board (ISSB), ongoing work on sustainability reporting by the European Financial Reporting Advisory Group (EFRAG), and the draft European Sustainability Reporting Standards (ESRS), collectively indicate both the rising importance and impact of sustainability reporting, and the need for audit services of such reporting activities. This literature review covers 40 articles published during a five-year period (2017–2021) in 27 top-ranked accounting journals (3, 4, and 4*) per DOI: 10.4324/9781003411390-14

Organising for quality in sustainability assurance 229 the 2021 Academic Journal Guide (AJG) (CABS, 2021). Following exclusion criteria as explained in the Appendix, the final selection of articles addresses sustainability assurance, sustainability reporting, integrated reporting, and financial audit as linked to drivers of assurance quality and report quality. As financial audit is an established research field, anchoring the literature review in this way allows for a juxtaposition of financial audit quality measures and drivers against sustainability reporting characteristics. This sheds better light on what may constitute quality in sustainability assurance. In sum, organisations face mounting pressure to provide sustainability reports. Such reports must not only be credible and legitimate but must also comply with newly adopted reporting and assurance requirements. In this shifting landscape, a clear understanding and approach towards the quality assurance of sustainability reports is an important task for not only companies but also assurance providers. Compared to the more established and regulated domain of financial reporting, sustainability reporting lies at the intersection between emerging regulations, voluntary guidelines, and evolving societal norms. Sustainability reporting thus still lacks established quality measures, and legitimising sustainability reports through credible assurance remains a challenging task. While the above-identified developments affect auditing, the implications for audit services remain murky. Therefore, the purpose of this chapter is to perform a literature review that addresses the current state of knowledge regarding assurance and its quality as relevant to sustainability reporting. Collectively, the literature review indicates the importance of how sustainability assurance is organised – who provides assurance, what procedures assurance is based upon, and what knowledge or expertise is required to engage in assurance. It identifies how the concept of quality relates to both reporting and assurance, and what issues assurance providers may wish to consider as the field of sustainability reporting develops. Motivation On 28 November 2022, the European Commission (EC) formally adopted the CSRD, which replaced the EU Non-Financial Reporting Directive (NFRD). The CSRD, which entered into force on 5 January 2023, arguably brings sustainability reporting up to par with financial reporting, including in terms of reporting harmonisation.2 The CSRD applies to EU companies and non-EU companies with subsidiaries within the EU and widens the scope of inclusion for both public interest and listed companies. In addition to outlining an integrated reporting format,3 the CSRD also introduces third-party and annual statutory audit requirements on sustainability reports. Collectively, this introduces significant changes to the reporting and assurance frameworks that apply within Sweden and the EU. This evolution in EU sustainability reporting and assurance regulation increases the depth and complexity of interactions between regulators and both

230  Katarzyna Cieslak et al. public and private sector standard setters. The EC has, under the CSRD, appointed the EFRAG, a private sector organisation, as a technical advisor for the developing European Sustainability Reporting Standards (ESRS). In parallel, under the aegis of the IFRS Foundation, the recently established ISSB is developing global baseline sustainability disclosure standards in line with investor and financial market interests. Both EFRAG and the ISSB are also cooperating with the Global Reporting Initiative (GRI), an international and independent standards organisation that has created a voluntary sustainability reporting framework. Although assurance of sustainability reports remains underdeveloped (Boiral et al., 2019), the emerging standards and frameworks share similar guiding concepts as the IFRS framework regarding how sustainability information should be reported. Collectively, such parallel developments and conceptual similarities indicate that where there is a lack of research into sustainability reporting drivers, insights from financial reporting and assurance may be valuable. At the industry level, the CSRD extends the scope of assurance providers to include actors beyond accounting firms.4 This increases potential competition between audit service providers. The debate about whether sustainability report assurance falls under the purview of accounting firms or non-accounting firms is likely to intensify as new regulatory requirements on sustainability reporting are implemented (see e.g. Farooq & de Villiers, 2020). At the firm level, there remains a wide variance in the content of sustainability reports, with indications that firms are challenged to improve policy implementation and the establishment of performance indicators (see e.g. PWC, 2020). Concurrently, the developing ESRS introduce increased disclosure requirements but still afford firms some level of discretion in deciding what to disclose. Given double materiality in sustainability reporting (financial materiality of how sustainability matters generate significant risks or opportunities that may influence cash flows; and impact materiality by the firm on people and environment),5 the draft ESRS 1 expands boundaries of the reporting entity to include upstream and downstream value chains of the firm’s activities (in accordance with specific requirements of ESRS, or following the outcomes of sustainability due diligence process).6 Firms may estimate any missing information about their value chains using sector-average data and other proxies if collecting the information is challenging.7 These subjective components of the draft ESRS highlight that the process by which firms engage in internal decision-making and assessments of sustainability management and reporting are also important areas of inquiry for assurance providers. With more detailed requirements on the substance and structure of sustainability reports and potentially shifting levels of assurance on such reports, the most salient conceptual considerations seem to be those related to double materiality and the scope of sustainability assurance. These are important in the context of reporting boundaries and in understanding how quality is constituted and assured in sustainability reporting. Regulation notwithstanding,

Organising for quality in sustainability assurance 231 the quality of sustainability reports and tendencies of ‘greenwashing’ is a longstanding concern in academic debates (e.g. Diouf & Boiral, 2017; Perkiss et al., 2021). Ensuring the quality of the assurance process itself may be problematic (Boiral et al., 2019; Farooq & de Villiers, 2020). It is also unclear how assurance and report quality are related, and what constitutes quality in sustainability assurance. These considerations motivate the current literature review. As we do not find any reviews that link the concept of quality in reporting and assurance, the present chapter addresses this important gap. Literature review This literature review identifies four clusters of articles recently published in top accounting journals: (1) articles concerning how the process and quality of sustainability assurance are currently understood; (2) articles on drivers of assurance quality; (3) articles on the relationship between assurance and the quality of sustainability reports; and (4) articles covering the impact of assurance on investor reactions to the reported information. These four clusters are reviewed in the following sections. Sustainability assurance: How can it be understood?

The six articles in this section relate to either sustainability or integrated reporting. They address the process of sustainability assurance, the actors and methods used for such assurance, and the quality of sustainability assurance in its current state. The articles identify two main types of assurance providers: accounting firms and non-accounting firms, such as sustainability consultancies. One article suggests that assurance might additionally be performed within organisations through internal audit and senior management functions (Maroun, 2017). Several articles highlight the emerging competition between accounting and non-accounting firms (Boiral et al., 2019; Canning et al., 2019; Farooq & de Villiers, 2018). Since these two groups of assurance providers have rather different knowledge and experiences regarding the topics included in reports and the methodologies used in the assurance process, such competition evokes questions of how assurance can be achieved and what constitutes quality in the process. Furthermore, the respective groups of assurance providers seem to undertake purposive work to create legitimacy for their methods and skills in order to advance their competitiveness. How assurance is approached for integrated reporting and sustainability reporting can also vary significantly. For instance, Briem and Wald (2018) point to inconsistent definitions, poor consensus on the importance of quality and quantity of non-financial information in integrated reporting, and vague legal rules on the assurance requirements of integrated reports. Similarly, a lack of consensus can be seen concerning how to determine the materiality of sustainability report content and the scope of the assurance of such reports

232  Katarzyna Cieslak et al. (Canning et al., 2019; Farooq & de Villiers, 2020). Importantly, materiality seems to be constructed and operationalised reflexively during the assurance process itself, rather than solely dependent on auditee perceptions of what information is material or not (Canning et al., 2019). Furthermore, both accounting and non-accounting firms seem to approach the assurance process largely from a financial audit perspective. Canning et al. (2019) and Farooq and de Villiers (2018) find that assurance providers generally prefer to use existing financial accounting- and audit-based standards and methods in sustainability assurance activities. This may be attributable to the familiarity, comfort, and perceived legitimacy of such approaches, and the demands of both internal and external stakeholders. In the context of sustainability reporting and assurance, these articles suggest that the audit profession may be translating existing technologies into the emergent arena of sustainability assurance. At the same time, as evidenced by Farooq and de Villiers (2018), tension exists between accounting and non-accounting firms regarding who should provide sustainability assurance and how. The emergent view is that accounting firms may wish to adopt more flexible methods and standards in the assurance process. This importantly indicates that the audit profession could consider not only how current expertise may be translated, but also transformed, to meet the call of sustainability reporting and assurance. The quality of current sustainability assurance practice is also debated in the literature. Some articles indicate that preparers and assurers believe that assurance advances better alignment between report content and conceptual drivers (such as ‘materiality’ and ‘relevance’) of reporting (Canning et al., 2019; Maroun, 2017). Hence, assurance may benefit report quality. Other articles are negatively inclined towards the current state of sustainability assurance. For instance, based on interviews with accounting and non-accounting firms, Boiral et al. (2019) offer a critical view of sustainability assurance quality. They note that while such assurance requires multifaceted skills, the field still suffers from a lack of training or certification programmes and other forms of adequate professionalisation. In line with some prior research (e.g. Farooq & de Villiers, 2018), the authors document impediments to achieving high assurance quality, including the identification of tensions between accounting firms and non-accounting firms. They further point out that a continuing lack of awareness on the part of assurance providers regarding report quality characteristics as called for under voluntary frameworks such as the GRI indicates that such frameworks may be used more as legitimising tools rather than quality-enhancing mechanisms when used to assess and assure sustainability reports. Farooq and de Villiers (2018) similarly find that the competition between accounting and non-accounting firms may negatively impact the independence of the assurance providers and the quality of the assurance provided. Farooq and de Villiers (2020) further describe how flexible assurance scopes are often offered to clients in order to capture revenues, and how managerial preferences encourage a narrower scope of focus on less risky areas such as the reliability of the disclosed content, rather than a

Organising for quality in sustainability assurance 233 broader scope on assuring the balance of the report (i.e. what is, and what is not, reported). A narrow scope of assurance diminishes assurance providers’ ability to add value and enhance credibility, and thus negatively impacts the quality of assurance. In summary, the literature provides an image of sustainability assurance as having the as-yet unrealised potential to increase audience perceptions of report quality and actual report quality. Both accounting and non-accounting firms compete in this emerging field, each group attempting to create legitimacy for their respective skills and methods. While methods related to financial audit seem prevalent, the literature suggests that other knowledge is also relevant. The identified literature questions the quality of current sustainability assurance practices and points to a lack of uniformity in approach. Having briefly outlined the current understanding and state of sustainability assurance, we will now discuss sustainability assurance related to certain drivers and effects. What are the drivers of sustainability assurance quality?

Empirical research on sustainability assurance quality is scant. As the previous section identifies, sustainability assurance contains the scope of both translation and transformation of extant financial audit practices. In this section, we review 17 articles. Three of these treat sustainability reporting, and 14 address financial audit as relevant for sustainability assurance. From these articles, we identify three main drivers of assurance quality, namely: specialisation, complexity, and assurance organisation. We discuss them below. Xu and Andrew (2021) indicate how the competitive tension between groups of potential assurance providers may impact the formation of and compliance with regulatory frameworks. Their study of the Australian audit industry identifies how conflicting knowledge claims and resistance within the industry impacted an ultimately failed regulatory bid to register greenhouse and energy auditors. In addition to highlighting the links between professional and political tensions in new spaces of regulation and practice, these findings echo the gist of the earlier section on the issues of who, what, and how to regulate sustainability reporting and assurance. As long as these more fundamental questions remain unanswered, the bid to address what constitutes and drives sustainability assurance quality is explorative at best. Given the strong links between financial reporting frameworks and the emerging developments in sustainability reporting, there are benefits to be drawn from extending understandings from financial auditing to sustainability assurance. In this section, we thus anchor our literature review in financial audit research and draw possible conclusions about how such research may be useful when we try to determine the drivers of sustainability assurance quality. In empirical studies of financial audit quality, measures of high quality vary between using accounting outcomes and capital-market outcomes. Measures used include discretionary accruals (e.g. Ahn et al., 2020), accounting

234  Katarzyna Cieslak et al. restatements, going-concern opinions, and audit fees to total fees. Accounting outcomes such as discretionary accruals may be primary measures of financial report quality. Financial report quality may in turn be affected by audit quality. However, audit quality is probably only one of several inputs that affect report quality. The more direct measures of audit quality are restatements and going-concern opinions, where, for example, fewer restatements signal a higher quality. A recent study by Rajgopal et al. (2021) validates restatements as a major proxy for audit quality, finding a strong positive link between restatements and audit failures. If we agree that fewer restatements are the signal of higher audit quality, and that the correct issuance of goingconcern opinions signals high audit quality, we can draw some conclusions from the financial auditing research. Ahn et al. (2020) show how restatements decrease as auditor specialisation increases in situations where auditing is complex. Zhang (2018) shows that comparability among firms appears to have a positive effect on audit quality, which seems closely related to the findings of Ahn et al. (2020). From these articles, it appears as if specialisation has a positive effect on audit quality. Further, both Ahn et al. (2020) and Cassell et al. (2020) find that audit complexity seems to increase the frequency of restatements. Donelson et al. (2020) investigate accounting firms’ acquisitions of ERP (enterprise resource planning) expertise and non-ERP expertise firms. Based on interviews, they argue that acquiring ERP expertise should reduce the number of restatements. However, their findings show that acquiring non-ERP expertise increases restatements while acquiring ERP expertise does not reduce restatements. The study thus weakly supports the proposition that audit quality is positively related to specialisation. Similarly, Beardsley et al. (2021) find that restatements increase as an accounting firm increasingly engages in selling nonaudit services and that this also affects firms that purchase a minimal amount of non-audit services. Rajgopal et al. (2021) also document that the ratio of audit fees to total fees is negatively associated with audit failures. Collectively, there is evidence that specialisation may increase audit quality and that audit complexity reduces audit quality. There is also evidence that widening the scope of accounting firm operations may lead to reduced audit quality, but the mechanism is unclear; it may be both due to a distraction effect and to a lack of independence affecting the accounting firm (Beardsley et al., 2021; Donelson et al., 2020; Sun et al., 2020). Che et al. (2021) document no significant reduction in audit quality (captured with number of restatements) resulting from selling consulting services to non-audit clients. They suggest that distraction and independence are not relevant at an individual auditor level. It is in contrast to Sun et al. (2020), who report that when auditors are selected based on network ties to the CEO/CFO, independence is negatively affected. Other than the lack of independence due to network relation, the mechanism could be more of a firm-level phenomenon. The predominantly quantitative research cited above is complemented by a review article on the use of specialists in the area of valuation, tax, IT,

Organising for quality in sustainability assurance 235 and forensic auditing (Hux, 2017), and interview and survey studies such as Boritz et al. (2020) and Jenkins et al. (2018). Jenkins et al. (2018) document how forensic specialists used on riskier involvements introduce new methods (e.g. fraud brainstorming) that enrich the audit process and audit quality. This adds credence to the proposition that a positive relationship exists between audit specialisation and audit quality. Even so, as the other articles in this section jointly suggest, the lack of consistency in pattern may indicate that the relationship only holds for complex audit situations. Sustainability assurance is arguably more complex than financial audit, as it spans environmental, social, and governance assurance. Moreover, as suggested earlier in this chapter, standards and norms for what to report, how to report, and how to organise the assurance process are only emerging. In light of this, research insights on specialisation within financial audit studies, are likely to remain highly relevant for the developing field of sustainability assurance. From the literature, there are indications that auditor specialisation may be even more important for increasing sustainability assurance quality than for financial audit quality. This could imply that sustainability assurance may be better allocated to specialised non-accounting firms, rather than to accounting firms. For example, Hux (2017) argues that there is evidence that outside-specialists’ input to the audit process is scrutinised more carefully than in-house source specialists’ input is and that this more-critical perspective increases the audit quality. To this, we may add the findings from Beardsley et al. (2021) and Donelson et al. (2020); Beardsley et al. (2021) find that audit quality is negatively related to accounting firms’ distraction and lack of independence effect, and Donelson et al. (2020) show that non-ERP expertise acquisitions reduce audit quality. This indicates that sustainability assurance quality could be negatively related to sourcing both financial audit and sustainability assurance from the same assurance provider. However, the use of non-accounting firms may not always be the best solution for increasing sustainability assurance quality. Evidence exists that lower quality from the use of in-house specialists may be due to poor internal organisation (Hux, 2017). For example, Ekasingh et al. (2019) investigate team effectiveness in greenhouse gas assurance teams and find that methods such as taking the time to share, explain, and reconcile different information and perspectives may increase team effectiveness. Hux (2017) argues that some problems with internally sourced specialists may be due to a lack of timely communications. That a lack of communication/knowledge sharing has a negative effect on audit quality is also detected by Beck et al. (2019), who find that inter-office audit quality is reduced as the physical distance between the offices increases. This means that the organisation of intra-firm sustainability specialists may be improved. Further, if the lack of proper internal organisation is alleviated, it may be beneficial for companies to use accounting firms for complex tasks such as sustainability assurance. A better internal organisation of accounting firms may thus affect the existing

236  Katarzyna Cieslak et al. tension between accounting and non-accounting firms discussed in the previous section. Firms may also reap beneficial external effects when they engage the same assurance provider for both financial audit and sustainability assurance services. Maso et al. (2020) report that there are positive spill-over effects on the financial audit from the sustainability assurance when both processes are performed by the same assurance provider. Going-concern opinions increase when the same accounting assurance provider does both the financial audit and the sustainability assurance. The authors argue that the sustainability assurance process helps identify risks that serve as input into the financial audit process, which generates higher audit quality in the form of more going-concern opinions. Asante-Appiah (2020) shows that such spill-over does not necessarily have to follow the processes proposed by Maso et al. (2020), since when firms get a tainted ESG reputation from negative publicity, it also leads to fewer restatements. A major difference between these two studies is that the latter study requires a ‘scandal’ whereas the former study shows how sustainability assurance preemptively can reduce the number of restatements. In summary, the literature indicates that sustainability assurance is more complex and less standardised than financial auditing and that audit quality is negatively related to complexity. Hence, the number of restatements may be more prevalent in sustainability assurance. The use of specialists may help reduce restatements, perhaps especially in complex assurance processes. As noted in the coming section, however, the number of restatements can also be seen as an indicator of report quality by some, so the discussion will continue in that section. Some empirical evidence indicates that such assurance may benefit from not being in-sourced into accounting firms. However, this phenomenon may be due to a lack of a proper organisation among the accounting firms. Besides specialists, complexity, and audit organisation, the literature suggests that the amount of time available to do the audit affects restatement frequency. Both Cassell et al. (2020) and Chen et al. (2020) find evidence that a lack of time to perform audits reduces audit quality. We will now outline evidence of why assurance and assurance quality are important and how they are linked. How does assurance impact sustainability report quality?

As seen earlier in the chapter, there is ambiguity and a lack of consensus, related not only to sustainability assurance but also to reporting. Content and form are more flexible for sustainability reporting than for financial reporting and, possibly as a consequence, its quality is debated (see e.g. Bradford et al., 2017; Diouf & Boiral, 2017; Perkiss et al., 2021). Moreover, as suggested earlier, how assurance is organised seems important for how its quality unfolds. Therefore, in this part of the literature review, we look more closely at what assurance might imply for report quality and, ultimately, what this possible link could mean for how assurance is organised. We have found a total of 13 articles that investigate the impact of assurance on report quality,

Organising for quality in sustainability assurance 237 including six articles that discuss the link between assurance and sustainability report quality (integrated reporting included). Except for one conceptual article, the articles are based on quantitative data. We have identified two themes across these articles: who does the assurance and how the assurance is done. We start by outlining how report quality is defined in these studies and then continue to discuss how report quality might be linked to who does the assurance and how the assurance is done. One way of measuring report quality in these studies is by the occurrence of restatements (Ballou et al., 2018; Michelon et al., 2019; Pinnuck et al., 2021). Sustainability research distinguishes between error and non-error restatements, where the former concerns miscalculations and omissions and the latter is related to changes in definitions or methods for collecting and measuring data leading to updates of previously issued information. Importantly, sustainability restatements are seen as indicators of high report quality. As sustainability reporting is still in its infancy, with a diversity of definitions and methods and only limited guidance from standards, restatements can be seen as signs of reporting entities becoming more knowledgeable. This is in contrast to financial audit research, where restatements are used as an indicator of low report quality (e.g. Marshall et al., 2019). Interestingly, as was highlighted in the section on assurance quality drivers, restatements are also used as a proxy for low audit quality. This could be seen as indicative of the assumptions about the relationship between assurance and report quality. Financial reporting research has a user perspective, and report quality is evaluated based on a user perspective, whereas sustainability report research is in its infancy and seems not yet to have adopted such a perspective. This may contribute to the differing use of restatements. Another understanding of report quality among these studies builds on definitions found in conceptual frameworks. Maroun (2019) uses the International Integrated Reporting Council’s definition of report quality, which is measured according to an index developed by EY that has been validated by prior studies. In essence, they emphasise that information be provided in sufficient detail and in a comprehensive and balanced way, yet without compromising clarity and comparability.8 Some studies in this category discuss quality in more general terms such as ‘reliability’ as perceived by investors (Hoang & Phang, 2021) and ‘credibility’, measured as the occurrence of bad CSR-related news about the company (Du & Wu, 2019). These studies approach report quality as perceptions and actions in relation to reports, rather than characteristics of the reports (see the discussion in the coming section on investor perceptions of the value of assurance). On an overarching level, we find evidence of a positive link between assurance and different conceptualisations of report quality (Ballou et al., 2018; Du & Wu, 2019; Hoang & Phang, 2021; Maroun, 2019; Michelon et al., 2019; Pinnuck et al., 2021). This is similar to the field of financial audit (e.g. Lennox et al., 2018; Marshall et al., 2019). We will now address this link in

238  Katarzyna Cieslak et al. more detail, first from the perspective of who provides assurance, and then from the perspective of how assurance is provided. Studies have investigated whether report quality is affected by who provides assurance. Namely, whether assurance is provided by accounting or non-accounting firms matters for report quality. Ballou et al. (2018) find that assurance undertaken by accounting firms is associated with higher report quality than assurance provided by consultancies. The authors argue that this might be due to the general knowledge and experience of accounting firms in detecting numerical errors and applying professional scepticism. Accounting firms thus enhance report quality by means of detecting errors. Non-accounting firms seem more likely than accounting firms to issue non-error restatements and also non-material restatements, possibly due to knowledge and experience differences (Michelon et al., 2019). For example, accounting firms have strong knowledge of financial reporting materiality thresholds and are probably more used to detecting errors. They also seem more reluctant to issue non-material restatements (Michelon et al., 2019). Pinnuck et al. (2021) also discuss typical traits of accounting firms; they find that restatements detected by accounting firms often concern overstatements rather than understatements, likely due to their focus on overstatements in the context of financial audit. Furthermore, Michelon et al. (2019) highlight the possibility that the detection of misstatements, in particular non-material ones, constitutes an attempt to build legitimacy for the assurance profession. By demonstrating the detection of misstatements, assurance providers show that they play an important role. The ongoing debate relates to whether accounting firms or non-accounting firms should provide assurance. Looking at financial reporting, where accounting firms are the sole assurance providers, the discussions revolve around whether size (Choi et al., 2018), tenure of the auditor, or specialisation of the accounting firm (Garven et al., 2018) matter for report quality. Here, specialisation seems to constitute the most significant positive influence on report quality. A study on auditing in the non-profit sector (Garven et al., 2018) shows that report quality increases with accounting firm specialisation, measured as the number of non-profit audits undertaken by the firm. This relates to the knowledge and experience of assurers and raises the question of the extent to which sustainability assurance should be specialised, not only in regard to sustainability versus finance but also in regard to particular industries. The fact that sustainability reporting is an emerging field (Pinnuck et al., 2021) highlights the need for specialisation and additional auditor expertise (Knechel, 2021) to improve report and assurance quality. In summary, discussions on the choice between accounting firms and accounting firms as assurance providers of sustainability reports have implications for both assurance and report quality. The two types of assurance providers seem to have somewhat different expertise, which in turn might influence to what extent they discover and highlight errors and non-error misstatements. We argue that the discussion needs to extend beyond the audit–non-audit

Organising for quality in sustainability assurance 239 distinction to focus also on whether assurance providers should specialise to learn the specifics of sustainability in particular contexts or industries. Could industry specialisation of assurance providers contribute to higher report quality, just as it seems to do for financial reporting? What are the potential downsides and risks associated with such an approach? Having outlined current knowledge on whether it matters who provides assurance, we now continue to discuss the somewhat related question of how assurance is provided and whether that matters for report quality. The literature reveals different ways in which assurance can be provided. Maroun (2019) distinguishes between limited and reasonable assurance of integrated reports in South Africa. Interestingly, Maroun finds no significant difference in how the two levels of assurance influence report quality; both levels of assurance have an impact. What seems to matter are the types of information presented in the report, where, for example, items prescribed by the GRI framework increase in quality as they are assured. Another aspect of how assurance is provided is through the combined assurance of sustainability reports as issued by a third-party assurer, together with internal audit and management. Hoang and Phang (2021) study investor perceptions of the reliability of such reports and their willingness to invest. They find that both of these increase when reports have undergone combined assurance. This relates to the question of who provides assurance. In line with Knechel (2021), it also illuminates that assurance can be done in different ways. This is one of the studies that focus on perceptions as proxies for report quality rather than on characteristics of the reports. Unlike the other studies that we have presented in this section, Hoang and Phang (2021) hence do not lend support to any conclusions about reports. Rather, they indicate that the act of assurance is important in its own right (see the reasoning on investor perceptions in the next section). The question of how assurance is provided seems to have earned less attention than the question of who provides assurance. This is unsurprising, as sustainability reporting and assurance are young practices with limited guidance and professionalisation thus far (Boiral et al., 2019). Based on our review of the literature, we believe that deeper inquiry is needed as the debates on assurance and report quality continue. Is it the mere act of assurance that matters for report quality, rather than the level or process of such assurance? And to what extent is it relevant for assurance providers to disclose information on how the assurance has been done, for example, the scope and the materiality thresholds involved? Does such disclosure influence report quality or not? The field of financial auditing has seen some changes in what information auditors are required to disclose, following, for example, a new regulation on key audit matters (see Rahnert, in this volume), and researchers have begun to investigate its effects on report quality. For example, Reid et al. (2019) find that disclosing key audit matters is linked with higher report quality captured with significant decreases in absolute abnormal accruals and the propensity to just meet or beat analyst forecasts, as well as a significant

240  Katarzyna Cieslak et al. increase in the earnings response coefficient. In a similar vein, Buchanan et al. (2021) find that managers are less inclined to engage in real earnings management when they expect auditors to communicate their concerns to the board. In summary, there are discussions on how assurance of sustainability reports is provided, for example, at what level and by which means, and what it might imply for report quality. Such studies are, however, less common than studies on who provides assurance. Overall, these findings seem worthy of further investigation in the context of sustainability reporting, considering, for example, that the level of assurance will be regulated following the implementation of the new EU directive on corporate sustainability reporting (CSRD). Our literature review provides evidence in support of a positive association between assurance and report quality. Discussions relate mainly to who provides the assurance and to some extent to how the assurance is provided. Due to different competencies and mindsets, accounting firms and non-accounting firms seem to differ in the types of misstatements they detect in sustainability reports. Based on our review, we suggest that other aspects of assurance also need to be considered, for example, how specialised the assurance firm should be and how the assurance should be communicated to the audience. Also, the idea of reporting quality deserves further discussion, for example, as to whether it is the characteristics of the report or receivers’ perceptions that are important to address by assurance. Another interesting question is whether investors and other receivers can understand differences in quality. How does sustainability assurance impact investors’ reactions to the reported information?

In addition to articles on the link between assurance and report quality, four articles also discuss assurance in terms of the quality of the assurance process and the effects of assurance on investor reactions. Fuhrmann et al. (2017) document that high assurance levels through detailed, numerical data, and substantiated assurance statements decrease information asymmetry as captured by bid-ask spreads in capital markets. The study criticises the lack of standardisation in sustainability assurance processes and indicates that capital markets, while responsive to high assurance levels (tests of details of numerical data), do not assign as much value to the assurance of how the disclosed data is collected. Indeed, the authors identify that descriptions of sustainability assurance-specific work steps are not valued unless the auditor is a non-Big 4 firm. Reimsbach et al. (2018) and Caglio et al. (2020), while agnostic to the quality of the assurance process, underscore the importance of assurance for capital market consequences. Based on an experiment involving a sample of professional investors, Reimsbach et al. (2018) argue that assurance of sustainability information leads to higher weighting of this information in

Organising for quality in sustainability assurance 241 investment decisions, higher evaluations of firms’ sustainability performance by investors, and higher investment-related judgements. The study finds that this ‘assurance effect’ is stronger for stand-alone reports, and weaker for integrated sustainability reports. Caglio et al. (2020) study the assurance of integrated reporting in South Africa, and similarly argue that assurance impacts capital markets as a credibility-enhancing mechanism. The study investigates three characteristics of integrated report quality, namely reading difficulty, verbosity, and tone,9 and identifies their link to market values, stock liquidity, and the dispersion of analysts’ forecasts. The results show that the assurance of integrated reports moderates the negative capital market effects of poor-quality reports that are overly optimistic, unclear, or long. In summary, sustainability report assurance seems to have non-trivial and positive capital market consequences. This is in line with financial audit research. For example, He et al. (2019) document that assurance quality, as captured by Big 4 auditor status and auditor client-industry specialisation, increases the importance of public information, relative to private information, for analysts revising their forecasts after release of yearly earnings announcements. There is some evidence that sustainability assurance has consequences independent of the quality of the assurance process (Caglio et al., 2020; Reimsbach et al., 2018). It is possible that the very act of assurance may result in positive capital market reactions, even to poor-quality reports (Caglio et al., 2020). It is thus very important to consider the professional obligations of assurance providers to ensure assurance quality. Consequently, there may be a strong argument for mandatory sustainability reporting and assurance standards to guide not only sustainability reporting but also the process of sustainability assurance. Conclusions and implications This chapter provides a literature review of 40 articles published in 27 top accounting and audit journals over a five-year period from 2017–2021, with a focus on the current state of knowledge regarding sustainability assurance and its quality. Our analysis identifies four emergent themes of how sustainability assurance is understood within current research and practice, what drives assurance quality, how assurance and sustainability report quality are related, and how sustainability assurance may impact investor reactions to reported information. Collectively, this analysis provides important insights into how sustainability assurance quality is approached today, and what some meaningful future directions might be for industry professionals, educators, and researchers. Ongoing regulatory developments create significant changes by expanding the scope and depth of reporting and assurance. Reporting on emissions throughout the whole value chain (Scope 1, 2, and 3 GHG emissions), on ‘avoided GHG emissions’ or on ‘circular material use rates’, to mention a few examples from the proposed ESRS, is likely to require both estimations and

242  Katarzyna Cieslak et al. judgement on part of firms and assurance providers. As the reporting boundaries are broadened to include ‘material value chain information’ under ESRS 1, which also allows estimations, the subjectivity of sustainability reporting is heightened. Such subjectivity is likely to exacerbate issues of poor report quality and ‘greenwashing’. Together with the inherent difficulty of capturing all essential factors/risk-related measurements in sustainability reports, this provides a context in which we can discuss some conclusions from our literature review. First, compared with the well-established process of financial audit that focuses on substantive procedures and reliability of the disclosed content, the uncertainties of sustainability reporting may entail a transformation of the assurance process (Canning et al., 2019; Farooq & de Villiers, 2018). A focus on error restatements, rather than non-error restatements (Michelon et al., 2019), does not suffice for sustainability assurance, as arguably even more judgement is required in sustainability reporting. The fact that restatements are, unlike in financial audit, used as a measure of high report quality (Michelon et al., 2019), shows that the sustainability assurance may be as much a learning process as a well-established control. In sustainability assurance, reliability of disclosed content, being a challenge due to the wide scope of information to assure reaching into the firm’s value chains, is only part of the assurance task. Completeness and balance (what is or is not reported) are also important for sustainability assurance (Farooq & de Villiers, 2020). Second, the lack of an established sustainability assurance process challenges and limits professionalisation (Boiral et al., 2019). An important insight from the literature review is that in risky or complex audit situations, specialists positively affect both assurance and report quality (see also the discussion on expertise in chapters by Carrington and Catasús, and Backman et al., in this volume). In risky financial audit projects, especially, financial audit literature shows how specialists can, through expertise, shift focus from reliability to balance in the information provided (Boritz et al., 2020; Hux, 2017; Jenkins et al., 2018). In sustainability assurance, financial audit specialisations in areas such as fraud testing (Jenkins et al., 2018), may inspire approaches through which sustainability specialists may similarly design ways to detect ‘greenwashing’. For assurance providers, the complexity of sustainability assurance may further indicate a need to consider the implications of industry specialisation (Garven et al., 2018). Third, the question of who should provide assurance should be complemented, if not replaced, by the question of how assurance procedures should be organised. One continuing broad consideration for assurance providers is a reckoning of the benefits and challenges related to combining both audit and non-audit services in the same firm (Donelson et al., 2020; Maso et al., 2020). As with financial audit, the sustainability assurance process is likely to be vulnerable to potential negative effects from distraction (Beardsley et al., 2021; Donelson et al., 2020), workload (Cassell et al., 2020; Chen et al., 2020), and independence (Sun et al., 2020). Yet, some research indicates that

Organising for quality in sustainability assurance 243 having sustainability assurance and financial audits performed by the same firm could result in positive spill-over effects to financial audit (AsanteAppiah, 2020; Maso et al., 2020). This is an interesting consideration for the organisation of the sustainability assurance process. Finally, the literature review shows that sustainability assurance has important positive effects on investors’ judgements and decisions (Caglio et al., 2020; Fuhrmann et al., 2017; Reimsbach et al., 2018). This underscores the importance of effectively organising sustainability assurance processes to ensure efficient capital allocation, robust markets, and societal well-being. Moreover, it highlights the importance of achieving a reliable and consistent approach in regulation and practice when it comes to issues of double materiality and subjective judgements on the content and scope of sustainability reports. While further discussions of these issues are beyond the purview of the present chapter, they represent rich veins for future inquiry. Implications for the audit industry

The literature, when considered together with ongoing regulatory and standardsetting developments, highlights the concept of double materiality as important to the audit industry. The potential shift from limited to reasonable assurance of sustainability reports and the rising focus on integrated reporting is similarly important. Further, companies are increasingly recognising not only the necessity but also the potential for incorporating sustainability in their strategies and business models (Blomkvist et al., 2021). This could also blur the lines between sustainability and finance. Collectively, these shifts indicate that accounting firms may be better positioned than non-accounting firms to provide sustainability assurance services, due to the potentially high degree of interconnection between financial and sustainability reporting and assurance. Nonetheless, the audit industry still faces challenges in the emerging arena of sustainability assurance. In addition to understanding the interconnections and complexities between financial and sustainability issues, there is a need to reassess the assurance process to acknowledge and address the dangers of incomplete or unbalanced disclosures (Canning et al., 2019; Farooq & de Villiers, 2020) that may arise out of what is still a relatively high degree of subjectivity in sustainability reporting (Pinnuck et al., 2021). Ensuring the quality of sustainability assurance requires objectivity regarding where existing knowledge and methods can be adapted or translated effectively, and where new techniques and approaches are needed. In addition to this, sustainability assurance will also require some degree of specialisation. A deep understanding of certain fields and industries, for example, is likely to be beneficial to understand the logic underlying the interlinkages between sustainability and finance. Moreover, specialisation at the firm or individual auditor level may be even more important for sustainability assurance as compared with financial audit, given that performance metrics in

244  Katarzyna Cieslak et al. sustainability are still not established or well understood. Ensuring the quality of sustainability assurance is particularly important given that assurance is generally perceived by investors and other stakeholders as a positive signal. Ultimately, the role of the audit industry in sustainability assurance depends on how the purpose of assurance is understood. As the literature review suggests, there are several interpretations of this purpose that can be of use to the audit industry. Implications for audit education

The demand for sustainability assurance services is likely to rise in the coming years. Education thus faces the challenge of meeting rising demands for student capacity and novel knowledge transfer. Educators must build a methodologically and conceptually rigorous curriculum that incorporates the standards of both sustainability reporting and financial reporting, with attention given to conceptual frameworks and understanding the importance of the concept of judgement. Such incorporation is an important step towards the professionalisation of the field. Students of accounting and auditing may further need to acquire knowledge on sustainability and related fields, to build specialised knowledge. It is thus important that education programmes collaborate with other relevant fields, and offer specialised courses within accounting and audit to build and provide the needed knowledge and expertise. Education initiatives for working professionals such as certification programmes, executive MBA programmes, and similar enterprises are also likely to be of importance in an ongoing context. Implications for audit research

This chapter identifies some interesting patterns in the articles reviewed and points to some promising areas of future research. The reviewed literature sheds light upon a number of challenges related to sustainability assurance and how these may be addressed. Yet, the scope of this chapter is limited. Sustainability reporting and sustainability assurance can be studied from several theoretical angles. Extending this study to cover more journals beyond accounting and include other fields would almost certainly generate additional insights. The covered articles on sustainability assurance are more descriptive than functional, and focus on conceptualisations rather than causal relationships or drivers. This is unsurprising given the young and emerging nature of the field. As the field grows more established, research into sustainability reporting may focus more on the functional aspects, measurable impacts, and drivers of sustainability reporting and assurance. More research is thus needed to establish valid proxies for report quality and assurance quality in the sustainability area. Our review also identifies indications regarding the limits of sustainability assurance and reporting. Several articles hint at the role and links between sustainability assurance, on the one hand, and management accounting and

Organising for quality in sustainability assurance 245 control systems, corporate governance, and internal control, on the other hand. These links are also implicit in ongoing regulatory and reporting developments. They represent important and interesting areas for future research. Notes 1 Ch 9, 31§, The Swedish Companies Act. 2 The CSRD also puts forth amendments to multiple existing instruments as relevant to reporting and assurance in the EU, namely: Directive 2013/34/EU; Directive 2004/109/EC; Directive 2006/43/EC; and Regulation (EU) No. 537/2014. 3 Preamble 57 of the CSRD. 4 Preamble 61 of the CSRD. 5 40–55§ of the Draft ESRS 1 (November 2022). 6 67–68§ of the Draft ESRS 1 (November 2022). 7 72–77§ of the Draft ESRS 1 (November 2022). 8 Report quality is discussed in other studies in our review. While these do not directly address the possible role of assurance in attaining report quality, they discuss report quality in similar terms, for example, completeness, balance, and reliability (Bradford et al., 2017; Diouf & Boiral, 2017; Islam et al., 2021; Journeault et al., 2021; Melloni et al., 2017; Perkiss et al., 2021; Safari & Areeb, 2020). 9 These characteristics resonate well with quality characteristics of clarity and balance as outlined in GRI standards. 10 We additionally included one article on the impact of financial audit on investors’ reactions to the reported information.

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Appendix: Research design As a first step, we determined that it would be appropriate to limit our scope of inclusion to articles published in peer-review journals of an established high quality, using the CABS ranking list to identify and include the twentyseven journals that were classified as 3, 4, and 4* stars from the 2021 Academic Journal Guide (AJG) list in the field of accounting from 2017–2021. Given the relatively short period of time included in the review, the quality of journals selected from the 2021 AJG is unlikely to have been significantly different over the five-year period covered. We began by manually assessing the titles and abstracts of all the articles published in these journals over the covered time period, identifying a total of 219 relevant articles. We then further screened each article for inclusion or exclusion based on their relevance to the key concepts of ‘sustainability assurance’, ‘sustainability reporting’, ‘integrated reporting’, ‘financial audit’, and ‘financial reporting’. Where assessment was unclear based solely on the titles and abstracts, we briefly read the articles to make a final decision on their relevance. This process narrowed our selection to 91 articles. We next made a deeper assessment of the quality and relevance of the articles by reading the articles, summarising them, and discussing each article amongst the four authors based on the abstracts. This allowed for parallel

Organising for quality in sustainability assurance 249 independent assessment of the articles, and the resolution of any discrepancies in an open and transparent manner. After a careful review, we excluded articles from financial audit unless they discussed assurance quality and its linkages with report quality.10 This excluded, for example, articles with a sole and deep focus on intra-firm dynamics in accounting firms or within audit teams, and articles on audit committee interactions and influences on financial audit. We included papers on financial audit expertise as this was importantly linked to audit quality. With regard to sustainability assurance and sustainability and integrated reporting, we excluded articles if: (1) they addressed non-financial disclosure practices or regulatory pressures that were not relevant to the scope of the review; (2) they related to assurance practices in the context of impacts on the firm but did not link to assurance or report quality; or (3) they focused on sustainability reporting practices, with no link to assurance. Amongst the papers excluded were critical papers describing cases of disconnection between sustainability reporting and sustainability performance (e.g. Perkiss et al., 2021). The excluded articles were, at best, weakly relevant to the focus of the study, and did not serve to build directly relevant insights. Here, it is important to note that the limitations that generally apply to literature reviews also apply to this chapter. In addition to limitations of scope, some potentially relevant articles may of course have been missed or excluded in following the process above. A final total of 40 articles were included in the review. The articles were then coded across the emerging categories of ‘current understanding and state of assurance’, ‘drivers of assurance quality’, and ‘effects of assurance (quality)’. The distribution of articles across these categories is presented in Table 11.1. As our analysis of the articles progressed, the themes around which they centred gained clarity, resulting in the current structure and focus of the chapter.

Table 11.1  Reviewed articles. Main classification

Sub-category Sustainability reporting (SR)

Financial Reporting (FR)

Current understanding and state of assurance Drivers of assurance quality Effects of assurance and its quality:

6 3

0 14

• impact on report quality • impact on investors’ reactions to reported information

6 3

7 1

18 40

22

Total per sub-category Total

12 Challenges of sustainabilityassurance practices Insights from the Big 4 accounting firms Daniela Argento, Mashal Iqbal, and Fatou Sonko Introduction This chapter deals with how the increased importance of sustainability, as well as more stringent regulations of sustainability reporting and assurance, act as drivers that transform the audit industry. The importance of balancing the achievement of financial goals with environmental and social impacts generated by organisational activities is widely recognised. Many organisations strive to integrate sustainability in their operations, especially environmental and social aspects, to meet society’s expectations and be profitable in the long run (Bebbington et al., 2017). Society is demanding more sustainability disclosures from organisations (see Cieslak et al., in this volume), and there is a quest for transparency and accountability about the multiple dimensions of organisational performance (Farooq & de Villiers, 2020). Within the European context, a milestone is represented by the European Union (EU) Non-Financial Reporting Directive, NFRD (Directive 2014/95/EU) that obliged organisations with more than 500 employees to disclose non-financial information related to environmental, social, and personnel matters, respect for human rights, anti-corruption, and board diversity issues in their annual financial reports or in a separate standalone report. A result of these developments is that many organisations have changed their strategy and business model to pursue sustainability, and a proliferation of sustainability reporting is visible (Unerman et al., 2018). However, greenwashing and immaterial disclosures have cast doubts on the reliability of sustainability reports and the usefulness of the information provided to users. The true purpose of sustainability reports has been questioned, given a gap between organisations’ sustainability discourse and stakeholders’ expectations (Higgins et al., 2020). Against this background, sustainability assurance – the assurance services for sustainability-related information in corporate reports – has become an increasingly common practice (Channuntapipat et al., 2020). Organisations seek third-party assurance of their sustainability reports and by doing so they can also improve their image DOI: 10.4324/9781003411390-15

Challenges of sustainability-assurance practices 251 and legitimacy (Silvola & Vinnari, 2021). Assurance providers are deemed to create societal trust in organisations’ sustainability reports by signalling the credibility and completeness of the disclosed information (O’Dwyer, 2011). The Big 4 accounting firms, Deloitte, EY, KPMG, and PwC, have a prominent position in the sustainability-assurance market (Wong et al., 2016). They provide sustainability assurance as an additional service in their audit engagements (Channuntapipat et al., 2020). Due to their reputation, they are expected to issue high-quality assurance (Cuadrado-Ballesteros et al., 2017). However, sustainability assurance is different from financial auditing and requires specific knowledge and skills (Boiral et al., 2020). It is challenging because the landscape of sustainability reporting is diverse. First, by translating the NFRD into national laws, member states created regulatory heterogeneity within the EU (La Torre et al., 2018). Second, sustainability reporting has not been regulated as financial reporting, meaning that disclosures can vary within and across organisations, industries, and countries (Channuntapipat et al., 2019). Third, there are various sustainability reporting guidelines and standards, meaning that sustainability reporting is heterogeneous. The heterogeneity of sustainability reporting challenges the work practices of assurance providers employed at the Big 4 firms. Unlike financial auditing, sustainability assurance has so far been voluntary and not subject to extensive regulation, which results in not having stringent requirements on who and how to execute such audits (Channuntapipat et al., 2020). The process of sustainability assurance is often client-specific, and the duration differs depending on the objective and the scope of the assurance engagement (Kolk & Perego, 2010). Furthermore, there are no strict guidelines on how an assurance engagement should be structured (Farooq & de Villiers, 2020). To ensure that users of sustainability reports have access to comparable, relevant, and reliable sustainability information, the EU has taken initiatives towards making sustainability reporting requirements more stringent and sustainability assurance compulsory. The Corporate Sustainability Reporting Directive, CSRD, Proposal published in April 2021, and later approved by the European Parliament in December 2022 (see Directive 2022/2464/ EU), extends the scope of the reporting requirements to additional organisations, specifies the information that organisations should report, and requires them to report in line with mandatory EU sustainability reporting standards. The European Commission will adopt the first set of sustainability reporting standards by June 2023. The CSRD requires sustainability assurance by stating that the provided sustainability information must be subject to independent auditing and certification to ensure it is reliable. In addition, it also allows independent assurance service providers to provide assurance opinions on sustainability reporting. In other words, the European Commission welcomes an open and diversified sustainability audit market. The increased demand for and upcoming compulsoriness of sustainability assurance are leading to a transformation of the audit industry. Consequently, the services offered to clients require specific knowledge and skills in

252  Daniela Argento, Mashal Iqbal, and Fatou Sonko the field of sustainability in general and sustainability assurance in particular (see Backman et al., in this volume). Since the Big 4 firms currently cover most of the sustainability-assurance market, investigating their sustainability-assurance practices is of interest. This holds not least for Sweden, where a relatively high number of sustainability reports are issued (KPMG, 2020) and whose institute for the accountancy profession (FAR) has developed a sustainability specialist group to handle current and relevant sustainability issues (FAR, 2022). The purpose of this chapter is to increase the understanding of how the Big 4 firms cope with the challenges of sustainability assurance by exploring the knowledge and skills that are deemed important when executing such task. This chapter contributes to the existing literature, given the regulatory uncertainty at the time of conducting the study. Motivation The growing pressures towards implementing sustainability assurance pose challenges to assurance providers. Sustainability assurance is currently taking place in an evolving context characterised by complexity (see Crawford et al., in this volume). The market for sustainability assurance is competitive because auditors and non-auditors (i.e. consultants with various degrees of specialisation in sustainability services) can provide such services (Channuntapipat et al., 2020; Martínez-Ferrero & García-Sánchez, 2018; Wong et al., 2016). This leads to the question of how accounting firms are dealing with the possibility of broadening their service portfolio and legitimising their offering of sustainability assurance in addition to the traditional financial audit (O’Dwyer, 2011). The literature has highlighted that sustainability reports are deemed more credible when assurance is provided by auditors working at the Big 4 firms (Cuadrado-Ballesteros et al., 2017). These auditors are assumed to be competent and professional sustainability assurance-service providers (Martínez-Ferrero & García-Sánchez, 2018). However, this assumption is not fully corroborated (Silvola & Vinnari, 2021), because sustainability assurance cannot be equated with financial auditing and requires auditors to gain specific knowledge and skills through training and experience (Boiral et al., 2020). The recently approved CSRD states that auditors need to possess the necessary theoretical knowledge of subjects relevant to the assurance of sustainability reporting and the ability to apply such knowledge in practice. The role of auditors is evolving because they need to oversee new reporting processes and monitor the effectiveness of information systems and controls setup (Wollmert & Hobbs, 2021). To provide sustainability assurance, accounting firms need to cope with the challenges of understanding the areas of sustainability, obtaining expertise to provide assurance, developing verification processes, and committing to a system of organisational support (Knechel, 2021).

Challenges of sustainability-assurance practices 253 Auditors need to have knowledge about the various sustainability reporting standards developed by different standard-setters. They need knowledge about the work of the Task Force on Climate-Related Financial Disclosures (TCFD) via the Climate Disclosure Standards Board (CDSB) (see www.cdsb. net); the Global Reporting Initiative – GRI (see www.globalreporting.org); the Sustainability Accounting Standards Board – SASB (see www.sasb.org); the International Integrated Reporting Council – IIRC (see www.integrated reporting.org); the new International Sustainability Standards Board (ISSB), created by the International Financial Reporting Standards Foundation (IFRS Foundation) with the task of supporting organisations that must meet reporting demands on climate and other environmental, social and governance (ESG) matters (see www.ifrs.org), as well as the upcoming sustainability reporting standards to be adopted by the European Commission. In addition, auditors need knowledge about assurance standards (ISAE3000 versus AA1000AS) to be able to issue an opinion which can be either ‘limited/ moderate’ or ‘reasonable/high’. Reasonable assurance engagements require a higher level of verification than the limited assurance (Cuadrado-Ballesteros et al., 2017). Therefore, auditors must possess more knowledge and skills about sustainability and the capability to seek relevant information in the data sets and information systems of clients. This is confirmed by the CSRD, claiming that the amount of work in a reasonable assurance engagement entails extensive procedures including consideration of internal controls of reporting and substantive testing, and is therefore significantly greater than in a limited assurance engagement. There have been few studies on the knowledge of auditors executing sustainability assurance. Given that the Big 4 firms cover most of the sustainabilityassurance market (Wong et al., 2016) but are exposed to competition, they must deal with the challenges of sustainability assurance and ensure that auditors are competent and independent from their clients (Boiral et al., 2020). The pressure of recruiting and retaining ‘sustainability auditors’ with knowledge and skills about sustainability matters increases when the goal is to provide a quality service and remain competitive. However, Wong et al. (2016) concluded that accounting firms do not have sufficient knowledge and skills in this area. While some research has focused on the practical aspects of non-financial assurance services offered by Big 4 firms (e.g. Canning et al., 2019; MartínezFerrero & García-Sánchez, 2018), more needs to be known about sustainability assurance and the auditors engaged. This chapter presents an analysis of eleven interviews conducted with nine professionals working at the Big 4 firms in Sweden. The firms were contacted via email and suitable interviewees, with a variety of positions and experience, were identified and contacted. The interviews were held online because of the COVID-19 pandemic and because it made it possible to reach experts from various parts of the country. More details about the research methodology are provided in the Appendix (Tables 12.1 and 12.2).

254  Daniela Argento, Mashal Iqbal, and Fatou Sonko Literature review Research focusing on sustainability assurance has grown in recent years, and various themes related to the challenges faced throughout the assurance process can be identified (see Gillet-Monjarret & Rivière-Giordano, 2017). The following subsections depict those challenges by pointing to the consequences for the audit industry and the knowledge and skills perceived to be fundamental for auditors involved in sustainability assurance. Sustainability assurance: A desirable but competitive market

One theme relates to the choice of the sustainability-assurance provider (i.e. the assuror) to give an opinion on whether the sustainability report has been prepared according to regulations (Cuadrado-Ballesteros et al., 2017; Farooq & de Villiers, 2020). So far, there have been no clear restrictions on who can provide sustainability-assurance services and how to structure sustainability-assurance practices (Farooq & de Villiers, 2020). The market for sustainability assurance comprises members of the audit profession and non-accounting firms (Channuntapipat et al., 2020; Silvola & Vinnari, 2021). Wong et al. (2016, p. 239) identify three types of assurance providers: (1) accounting firms (particularly the Big 4), (2) non-accounting specialist consulting firms, i.e. consultants specialising only in sustainability issues, and (3) non-accounting general consulting firms, i.e. consultants providing general advisory services. Given that various types of assurance providers can operate in the market, possessing the knowledge and skills necessary to offer quality sustainabilityassurance services can foster a competitive advantage. There is intra-professional competition among the accounting firms and inter-professional competition between the accounting and the non-accounting firms (Silvola & Vinnari, 2021). Some studies have focused on the reasons for choosing accounting or non-accounting sustainability-assurance providers (Simnett et al., 2009; Wong et al., 2016). The Big 4 firms are chosen due to their capacity to reach economies of scale and their reputation for providing higher assurance quality (Cuadrado-Ballesteros et al., 2017; Wong et al., 2016). For accounting firms, sustainability assurance represents an emerging market, and they make efforts to institutionalise it as a practice by establishing teams composed of professional sustainability auditors with appropriate knowledge and skills (Silvola & Vinnari, 2021). Professionalism and independence

There are inherent difficulties involved in transferring financial audit-based methodologies and underlying concepts to sustainability assurance, which is characterised by ambiguous qualitative information (Channuntapipat et al., 2019). In the case of ‘materiality determination and assessment process within sustainability assurance, assuror flexibility, underpinned by assuror intuition,

Challenges of sustainability-assurance practices 255 is central to uncovering assurance technologies deemed capable of addressing the materiality of ambiguous sustainability data’ (Canning et al., 2019, p. 1). Thus, a professional assuror needs to be flexible but also follow structured financial audit methodologies to translate financial audit knowledge into nonfinancial assurance processes. In addition, the validity of materiality assessment in sustainability assurance is recognised (see Öhman et al., in this volume). Sustainability-assurance providers can have heterogeneous professional backgrounds (Ruiz-Barbadillo & Martínez-Ferrero, 2022). The team working on an assurance engagement can be composed of assurors with or without a financial audit background who are more or less specialised in specific areas of sustainability. Within sustainability-assurance teams, ‘the collaboration among (accountant and non-accountant) “expert” assurors merging formal and tacit knowledge’ is important to establish good assurance processes (Canning et al., 2019, p. 1). Hence, professionalism is related not only to the knowledge that individuals gain while working on sustainability-assurance assignments but also to their interaction skill with colleagues having diverging backgrounds and mindsets. Besides collaborating with peers, sustainability assurors need to interact with their clients while remaining independent. Independence refers to the ability and willingness to report the material misstatements found in the sustainability reports of clients. It is important to ensure a rigorous sustainability-assurance process beneficial for the stakeholders (Hummel et al., 2019). The Big 4 firms tend to be less economically dependent on individual clients than their competitors, which might increase their level of independence (Cuadrado-Ballesteros et al., 2017). However, ethical problems can appear due to the competitive and commercial pressures underlying sustainability assurance (Boiral et al., 2019). If the assuror is influenced by the clients and the scope of the engagement is tailored to suit their needs, the goal to increase the credibility of sustainability reports cannot be fully achieved (Farooq & de Villiers, 2020). Assurance standards and quality

Apart from the existence of multiple sustainability reporting standards, causing variety in sustainability disclosures, sustainability assurance is influenced by interpretations of assurance standards and the process of sustainability assurance itself. One of the main challenges is the vagueness of existing standards (Canning et al., 2019) and a lack of consensus on how sustainability assurance should be undertaken (see Crawford et al., in this volume). Therefore, knowledge and interpretations of sustainability-assurance standards play an important role in shaping the accounting firms’ views on the overall objective of sustainability-assurance services. Since the Big 4 firms operate globally, a certain level of homogeneity among them would be expected, while research has shown that they do not behave uniformly when performing sustainability assurance (Larrinaga et al., 2020). The reason for this variation can be linked to the extent to which

256  Daniela Argento, Mashal Iqbal, and Fatou Sonko countries commit to sustainability, which in turn impacts the sustainabilityassurance market. In addition, cultural factors at the country level affect the homogeneity of the assurance market (Fernandez-Feijoo et al., 2018). Hence, the Big 4 firms consider country differences when designing their strategies and penetrating new markets. Sustainability auditors need to possess knowledge and adaptability skills related to how their accounting firm intends to cope with the sustainability-assurance services. The quality of sustainability assurance is related to the depth of the assurance process (i.e. the ability to discover issues) and the breadth of the assurance statement (i.e. the ability to report issues) (Hummel et al., 2019). To guide assurance providers during the sustainability-assurance process, some assurance standards are available (Farooq & de Villiers, 2020). The most common and widely accepted standards are the AccountAbility (AA)1000 Assurance Standards (AS) and the International Standard on Assurance Engagements (ISAE)3000 (Hummel et al., 2019). The purpose of the AA1000AS is to assess the extent to which an organisation adheres to the AccountAbility Principles of inclusivity, materiality, responsiveness, and impact. It was developed by the Institute of Social and Ethical AccountAbility, commonly known as AccountAbility (Perego & Kolk, 2012). Assurance providers use it to emphasise the relevance of reported information to stakeholders (Channuntapipat et al., 2020). The ISAE3000 is issued by the International Auditing and Assurance Standards Board (IAASB). It provides guidance in the form of basic principles and essential procedures on how to conduct non-financial assurance engagement (Perego & Kolk, 2012). However, this standard is a general one that is not specifically developed for sustainability-assurance engagements (Channuntapipat et al., 2020). Its guidance is less precise than that for financial auditing (Canning et al., 2019). The two standards described above (i.e. AA1000AS and ISAE3000) have complementary objectives and combining them tends to give better results than using them separately (Gillet-Monjarret & Rivière-Giordano, 2017). While the ISAE3000 takes an assurance-statement approach focusing on the reliability of information (therefore having a stricter scope of sustainability assurance), the AA1000AS examines the relevance of the information reported from the standpoint of all stakeholders. While using the ISAE3000 facilitates a rigorous sustainability-assurance procedure founded on financial auditing methodology, the assurance provider has only limited options for expressing the assurance (Channuntapipat et al., 2020). Combining it with the AA1000AS has the advantage of offering further opportunities for expression and explanation of the assurance provider’s opinion. As well as certifying the reliability of the data, the relevance of the reporting is assessed from a stakeholder perspective (Gillet-Monjarret & Rivière-Giordano, 2017). None of these standards are mandatory, but assurance providers can use them to increase the quality of the assurance statements (Farooq & de Villiers, 2020; Hummel et al., 2019). However, a combined use is rare (Gillet-Monjarret & Rivière-Giordano, 2017), and accounting firms tend to use the ISAE3000

Challenges of sustainability-assurance practices 257 because it reminds them of the procedures followed for financial auditing (Channuntapipat et al., 2020). Sustainability auditors need both theoretical knowledge of those standards and the capacity to apply them in practice in addition to prioritisation skills on which one to use in specific circumstances. Summary of literature

To date, there is no detailed guidance on assurance procedures, and heterogeneous practices exist (Martínez-Ferrero & García-Sánchez, 2018). Studies have pointed to the importance of following a clear assurance process and being transparent about the assurance process in the assurance statements. A transparent statement provides detailed information on the work carried out by the assurors, the scope of the engagement, the results obtained, and recommendations that can be understandable for the stakeholders. Sustainability-assurance statements’ content can depend on the characteristics and the nature of the work performed by the assuror and on the existing requirements (Larrinaga et al., 2020). All in all, the literature review indicates that studies on sustainabilityassurance processes are growing. Practice variation has been recognised and can be explained by various factors (Channuntapipat et al., 2019) related to the challenges that are inherent in sustainability assurance and the need for specific knowledge and skills in an evolving field. In addition, empirical evidence on the heterogeneity of sustainability-assurance practice has been derived primarily from the content analysis of sustainability-assurance statements, while interviews are more desirable to better understand practice variation (Channuntapipat et al., 2020). Therefore, explorative studies based on interviews, such as this one, can contribute to the literature by increasing our understanding of the knowledge and skills required for sustainability assurance. Results This section presents an analysis of the interviews conducted with representatives of Big 4 accounting firms in Sweden. The arguments about knowledge and skills needed to face the challenges of sustainability assurance relate to the following themes: assurance responsibilities, sustainability reporting and assurance standards, sustainability-assurance process, and assurance statement and quality issues. The section concludes by summarising the most relevant knowledge and skills. Assurance responsibilities

The Big 4 firms must respect the national laws that are valid in each country in which they operate. Sustainability auditors need knowledge of European and national regulations, their updates, and developments related to the recently approved CSRD (Briem & Wald, 2018; Gillet-Monjarret & Rivière-Giordano,

258  Daniela Argento, Mashal Iqbal, and Fatou Sonko 2017). Member states translated the NFRD into national laws. The Swedish Annual Accounts Act (Årsredovisningslag – ÅRL 1995:1554) includes the Swedish implementation of that Directive. It is especially demanding regarding the organisations that must disclose sustainability information, e.g. by having a lower limit of employees at 250 instead of 500. According to the Swedish Annual Accounts Act, the management report (förvaltningsberättelsen) of large organisations must include sustainability disclosures addressing issues related to the environment, social conditions, personnel, respect for human rights, and the fight against corruption. Alternatively, these organisations can prepare a standalone sustainability report, which must be submitted to the auditor within the same period as the annual report. In such cases, the auditor must declare whether that report has been prepared or not. Because national laws are vague, the Big 4 firms have interpreted the Swedish Annual Accounts Act into their own checklists. According to one interviewee: ‘[…] the Swedish Annual Accounts Act is very brief. So, there is room for interpretation. And we have interpreted it one way […]’ (Int. 01). It emerged from the interviews that if clients disclose their non-financial information in the management report, the financial audit team is obliged to assure it within the framework of financial audit engagements. Usually, the financial audit team uses checklists to verify that the management report discloses the information that should be included. The sustainabilityassurance team might be consulted if needed, acting as support. However, if clients disclose their non-financial information in a standalone sustainability report, then the sustainability-assurance team is responsible for the assurance process. Usually, these teams use their own internal guidelines to assure the disclosed information. The sustainability-assurance team interacts with the financial audit team if needed. If the sustainability report includes financial figures, the sustainability-assurance team can ask the financial audit team for support before asking the client for clarifications. If – as expected – financial and sustainability information becomes more integrated, then the interactions and collaboration between financial and sustainability auditors will become more important. As posed by one of the interviewees: We are working very closely together with the financial team. We have both the financial team doing the audit and the assurance team doing the sustainability audit. We work together with them. But I think that is going to increase also, like how much we work together with them. The taxonomy is a really good example. Because then yeah, it’s like, we need someone who can look into the financial numbers. So, then we really need them, because that is in relation to sustainability. And they need us to understand the technical screening criteria that are matched with the financial numbers. So that is really like a marriage of the sustainability and the financial teams. (Int. 09)

Challenges of sustainability-assurance practices 259 While creating ‘alliances’ with financial auditors is an important skill (Canning et al., 2019), the capacity to work with colleagues with alternative backgrounds is also paramount. The interviewees admitted that sustainability is broad, its boundaries are not clearly defined, and it is almost impossible to gain detailed knowledge on all its areas, e.g. health and safety, energy, waste, and greenhouse gas (GHG) emissions, in relation to the industry/ sector of the client. Therefore, to be competitive and ensure quality assurance, the Big 4 firms may tend to create a diverse sustainability-assurance team with some specialists that have more in-depth knowledge of specific areas of sustainability. In sum, the findings indicate a clear attribution of responsibility within an engagement in that a sustainability-assurance team conducts the assurance of standalone sustainability reports and prepares the assurance statement. However, since things are changing rapidly, the assurance providers need to gain knowledge of sustainability terminology, types of data produced by clients that need to be analysed and continuously update their knowledge on regulations and standards, as stated by one interviewee: I feel like we need to know very quickly, we need to understand it very quickly to be able to help our clients. So, it’s quite the urgency when a new standard or a new framework, or whatever it could be, is published and we need to be up to par and to be able to help our clients. (Int.10) Sustainability reporting and assurance standards

To prepare a standalone sustainability report, organisations can use various reporting standards. It seems that in Sweden the most popular standards are those issued by the Global Reporting Initiative, GRI (see www.globalreporting.org). Approximately 95–98% of Swedish organisations publishing sustainability reports use them (KPMG, 2020). The interviewees confirmed the need to know the GRI and other reporting standards in order to be able to audit the sustainability reports. It emerged that, given that such reporting standards are not compulsory, clients might feel confused, leading them to also seek advisory services to restore comfort. The Big 4 firms have global interpretations of voluntary reporting standards, e.g. GRI, and assurance standards, e.g. AA1000AS and ISAE3000. However, as explained during the interviews, those global interpretations are twisted further into Swedish conditions in order to be applicable. Given that the Big 4 firms have their own interpretations of national laws as well as reporting and assurance standards, the sustainability-assurance landscape is heterogeneous among the firms and across the countries they operate in (see Channuntapipat et al., 2019; 2020; Fernandez-Feijoo et al., 2018; Larrinaga et al., 2020). The interviewees revealed that they most commonly use the ISAE3000 assurance standard. Some of them did not even question why the ISAE3000

260  Daniela Argento, Mashal Iqbal, and Fatou Sonko is more appropriate than the AA1000AS. They rely on the standard because it follows the same logic as for financial audit. In addition, there was an indication that the ISAE3000 is a global assurance standard, and there are pressures or expectations on Big 4 firms to use it. Other interviewees provided a more elaborated explanation, saying that the typical expectations of independence and quality are part of the ISAE3000, and therefore an assurance is more reliable when using that standard than the AA1000AS. According to the interviewees, when following the ISAE3000, the sustainability auditor needs to possess the skills of being analytical and sceptical, which are not so paramount when using the AA1000AS. As claimed by one interviewee: ‘The main thing I would need to do is to understand if the data is correct’ (Int. 07). In this respect, adopting a standard that originates from the financial auditing tradition maintains the prestige of the audit profession and provides comfort: ‘For quality assurance procedures, you have certain methods in place, which the ISAE3000 requires’ (Int. 08). While the ISAE3000 is commonly used, there could be exceptions in case the clients ask for the AA1000AS. This result confirms that a combined use of these two standards is rare and that accounting firms tend to use the ISAE3000 (Channuntapipat et al., 2020; Gillet-Monjarret & RivièreGiordano, 2017). Even if the use of the assurance standard ISAE3000 results in a slowly evolving homogeneity of sustainability-assurance processes, which may resemble the assurance practices from financial audit, assurance practices can vary depending on the client at stake and how they deal with different reporting standards. The rapid changes in sustainability reporting standards, in addition to recent regulatory developments, affect clients’ behaviours and reporting choices. As admitted by one of the interviewees: ‘The regulatory tornado is probably creating more work for the clients than for accounting firms. Because [as sustainability auditor] the audit you can always do if you know what to audit’ (Int. 08). This quote shows that even if the auditor knows what to audit, the skill of being able to understand their clients’ sustainability reporting processes and to interact with them is crucial. Sustainability-assurance process

An assurance engagement starts when accounting firms communicate the assurance process to the client and ends when an evaluation of the sustainability report is completed in the form of an assurance statement (Martínez-Ferrero & García-Sánchez, 2018). Regarding the sustainability-assurance process, the interviewees listed and described steps that are formally similar to those of a financial audit (i.e. planning, risk assessment, execution, and reporting) with some variations in the name of the stages (not revealed because of confidentiality). However, they also argued that the execution phase is challenging because the data does not consist of financial figures. Sustainability auditors develop their tools to check the accuracy of data and prepare the assurance statement.

Challenges of sustainability-assurance practices 261 The interviewees further stated that checklists or internal guidelines are used to the extent it is necessary to fulfil the engagement at stake, i.e. depending on whether sustainability information is disclosed in the management report or in the standalone report, the size of the clients, and the type of assurance asked for by them. Checklists and internal guidelines count as ‘supporting tools’ to evaluate how the clients implement sustainability-related policies and manage related risks. They include ‘the questions that we have to answer, and we have to collect evidence to answer them’ (Int. 05). Checklists used during the assurance process are generic and could be applied to several client engagements. According to the interviewees, a checklist can have up to 50 items of supporting evidence to be analysed in the sustainability information disclosed by the clients. Checklists are often used by the financial audit team to check if the management report is prepared in accordance with the Swedish Annual Accounts Act. In such cases, a ‘brief’ assurance is conducted to confirm that the clients have actually disclosed the sustainability information mandated by the law. The information disclosed is verified following the checklist by reviewing supporting documentation from the client. A risk analysis is expected to be done, as well as a verification that main issues, such as Key Performance Indicators (KPIs), information on corporate governance, environmental aspects, risk of not meeting targets, policies, etc. have been addressed by the client. In short, the brief assurance certifies compliance as shown in the following quote: So basically, it is the signing financial auditor’s responsibility to actually say that we have done an examination of the sustainability report. […] do like a ticking the box thing. (Int. 03) Some clients try to enhance credibility by seeking assurance on their standalone sustainability reports (Cuadrado-Ballesteros et al., 2017; Farooq & de Villiers, 2020; Fuhrmann et al., 2017; Simnett et al., 2009). A detailed assurance is then performed by following internal guidelines, and it consists of a limited assurance or a reasonable assurance, the latter being more extensive than the former. In the limited assurance, a small sample size is chosen to do analysis and inquiries. The process starts with a risk analysis in which the sustainability auditors analyse the relevance of the information disclosed and the likelihood of material misstatements. The risk analysis shows how complex the disclosed information is to assure and leads to the identification of the most important topics in the sustainability report. The disclosed information is categorised into complex and important information or non-complex but important information. Health and safety, energy, waste, GHG emissions, etc. are examples of complex and important information. Discrimination, anticorruption, human rights, etc. are examples of non-complex but important

262  Daniela Argento, Mashal Iqbal, and Fatou Sonko information. After categorising the disclosed information by its complexity, a meeting is held with the client. In addition, a media check (news articles, social media, etc.) is done to verify if some material information has been publicly available but not addressed in the sustainability report. Furthermore, a review of supporting internal documentation, such as climate files and social files, is executed. One interviewee explained why the limited assurance is most common: We provide a limited assurance, as it is called. You can have either limited assurance or you can have a reasonable assurance. […] I don’t think even one company in the whole of Sweden asks for reasonable assurance. Because the reasonable assurance is very very [detailed], you go into a lot of details and sustainability […] is not in-depth at the detail level. So we provide limited assurance statements, we go through documents to a certain extent, and then we can provide a statement that sets or that says that this information is correct, to a certain extent […]. (Int. 06) This quote confirms that conducting a reasonable assurance is a very detailed process and still not the most common assurance practice for sustainability disclosures (Reimsbach et al., 2017). The following quote is revealing: ‘I would say that most organisations are not ready for reasonable assurance. And even if they are mature, it would not be cost beneficial for them’ (Int. 08). Even if the sustainability auditors possess the knowledge and skills to execute reasonable assurance, they might not be willing to ‘go that far’. The interviewees explained that the assurance engagement is tailored to the specific client because sustainability is broad and differs for different clients. In addition, sustainability information systems vary across clients and influence how the sustainability auditors perform the assurance process. Sustainability auditors may adapt how they collect and verify the information. One interviewee claimed: ‘It is based on that we understand their routines and processes, how they collect the material that builds up to the figures. So, we need to understand how they collect and how they perform, before we can go into what they present’ (Int. 11). In general, the internal control systems are not perceived to be well developed, indicating that clients are not yet ready to prepare sustainability reports that are subject to reasonable assurance. Therefore, limited assurance is more common, with some exceptions when the reasonable assurance is executed only for some areas of the sustainability report. Since the amount of information is substantial and different from financial data, the sustainability auditor needs to stay alert: ‘… Can I understand that the data is correct without understanding the terminology?’ (Int. 07). At the same time, the sustainability auditor should: ‘… take a step back and try to think okay, how is this organisation impacting its surroundings?’ (Int. 10). Seeking a balance between going deep into details while not getting lost in

Challenges of sustainability-assurance practices 263 the data is a challenge. The interviewees stated that having the knowledge of what to review and the skill of identifying the risks and materiality levels are essential when auditing non-financial data. Assurance statement and quality issues

The Big 4 firms conclude the assurance process by preparing a statement on the evaluation of clients’ sustainability report, which is supposed to increase stakeholders’ confidence in the disclosed information (Fuhrmann et al., 2017; Martínez-Ferrero & García-Sánchez, 2018). It is challenging for the sustainability auditor to define the scope of the audit (Kolk & Perego, 2010), and one of the interviewees confessed that: It is still a fairly new area to get assurance within. And you still do not have a very clear framework to work with… A lot of organisations use GRI but then that is voluntary. So, I think it is too difficult to define the scope. (Int. 10) The findings show that the structure of an assurance statement among the Big 4 firms in Sweden is very similar, as they tend to use the same template recommended by FAR. The stages of the assurance process are not described in the assurance statement, and therefore a general template is applicable. The content of the assurance statement is not fully transparent since it does not include the checklists or internal guidelines that are used throughout the assurance process. The findings show that the firms do not want to risk losing competitive advantage by revealing their assurance procedures. According to the interviewees, the sustainability-assurance statement is signed by an authorised auditor, i.e. the signing partner is the same auditor who signs the financial-audit statement. However, a sustainability auditor can co-sign the sustainability-assurance statement if they are a member of FAR’s sustainability specialist group. This group gathers those who have at least five years of experience with sustainability assurance and are recommended by their management to apply. As posed by one interviewee: ‘It is the head auditor that signs the sustainability assurance statement, but then we also call ourselves right hand signers’ (Int. 07). Thus, the sustainability auditor’s signature is optional and ceremonial according to another interviewee who claimed that: ‘And that specialist member can sign the assurance report as well. But that signature is basically just for show. It doesn’t mean anything’ (Int. 08). Apart from the symbolic value of the second signature, having a member in FAR’s specialist group probably provides an opportunity for the Big 4 firms to be active in sustainability within FAR and, in turn, be able to transfer updates and new knowledge into their firms, thereby improving assurance processes.

264  Daniela Argento, Mashal Iqbal, and Fatou Sonko Having the responsibility to sign the sustainability-assurance statement, the financial auditor has to carry out quality assurance of the work done by the sustainability auditor, who actually prepares the statement. The financial auditor and the sustainability auditor meet to discuss the assurance process and review documents. Having knowledge and information on the sustainability-assurance process makes financial auditors feel more comfortable signing the assurance statement. However, in some of the firms, the financial auditors do not thoroughly review the sustainability-assurance process and rely entirely on the sustainability auditor’s judgement. The quality of assurance relies on the assuror’s probability to discover and report problematic issues in the client’s sustainability report (Hummel et al., 2019). This is based on the assuror’s knowledge and skills within sustainability, regulation, assurance process, etc. The interviewees argued that knowledge spill over from financial auditing to sustainability assurance improves the assurance quality. According to them, the basic concepts of assurance, such as making risk analysis, media checks, and reviewing files, are nearly the same in sustainability assurance as in financial audit. Having a background in financial audit, or at least basic knowledge of financial auditing and analytical skills can be beneficial for sustainability auditors. To perform quality sustainability assurance and prevent miscommunication, a clear dialogue between auditors and their clients is important. Sustainability auditors must understand ‘where the information is coming from’ (Int. 07). Supporting materials that come with a sustainability report are not always adequate. Clients are said to face difficulties in organising a good information-gathering system that renders the supporting documentation sufficient. Furthermore, not every organisation has a sustainability function or a specific person responsible for sustainability matters. This makes it more challenging for sustainability auditors to assure sustainability reports, forcing them to actively seek the right persons to contact: ‘You really need to understand who you have to talk to, who you have to ask questions’ (Int. 10). It is argued that the Big 4 firms have a good reputation in the assurance market because they are less likely to be influenced by their clients (Cuadrado-Ballesteros et al., 2017). Indeed, the interviewees claimed that they are well trained to maintain independence and quality. Summary of knowledge and skills

Based on the findings presented in the previous subsections, the Big 4 firms and their sustainability auditors face the following challenges: regulatory instability, multiple and developing reporting standards, vague assurance standards, immature clients, and consequent variation in assurance practices. Training provides sustainability auditors with the knowledge and skills needed to perform sustainability assurance (Farooq & de Villiers, 2020). This study confirms that sustainability auditors in the Big 4 firms receive training on various sustainability areas, e.g. energy, waste, GHG emissions, discrimination, and human rights, which helps them in building knowledge

Challenges of sustainability-assurance practices 265 on specific sustainability terminology. As stated by one interviewee: ‘[…] what happened first when I started is that I got an education in how to assure something. We have kind of an internal school […] on how to provide assurance. So, we did a training session, and we learned like all the necessary methodology’ (Int. 06). However, like financial auditors, sustainability auditors can also experience lack of knowledge in certain areas, which could create difficulties in verifying the disclosed sustainability information. Therefore, some accounting firms hire specialists with sustainability background to have the right competence base to perform the assurance. Since assurance is teamwork and team composition matters (see Annelin & Svanström, in this volume), members can learn from each other, especially from those that are more senior within sustainability assurance. Teams can include sustainability generalists and sustainability specialists with diverse educational background and previous professional experience. Some team members may have a business administration background and experience with financial audit, while other members may have a different educational background (e.g. sustainability management). The findings therefore indicate that being proactive and able to communicate with colleagues and seeking help are important skills. Besides the skill of being able to work in teams and communicate with people having a diverse background, curiosity seems to be important in gaining knowledge. The interviewees revealed that knowing the ISAE3000, GRI standards and legislation is not sufficient. Sustainability is broad and constantly evolving. Although there is some internal training, knowledge relies on the individual’s willingness to read and stay up to date on standards, regulations, and sustainability as such, beyond the minimum: ‘If you want to be an expert in an area like sustainability, then you need to be a reader’ (Int. 09). The findings also revealed the importance of being able to communicate with clients, understand their reporting processes and choices, and identify the proper source of information. In addition, the interviewees recalled the criticalthinking skill by explicitly emphasising the importance of a critical analytical approach, being able to identify risks, assess materiality, and find significant information. Having theoretical and practical knowledge of what information and data are needed makes it easier to identify risk areas. According to the findings, knowledge spill over from financial auditing to sustainability assurance improves the quality of assurance processes, even if the non-financial nature of the audited information makes it complex. Having the mindset of an auditor is crucial because: ‘audit is audit, whether it is financial or non-financial’ (Int. 08). In this respect, the competence of audit associates is influential because they may become authorised auditors in the future. This study indicates that more needs to be done because: ‘[…] we have a lot of internal guides and studies […] there is a lot about sustainability too, I have not done anything about it, but I know they exist’ (Int. 04). One interviewed audit associate revealed their unfamiliarity by stating: ‘[…] I look through the annual report and accounts behind the numbers […], not that much with sustainability, I would say’ (Int. 02). If audit associates do not become familiar

266  Daniela Argento, Mashal Iqbal, and Fatou Sonko with the process of sustainability assurance in an early stage of their career, they might not be fully comfortable when signing a sustainability-assurance statement as a financial auditor in the future. Conclusions and implications Sustainability reporting is evolving, and assurance is becoming common (Channuntapipat et al., 2020). However, sustainability reporting is still immature and a third-party assurance is necessary to ensure organisations are moving towards sustainable development (Bebbington et al., 2017; Silvola & Vinnari, 2021). The increasingly tough regulations (CSRD) further impact the demand for sustainability assurance in the EU, including Sweden. Accounting firms are willing to be at the forefront of providing the assurance service (Briem & Wald, 2018; Gillet-Monjarret & Rivière-Giordano, 2017). This chapter advances our understanding of the practical aspects of nonfinancial assurance services offered by Big 4 firms. It demonstrates how the firms have interpreted the regulations and voluntary standards, e.g. GRI and ISAE3000, by creating internal guidelines that facilitate the assurance process and enable them to gain competitive advantage. While these interpretations and guidelines are adapted to Swedish conditions, not having clear guidance on how to prepare sustainability reports (uncertainty on the clients’ side) and on how to assure sustainability reports (uncertainty on the Big 4 firm side) is a challenge according to the findings. Furthermore, the process of assurance depends on the maturity level of the clients and the type of assurance they demand. These differences create heterogeneity in sustainability-assurance practices and therefore no precise answer or correct process is implemented yet (see also Farooq & de Villiers, 2020). However, once transformed into national legislations, the CSRD might reduce the current practice variation and uncertainty. The chapter emphasises that there are some similarities between financial audit and sustainability assurance in terms of conducting risk analysis and media checks, as well as reviewing files. In line with Canning et al. (2019) and Channuntapipat et al. (2019), it also shows differences since the sustainabilityassurance process has to be tailored to the choice of the reporting standards the clients have made and how they have collected data. Sustainability auditors working at Big 4 firms need knowledge about sustainability, laws and regulations, sustainability reporting standards, and sustainability-assurance standards. Concerning skills, the findings reveal that auditors involved in sustainability assurance should possess adaptability skills, interaction skills, analytical skills, and critical-thinking skills. They should also be able to understand and prioritise clients’ needs. In the current situation, sustainability auditors need to be equipped with curiosity, patience, and willingness to read and stay up to date. The new regulations and sustainability reporting standards give the Big 4 firms new opportunities to expand their businesses. This means that the thin line between sustainability assurance and consultancy needs to be monitored to

Challenges of sustainability-assurance practices 267 ensure that independence and quality are not threatened, which is a concern expressed by the European Commission. Sustainability auditors, like financial auditors, need to be critical thinkers and able to find (and report) misstatements. In this respect, sustainability auditors might need to be even more skilled in terms of where to find the information at stake, given that data do not only consist of financial figures. Not having easily quantifiable KPIs makes it difficult to perform sustainability assurance and to set materiality thresholds. Sustainability touches very broad areas of different segments of organisations, which pressures sustainability auditors to be experts or to rely on the expertise of peers that are specialised. This discussion leads to the question of whether sustainability auditors should be sustainability specialists, sustainability generalists, or both. This chapter reveals various pros and cons, and it can be expected that sustainabilityassurance teams will be increasingly composed of members with mixed competences and expertise. It seems that having the right people in the teams is crucial for the Big 4 firms, and their recruitment strategies are important. In some of the Big 4 firms, financial auditors are currently more involved in the sustainability-assurance process than in others. In some of the firms, sustainability auditors work together with the financial auditor and in some they work separately. Furthermore, it seems that audit associates are generally not familiar with the sustainability-assurance processes, which means that they might not be comfortable when signing sustainability-assurance statements in the future. At the time this study was conducted, and the final CSRD version was on the way, one interviewee speculated that in the near future there would probably be a certification for the sustainability auditors as well, indicating that financial auditors would need this certification to be able to sign the sustainability-assurance statement. There are also indications that sustainability and financial reporting are becoming increasingly integrated. It follows that sustainability and financial auditors need to cooperate and cannot work in silos. This discussion about the future of auditing provides some implications for practice. Big 4 firms, but also smaller accounting firms that wish to engage with sustainability assurance, need to think about their recruitment strategies to ensure that their sustainability-assurance team has the right knowledge and skills to provide high quality. If they seek the integration of financial and sustainability auditing, then some more actions need to be taken for collaboration to become a natural working practice. Business programme directors of universities that wish to have a competitive advantage in the educational system must rethink traditional accounting and auditing courses offered to students. This study has shown that audit associates with traditional financial accounting education might not be ready for the challenges related to sustainability assurance. Concerning limitations, this chapter presents findings based on a limited number of interviews conducted at a time when the final CSRD version was not yet approved. More research is needed once the regulatory environment has become stable. In addition, this chapter has emphasised that sustainability

268  Daniela Argento, Mashal Iqbal, and Fatou Sonko auditors need to interact with clients not always knowing with whom they need to talk and where to find relevant information. This type of interaction could be further studied. Apart from the relationships with clients, the internal interactions among the different types of sustainability auditors also seem to be a promising area for future research. Finally, an investigation of the proactiveness or reactiveness of universities in how they are dealing with sustainability assurance in their educational programmes could be valuable. References Bebbington, J., Russell, S., & Thomson, I. (2017). Accounting and sustainable development: Reflections and propositions. Critical Perspectives on Accounting, 48, 21–34. Boiral, O., Heras-Saizarbitoria, I., & Brotherton, M.-C. (2020). Professionalizing the assurance of sustainability reports: The auditors’ perspective. Accounting, Auditing & Accountability Journal, 33(2), 309–334. Boiral, O., Heras-Saizarbitoria, I., Brotherton, M.-C., & Bernard, J. (2019). Ethical issues in the assurance of sustainability reports: Perspectives from assurance providers. Journal of Business Ethics, 159(4), 1111–1125. Briem, C.R., & Wald, A. (2018). Implementing third-party assurance in integrated reporting. Accounting, Auditing & Accountability Journal, 31(5), 1461–1485. Canning, M., O’Dwyer, B., & Georgakopoulos, G. (2019). Processes of auditability in sustainability assurance – The case of materiality construction. Accounting and Business Research, 49(1), 1–27. Channuntapipat, C., Samsonova-Taddei, A., & Turley, S. (2019). Exploring diversity in sustainability assurance practice. Accounting, Auditing & Accountability Journal, 32(2), 556–580. Channuntapipat, C., Samsonova-Taddei, A., & Turley, S. (2020). Variation in sustainability assurance practice: An analysis of accounting versus non-accounting providers. The British Accounting Review, 52(2), 100843. Cuadrado-Ballesteros, B., Martínez-Ferrero, J., & García-Sánchez, I.M. (2017). Mitigating information asymmetry through sustainability assurance: The role of accountants and levels of assurance. International Business Review, 26(6), 1141–1156. FAR (2022). Hållbarhetsarbete hos FAR. In Swedish (Sustainability work at FAR). https://www.far.se/om-far/hallbarhet-hos-far/ Farooq, M.B., & de Villiers, C. (2020). How sustainability assurance engagement scopes are determined, and its impact on capture and credibility enhancement. Accounting, Auditing & Accountability Journal, 33(2), 417–445. Fernandez-Feijoo, B., Romero, S., & Blanco, S.R. (2018). Regional differences in industry specialization in the sustainability assurance market. Management Decision, 57(3), 669–687. Fuhrmann, S., Ott, C., Looks, E., & Guenther, T.W. (2017). The contents of assurance statements for sustainability reports and information asymmetry. Accounting and Business Research, 47(4), 369–400. Gillet-Monjarret, C., & Rivière-Giordano, G. (2017). Sustainability assurance: A literature review. Accounting Auditing Control, 23(2), 1–46. Higgins, C., Tang, S., & Stubbs, W. (2020). On managing hypocrisy: The transparency of sustainability reports. Journal of Business Research, 114, 395–407.

Challenges of sustainability-assurance practices 269 Hummel, K., Schlick, C., & Fifka, M. (2019). The role of sustainability performance and accounting assurors in sustainability assurance engagements. Journal of Business Ethics, 154(3), 733–757. Iqbal, M., & Sonko, F. (2021). Who performs sustainability assurance? A study of the Big Four accounting firms in Sweden. Master Thesis in Business Administration: Auditing and Control. Kristianstad University. Knechel, W.R. (2021). The future of assurance in capital markets: Reclaiming the economic imperative of the auditing profession. Accounting Horizons, 35(1), 133–151. Knechel, W.R., Mintchik, N., Pevzner, M., & Velury, U. (2019). The effects of generalized trust and civic cooperation on the Big N presence and audit fees across the globe. Auditing: A Journal of Practice & Theory, 38(1), 193–219. Kolk, A., & Perego, P. (2010). Determinants of the adoption of sustainability assurance statements: An international investigation. Business Strategy and the Environment, 19(3), 182–198. KPMG (2020). The time has come: The KPMG survey of sustainability reporting 2020. Link: https://assets.kpmg/content/dam/kpmg/xx/pdf/2020/11/the-time-hascome.pdf (Accessed on 3 March 2021). La Torre, M., Sabelfeld, S., Blomkvist, M., Tarquinio, L., & Dumay, J. (2018). Harmonising non-financial reporting regulation in Europe. Meditari Accountancy Research, 26(4), 598–621. Larrinaga, C., Rossi, A., Luque-Vilchez, M., & Núñez-Nickel, M. (2020). Institutionalization of the contents of sustainability assurance services: A comparison between Italy and United States. Journal of Business Ethics, 163(1), 67–83. Martínez-Ferrero, J., & García-Sánchez, I.M. (2018). The level of sustainability assurance: The effects of brand reputation and industry specialisation of assurance providers. Journal of Business Ethics, 150(4), 971–990. O’Dwyer, B. (2011). The case of sustainability assurance: Constructing a new assurance service. Contemporary Accounting Research, 28(4), 1230–1266. Perego, P., & Kolk, A. (2012). Multinationals’ accountability on sustainability: The evolution of third-party assurance of sustainability reports. Journal of Business Ethics, 110(2), 173–190. Reimsbach, D., Hahn, R., & Gürtürk, A. (2017). Integrated reporting and assurance of sustainability information: An experimental study on professional investors’ information processing. European Accounting Review, 27(3), 559–581. Ruiz-Barbadillo, E., & Martínez-Ferrero, J. (2022). The choice of incumbent financial auditors to provide sustainability assurance and audit services from a legitimacy perspective. Sustainability Accounting, Management and Policy Journal, 13(2), 459–493. Silvola, H., & Vinnari, E. (2021). The limits of institutional work: A field study on auditors’ efforts to promote sustainability assurance in a trust society. Accounting, Auditing & Accountability Journal, 34(1), 1–30. Simnett, R., Vanstraelen, A., & Fong Chua, W. (2009). Assurance on sustainability reports: An international comparison. The Accounting Review, 84(3), 937–967. Unerman, J., Bebbington, J., & O’Dwyer, B. (2018). Corporate reporting and accounting for externalities. Accounting and Business Research, 48(5), 497–522. Wollmert, P., & Hobbs, A. (2021). How the EU’s new sustainability directive will be a game changer. Link: How the EU’s new sustainability directive will be a game changer (ey.com) (Accessed on 9 February 2022). Wong, J., Wong, N., Li, W.Y., & Chen, L. (2016). Sustainability assurance: An emerging market for the accounting profession. Pacific Accounting Review, 28(3), 238–259.

270  Daniela Argento, Mashal Iqbal, and Fatou Sonko Appendix: Research design Semi-structured interviews were carried out to collect data in an interactive manner, to benefit from the inherent flexibility to spontaneously ask relevant follow-up questions during the interviews. To identify suitable interviewees, an email explaining the purpose of the study was sent to the Big 4 accounting firms in Sweden, and they subsequently provided the contact information of suitable employees knowledgeable in the studied area. The interviews were held online as the COVID-19 pandemic made it nearly impossible to conduct interviews face-to-face. A total of 11 interviews were conducted in English. In an initial stage (Spring 2021), six interviews took place with the aim of understanding how the Big 4 firms organise sustainability-assurance practices, who are the professionals that execute the sustainability assurance, and what knowledge and skills are important when executing such task. The results of those interviews were presented in a master’s thesis by Iqbal and Sonko (2021). In a second stage (Spring 2022), five additional interviews were conducted with a particular focus on the knowledge and skills that increase the professionalism of sustainability-assurance providers working in Big 4 firms. Table 12.1 presents an overview of the interviews. To preserve the anonymity of the interviewees, Table 12.1 does not reveal the gender and position of each interviewee or the name of the Big 4 firm where each interviewee works. They are developing their methods and procedures, and some of the interviewees were keen on preserving the confidentiality of some of the information provided. A few remarks can be made regarding the interviewees. The majority of them are women (which is an interesting choice made by the firms that Table 12.1  Overview of interviews. #

Date

Length

Content of the interview

Int.01 Int.02 Int.03 Int.04 Int.05 Int.06 Int.07

2021-05-04 2021-05-04 2021-05-05 2021-05-05 2021-05-11 2021-05-12 2022-04-06

36 minutes 14 minutes 80 minutes 25 minutes 40 minutes 56 minutes 63 minutes

Int.08

2022-04-22

60 minutes

Int.09

2022-04-22

53 minutes

Int.10

2022-04-27

50 minutes

Int.11

2022-05-04

30 minutes

Sustainability-assurance processes and practices Short discussion about knowledge of new entries Sustainability-assurance processes and practices Short discussion about knowledge of new entries Sustainability-assurance processes and practices Sustainability-assurance processes and practices Sustainability-assurance processes and practices, with a specific focus on knowledge and skills Sustainability-assurance processes and practices, with a specific focus on knowledge and skills Sustainability-assurance processes and practices, with a specific focus on knowledge and skills Sustainability-assurance processes and practices, with a specific focus on knowledge and skills Sustainability-assurance processes and practices, with a specific focus on knowledge and skills

Challenges of sustainability-assurance practices 271 selected the individuals to be interviewed). They are at different stages of their careers, given that their positions range from assistant managers to senior managers. Two audit associates were briefly interviewed to gather information about the knowledge that new entries have about sustainabilityassurance practices in their respective accounting firms. Since two interviewees who participated in the first stage provided particularly relevant information, they were interviewed again in the second stage. This means that a total of nine persons were interviewed. The interview guide covered several themes as follows: background information, sustainability-assurance practices, standards, level of assurance, assurance statement, expertise, knowledge and skills, challenges, and changes in the audit industry. The interviews conducted in the second stage had a stronger focus on knowledge and skills. A simplified version of the interview guide is presented in Table 12.2. The interviews were transcribed to facilitate subsequent analysis, which was conducted using an abductive approach. Since this is an explorative study, the analysis of the findings followed an approach in which the themes and concepts emerged as relevant.

Table 12.2  Simplified interview guide. Background information • Position, previous working experiences, educational background How sustainability-assurance works in practice • • • • •

Sustainability-assurance processes/routines/steps Similarities/differences compared to financial audit Team composition and internal interactions External interactions with clients Use and usefulness of key regulations, standards, and internal checklists/ guidelines

Level of assurance and assurance statement • Levels of provided assurance • Assurance statement structure and content • Signing auditor Knowledge and skills • • • •

Most important knowledge and skills How to get the right competence How to keep up to date Confidence compared to competitors (e.g. engineering and consultancy firms)

Conclusions • Main challenges of sustainability-assurance • Future of sustainability-assurance market and effects on audit industry

Part IV

Auditor characteristics

13 The average professional On the selection and socialisation of auditors Thomas Carrington, Tobias Johansson-Berg, Gustav Johed, and Peter Öhman Introduction An overlooked aspect in previous research is whether newly recruited auditors are formed by the audit profession and/or their accounting firms or if they are already more or less ‘pre-programmed’ when they are employed. Related to this is the discussion of who becomes an auditor in the 21st century. Accordingly, the extent to which the socialisation has taken place on a broader scale – pointing to a homogeneity of the recruits’ background variables, values, and attitudes – deserves attention. When the Swedish audit association FAR was founded in 1923, the only domestic academic institution a person could attain the relevant education from in order to qualify as an auditor was the Stockholm School of Economics (SSE), founded in 1909. Two of FAR’s three founders, Lars Thure Bohlin and Seth Svensson, were in the first class that graduated from the SSE in 1911 (the year before the first six auditors were authorised in Sweden), and the third founder, Oskar Sillén, became the school’s first Professor of business administration in 1933 (Wallerstedt, 2009). For many years, a degree from SSE was a requirement for becoming an auditor, effectively connecting the profession with the most prestigious business school in Sweden (Holmqvist, 2018). Unsurprisingly, the foundation of SSE is a critical event for the development of the audit profession in Sweden (Öhman & Wallerstedt, 2012). Today the SSE remains the most prestigious business school in Sweden, and all Big 4 firms, i.e. Deloitte, EY, KPMG, and PwC, are corporate partners of the school. However, the accounting firms’ love for the SSE seems unrequited, as few, if any, of the new audit recruits have a degree from the SSE. For elite students, accounting firms today do not seem to offer a sufficiently attractive and prestigious workplace. Another distinct change in the Swedish audit profession during its first century was the representation of female auditors. The first two female auditors, the sisters Thyra and Dagmar Svensson, were authorised as early as 1914, but it took another 37 years until Barbro Kylin became the third female to be authorised (in 1951). Today, the gender balance is more even, although men are still overrepresented among authorised and approved auditors (65%), as well as at the partner level of DOI: 10.4324/9781003411390-17

276  Thomas Carrington et al. accounting firms (71%) (Öhman, 2023). Moreover, international studies have documented an explicit ambition of accounting firms to aim for a more developed recruitment strategy to achieve their goals (Duff, 2017; Gebreiter, 2020). Taken together, Swedish auditors are no longer exclusively white men who all have their higher education from the same (elite) school. As we will show in this chapter, auditors of today are still a homogeneous group, and the audit assistants are, in fact, remarkably ‘average’ in many respects. An important driver of change is the composition of the Swedish labour force. The gender balance has improved considerably since the early 1900s (Öhman, 2023), and an increased number of non-ethnic Swedes has entered the labour market (Östh et al., 2010). There has also been a substantial increase in the level of education of those ready to enter the labour market. In the 1920s, there were only 6,500 students, almost exclusively men, enrolled in higher education of any kind in the whole country (UKÄ, 2022). Studying at SSE, or any university, was thus clearly an elite undertaking. In 1945, there were still no more than 14,000 students at Swedish universities, and only 20 percent of those were women. However, the number of universities has increased gradually, and today there are 50 universities, colleges, and individual providers of higher education in Sweden (UKÄ, 2022), more than half of them offering business administration programmes. Of those who left high school in 2016, half had entered higher education within three years. More specifically, 56 percent of the women who left high school that year had started the university education within three years, and the corresponding figure for men was 44 percent. Among those in the 30–34 age group, a quarter had a higher level of education than one of their parents and a fifth had a lower level of education than the most highly educated parent. From this it was concluded that ‘[t]he trend indicates that it is soon as common to have a lower education level as to have a higher education level than one of the parents’ (Statistics Sweden, 2020). The changes in the labour market and other general changes in society during the lifespan of FAR have, indeed, affected the pool of people that accounting firms recruit from. Despite the fact that the person recruited as an audit assistant is different today than in the past, we know little about that person’s characteristics. For example, we lack answers to basic questions such as their educational background, their confidence in formal institutions in society, their perceptions of why they were hired, and their positions on central values of the audit profession. Questions like these relate to research on the socialisation of individuals in the profession (e.g. Carrington et al., 2013, 2019; Cooper & Robson, 2006; Suddaby et al., 2009), and analyses of such data offer input to discussions about auditor commitments to core values (Knechel et al., 2020). Because auditors enjoy societal privileges in the form of a monopolylike position in the labour market, it is of societal interest to not only chart those who become auditors but also analyse their opinions vis-à-vis the more highly educated population and their value commitments in relation to the auditors that currently constitute the established profession.

The average professional 277 Recruitment and socialisation are about social reproduction. Such reproduction might not necessarily imply a better auditing practice, but it can be used to secure privileges. However, we know surprisingly little about who and what aspects are socialised. Therefore, the present chapter aims to analyse key aspects of becoming an auditor. The following interrelated research questions are addressed: RQ 1: Who are the individuals who start a career at an accounting firm, and to what extent do their opinions coincide with the opinions of the part of the population with tertiary-level degrees? RQ 2: What are their value commitments, and to what extent do they coincide with those of senior auditors? These questions enable us to analyse whether or not there is diversity in the audit profession as a result of the more varied backgrounds of the audit assistants. An important note here is the element of interrelatedness between the young individuals who aim to enter the audit profession (the supply side) and the accounting firms that ultimately select whom to recruit (the demand side) (Durocher et al., 2016). Accounting firms can only select among the pool of applicants that exists. At the same time, who they typically recruit can be expected to send signals to future and potential applicants (Gebreiter, 2020), thereby influencing the supply. Therefore, hiring is not only an important part of the socialisation process of becoming an auditor but it is also an act of social reproduction, as it affects the future supply of staff. Motivation Auditors’ attitudes and behaviours result, on the one hand, from regulation and, on the other hand, from auditors’ interactions with colleagues, clients, and supervisory bodies. Previous research has pointed to the importance of the respective sites of the accounting firm (e.g. Cooper & Robson, 2006) and the client firm (e.g. Lawrence et al., 2011) for the more thorough socialisation and learning of the craft. Socialisation is assumed to be powerful, and it is through socialisation that newly recruited auditors come to identify themselves as professional auditors. The research field of auditors’ socialisation and professionalisation utilises both quantitative and qualitative research methods, and these various research efforts agree that auditors constitute a homogenous group with respect to their commitment to core values, i.e. professional commitment (PC), commitment to rigour in enforcing independence requirements (REIR), organisational commitment (OC), and client commitment (CC) (Carrington et al., 2013; Suddaby et al., 2009). Homogeneity in commitments is also mirrored in popular culture, where auditors with few exceptions are portrayed as dull and boring, illustrated in the best-selling crime novel ‘The Dying Detective’ where an auditor assists the criminal inspector in solving a cold case. The male auditor is described as

278  Thomas Carrington et al. a person who, on his wedding day, travels home from his own party by public transit, despite being ridiculed by his wife’s brothers for his stinginess and inflexible personality. However, the author let us readers know that Alf Hult, the auditor, ‘simply could not care less’ what others think about him and his doings (Persson, 2010, pp. 219–220). Indeed, integrity and an independent mind are valued behaviours, signalling commitment to the profession. The increased pressures of commercialisation that auditors are facing (Zeff, 2003a, 2003b) are a common lament, and there are good reasons to assume that these pressures have increased in recent years. For example, the incessant consolidation and internationalisation of the audit industry are the continuation of a trend with no apparent inflection point having been passed so far. Elsewhere, in the political sphere, such a point can be said to have been passed, however. For example, in 2010, the decision to make auditing voluntary for the majority of companies in Sweden, resulting in the shrinkage of the overall market (Riksrevisionen, 2017), adding extra commercial pressure on remaining audit engagements. Additionally, the recently changed educational requirements decided by the Swedish Inspectorate of Auditors (RIFS, 2018) formally removed the requirement of a university degree in business administration, as an exclusive qualification to enter the audit profession. The profession is now open to people with any type of university qualification as long as it includes some studies in accounting and auditing. Additional studies in accounting and auditing can be carried out by FAR or the accounting firms, particularly the Big 4 and mid-tier firms. Taken together, these changes will possibly strengthen the intra-firm commercial pressures described above, and concerns have been raised about the fact that so much of the socialisation of an auditor takes place at the accounting firms, and so little is influenced by academia and audit associations like FAR, making commercial pressures central to the socialisation of auditors (Carrington et al., 2013). The traditional view of a profession is that values are promoted and sustained among its members, and, like the fictional auditor Alf Hult mentioned above, these members act as a counterweight to commercial pressures. In this view, professional values are best promoted in professional organisations, such as FAR, or at least in organisations not primarily driven by commercial interests. However, increasing commercial pressures resulting in the commercialisation of technical expertise seem to affect professional values at the sites of the accounting firm and the client (Cooper & Robson, 2006), and academic debates should therefore focus their analytical efforts on how value commitments develop among auditors. For example, in what way can the driver of transformation, outlined in the introduction, affect the devaluation of professional values described in this section? To be able to address value commitments among early-career auditors, an email-administrated survey was sent to all newly employed audit assistants at the seven largest accounting firms in Sweden, as well as smaller firms included in the industry network constellation. The survey was submitted to the respondents in the autumn of 2019. Related to RQ 1, we also used secondary

The average professional 279 data from the Swedish Higher Education Authority (UKÄ), Statistics Sweden, and the SOM Institute. To compare the audit assistants’ and senior auditors’ value commitments with respect to RQ 2, we used previous data from a large sample of authorised and approved Swedish auditors in 2010. More information about methodological issues can be found in the Appendix. Literature review It is worth noting that auditing, on the one hand, is a business of confidence and trust towards society resembling a public good and, on the other hand, a capitalistic business of trust towards the audit clients. In parallel with their main task to serve shareholders and other external stakeholders and to uphold the profession’s responsibility to act in the public interest, auditors have to satisfy their clients so that the accounting firms can continue to receive their business. According to Jenkins and Lowe (1999), some auditors primarily perceive themselves as public watchdogs serving external stakeholders, while others primarily perceive themselves as advocates for their clients. This means that auditors have divided loyalties (Öhman et al., 2012). Early literature on how individuals recruited to accounting firms are socialised into auditors was based on ethnographic and interview-based studies (e.g. Grey, 1998). A central finding that still influences much of the research focus is that the socialisation of auditors mainly takes place in the workplace (Cooper & Robson, 2006) and in the client-context (Lawrence et al., 2011). This shapes the auditors in a clearly uniform direction. A consequence of this socialisation was that the recruits’ perceptions of how an auditor should be in order to be considered professional meant that they dressed in a certain way and realised early on to prioritise the client’s wishes. Social skills such as informally building networks and nurturing client relationships became important for junior auditors wishing to continue a successful career in accounting firms (Carter & Spence, 2014). To succeed as an auditor, the argument that technical knowledge in accounting and auditing is subordinate to social agility, formability, and ability to keep time budgets is now a dogma. Accordingly, studies continue to draw conclusions that ‘surprisingly, technical ability or professional knowledge were not mentioned when our informants spoke of partner material’ (Kornberger et al., 2011, p. 33). That newly hired audit assistants realise that they must focus on their social networking skills to start and continue a career also means that personal ethical considerations and reflections on higher vocations and societal benefits are largely replaced by immediate business practical chores (Johed & Catasús, 2018). These practical tasks, described in previous studies, are often more or less clearly linked to goals such as meeting the firm’s performance measurements, e.g. formulated in billing rate or meeting the time budget for a client (Kornberger et al., 2011). The development of the audit profession suggests that what historically defined and distinguished the audit profession – its technical and professional knowledge base and in

280  Thomas Carrington et al. many contexts’ exclusive links to elite academic institutions – has become less central to who eventually becomes an auditor and how his or her professional identity is formed (Carter & Spence, 2014; Duff, 2017). Analyses of how auditors are formed are often anchored in descriptions of how the whole audit field develops (Zeff, 2003a, 2003b). How auditors are socialised goes hand in hand with how accounting firms operate at the level of the field. For example, in broadening their range of services, commercial values are prioritised at the expense of traditional values such ​​ as independence, professional scepticism, and contributing to society (Greenwood & Suddaby, 2006). A conscious broadening of the range of services offered is considered to render the Big 4 and mid-tier firms attractive workplaces for various types of students who would not traditionally pursue a career in accounting. This could influence the next cohort of auditor associates, ultimately influencing the very understanding of being a professional auditor. Along the same line of development, the decision in Sweden to alter the formal academic requirements needed to enter the profession has, potentially, further broadened the recruitment base, in turn potentially influencing central value commitments. Moreover, accounting firms present themselves as colourful and dynamic workplaces rather than a residence for grey auditing technocrats (Jeacle, 2009) has also made firm representatives eager to meet potential recruits during their time at university (Gebreiter, 2020). For many accounting firms, early contacts with students are now central, as they compete with traditional management consulting firms, and the firms themselves are becoming workplaces for many different professionals. Accounting firms invest time and resources to market themselves as attractive employers through, for example, sponsored case competitions, network meetings with interesting lecturers, and so-called internships. According to Gebreiter (2020), this means that the actual recruitment of students takes place from a pool of candidates who have already been formed into employable audit assistants during their time at university. At the same time, Gebreiter (2020) argues that the accounting firms have improved, and even achieved, good variation in gender and ethnicity among those recruited. Still, whether the personality traits, attitudes, and ethical positions of these groups de facto represent different attitudes towards the profession, business, and society has not been previously investigated. The monopoly-like position of the audit profession to practice audit work rests on the premise that society as a whole has confidence in the auditors’ competence and integrity and that they properly evaluate risks and financial reliability. This enables a focus on the typical recruit and how this person differs (or not) from measurements made in other professions and among citizens in general. Based on Gebreiter’s (2020) results that the socialisation begins prior to entering the profession, it is an overlooked aspect of previous research to ask whether or not the accounting firm recruits are more or less already ‘pre-programmed’ when they are employed and thus imitate established auditors even before they start their careers. The literature on the socialisation of auditors often assumes that recruits over time are formed into the occupation, and a main hypothesis is that

The average professional 281 individuals’ attitudes and opinions become more and more similar over time (e.g. Carrington et al., 2019). At the same time, researchers have frequently pointed out that studies of socialisation over time are lacking (e.g. Gebreiter, 2020). Whereas previous research has assumed that the explanation for why auditors think and behave uniformly when examined in cross-sectional studies is to be found in processes of professional socialisation (e.g. Suddaby et al., 2009), this remains an uncorroborated thesis. Moreover, the fact that auditors are socialised into a particular way of thinking and behaving at the site of the accounting firm goes against Gebreiter’s (2020) argument that important socialisation efforts occur at the university in interactions with accounting firm representatives. Results Newly recruited auditors’ educational, socio-economic, and geographical background

Unlike those from the inception of the audit profession in Sweden, auditors of today have received their education from a wide range of institutions of higher education (see Figure 13.1). The audit assistants in our sample come from a total of 26 different Swedish educational institutions. According to the survey data, Stockholm University produces most of the newly recruited auditors but is in no way dominant. In second place, we find Lund University, closely followed by the Linnaeus University, Örebro University, Umeå University, and Uppsala University.1 The largest providers of education for future auditors are thus well distributed both in terms of geography and the age of the university. For many years, most authorised auditors in Sweden received their education from SSE. The picture portrayed by the recruits’ educational background

Figure 13.1  2019 respondents’ alma maters. Source: 2019 survey. Only higher education institutions with five or more respondents are shown.

282  Thomas Carrington et al. today is thus a perfect negative of the same picture taken in the early days of the audit profession. In fact, if 2019 is not particularly different from other years, there will be few, if any, auditors with an education from this prestigious business school in the future. When the audit profession emerged in Sweden, all auditors, with very few exceptions, were men (Wallerstedt, 2009). In our sample, half of the respondents are men (see Table 13.1). Considering that more women than men enter higher education, women are still slightly underrepresented as audit assistants. In terms of family background, 55 percent of the respondents report that their parents have a university degree, which is higher than the national average (29%) according to Statistics Sweden (2021).2 Moreover, 17.2 percent report coming from a city with a population larger than 250,000 inhabitants (i.e. Stockholm, Gothenburg, or Malmoe) compared to around 25 percent of the total population, and 11.4 percent report coming from a town larger than 100,000 but smaller than 250,000 inhabitants. The latter figure is about half a percentage point above the population mean. Compared to the population at large, newly recruited auditors more often come from smaller towns. The difference is notable but not extreme. The interesting general pattern is instead how ‘average’ the audit recruits are. The recruits come from all corners of the country, from families with Table 13.1  Background characteristics of respondents from the 2019 survey. Share (total 100 percent) Gender Male Female Other Education level of parents University degree No university degree Upbringing (town size) Below 10,000 inhabitants Between 10,000 and 100,000 inhabitants Between 100,000 and 250,000 inhabitants Above 250,000 inhabitants Type of degree Business administration Other Highest degree Bachelor (three-year university education) Magister (four-year university education) Master (five-year university education) Relevant work experience (administration, bookkeeping, etc.) Yes, to a large extent Yes, partly No, none

50.2 49.5 0.4 55.0 45.0 23.8 47.6 11.4 17.2 95.0 5.0 53.8 35.3 10.9 9.1 44.5 46.4

The average professional 283 slightly higher educational levels than the average, but they are also prone to social mobility to a larger extent than the average person. Although they are less likely to come from larger cities, they otherwise are dispersed across towns of all sizes. In short, the audit assistants recruited to the profession today are a surprisingly diverse group, especially compared to their counterparts in the first half of the 20th century. It is worth mentioning that a vast majority of the respondents (95%) have a degree in business administration (see Table 13.1). About half have a bachelor’s degree as their highest degree. It is also notable that 53.6 percent had some experience of working with bookkeeping or other administrative tasks they deemed relevant to their new employment. Whether the recently changed educational requirements in Sweden will eventually lead to a change in these respects remains to be seen. What abilities and knowledge do the hiring firms value?

Considering the focus on hiring people with a firm foothold in the academic subject and practice of business administration, we recorded that the respondents did not believe that they were employed because of their (hard) skills, i.e. knowledge in accounting, financial reporting, or similar skills (see Figure 13.2). Instead, the respondents perceived that their social (soft) skills had landed them their job. Regarding how experienced auditors value their roles as experts, see Backman et al. in this volume.

Figure 13.2 Perceived employers focus on hard and soft skills when hiring audit assistants. Source: 2019 survey. Measures the perceived focus (low=1 to high=7) put on hard versus soft types of skills when being employed (in the interview and recruitment process).

284  Thomas Carrington et al. On average, the audit recruits perceived that their ability to cooperate with colleagues was twice as important as their knowledge of audit methodology. Similar but less extreme ratios can be found between communication skills, ability to meet a deadline, speed of work performed, ability to initiate and conclude tasks, ability to keep time budgets, and ability to lead and inspire others, on the one hand, and knowledge about accounting and financial reporting, knowledge of accounting and financial reporting rules and regulations, and knowledge of tax law, on the other. Anecdotally, socially skilled students are the ‘right person’ to hire rather than students who passed with distinction in advanced courses in accounting and auditing, and this recruitment strategy is evidence of a mismatch with the classic stereotype of the auditor (Jeacle, 2009). Instead, it resonates with the more general development at the Big 4 and mid-tier firms, where a few experts represent the technical specialisation while other senior auditors function more as project and team coordinators/members or account/client managers. Newly recruited auditors’ trust in democratic, political, and capitalist institutions

Because auditing is a business of confidence and trust not only vis-à-vis clients (Öhman et al., 2012), it is relevant to focus on the confidence that those recruited as audit assistants have in formal institutions of society. Indeed, as auditors serve the public interest, it is reasonable to demand that their trust in key institutions of the society will not be greatly different from that of the general public, because it is reasonable to assume that part of this legitimacy comes from being seen as representative of the society at large. In line with the rest of the highly educated citizens (SOM, 2020),3 our respondents report high confidence in the universities, the legal system, and the police (see Figure 13.3). The values show a balance score of 70 percent or higher for these three institutions. The audit assistants demonstrate a higher level of confidence placed in the legal system, but overall, the differences are not substantial. More interesting, then, are other differences noted between the respondents and the general population. Figure 13.3 shows that newly recruited auditors place comparatively little confidence in the pillars of democracy (i.e. the parliament and the government), and traditional media (i.e. television and newspapers). In fact, when it comes to their confidence in traditional media, the balance measure is even negative, meaning that there are more respondents espousing low than high confidence (see notes under Figure 13.3). Auditors are supposed to be sceptical (IAASB, 2012), and this might explain why people suspicious of the political system and traditional media are accepted into the audit profession. The low confidence in parliament/government and traditional media could further be interpreted more generally in terms of political affiliation and ideological views. Either way, these are distinguishing attitudes. However, further analysis of what might explain the differences in confidence placed in different institutions in society is beyond the scope of this investigation.

The average professional 285

Figure 13.3  Confidence placed in formal institutions of society. Source: 2019 survey and SOM-data (SOM, 2020). The original scale in the 2019 survey is 1–7. The figure reports a balance measure: high confidence (5–7) in relation to low confidence (1–3). The SOM-data used an original scale of 1–5 for calculating the balance measure.

Two institutions that normally receive low confidence scores from citizens are big corporations and banks, i.e. financial institutions (SOM, 2020), not least because of the corporate scandals reported in the media. In this respect, the respondents instead deviate positively compared to the benchmark population. On the one hand, this means that those recruited as audit assistants cannot be said to represent the population at large in terms of their views of how big corporations and banks conduct their business. Auditors often claim that they work in the public interest (Zeff, 2003a, 2003b). Extending this logic, it would make sense that auditors’ values would match the values of society at large, particularly in the one area where their services are a substitute for more state-led inspections (Mennicken, 2010). On the other hand, auditors are by tradition in the business of trust, and it would perhaps be difficult for auditors to do their jobs without having confidence in the organisations they are tasked to audit and provide assurance for. Value commitments of the audit profession

As indicated, becoming an auditor and the creation of a professional identity often build on the idea that this is something accomplished by intense socialisation at the accounting firms (Cooper & Robson, 2006) and when interacting with clients (Carrington et al., 2019; Lawrence et al., 2011). Of particular interest is how far from, or close to, newly recruited auditors’ commitments to core values are (after a couple of weeks of work experience/ training) the professional identity of experienced auditors.

286  Thomas Carrington et al.

Figure 13.4  Value commitments of audit assistants and senior auditors. Source: The 2019 survey and the Carrington et al. (2013) survey. Standard deviations are not substantially different between the two samples. PC=professional commitment; REIR=rigour and enforcement of independence requirements; OC=organisational commitment; CC=client commitment.

In Figure 13.4, we display measurements from the 2019 survey of these newly recruited auditors and the same measures from the sample of authorised and approved auditors in 2010 (Carrington et al., 2013). It is apparent how similar the new recruits are to the already established auditors. With the exception of OC, the remaining differences are more or less negligible. The lack of meaningful differences on three of the four value commitments (i.e. PC, REIR, and CC) is already aligned with those of the senior colleagues when the audit assistants start their employment. These findings challenge the overemphasis on the accounting firm as the key site of socialisation and lend support to the argument that much of the socialisation of auditors takes place at university and through the recruitment activities of the accounting firms (Gebreiter, 2020) or is a result of the accounting firms’ recruitment processes that lead to the new audit assistants mirroring those already on site. This indicates that accounting firms do influence young auditors’ value commitments even before they employ them (or during the recruitment process). Possibly, such pre-accounting-firm-employment socialisation effects also come through interaction with textbooks, lectures by teachers that in many cases have a background in accounting firms (or indeed are still working for these firms), and/or through study visits to accounting firms during university studies. This seems to influence young auditor’s values of what it means to be an auditor in terms of norms. If there is support for this latter explanation then this is of considerable interest, because in the Swedish context the education requirements for auditors have been reworked with the explicit aim to broaden the recruitment

The average professional 287 base of auditors (RIFS, 2018). If auditors in the future are educated at business school departments to a lesser extent than today, this might also affect the commitments to core values of the audit assistants recruited. A competing interpretation of the similarity is that it is the result of self-selection. It does not seem implausible that a profession known for certain types of values, behaviours, and traits will attract people with a liking and disposition for these values, behaviours, and traits. A final and related interpretation of why newly recruited auditors are so similar to authorised and approved auditors in their value commitments is that senior auditors tend to select new recruits that are like themselves. At stake here is the social and economic reproduction of the audit profession, and during the job interviews people with good social skills might read in what is expected of them and reproduce that in order to be selected. A form of social desirability bias might then be the explanation for the small differences we record between the group of newly recruited auditors and the more established group of auditors. It is thus not certain whether the audit assistants believe and embody these opinions as firmly as an experienced auditor might. However, at a minimum, it seems that they have mastered how to ‘behave like an auditor’ and that this resonates with the recruitment team’s idea of an ideal recruit. What our discussions boil down to is that while recruitment has become much more diverse in terms of gender, socio-economic, and geographical background vis-à-vis the year FAR was founded, the recruits are quite ‘typical on the inside’. While diverse in a number of ways, our study shows that the audit assistants are still very similar to a ‘typical experienced auditor’ when it comes to core value commitments of the profession. Still, whichever (combination) of these interpretations of the similarity in measures of value commitments turns out to be correct, this does not mean that the employing firms do not matter in terms of socialisation. Professional and social values in general are not static, and the reproduction of certain value commitments will persist mostly within the walls of the accounting firms (Cooper & Robson, 2006). The only value commitment where the recruits differ meaningfully from the authorised and approved auditors is OC, and that observation alone lends credibility to the interpretation that the employing organisation matters. The reason that the auditors in Carrington et al. (2013) reported considerably stronger value commitments towards the employing organisation than the recruits in the 2019 survey is argued that while the authorised and approved auditors have made their careers and come to identify with their organisations, to the recruits the accounting firm is new. Conclusions and implications In this chapter, we discuss the selection and socialisation of audit assistants against the backdrop of societal changes and a general trend of inclusiveness in the labour market over the last century. Sweden, like most Western

288  Thomas Carrington et al. democratic countries, has witnessed an immense transformation in the progressiveness of society (Öhman, 2023; Östh et al., 2010). Higher education and working within prestigious professions have become not only a call for a few. Instead, the recruitment base has expanded to the broader masses of the middle-class. In conjunction with other changes in norms and institutions of society and the ambitions of the Big 4 and mid-tier firms to broaden their recruitment base, we focused on who is selected to become an auditor more than 100 years after the audit profession began to take shape in Sweden. Our investigation shows that the typical recruit at an accounting firm of today is from the middle-class of young adults that have passed through the higher-education system. The elite education institution, SSE, which previously was the entrance ticket to the audit profession, is now more or less absent from the group of new recruits. In that sense, the recruitment of auditors seems to follow the general developments of society. While the recruitment base has changed drastically, it would be reasonable to expect that the pioneers Lars Thure Bohlin, Oskar Sillén, and Seth Svensson were hired for their technical skills. Today, however, audit assistants consider themselves typically selected for being high performing, communicative, and socially skilled rather than technically versatile in accounting and financial reporting. On a general level, one interpretation of our results is that social (soft) skills are perceived harder to acquire by training than accounting and financial reporting (hard) skills in a fast-paced environment. Alternatively, it seems from our results that, from the perspective of the employing firm, it is too time-consuming to make a salesperson out of someone with a passion for accounting. A possible interpretation of this is that a selling and confident person who managed to graduate from a university must have the capacity to learn the technical side of accounting and auditing. If so, it is not self-evident that having technical knowledge from the start is important, because such knowledge is assumed to be developed at the accounting firm, and the mass recruitments of auditor associates ensure that the firm eventually ends up with a sufficient number of partner material. Reasonably, accounting firms in Sweden seek to mirror what society looks like in general when they recruit audit assistants in order to subsequently attract various types of clients. A focus on the recruits’ social skills and a workforce that reflects society at large is in line with arguments that mid-tier firms in the UK seem to emphasise, namely the importance of being able to serve a wide range of clients and to think commercially (Duff, 2017). At the same time, Duff (2017) suggests that the Big 4 firms in the UK still employ a discourse of hiring ‘the brightest and the best’. From that point of view, it can be argued that the audit profession in Sweden has declined in prestige among university students, and visà-vis other industries since the time when technical skills were in focus and the elite education institution was the entrance ticket to the accounting firms. Compared to other highly educated people in Sweden, the audit assistants recruited seem to have significantly greater confidence in important institutions of capitalism such as big corporations and banks, and less confidence in

The average professional 289 institutions of democracy and the media. Thus, they seem quite fit to uphold and serve their accounting firms, i.e. yet another private institution of capitalism. Moreover, they seem to already closely reflect the identities of authorised and approved auditors when being employed. This then lends support to the following conclusion: the types of individuals recruited to the audit profession today are not, on a more fundamental level, that different from their former counterparts, despite the apparently broadened recruitment base. Recruiting with an eye to achieving surface diversity is a part of the accounting firms’ social and economic reproduction of the field in a distinct way. We believe that our investigation and discussions give rise to several implications for scholarly debates and the practice and policy of auditing. Perhaps the most apparent implication for research into the socialisation of audit assistants and the formation of a professional identity is that they seem to be well aligned with what it means to already value certain aspects of the occupation when starting their careers as auditors. In this respect, the chapter lends support to Gebreiter’s (2020) recent study of the socialisation and identity work among university students made by the Big 4 and mid-tier firms in the UK. At least part of the prefabrication of a homogeneous group of auditors has already been completed during the time at university, which then would suggest that the client-centric discourse of auditing is less unique to the auditing field, but a more general business and management discourse. Importantly, evidence of audit assistants being pre-accounting-firm socialised into the profession in key ways complements previous studies that argue that the socialisation of auditors mainly takes place in the workplace (e.g. Cooper & Robson, 2006) and when interacting with clients (e.g. Carrington et al., 2019; Lawrence et al., 2011). For the practice of recruiting new auditors, we note that, while it seems like the accounting firms exert effort in being inclusive in terms of recruiting men and women coming from most of the higher education institutions in Sweden, the ‘typical recruit’ might perhaps be a bit too typical. If maintaining the status quo of the audit profession is the aim, this might be appropriate. For plurality and the potential for adaptation and change in the future, more variation in the pool of recruits when it comes to attitudes about society and auditing might be necessary. A further note about skills valued in the recruitment process concerns the relative weight placed on the values of social and technical skills, respectively. As educators of accounting at universities, we find it disappointing that more focus seems not to be put on hard skills in accounting and financial reporting (cf. Carter & Spence, 2014; Kornberger et al., 2011). This might imply that all recruits are enough skilled in accounting to be employed and that it is the complementary social skills that are important to focus on, but our experience is that this is not necessarily the case. The fact that only half of the audit assistants surveyed had some experience of working with bookkeeping or other administrative tasks they deemed relevant to their new employment suggests that the supply of applicants with technical skills is limited or that these skills are not those that are valued the

290  Thomas Carrington et al. most. In addition, and as discussed by Annelin and Svanström in this volume, working in audit teams might negatively affect the requirement for technical competence in financial accounting and auditing. Nevertheless, some kind of a revival of the grey auditing technocrat in Jeacle (2009) terminology might be something to focus more on when employing audit assistants. In order to secure the future supply of skilled auditors that can take part in the Swedish model of close interaction between the audit profession and the legislators of the field to enhance high-quality financial reporting and auditing, it would be beneficial, in our view, if the technical skills could be nudged more to the centre of what it means to be and become a professional auditor. Admittedly, this study has limitations, including general limitations of survey research, and the risk of social desirability bias when data are self-reported. However, following Randall and Fernandes (1991), we have tried to reduce the influence of bias by including computer administration of the questionnaire, thus ensuring anonymity, forced-choice items, and randomised response methods. Unfortunately, there are no official statistics on non-business graduates, but we believe that the group of highly educated people (i.e. those with a university degree) is relevant for the comparison related to RQ 1. Regarding RQ 2, we acknowledge that the current study on audit assistants and the one on senior auditors from 2010 are not directly comparable due to the time lag. However, the two samples received the same questions on core values, and the same scales were used. The results, thus, allow us to argue that the group of audit assistants is not only homogeneous but also similar to senior auditors in terms of their perceptions of value commitments. To sum up, the one word that best describes the findings of this investigation is ‘average’. As the empirical material suggests, becoming a professional auditor is aligned with a disposition of being average. While newly recruited auditors diverge from the general public in some respects, what stands out is how similar they are to the general public in most respects. Likewise, while audit assistants do not have the same relationship with the employing firm as more senior auditors do, they do closely share the views of senior auditors in all other measured respects. What does this mean, and what are the implications of this averageness for the notion of expertise? Whether the recently changed educational requirements in Sweden – with less focus on business administration and accounting – will change the homogeneity is something only the future can tell. More important right now, we argue, is a reflexion and discussion within the accounting firms and the audit profession at large about whether, and when, ‘average’ is good, and when it is not. As such, readers might see the results presented here as ‘a call for action’, but not only for the accounting firms and the audit profession, which talk enthusiastically about diversity. Time for self-reflection could also be of value to the universities regarding how the education of accounting and auditing is organised. It might be that textbooks and classroom accounting knowledge do not really prepare the students for everyday audit practice and/or that the education in technical skills needs to be improved.

The average professional 291 Notes 1 Due to potential non-response biases of the sample (n=280), the true distribution might be slightly different. 2 In the part of the population that are 25–64 years old, 44 percent have continued their studies after high school and 29 percent are highly educated, which means that they, in Statistics Sweden’s classification, have an education of three years or more after high school (Statistics Sweden, 2021). 3 We chose citizens with high levels of education as the reference point since education level is an important determinant of confidence levels in institutions (SOM 2020). Regarding other benchmarks, the respondents also deviate on, for example, being critical of traditional media compared to a population mean for young adults.

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The average professional 293 Wallerstedt, E. (2009). Revisorsbranschen i Sverige under hundra år. In Swedish (The accounting industry in Sweden for one hundred years. Stockholm: SNS Förlag. Zeff, S.A. (2003a). How the US accounting profession got where it is today: Part I. Accounting Horizons, 17(3), 189–205. Zeff, S.A. (2003b). How the US accounting profession got where it is today: Part II. Accounting Horizons, 17(4), 267–286.

Appendix: Research design The survey data comes from a data-collection effort connected to socialisation of accounting firm employees during the first forming years of the occupation. With generous support from the big and mid-tier firms regarding access and contact details, we submitted an email-administrated survey to all newly recruited employees at the seven largest accounting firms in Sweden, i.e. BDO, Deloitte, EY, Grant Thornton, KPMG, Mazars and PwC. With support from FAR, we also included smaller firms, i.e. network constellations, which employed audit assistants at the time of the study. The survey was submitted to the respondents in the autumn of 2019. Of the 500 respondents contacted, we received and analysed 280 usable answers (after three reminders). The survey included items related to educational, socio-economic, and geographical background variables, the abilities and knowledge valued by accounting firm representatives, trust in formal institutions, and value commitments. In addition, for RQ 1 we used different sources of secondary populationlevel data as benchmarks for our targeted population, i.e. the Swedish Higher Education Authority (UKÄ), Statistics Sweden and the SOM Institute, i.e. an independent research organisation at the University of Gothenburg. To address issues about representation, we asked the recruits about the confidence they put in institutions such as the legal system, the police, the parliament, and banks. We compared the received responses with data collected from a large-scale general citizen survey in 2019 (SOM, 2020). As a benchmark, we picked other highly educated citizens, i.e. those possessing a university degree, because citizens’ attitudes about institutional trust differ evidently depending on education level. The additional information also included data from a large sample of 1,646 authorised and approved Swedish auditors in 2010 collected by the chapter authors. These data were used when we examined RQ 2 and compared the audit assistants’ and senior auditors’ value commitments.

14 The importance of the engagement partner Jan Marton and Savvas Papadopoulos

Introduction The engagement partner has a central role in an audit, as this partner directly negotiates accounting choices with the client and makes the final decision on what audit opinion to give. As pointed out in other chapters of this book, there are several mechanisms in place to reduce reliance on the judgement of a single individual. Legislators and other regulators are increasingly introducing legislation and standards that the engagement partner must adhere to. Accounting firms – in particular, the Big 4 – have internal processes, including control systems, mandatory internal reviews, and functional expertise, to standardise the quality of audits (Jeppesen, 2007). The audits of listed companies involve a team with several members in addition to the engagement partner (see also Annelin & Svanström, in this volume). Still, with all mechanisms in place to reduce the effect of the engagement partner, research shows that there are several explanations why individual characteristics still matter for the quality of the audit (Gul et al., 2013; Lennox & Wu, 2018). The audit team often has only a limited ability to moderate the engagement partner’s judgement, as this partner instead influences the behaviour and attitudes of the team (Proell et al., 2022). Regulations, standards, and internal accounting firm processes affect the engagement partner’s behaviour, but these mechanisms leave room for the individual to exercise judgement when performing the audit (Knechel et al., 2015). Research is consistent with the view of audit regulators, that it is the lead auditor who is responsible for making the final assessment and decision as to whether financial statements are free from material misstatement, whether due to error or fraud (PCAOB, 2015). Furthermore, there are structures that increase the role of the individual engagement partner. Accounting firms have compensation schemes that are strongly linked to sales of each individual partner. Supervisory authorities can act against the individual auditors in case of wrongdoing in the audit process. There is also a risk of litigation, which affects not only the accounting firm

DOI: 10.4324/9781003411390-18

The importance of the engagement partner 295 but also the individual engagement partner. Given such strong incentives, it is not surprising that the preferred balance between compensation and risk of negative consequences differs across individuals with, for example, different risk preferences (Lennox & Wu, 2018). To summarise, the judgement of the engagement partner is important in the audit process, and the partner is subject to strong incentives. The reaction to incentives differs with partners’ personal characteristics, and decisions made by engagement partners affect audit quality. It is, therefore, no surprise that research finds a link between the engagement partner’s personal characteristics and audit quality (Gul et al., 2013). The purpose of this chapter is to identify what is known in the literature about the effect of individual characteristics of the engagement partner on the quality of the audit. Specifically, we contribute by identifying the characteristics that have been shown to have an effect and the assumed mechanism that leads to this effect. Meanwhile, the literature referred to in this chapter is based on identifying empirical associations between quantified variables. For example, partner characteristics such as risk aversion, expertise, and narcissism are identified through proxies that do not directly measure the characteristic in question. In the chapter, we discuss limitations caused by the use of proxies and how the use of unique Swedish data can remedy some of the limitations. Furthermore, the literature often attempts to establish causality between variables, which is normally difficult to do in research when many different factors interact. In the chapter, we report on recent attempts to disentangle effects. Overall, this book focuses on external drivers of change in auditing. In this chapter, we focus instead on an impediment to change: the personal characteristics of current members of the audit community. In defining personal characteristics, research has focused on proxies that do not change over time or that change only slowly. Examples include ability, risk preferences, ethics, and conservative versus aggressive style. In research, these characteristics are identified through observable proxies such as IQ scores in young adulthood (Kallunki et al., 2019), gender (Ittonen et al., 2013), and family situation (Horton et al., 2022). The assumption made in the studies mentioned is that the characteristics are stable over time (cf. He et al., 2018). The effect on audit practice of external drivers of transformation is determined by how the drivers affect behaviour inside accounting firms. Auditors with different personal characteristics are expected to react differently to external drivers, for example, those discussed in this volume: regulation, digitalisation, and the increased importance of sustainability reporting. To the extent that partner characteristics – and, therefore, partners’ responses to external drivers – are stable, existing partners will add inertia to accounting firms’ responses to external drivers of transformation. This will reduce or delay the effects of those drivers.

296  Jan Marton and Savvas Papadopoulos Motivation This chapter presents a review of quantitative literature on the effect of engagement-partner characteristics on audit quality. Given the importance of high-quality audits for well-functioning capital markets, it is essential to gain knowledge about the relationship between partners’ personal characteristics and audit quality. Investors and other capital providers – the primary beneficiaries of audits – have an interest in the quality of the audit. This helps them to determine how much they can rely on the audit, and, ultimately, the reliability of financial statements (Francis & Ke, 2006). Investors must make this assessment without first-hand knowledge of the individual audit partner. A common signal to outside capital providers is that audit quality is ascertained through a Big 4 auditor (Becker et al., 1998; Francis et al., 1999). While most research shows that Big 4 accounting firms on average are associated with higher audit quality than non-Big 4 firms, there still seem to be substantial remaining differences in audit quality between engagement partners at the Big 4 firms (Church et al., 2008; DeFond & Francis, 2005). Therefore, to be able to assess audit quality, additional information is needed. Audited companies have more detailed information about the engagement partner. Often, company representatives have a relationship with an individual auditor instead of with an accounting firm (Brown & Knechel, 2016). The audited companies will have preferences regarding the personal characteristics of the appointed auditor. They will also have experience in assessing the characteristics of the auditor. Meanwhile, the most detailed information about individual auditors is found within the accounting firms where they are employed. In career planning and internal quality assessments, it is important to have knowledge of what personal characteristics matter and how such characteristics are associated with audit quality. Research can contribute information that is useful for both audit clients and accounting firms by adding detail and rigour to knowledge gained through experience and conventional wisdom. Regulators confirm the significance of the personal characteristics that come with the individual auditors. The Public Company Accounting Oversight Board (PCAOB) – the main audit regulator in the US – has issued regulations for listed companies, requiring disclosure of the engagement partner’s name. In introducing the regulation, the PCAOB notes: [T]he name of the engagement partner could, when combined with additional information about the experience and reputation of that partner, provide more information about audit quality than solely the name of the firm. Through its oversight activities, the Board has observed that the quality of individual audit engagements varies within firms, notwithstanding firmwide or networkwide quality control systems. Although such variations may be due to a number of factors, the Board’s staff uses engagement partner history as one factor in making

The importance of the engagement partner 297 risk-based selections of audit engagements for inspection. Some firms closely monitor engagement partner quality history themselves, utilizing this information to manage risk to the firm and to comply with quality control standards. (PCAOB, 2015, pp. 2–3) The literature review of the research on individual characteristics and audit quality is based on studies that have gained particular attention in the last ten years. It also reports on a particular study conducted by the authors of this chapter (i.e. Horton et al., 2022). That study identifies a proxy (family situation) for risk aversion and scepticism, both of which are important characteristics in conducting audits. The main contribution of Horton et al. (2022) is to use a proxy (gender of child) which is assumed to be unrelated to career choices, thereby disentangling the effect of partner characteristics from other factors. The literature covered in this chapter differs from most other chapters in the book as it builds almost exclusively on quantitative studies utilising secondary data. Quantitative studies allow researchers to identify patterns in large data sets and assess the likelihood that patterns are generalisable to other situations. For example, such research can identify the association between a specific personal characteristic and its effect on audit quality, as well as the likelihood that the effect will prevail in future situations. Secondary data is material that is not collected by the researcher but instead comes from, for example, pre-existing databases or annual reports (often referred to as ‘archival studies’). The strength of secondary data is that it is affected neither by choices made by researchers in the data creation nor by research subjects’ interpretations. The latter is an issue in the analysis of interviews and questionnaires. Further, quantitative studies based on secondary data are more easily reproducible, an essential quality consideration in research. A limitation of quantitative studies is that all variables must be quantified, and this requires access to high-quality data. This book focuses on audit research with some connection to Sweden. A substantial proportion of research on engagement-partner characteristics is carried out in Sweden (Lennox & Wu, 2018). The name of the engagement partner has historically been disclosed in Sweden, so researchers have access to historical data with an identifiable individual auditor. In addition, the Swedish government’s policy of public access to information means researchers have access to information on individuals – linked to personal characteristics – which is not available in most countries. Examples include information on taxable income and family situation. Consequently, Sweden presents a suitable empirical setting for carrying out quantitative studies on the effects of partner characteristics. The method used to identify relevant literature closely follows the method employed by Lennox and Wu (2018). We went through the most important journals for quantitative research on engagement-partner characteristics and identified relevant articles. In addition, the Social Science Research Network

298  Jan Marton and Savvas Papadopoulos (SSRN) was used to find currently ongoing research, and a search for additional studies based on Swedish data was conducted. For details, see the Appendix. Literature review and results Establishing a link in research between engagement-partner characteristics and audit quality requires several steps and definitions. First, audit quality must be defined. Second, relevant and observable partner characteristics have to be identified. Third, if an association between a certain characteristic and audit quality is established, a mechanism must be identified that explains the link for results to be valid. Fourth, as most studies are performed within a specific jurisdiction (e.g. Sweden), their generalisability to other jurisdictional contexts needs to be discussed. Fifth, the issue of self-selection bias (often called ‘endogeneity’ in research) needs to be managed. It has to do with the tendency of partners with certain characteristics to self-select certain career paths. For example, if research finds that partners with a certain characteristic (such as accepting high risk) produce lower-quality audit, it could be caused by individuals with that characteristic self-selecting riskier clients, where achieving high audit quality is more difficult. We go through each of the five steps in separate sections. Table 14.1 provides an overview of the main studies discussed in this section. Audit quality

Audit quality is a feature of the work carried out by the audit team in conducting the audit. According to DeAngelo (1981, p. 186), audit quality ‘[…] is defined to be the market-assessed joint probability that a given auditor will both (a) discover a breach in the client’s accounting system, and (b) report the breach.’ Inherent in this audit quality definition is that the probability that an audit partner will discover a breach is conditional on, for example, the partner’s technological capabilities, the audit procedures applied to a given audit task, and the extent of sampling. Meanwhile, the probability of reporting a discovered breach is conditional on the auditor’s independence. Audit quality can also be defined ‘in terms of the level of assurances – the probability financial statements contain no material omissions or misstatements’ (Palmrose, 1988, p. 56). In this definition, higher levels of assurance imply higher audit quality. An important implication of this audit-quality definition is that audit failure is a reverse probability of higher audit quality, i.e. higher failure rate indicates lower quality. A core implication derived from these definitions is that audit quality is difficult to measure because the probability of discovery and the amount of ‘assurance’ provided by auditors are both unobservable (DeFond & Zhang, 2014). Research, therefore, identifies proxies of audit quality. There are potentially many proxies that could be used to estimate audit quality. In this chapter, we primarily focus on proxies used in the literature

Table 14.1  Overview of studies on engagement-partner characteristics. Year

Journal

Country

Firms

Proxy for partner characteristic

Amir, Kallunki, Nilsson Berglund, Eshleman

2014

Sweden

Listed

Criminal conviction (proxy for risk preference)

US

2022

Not-forprofit Listed

Ethnicity (proxy for diversity)

Cameran, Campa, Francis Carey, Simnett Chi, Myers, Omer, Xie Chou, Pittman, Zhuang Gul, Wu, Yang

2021 2013

Review of Accounting Studies Managerial Auditing Journal Journal of Accounting, Auditing & Finance The Accounting Review Review of Accounting Studies The Accounting Review The Accounting Review

Taiwan China

Listed Listed & private Listed Listed

Horton, KrishnaKumar, Marton, Papadopoulos Ittonen, Vähämaa, Vähämaa Kallunki, Kallunki, Niemi, Nilsson Knechel, Vanstraelen, Zerni Li, Qi, Tian, Zhang Pittman, Stein, Valentine Sundgren, Svanström

2022

Working paper

Sweden

Listed

2013

Accounting Horizons

Listed

Gender (proxy for risk preference, diligence)

2019

IQ test (proxy for cognitive ability)

China US Sweden

Listed & private Listed & private Listed Listed Private

Zerni

2012

Sweden

Listed

Zerni, Haapamäki, Järvinen, Niemi

2012

Contemporary Accounting Research Contemporary Accounting Research The Accounting Review Working paper Contemporary Accounting Research Contemporary Accounting Research European Accounting Review

Finland & Sweden Sweden

Sweden

Listed & private

2019

2006 2017

2015 2017 2020 2014

UK Australia Taiwan

Sweden

Fixed effects as statistical control (proxy for unobserved partner characteristics) Tenure (proxy for independence) Experience (proxy for expertise and independence) Size of signature (proxy for narcissism) Education, gender, experience, rank (proxy for conservatism) Child gender (proxy for risk preference, protective)

Aggressive versus conservative style over time (proxy for consistency and stability) Audit failures over time (proxy for consistency) Criminal conviction (proxy for risk preference) Number of assignments (proxy for busyness) and age (proxy for experience) Specialization (proxy for industry expertise) Joint audit (proxy for independence)

The importance of the engagement partner 299

Authors

300  Jan Marton and Savvas Papadopoulos Table 14.2  Proxies for audit quality in the literature on engagementpartner characteristics. Cost of audit • Total cost of audit as disclosed in client’s annual report Qualified audit opinion • Likelihood of qualified audit opinion • Going concern opinion Accounting quality • Accruals measures • Conditional conservatism Regulatory action • Action against the auditor • Action against the reporting company

on engagement-partner characteristics. There are four main proxies for audit quality in this literature: cost of audit, likelihood of qualified audit opinion, accounting quality, and incidence of regulatory action. Table 14.2 summarises the actual proxies used in research. Note that a single study may use multiple proxies. For those interested in a more general discussion of audit quality in the literature, see, for example, Francis (2011) and Knechel et al. (2013a). More costly audits are seen as being of higher quality, so a positive association between cost and quality of audit is assumed. While a high cost can be an indication of inefficiencies, the assumption is that, given a somewhat standardised level of efficiency, higher audit costs indicate higher audit effort. Higher effort is expected to be associated with higher quality, simply because more work on the audit gives the audit team a higher probability of discovering errors, etc. (DeFond & Zhang, 2014). As noted in the definition by DeAngelo (1981), independence is a basic requirement for reporting discoveries of error. Consequently, independence is assumed when cost is used as a proxy for audit quality. The role of an auditor is to give a clean opinion when audited financial statements are of sufficient quality and to give a qualified opinion when the financial statements are not of such quality. Meanwhile, there are economic incentives that work against qualified opinions. Within accounting firms, auditors are compensated based on sales, giving them an incentive to maintain good relations with clients. Giving a qualified audit opinion on a client’s financial statements leads to strained relations. A higher incidence of qualified audit opinions, therefore, is an indication that the auditor has professional integrity through independence from the client, which is also a definition of quality in auditing (DeFond & Zhang, 2014). Note that a going-concern opinion works in a similar way as a qualified opinion.

The importance of the engagement partner 301 The ultimate objective of a financial statement audit is to give the user a certain level of comfort that financial statements are prepared in accordance with applicable regulation. In this area, audit research uses definitions from research on financial statement quality to, indirectly, determine audit quality. Much of the focus in research on financial statements is on the income statement, specifically earnings, based on the assumption that it is the most important line item for users such as equity investors. Earnings quality is often measured through accruals, where a higher level of accruals indicates lower quality. Sometimes, a distinction is made between ‘good’ and ‘bad’ accruals (bad accruals are often called ‘discretionary’ or ‘abnormal’), and a higher incidence of bad accruals indicates lower quality. Another quality indicator is conditional conservatism, which means that economic losses are recognised sooner than economic gains in the income statement. Research shows that such conservatism is associated with higher quality, especially considering financial statement preparers’ tendency towards a positive bias (DeFond & Zhang, 2014). Regulators and enforcers will act when financial statement errors are discovered or suspected. The incidence of such action, therefore, is negatively associated with quality of either financial statements or audits. Based on the auditor’s responsibility in relation to financial statements noted above, regulatory action is an indication of not only low quality in preparers’ work but also of the audit. Audit enforcers can also take direct action against auditors when they receive signals that an audit does not meet regulatory requirements (Knechel et al., 2013a). Partner characteristics

The most important issue in this chapter is the definition of relevant partner characteristics. Most quantitative studies based on secondary data within the field of auditing focus the analysis on the accounting firm level (Gul et al., 2013; Lennox & Wu, 2018). This is not surprising considering accounting firms’ desire to maintain a high level of consistency in audit quality by constraining individual audit partners’ influence on audit outcomes through various control mechanisms, such as standardisation of work procedures, centralised systems for controlling risk and materiality decisions, and auditpartner socialisation (Jeppesen, 2007). However, we have witnessed a sharp increase in research on individual audit partners (Lennox & Wu, 2018). This growing body of literature coincided with another shift in the unit of analysis in auditing research: from the firm to the office. The shifts are due to limitations inherent in conducting analyses at the accounting-firm level. Audits are administered by engagement partners, which makes auditor incentives far more salient at the individual partner or local office levels than at the accounting-firm level (DeFond & Francis, 2005; Francis, 2011; Lennox & Wu, 2018; Reynolds & Francis, 2000). Therefore, in assessing auditor independence, and by implication audit quality, the focus should be on ‘the

302  Jan Marton and Savvas Papadopoulos individual, office and other unit of the firm making decisions with respect to a particular audit client’ (Wallman, 1996, p. 78). Even though engagement partners demonstrate substantial differences in economic incentives and other characteristics, research at the firm and office levels assumes that audit partners are homogeneous with respect to the quality of the audit services delivered within firms and offices (Lennox & Wu, 2018). However, as Nelson and Tan (2005, p. 42) claim, ‘[a]uditors need to perform a variety of tasks to form an overall assurance or attestation opinion. To do so, various personal attributes of the auditor (e.g. skills and personality) influence the outcome.’ In line with this reasoning, DeFond and Francis (2005) suggest a shift in research focus from firm and office levels to the individual-auditpartner level. Conducting analyses at the individual-engagement-partner level will eventually provide new insights beyond what is already known from studies performed at the firm and office levels (Lennox & Wu, 2018). A key question when doing research on the importance of individual engagement partners is how essential the individual is for audit quality in relation to the accounting firm or office. Recent empirical studies that employ a partner-fixed-effects methodology (a statistical method to identify the importance of the individual) find systematic differences in audit quality across individual partners (Gul et al., 2013). These partner effects have greater explanatory power on audit quality than the firm and the office (Cameran et al., 2022), which points to the importance of the individuals. The next question is what characteristics explain differences between individual engagement partners. It turns out that only a relatively small proportion of the partner effects is explained by observable demographic partner characteristics, suggesting that unobservable partner attributes such as their preferences and attitudes may explain a substantial part of the variation in audit quality (Cameran et al., 2022; Gul et al., 2013). This creates a difficulty in research, as – just as in the case of audit quality – research must identify proxies for unobservable variables. Table 14.3 summarises characteristics used in research. Research shows that all characteristics listed in Table 14.3 influence audit quality. The prior experience of the engagement partner, including education, pre-client experience, and tenure, affects the way the audit is performed. Consequently, there is evidence of an association between audit quality and the engagement partner’s education (Gul et al., 2013), pre-client experience (Chi et al., 2017), and tenure (Carey & Simnett, 2006). These measures could proxy for expertise, which is discussed in more detail in Backman et al. (in this volume). There is also an effect of the current work situation. Using the number of audits as a proxy for engagement-partner’s busyness, Sundgren and Svanström (2014) find a negative association between partner’s busyness and the likelihood of issuing a going-concern opinion in soon-to-be-bankrupt private companies, concluding that a heavy workload impairs audit quality. Zerni (2012) finds a positive association between audit partners’ industry expertise, proxied either by the size or the number of auditors’ clients within an

The importance of the engagement partner 303 Table 14.3  P  ersonal characteristics in the literature on engagementpartner characteristics. Characteristics connected to the individual • • • •

Education Gender Ethnicity Family situation • Marital status • Children

• IQ scores • Criminal conviction Characteristics connected to employment • • • • • • • • • •

Clients Pre-client experience Industry specialisation Expertise Busyness Tenure Past reporting decisions Two audit partners on one assignment Personal income Non-audit fees

Style and psychological traits • Conservative versus aggressive style • Level of narcissism

industry, and audit quality. The voluntary use of two engagement partners is relatively frequent in Sweden (see, e.g. Ittonen & Trønnes, 2015), and it is associated with higher audit quality (Zerni et al., 2012).1 Ethnicity is not linked to audit quality, but Berglund and Eshleman (2019) show that auditors and clients tend to share ethnic backgrounds. Research in sociology and economic psychology shows that risk preferences are associated with gender, with women being more risk-averse than men (Faff et al., 2011). Further, auditors, who are married, and those with children, are assumed to be more risk-averse (cf. Cronqvist et al., 2015). Risk preferences affect the way the audit is conducted, and therefore audit quality. Consistent with this research, gender and family situation of the engagement partner are associated with audit quality (Ittonen et al., 2013). There is also research on more innate characteristics of auditors. Knechel et al. (2015) use going-concern opinions to classify audit partners either as conservative or aggressive in terms of their reporting style. They show that past conservative (aggressive) reporting errors predict future conservative (aggressive) reporting errors by the same engagement partners, suggesting that individual auditors’ reporting styles not only persist over time but also

304  Jan Marton and Savvas Papadopoulos extend to other clients of the same auditor. This supports the notion that the quality of the audit services delivered is significantly influenced by the engagement partners’ characteristics. The literature on engagement partners’ innate personality traits further shows that the quality of the audit services delivered is associated with partners’ level of narcissism as proxied by the size of their signature (Chou et al., 2021), the level of partners’ ethics as proxied through criminal convictions (Amir et al., 2014), and cognitive ability as proxied through IQ scores (Kallunki et al., 2019). Mechanisms

Empirical research can establish associations between personal characteristics of engagement partners and audit quality. However, to make the empirical research believable, it is necessary to provide theoretical and logical explanations of the mechanisms that justify the association. The mechanisms are summarised in Table 14.4. The items listed are not mutually exclusive but are, to a high degree, linked with each other. Note that there is a partial overlap with personal characteristics in Table 14.3, as some variables can both be seen as explanatory variables for audit quality and describe the mechanism of the association between characteristics and quality. It is no surprise that more knowledge and higher ability in an engagement partner are associated with higher audit quality. Knowledge and ability can be gained either through education or through experience, including industry expertise and prior experience with the specific client (Backman et al., in this volume; Chi et al., 2017; Gul et al., 2013; Zerni, 2012). IQ scores, meanwhile, are generally seen as a potential cognitive ability rather than something that is obtained through experience (Kallunki et al., 2019). Table 14.4  M  echanisms to link personal engagement partner characteristics with audit quality. Knowledge and ability • • • • •

Education Industry expertise Audit experience Client tenure IQ scores

Innate characteristics • • • •

Risk preferences Ethics Conservative versus aggressive style Narcissism

Incentives • Non-audit fees • Personal income

The importance of the engagement partner 305 Mechanisms involving innate characteristics are linked with incentives. Overall, auditors have incentives to increase their personal income through higher sales and more profitable audit engagements. They also have incentives to reduce the probability of regulatory action and lawsuits (Lennox & Wu, 2018). Risk preferences are assumed to be associated with auditors’ balancing of the two incentives. More risk-averse auditors will focus more on reducing the risk of regulatory action and lawsuits and less on increasing their personal income (Pittman et al., 2020). Ethics is a different mechanism, as it reflects an innate preference to ‘do the right thing’ and is therefore not necessarily linked with incentives (although ethics and incentives can be hard to separate in practice). An aggressive style, and high narcissism, are likely to be associated with a lower risk aversion (Chou et al., 2021; Knechel et al., 2015). Narcissistic auditors tend to overestimate their own ability, leading them to understate the risks they are being subject to in the audit. Generalisability

The main challenge in conducting research on the individual audit partner level is data availability. Until recently, in most of the major economies worldwide, including the US, information pertaining to engagement partners’ identities and characteristics was either undisclosed or disclosed only to a limited extent (Li et al., 2017). This is changing in some countries. For example, in compliance with rules adopted by the PCAOB and the Securities and Exchange Commission (SEC), accounting firms in the US are required to disclose the identity of engagement auditors, effective for audit reports issued on or after January 31, 2017 (PCAOB, 2015). Still, it will take time for historical data useful for archival studies to be available in the US. The previous lack of publicly available partner-specific information explains why the research on the influence of individual auditors on audit quality is relatively scarce (Kallunki et al., 2019; Li et al., 2017) and is often performed in specific jurisdictions where audit-partner identification has been required for many years. To date, much of the research has been done on Chinese and Swedish data (Lennox & Wu, 2018) (see Table 14.1). Sweden is one of the pioneering countries in research pertaining to individual audit partners. Until May 2017, 13% of the published studies in highly ranked academic journals (for the selection of journals, see the Appendix) used Swedish data (Lennox & Wu, 2018). This is a high number, given the relatively small size of the country, and Sweden provides a suitable context for research on individual audit partners for two main reasons. First, Sweden has a long history of requiring the disclosure of engagement-partner names on the audit report, for both public and private companies. Second, official government documents are accessible to the public, enabling researchers to identify and obtain information on audit partners’ personal characteristics for the whole population of engagement partners that is not available in other countries, mitigating any potential bias in the empirical findings arising

306  Jan Marton and Savvas Papadopoulos Table 14.5  S pecific availability of data in Sweden for quantitative research on auditpartner characteristics. • • • • • • •

Private companies: full financial statements, management, board, and auditor Authorised auditors, and all their clients Auditor gender and family situation, including marital status and children History of criminal convictions Education Personal income IQ, obtained from military draft, but generally not publicly available

from a sub-selection of the population under study. Specific data availability in Sweden that has been used in quantitative research on effects of audit partner characteristics is listed in Table 14.5. Sundgren and Svanström (2014) use the full availability of data on private companies in using the number of audits as a proxy for an engagement partner’s busyness. They find a negative association between partners’ busyness and the likelihood of issuing a going-concern opinion in soon-to-be-bankrupt private companies, concluding that a heavy workload impairs audit quality. Knechel et al. (2015) also use private Swedish companies in their study of going-concern opinions. They find that auditors’ reporting style is consistent across multiple engagements. These studies are more easily carried out on private companies than on listed companies, as they require auditors that have many clients. Zerni (2012) uses public data on auditors and their clients to find a positive association between audit-partner’s industry expertise, where either the size or the number of an auditor’s clients within an industry is used as proxy, and audit quality. The voluntary use of two engagement partners is relatively frequent in Sweden (Ittonen & Trønnes, 2015), and it is associated with higher audit quality (Zerni et al., 2012). Audit partner’s gender is also found to be associated with audit quality, as female audit partners tend to deliver higher-quality audits relative to their male counterparts (Ittonen et al., 2013). Several studies exploit the opportunity to access proprietary Swedish data on individual engagement partners. Amir et al. (2014) find that partners with a criminal conviction in the past are associated with lower audit quality and riskier clients. In particular, the clients of the convicted partners have higher discretionary accruals, a lower proportion of outside directors sitting on the board, more board members with prior criminal convictions, and are more likely to have a principal owner with a past criminal conviction. Utilising information pertaining to individual engagement partners’ taxable income from the Swedish Tax Authority (Skatteverket), Knechel et al. (2013b) find that auditors’ compensation is positively associated with client-firm size and the number of publicly listed clients, as both represent income-generating opportunities for the engagement partner. Using data on audit partners’ IQ scores maintained by the Swedish Armed Forces, Kallunki et al. (2019) show that engagement partners’ cognitive ability is a significant determinant of

The importance of the engagement partner 307 audit quality, as partners with higher IQ scores are associated with higher going-concern audit reporting accuracy and audit fee premiums, and lower income-increasing abnormal accruals. Employing information on individual partners’ family background, including marital status, and children’s age and gender, obtained from Skatteverket, Horton et al. (2022) provide evidence of an association between the gender of audit partners’ firstborn child and audit quality in publicly traded companies. Specifically, partners with a firstborn daughter are found to deliver higher quality audit services relative to their counterparts with a firstborn son. The intuition behind these findings is that the gender of the firstborn child influences audit partners’ risk preferences and professional scepticism. That is, audit partners with firstborn daughters are more risk averse and more sceptical relative to partners with firstborn sons. There are reasons to utilise Swedish (and Chinese) data in audit research, in particular for researchers interested in effects of individual partner characteristics. A question is to what extent results from Swedish (or Chinese) studies are generalisable to other countries. We argue that Swedish studies, in particular, are generalisable to other Western countries, as there are many similarities (generalisability of Chinese studies is less clear, see Gul et al., 2013). In Sweden, as in most Western countries, the Big 4 firms are dominant for listed companies (less so for private companies). These firms have similar compensation structures in all Western countries, giving auditors similar incentives. The regulation and supervisory structures are also similar, although the use of lawsuits may be more prevalent in the US than in other Western countries (Carrington et al., 2019). Other social structures may differ, which, for example, can have an effect on studies on gender and family situation. However, as Sweden has higher gender equality than most countries, effects of gender discovered in Sweden should be even stronger in other countries. Endogeneity

A common objective in quantitative research is to identify causal relationships between variables. In this chapter, we suggest that partner characteristics cause differences in audit quality. Endogeneity is a technical term that means there could be unobserved factors that actually cause the measured effect on, in this case, audit quality. Therefore, the existence of endogeneity is a problem in quantitative research. It is well known that audit studies at the firm and office levels are subject to endogeneity issues (DeFond & Zhang, 2014). However, endogeneity can also affect studies at the individual audit-partner level because it is unlikely that the process of assigning partners to clients is totally random. When aligning partners and clients, accounting firms consider several parameters – including the client’s needs and situation, the partner’s skills and availability, and the accounting firm’s available resources in partners – in order to optimise the

308  Jan Marton and Savvas Papadopoulos client-partner matching. Meanwhile, engagement partners can also influence the client-partner alignment process, as partners actively engage in attracting new clients, and negotiate with clients about audit fees and financialreporting decisions (Beattie et al., 2000; Gibbins et al., 2001). In general, it is likely that auditors’ life choices are a ‘package’. For example, auditors who choose to have children are likely to make different career choices than those who choose not to have children. These career choices would then represent an unobserved factor in a study of a link between children and audit quality. Given that clients are not randomly assigned to partners, as both client and partner characteristics are considered in the process, it is relatively hard to draw unbiased causal inferences from many studies mentioned in this chapter. The endogeneity problem in these studies is that it is unclear whether the empirical results are driven by individual partners’ characteristics, or by the characteristics of the clients to whom the partners are assigned. The endogeneity issues are even more salient when studies employ measures of financialreporting quality (e.g. discretionary accruals) as proxies for audit quality. Financial-reporting quality is the outcome of a joint effort made by the client representatives and the audit partner. Therefore, the likelihood is high that the researcher will incorrectly attribute the client’s financial-reporting quality to the individual engagement partner rather than to the characteristics of the client (Lennox & Wu, 2018). Studies examining the effect of engagement-partner gender on audit quality (e.g. Ittonen et al., 2013) show that, on average, female partners are associated with higher audit quality. However, it is hard to know whether female auditors provide better quality audit services, or clients with better financialreporting quality prefer and attract female auditors. In other words, is it the audit partner’s gender or the client’s characteristics that determine audit quality? Further, as Kallunki et al. (2019) acknowledge, when studying the association between audit partner IQ and audit quality, it is difficult to disentangle the ability of partners with higher IQ scores to choose ‘better’ clients in terms of financial-reporting quality from conducting better audits. However, there are studies that suffer less from endogeneity issues, allowing researchers to draw causal inferences. To do so, it is necessary to find a proxy that reflects partner characteristics but is unrelated to career choices. As noted, Horton et al. (2022) investigate the effect of audit partners’ firstborn daughters on the quality of audit and find that partners with daughters have higher-quality audits. The sociology and economic psychology literature shows that the birth of the firstborn child is a life-changing event for the parents and that the effect of this event differs when the child is a daughter compared to when it is a son. The literature suggests that having a daughter leads to more risk aversion and scepticism, both of which are associated with higher audit quality. The benefit of examining the gender of the firstborn child is that it is exogenous to other partner characteristics (e.g. gender and IQ scores), as nature randomly allocates a firstborn child’s gender. Therefore, it is unlikely that in the process of matching audit partners with clients, the

The importance of the engagement partner 309 gender of a partner’s firstborn child is considered by the accounting firm, or that partners with firstborn daughters have higher cognitive ability compared to their counterparts with firstborn sons, and therefore would be better at choosing companies with higher financial-reporting quality. Conclusions and implications With an increase in research on the association between individual-engagement audit-partner characteristics and audit quality during the last decade, substantial new knowledge has emerged. There is great variation in audit quality between different engagement partners, and this variation is explained by factors with theoretical and logical backing. In fact, the individual-partner effects appear to be stronger than accounting-firm effects. Many of the partner characteristics are assumed to be stable over time, and therefore represent a potential impediment to changes driven by the transformations in focus in this book. While research is silent on the exact interaction effects on audit quality of external changes with individual characteristics, the mechanisms discussed in this chapter provide clues as to what to expect. The literature suggests that effects on audit quality are driven by incentives, as partners with different characteristics – for example, in terms of risk preferences and professional scepticism – react differently to incentives. Regarding digitalisation and sustainability reporting, it is difficult to see apparent interaction with partner characteristics, as the effect on audit partners’ incentives is unclear. Instead, it is likely that the relations identified between characteristics and audit quality will remain even with more digitalisation and focus on sustainability reporting. To the extent that audit partner characteristics add inertia in how audits adapt to new circumstances, real change could possibly require changes to the pool of active partners. Changes in regulation, however, could have an immediate impact on audit quality. Regulation has the potential to affect incentives, to which partners with different characteristics do react differently. For example, mandatory auditor rotation will lessen incentives to have long-term relations with clients. Stronger regulation overall could increase incentives to be sceptical in the audit. Still, research shows that even with the strong internal processes within the Big 4 firms, individual partner characteristics still matter to a large extent. We, therefore, expect that the identified associations between characteristics and audit quality will remain even with changes in regulation. Ultimately, however, it is an issue for future research to determine effects on audit quality of recent changes in regulation. Another area for future research is the potential distinction between listed and private companies. As shown in Table 14.1, most studies are conducted on listed companies, but there are several studies involving private companies (and one study on not-for-profit organisations). As pointed out by Beuselinck et al. (2023), the economic environment differs substantially between listed and private companies, which could affect incentives of auditors

310  Jan Marton and Savvas Papadopoulos and the relationship between the auditor and the client. There could also be differences within the group of private companies, depending on, for example, size or financing structure. Some of the studies listed in Table 14.1 include both listed and private companies, based on an implicit assumption of similarity between the two types. While it appears that, in general, partner characteristics have similar effects for both types of client companies; this is still an issue for future research. Swedish researchers – and researchers from other countries that use Swedish data – are essential in this research stream. Sweden has access to unique observable data about individuals, and enough similarities with other Western countries to be of interest on an international level. The importance of Sweden may decrease somewhat with the recent publication of information on individual auditors in the US, but Sweden will still have additional individual information not found in the US. The knowledge gained is of interest to investors, regulators, preparers, and accounting firms. Accounting firms are interested in standardising the quality of audits across engagement partners. They should be aware of characteristics that are often associated with lower quality and take particular action in those cases. In addition, they could use the knowledge gained from research to think about which auditors should be assigned to particularly risky clients. Of course, accounting firms have richer information about their employees, so the characteristics will only be one of several considerations used internally in the assignment of engagement partner to audits. An additional idea for future research is to do case studies using richer internal information to learn more about the mechanisms at play that explain the association between individuals and audit quality. Acknowledgements Savvas Papadopoulos is grateful for financial support received from the Jan Wallander and Tom Hedelius Foundation (Wallander scholarship W19-0052). Note 1 To some extent, this is due to the largest accounting firm for listed Swedish companies, PwC, having a policy of including both a senior and a junior partner on audit engagements.

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The importance of the engagement partner 313 Appendix: Research design The chapter reports the results of a literature review focused on engagementpartner characteristics. Identification of relevant literature closely follows the method used by Lennox and Wu (2018). We identify relevant articles primarily in seven journals: The Accounting Review (TAR), Journal of Accounting and Economics (JAE), Journal of Accounting Research (JAR), Contemporary Accounting Research (CAR), Review of Accounting Studies (RAST), Accounting, Organizations and Society (AOS), and Auditing: A Journal of Practice and Theory (AJPT). The first six journals represent all journals in accounting that are categorised as ‘4’ and ‘4*’ in the Academic Journal Guide from the Chartered Association of Business Schools, i.e. the highest-ranked journals. AJPT is a specialised journal in the field of auditing. We identify articles using archival data that focus on the effect of engagementpartner characteristics on audit quality. Most articles are from TAR, CAR, and AJPT. Based on subsequent citations to articles in the seven journals, we find working papers and additional articles in other journals. To identify current research, we also search for working papers in the SSRN, in conferences, and through networks of researchers. Where relevant, we especially identify studies that use Swedish data. To facilitate the readers’ understanding of the research field, we structure and present the research by dimensions. First, we look at different definitions of audit quality, i.e. the dependent variable in the reviewed literature. Second, we identify the various engagement-partner characteristics in focus in the literature, i.e. the independent variable. Third, we go through the proposed mechanisms that explain the associations shown between engagementpartner characteristics and audit quality.

15 Transformation in audit teams Implications for team competence Alice Annelin and Tobias Svanström

Introduction Audit engagements are typically performed by audit teams. Audit teams are a ‘set of auditors who have been assigned collectively to plan and execute the audit’ (Rich et al., 1997, p. 90). Most of the audit assignments refer to financial audit, and the purpose of the financial audit is to determine whether there are material misstatements in the financial statements of the audited entity. To assure this, a set of tests and procedures are performed. The various tasks that make up an audit require division of effort across subgroups within the audit team (Cameran et al., 2018) and sufficient competence among audit team members. This chapter focuses on the new demands and challenges for audit team competence, and it is reasonable to expect a need for refined competences because of transition in the audit industry. In this chapter, we view particularly digitalisation of audit tasks but also sustainability reporting and assurance and regulatory reforms as drivers of change. Developments and adjustments are likely needed in all dimensions of audit team competence due to (new) specific demands from audit clients, users of audited information, regulators, and society at large. Our focus on team competence involves three components: (i) audit team composition, (ii) audit team expertise, and (iii) audit team dynamics. The first key driver of audit team competence development is the digital transition of the audit industry. Technological developments offer the possibility of analysing audit evidence using Big Data, Artificial Intelligence (AI), and other technical tools. However, digitalisation also allows for more remote work. The transition has been going on for some time, but the use of these technologies and new expertise is now being propelled and integrated into the whole audit team’s process of audit work. Considering the fast-paced changes in use of technology in the audit industry that are now taking place related to the COVID-19 pandemic, audit teams have had to adapt to the new tools, knowledge, and expectations required to implement these technological changes efficiently and effectively. Auditors have had to consider alternative procedures when travel and/or physical attendance is restricted, such as video conferencing and drone technology (Financial Reporting Council, 2020). DOI: 10.4324/9781003411390-19

Transformation in audit teams 315 The second key driver of audit team competence development is sustainability (reporting). There is a rapidly growing demand for assurance in a variety of specialisations, particularly sustainability assurance. The development of integrating sustainability accounting into the annual report and making the sustainability information more informative and verifiable will lead to a greater need for the audit team to better understand sustainability issues and sustainability reporting. This means that this understanding is no longer relevant only for those who used to confirm the existence of a sustainability report but instead typically for everyone in the audit team. Assurance of sustainability reporting has traditionally been voluntary, and only a very limited level of assurance of the sustainability information has been provided. This situation is changing, however, and significant development is expected. Important regulatory changes are being introduced in this area that serve to enhance reporting and assurance of sustainability-related information (see the introductory and concluding chapters by Marton et al., in this volume). The third key driver of audit team competence is regulatory requirements. At the same time, there is the ongoing implementation of regulatory requirements for auditors and accounting firms from the audit directives within the European Union on mandatory accounting firm rotation and reporting of key audit matters etc. (Regulation (EU) 537/2014; Directive 2014/56/EU; see also Rahnert, in this volume) alongside renewed discussions about how audit and non-audit services should be provided in the future to best ensure the independence and competence of auditors (i.e. audit quality), specifically whether the audit should be performed in a multidisciplinary firm offering a broad range of different (consulting) services or in a stand-alone accounting firm (Donelson et al., 2022). In response to these regulatory discussions, EY has announced that they are planning to split up their audit and advisory operations. At a minimum, audit firms need to adapt to these new demands and requirements (i.e. key drivers) in the structuring of engagement teams and in the work of audit teams. Firstly, a new composition of diverse teams is needed to offer the various competencies required to conduct audit teamwork in this new environment. Audit teams have traditionally been homogeneous, with members largely sharing the same educational background, the same culture, and several other factors. In future, audit-team-competence decisions, such as recruiting and staffing, education and training, team composition, resource allocation, and the audit labour mix, can be expected to involve considerations of heterogeneous and multi-skilled team members from different educational backgrounds. Such a development would also correspond with recent changes in the educational requirements for auditors (Swedish Inspectorate of Auditors, 2017).1 In the conclusion section, we develop a figure to facilitate discussions about potential avenues for audit team developments in the future. Secondly, various types of audit team expertise are needed to deliver audits of high quality in the future. During the COVID-19 pandemic (starting 2020) and currently because of global inflation and expected global recession, there

316  Alice Annelin and Tobias Svanström has been an extraordinary level of uncertainty about the economic conditions, future business performance, stability of supply chains, and costs of several inputs that affect client management estimates and judgement (e.g. going-concern and accounting estimates). This uncertainty might increase the risk of errors or fraud. Furthermore, it is likely an increased demand for assurance and increased litigation risks (Albitar et al., 2021) thereby will necessitate greater levels of effort, professional judgments, and scepticism as well as skilled, experienced, and motivated audit team members. For audit teamwork, the pandemic situation provided opportunities to work remotely and use different digital tools in team interactions more extensively than was otherwise justified. While the pandemic should not be viewed as a driver of digitalisation per se, it has impacted how audit teams interact today and probably will tomorrow. Thirdly, audit teams perform differently compared with work conducted by individuals. This can be understood from the perspective of audit team member interactions being one of several important components of audit team competence that influences audit quality (Bauer et al., 2022). The team’s competence to communicate using different methods (Bauer et al., 2022) influences how valuable information is shared and the quality of audit work performed by the team (Andiola et al., 2019; Annelin & Svanström, 2022). This may be particularly important during uncertain transitions in the industry that change the composition of the team. Also, the process in which the team functions while adapting to more remote work (Annelin & Che, 2019) could have influences that lead to consequences for the audit tasks and the control process (Bauer et al., 2022). The ability to develop audit-team competencies that meet the new demands will ultimately determine audit efficiency and the audit quality. Motivation The transitional changes as discussed above will offer many opportunities and challenges for future audit teams. In this section, we present some of them to further illustrate the need to consider how new demands impact audit teams and audit-team competence. Technological developments and the changing working environment of audit teams that have begun to appear in the audit industry involve a trend to work more frequently at a distance from the client and other team members (Annelin & Che, 2019; Downey et al., 2020), as the technologies put in place enable remote work with potentially improved efficiencies. The rate at which audits are digitalised is influenced by the size of the accounting firm and the client’s capacity and willingness to adapt to the new technologies. Audit teams will be able not only to implement different AI technology to conduct the audit but also to conduct various innovative work with the inspiration that comes from the introduction of such new tools and competencies. However, such changes would lead to less time for the team to meet in person, which can have negative consequences for the thoroughness of information exchanged between team members. The digitalisation of

Transformation in audit teams 317 the audit team process influences decisions and judgements of auditor-client relations regarding adaptation to technology and the efficiency of using said technologies. For example, the demonstration of a questioning mind and the critical assessment of audit evidence will have to be assessed differently. One could also note the risk that technical competence in financial accounting and auditing is negatively affected if the development of new multidisciplinary teams (MDT) discussed in Pimentel et al. (2021), among others, leads to core audit competencies becoming scattered and more ambiguous (see Carrington et al., in this volume). Related to the quality of communication in the audit team, it may be problematic if team members in MDT with different backgrounds don’t share the same vocabulary and key expressions and if concepts are not understood by everyone on the team. This discussion illustrates the trade-off between the need for (individual) specialisation and integration of the audit function to be understood by all team members. There are many audit team member factors (at a team level rather than an individual level) related to expertise and interaction that could potentially impact audit teamwork and ultimately audit quality, but only a very few have been investigated. Ultimately, the ability to adapt and develop new ways of efficiently and effectively meeting new demands and requirements will impact audit quality. The purpose of this chapter is to review and discuss literature of relevance to audit-team competence that includes team composition, team expertise, and team dynamics. It does not include an extensive review of individual auditor literature, nor the vast team literature outside of the audit context (see the Appendix for more information about the research design of this review). We develop specific propositions about audit-team competence to be tested in future research and conceptualise possible future audit-team structures, impacts on audit teams, and outcomes of these transitions. To our best knowledge, there is no prior work that focuses on how the transition in the audit industry and the new demands impact various aspects of audit-team competence. The exclusion of findings from outside the audit context limits the richness and completeness of the review. Limitations of our review design are further discussed in the Appendix. Literature review and results In this section, we define audit-team competence broadly and include composition, expertise, and dynamics as components of competence. Team competencies have been constructed from knowledge, skills, and abilities (Cannon-Bauwers et al., 1995; Figl, 2010). In Table 15.1, we present each of the components of team competence and the main findings from the previous research. The composition of the audit team

To reduce the risk of not detecting material misstatements in the financial statements to an acceptable level at a minimum cost during the audit process,

Author(s)

Year

Title

Journal

Location

Method

Citation impact

Focus

Section 1: Audit team composition and multidisciplinary teams (MDT) Annelin, Svanström 2019 & Willekens Bell, Doogar & Solomon Cameran, Ditillo & Pettinicchio Causholli

2008

Che & Svanström

2019

Contessotto, Knechel & Moroney

2019

Contessotto, Knechel & Moroney

2021

Hay, Shires & Van Dyk

2021

Hossain, Yazawa & Monroe

2017

2018 2016

Opening the black box of audit teams: qualitative evidence on composition and role structure Audit labor usage and fees under business risk auditing Audit-team attributes matter: How diversity affects audit quality Evidence of organizational learning and organizational forgetting from financial statement audits Team Composition and Labour allocation in audit teams: a descriptive note The association between audit manager and auditor-in-charge experience, effort and risk responsiveness How do audit-team industry- and client-specific experience impact audit effort and audit fees?

In Annelin (2019). Doctoral Dissertation, Umeå University Journal of Accounting Research European Accounting Review Auditing: A Journal of Practice & Theory

Sweden

QualitativeInterview

USA

Quantitative

18.62

Italy

Quantitative

20.67

USA

Quantitative

5.60

Managerial Auditing Journal

Sweden

Quantitative

3.50

All team memberscomposition

Auditing: A Journal of Practice and Theory

Australia

Quantitative

7.00

International Journal of Auditing

Australia

Quantitative

3.00

Auditing in the time of COVID – the impact of COVID-19 on auditing in New Zealand and subsequent reforms The relationship between auditteam composition, audit fees, and quality

Pacific Accounting Review

New Zealand Qualitativediscourse analysis

10.00

Audit team (partner, manager & AIC)manger impact on AQ Audit team (partner, manager & AIC)manger impact on AQ Impact COVID-19 on audit and reforms

Auditing: A Journal of Practice and Theory

Japan

10.00

Quantitative

N.A.

All team memberscomposition Impact of Business Risk Audit (BRA) Impact of hours etc. on AQ Client tenure on efficiency between ranks

All Audit team on Fee/AQ (Continued)

318  Alice Annelin and Tobias Svanström

Table 15.1  Literature review papers and classification of the research.

Table 15.1  (Continued) Author(s)

Year

Title

Journal

Location

Method

Citation impact

Focus

Pimentel, Boulianne, Eskandari & Clark Rich, Solomon & Trotman

2021

Systemizing the Challenges of Auditing Blockchain-Based Assets

Journal of Information Systems

Canada

Qualitative interviews

1997

Multi-auditor judgment/ decision-making research: A decade later

Journal of Accounting Global Literature

Qualitativeconceptual

6.08

Accounting, Organizations and Society

Croatia

Quantitative

8.00

Auditor on audit performance (tax adjustment)

Managerial Auditing Journal Accounting & Finance

Sweden

Quantitative

N.A.

Audit teams

Global

Qualitative

17.33

Tech changes and behaviour audit

Sustainability

Global

Qualitativediscourse analysis

36.00

Impact COVID-19 on tech use with VSS

Contemporary Accounting Research

Sweden

Quantitative

N.A.

QuantitativeExperiment

2.33

Audit teams’ industry knowledge and the impact on audit production Group decisions using info tech on AQ

Auditing of blockchain companies, challenges for the audit opinion Dyad interaction

Section 2: Audit team expertise 2014

Annelin

2022

Arnold

2018

Castka, Searcy & Fischer

2020

Cahan, Che, Knechel & Svanström

2022

O’Donnell, Arnold & Sutton

2000

An empirical investigation of the impact of audit and auditor characteristics on auditor performance Audit-Team Equality and Audit Quality Threatening Behaviour The changing technological environment and the future of behavioural research in accounting Technology-enhanced Auditing in Voluntary Sustainability Standards: The Impact of COVID-19 Do Audit Teams Affect Audit Production and Quality? Evidence from Audit Teams’ Industry Knowledge An Analysis of the Group Dynamics Surrounding Internal Control Assessment in Information Systems Audit and Assurance Domains

Journal of Information USA Systems

(Continued)

Transformation in audit teams 319

Alissa, Capkun, Jeanjean & Suca

Author(s)

Year

Title

Journal

Location

Method

Citation impact

Focus

Westermann, Bedard & Earley

2015

Learning the ‘Craft’ of Auditing: A Dynamic View of Auditors’ On-the-Job Learning

Contemporary Accounting Research

USA

QualitativeInterview

34.00

How technical knowledge is created

International Journal of Accounting & Information Management Auditing: A Journal of Practice & Theory

Global

71.00

COVID 19 on AQ

USA

Desk studyqualitative conceptual paper Quantitative

14.50

Subordinate affect interaction with Superior

In Annelin (2019). Doctoral Dissertation, Umeå University International Journal of Auditing

Sweden

Quantitative

All team membersdistance

Sweden

QualitativeInterview

All team membersstress

Auditing: A Journal of Practice and Theory

Global

QualitativeLiterature Review

Auditing: A Journal of Practice & Theory

N.A.

Commentary

COVID-19 impact interactions between auditors & research methods Communication

Section 3: Audit team dynamics Albitar, Gerged, Kikhia & Hussainey

2021

Auditing in times of social distancing: The effect of COVID-19 on auditing quality

Andiola, Bedard & Westermann

2019

Annelin & Che

2019

It’s Not my Fault! Insights into Subordinate Auditors’ Attributions and Emotions Following Audit Review Audit-Team Distances and Audit Quality Threatening Behavior

Annelin & Svanström

2022

Bauer, Humphreys & Trotman

2022

Canning, Gendron & O’Dwyer

2018

The triggers and consequences of audit-team stress: Qualitative evidence from engagement teams Group judgment and decisionmaking in auditing: Research in the time of COVID-19 and beyond Auditing in a Changing Environment and the Constitution of CrossParadigmatic Communication Channels

(Continued)

320  Alice Annelin and Tobias Svanström

Table 15.1  (Continued)

Table 15.1  (Continued) Year

Title

Christensen, Newton & Wilkins

2021

Frank & Hoffman

2015

Gertsson, Sylvander, Broberg & Friberg Guthrie & Jones III

2017

Journal

Location

Method

Citation impact

Focus

How do team workloads and Accounting, team staffing affect the audit? Organization and Archival evidence from U.S. Society audits How Audit Reviewers Respond The Accounting to an Audit Preparer’s Affective Review Bias: The Ironic Rebound Effect Exploring audit assistants’ Managerial Auditing decision to leave the audit Journal profession

USA

Quantitative

16.00

All team membersworkloads on AQ

USA

QuantitativeExperiment

5.17

Sweden

Quantitative 10.40 questionnaire

Why auditor assistants leave

2012

Job Burnout in Public Accounting: Understanding Gender Differences

Journal of Managerial Issues

USA

QuantitativeQuestionnaire

6.90

Peecher, Piercey, Rich & Tubb

2010

USA

Quantitative experiment

7.67

Piercey

2009

USA

Quantitative experiment

8.69

Dyad relationshipdecision-making

Smith, Emerson & Boster

2018

The Effects of a Supervisor’s The Accounting Active Intervention in Review Subordinates’ Judgments, Directional Goals, and Perceived Technical Knowledge Advantage on Audit-Team Judgments Motivated reasoning and verbal Organizational vs. numerical probability Behavior and assessment: Evidence from an Human Decision accounting context Processes An examination of reduced audit Managerial Auditing quality practices within the Journal beyond the role stress model

Impact stress-burnout on satisfaction, performance, and turnover intention Dyad relationshipjudgement

USA

Quantitative questionnaire

5.67

Stress & burnout on satisfaction and behaviour

Dyad relationshipjudgement

Transformation in audit teams 321

Author(s)

322  Alice Annelin and Tobias Svanström audit labour is important. A key input to each audit is therefore the composition of the audit team (Contessotto et al., 2019). Each audit team consists of individuals with unique knowledge and experience who have different roles in determining the outcome of the process. Engagement audit teams are structured during audit planning. The characteristics of the client (size, complexity, and risk), the level of seniority required for the specific tasks, and the level of expertise/knowledge (including industry knowledge and organisational constraints such as timing, availability, and rotation rules) are considered (Contessotto et al., 2019). Audit teams are structured and composed hierarchically with partners at the top (see Table 15.1, Section 1 – Audit team composition and multidisciplinary teams). The role of the lead auditor is to plan the audit, monitor the audit process, communicate with the clients, and report the findings in the audit report, among other duties. Partners have limited involvement in the day-to-day planning and execution of an audit, retaining certain key decision-making authority and focusing on client relationships (Contessotto et al., 2019). Directors are highly experienced auditors who have a supervisory role within the audit team (Che & Svanström, 2019). Audit managers have significant responsibility in terms of communicating with clients, audit partners, and associates during the audit and in performing key audit work (Annelin et al., 2019; Contessotto et al., 2019). Associates or staff are at the bottom of the hierarchy, and they undertake mostly routine audit testing work; however, some begin to take on more responsibility after 2–3 years of audit experience, such as managing the audit teamwork on smaller audit engagements (Annelin et al., 2019). Much of the audit work is not performed by partners (Che & Svanström, 2019). While the definition of the different roles varies between the different empirical studies conducted in different jurisdictions, the fewest hours are performed by partners. Contessotto et al. (2021) study Italian companies and report that 7% of total hours were performed by partners, 19% by managers, 40% by senior (associates), and 34% by staff auditors (i.e. junior associates). Internal experts performed a negligible percentage of the audit hours. Using partly different labour ranks, Che and Svanström (2019) use a sample of public (92) and private (816) companies and report that in total 8% of the audit work was performed by partners, 8% by directors (i.e. very experienced auditors not equity partners in the accounting firm), 43% by managers, and 40% by associates. The proportions for public clients were 14% partners, 11% directors, 41% managers, and 32% associates. Causholli (2016) used a sample of large companies (66% of companies were public, and the mean of total assets was USD 1,710 million) and reported that partners represent 6% of audit time, managers 16%, in-charge auditors 27%, and staff 50%. The limited research has indicated that competence, availability, and development opportunities of team members are among the important determinants of team composition (Annelin et al., 2019; Contessotto et al., 2021). Unavailability of the optimal team member(s) can sometimes be an issue, and

Transformation in audit teams 323 especially in lower ranks, partners may need to select team members based on who is available at the relevant point in time because of time constraints (Annelin & Svanström, 2022). Development opportunities have to do with long-term planning in the sense that junior team members need to have the chance to test new and challenging audit tasks to learn for the future (Annelin & Svanström, 2022). In the short run, this could lead to a less-than-optimal team composition, resulting in more total audit hours and more dysfunctional auditor behaviours. Some empirical evidence supports that the characteristics of the audit client impact resource allocation decisions for audit teams. For example, the proportion of audit hours allocated to higher-rank auditors (i.e. partners and directors) and lower-rank auditors (i.e. managers and associates), respectively, differs between engagement in public and private firms (Bell et al., 2008). There are in general a greater number of audit hours distributed to partners in public than in private engagements likely because of the higher risks of reputation loss and litigation in case of an audit failure, while results for lower-ranked auditors are more mixed. Audit team composition propositions

When the audit industry is transitioning towards more MDT, audit teams are likely to be structured in new ways that can affect the competence and behaviour of the team. Digital developments also provide opportunities to include team members from different geographical locations in the composition of audit teams. This may lead to various advantages and disadvantages for audit teams that may impact audit quality. Therefore, future research about audit team composition would be beneficial. We propose that future studies investigate the following set of research questions related to audit team composition: 1a. What audit team compositions can be considered a highly competent audit team in the future? 1b. What audit team compositions are required to achieve high audit quality in the future? Audit team expertise

Audit team expertise is the expertise that all team members provide for the team, rather than the expertise of one individual auditor. Team expertise can come in a variety of forms. In this review, we discuss technical expertise, technology expertise, and sustainability-assurance expertise (read more about environment, social, governance (ESG) assurance in Crawford et al., in this volume). Technical expertise is the knowledge and understanding of the audit and the ability to apply that knowledge (see Backman et al., in this volume). Technology and sustainability assurance expertise are considered specialisations in the audit industry that are currently transitioning. For professional

324  Alice Annelin and Tobias Svanström services such as auditing, expertise plays a crucial role in delivering value to the client. Technical expertise

According to Westermann et al. (2015), partners indicate that the role of senior auditors (i.e. manager and partner roles) has dramatically changed due to the increased complexity of technical accounting standards. More complex accounting issues increase firm risk exposure and are therefore being addressed not only by partners but also by managers (Westermann et al., 2015). These results indicate that the characteristics of the various team members, and not only the (signing) lead audit partner, matters for audit efficiency, and audit quality. Hossain et al. (2017) use publicly available data from Japan and document that the number of accounting professionals in a team is associated with audit quality, while the number of non-accounting professionals (e.g. actuaries, real estate appraisers, and tax experts) is not. This is consistent with greater general audit-related knowledge in the audit team being associated with more effective audit outcomes. Audit teams are trained to develop their technical expertise in audit work through supervision and teamwork as an ongoing training system in the audit industry (Westermann et al., 2015). As more experienced audit team members take on different audit tasks, mostly working more closely with the client, more experienced auditors may also begin to lose some of the technical expertise to perform the ‘simpler tasks’ (Annelin & Svanström, 2022). The more experienced audit team members review the work of the subordinates, and if they lack the technical expertise to conduct the tasks themselves, it could jeopardise the quality of the review. Thus, an important element of the audit team process is to be able to assess and manage the different technical expertise available in the team. Evidence shows that auditors exert less effort when the task is perceived to be more difficult (potentially unattainable), thus implying that auditors do not exert effort if acquired knowledge does not sufficiently match the audit task at hand (Alissa et al., 2014). Contessotto et al. (2021) and Cahan et al. (2022) consider the role of industry-specific knowledge in audit teams within a production function model that examines both engagement effort and outcomes. Contessotto et al. (2021) find that the average industry experience of an audit team does not influence audit fees or effort, although teams with more industry experience rely more on junior staff. However, as Contessotto et al. (2021) note, in their mid-tier firm setting, in Italy, it is unusual for an auditor to become an industry specialist. Cahan et al. (2022) study Big 4 audit teams in Sweden and find that higher average industry knowledge is associated with more audit effort. Furthermore, they report that balanced teams (i.e. industry expertise is present at both junior and senior rank levels) produce higher quality audits than nonspecialist teams, while the audit quality of unbalanced teams (i.e. industry

Transformation in audit teams 325 expertise only at either senior or junior rank level) is not statistically different from the non-specialist teams. Much of the literature about technical expertise in the audit context discusses outcomes of the influence of an individual auditor’s technical expertise. However, we argue that all members of the team could be considered simultaneously when analysing technical expertise of the whole team to gain a full picture of how the team’s technical expertise influences audit outcomes. Technology expertise

Recently, there has been an increased focus and demand on an audit team’s technology expertise, since highly automated business processes have been integrated into the audit. Empirical evidence on the impact of different types of expertise among audit team members is sparse, however. Technological developments have presented a risk to the audit because they can diminish the audit trail (Arnold, 2018), making the audit tasks more difficult to assess. Auditors need to be able to apply complex accounting standards and conduct the audit process through support technologies (Arnold, 2018). Audit teams must also be able to collectively use the technical tools available so that planning, brainstorming, coordinating, and communicating information to solve problems in a collaborative manner. Albitar et al. (2021) suggest that the experience of COVID-19 pandemic restrictions has threatened the quality of the audit process due to remote work. As the audit team works to provide assurance of their client’s financial statements remotely, confidence in the quality of said assurance may decrease. Thus, the procedures put in place to assure the accounts remotely may lead to investment and other financial risks. If the confidence is lowered due to assurance conducted by audit teams without the expertise to use the technologies, how will audit teams build back that confidence after the pandemic period? The use of experts in different areas and specialisations among audit team members, particularly for audits of listed companies, may be altered quite considerably. Once the audit process changes towards the use of more technologies and the competencies for judgement and decision-making for different types of information are required, a certain minimum level of technological expertise will be required (Bauer et al., 2022) by all members of the audit team. Many more team members will need to be trained in the use and application of required technologies, as well as know how to detect the misuse of technologies that might hide misstatements or errors made by the client (Krieger et al., 2021). In addition, there will be a need for team members with more advanced technological expertise to serve as IT experts in audit engagements. Sustainability assurance expertise

The European Union has adopted a new directive on Corporate Sustainability Reporting Directive (CSRD), where sustainability reporting will be integrated

326  Alice Annelin and Tobias Svanström into the annual report, and, as such, also subject to mandatory audit (see the concluding chapter by Marton et al., in this volume). The directive includes more detailed reporting requirements and mandates that all large unlisted companies must also report on their sustainability performance. These regulatory developments should be viewed in the light of sustainability reporting being considered highly relevant but at the same time challenging to verify with sufficient evidence, and the credibility and value of voluntary sustainability assurance having been questioned (Hay et al., 2021). These developments entail that the audit team needs to fully consider how sustainability implications are reported by the client as part of (normal) audit work. While most accounting firms have begun to use specialists to perform an audit of sustainability reports, the traditional audit also uses more of a sustainability perspective. This indicates that sustainability perspectives may soon become the norm of the audit process, and therefore a different set of expertise will be needed among all audit team members. This could be particularly challenging, as evidence to assurance sustainability information preferably requires either in-person interaction or advanced and trustworthy technologies (Castka et al., 2020). With support from the Global Reporting Initiative guidelines, audit firms have used the framework of the United Nation’s Sustainable Development Goals. How well this has helped sustainability assurance has yet to be determined. As specialist techniques integrated into the audit process, for example, sustainability assurance, the audit will be impacted and require new levels of expertise (see Argento et al., in this volume). Existing audit teams will need to adjust expectations and preferences for certain work tasks, while satisfaction and intentions to leave the audit profession could be influenced. The accounting firm culture is also likely to change with newly assigned tasks requiring different types of output. Audit team expertise propositions

There is still much to be learned about audit teams and the importance of different types of audit team expertise. As the audit industry transitions towards more high-tech solutions and more sustainability assurance, audit teams are likely to be structured in innovative manners, with different members bringing various types of expertise. This may lead to a variety of advantages and disadvantages for audit teams. Therefore, future research about the consequences of audit team expertise would be beneficial. We propose that future research investigate the following set of research questions related to audit team expertise: 2a. What types of expertise are needed for individual audit team members and for the audit team to meet future demands on audit and assurance services? 2b. What team-level considerations should be accounted for when composing the audit engagements for the future audit?

Transformation in audit teams 327 When considering these research questions, it is important to emphasise that the answer may vary depending on the specific characteristic of the audit engagements (e.g. client characteristics, regulation, and audit competition). However, there is also likely to be some common audit team expertise that is important in the delivery of high-quality audits and assurance services in the future. Audit team dynamics

Key elements of audit team dynamics and how the team might function due to ongoing transitions are discussed below (see also Table 15.1, Section 3 – Audit team dynamics). Supervisor and subordinate: Dyad interactions

Team dynamics include the interactions of team members, the process that the team follows, and any change that the team experiences. Team dynamics can be influenced by the team’s characteristics; thus, audit team dynamics can influence how much an audit team utilises the industry-specific knowledge of team members. Audit work is also affected by the interaction and communication between team members (Annelin & Svanström, 2022; Cameran et al., 2018), for example, between senior and junior team members. Senior auditors (e.g. partners) act as supervisors to guide and review subordinates’ work and thereby improve audit judgements of subordinates and ultimately the audit team. It has been assumed that knowledge is mostly gained by auditors on the job in team settings, in the form of supervised, progressively more complex work (Westermann et al., 2015). Thus, on-the-job learning in auditing is essentially a professional ‘apprenticeship’, in which an experienced guide shows a learner (audit staff) how to perform a task, providing guidance that is gradually withdrawn as mastery is attained. Through this process, the apprentice learns to translate knowledge of his/her ‘craft’ into practice (Westermann et al., 2015). Research has found that the way in which supervisors coach subordinates via active intervention impacts the quality of audit judgements (Andiola et al., 2019). Specifically, supervisors’ coaching or active intervention may bias the subordinates’ judgement when they allude to preferred audit conclusions (Piercey, 2009) as well as supervisors’ final judgement (Peecher et al., 2010). The best review experiences of subordinates have been perceived to be associated with reciprocal relationships and effective communication with their supervisor (Andiola et al., 2019). Virtual teams

The COVID-19 pandemic has rapidly and fundamentally changed the ways auditors work and interact with team members and others in the financial

328  Alice Annelin and Tobias Svanström reporting process (Bauer et al., 2022). The most prominent change has been a move away from face-to-face interactions to the use of virtual teams. There are also strong indications that many of these changes will remain in effect post-pandemic. For example, while it was common that the entire team visited the client’s site and worked there for weeks to gather sufficient and appropriate audit evidence five years ago, these days are unlikely to be back in post-COVID-19 time periods. However, this is likely to come with some negative consequences as well. There are certain efficiency gains when the audit team works together onsite (with a specific task), compared to the situation when communication and documents are passed through one (virtual) team members at a time. In the latter situation, there is a risk that progress may stop completely, for example, if one member is not available to carry the task forward (e.g. a signature is missing) and the rest of the team needs to wait. The future challenges for the audit team will be communicating and coordinating tasks and findings in these virtual teams. While the use of technology can help develop team competencies to do the audit tasks well, there is also evidence that shows that the use of technology can lead to negative attitudes and behaviours (Westermann et al., 2015). Complex technical environments can help audit team decision-making if the decisions are made together (O’Donnell et al., 2000). However, it is also true that group decision-making can increase information-sharing bias due to team dynamics. The use of more technology due to an increase in remote activities since the COVID-19 pandemic also brings with it various risks (Bauer et al., 2022), such as observing inventory, collecting documentation and making risk assessments. There are still many aspects of the audit process that preferably should be conducted (to an extent) by physical presence (inspection of inventory, observation, and questioning the client). Team member distance and affect

Experiences of effect (emotions or feelings) for the audit team can arise when interacting with each other (Frank & Hoffman, 2015). For example, audit team communication distance occurs when an audit team feels a sense of distance between team members due to the amount of communication that is conducted by technology rather than face to face (Annelin & Che, 2019). This communication distance can increase the frequency of audit team behaviours that threaten the quality of the audit. It has been found that the use of communication technologies negatively influences audit coordination (Canning et al., 2018) and that face-to-face communication is preferred by auditors (Agoglia et al., 2009). Teams also often fail to recognise team members with different expertise (Estep, 2021). As a result, knowledge sharing between team members may not occur. Annelin and Che (2019) found that audit team subjective distance can increase the frequency of audit team behaviour that can threaten the quality

Transformation in audit teams 329 of audit work. Subjective distance is an emotional sense of how close a team member feels to other team members, which can occur when audit teams interact during the audit process. This can occur no matter where the audit team member is located (their physical proximity). The audit process has been documented as producing affects and behavioural consequences (Andiola et al., 2019; Frank & Hoffman, 2015). Team members located in different physical locations have been found to experience challenges in communicating and coordinating audit work (Downey & Bedard, 2019). Audit team stress and affect

Audit work can also be stressful, as it includes time deadlines, time budgets, heavy workloads and high turnover (Smith et al., 2018). There is also evidence suggesting that stress and workloads influence the work-life balance and may cause auditors to leave the profession before becoming a partner or junior staff to leave before becoming authorised (Gertsson et al., 2017) and may also lead to burnout (Guthrie & Jones III, 2012). Furthermore, it may cause audit errors that impact audit quality and increase the litigation risks. There are only a few papers that focus on audit team stress (Annelin & Svanström, 2022) and workload of the audit team (Christensen et al., 2021). Annelin and Svanström (2022) interviewed team members of various ranks and teams and reported that stress can be experienced at a team level and that team stress is triggered by specific team experiences. More specifically, unclear audit planning, lack of communication, and team changes can trigger inter-team stress in audit teams and result in audit errors and other audit quality-threatening behaviours. Lack of competence and autonomy, as well as high workloads, are further team factors triggering team stress that could lead the individual auditor to work too hard, resulting in auditor burnout or auditors leaving the profession. Teamwork and team interactions can help to create positive outcomes from stressful experiences. The implication of workload has been further studied by Christensen et al. (2021), who use proprietary data from one accounting firm in the U.S. and find that heavier workload in total for the team and for auditor ranks are associated with lower audit quality, especially when team members have workloads of 60 hours or more per week during the busy season. Christensen et al. (2021) also report that greater year-overyear team staffing continuity is associated with improved audit quality, efficiency, and profitability. Audit-team dynamics propositions

Increased digitalisation and new regulatory standards will likely impact audit tasks and audit processes in audit teams. Future research that reveals how these changes influence audit team interactions and dynamics can contribute to knowledge about the advantages and disadvantages of such transitions.

330  Alice Annelin and Tobias Svanström We propose that future research investigate the following research questions related to audit team dynamics: 3a.  How are audit team interactions changed when transitioning from mostly face-to-face communication to greater use of various types of digital communication (i.e. virtual teams) in future audits? 3b. How do changes in audit team interactions impact audit-team behaviours and audit quality in future audits? Conclusions and implications This chapter contributes to the audit literature by reviewing the literature connected to different aspects of audit-team competence while at the same time considering the new demands arising from the transition in the audit industry. The focus is on the team level and acknowledges the influence of auditors’ social interaction alongside the experience of transitions in auditing. We conclude the chapter with a conceptualisation of audit-team competencies and discuss study implications for various practitioners. In our conceptualisation, we propose that the future development of audit team competence may follow two alternative paths (or a combination of both). The first path, presented to the left in Figure 15.1, means that the audit teams continue to develop their competences to adapt to the transition of the audit industry and to meet the new demands. However, changes occur within existing systems, policies, and routines and they are less extensive and pervasive than in the alternative second path presented to the right in Figure 15.1. While the first path is described as ‘business as usual’, the alternative path is heavily impacted by transitional drivers and involves a fundamental systemic and structural change in how audit teams are composed, operate, and function in practice. In this review, we have identified transitional changes documented in research, and these will also continue to develop in the first path (see Box 1: What we know). However, the alternative path presented in Box 2 (Transitional influences) highlights how transitional drivers might also influence the audit team more fundamentally in terms of changes in structure, expertise, and dynamics. Box 3 (What are future goals?) considers what might be the major future goal of the audit team and, depending on the goal, the way ahead follows the path that the audit team considers will best address the future demands on audit-team competencies. Audit teams need to adapt to future demands, so much could depend on what future goals are set by the accounting firms or other stakeholders. Therefore, future goals of the audit team and audit process will influence: (i) how the audit team influenced and is influenced by different stakeholders, (ii) how audit-team competence develops, (iii) what influence multi-disciplinary teams (MDT) have on audit-team behaviour, or (iv) on audit quality. In this regard, audit teams could either respond to the goals or be proactive goal setters.

Transformation in audit teams 331

Figure 15.1  Conceptual framework of transitioning audit teams.

Basically, audit teams may include using MDT with different specialists incorporated into the team, alternatively integrating new competencies into the whole team, or a hybrid of both, where competencies are developed up to a certain level for all team members and then some team members advance further into specialised knowledge areas (see Figure 15.1). Based on our literature review, we visualise that the audit teams could function like MDTs even more than is currently being incorporated (Pimentel et al., 2021) into the structure of the audit team. The literature could provide insightful information about the advantages and disadvantages of MDT and audit quality. MDT could better develop audit team competence for incorporating

332  Alice Annelin and Tobias Svanström technology and sustainability assurance, as well as taking on new challenges of team dynamics in remote work. If audit teams follow the first path of separate specialised competencies in technology or sustainability assurance (see Figure 15.1), auditors are likely to learn about technology and sustainability at different levels and to varying extents. Learning about sustainability helps the audit team to understand the facts of such assurance and develop their work of assessing compliance with GRI guidelines and/or new international reporting standards (IFRS) about sustainability. Such measures are hard to define and quantify, and it is difficult to create a realistic understanding of business processes, which could mean that assurance of sustainability accounts continues to be untrustworthy (Silvola & Vinnari, 2021). This path of specialised progression in MDT audit competence will possibly produce subgroups of audit teams as well as audit teams that are likely to be dispersed in character, which can lead to varying influences on audit team interactions and resulting behaviours. It is in line with how accounting firms have organised their work so far and could be considered a business-asusual approach to audit team competence progression. This approach does not mean no developments or improvements at all are needed, but instead the transition occurs within the current well-established system. Training of individual specialised competence can provide deeper knowledge than perhaps training all auditors in a specific knowledge area could ever achieve, and therefore prove to be more beneficial for an audit. Advantages and disadvantages of (different types of) team specialisation could be investigated further. If audit teams instead follow an alternative path where technology and sustainability competence are integrated to a high degree in the whole team, the audit team is likely to learn for sustainability. The key competencies to learn for sustainability (Redman & Wiek, 2021) can help organisations to work towards the UN’s sustainable development goals. The audit team would be self-aware, able to consider the whole system and the best strategy to achieve future goals and able to work in a flexible manner, where team members interact to varying degrees depending on their needs. The audit team will be able to properly assure the sustainability of the client’s accounts if the audit team is trained to fully understand the future sustainable goals of their clients. To do this, the team needs to consider the whole system that the client’s business activities function in, which includes all collaborators, the strategies that the client uses, what values for sustainability the client articulates, how the client’s self-awareness for sustainability is present in their work, and how the client acts for sustainability. Integrated sustainability and technology competences in the audit team will help the audit team to adapt to and lead future transitions and challenges in a less problematic manner so that all team members are competent in multiple disciplines. However, training all auditors to accomplish such a high level of competence in several areas could be problematic, costly, and time-consuming. There are important trade-off considerations between

Transformation in audit teams 333 specialisation, full integration of functions, and ensuring a high (technology and sustainability) competence level among all team members. Accounting firms of different sizes and goals might make various such trade-off considerations that impact their future role in the audit market. Advantages and disadvantages of all team members mastering all disciplines could be investigated further. Finally, audit teams could follow a third path for coping with audit transitions and a continued high-quality audit. This path combines the previous two paths, where all team members are competent in new technologies and sustainability assurance up to a certain extent, but some team members are trained to be more competent at technology or sustainability assurance than others. Here a more traditional MDT approach is followed, where the team members have separate specialities at an advanced level but help team members to learn about and sometimes for the sustainability and technological challenges that need to be addressed. Study implications for practitioners are many, not least since audit team inputs of allocation and composition, team competence and specialities are transitioning alongside the digitalisation of the audit process. Also, the audit team process of communication through technologies and team interactions involves important factors that audit teams need to manage well to motivate team members and reduce stress, and to deliver high-quality audit work. There are also important specific considerations for users of financial statements, regulators, and universities. The transition may impact the demand for different types of assurance services to be provided, while regulators need to adapt standards that are relevant in enhancing audit quality in a (partly) new environment. For the universities, the main task is to equip the student with such generic competencies that facilitate a capacity to quickly learn new techniques, technologies, tools, and methods of relevance for future work in the audit industry. Since there is much more that can be learned about these audit team inputs, however, we encourage academics to investigate audit teams further. As a starting point, the six proposed research questions should be investigated and addressed to further benefit practitioners and the research community. Note 1 In Sweden, the number of authorised and approved auditors has decreased from 4,050 at the end of 2011 to 3,063 at the end of 2020 (Swedish Inspectorate of Auditors 2019; 2011). This is a decrease of 24.1% and has led to a shortage of auditor supply as well as a new, more flexible educational requirement for becoming an authorised auditor in Sweden (RIFS 2018:1).

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336  Alice Annelin and Tobias Svanström perceived technical knowledge advantage on audit team judgments. The Accounting Review, 85(5), 1763–1785. Piercey, M.D. (2009). Motivated reasoning and verbal vs. numerical probability assessment: Evidence from an accounting context. Organizational Behavior and Human Decision Processes, 108(2), 330–341. Pimentel, E., Boulianne, E., Eskandari, S., & Clark, J. (2021). Systemizing the challenges of auditing blockchain-based assets. Journal of Information Systems, 35, 61–75. Redman, A., & Wiek, A. (2021). Competencies for advancing transformations towards sustainability. Frontiers in Education, 6, 785163. Rich, J.S., Solomon, I., & Trotman, K.T. (1997). Multi-auditor judgment/decision making research: A decade later. Journal of Accounting Literature, 16, 86–126. Silvola, H., & Vinnari, E. (2021). The limits of institutional work: A field study on auditors’ efforts to promote sustainability assurance in a trust society. Accounting, Auditing & Accountability Journal, 34, 1–30. Smith, K.J., Emerson, D.J., & Boster, C.R. (2018). An examination of reduced audit quality practices within the beyond the role stress model. Managerial Auditing Journal, 33(8/9), 736–759. Westermann, K.D., Bedard, J.C., & Earley, C.E. (2015). Learning the “craft” of auditing: A dynamic view of auditors’ on-the-job learning. Contemporary Accounting Research, 32(3), 864–896.

Appendix: Research design This chapter uses a structured literature review (SLR) approach (Massaro et al., 2016) to discuss auditing in transition for audit teams. The review included literature on audit teams that has relevance for the transition of audit teams into the new audit landscape with digitalisation, Big data, robotics, as well as for other future challenges and opportunities such as sustainability assurance. We follow that teams consist of three members or more and refer (primarily) to work using data with three or more members in a team, which is a limited source within the audit literature. Except for some engagements in very small private firms, audits are performed by three members or more. Most audit teams have conducted experiments about the dyad relationship between the superior and subordinate team members. The review does not include much team literature outside the audit context and is limited to published articles ten years old or less (with a few exceptions due to consideration of being particularly relevant). Table 15.1 presents how the SLR was appraised, synthesised, what methods were used in the articles, the articles’ impact, and our framework for analysis. There are also a limited number of working papers included in the review. The papers included are peer-reviewed and published in scientific journals. In addition, we also refer to two studies in a dissertation on audit teams. The review includes papers using all types of data collection methods (e.g. archival, experiential, survey, and interviews) used to investigate audit teams, including those that measure at a team level and those that collect data at an individual measurement level. To relate to what is ongoing in the audit

Transformation in audit teams 337 industry, we also include information and discussions in relevant professional magazines, reports written on commission from the professional institute of the audit profession in Sweden, EU directives, and EC reports, as well as some books. These references are primarily used in the introduction and motivation of this chapter and not in the review section. We used Scopus and Google Scholar to search for articles relevant to the subject of transitions with audit teams. The search terms included: Audit team, Group audit, Audit team AND Information systems, Audit team AND Trend, Audit team AND Transition, and Audit team AND Change. Those papers published most recently were chosen first (2018 and more recent), followed by those published earlier (before 2017). We also reviewed articles that were cited in the research we had found relevant for the subject of transitions in the audit industry and audit teams. Since we are active researchers in the field (as audit teams), we were aware of potentially relevant papers before performing the literature search itself. The final decision on which papers to include was based on our subjective discretion. The literature search was performed from November 2021 to February 2022. We established reliability and validity of the SLR by manually coding the data (literature sources) by the transitioning audit themes found. The outcome of these codes is represented in the subtitles of the literature review sections. We developed insights and critiques through analysing the data set and presented future research paths and questions from this review. So far, prior research has investigated audit-team composition and diversity, as well as some work about audit-team dynamics. Team literature outside of audit context is broad and could help to explain the audit team’s influence on audit quality. However, much could also be learnt from the audit-team context, as the profession functions in a unique manner. We acknowledge limitations to this review, including, the exclusion of the audit literature that has established knowledge about individual auditor competence and the exclusion of the vast literature about teams outside audit literature, which could lend insights into team interactions during transitioning experiences in an industry.

16 Expertise in financial auditing Jenny Backman, Michael Grant, and Fredrik Nilsson

Introduction Auditing1 is a domain where professionals are expected to have long experience and deep knowledge. Therefore, the title ‘authorised auditor’ is protected in Sweden and in all other EU countries. In 2018, the requirements to become an authorised auditor in Sweden changed, one reason being the rapid pace of digitalisation and its expected long-term effects on auditing (RIFS 2018:1). After these changes, the professional needs to have at least a bachelor’s degree, three years of qualified practice, and a certificate of having passed a written exam.2 The high expectations on authorised auditors are also evident in media reporting, in which their performance is critically scrutinised. Without doubt, most stakeholders expect auditors to have a high level of integrity and, underpinning that, strong experience and knowledge of auditing and accounting. The Swedish Inspectorate of Auditors (SIA) and the Institute for the Accountancy Profession in Sweden (FAR) have issued detailed regulations and recommendations that provide guidance regarding the minimum level of experience and knowledge required for becoming an authorised auditor. However, as in many other professions, it seems that some individuals reach a higher level of experience and knowledge than many of their peers (e.g. are more likely to make more accurate judgements). They become so-called experts in their domain (Gobet, 2016). What is considered expertise within a certain domain does not have to be constant, and auditing is no exception. During the last decade, this domain has been affected by several drivers of transition in areas such as regulation (e.g. Directive 2014/95/EU; IFRS 9) and digitalisation, but also in other areas, such as sustainability. Against this background, we argue that the expertise required for drawing sound conclusions and making critical evaluations in complex audit judgements could have changed as well. Therefore, this chapter explores empirically the concept of expertise within the domain of auditing, how expertise can be discerned in contemporary audit judgements and decision-making, and how various drivers of change, such as regulation and digitalisation, are perceived to influence audit expertise today and in the future. DOI: 10.4324/9781003411390-20

Expertise in financial auditing 339 More precisely, we empirically study auditors’ perception of expertise and how they perceive that it can be recognised in their judgements. Theoretically, our definition of expertise departs from the work by Ericsson and Lehman (1996, p. 277) but rather than adopting a strictly narrow definition of expertise as ‘superior performance’, we treat expertise as a continuum (Grant & Nilsson, 2023). Thus, we focus on the type of expertise demonstrated in judgements made by a senior, highly experienced auditor (an expert), which a less-experienced auditor (a novice) is unlikely to express in their judgements. For this study, 11 senior auditing professionals (partners, directors, and managers) of one of the Big 4 firms in Sweden were interviewed. The interviewees were prompted to recall and elaborate on various complex audit judgement situations in order to extract an account of the auditor’s individual perception of what characterises expertise in the domain of auditing. Furthermore, the interviewees were asked to elaborate on how they anticipate various drivers of change to influence the development of expertise in this domain. The findings of the study show that interviewees’ perceptions of audit expertise and how it is demonstrated in judgements can be categorised into the following five areas: (1) judging how accounting (and other) regulations should be applied; (2) making risk judgements; (3) judging materiality; (4) judging people; and (5) basing judgements on a holistic understanding of the issue at hand. Furthermore, the findings indicate that the perception among practitioners about what actually constitutes ‘expertise’ in this domain has changed over the last decade, primarily driven by increased and more detailed regulation and digitalisation. Motivation Developments in regulation and digitalisation have arguably brought changes to the audit industry. However, we have limited knowledge of how these drivers of transition potentially have affected and will continue to affect, audit expertise in the future. Furthermore, there is a dearth of knowledge about what contemporary auditors actually perceive audit expertise to be, and how it is applied in ‘real-life’ judgemental situations. On these grounds, we have conducted a study that qualitatively explores how senior auditing professionals perceive the concept of audit expertise and how they anticipate drivers of change, particularly increased regulation and digitalisation, will impact the future development of expertise within this domain. The rationale for focusing on the aforementioned drivers is briefly outlined below. Parallel to the development of the auditing profession, regulation has increased, and the profession has been dependent on legislation to achieve and consolidate its position today (Öhman & Wallerstedt, 2012; Power, 1997). For example, the crises that the audit profession has faced, caused by accounting frauds, such as in Enron and Worldcom, led to substantial changes

340  Jenny Backman, Michael Grant, and Fredrik Nilsson in regulation (e.g. Eilifsen & Willekens, 2007), thus bringing more legislative demands but possibly also more legislative legitimacy to the auditing profession. Contemporary regulatory developments in financial reporting and auditing also seem to continuously affect the auditing profession. A more recent example of this is the International Financial Reporting Standards (IFRS) accounting regime move from historical cost accounting to fair-value accounting (e.g. IFRS 9), which increases the requirements for making predictions of future economic developments (e.g. Ahn et al., 2020). Digitalisation is another driver of change that has started to impact the practice of auditing in recent decades. For example, the use of artificial intelligence (AI) and other similar applications was one of the reasons for the SIA to change the requirements for becoming an authorised auditor in 2018. That digitalisation is recognised as an important driver of audit transition is also visible in leading auditing and accounting journals (e.g. Appelbaum et al., 2017; Bertomeu et al., 2021). However, while digitalisation has been acknowledged for having a potential to increase both audit quality and efficiency, it is not clear how the use of various applications will impact the future role of auditors, such as the need to develop expertise outside the traditional boundaries of auditing. Literature review The concept of expertise has long been recognised in the psychology-rooted judgement and decision-making literature. As judgement and decision-making are central parts of the auditing process, it can thus be argued that cognitive theories of expertise are important in explaining an individual auditor’s judgements. Libby and Luft (1993, p. 425) characterise research of accounting and audit judgement and decision-making in the following way: its central themes have remained unchanged: assessing decision performance, establishing the factors which determine decision performance, and testing theories of the cognitive processes which produce the decisions. Research in auditing, especially prior to the 2000s, used theories of expertise to understand what factors affect expertise and judgements. Since then, theories of expertise and judgements have been further developed and applied in a variety of economics-related domains that share similarities with auditing, such as financial decision-making (e.g. Grant & Nilsson, 2020; Grant & Nilsson, 2023). However, we argue that this development cannot be observed in contemporary audit research (Griffith et al., 2016; Wolfe et al., 2020). Thus, there is a lack of research in auditing using current knowledge of expertise and judgements. Moreover, and as argued in the previous sections, expertise in the audit domain has also likely changed over the last decade due to drivers such as digitalisation and regulation.

Expertise in financial auditing 341 Defining expertise

Expertise is about performance within a given domain. Expertise can be described as a continuum from someone showing ‘consistently superior performance’ (Ericsson & Lehman, 1996, p. 277) to ‘somebody who obtains results that are vastly superior to those obtained by the majority of the population’ (Gobet, 2016, p. 5). Following earlier studies on expertise (for an overview, see Grant & Nilsson, 2023), we have chosen to define an expert within the domain of auditing as an auditor who consistently shows higher performance than many of their peers, that is consistently making more accurate judgements (‘the capacity to recognize relationships, draw conclusions from evidence, and make critical evaluations of events and people’ [APA, 2022]). Since expertise is visible in consistent and high performance over an extended period of time, luck is ruled out. Furthermore, even if some individuals learn tasks faster than others, an expert can be expected to have many years of experience and deep knowledge as the domain of audit involves many and complex tasks in different contexts (e.g. industries). Hence, arguably, an expert auditor makes judgements that a less experienced auditor can hardly make.

Acquiring expertise and keeping it

To become an expert, whatever the domain is, typically requires an extensive period of high-quality practice, although research has shown that heritage and environmental factors also play a role. For example, ‘grit’, referred to as ‘passion for and perseverance towards especially long-term goals’ (Duckworth & Gross, 2014, p. 319), is partly genetic and has been shown to affect acquisition of expertise. However, while grit or natural talent may have facilitating or amplifying effects, a general prerequisite for developing expertise is extensive, high-quality training, so-called ‘deliberate practice’ (Ericsson et al., 1993). That type of practice is fundamental for the development of expertise, regardless of whether the domain is in sports, or in more academic-oriented domains focusing on nurses, medical doctors, and teachers (e.g. Miller et al., 2020). In these latter studies, typical characteristics of deliberate practice are extensive experience that has been accumulated over a long period of time, has encompassed constructive feedback, and allowed for successive refinement and challenges. A common statement is that expertise is obtained after at least 10,000 hours or 10 years of experience. However, whereas these numbers emanate from studies of expertise (Ericsson et al., 1993), they relate to specific studies of chess or sports and are not generally applicable. They should instead be seen as an indication that extensive practice is required to develop expertise in a domain. Field studies in financial decision-making, a domain with similarities to auditing, indicate that 10–20 years of experience is required to acquire expertise (Grant & Nilsson, 2023). Furthermore, expertise can be perishable

342  Jenny Backman, Michael Grant, and Fredrik Nilsson due to changes and developments in knowledge requirements. As knowledge, methods, and tools develop within a domain, so do the requirements for reaching a level of expertise. Experience and deliberate practice are therefore typically required in order to maintain expertise. Two mechanisms affecting expertise

From a neurological perspective, parts of the underlying explanation as to why deliberate practice is central for developing expertise is that areas and connections of the brain involved in a certain task increase and strengthen with practice. One of the first examples of this in neurological research was a study of taxi drivers in London that shows that extensive training enlarges the area of the brain related to navigation and spatial memory (Maguire et al., 2000). Since then, several studies in domains such as music, mathematics, simultaneous interpretation, and sports have shown similar effects (Jeon et al., 2019; Ullén et al., 2016). Combined, these studies suggest that the structure and function of the brain, related to the task at hand, are affected by extensive experience and deliberate practice. Research has also shown that experts, relative to novices, cognitively ‘see’ different things. This relates to what is stored in and recalled from memory (Ward et al., 2013). For example, expert chess players do not see single chess pieces but larger chunks of chess pieces on the chess board. In a similar way, experienced readers do not see single letters but words, sentences, and paragraphs when reading a text. Research shows how these perceptual patterns help in mathematics and physics to identify and solve complex problems as well as help football players to anticipate how opponent players will move (Gobet, 2016). Arguably, what experts cognitively ‘see’ is important for their judgements and ultimately for the decisions they make. For example, in judgements of complex tasks, research shows that experts use intuition, so-called intuitive expertise. It is based on holistic associations and has been shown to be especially effective in complex tasks involving assessments, used when judging for example the future or people. These types of assessments are important in early-stage investments, credits, and financial investments (Grant & Nilsson, 2023). Expertise in auditing

A substantial part of auditing involves making judgements, and thus, this is a domain where deep and long experience and knowledge play a vital role (e.g. Mala & Chand, 2015; Nelson & Tan, 2005). Judgement and decisionmaking research have generally, and so also in the domain of auditing, focused on evaluating individual judgements and decisions primarily with a normative aim, that is, with a focus on what deficiencies exist and what can be done to remedy them and improve outcomes. Studies have examined this from two perspectives. The first perspective investigates factors

Expertise in financial auditing 343 affecting auditor expertise and ultimately the quality of judgements made. The other perspective analyses how task and industry expertise affect judgements. Early studies, prior to the 2000s, examine attributes of expert auditors typically by using questionnaires or experiments. However, later studies also use quantitative ‘real-life’ data from accounting firms. Taken together these studies show how factors like knowledge, problem-solving ability, and communication skills affect auditor expertise, and ultimately the quality of audit judgements (for overviews see Mala & Chand, 2015; Nelson & Tan, 2005). An example of a later study is Che et al. (2018), who examine how audit partners’ ‘knowledge factors’ – measured as formal education (a bachelor’s or master’s degree), continuing professional education and professional experience – affect audit effort. The authors show that each of these factors increases audit effort,3 and also audit quality, measured as accuracy in going concern reports. The factors in Che et al. (2018) can all be seen as being encompassed in expertise and deliberate practice. Thus, the study supports the notion that expertise leads to higher audit quality. Studies have also examined how tasks and industry expertise affect judgements and decisions and the resulting audit quality (Bratten et al., 2013). Related to this is also specialisation, that is, the use of specialists in areas like tax, valuation, and pensions. Considering the substantial increase in rules and regulations in accounting and auditing over the last decade, retaining expertise across all tasks and industries has become unsurmountable for an individual auditor. Based on what is known about expertise, it becomes evident that in order to develop expertise in an industry or for certain tasks auditors need to have a lot of experience in that specific area. It is therefore not surprising that industry and task expertise, and their effect on audit quality, have been a research interest in the literature. The effect of expertise on audit judgements has been studied in various situated practices, and focusing on various types of judgemental tasks. Some examples are fair-value accounting (Ahn et al., 2020), risk assessments (Messier & Austen, 2000), materiality judgements (Messier et al., 2005), fraud detection (Mui, 2018), and going-concern assessments (Che et al., 2018). Combined, these studies indicate that expertise, typically measured as experience or exposure to the task, increases audit quality. However, the unit of analysis in several of these studies is the audit office, whereas expertise and judgements are constructs that have a clear individual focus. Additional studies on industry experts’ judgements also suggest, in line with the reasoning above, that industry expertise leads to better judgements. For example, Hammersley (2006) shows in an experimental study that auditors who possess an industry specialisation are better at recognising patterns implicating misstatements. A review study of auditor industry specialisation concludes that the result of these studies ‘suggests that auditor industry specialisation improves earnings quality’ (AudoussetCoulier et al., 2016, p. 142).

344  Jenny Backman, Michael Grant, and Fredrik Nilsson Taken together, the studies discussed above have contributed to our knowledge about what factors affect expertise, and how industry and task expertise can affect judgements. However, what has not been examined is how individual auditors, themselves, perceive the concept of expertise, and how this expertise can be discerned in their judgements. Furthermore, most of the studies conducted so far have been based on experiments or quantitative data where expertise, as a variable, has been defined in different ways across studies. To advance our knowledge about expertise in auditing, we argue that it is vital to also capture a deeper, qualitative view of auditors’ perception of expertise and how it is expressed in judgements. Results The section presents findings from our interviews. First, we provide an account of what the interviewees perceive expertise in auditing to be, and how this expertise can be discerned in various judgement and decision-making situations. Then, we present how drivers of change in the form of increased regulation and digitalisation are perceived to affect the development and characteristics of audit expertise in the present and in the future. Expertise in auditing and how it is used

In colloquial terms, the term ‘expertise’ may, in the domain of auditing, bring associations to innate or built-up skills such as, for example, projectmanagement skills, presentation aptitude, and strong sociability. These characteristics are without doubt important, but they are too general (not unique enough) and do not fulfil the criteria for being considered an expert as per our definition discussed in the literature review. Given this, our interviewees were asked to elaborate and share their reflections on ‘expertise’ after first being given the definition of expertise adopted in this study. In the following accounts, we present our findings of this in some detail. Not surprisingly, the ability to understand and apply accounting regulations is considered to be an important area of expertise. Several interviewees point out that a lack of solid accounting knowledge can lead to the auditor operating at a too high risk level. Hence, the auditor needs to understand accounting but also how regulations should be applied. As one interviewee explains it: It all comes down to financial reporting. We need to understand and be good at accounting. In fact, this is a basic requirement. The clients do not work with auditing, they work with accounting. We must understand accounting regulations, what they say and how they should be applied. This is extremely important. (1C)

Expertise in financial auditing 345 In the quote above, the interviewee stresses the importance of applying accounting regulation. Not seldom, this is where the need for expertise becomes visible. The interviewees give several examples of such situations. What they have in common is that the auditor must make a judgement based on his or her long experience. In these situations, there is seldom one correct answer but several, depending on which assumptions are applied: Well, when discussing judgements, they are related to valuation. An example is when performing an impairment test for a possible goodwill write-down. In other words, ideally when should a write-down be made? […] An impairment test is built on forecasts, but the future has not happened and therefore, it is up to my experience to make a judgement: Can we trust this? Is it reasonable considering the surplus value that they report? (2A) The auditor thus needs to have long experience from the specific industry to be able to make the necessary judgements. An example is to evaluate whether the expected future profit margin that the company uses is realistic. Another example is how to judge macro-scenarios that banks are using when applying the IFRS 9 accounting regulation. To be able to have a qualified opinion about these scenarios, the auditor must understand in detail the specific bank’s business model, its customers, etc., but also how general economic conditions can be expected to affect the credit portfolio. This requires deep industry expertise as well as expertise in accounting. This is especially important when regulations are changed: It is also about having experience and being confident that you understand the regulations, even if they are new. That is more difficult for someone who does not have a point of reference, both to learn but also what it means in practice. (2C) In certain industries, such as the finance industry, it is not sufficient to know the accounting regulations. Auditors also need to understand the regulatory framework and how it should be applied. One of the interviewees even considers them to be more important and difficult to apply than accounting regulations: Accounting issues are sorted out immediately. They are not an open issue in the end…well at least in most cases. They have been handled, judged; this is how it will be. And we tell them if they are out of bounds. But these other questions [the regulatory framework4] are much, much more difficult to judge. There is no black or white. (1A)

346  Jenny Backman, Michael Grant, and Fredrik Nilsson Several of the interviewees mentioned risk judgement as a task for which expertise is important. There are tools used to identify a high inherent risk, but the auditor needs to judge which risks to focus on. One example: Basically, you put it through the tool, it runs an algorithm behind the scenes based on some parameters […] and then its sorts of spits out samples for you… I would say that … they should not be judgement items, well from a risk assessment perspective, of course there are judgements. Because we have to decide what is high risk or low risk at the end of the day. Sometimes it is more obvious than others. But that part is the judgement I would say. (2D) The use of checklists for judging risks does not always seem as important as expected, especially not for the type of deliberate practice discussed in the literature review. One of the interviewees explains: It is a fairly small share of the profession that is related to checklists. Perhaps you learn from them that some areas are important. But not how to handle them. Not how to … reflect on what can affect the risk level etc. I would say that it is a very small share, let’s say 10% perhaps of the actual learning that comes from checklists. The other learning comes from actually working with the client. (3B) Related to risk judgements is judgement of materiality. Based on the accounts from interviewees, there is no doubt that this task is of utmost importance and also a task in which expertise surfaces. As expected, the interviewees consider materiality to be not entirely black or white. It must, for example, be related to the rather vague concept of a ‘true and fair view’ and what stakeholders would consider to be material: Our profession, and the auditor´s report, are all about if the financial reports give a true and fair view without any material misstatements. They should be as true and fair that an external reader will make correct decisions based on the figures reported […] It is quite challenging, to know what an external stakeholder would consider to be material. Is it 10 million or is it 100 million? (1C) To have expertise, it is also necessary to understand whether an accounting issue is material or not. Even though this is often evident, there are many situations in which there is a need for discussions and judgements. In the finance industry, it is not uncommon for the client, the auditors, and their experts to

Expertise in financial auditing 347 come to somewhat different values of what is an accurate provision. This is illustrated as follows: We have our methodology that is based on materiality. It is calculated and set for each engagement and we need to take it into consideration when evaluating results and findings. It is about understanding if the deviation or difference identified is a misstatement after all? Many times it is a grey zone, everything is not black or white. We are focusing on the evaluation of these situations and questions in the audit. Both individually but also from an overall perspective. When doing this seniority and experience is important as that ensures that we make knowledgeable decisions that are within the thresholds set in our methodology. (1C) The discussion of materiality can also be very technical in nature and in these cases even very experienced auditors need to ask other experts. Several of the interviewees even seem to consider that a good knowledge of the limits of their expertise is typical of a high-performing auditor. An example is given below in which an expert describes how materiality is judged and how they discuss such an issue with the clients: How much provisions should be made to create a safety margin? I believe that we should argue that the client must be able to prove that this is a good, lowest or highest level. There is always an uncertainty interval, and you can be within that interval. To be outside it is not OK, and in that case you need to discuss with the company’s management about the factors that drive this uncertainty. (1D) Even though audit expertise seems to consist of mostly technical areas, such as judging materiality, it also encompasses an area related to the realm of psychology, that is the ability to judge people. At the most fundamental level judgement is about who to trust and who not. One of the interviewees explains: In most relationships you trust some people more than others. Perhaps there is even a tendency to accept accounts from people you trust and that have a good track record, compared to someone that ‘shoots from the hip’ and that is wrong or someone that you do not know that well. (2A) An open attitude and a willingness to explain are examples of personal characteristics that build trust. A negative attitude towards the auditor has the opposite effect, as shown in the quote below: It cannot be denied that if you visit a client that gives you clear answers, that is open and shows how they work will affect you, compared to

348  Jenny Backman, Michael Grant, and Fredrik Nilsson when they do not answer questions or claim that ‘we have acted in the right way.’ (1C) Most situations are related to a specific task of the audit assignment. Nevertheless, even in the most mundane of tasks, judgement of people seems to be of importance: So, when we come around to do the substantive part of test work, I will know that okay, this person did not really know the doubtful debt process, that detail, even though they are the control operator and the person, you know with the final review, how likely are they going to actually detect their misstatement. Maybe it is a little less likely than someone who knows the process and the accounting standard really well. (2D) In the following quote, the interviewee offers a reflection on what separates a novice from an expert when making judgements. It is especially interesting to note how the usefulness of checklists can depend on the quality of the information auditors will get from other people: A novice can ask ‘what do you mean by that’ but they do not really know themselves what they are looking for because they have only studied a checklist. They do not get the precise answers they have hoped for and to get that is an ability that one needs to develop. It has a lot to do with building relationships and trust with them who you are talking to. (3A) Finally, the interviewees consider holistic judgements to be an important area in auditing. This area is related to other areas identified: applying accounting regulations, risk judgements, and judgements of materiality. One of the interviewees describes what such a holistic judgement can mean and how it can be applied: You need to really understand the context in which the question applies. It is more about putting the right questions to management and to those who really understand the company. Because sometimes you ask the wrong person […]. It is more about…How will they develop this? What type of problems have they encountered before? […] To capture the right information and then use it in the audit. That is vital. Because you can be technically correct in your audit but still miss important aspects if you have not taken into account what is necessary when making the judgement. (3A)

Expertise in financial auditing 349 It takes many years of experience in auditing, as well as deliberate practice, to be able to apply a holistic understanding when making judgements. At the same time, there is a tendency to emphasise specialisation. The long-term consequences of this development are not clear as shown in the quote below: It feels like we tend to be moving towards people just specialising in one thing and becoming really good at that and they are the specialists as opposed to trying to know a bit of everything. I do not know which direction it will head in, but we tend to have a specialist who knows one thing, and they are really good at that one thing, and they just do it for everybody. (2D) How drivers of change affect the development of auditing expertise

The factor that the auditors themselves expressed had a most profound impact on their professional role and practice was the development towards increased regulation (in terms of expanded regulation and an increased complexity in regulatory frameworks). The interviewees described this development as, to a substantial extent, being triggered and substantiated by the financial crisis in 2007–2009 (e.g. the collapse of Lehman Brothers) and the earlier mentioned accounting frauds (e.g. Enron and Worldcom), forcing regulators to take increased measures to block potential holes in current frameworks. This advancement in regulatory frameworks has made it more demanding and challenging for (large) businesses to interpret and follow contemporary regulations, which in turn has made it more difficult for auditors, at a later stage, to monitor whether these businesses, that is their clients, meet all aspects of these regulatory requirements. In terms of what consequences this development in the legal domain has had for the role of the auditor, several interviewees express that it has led to an increased formalisation and specialisation in the work of the auditor. One interviewee argues that the increased use of checklists and the attention put on formalities – an even stronger emphasis on structures – is a result of increased regulations: I have to say that this [increased regulation] is what has had the biggest impact on my role as an auditor… and not just me as an individual but it has affected the work of the entire firm, how we conduct our work… and that’s where we are today with checklists and formalities. (1A) When the interviewees were asked to more concretely describe how this development towards more formalistic work procedures manifests itself, recurring examples were increased demands or expectations that the work of the auditor gets formally documented and that checklists are used in various

350  Jenny Backman, Michael Grant, and Fredrik Nilsson work processes. The structures become more important, or as one interviewee describes it: …there is today clearly a larger pressure and demands on us [auditors] to document more of our work. (1C) Another auditor made a similar comment illustrating a general perception that regulation has led to a much stronger focus on compliance and thus the formal aspects of auditing: The requirements of today are completely different, there is nowadays a lot more focus on compliance compared to just 10 years ago. (3B) Statements from various interviewees reflect a general ambivalence in attitude towards the increased presence of checklists in the operational work of the auditor. On the one hand, checklists seem to be perceived as tools that, to a certain degree, have reduced the individual freedom and flexibility of auditors, which is considered disadvantageous for the learning process and the development of expertise in auditing. As one auditor formulated it: … due to this use of checklists, more junior auditors have become less generally educated in their role as auditor. (2A) Similar deductions regarding the general effect of increased regulation on the human learning process were drawn by several of the interviewees. A compliance-driven demand for detailed knowledge in a dynamic and changeable environment was repeatedly mentioned as the reason why the possibilities for developing a wider palette of knowledge have been substantially reduced for newly authorised auditors. The extensive use of formalised and compliance-driven methodologies thus seems to require such a detailed knowledge about specific regulations that these requirements risk becoming fulfilled at the expense of foregone holistic learning and a more profound understanding of interconnectedness. A similar but more elaborated comment was given by another interviewee, reflecting on how this development can also have an influence on how judgements are made: … it is kind of like, if it is not on the checklist I do not need to look at it, or alternatively, now the checklist tells me to look closer at something but maybe I do not understand the relevance of doing so… I believe that our younger colleagues have not been trained to conduct their work without these checklists, and in this dependency on checklists, I do believe that some knowledge gets lost. … When I was young, we had

Expertise in financial auditing 351 to think for ourselves more on a case-by-case basis. But now it is more like, the checklist says I should do this so therefore this is what I do, even if it may not be relevant, or even correct. (2C) Several interviewees also made related comments that the increased focus on checklists and documentation, risks making the work of the auditor more mechanical, with less reliance on qualified judgements; and as a result, more boring. One interviewee made the following personal reflection: I can sometimes feel, as I had my training done before the implementation of all these checklists that back in the days maybe there was a short checklist with 10 questions or so, and now you sometimes have to go through checklists that are 80 pages long. (2C) However, the increased use of checklists was not rejected altogether as several interviewees pointed out that these documents, at the same time, also have a valuable methodological function. One auditor sums up what seems to be a general duality of pros and cons associated with the increased use of checklists: I know that many are of the opinion that the work has become more boring due to all these checklists, that there are so many demands and that everyone has to do the same task in the same way. And to a certain degree, I agree with this viewpoint, but then, on the other hand, these checklists also enforce us to perform our work in a more consistent manner. We are forced to work in a more uniform way so that we know that if our checklists are followed, then our auditing work is of high quality. And as an accounting firm, that is, at the end of the day, the most important thing, that nobody can question the quality of our audits, because if someone starts doubting the quality of what we do, then we are gone. (1C) Apart from regulations increasing formalisation and making procedures more compliance-driven, interviewees described a need for specialisation as another effect of the increased regulatory complexity. This seems to have significant effects on learning, not only for younger auditors but also for highly experienced and senior auditors. To keep pace with the rapid development, some auditors choose to narrow down their domain of expertise, as illustrated in the quote below. …our work has become more complex, which has forced me and other auditors to become more specialised… I have become a lot narrower in

352  Jenny Backman, Michael Grant, and Fredrik Nilsson scope and the boundaries of the domains in which I can work nowadays have become much tighter. (1A) Another key factor that the auditors emphasised as an important driver for change in the domain of auditing was digitalisation and developments in AI. Several interviewees explicitly pointed out that they foresee that the digital transformation will fundamentally change many aspects of how auditing work is conducted in the future. When asked to provide concrete examples for this, several auditors mentioned the use of much larger data samples and real-time monitoring of client transactions. As one of the interviewees expressed: …this will be a revolutionary change in how the auditing gets done. I believe, or I would be surprised if we, in five years, or I don’t know about five, but at least within a certain limited number of years, are not connected online in real-time with our biggest clients. That we monitor their flows of transactions in their accounting system on a daily basis. That we will be able to draw conclusions long before the business client may have drawn theirs, or that we will be able to draw conclusions at the same time. And that this will be based on data not only from samples, but from complete sets of data. We are heading towards this scenario, and that will require, which we are already experiencing, a completely different skill set. We need computer engineers; we need many more mathematicians. (1A) When asked specifically about the experienced and/or anticipated effects of these changes on learning or development of expertise in auditing, several reflective comments were made. For example, one interviewee expressed concerns regarding how standardisation can affect the training necessary to be able to make judgements: …the work will not be as much craftsmanship; it will be more standardised work. Maybe we will lose some parts in the auditing work if we become too standardised, I mean, how will the new generation of auditors get the training that will build their ability to make judgements? (3A) Similarly, another auditor made the following reflection of possible difficulties in developing expertise when digitalisation automates many tasks that are important to master in order to be able to make sound judgements: The issue, as I see it, is how do you get there [to be an expert]? How do you scrape up 10 000 hours on the way to become a highly skilled auditor, an expert in making certain judgements? If a computer does

Expertise in financial auditing 353 much of the work that you otherwise would have had to learn, calculating taxes and considering how the tax laws work… I mean, maybe it works, and it will work one way or another, but it deviates from the current way that we have to travel this road ourselves and learn things the way you build a kind of craftsmanship. (3A) At the same time, there seemed to be a general conviction among the interviewees that their roles would not be made obsolete in the future due to developments in IT. As one interviewee stated: …my role, that I have today, will still remain. Judgements based on collection of facts or information will still need to be made somehow. (3A) Another interviewee made the following comment, believing that judgements will always need to be made: …you push a button and then you get the information, but then someone still needs to make judgements based on this information. (1B) However, while there seemed to be consensus that the need for human judgement is, and will continue to be, irreplaceable in the domain of auditing, some interviewees offered reflections on whether their current roles may be filled by people with somewhat different profile in the future. A comment that illustrates this follows below: I think that there may be somewhat different kind of people that work with this in the future compared to today. Those people will be more skilled at analysing big sets of data, such as large flows of transactions, which to some extent we already do today although audit standards are yet not written for this. We already have the technology for it… but the audit standards are quite not there yet, we still need to do quite a lot of manual work. (3A) Conclusions and implications This chapter contributes to the literature on expertise in auditing by exploring what senior audit professionals perceive the concept of expertise to be in a ‘real-life’ auditing setting. The chapter also sheds light on two drivers of change that auditors perceive have affected – and will affect – the development and characteristics of audit expertise. Below, we discuss the findings and contributions of our study in some detail and relate them to earlier research in the area

354  Jenny Backman, Michael Grant, and Fredrik Nilsson of auditing expertise. There are also several chapters in this volume that discuss similar matters, especially the chapters by Annelin and Svanström, Carrington et al., Lennartsson, and finally, Marton and Papadopoulos. The findings of how auditors perceive expertise and how it is expressed in judgements can be categorised into five areas. The first area is judging how accounting (and other) regulations should be applied. Several of the interviewees described that the high level of expertise required had led them to specialise and only work with companies within one industry. An example was expertise in the finance industry requiring long experience and deep knowledge to interpret not only accounting and auditing regulation but also specific finance regulations. The second area is making risk judgements. Even though tools and checklists are available, interviewees stressed the vital importance of long experience and deep knowledge in these complex judgements. The third area is judging materiality. In many cases, that type of judgement is not clear-cut and must, for example, be related to whether the annual report gives the reader a true and fair view. To do that, the auditor needs to interpret and analyse a myriad of data. Not seldom, these judgements are difficult to make even for an experienced auditor since they can be affected by events that have not happened yet. The three areas of auditing expertise discussed above represent findings in agreement with earlier research (e.g. Ahn et al., 2020; Messier et al., 2005). Our findings contribute to this research by focusing on how audit expertise is perceived at the individual level. The other two areas of auditing expertise are judging people and basing judgements on a holistic understanding of the issues at hand. Judgement of people is an expertise to assess knowledge and capabilities of people at the client, or as one of the interviewees expressed it ‘reading the client’. A holistic understanding when making judgements is an expertise to grasp the ‘whole picture’, described by an interviewee as to ‘be able to solve the whole puzzle’. Since these two areas are not salient in audit research, we argue that their identification as significant areas of auditing expertise is a contribution to the literature. Furthermore, the findings show that expertise in auditing has changed over the last decade, driven by increased and more detailed regulation and digitalisation. Being an expert in auditing has thus meant to continuously learn and gain new experiences. The findings indicate, in line with previous research, that acquiring new expertise involves deliberate practice, that is, experience in combination with feedback and gradual refinement (Ericsson et al., 1993). Furthermore, an effect of the changes observed seems to be an even stronger specialisation of auditor expertise, for example, by focusing on specific industries. This is in line with research showing that industry specialisation increases audit quality (e.g. Audousset-Coulier et al., 2016). Similarly, the interviews provide examples of an increased use of specialists for tasks such as fair-value judgements or cybersecurity. This development further strengthens the direction towards specialisation in audit work. An explorative study of the kind we have performed can only provide us with tentative insights that need to be corroborated by doing more research in

Expertise in financial auditing 355 the area. Still, we argue that our study has several implications for scholars. First, it increases our knowledge about how auditors perceive expertise in a time period characterised by increased regulation and digitalisation. This provides a foundation for future studies to further investigate expertise within this domain. Second, the empirically generated insights about the perceived effects of these drivers of change could help researchers to re-calibrate their research agenda. The drivers that have been observed in this study, for example, the development of new information technology solutions, could lead to fundamental changes in what is perceived to be auditing expertise in the future. At the same time, it is far from certain that the type of expertise discussed in this chapter can be replaced by a machine. Thus, more research in this area is needed. For practitioners, this study contributes in a number of ways. First, and as pointed out earlier, practitioners sometimes have difficulty expressing in informal talks what they consider to be auditing expertise and instead mention generic skills like project management. To us, that type of skill is important but does not explain why certain auditors make more accurate judgements than their peers. Second, insights to how auditing expertise is perceived are valuable for understanding how it can and should be developed. This has implications for the audit profession, higher education, and authorities that decide on what grounds an authorisation should be given or revoked. To us, there is no doubt that expertise requires long and deliberate practice to reach the level of deep insights that are necessary to make the type of difficult judgements that an auditor typically does. At the same time, the study shows that to make these judgements it is necessary to have a holistic understanding of the company being audited as well as the auditing domain as such. This situation can be difficult to handle for the auditor since it is a great challenge to combine deep knowledge in a domain with breadth of knowledge. In addition, increased regulation can lead to a situation where specialisation is inevitable and where we need to redefine what we mean by a holistic understanding. Perhaps it can only be related to a subset of areas and in a particular industry. Such developments are clearly visible in other professions. In conclusion, the interviewees’ show that the context in which auditors operate is dynamic and continuously changing. In terms of perceived expertise, this gives rise to several important questions, such as what competencies contemporary and future auditors will actually need to possess in order to become an expert in the domain of auditing. Against this background, it becomes clear that the increase in regulatory requirements has significant implications for the development of expertise. Regulatory requirements are furthermore not static over time. Frameworks seem to be continuously changing, partly due to them being made more rigorous but also due to the incorporation of additional aspects such as sustainability and globalisation (mainly adaptation to the US regulations). The classic example in the literature on expertise is the chess player who reaches a superior level of playing this game due to talent, time, and effort. We can now conclude that such a traditional view of expertise is clearly not translatable to the contemporary auditor. Unlike the case of a chess player,

356  Jenny Backman, Michael Grant, and Fredrik Nilsson where the rules of the game do not change over time, the game plan seems to be continuously changing for the contemporary auditor. These contextual conditions thus need to be considered in order to genuinely understand expertise in the domain of auditing. Furthermore, if continuous regulatory changes pose a challenge to what the auditor needs to develop their expertise in, the digitalisation of many business practices has also given rise to changes in how the auditor develops their domain knowledge in the first place. As pointed out, the automation of more basic-level tasks has significantly reduced the time that younger auditors spend on practising and learning these more rudimentary aspects of the work, clearly posing an interesting revaluation of the standard point of reference in the literature that at least 10,000 hours of focused training are needed to become an expert. Will it be possible to skip that part of deliberate practice and still become an expert? This is a question for future research. When approaching this question however, we argue that it is crucial that drivers of change are considered in the development of a more profound understanding of what expertise actually is, and how it can be developed and maintained in the domain of auditing. Acknowledgements We are grateful to the Big 4 firm and the interviewees for generously contributing to this study with both time and expertise. Notes 1 We use the term ‘auditing’ in the running text instead of the longer term ‘financial auditing’. 2 See the webpage of the Swedish Inspectorate of Auditors (www.revisorsinspektionen. se/en/English). 3 ‘there is a nonlinear, or quadratic, relation between professional experience and audit effort; that is, the least experienced auditors exert the least audit effort, while the most experienced auditors exert less effort than the moderately experienced auditors, but still more than the least experienced auditors.’ (Che et al., 2018, p. 111) 4 Text in square brackets is filled in by the authors. Three dots in square brackets correspond to deleted text.

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Appendix: Research design This study is explorative and based on interviews. The overall objective is to gain knowledge of the concept of expertise in auditing by studying auditors’ perceptions of expertise and how drivers of change affect the expertise needed. The qualitative method used provides a nuanced and rich description of auditing expertise in ‘real-life’ settings, something that experimental (e.g. Mala & Chand, 2015) and quantitative studies (e.g. Che et al., 2018) lack. We contacted one of the Big 4 firms and were granted access to interview members of three audit teams of large companies in the finance, manufacturing, and retail industries. The reason for interviewing audit team members of large companies was to reach highly experienced professionals in the domain. In total, we performed 11 interviews with partners, directors, and managers. One of the interviewees was a specialist (1D in Table 16.1), providing important insights into boundaries and limits of auditing expertise. The interviews were based on an interview guide with broad questions. To ensure consistency in how the interviewees answered the questions, each interview started with a presentation of our definition of expertise. The following themes were covered during the interviews:

• The interviewee’s professional journey • Examples of judgements where the interviewee’s expertise in auditing has played an important role

Expertise in financial auditing 359 Table 16.1  Description of interviewees. Interviewee1

Age

Years of audit experience

Position

1A 1B 1C 1D, specialist 2A 2B 2C 2D 3A 3B 3C

>45 >45 >45 >45 >45 >45 >45 35–45 >45 35–45 35–45

>20 >20 >20 >20 >20 >20 >20 >10 >20 >10 >10

Partner Partner Partner Director Partner Partner Partner Manager Partner Partner Manager

• Changes during the last 5–10 years that have affected the interviewee’s work as an auditor and especially the requirements to continue being an expert

• Challenges in the coming 5–10 years affecting auditors’ work and requirements to continue being an expert

All interviews were carried out over Zoom and were recorded and transcribed. Each author interviewed the members of one audit team (one by one). To ensure consistency in how the interviews were conducted, one of the researchers participated in the first interview with the other two researchers. Subsequently, the first two interviews were discussed among the three researchers, and the way of conducting the remaining interviews was calibrated. The interviews were 50–90 minutes long, with an average length of 63 minutes. The analysis is founded on emergent findings in the data and the literature. The description of our analysis can be simplified into three main steps. First, one of the researchers read each interview and identified data related to auditors’ perception of expertise and how it is expressed in judgements. These fairly large pieces of text from each interviewee were copied to tables relating to each of the research questions. As a second step, the text was analysed in further detail, to identify categories. This part of the analysis was conducted jointly by all researchers. In the third step, an additional analysis was made of the text and categories, resulting in the themes presented in the findings. It should be noted that the quotes are translated (except in one case) from Swedish to English. Note 1 A is the signing partner, whereas B–D are the other experienced team members. All are authorised auditors except 1D, who is a specialist.

17 Auditing transformation Practitioners’ views Rakel Lennartsson On assignment from FAR

Introduction: Auditing into the future ‘Status quo is not an option’. This phrase is attributed to the former EU Commissioner Michel Barnier, who was responsible for the measures to tighten up EU auditing legislation in the aftermath of the financial crisis in 2008. Today, more than a decade later, it is repeated by Johan Rippe, auditor and partner at PwC, and Chair of the FAR strategy group ‘Auditing’, to express how the industry is undergoing constant change, to which it needs to adapt if auditing is to remain relevant. For the present and the foreseeable future – i.e. the coming 5–10 years – there are principally four underlying phenomena that are powering development in the industry: globalisation, regulation, digitalisation, and sustainability. In this chapter, we discuss how each of these four drivers is likely to affect and shape the audit industry. Their influence is not unidirectional, given that the relationship between external and internal factors is dynamic, where, on the one hand, the auditor is the object of legislation and, on the other, he/she is involved in creating and developing standards and regulations that are often assimilated into the legislation. As such, the auditor is not merely a passive recipient of change but also – and to a large extent – an active actor for change. This, in turn, is linked to the fact that auditors do not devote themselves exclusively to statutory audits; rather, the auditing profession has developed over the years into what is increasingly described as an industry where four strong brands have become truly global and now offer services other than audits per se: namely, accounting, tax assistance, consultancy, and the like. In Sweden, the various professional roles of the industry are brought together in the professional organisation FAR, which was founded in 1923. At that time, FAR stood for Föreningen auktoriserade revisorer, ‘The Association of authorised auditors’. Since 2010, however, FAR is no longer an acronym but the name of the professional organisation that has been developed over the years to encompass all professional groups who work at large – or small – accounting firms. In addition to auditors, these groups include bookkeeping services, tax advisors, and payroll services. While these services are DOI: 10.4324/9781003411390-21

Auditing transformation 361 provided by accounting firms of all sizes, the chapter primarily focuses on large accounting firms (the Big 4). It is important to emphasise that some changes have very different effects on large and small firms. For example, there is a tendency for standards to be developed such that they principally suit large companies and their auditors, which has resulted in objections from the smaller firms. Interestingly, their objections are increasingly coordinated at a global level, meaning that not only can the multinational accounting firms act globally – the smaller firms can do so too, through their professional organisations, for instance. The biggest firms with their seemingly inexhaustible resources and increasingly internationally integrated structures are, however, more able to position themselves at the cutting edge and act as drivers of development. That is why they constitute a strong example of the dual-directional dynamic linked to the four drivers for change studied here. The reflections presented in this chapter are based on three interviews. All interviewees hold central positions in the Swedish audit industry: Anders Bäckström, auditor and partner of KPMG, as well as Chair of FAR’s specialist group ‘Ethics’; Pernilla Lundqvist, accounting expert and partner of EY, as well as Chair of FAR’s strategy group ‘Accounting’ and FAR’s operative group ‘Financial reporting – accounting’; and Johan Rippe, auditor and partner of PwC, as well as Chair of FAR’s strategy group ‘Auditing’. The objective of the chapter is to forecast what we can expect in the coming 5–10 years. As such, this is a future-oriented chapter, which does not, however, prevent us from including an occasional look back to view the changes in context and to lean on history with a view to chiselling out a more finely detailed picture of the future. Globalisation: The audit is expanding In recent years, the slowing or decelerating globalisation, also known as deglobalisation, has been in focus. The COVID-19 pandemic of 2020 affected the global economy for almost two years, and it continued to have an effect on global supply chains thereafter. This was immediately followed by Russia’s war of aggression against Ukraine, which has inevitably exacerbated the problem: the energy crisis has driven inflation to record highs, and geopolitical unrest has risen significantly. All in all, these different sources of disquiet have resulted in both nations and companies re-evaluating their exposure and presence in certain countries, often as an effect of imposed sanctions. For example, as a result of Russia’s attack on Ukraine, the global accounting firms were obliged to cut ties with their Russian operations in the space of just a few months. At the same time as deglobalisation has become a regular topic of conversation, the global accounting firms have become more tightly integrated than ever, and these firms have transformed from their previous setup as networks to become increasingly integrated organisations, while standard setting and

362  Rakel Lennartsson regulation are being harmonised to an ever-greater extent. Auditors are not simply passive recipients of the regulation; they are largely involved in developing it, as it is in their best interests to do so. In the service of globalisation

The 1980s saw widespread deregulation of capital markets around the world, and this period can be seen as the start of a new era for the international economy, often referred to as ‘globalisation’. When capital and investments can flow freely across international borders, national accounting firms simultaneously begin to team up in global networks in order to help international investors and multinational companies in their business. For financial globalisation to succeed, however, new rules are required in the form of standardisation or harmonisation, and this is where the auditing and accounting profession has played a key role through its international organisations for setting standards. Pernilla Lundqvist relates that the IASC, the precursor to the International Accounting Standards Boards (IASB), was financed directly by the accounting firms and was composed of ‘people who worked at accounting firms during the day and wrote recommendations and standards at night’, as she puts it. In 2001, the IASC was reorganised and became the IASB. ‘This reorganisation was driven by the fact that it was not considered sufficiently impartial to have auditors write the standards and then review the financial reports prepared on their basis. Today, the establishment of standards is considered to have become more independent of the profession, but it is, of course, not completely separate. A balance must be struck between the desire to help influence and drive development, drawing on all the skill and experience we possess in the profession, and the desire to be independent’, explains Pernilla Lundqvist. Put another way, it is a combination of deregulation, on the one hand, and harmonisation, on the other, that has powered financial globalisation. ‘A precondition for the globalisation of the business community is a globalised regulation, combined with some degree of harmonisation or standardisation. If you are to be able to do business with the outside world, you must be able to understand the language of business – and to examine it’, adds Pernilla Lundqvist. In the wake of the 2008 financial crisis, there were many who thought that deregulation had gone too far. The EU launched a comprehensive legislative project to tighten requirements on the financial market actors, where the emphasis was primarily on banks and other financial institutions, but also on the work of auditors. The strict new regulations applied in particular to the auditing of Public Interest Entities (PIEs). As a result, this has caused a widening gap between being an auditor at an owner-operated enterprise and being an auditor at a large, listed company. In principle, all global companies are, by definition, Public Interest Entities (PIEs). The capacity to audit them correctly requires a global organisation.

Auditing transformation 363 When the EU tightened requirements on audits of PIEs, one of the objectives was to dilute the concentration on the audit market, which was dominated by the four big firms (the Big 4). For example, one of the new regulations was the introduction of mandatory rotation of auditors, principally to underpin the independence of the auditor, but also to open the market to additional competitors (European Commission, 2017). In practice, however, the tighter regulations for auditing of PIEs seem instead to have reinforced the dominance of the Big 4 on the market (ICAEW, 2021). ‘Increasingly high demands require more resources for R&D and for developing technologies, etc. – and this is so demanding that you have to have a global organisation. That is why there is less room for small accounting firms to carve out a place for themselves on the market’, says Anders Bäckström. The strict requirements are not only being imposed from the outside, however, but as the interviews reveal, the global auditing networks themselves are raising the requirements on their members. At the same time as additional requirements from the legislators are resulting in larger and larger global organisations; integration is on the rise within the global accounting firms, as Anders Bäckström explains. ‘The regional firms are becoming more or less one and the same firm. And if we suffer a failure in any country, it damages the entire brand. This means that we have to tighten up the structure, which is what we have done. Within KPMG, we have a new membership agreement which gives the global organisation much more influence than previously’. Big 4: A global power factor

The influence of the global accounting firms reaches much further than one might imagine. It is not just a question of influence based on size and resources but also through the relative superiority of knowledge that these firms enjoy. The big accounting firms have de facto interpretation precedence in advanced reporting and measurement issues. The International Financial Reporting Standards (IFRS) constitute the global accounting standard that all listed companies in the EU must apply. This standard is based on a set of principles, which means that the party applying them (i.e. the company, led by its CEO/CFO) has some room for judgement. In practice, however, the judgement is performed by large, global accounting firms. ‘If you were to ask the IASB [that publishes the IFRS], they would say: No, the Big 4 do not take precedence with regard to interpretation; it is up to the preparers to interpret the standards. In practice, however, we specialists at KPMG, Deloitte, PwC and EY have our bible-thick IFRS manuals, which we are obliged to comply with’, relates Pernilla Lundqvist. All listed companies in the EU have been obliged to comply with IFRS since 2005. The reform implemented is one of the clearest expressions of the globalisation in the field of accounting. Complex reporting and measurement issues are also crucial to the audit, so auditors consult with accounting

364  Rakel Lennartsson experts in their work to ensure that the company is acting correctly and appropriately. The switch from national to international accounting standards has placed more power in the hands of the global accounting firms. Before 2005, the major companies in Sweden followed the recommendations of the Swedish Financial Accounting Standards Council (Redovisningsrådet); while these were based on IFRS, the Council enjoyed supremacy in interpretation, which meant, for example, that IAS 18 could be interpreted differently in Sweden than in Germany, explains Pernilla Lundqvist. Today, no national body has a mandate to interpret IFRS. ‘FAR is not entitled to interpret IFRS; we work with IFRS questions, and we write referrals, but there is no suggestion that FAR should present a recommendation about how to interpret IFRS. The switch from national to international is, after all, a question of who holds supremacy in the interpretation’, affirms Pernilla Lundqvist. Each global firm has its own ‘bible-thick’ manual for how IFRS is to be interpreted, and it all comes down to precisely what Anders Bäckström mentioned: one and the same high level of quality must apply in all areas of the organisation. It has to do with protecting the brand – maintaining QRM perspective, as Pernilla Lundqvist says in the industry lingo. The acronym QRM can have a number of meanings, but in this particular case, it refers to Quality & Risk Management. In other words, the global accounting firms devote substantial resources to the quality assurance of everything they do, and this is ultimately all about risk management. Quality control as risk minimisation

The International Auditing and Assurance Standards Board (IAASB) is the independent global standard-setter for auditing. IAASB sets International Standards on Auditing (ISA), as well as the profession’s own quality standards: the International Standard on Quality Management, previously called the International Standard on Quality Control. ‘Only one letter differs, but the actual differences are huge. ISQC1 features a checklist approach, but ISQM1 sets out much greater demands on documentation and follow-up. We have to prepare a policy, implement it, appoint someone to check that we are complying with it, and someone else to test it; in short, it’s a SOX-type approach to quality management’, explains Anders Bäckström. For KPMG, the new standard has entailed hundreds of new checkpoints, some global and others regional. In Sweden alone, fully 350 new controls have been implemented, relates Anders Bäckström: ‘There is incredibly tight followup on all this, with the purpose of ensuring that we are not affected by any failure. We experienced one in South Africa a few years ago, and it affected the entire network. Not only does a failure require us to replace managers and implement new structures, but it also results in losses on the market.’ As such, the legislators and standard-setters are not the only ones raising the bar for internal quality control – the global firms are also contributing. It is expected that the development of higher and more cohesive QRM

Auditing transformation 365 requirements will continue with undiminished strength over the coming 5–10 years. ‘Of course, something could happen that will challenge everything that we hold as true today, but it’s difficult to see what that could be’, says Anders Bäckström. Regulation: En route towards two professions? In one sense, regulation is the most tangible and best defined of the four identified drivers for change: it comprises legislation and regulations set out in black and white. At the same time, it is hard to pin down as a driver, because it is not distinct, but – as we have seen – closely linked with, for example, globalisation (financial deregulation/regulation) and – as we will see shortly – the transition towards a more sustainable economy. Auditing is a tightly regulated field, but the situation is not completely unambiguous. On the one hand, there is a trend towards simplifying and reducing the regulatory burden for business owners and entrepreneurs. This has, for example, resulted in Sweden having abolished statutory audit for small enterprises since 2010, with bodies such as the Confederation of Swedish Enterprise pushing for more companies to be exempt. Over the past few years, other parts of the audit industry – with FAR and other Nordic professional organisations taking the lead – have increasingly been recommending that less complex companies should be offered a simplified form of auditing (Malmström, 2021). On the other hand, there is, as we saw in the section about globalisation, a trend towards increasingly strict requirements for PIEs, combined with tougher internal controls at the biggest accounting firms (see also Broberg & Tagesson, and Sonnerfeldt & Eklöv Alander, in this volume). External and internal regulation

The call for an alternative auditing standard for less complex companies aligns with precisely those trends that were mentioned in the section about globalisation: a combination of political keenness for regulation and the industry’s increasingly sophisticated risk management has resulted in exceptionally high requirements on the auditing of PIEs, i.e. large, listed companies, and multinationals. ‘The difference between being an auditor at a PIE and being the auditor at a different kind of company is growing wider and wider’, says Anders Bäckström. It has occasionally been said that being an auditor at a large, listed company and being an auditor at a smaller, owneroperated company are almost two different professions and that the audit itself should therefore be differentiated (Emilsson & Malmström, 2022). This issue is linked to the debate about the threshold for statutory audit, where one argument for raising it (i.e. exempting a larger proportion of companies from statutory audit) has been that audits are not relevant to these companies. However, if audits were adapted to the needs of smaller companies, they would be more cost-effective and relevant to these companies, too. FAR has

366  Rakel Lennartsson been pushing the issue of an adapted audit for Less Complex Entities (LCE), and the IAASB is now working to develop an ISA-based standard for these companies (Lennartsson, 2020). On the one hand, there is a trend towards deregulation and simplification, while on the other, there is a trend towards higher requirements on PIEs and their auditors. To an extent, the profession, therefore, finds itself in a dual position whereby it is both defending statutory audit and asserting the market value of audits to clients. ‘Had there been no regulation at all, I’m convinced that the stock- and other capital markets would have wanted auditing of certain types of companies’, says Johan Rippe, who continues: ‘But as you are dealing with the general public’s money – pension funds, for example – you cannot place the decision in the hands of a board; there has to be a set of external regulations about how an audit should be performed and how an accounting firm should act.’ Johan Rippe differentiates between external and internal regulation, where external regulation centres on legislation, while internal regulation has to do with how accounting firms organise their operations so as to optimise their business at the same time as minimising risks. Between the legislator and the accounting firm, there is an intermediate level consisting of the profession’s own organisations and standard-setting bodies. Sometimes, they operate on delegation from the legislators, while at other times they serve as referral bodies or lobby organisations in the legislative process. A general perception in the audit industry is that crises and failures lead to a demand for tougher regulation to prevent future failures. A clear example of this is what is known as the ‘audit package’ that the EU introduced in the wake of the 2008 financial crisis. ‘When companies and banks collapsed, it cost society a great deal of money and investors lost their investments – and this all happened shortly after these banks had been given clean audit reports from their auditors’, says Anders Bäckström. He continues: ‘When the cost to society is high, it is essential for politicians to demonstrate their power to act, and the tool they use in this context is regulation; they are evaluated on the basis of their activity in legislative assemblies.’ Ambiguous relations to regulation

Despite the fact that, in principle, new regulation always entails increased demand for the services of the audit industry, FAR and other professional organisations are often critical of regulations that the business community considers unnecessary or inappropriate. ‘We in the profession often hear that we create regulations in order to generate more work, but this is simply not true. Go out and ask the auditors and providers of bookkeeping services themselves; they will generally tell you that they don’t want more regulation’, says Pernilla Lundqvist. Calling to mind the profession’s irritation with EU Commissioner Michel Barnier in connection with the EU’s adoption of its new auditing legislation in the early 2010s, Pernilla Lundqvist’s statement reflects a relatively widespread

Auditing transformation 367 opinion among auditors and accounting specialists. The push-back against the regulations from the EU was strong, and Swedish auditors found a sympathetic audience in the Swedish government, which, jointly with the British government, took a stand against what was perceived as increased centralised control stemming from France. Since then, the UK has been hit by a number of major corporate failures (Carillion, BHS, Patisserie Valerie), left the EU and actually sharpened its tone against its domestic audit industry (Jones, 2022). The Brydon Report that was published in the UK in December 2019 received some attention in Sweden. It was followed by several reports and white papers in the UK, while within the EU, the Commission has held an open consultation on how the quality of corporate reporting can be enhanced. The outcome of this consultation, which was published in July 2022, reveals broad support for audit and a desire for continued harmonisation of auditing legislation at the EU level. For example, a majority of the respondents would like to see greater coordination of the regulation concerning mandatory rotation of auditors, and the respondents are generally in favour of a limitation of national exemptions (European Commission, 2022). Almost ten years after the audit package came into effect, Anders Bäckström answers ‘yes’ to the question of whether the tightened legislation has had the intended effect: ‘I think so. I’m convinced that you make an extra effort when you’re exposed to external pressure. I’ve been working with auditing for 32 years now, and there is such a huge difference between what we do today and what we did 32 years ago; it might as well be two different planets. The quality today is much, much better.’ At the same time, Anders Bäckström emphasises that the audit is part of an ecosystem, and that it is the entire system that has improved: the regulation, the companies’ internal controls, and the development of technology. ‘We are witnessing constant development in all areas of this ecosystem, and the auditor is contributing to the pot.’ The profession is prepared for additional tightening of the regulations, and this is not necessarily viewed as a risk: ‘No, I don’t actually see it as a risk, more of an opportunity. It is important to remember that the changes in the UK are being made to reinforce the industry; the regulations are being tightened because audits are in high demand and extremely important’, says Johan Rippe. He underlines that for the audit industry the risk is not to be found in regulation itself, but in being too late to adapt to new rules. This applies in particular to the area of sustainability. Is the EY split showing the way?

In the summer of 2022, it was announced that EY planned to separate its auditing and consultancy services in order to avoid conflicts of interest and to reinforce independence. A separation is something that the legislators have previously threatened to impose but have not yet followed through. Instead, it may now be a case of the industry taking the step on its own initiative. That said, great attention is being paid to the underlying driving forces. When PwC was

368  Rakel Lennartsson considering a similar proposal a few years ago, it reached the conclusion that separation was not the way to go, and Johan Rippe is sceptical as to whether the audit stands to gain anything from such a separation: ‘The proposal may well stem from certain consultants who want to implement a split because they feel they can grow more quickly if they are not part of an accounting firm. That is not to say that this is the best way to go for EY as a whole’, he says. Both Johan Rippe and Pernilla Lundqvist stress that the audit needs the assistance of expert consultants from the areas of accounting, tax, and sustainability. This means that even if auditing and advisory were to be separated, there would still be a need to work together across these two areas. For this and additional reasons, Johan Rippe does not believe in enforced separation: ‘There are a few politicians in favour of it, but this is not currently the view of the majority.’ Anders Bäckström presents a slightly different interpretation: ‘KPMG has said that it is important to retain the multidisciplinary model, but I’m not sure that this is what will happen at the end of the day. It may well be that EY is a pioneer, and that we will see this kind of separation taking place within the other members of the Big 4’, he says. ‘I think that the independence “in appearance” is so important that it makes no difference whether it is good or bad, as long as – from the politicians’ perspective – it looks better and reduces the risk of the auditor not appearing independent. But it is not certain that separation will have to be enforced through legislation. We are already noting that large audit clients are less inclined to purchase advisory services from their auditors. My interpretation of this is that the audit clients themselves realise that independence is important, and that they are demonstrating this by separating the purchase of audits and audit-related services from other services’. At the same time, it seems that the audit industry would rather anticipate than be pre-empted. As of December 2022, the International Federation of Accountants’ (IFAC)1 independent ethics body, the International Ethics Standards Board for Accountants (IESBA), has updated the code of conduct for auditors in a direction that goes much further than what has been suggested by the legislators. In brief, it has to do with extending the definition of PIEs, which means that more companies will be subject to tougher regulations, such as stricter requirements regarding the independence of the auditor and a longer list of ‘prohibited services’ (i.e. consultancy services that may not be sold to an audit customer), as well as requirements for pre-approval from the audit committee to conduct other types of services (than auditing), to the extent that they are permitted. In other words, this is quite a tough tightening of the rules coming from the industry itself – rather than from the legislators. Digitalisation: Improving the efficiency of the audit During the 2010s, digitalisation was heavily in focus with regard to transformation of the audit industry. Today, ten years later, the focus is largely on geopolitics, the climate crisis, and sustainability issues, but the impact of

Auditing transformation 369 digitalisation remains highly tangible. It affects all levels of the organisation, from workplace design to how legislation and accounting standards must be adjusted to encompass all new phenomena and business models that stem from digitalisation. In contrast to other drivers of change, digitalisation has to do with a technology shift, but, as everyone knows, new technologies always give rise to major social upheavals. The printing press, the telephone, the TV, the VCR, the mobile phone, the Internet, and the smartphone all revolutionised some aspects of human existence in just a short period of time. For the audit industry, digitalisation entails changes in all dimensions of the business. The paperless office

In recent years, both KPMG and EY have relocated their Stockholm offices to new premises built to accommodate the demands of the new working life (Lennartsson, 2021). In connection with KPMG’s relocation in 2016, it was decided that the new office was to be not only completely digital (no hardcopy folders), but also completely activity-based (no separate rooms, not even for managers). ‘This didn’t suit everyone, with many people choosing to retire a little earlier than they otherwise would have been planning to. A lot of people really do want to sit in their own office, but there are no “fixed” desks here, not even for our managers. So, it has been quite a journey, but we now work completely and fully digitally’, says Anders Bäckström. Immediately before the pandemic broke out in the winter/spring of 2020, Microsoft launched its Teams app, and many accounting firms had recently introduced this new, improved alternative to Skype. Conditions for starting to work remotely were therefore pretty good when employees were encouraged to work from home in order to limit the spread of infection. Actually, the Big 4 were quicker than the authorities to implement such policies. Many people in the audit industry have confirmed that the pandemic added impetus to the digital transformation in the various firms. ‘Teams and the pandemic meant that we could take a giant step forward, and they helped us skip several years in our digital development’, says Anders Bäckström. The pandemic has irrevocably altered working life. Now that everyone has experienced the potential of remote working, no one wants to turn the clock back to the humdrum existence of office life. Allowing employees to choose where they want to work from has become a competitive parameter, especially in industries where competition for labour is tough – which applies in particular to the audit industry. Accommodating individual wishes regarding working from home at the same time as covering the needs of the accounting firm for team building and knowledge transfer between generations is quite a challenge. In other words, even though the technical opportunities for remote working are in place, this leads to new difficulties: there is a risk that new employees will feel isolated, while team leaders and experts are increasingly overbooked. ‘It’s absolutely hysterical; there are times when I receive literally

370  Rakel Lennartsson hundreds of e-mails a day. That means I spend my entire working day doing nothing but reading my e-mails. It has become so simple to fire off enquiries and to book meetings, and the situation has only been exacerbated by the pandemic’, relates Pernilla Lundqvist. Although gains have been made through the opportunities opened up by remote working – for example, international exchange has increased in step with the lowering of the threshold for digital meetings – there have been losses, too. Over and above the opportunity to interact with new employees and to give them a solid introduction to the skill of auditing, digitalisation has meant that important breaks and periods spent travelling have been erased from the diary. Previously, there was much that could be discussed when you ran into a colleague on his/her way between two meetings or in the queue for the coffee machine; today, however, all working hours are neatly scheduled in the digital calendar that is shared with everyone. The locationdependent obligation for presence has disappeared, but working life has, in a way, become even more humdrum. New opportunities: New challenges

Digitalisation has also changed auditing as such, given that it has brought with it a set of new and revolutionary tools. At a fundamental level, it has to do with the fact that paper and cardboard folders have been replaced with cloud solutions and web portals. Everything is accessible at all times and from anywhere in the world. Digitalisation means that time and space cease to be limiting factors. Not only can employees work remotely, but companies can now have employees in several time zones. Large accounting firms increasingly outsource simple tasks to what are known as ‘delivery centres’. These are tasks that cannot actually be automated but that can advantageously be performed by students or by cheap labour overseas. These centres can thus be located in university towns or in low-cost countries in Eastern Europe. India is also a popular choice because its location in a different time zone allows accounting firms to utilise more hours of the day. A key aspect of digitalisation is automation. Software robots and Artificial Intelligence (AI) can process volumes of data that are simply overwhelming for human beings – incredibly quickly, too. ‘We perform audits much, much more efficiently now with the aid of digital tools. Today, we can monitor entire transaction volumes instead of having to take random samples, so we have witnessed a huge change over the past 5–10 years’, says Johan Rippe. It is particularly applicable when you have to review the valuation of a securities portfolio or a warehouse inventory. ‘If you look at different industries from the perspective of digitalisation, it is clear that the audit industry has undergone the greatest change. Around 15 years ago, it was common to work with review programmes in Excel. Audits with data analysis are a whole new world, a whole new way to carry out reviews – and you can examine much more’, says Pernilla Lundqvist.

Auditing transformation 371 There is a general consensus that digitalisation has had a revolutionary effect on audits. On the other hand, the change of pace has sometimes been exaggerated, argues Johan Rippe. ‘It is highly unlikely that companies will be able to generate their financial information at the click of a button – and in the same way, it will not be possible to press a button and run an audit. I think that there is sometimes a tendency to over-estimate the speed; I don’t think things will really move as quickly, and a part of the reason for this is that we live in a regulated world; we cannot run faster than the supervisory authorities’. Nor do the increasingly sophisticated tools eliminate the auditor’s responsibility, according to Anders Bäckström (see also Carrington & Catasús, and Jansson et al., in this volume). In 5–10 years, one can still expect that the international auditing standards (ISA) will have been updated to align more neatly with the new reality involving greater involvement of automation and AI. For example, the IESBA is working to prepare a new standard concerning reliance on Information Technology. However, for accounting experts, in contrast to auditors, digitalisation has relatively little impact on their work in practice. ‘Indirectly, it does have some effect; for example, if I need the supporting documents for something or other, I can access them quickly. But I can’t deal with the actual accounting issues any more quickly on account of the digital aspect. In fact, it’s more like we accounting experts have been handed a new set of problems to solve’, says Pernilla Lundqvist. Thus far, digitalisation has given rise to servicification, such that companies have moved from investing in things to purchasing services instead. ‘Instead of owning and controlling your own IT system, everything is cloudbased now, and this naturally gives rise to new types of accounting issues: What happens to investments if I choose to invest in a cloud solution rather than a system developed in-house? Can you actually capitalise an investment of this kind, or do you have to expense it?’ asks Pernilla Lundqvist. She highlights the difference from an accounting perspective between buying and leasing an asset, as opposed to purchasing a service: ‘If you buy an asset, it appears on the balance sheet; if you lease an asset, it appears on the balance sheet under IFRS but not normally under the Swedish GAAP, and if you were to purchase this as a service – as a part of a vehicle pool, for instance – then the underlying asset is not recognised on the balance sheet. And if you buy this as a service instead of purchasing it as a system, your up-front expenses may be just as big, or almost as big, but you cannot capitalise it. This naturally affects the accounting, and it will take an analyst to make sense of it, because all types of digitalisation give rise to a host of new accounting issues’. Pernilla Lundqvist believes that the greatest challenge from digitalisation to the field of accounting is linked to intangible assets. ‘Industrialisation was characterised by a great deal of tangible fixed assets, which we have learned to deal with. You can see a factory; you can go in and physically touch the production line – you can see that it is there. But all the know-how, all the technology, all the digital stuff, how can this be reflected on the balance

372  Rakel Lennartsson sheet? Intangible assets constitute a huge challenge for accounting because they raise completely new questions’. The battle for talent

In the early days of digitalisation, one of the biggest concerns in the audit industry was that the work would be taken over by machines. This applied primarily with regard to bookkeeping and simpler accounting tasks, but there was a feeling that auditing itself would be under threat in the long term. Ten years down the road, however, the industry is in need of recruits like never before. Less complex tasks have been automated to some extent, but at nowhere near the same pace as new tasks have appeared; burgeoning volumes of data are creating more, rather than less, work. In addition, more sophisticated auditing tools are raising, rather than lowering, the requirements on staff. This is all happening at the same time as the industry is finding it increasingly difficult to attract and retain employees, for reasons that are, in part, related to digitalisation, but also to other megatrends that are shaping society and the coming generations. Johan Rippe views this as a broader societal change: ‘Previously, when you went to college and university, you targeted your education to a greater extent towards a specific profession, and once you had done so, you largely stayed in this profession. Today, it is striking to see how often people switch jobs, industries, and professional roles. I think that the accounting firms need to take this into account: what does a lifetime journey actually entail for a highly qualified person? After all, everyone wants to make the most of their life, and I think that a lot of people fast-forward through their life journey by switching jobs from time to time’. The younger generation’s approach to their working life and career poses a significant challenge to the organisation and incentive structure of the audit industry, which are based on people building a career at one and the same firm, and then receiving their reward if/when they are made a partner. According to Johan Rippe, the industry – and particularly the Big 4 – needs to take a long, hard look at the career paths: ‘A lot of employees can find better paid work by leaving the accounting firms and seeking new opportunities in the business community. This has to do with the fact that your salary only rises at an accounting firm if you stay there for a longer time. Is the gap in remuneration compared to the rest of the business community justifiable?’ The challenge facing the accounting firms over the coming 5–10 years is not only to be a competitive employer but also to recruit the right skills when, as Johan Rippe puts it, ‘the whole of society is looking for qualified knowledge’. He believes that the industry needs to establish a clear image of what it needs in terms of people and skills 5–10 years from now. ‘It’s a really short timeframe. If universities are to educate different types of people, they need to reorganise their courses, and this takes time’ (see also Carrington et al., in this volume).

Auditing transformation 373 At KPMG, people are one of the three pillars of the firm’s strategy. It is a question of relations; it is essential to have staff who can build relations. In addition to the right mix of technological skill and expertise in areas such as accounting, tax, or sustainability, accounting firms need staff who are both creative and social. Anders Bäckström emphasises that they must be able to recruit people who can become skilled not only in the craft itself but also in interaction with clients, with the capacity to communicate in a relevant manner. Johan Rippe concurs: ‘Previously, we employed people because they were interested in accounting and liked to work with numbers. It’s fine if you like accounting, but you’ll never become a good auditor simply because this is your passion. There are a range of other skills that are essential if you want to be a good auditor’, he says. Sustainability: The future promise of the audit Over the coming 5–10 years, the rapid expansion of the sustainability issue is expected to power growth in the audit industry. The impact will be felt in particular within the Big 4: this is where the biggest clients are to be found, those who are first to be hit by the expanded sustainability regulations from the EU. However, smaller enterprises and their auditors will also be concerned as the EU’s new sustainability directive – the Corporate Sustainability Reporting Directive (CSRD) – is progressively being expanded to encompass more companies. Moreover, the CSRD requires concerned companies to report their impact through the supply chain. The objective for both legislators and firms in the industry is for sustainability reporting to be on par with conventional financial reporting and, thereby, to become a key tool in the financial transition necessary to fulfil the UN Sustainable Development Goals (SDG) by 2030, as well as the EU’s promise of carbon neutrality by 2050. Historical development

The concept of ‘sustainable development’ was first mentioned as early as the late 1980s, but it has become increasingly disseminated over the past decades. Before the 2010s, it was more common to speak of environmental accounting and environmental audits. Precisely ten years ago, in 2013, the IAASB established a standard for auditor certification of non-financial information: ISAE 3000. There is also a Swedish version of the standard, prepared by FAR under the name of RevR 6. That same year, the EU adopted the NonFinancial Reporting Directive (NFRD), which made sustainability reporting mandatory for the largest enterprises. In 2015, the Board of FAR decided, at the urging of employees, that as of 2016 the organisation was to establish its own sustainability reporting. It was a question of not only credibility but also upskilling. Subsequent events have shown that this was the correct move to make, even though not everyone was

374  Rakel Lennartsson equally convinced at the time. The market for sustainability auditing is expected to become something of a gold mine. It has mobilised the industry to defend its unique skill set, from the perspective of the risk of losing a market potentially worth billions. The European Commission has estimated that the annual market for sustainability assurance in Europe will generate revenues of between USD 4 and 8 billion (Schwartzkopff, 2022). Influential voices in the EU Parliament have argued that sustainability assurance should be performed by special independent assurance service providers in addition to auditors, who are already considered to hold an overly dominant position in the market. For its part, the audit industry has argued that as the financial auditors are familiar with the methodology, they are best qualified to guarantee the quality of the audit. Moreover, there is a direct link between the financial information and the sustainability information. Over time, these two are likely to become increasingly integrated, which means that it would be only logical to have one and the same auditor. The political compromise – thus far – is to allow both auditors and other qualified reviewers to certify companies’ sustainability reports when the CSRD comes into effect in 2024. The EU is now to prepare a standard for sustainability audits: according to the schedule, a standard for limited assurance should be ready in 2026 and one for reasonable assurance in 2028. Are developments in the field of sustainability moving quickly or slowly? Given that her doctoral thesis from 2014 centred on the development of accounting standard-setting and practice since the end of the 1800s, Pernilla Lundqvist is well placed to put sustainability audits in an historical perspective. When IFRS became mandatory within the EU in 2005, the issue of international harmonisation had actually been under discussion since the 1960s and dealt with in practice since the 1800s. From this perspective, sustainability reporting has developed quickly. On the other hand, when the European Sustainability Reporting Standards (ESRS) are adopted in 2023, it will have been close to 40 years since the concept of ‘sustainability’ was first introduced and more than 20 years since the Global Reporting Initiative (GRI) introduced the first guidelines for sustainability reporting. For her part, Pernilla Lundqvist did not think that she would personally be involved in the shift. She relates that she considers herself to be firmly ‘core financial’ and had not envisaged taking an interest in the broader perspective. ‘It is only now that, as a financial accountant, I am really starting to take this seriously; I can no longer refer tasks to sustainability specialists, we have to merge our skills’. No longer non-financial

A common objection to sustainability reporting is that it cannot be boiled down to a result on the bottom line. The reason for this is that different units are used to measure different aspects of sustainability: tons of carbon

Auditing transformation 375 dioxide, litres of water, numbers of employees, etc. such that it is not possible to add them together to produce a weighted result. However, this should not be misunderstood as meaning that sustainability data are not financially significant. Quite the reverse, according to Pernilla Lundqvist, who emphasises that the change of name from the ‘Non-Financial Reporting Directive’ to the ‘Corporate Sustainability Reporting Directive’ is not without significance. ‘One of the reasons for the decision to switch from NFRD to CSRD was to eliminate the expression “non-financial”, because this issue most certainly does have a financial impact’, she says, continuing: ‘Whether you call this integrated reporting or whether you’re not really bothered, it doesn’t matter what label you put on it, but you shouldn’t draw any boundaries between financial and non-financial, or between monetary and non-monetary; you need to take a company’s value as the basis’. Pernilla Lundqvist believes that we can already generate figures that reflect the value of a company from the perspective of sustainability. As a pedagogical example, she highlights mail and parcel carriers. On the one hand, there is a state-owned mail service with a statutory assignment to deliver letters and parcels in all areas of the country, while on the other, there is a string of private operators offering their services in areas where a profitable market exists. ‘If you were to compare the state-owned company with the private challengers, the financial statements of the latter would look much more profitable, and if you were to evaluate the company on this financial information alone, the state-owned mail carrier would be a no-go’, she says. The point is that when you evaluate a company on the basis of sustainability and talk in terms of impact, the state-owned mail carrier with its societal mission will score much more highly than the challenger, which may well be financially profitable but does not have the same impact as the state-owned mail carrier. So, the sustainability information will gradually become noticeable in the financial figures, as Johan Rippe explains: ‘The figures will be affected in that a company that is profitable but does not work in an ethically, socially or environmentally sustainable manner does not have a future, and it will not have long-term positive earnings either’. Growth and trust

When the CSRD comes into effect in the immediate future, the task of the auditor is certain to develop significantly. In a ten-year time horizon, the sustainability audit may well become just as large a business area as the conventional areas of audits, consultancy and tax. If this is indeed the case, sustainability auditing alone might account for growth of around 25 per cent. Demand is undoubtedly set to be strong; it is the access to human capital that will be the limiting factor, i.e. the capacity to recruit people with the right skills sufficiently rapidly to meet demand. Nor will auditors have exclusive rights to the market given that other experts in sustainability may have the opportunity to compete on the new review assignment that will stem from the CSRD.

376  Rakel Lennartsson A critical factor for the growth of the audit industry over the coming years will thus be skill development. The industry is ‘in great need of sustainability skills’, says Pernilla Lundqvist. At the same time as the firms are attempting to recruit as many as they can, they are also training their existing staff in sustainability. All departments must have a minimum measure of understanding of sustainability, as sustainability affects all areas of a company’s business and operations. ‘We run a mandatory training course for both auditors and non-auditors – all our staff at global level. It is a huge undertaking, and we see huge opportunities with regard to ESG’, says Anders Bäckström. Another expected development is the acquisition of entire companies in the form of consultancy firms specialising in sustainability accounting. This is set to mirror what happened in connection with digitalisation a few years ago when accounting firms quite simply acquired skills by purchasing digital consulting firms. That said, there is more to sustainability than just capturing a share of the new, rapidly expanding market. Sustainability is also of interest from a strategic perspective, as it builds trust – which is the very foundation of auditing. ‘As a member of society and a representative of the industry, it is clear to me that we can no longer continue passing on responsibility to the next generation’, says Pernilla Lundqvist, who adds: ‘We sell trust, after all – and sustainability is a key confidence generator’. Anders Bäckström concurs. In his opinion, sustainability has a bearing on not only growth, but also trust, which is why ESG (Environmental, Social, Governance) is a key pillar of KPMG’s global strategy: ‘If we are to be credible, then we ourselves must have a strategy built on sustainability’. Summary and conclusion: The audit ten years from now In spite of geopolitical unrest and indications of forces opposing globalisation, there is no sign that the growth of the biggest accounting firms is approaching saturation. For 2021, Deloitte increased its global reported revenues by almost 20 per cent, which means that the largest accounting firm in the world generated income of almost USD 60 billion. For the same period, PwC and EY reported global income of USD 50 billion and USD 45 billion, respectively. KPMG, which is the smallest of the Big 4, still reported global revenues of USD 32 billion for the financial year 2021. If we add up the amounts available in 2022, they point to global revenues in the neighbourhood of USD 190 billion, which is comparable to the EU budget for 2022 that totalled approximately EUR 170 billion. Historically, globalisation has played a crucial role in the success of the Big 4, and this is likely to remain the case, despite indications of a certain amount of global de-integration. Over the coming 5–10 years, growth is expected to be driven to an increasing extent by digitalisation and sustainability. In addition to automation and efficiency improvements, digitalisation

Auditing transformation 377 entails the development of new business models, which, in turn, demand development in the fields of accounting and auditing. Digitalisation has also opened the door to an intangible universe of data, services, and ideas, where growth is not restricted by physical constraints. Capturing this new dimension of the economy is quite a challenge – particularly from the perspective of accounting. The world has been talking about sustainability for more than 35 years, but it is now that things are actually happening. The requirement from the EU that large enterprises present audited sustainability reports is opening the door to a new market that is worth billions for auditors in Europe. However, it is not limited to Europe. Not only are similar initiatives being adopted in other parts of the world, but also sustainability reporting is, by definition, a global phenomenon because the reporting companies must also control their supply chains. This aspect also means that even small enterprises will ‘feel the effects’ of the legislation; even though they are initially not directly hit by the laws, being suppliers to companies that are obliged to submit sustainability reports they will feel the impact indirectly. The complexity and scope of the issue make the field of sustainability an immense emerging market for the big accounting firms. So, is there nothing that can stop the growth of the audit industry? Yes. There is a critical factor that limits how fast the industry can grow, namely, human capital. The accounting firms are engaged in an actual recruiting race, where they are in competition not only with one another but also with alternative careers and other consultancy firms that offer attractive positions, especially in the field of sustainability. The battle for talents is likely to ramp up the pressure on the biggest accounting firms to accelerate the pace of their internal work with diversity and equality, and to reform both career paths and remuneration models. These are issues that have been debated for many years, and there is every reason to believe that the discussion will continue unabated. While it is naturally a matter of being the most attractive employer brand, it also has to do with the accounting firms’ internal work with sustainability. As a major supplier of sustainability services, there is an obligation to ‘walk the talk’, and this will certainly require firms to report their climate impact and their gender pay gap; moreover, firms will have to be transparent about their tax situation, about the working conditions at their suppliers, and so on. Accounting firms possess the skills required to generate state-ofthe-art sustainability reports, and as their undertakings in this area increase, so will society’s expectations. Historically, auditors have played a key role in the development of the global economy with the dismantling of obstacles to trade and the deregulation of capital markets. If this trend has peaked and we are en route to an actual de-globalisation – or, at least, a new global world order (Foroohar, 2022) – then partially new tasks await the auditors. When the EU Parliament adopted CSRD with a large majority in November 2022, the enclosed press release stated that: ‘This would end greenwashing, strengthen the EU’s social

378  Rakel Lennartsson market economy and lay the groundwork for sustainability reporting standards at global level’. The new task facing the auditor as an assurer of the company’s contribution to the transition of the economy may also unite the two objectives that the audit is to achieve: to both work on commission from the shareholders, and in the public interest. In summary, the general impression is that the relevance of the audit is not under threat at all – quite the reverse. There is nothing to indicate that digitalisation, automation, and AI will replace the human auditor. In addition, auditors have been given a whole new area to focus on: the field of sustainability. When auditors team up with engineers and other experts in order to apply their skills to the new economy, they have an opportunity to make a significant difference. If they accept this challenge, they will have not only succeeded in securing their market for the foreseeable future but also managed to maintain and potentially reinforce the relevance of the audit. Note 1 IFAC is the international umbrella organisation for the accountancy profession, whose members include FAR and other national professional organisations.

References Emilsson, E., & Malmström, E. (2022) Synen på vad som är en revision behöver differentieras (The view of what constitutes an audit needs to be differentiated), Balans Fördjupning, 1/2022. European Commission. (2017). Monitoring developments in the EU market for providing statutory audit services to public-interest entities. European Commission. (2022). Summary Report: Public Consultation on the Strengthening of the Quality of Corporate Reporting and its Enforcement. Foroohar, R. (2022). My Guide to a Deglobalising world, Financial Times, 21 October 2022. ICAEW (2021). European audit market battles concentration and quality issues. Institute of Chartered Accountants in England and Wales. Jones, H. (2022). UK audit shake-up targets big firms after spate of corporate failures, Reuters, 31 May 2022. Lennartsson, R. (2020). Det går faktiskt att påverka systemet (It is actually possible to influence the system), Balans 3/2020. Lennartsson, R. (2021). Från arbetsplats till mötesplats (From workplace to meeting place), Balans 3/2021. Malmström, E. (2021). An audit is an audit, Doctoral Thesis, University of Stockholm. Schwartzkopff, F. (2022). An $8 Billion ESG Market Pits EU Lawmakers Against Audit Firms, Bloomberg, 20 June 2022.

18 Concluding remarks Jan Marton, Fredrik Nilsson, and Peter Öhman

It is easy to understand why scholars and practitioners are so interested in transformations. By analysing processes of change – especially their drivers and their effects – it is possible to increase our knowledge of how and why a phenomenon has developed in a certain way. We are also in a much better position to make predictions about how the phenomenon will develop in the future. Needless to say, these predictions and scenarios are seldom entirely correct, but at least they can be a help in preparing for different scenarios (cf. Mintzberg, 2000). A critical analysis of drivers and effects can also unravel unexpected and unintended consequences that are difficult to detect unless a holistic analysis is applied. This book has been written and edited in such a spirit. It presents and consolidates novel research related to three external drivers of auditing transformation: regulation, digitalisation, and sustainability. In addition to these drivers, the role of the individual auditor is discussed. In summary, the book provides the reader with three main findings: (1) there are unexpected and unintended consequences of auditing transformation, (2) developments are not linear and unidirectional, and (3) competences of individual auditors – and the ability of accounting firms to recruit and retain high-performing employees – are essential for successful transformations. The book shows that the external drivers have different origins. Regulation is a deliberate political choice by governments and regulatory bodies intended to improve the functioning of, and trust in, capital markets through the avoidance of costly scandals or audit failures. Sustainability is affected by politics as well, and the ambition is to improve the long-term welfare of humanity, by not allowing current activities to impede the welfare of future generations of humans. Sustainability also creates new business opportunities, both for auditors and their clients. Digitalisation is driven by technological development, and new digital solutions promise significant efficiency and quality gains. However, the character of all three is similar, in the sense that they are driven by a will to achieve societal improvements. While there are positive intentions behind the three drivers, research presented in this book shows that there are also negative and unintended consequences of auditing transformation. In addition, there are many difficulties in DOI: 10.4324/9781003411390-22

380  Jan Marton, Fredrik Nilsson, and Peter Öhman the implementation of the changes. This should not come as a surprise, since transformations should be expected to lead to fundamental changes in audit practice, and not all effects of the changes can be foreseen. Learning and establishing new practices takes time. Often, it is possible to observe initial enthusiasm and high expectations for a change, followed by realisations of reduced hopes in the implementation phase. The initial predictions tend to overstate the effects following the transformation. This is a tendency that has been observed, for example, within digitalisation processes in accounting firms (Bakarich & O’Brien, 2021). The book starts with chapters discussing regulation as a driver of transformation. These chapters take their departure from two significant and longterm trends: (1) regulations are increasingly strict, putting higher demands on accounting firms and individual auditors, and (2) regulations become more international and harmonised across countries. Globally, the International Standards of Auditing (ISA) have been developed to be useful in audits of public-interest entities, e.g. listed companies. Meanwhile, Swedish auditors have been subject to increasingly strict regulatory requirements from the EU. The intended benefit of these types of increased regulation is to obtain increased auditor independence and improved audit quality, reducing the probability of audit failures, and the resulting corporate scandals. Such scandals can be very costly, as they also risk reducing trust in financial markets. Without investor trust, financial markets do not function well or at all (Baldvinsdottir et al., 2011). A potential negative effect of increased regulation, pointed out by Power (1997) more than 25 years ago, is that auditors’ focus may change from professional judgement to compliance. Such a development may actually lower audit quality (a consequence that is probably unexpected for many regulators). In addition, it is costly to follow regulations, and to date, no comprehensive cost-benefit analysis has been undertaken to determine whether stricter requirements are indeed economically optimal. Even though such an analysis would be difficult to conduct, it could provide valuable input for the debate on regulations and their effects. Another unexpected effect is related to the regulatory objective of increasing competition in the industry, by promoting non-Big 4 firms. As pointed out in Chapter 17, regulatory requirements do not seem to be achieving this objective. On the contrary, they rather lead to a strengthening of the competitive position of the Big 4 firms. In Chapter 3, there are more examples of unexpected and unintended effects of stricter regulation. The requirement that audit clients should have audit committees is intended to strengthen the auditor’s communication with the client’s board. Instead, by reducing direct communication between the auditor and board members that are not on the audit committee, the regulation actually decreases the status of the auditor. Chapter 4 gives an example of an incomplete implementation of a new regulation. The requirement to disclose key audit matters appears to lead to ‘sticky’ disclosures that are only updated when a new auditor or accounting firm is appointed.

Concluding remarks 381 With increasing internationalisation of the economy, it becomes natural to regulate auditing on an international level and to harmonise audit work across countries. However, to the extent that not all political, legal, and economic factors are harmonised, there are settings where international regulation is not ideal. Chapter 2 provides an example by discussing how audit standards for specific national needs (audits of SMEs and sustainability audits) were hindered by international regulation. Thereby, auditing became less socially relevant in the local context. In line with these insights, Chapter 5 shows how an adaptation of international regulation is necessary in special cases, such as for audits of municipalities. It describes a situation where there is a local regulatory structure to support specialised audit regulation, unlike the situation described in Chapter 2, where such a structure is lacking. Digitalisation is a driver that most scholars and practitioners argue has already led to significant changes in auditing practices (e.g. Kokina & Davenport, 2017). In the near future, this transformation can accelerate when even more advanced applications, such as artificial intelligence (AI), are implemented on a large scale. Indeed, as pointed out in Chapter 16, the introduction of these advanced technical solutions was an important reason why the Swedish Inspectorate of Auditors (SIA) changed the requirements for becoming an authorised auditor. It is not surprising that digitalisation is receiving substantial attention and affecting important regulations. Unlike industries such as real estate, mining, or transportation that require physical assets, auditing services can be fully digitalised as they are based entirely on information. Recent examples of highly disruptive technology remind us of the severe effects they can have on information-based industries. Of course, auditing has an additional layer of protection in that the business is restricted to actors that are authorised in accordance with regulated structures. Still, if more efficient digital solutions become available in the future, it is likely that long-term regulation will change. Only a few years ago, a common expectation in the industry was that digitalisation would lead to a decrease in demand for junior audit assistants and, therefore, a decrease in the recruitment of university graduates. To date, this has not happened. Instead, as pointed out in Chapter 17, the industry is having difficulty filling all available positions. It thus appears that the fundamental efficiency gains resulting from digitalisation are still in the future (see Chapter 9). Another possible explanation for this development, discussed in Chapter 6, is that digitalisation does not reduce the need for judgement to the extent envisioned in the most optimistic scenarios. Instead, there seems to be a possibility that new digital solutions will increase the need for judgements. In addition, as pointed out in Chapter 16, it is far from certain that auditor expertise can be replaced in the short term by even the most advanced digital solutions. Yet, the long-term developments in this area are much more difficult to predict. What we do know is that several unintended consequences of digitalisation have been observed in terms of professional judgement, scepticism, and

382  Jan Marton, Fredrik Nilsson, and Peter Öhman identity. Chapter 6 points out that the increased structure, for example in the form of new digital solutions, can have both positive and negative effects on judgement and audit quality, depending on the type of structure introduced. Chapter 7 makes a similar point, showing that professional scepticism can increase or decrease with digitalisation, depending on individual auditor characteristics. The two chapters, therefore, point out potential negative consequences of digitalisation, by emphasising that the effects of the introduction of new digital solutions are context dependent. Chapter 8 has a different message, discussing the effect of digitalisation on the professional identity of auditors. Digitalisation challenges the existing professional identity, and if not managed correctly, it can result in decreased audit quality. Overall, the chapters show the need for management awareness of the potential effects when accounting firms implement new digital solutions. Ultimately, it could have negative effects on audit quality. As suggested in Chapter 17, sustainability is to a large extent related to a significant increase in such reporting. To date, regulation of sustainability reporting – including auditing of such reporting – has been weak or nonexistent. Instead, the field has largely developed based on voluntary efforts by reporting companies. As a result, there is lack of comparability and questions about reliability. Thus, it is reasonable to question if unregulated reporting can solve the problem of information asymmetry between listed companies and investors (and other stakeholders). This creates two related problems: (1) companies with sustainability ambitions are unable to effectively communicate the substance of this ambition, and (2) investors do not consider the information provided by companies to be reliable. In 2017, Sweden implemented the EU Non-Financial Reporting Directive (NFRD), leading to some regulation of sustainability reporting for large companies. The NFRD, however, is general and limited, and does not require that the information be audited (see also Chapter 1). As argued by Alsahali and Malagueño (2022), and pointed out in Chapters 11 and 12, current reporting practices are characterised by high variation, and both companies and auditors are in a learning phase. The identification of this variation contributes to our knowledge of why sustainability reporting, so far, has been criticised for issues regarding comparability and reliability. In addition, the findings are clear indications of the possibility that sustainability auditing will go through a much more significant transformation in the future, especially compared to what has been observed so far. A reason for the predicted transformation is the EU adoption of the Corporate Sustainability Reporting Directive (CSRD), complemented by European Sustainability Reporting Standards (ESRS). The quickly implemented regulation will require a substantial development of sustainability reporting competence (see Chapters 12 and 17), and will, therefore, be costly for reporting companies. Since no cost-benefit analysis has been provided by the EU, it is unclear to what extent the substantial implementation costs incurred will lead to corresponding benefits.

Concluding remarks 383 It is also important to note that the CSRD introduces the concept of ‘double materiality’ into sustainability reporting regulation (see Chapter 1). At the time of writing, it is not clear how reporting companies and auditors will assess double materiality. The proposed solution to use a structured and quantitative approach to determine double materiality, presented in Chapter 10, is therefore an important contribution to facilitating the transformation of sustainability reporting and auditing. As pointed out in Chapter 17, one reason for the EU to change the name of its directives, from ‘non-financial’ to ‘sustainability’ is to emphasise the fact that environmental and social sustainability issues may have financial effects on companies. Meanwhile, there is strategic jostling going on between global standard setters in sustainability reporting. Both the US, through the Securities and Exchange Commission (SEC), and the International Financial Reporting Standards (IFRS) Foundation, through its recently created International Sustainability Standards Board (ISSB), are promoting standards based on single materiality. The EU, meanwhile, through the CSRD and the ESRS, promotes standards based on double materiality. The difference between the two viewpoints is greater than what might first be apparent. The objective of reporting standards based on single materiality is to help investors and creditors make financial decisions. Standards based on double materiality have a much broader objective, i.e. to reduce the negative environmental and social impact of companies’ activities. For companies affected by EU regulation, it would seem that they cannot follow any other regulation. However, in the development of ESRS, the EU would like to see more consideration of global developments. Therefore, the final regulatory outcome is still uncertain, and at the time of writing (Spring 2023), the future relationship between the ESRS, the ISSB, and the GRI, is unclear. So far, there is substantial variation in sustainability reporting assurance (see Chapter 11). While the CSRD introduces requirements that sustainability information be audited, it is currently unclear whether this service will be provided by accounting firms or by other service providers (see Chapters 9, 10, and 12). The need for new competencies in auditing brings us to the fourth area covered in the book: individual auditor characteristics. To a large extent, the effects of the three drivers of auditing transformation are related to competencies of individual auditors. For example, to the extent that regulation becomes more detailed, compliance may become more important at the expense of professional judgement. Digitalisation may require advanced skills in using technical solutions and more knowledge about quantitative data analysis. Sustainability, as noted, often requires specialised knowledge, which, at least partly, differs from knowledge required for financial reporting. This book points to several challenges for accounting firms in the development of competencies in relation to ongoing developments. First, there is a difficulty in overall recruiting of recent university graduates into auditing (see Chapter 17) but also in retaining them in the profession until they become

384  Jan Marton, Fredrik Nilsson, and Peter Öhman authorised auditors and even beyond that point in their careers. Second, Chapter 14 shows how auditors’ innate characteristics are unlikely to change over time. Meanwhile, Chapter 13 points out that even new recruits into auditing tend to be socialised into the firm to end up with values that are similar to the existing employees. Both innate characteristics and socialisation, therefore, lead to inertia that creates impediments to changes in accounting firms. In other words, these impediments make it more difficult to predict the long-term effects of regulation, digitalisation, and sustainability on auditing transformation. However, the book also points to some possible ways forward for the development of competences in accounting firms to meet this uncertainty and the possible needs arising from drivers of transformation in auditing. Chapter 15 discusses the role of audit teams in utilising existing competencies. A fundamental question here is to what extent specialisation is the only solution to handle the increased demand for auditing expertise. Chapter 16 defines categories of expertise which can be used to better understand specific aspects of competencies required. Not surprisingly, these competencies are very much related to having a solid and deep knowledge of accounting and auditing. The book has 15 chapters based on research (Chapters 2–16) and a chapter based on practitioners’ views (Chapter 17). The differences and similarities between the two types of chapters can be seen as a finding in their own right. In the research chapters, the drivers of transformation are based on trends that have garnered the interest of scholars, as they are long term and affect many sectors of society. The practitioners’ view reflects what is in the minds of experienced auditors and accounting specialists that work for accounting firms and FAR. It is based on open interviews, where interviewees talk freely about issues that they see as current and important. The practitioners’ views differ from those of researchers in several ways. Globalisation is emphasised more, while in the research chapters it is only covered indirectly as globalisation of regulation. In relation to digitalisation, practitioners mention the paperless office and how digitalisation creates new accounting issues to be resolved. For sustainability, practitioners mention the accounting firms’ work with sustainability in their own operations, and the overall difficulty of recruiting in the audit industry. Apart from these differences, there are also similarities between the two types of chapters. The three drivers of transformation are discussed, suggesting that the focus in the research chapters has relevance for audit practice. In this book, we report results of original research studies and literature reviews that summarise entire fields of research. Overall, existing research adds substantial knowledge about auditing in general and how current drivers of transformation affect auditing. Still, many important research questions remain to be studied. For example, we do not know whether efficiency gains from digitalisation (to the extent that they are realised) will benefit the auditor or the client and to what extent new technical solutions like AI will affect the type of auditing expertise needed (see Chapters 8 and 9). Another

Concluding remarks 385 example of an area for possible future research is to analyse in more detail the costs and benefits of stricter audit regulations. Furthermore, future research on sustainability reporting may study to what extent stricter regulation leads to increased comparability, and whether the effects on the environment and social factors (as intended by the EU) are actually realised. The avenues for future auditing research outlined above represent only a few examples of possible research endeavours. As shown in this book, regulation, digitalisation, and sustainability have already affected auditing, often in unexpected ways. In the areas of digitalisation and sustainability, there are also reasons to believe that we are in an early phase of transformation. Hence, only the future can tell how they will affect auditing. What we know for certain is that we need to be prepared for different scenarios, and research can help with that. In the spirit of Hopwood (1996), we therefore encourage colleagues around the world to continue investigating the audit profession, accounting firms, and the work of auditors using a variety of theoretical frameworks and empirical methods. References Alsahali, K.F., & Malagueño, R. (2022). An empirical study of sustainability reporting assurance: Current trends and new insights. Journal of Accounting & Organizational Change, 18(5), 617–642. Bakarich, K.M., & O’Brien, P.E. (2021). The robots are coming… but aren’t here yet: The use of artificial intelligence technologies in the public accounting profession. Journal of Emerging Technologies in Accounting, 18(1), 27–43. Baldvinsdottir, G., Hagberg, A., Johansson, I.L., Jonäll, K., & Marton, J. (2011). Accounting research and trust: A literature review. Qualitative Research in Accounting & Management, 8(4), 382–424. Hopwood, A.G. (1996). Introduction. Accounting, Organizations and Society, 21(2/3), 217–218. Kokina, J., & Davenport, T.H. (2017). The emergence of artificial intelligence: How automation is changing auditing. Journal of Emerging Technologies in Accounting, 14(1), 115–122. Mintzberg, H. (2000). The rise and fall of strategic planning. London: Prentice Hall, Financial Times. Power, M. (1997). The audit society: Rituals of verification. Oxford: Oxford University Press.

Index

Note: Italicized pages refer figures, bold tables and with “n” notes in the text. abnormal accrual 239, 301, 307 Accounting Directive 2013/34/EU 28–29 accounting profession 22, 40n2; accounting research 159; audit quality 324; financial globalisation 362; investment in technologies 114; professional insecurity 160 advanced digital technologies (ADTs) 9, 180–196; auditor-client dynamics 190–192; embedding 190–192; emergence of alternative solution providers 192–193; implications 193–196; literature review 183–187; motivation 182–183; results 187–193; sustainability assurance 184–185, 188–190, 199; sustainability regulation 184–185; sustainability reporting 184–185, 188–190; use in adjacent fields 185–187 alliances 259 alternative solution providers, ADTs 192–193, 201 American Institute of Certified Public Accountants (AICPA) 115, 126 analytical framework 25, 25–26 analytical structure, judgement in auditing 122–124 Annual Accounts Act (ÅRL) 188, 190, 258, 261 artificial intelligence (AI) 114, 180; audit research 205; BDA and 166, 180; cognitive technologies 176n3; outside-in approach 186; software robots and 370; threat of 163 see also double materiality, assessment of Assurance Engagements Relating to Sustainability Reports 33

audit assistants 279; background of 281; CAAT 150; employable 280; hard and soft skills of 283; person’s characteristics 276; recruitment/ employing of 283, 286, 288, 290; senior auditors and 279; socialisation of 289; value commitments of 286 ‘Audit Borg’ 118 audit committee: status in eyes of auditors 56; status in own eyes 53–55 see also auditor-audit committee relationship audited companies 1, 77, 87, 216, 296 audit education, implications for 244 audit explosion 113, 115, 135 audit guidance, judgement in auditing 120–122 audit industry: audit team composition propositions 323; changes in 91; crises and failures 366; expanding role of 191; general 92; implications for 196, 243–244; internationalisation of 278; processualisation 113; regulation and digitalisation 339; revolution 180; role in bridging the gap 189; software 139; sustainable development 183; technology and sustainability assurance 323; transitions 326, 330, 337, 368 auditing, defined 338 auditing expertise, drivers of change affecting 349–353 auditing software and BDA, judgement in auditing 122–124 auditing transformation 360–378; ambiguous relations to regulation 366–367; Big 4 363–364; challenges

Index  387 370–372; digitalisation 368–373; effect of automation 372–373; effect of EY split 367–368; efficiency of audit 368–373; external regulation 365–366; future of 360–361, 376–378; globalisation 361–365; growth and trust 375–376; historical development 373–374; internal regulation 365–366; non-financial 374–375; opportunities 370–372; paperless office 369–370; quality control as risk minimisation 364–365; regulation 365–368; sustainability 373–376 see also transformation in audit teams audit-in-transition 164–167 auditor–audit committee relationship 46–64; audit committee’s status in own eyes 53–55; audit committee’s status in the eyes of the auditors 56; auditors’ status in the eyes of the audit committee 59–61; auditors’ status in their own eyes 57–59; implications 61–64; literature review 50–52; motivation 48–50; results 52–61 auditor characteristics 11–13, 61 auditor-client dynamics 180, 190–192 auditor independence 3, 46, 48, 49, 63, 70, 160, 301, 380 audit package 366–367 audit-partner: characteristics 306; individual 302; socialisation 301 audit planning 57–58, 62–63, 322, 329 audit profession 101; accounting firms and 290; agenda 21; in digital age 157–176; legitimacy 71; processualisation of 113; in Sweden 282; value commitments of 285–287, 286 audit professional in digital age 157– 176; audit-in-transition 164–167; disruptive technology 161–162; identity of auditors 162–167; implications 174–176; literature review 160–163; motivation 158–159; professional insecurity 160–161, 167–174; professional role 164–167; results 163–174 audit profession standards in public sector 90–106; course of events 97–99; deinstitutionalisation 96, 100–101; diffusion of innovation

97; experienced performance gap 95; formation of attitudes 101–102; implications 104–106; implicit bargaining (legitimation) 96, 102–104; motivation 91–94; preinstitutionalisation 96, 101–102; process of knowledge and awareness 96, 100–101; results 97–104; theoretical framework 94–97; theorisation 96, 102–104; triggers and partial precipitating jolts 99–100; understanding actors and actions throughout the process 99–104 audit quality 298–301; adverse effects of 117; audit process and 235; audit structure 126; CAATs and 137, 139– 141; children and 308; digitalisation 139–141; empirical research 140; engagement partner 298–301; engagement-partner characteristics and 298; ethnicity and 303; financial 181, 229, 233; inter-office 235; KAMs 74, 79; negative effect on 235; perspective 123; positive effect on 234; professional judgement and 136; professional scepticism 143, 147, 150; proxy for 234; in publicly traded companies 307; regulation 309; risk for deterioration of 27; systematic differences in 302 audit reporting transformation 69–87; implications 84–87; literature review 72–75; motivation 70–72; results 75–84 audit research: artificial intelligence (AI) 205; audit quality 298–301; implications for 244–245; structure vs. judgement 129 audit risk model 118 audit society 2, 113, 116 audit technology 122, 124, 173, 176 automation 170; and AI 371, 378; of audit tasks 137, 142; basic-level tasks 356; digitalisation 370; effect in auditing 372–373; robotic 165 Big 4 73, 79, 98, 157, 181, 251; auditing transformation 363–364; firm auditor 164 big data analytics (BDA) 114, 157, 158, 162, 180; artificial intelligence and 166; auditing software and 122–124; visualisation 119

388 Index BigTech 181 blockchain 180 box-ticking 126 Brydon Report 367 Business Risk Auditing (BRA) 24 ceteris paribus 120, 126, 128, 129 challenges of auditing transformation 370–372 challenges of sustainability assurance 250–268; competitive market 254; implications 266–268; knowledge and skills 264–266; literature review 254–257; motivation 252–253; process 260–263; professionalism and independence 254–255; responsibilities 257–259; results 257– 266; standards 259–260; standards and quality 255–257; statement and quality 263–264; summary of literature 257; sustainability reporting 259–260 see also sustainability assurance checklists 115, 261, 354; documentation risks 351; financial audit team 261; judgement in auditing 126–128; for judging risks 346; mnemonic structure 126; in operational work of auditor 350 chief executive officer (CEO) 53, 59 chief financial officer (CFO) 52, 57–58, 61, 63 classification and regression trees (CART) algorithm 225 client commitment (CC) 12, 277, 286 Climate Disclosure Standards Board (CDSB) 253 coercive isomorphism 94 cognitive gap 192, 197n5 cognitive technologies 157–158, 176n3 Cohen Commission 69 comfort theory 175, 176n4 commercialisation 278 Companies Act of 1975 2, 23, 36, 46, 59 competence: in accounting firms 384; defined 51; knowledge and 91; nominal characteristics 51; shared by the European institutions 23; status and 52; sustainability and technology 332; technical 290 see also transformation in audit teams competitive market 254 ‘comply or explain’ approach 49

computer-assisted audit techniques (CAAT) 8, 136–137, 143–146; application of 139; audit quality and 139–141; professional judgement and 141–142; professional scepticism 138, 143, 147–150 computer-assisted audit tools and techniques (CAATTs) 139 connectedness 94 controlling structure, judgement in auditing 124–126 corporate environmental performance (CEP) 214–215, 221, 225 corporate social responsibility (CSR) 9, 221, 237 Corporate Sustainability Reporting Directive (CSRD) 9, 194, 197n1, 222n1, 228, 229, 245n2, 251, 253, 266–267, 373; adopted by the European Parliament 196; digital technologies 185; EFRAG 230; EU Parliament 377; implementation of 188–189, 240; non-financial 375; sustainability audit and assurance 182; sustainability audits 374; sustainability reporting 325–326; theoretical knowledge of auditors 252 Council of 16 April 2014 70 COVID-19 253, 314, 315, 325, 327, 328, 361 decision-making 38; audit committee 62; audit judgements 338, 340; audit team 328; Big 4 firms 79; collective process 96, 102–103; competencies for judgement and 325; data-driven 195; ESG data for investment 186; field studies in financial 341; of financial statement users 71, 74, 85; internal 230; psychology-rooted judgement and 340; strategic 191; sustainability assurance 194 deinstitutionalisation 96, 100–101, 105 Deloitte 78, 114, 183, 190, 200, 251, 275, 293, 363 descriptive statistics 89, 156, 212; digitalisation 143–144, 144 digitalisation 3, 7–9, 114, 136–150, 170; auditing transformation 368–373; audit quality 139–141; computer-assisted audit techniques (CAAT) 139–142; descriptive statistics 143–144, 144; implications 147–150; interaction effect

Index  389 146; literature review 139–143; motivation 137–139; Pearson correlations 144–145; professional scepticism 142–143; regression analysis 145–147, 146; results 143–147 Directive 2006/43/EC 23 discomfort 52, 120, 160, 176n4 discretionary accrual 301 disruptive technology 160, 161–162, 163, 381 double materiality, assessment of 205– 222; implications 220–222; literature review 207–210; motivation 206–207; results 210–220 Dow Jones Sustainability 218 dyad interactions 327 dynamic auditor 164 see also auditors empirical studies: of financial audit quality 233; impact of digitalisation on auditors’ professional profile 140; judgement in auditing 118–120; partner-fixed-effects methodology 302 endogeneity: effects 156; engagement partner 307–309; in research 298 engagement partner (EP) 12, 294–310; audit quality 298–301; characteristics 299–300; endogeneity 307–309; generalisability 305–307; implications 309–310; literature review 298–309; mechanisms 304, 304–305; motivation 296–298; partner characteristics 300, 301–304, 303; results 298–309; taxable income 306 environment, social, and governance (ESG) 3, 9, 180–182, 196, 197n2 ethics 305; for auditors and GAAS 91; level of partners 304 ethnicity 280, 303 European Commission (EC) 23, 184, 229, 251, 374 European Financial Reporting Advisory Group (EFRAG) 185, 189, 196, 228 European Parliament 70, 184, 189 European Sustainability Reporting Standards (ESRS) 9, 10, 185, 228 European Union (EU) 23, 36, 46; audit directive 49; audit firm rotation 70; audit reform 37; Directive 2014/56/ EU 29; less interested in regulating or standardising small entity audits 28;

Non-Financial Reporting Directive (NFRD) 184, 229, 250, 251 EU Taxonomy 194 experienced performance gap 95, 105 expertise: acquiring and keeping it 341–342; in auditing 342–344; defined 341; in financial auditing 344–349; mechanisms affecting 342 external regulation 115, 365–366 EY 78, 83, 190, 200, 251, 275, 293, 315, 361, 376; effect of split in auditing 367–368 FAR (the institute for the accountancy profession in Sweden) 1–2, 4–5, 9, 49, 91, 98, 102, 139, 287, 360, 366; capacity to take on leadership 33; development of RevR6 31–34; member of the Nordic Federation of Public Accountants (NRF) 26–27; pronouncement of 29; role to make audits more socially relevant 26; SALAR and 105; SKYREV and 99 financial auditing, expertise in 338–356; acquiring expertise and keeping it 341–342; defining expertise 341; drivers of change affecting auditing expertise 349–353; expertise in auditing 342–349; implications 353–356; literature review 340–344; mechanisms affecting expertise 342; motivation 339–340; results 344–353 financial crisis 22, 69, 349, 360, 362, 366 forms of audit structure 128, 128 future of auditing transformation 360–361, 376–378 see also auditing transformation gender balance 275–276 generalisability, engagement partner 305–307 Generally Accepted Auditing Standards (GAAS) 23, 27–29, 36, 90–91, 94, 98 Global Financial Crisis 22 globalisation 2; auditing transformation and 361–365; effect on audit profession’s autonomy 20; regulatory landscape 19; sustainability and 355; in transnational regulation 33 Global Public Policy Committee (GPPC) 24 Global Reporting Initiative (GRI) 9, 205–206, 209, 253, 374

390 Index greenhouse gas (GHG) 259 greenwashing 186, 225, 231, 242, 250, 377 growth and trust, auditing transformation 375–376 hard skills 12, 283, 288, 289 hiring firms, valuation of abilities and knowledge of auditors by 283–284 historical development, auditing transformation 373–374 IASC 362 identity of auditors 162–167 see also professional identity implications: advanced digital technologies (ADTs) 193–196; for audit education 244; for audit industry 243–244; audit professional in digital age 174–176; audit profession standards in public sector 104–106; audit reporting transformation 84–87; for audit research 244–245; digitalisation 147–150; double materiality 220–222; engagement partner 309–310; financial auditing 353–356; judgement in auditing 128–131; selection and socialisation of auditors 287–290; sustainability assurance 241–245, 266–268; transformation in audit teams 330–333 implicit bargaining (legitimation) 96, 102–104 independence, sustainability assurance 254–255 information and communications technology (ICT) 119 innovation: capacity for 28–29, 33–34; constraints on 27–28, 32–33; diffusion of 97; framework for analysing audit 25; in transnational audit regulation 24–25 institutional change 94; adjusted model of 105, 105; innovation process 95; process of 105 interaction effect 146, 309 internal regulation 365–366 International Audit and Assurance Standards Board (IAASB) 19, 36, 38, 121, 142, 256; Enhancing the Value of Auditor Reporting: Exploring Options for Change 71, 73; information gap 73; information

gathering and research activities 39; ISAE3000 256; NiVRA’s sustainability assurance 32–33; pronouncement 37; quality and fragmentation of audit 27; reinvest in audit profession’s legitimacy 71; RevR6 32; standards and guidance 39; strategic work plan 2022–2023 40n1; think-smallfirst approach 28; transnational accountancy firms 28 International Ethics Standards Board for Accountants (IESBA) 368, 371 International Federation of Accountants (IFAC) 23, 27, 32, 39, 46, 92, 368, 378n1 International Financial Reporting Standards (IFRS) 340, 363–364 International Financial Reporting Standards Foundation (IFRS Foundation) 253 International Forum of Independent Audit Regulators (IFIAR) 24 International Framework for Assurance Engagements (IAF) 32 International Integrated Reporting Council (IIRC) 253 International Standard for Audits of Less Complex Entities 94 international standardisation 19–40; analytical framework 25, 25–26; audit regulation in Sweden 23–24; audits of small entities 36–37; literature review 22–26; motivation 21–22; results 26–34; standard for audits of small entities (SASE) 26–29; standard for sustainability assurance (RevR6) 29–34, 31, 35; sustainability assurance 37–39; transnational audit regulation 22–23, 24–25 International Standard on Assurance Engagements (ISAE)3000 256 International Standards on Auditing (ISA) 19, 21, 71, 121, 137, 162, 171; adoption of 29; ISA 200 19; ISA 230 34; ISA 300–330 34; ISA 560–580 34; ISA 580 98; ISA 610–620 34; ISA 701 71, 74, 79; Public Interest Oversight Board (PIOB) 22; transnational audit model 20 International Standards on Quality Control (ISQC) 23, 34, 98, 100, 364 International Sustainability Standards Board (ISSB) 185, 253

Index  391 investors, sustainability assurance 240–241 ISAE3000 32, 33, 34, 256 judgement in auditing 113–131; analytical structure 122–124; auditing software and BDA 122–124; checklists 126–128; controlling structure 124–126; empirical studies 118–120; forms of audit structure 128, 128; implications 128–131; literature review 116–120; mnemonic structure 126–128; motivation 115–116; procedural structure 120–122; professional practice functions (PPFs) 124–126; results 120–128; standards and audit guidance 120–122 key audit matters (KAMs) 6, 84–86; audit firm (and audit partner) 78; auditor rotation 71, 72, 79–84, 80, 81, 83; auditors reporting on 78–79; definition of 70; disclosures of 72; qualitative specificity in 77, 78 key performance indicators (KPI) 189 knowledge and skills, sustainability assurance 264–266 KPMG 184, 190, 200, 251–252, 259, 363–364, 368–369, 373, 376 labour market 276, 287 Less Complex Entities (LCE) 366 literature review 22–26; advanced digital technologies (ADTs) 183–187; auditor–audit committee relationship 50–52; audit professional in digital age 160–163; audit reporting transformation 72–75; digitalisation 139–143; double materiality 207–210; engagement partner 298–309; financial auditing 340–344; judgement in auditing 116–120; selection and socialisation of auditors 279–281; sustainability assurance 231–241, 254–257; transformation in audit teams 317–330, 318–321 Local Government Act 90, 97, 98 London Stock Exchange 48 machine learning (ML) 130, 180, 186, 205, 225 materiality assessments in sustainability audits (MASA) 205, 217–218,

220–222; benchmark of 208; computation 216; inadequacies of 209; materiality assessment in financial audits 208; material sustainability 206; methodology 211; prerequisite for sustainability reporting 207; uncertainties in 209 material sustainability information 206 mechanisms, engagement partner 304, 304–305 mnemonic structure, judgement in auditing 126–128 motivation 21–22; advanced digital technologies (ADTs) 182–183; auditor–audit committee relationship 48–50; audit professional in digital age 158–159; audit profession standards in public sector 91–94; audit reporting transformation 70–72; digitalisation 137–139; double materiality 206–207; engagement partner 296–298; financial auditing 339–340; judgement in auditing 115–116; selection and socialisation of auditors 277–279; sustainability assurance 229–231, 252–253; transformation in audit teams 316–317 multi-disciplinary teams (MDT) 317, 330, 331 municipal auditing of financial reporting 91–92, 93, 100, 101, 103–104, 108 natural language processing (NLP) 185, 186, 190 newly recruited auditors 281, 281–283, 282, 284, 284–285 New York Stock Exchange 48 nitrogen oxides (NOX) 217 non-automated tasks 182 non-financial, auditing transformation 374–375 Non-Financial Reporting Directive (NFRD) 9, 184, 188, 229, 250–251, 373, 375, 382 Nordic Federation of Public Accountants (NRF) 26–27 on-the-job learning 327 opportunities, auditing transformation 370–372 organisational commitment (OC) 277 organisation theory 50 outside-in approach 186, 188, 192–193

392 Index paperless office, auditing transformation 369–370 partial jolts (events) 100, 101, 103–106 partner characteristics, engagement partner 300, 301– 304, 303 precision recall curve (PRC) 211, 213–214 predictive performance 213–216 preinstitutionalisation 96, 101–102 procedural structure, judgement in auditing 120–122 process, sustainability assurance 260–263 processualisation 113 professional commitment (PC) 277 professional identity 140, 158–160, 162–163, 285, 382 see also identity of auditors professional insecurity 160–161; at collective level 168–172; in digital age 167–168; on individual level 172–174 professionalism, sustainability assurance 254–255 professional judgement 120, 122, 129–130, 166; ability to exercise 138; audit quality and 136; CAAT 141–142; processualisation of audit 116; structure and 115, 148 professional practice functions (PPFs) 120; judgement in auditing 124–126 professional role 53, 163, 164–167, 171, 349, 360 professional scepticism 138, 154, 307, 309; CAATs and 146–150; digitalisation 142–143 professions: characteristic of 2; higher education and 288; regulation of 2, 365; strata of auditing 135 Public Company Accounting Oversight Board (PCAOB) 114, 125, 126, 296–297 Public Interest Entities (PIEs) 362–363 Public Interest Oversight Board (PIOB) 22 PwC 78, 97, 99, 157, 190, 251, 275, 361, 367 qualitative research 22, 42, 134 quality control, as risk minimisation 364–365 quality in sustainability assurance 233–240 quantitative research 234–235; on audit partner characteristics 306, 306, 306;

engagement-partner characteristics 297; objective in 307 random forest algorithm 211, 213, 213, 216, 221, 222n5, 225 regression analysis, digitalisation 145–147, 146 regulation 5–7; auditing transformation 365–368; globalised 362; juridification 113; professions 365–368; sustainability reporting and assurance 188–190 see also international standardisation responsibilities, sustainability assurance 257–259 rigour in enforcing independence requirements (REIR) 277 Sarbanes-Oxley Act (SOX) (2002) 5 Securities and Exchange Commission (SEC) 305, 383 selection and socialisation of auditors 275–290; abilities and knowledge hiring firms value 283–284; implications 287–290; literature review 279–281; motivation 277– 279; newly recruited auditors 281, 281–283, 282, 284, 284–285; results 281–287; value commitments of audit profession 285–287, 286 senior auditors 150, 277, 279, 286, 290, 324, 351 SHapley Additive exPlanations (SHAP) 211, 213, 215 SKYREV (The Swedish Association of Professional Local Government Auditors) 91, 97–99, 101, 103, 105, 106 softer materials 194 soft skills 12, 283, 283, 288 standards: judgement in auditing 120–122; sustainability assurance 255–257, 259–260 standard for audits of small entities (SASE) 26–29; capacity for innovation 28–29; constraints on innovation 27–28; development of 26–27 standard for sustainability assurance (RevR6) 29–34, 31, 35, 188; capacity for innovation 33–34; constraints on innovation 32–33; development of 29–31, 38 statement and quality, sustainability assurance 263–264 state scepticism 138

Index  393 Stockholm Stock Exchange 72 subjective distance 329 sulphur oxides (SOX) 218 summary of literature, sustainability assurance 257 supervisor and subordinate, transformation in audit teams 327 sustainability 9–11; assurance expertise 325–326; auditing transformation 373–376; regulation 184–185 Sustainability Accounting Standards Board (SASB) 253 sustainability assurance 37–39, 228– 245; advanced digital technologies (ADTs) 184–185, 188–190; implications 241–245; investors’ reactions to reported information 240–241; literature review 231–241; motivation 229–231; quality of 233–240, 256 see also challenges of sustainability assurance sustainability reporting: advanced digital technologies (ADTs) 184–185, 188– 190; sustainability assurance 259–260 Sustainable Development Goals 181, 326, 332 Sustainable Financial Disclosure Regulation (SFDR) 189 Sustainalytics 182 Swedish Accountant’s Act 28 Swedish Association of Local Authorities (SALAR) 91, 98, 99, 101, 102, 106 Swedish Higher Education Authority 279 Swedish Inspectorate of Auditors (SIA) 9, 23, 24, 90–91, 98–100, 106, 125, 127, 183, 338, 381 Swedish Tax Authority (Skatteverket) 306

Task Force on Climate-Related Financial Disclosures (TCFD) 253 taxonomy regulation 113 team member distance and affect 328–329 technical expertise 324–325 technology expertise 325 technology neutrality 197n4 theoretical framework 94–97, 105 theorisation of audit profession standards in public sector 96, 102–104 trait scepticism 140, 142 transformation in audit teams 170, 314–333; composition of 317–323; conceptual framework of 331; dyad interactions 327; dynamics 327–330; expertise 323–324; expertise propositions 326–327; implications 330–333; literature review 317–330, 318–321; motivation 316–317; proposition composition 323; proposition dynamics 329–330; results 317–330; stress and affect 329; supervisor and subordinate 327; sustainability assurance expertise 325–326; team member distance and affect 328– 329; technical expertise 324–325; technology expertise 325; virtual teams 327–328 see also auditing transformation transnational audit regulation 22–25 United Nations 206; Sustainable Development Goals 181, 326, 332 virtual teams 327–328