Adoption of International Standards on Auditing (ISA): Do Institutional Factors Matter?

• Published date: 01 March 2017
• Date: 01 March 2017
• Author: Pran K. Boolaky,Teerooven Soobaroyen
• DOI: http://doi.org/10.1111/ijau.12081

Adoption of International Standards on Auditing (ISA): Do Institutional

Factors Matter?

Pran K. Boolaky

1

and Teerooven Soobaroyen

2

1

Department of Accounting Financeand Economics, Griffith University, Australia

2

Centre of Excellence in Accounting, Finance and International Banking, SouthamptonUniversity, UK

Informed by the neo-institutional perspective, this study seeks for the first time to investigate empirically the

determinantsof ISA adoption and commitment to harmonisation on a cross-nationalbasis (89 countries). The findings

show that the protection of minority interests, regulatory enforcement, lenders/borrowers rights, foreign aid,

prevalenceof foreign ownership, educationalattainment and particular forms of political system (level of democracy)

prevailing in a country, are observed to be significant predictors of the extent of commitment to the adoption and

harmonisationof ISAs. Our statistical analysistherefore suggests that coercive, mimetic and normative pressurehave

a significant impact on ISA adoption relative to economic (efficiency-led) factors. Our findings imply that current

effortsby the International Federationof Accountants (IFAC)and other internationalagencies to implement ISAs need

to recognise that a broad set of institutional factors, rather than narrow economic ones, are of relevance in the

development of audit policymaking, practice and regulation worldwide.

Key words: International Standards on Auditing, neo-institutional theory, accounting

INTRODUCTION

It is often claimed that the international harmonisation of

accounting and auditing standards can be beneficial to

the development of an effective and efficient global

economy through the provision of relevant and credible

accounting information to users and markets (Radebaugh

& Gray, 1997; Needles, Ramamoorti & Shelton, 2002;

Zeghal & Mhedhbi, 2006; Smith, Sagafi-Nejad & Wang,

2008; Archambault & Archambault, 2009; Leuz, 2010),

culminating in significant attempts to bring convergence

over the last decade.Yet, several studies have documented

that thereremains differentlevels of adoption and diffusion

worldwide of international financial reporting standards

(IFRS) (Zeghal & Mhedhbi, 2006; Leuz, 2010) arising from

the different ways in which accounting developments

interact with specific national economic, social, legal,

cultural and political systems to generate particular

accountingoutcomes and/or practices. In thisrespect, both

Zeghal and Mhedhbi (2006) and Leuz (2010) express

doubts on the accounting convergence process, whether in

developed or developing economies. In contrast, there has

been little research on the adoption and/or degree of

commitmentto auditing standards, and specifically the case

of internationalstandards on auditing(ISAs) (Needles et al.,

2002; Ye & Simunic, 2013; Simunic, Ye & Zhang, 2016), in

spite of the fact that ISAs are considered to be one of the

key standards forsound financial systems by the Financial

StabilityBoard (FSB) alongside IFRS. Accordingto Simunic

et al. (2016):

Audits are performed to improve the validity and

reliability of information produced in compliance with

a set of accounting standards, and auditing standards

provide a measure of audit quality and articulate the

objectives to be achieved in an audit (p. 4).

Auditing standards seek, for example, to codify aspects

such as audit planning, audit engagement procedures, the

collection and analysis of audit evidence, the review of

internal control systems and the content of audit reports

(Mennicken, 2008). Whilst the auditor still has flexibility

in terms of how he/she executes the audit assignment

(e.g. how much evidence is deemed to be sufficient),

adherence to ISAs (or any other generally accepted

auditing standards) confers credibility to the audit exercise

and enables a third party (e.g. audit regulator, peer audit

reviewer, parties in a litigation process) to infer upon an

auditor’s approach, completeness and consistency in

carrying out an audit assignment. Furthermore, an audit

firm claiming to offer a service in line with international

standards can expect reputational and financial benefits in

terms of high profile clients a nd premium fees.

Relatedly, Leuz (2010) argues that auditing is a part of

the enforcement mechanism that ensures the accounting

and reporting of information is appropriate to the needs

of users and which moderates managerial discretion in

the production of the financial statements. However, the

potency of such enforcement depends partly on the way

the standard is used by t he auditor and the impor tance it

has been assigned in a particular jurisdictional context. In

this respect, according to the International Federation of

Accountants (IFAC), 126 countries have so far adopted

ISAs using different bases (wholesale adoption by law,

wholesale adoption by standard setter, or partial adoption

to meet country needs), which can be associated to the

extent to which a country is committed to ISAs. A

wholesale adoption of ISAs on a legal basis can be seen to

be a clearer and stronger signal to an international and

national ‘audience’(including audit firms) as to the

country’s priority to the development of a ‘weak or strong

form of harmonisation’

1

of audit practice. Other forms of

adoption admittedly also communicate a commitment,

inclusive of countries that have so far only stated an

intention ‘on paper’to adopt ISAs, but our contention is

that the different classifications of adoption represent

varying forms of ‘obligation’or engagement to ISAs.

Furthermore, Simunicet al. (2016) contendthat traditionally,

how national auditing standards were developed and

enforced tend to reflect a country’sbusinessenvironment

and legal systems, but the authors assertthat recently more

Correspondence to: Pran K. Boolaky, Department of Accounting Finance

and Economics, Nathan Campus, Griffith University, Australia. Email:

p.boolaky@griffith.edu.au

International Journal of Auditing doi: 10.1111/ijau.12081

Int. J. Audit. 21:59–81(2 017)

©2016 John Wiley& Sons Ltd ISSN 1090-6738

countries have tended to adopt a more uniform set of

standards, and in particular, it is predicted that ISAs will

be adopted (with or without modifications) by countries

with similar legal characteristics. However, to date, there

has been no empirical validation of such predictions, and

more importantly in our view, Simunic et al. (2016) do not

consider the relevance of other non-legal national

characteristics that might lead to different forms of

commitment to ISA adoption. The above discussion thus

raises two related questions:

First, what are the factors that have influenced national ISA

adoption, and second, to what extent do these factors explain

the different levels of commitment or engagement with ISA

as defined by the IFAC?

The motivations for this study are twofold. First, an

understanding of the extent of commitment to ISA

adoption cross-nationally and the determinants of such

engagement can enlighten one’s understanding of the

national factors influencing the spread (or not) of global

auditing standards. Recent work by Humphrey, Loft and

Woods (2009), Humphrey and Loft (2013) and Simunic

et al. (2016) have revealed how ISAs have gained

prominence within the international financial architecture

(Humphrey et al., 2009, p. 811), which is controlled by the

ISA issuer (International Federationof Accountants; IFAC),

international financial regulators (such as International

Organisation of Securities’Commissions; IOSCO) and

large audit firms. Anecdotally, the World Bank’sReports

on the Observance of Standards and Codes (ROSC)

indicate that (1) many countries’auditing standards are

not in line with ISAs,(2) even amongst those countries that

have implemented ISAs, full compliance has not occurred

mainly due to the lack of qualified professionals,adequate

education and training, and enforcement (see also Kohler,

2009). Whilst a few country-level case studies (e.g. Brody,

Moscove & Wnek, 2005; Dellaportas, Senarath-Yapa &

Sivanantham, 2008; Mennicken, 2008; Al-Awaqleh, 2010)

have provided some insights for specific countries (e.g.

US, Russia, Canada and China), and work by Humphrey

et al. (2009) and Humphrey and Loft (2013)has highlighted

the positioningof ISAs and IFACat the global level, there is

correspondingly little empirical work that has considered

the extent of harmonisation of ISAs cross-nationally

(a notable exception is Schockaert & Houyoux, 2007,

focusing on the EU). Second, our study seeks to complement

the extant audit literature which has typically paid more

attention to micro-level issues of audit independence, audit

fees, audit committees and audit opinions (e.g. Bedard &

Gendron, 2010; Ghafran & O’Sullivan, 2013). By providing

evidence of the varying spread of, and commitment to,

ISAs at a country level and the reasons, we argue that such

factors have a bearing on country or case studies which, for

instance, examine the operation and effectiveness of ISA

methodologies at the level of audit firms and/or audit

assignments.

Consequently, we developan explanatory model which,

in line with a neo-institutional perspective, postulates that

ISA adoption,in terms of the reported level of commitment

to global harmonisation of auditing standards is associated

to a number of social,cultural and politicalpressures which

could be conceptualised as coercive, mimetic and

normative forces, in addition to the typical economic

(efficiency-led) pressures associated with greater calls for

the harmonisation of auditing standards worldwide (e.g.

stock market and economic development). Variables

reflecting these institutional and efficiency-led pressures

were considered and selected initially in line with prior

studies (Needles et al., 2002; Zeghal & Mhedhbi, 2006;

Judge, Li & Pinsker, 2010). However, given the possibility

that a single proxy can hardly be expected to reflect all

facets of coercive, mimetic and normative pressures

respectively (as set out in the work of Judge et al., 2010)

and in light of the differences in the dynamics between

commitment to ISA and IFRS adoption, we consider

supplementary country-level data mainly from the Global

Competitiveness Reports of the World Economic Forum,

Economic Intelligence Unit and the World Bank’s World

Development Indic ators. The archival data that i s available

for 89 countries over a four-year period (2009–2012) forms

the basis of the empirical analysis. Briefly, the paper’s

findings suggest that specific coercive, mimetic and

normative pressures are associated to the extent of ISA

adoption. Furthermore, different analytical approaches

were used and a separate model was tested using the

adoption of ‘clarified ISAs’

2

to test the sensitivity of the

results, and mindful of the argument that the dependent

variable could alsobe seen as a categorical variable.

3

Fixed

effect models (year fixed effects and country fixed effects)

were also used to minimise both the effects of (i) omitted

variable bias and (ii) endogeneity.

This study providesa pertinent empirical explanation of

the institutional factors associated to the extent of the

national commitment to ISA adoption and harmonisation.

The findingsare of relevance to policy-makers and advisers

who are tasked with improving the quality of financial

reporting worldwide and ensuring ‘financial stability’,the

latter being an increasingly prominentagenda in the wake

of several financialcrises (Humphrey et al.,2009). Of note is

the fact that IOSCOdid not provide a clear endorsementof

the ‘clarified’ISAsin 2009.

4

As reported by Humphreyand

Loft (2013), IOSCO merely ‘encouraged’its members to

accept audits performed and reported in accordance with

ISAs whilst recognising that ‘the decision whether to do

so will depend on a number of factors and circumstances

in their jurisdiction’(cited in Humphrey & Loft, 2013, p.

335). Our study therefore sheds lighton the nature of these

factors and circumstances and why particular countries

would signal different levels of commitment to ISAs. The

remainder of the paper is structured as follows. A brief

analysis of the state of ISAs worldwide is first presented

followed by an explanation of the theoretical framework

and the formulation of hypotheses. The data and methods

are outlined followed by the findings, analysis and

conclusions.

OVERVIEW OF INTERNATIONAL

STANDARDS ON AUDITING (ISAs)

The increasedinitial attention to the stateand development

of ISAs has often been attributed to concerns about the

quality of financial statements and auditing standards in

the wake of the Asian economic crisis at the end of the

1990s and, more recently, to the regulatory implications

arising from the global financial crisis (Needles et al.,

2002; Mennicken, 2008; Humphrey et al., 2009; Simunic

et al., 2016). For instance, various international bodies

(WorldBank, International Monetary Fund) criticisedlarge

accounting firms for their apparent and uncritical

acceptance of local GAAP when preparing financial

statements, and highlighted the need for greater

coordination between international and national auditing

standards (Needles et al., 2002). In effect, a greater

60 P.K. Boolaky and T.Soobaroyen

©2016 John Wiley & Sons Ltd Int. J. Audit. 21:59–81 (2017)