The Effect of Auditors Industry Specialization and Auditors Independence on Audit Procedure to Detect Fraud Risk in a Financial Statement Audit, and Their Implications on Audit Quality

THE EFFECT OF AUDITORS INDUSTRY SPECIALIZATION AND AUDITORS INDEPENDENCE ON AUDIT PROCEDURE TO DETECT FRAUD RISK IN A FINANCIAL STATEMENT AUDIT, AND THEIR IMPLICATIONS ON AUDIT QUALITY
(Survey on Public Accountant Firm in the Indonesian Capital Market)

IMAN SARWOKO

ABSTRACT

The infringement of Public Accountant in the form of not fully comply with the Auditing Standards, especially in the audit procedures to detect material fraud in a financial statement audit, will lead to an audit failure. This condition if it is not dealt well will be lowering public confidence to the audits quality and reducing the reputation of Public Accountant Profession in Indonesia.

The purpose of this study is to obtain an empirical evidence about the influence of auditors industry specialization and auditors independence to the Auditing Standards (especially to the audit procedures to detect material fraud in a financial statement audit), as well as the influence of auditor industry specialization, auditor independence, and audit procedures to detect material fraud in a financial statement audit on the audit quality, partially and simultaneously.

The method used in this research is descriptive and verification methods. The unit of analysis in this study was 50 Public Accountant Firms (KAP) as a member of FAPM (Capital Market Public Accountant Forum), with its professional staffs (partners and staff) as respondents. The sampling technique used is purposive sampling and the analysis tool used is Path Analysis.

The results of this study indicate that simultaneously test of auditor industry specialization and auditor independence are significantly and positively effect on Auditing Standards (especially the application of audit procedures to detect material fraud in a financial statement audit). Results of this study also showed that simultaneously auditors industry specialization, auditor independence, and audit procedures to detect material fraud in a financial statement were significantly and positively effect on audit quality.

While the partial test results showed that there were no significantly and positively effects for each auditor specialization and auditor independence on audit quality, presumably because of the audit engagement period is too short ( due to auditor rotation regulation), causing both of them are not too dominantly raising the audit quality. Based on the above results it can be concluded that in order to improve the audit quality  generally in Indonesia, the current auditor rotation rules should not be too short (maximum 3 years for public accountants) so that the role of auditor industry specialization and auditor independence can be streamlined in raising the audit quality. Besides, the Indonesian auditing standards (SPAP) should be supplemented by more specific guidance, especially in the procedures to detect material fraud in an audit of financial statements.

Keywords: Auditor Industry Specialization, Auditor Independence, Auditing Standards,  Audit Quality

INTRODUCTION
          Fraudulent financial reporting practice is a phenomenon that could not be overlooked in today's auditing. Common frauds are the manipulation of sales management, negligent to record debt, postponement of written off, and intentionally reported false financial statements. As a result of these practices, in the United States in 2002 as many as 233 companies have to do a restatement on their financial statements which has been published (Pakenko, 2003). These cases are beyond the case of the financial scandals made ​​by of Enron, WorldCom, etc. in the United States in 2002. In Australia in the same year there was uncovered financial scandal by HIH Insurance Company Group involving its external auditors (Leung et.al 2011). Similarly, in Indonesia, at the beginning of this century there were uncovered fraudulent practices in the company financial reporting at PT.Indofarma Tbk in 2001 (www.bapepam.go.id), PT. Bank Global Internasional Tbk in 2003 (www.tempointeraktif.com), PT. Indosat Tbk in 2004 (www.tempointeraktif.com) and others. Exposure of the financial scandal has resulted in the erosion of public confidence in the financial information presented by the company management. Surely, as revealed by Healy and Palepu (1993) the quality of financial statements are not determined by the set number of accounting standards or auditing standards, but it is determined primarily by the commitment and full support of all parties concerned, and one of them is its external auditors.

           Following these phenomena the accounting profession has always had trouble explaining to critics why an audit conducted in accordance with professional standards might fail to detect a material misstatement of financial statements caused by fraud (Bragg, 2010:69). Based on press release from the Public Relations Bureau of the Indonesian Finance Department (PPAJP, 2010-2011), in the framework of its annual inspection, the PPAJP find many cases of infringement by Public Accountant Firm (KAP) in Indonesia that are not fully implemented Auditing Standards or SPAP (Public Accountants Professional Standards) which has also been determined by the IAPI (Indonesian Public Accountants Institute), so that resulting an audit failure. One of the auditing standards set by the IAPI (SPAP, 2011) is Auditing Standards Section 316 (Consideration of Fraud in a Financial Statement Audit) an audit procedures to detect fraud risk in a financial statement that is the adoption of Statement on Auditing Standards (SAS) No.82 (Consideration of Fraud in a Financial Statement Audit) issued by the AICPA in 1997. After the Enron case in 2002, the AICPA issued SAS No. 99 (as a replacement of SAS No.82) is more detailed/specific in detecting fraud risk in a financial statement (Bragg, 2010:69-95). The problem is the current auditing standards set up by the IAPI (SPAP, 2011) is still not adopting such SAS No.99.

           Furthermore, the not fully implementing the auditing standards demonstrated that the audit quality of Public Accountant in Indonesia is still not sufficient, which can be caused by lack of auditors understanding of auditing standards (SPAP) or due to the presence of SPAP is not up-to-date. High audit quality is very useful to produce reliable financial statements due to the high-quality auditing process could force the management (whom intends to fraud) to implement the Generaly Accepted Accounting Principles (GAAP) correctly. Therefore, reliable financial statements should show the high quality of the auditor behind them, because the compliance with auditing standards is an auditors professional responsibility  in the audit of historical financial statements.