Using a unique dataset of audit days in China from 2006 to 2011, this paper examines the relationship between audit effort and audit quality from the perspective of audit process and audit output. The results show that audit effort significantly increases the probability of audit adjustments, which inhibits positive earnings management and improves the quality of audited financial statements. We also find that audit effort does not have a significant effect on the issuance of modified audit opinions overall, but that a modified audit opinion is more likely to be issued in the absence of an audit adjustment. Furthermore, we find that the impact of audit effort on audit quality is attenuated when clients are more complex and when audit firms are larger. Collectively, our evidence suggests that audit effort plays an important role in improving audit quality by influencing audit process and audit output. Our study extends the literature on the impact of audit effort on audit quality in emerging markets, and the conclusions have important implications for the improvement of China’s audit market efficiency.

Introduction

Audit plays an important role as an external corporate governance mechanism, and the governance effect of audit is directly reflected in audit quality. The overall objectives of audit are to obtain reasonable assurance that there is no material misstatement caused by fraud or error in financial statements, and to issue audit reports in accordance with auditing standards and communicate with client management (MOF, 2019). To realize these objectives, in the modern risk-oriented audit model, the main line of audit work requires auditors to identify, evaluate and respond to the risk of material misstatement. Consistent with the audit objective, audit quality is defined as the joint probability that an existing material misstatement is detected and reported by an auditor (DeAngelo, 1981). The realization process of audit quality can be summarized as detecting, adjusting, and reporting material misstatements, and achieving audit quality. How to realize audit objectives and improve audit quality has always been the focus of audit research. Prior studies primarily investigate factors influencing audit quality from the perspective of auditor independence, including client importance, audit firm tenure, auditor mandatory rotation, and fees from audit and non-audit services (Reynolds and Francis, 2000; Frankel et al., 2002; Kinney et al., 2004; Carey and Simnett, 2006; Chen and Xia, 2006; Lennox et al., 2014; Zhang et al., 2017).