An Examination of the Credence Attributes of an Audit

TLDR

An audit consists of risk assessment and planning/execution, both requiring professional judgment, positioning the auditor as the expert best suited to assess risk and conduct audits per professional standards. The study aims to illustrate auditor strategies when the auditee cannot determine the appropriate effort level and to examine the credence attributes of audits. Using a simple decision‑making framework, the authors compare search, experience, and credence goods perspectives, analyze auditor incentives to under‑audit, over‑audit, or overcharge, and discuss professional and institutional arrangements that limit such behavior. The economic theory predicts that auditors may act strategically—under‑auditing, over‑auditing, or overcharging—which can undermine audit quality, efficiency, and regulatory oversight.

Abstract

SYNOPSIS: An audit consists of two main components: (1) the assessment of risk, and (2) the planning and execution of audit procedures. Both activities require a great deal of professional judgment. In this sense, the auditor is an expert who is best positioned to assess the risk and to conduct the audit in accordance with professional auditing standards. We use a simple decision-making framework to illustrate an auditor's possible strategies when an auditee cannot directly determine the effort level required to conduct an audit appropriately. We discuss and compare three economic perspectives for the audit: search goods, experience goods, and credence goods. Based on the economic theory of credence goods, we predict that a seller has incentives to act strategically when buyers are faced with considerable uncertainties relating to a service they purchase. Specifically, we argue that an auditor might have incentives to (1) under-audit, (2) over-audit, or (3) overcharge. These strategic actions have important implications for audit quality, efficiency, and regulation. We also discuss the professional and institutional arrangements that serve to limit the strategic behavior of auditors. Finally, we discuss previous empirical and behavioral audit evidence in the context of the credence aspects of an audit.