FS IV 91 - 31a
Quality Service - An Overview
Horst Albach
October 1991
ISSN Nr. 0722-6748
Forschungsschwerpunkt Marktprozeß und Unter
nehmensentwicklung (IIMV) Research Unit
Market Processes and
Corporate Development (DM)
Wissenschaftszentrum Berlin für Sozialforschung gGmbH, Reichpietschufer 50, W-1000 Berlin 30, Tel. (030) 2 54 91 - 0
An increasing pressure of customers for more services at no extra cost may lead to a moral hazard situation: In cases were the quality of the service can not be easily judged by the customer, one may be tempted to reduce quality. The paper deals with the question of quality of services rendered by public auditors, consisting of their evaluation and consulting. After giving an overview of the general trends in quality service (for example, changing risk tolerance of society and changes in the attitude towards the cost of quality) and their consequences, the paper goes on to examine developments in industrial quality control (like the transition from product control to process control) for their possible relevance for rendering quality service. In the final part of the paper strategic approaches to secure and improve professionalism, quality standards and quality services in CPA firms are introduced, including among others a discussion of the significance of publications in scientific journals and papers presented at professional conferences as criteria for the single auditor's professionalism and the quality of the services of the auditing profession in general.
ZUSAMMENFASSUNG
Qualitätsmanagement in der Wirtschaftsprüfungsgesellschaft
Dienstleistungsanbieter sehen sich zunehmend in der Zwangslage, immer mehr Service ohne zusätzliche Kosten erbringen zu müssen. In Fällen, in denen die Qualität der er
brachten Dienstleistung nicht ohne weiteres beurteilt werden kann, kann dieser stei
gende Druck zu einer Moral Hazard - Situation führen. Die Versuchung ist groß, die Qualität vom Kunden unbemerkt zu reduzieren. Diese Arbeit beschäftigt sich mit der Frage der Qualität der Dienstleistung, also Prüfungs- und Beratungsleistungen, die ein Wirtschaftsprüfer seinem Mandanten erbringt. Nach einer Darstellung der allgemeinen Trends in den Qualitätsanforderungen (wie etwa Veränderungen in der Risikotoleranz oder hinsichtlich der Preiselastizität der Qualität) und ihrer Auswirkungen werden Entwicklungen in der industriellen Qualitätskontrolle dargestellt und auf ihre mögliche Bedeutung für die Erbringung von qualitativ hochwertigen Dienstleistungen hin untersucht. Im abschließenden Teil der Arbeit wird eine umfassende Strategie zur Verbesserung von Professionalität, Qualitätsstandards und Dienstleistungsqualität im Prüfungswesen vorgestellt, in deren Rahmen unter anderem auf die Bedeutung des Kriteriums von professionellen Publikationen und Fachvorträgen für die Qualität im Berufsstand eingegangen wird.
HORST ALBACH
A. The Problem
B. The Definition of Quality
C. General Trends in Quality Service I. Changing Risk Tolerance
II. Changing Quality Requirements III. Changing Price Elasticity of Services
IV. Consequences
1. Setting Quality Standards 2. Professionalization of Services 3. Automation of Services
D. Lessons from Industrial Quality Control
I. From Heuristic to Analytic Quality Management H. From Integration to Value-Added Control III. From Product Control to Process Control
IV. From Control by Inspectors to Self-Control
E. Improving Service Quality - A Challenge for Public Auditors I. Strategic Aspects
II. Operational Aspects
1. The Organization of Integrated Quality Management 2. The Definition of Quality Objectives
3. Professionalism 4. Independence F. Conclusion
The Problem
"It's the quality that counts” has been the advertising slogan of a cigarette brand for many years. The slogan underscores all the problems in rendering quality service to the customer: the definition of quality, the planning of quality, and the assurance of quality in the final use.
In my paper I will not make an in-depth analysis of peer review as an instrument of quality control for a CPA firm. I will rather look at some developments in industrial quality control and comment on their relevance for rendering quality service.
The issue of quality in the service industries did not arise in Europe. Misgivings about the quality of the service rendered by CPA firms arose in the United States and led to peer reviews as a means of guaranteeing quality of CPA services. This may be due to cultural differences between the United States and Europe. The United States is a fault- tolerant society. The Germans are perfection maniacs - or rather used to be obsessed with perfection. The rate of product failure is higher in a fault-tolerant society than in a society that stresses perfection. In the United States learning is traditionally done on the job. In Germany, the apprenticeship system has dominated for many decades. Access to the accounting and auditing profession has traditionally been much easier in the United States than in Germany. Therefore, reliance on input quality of qualified labour can be much higher in Germany than in the United States, where process controls had to be introduced.
However, these cultural differences do not explain fully the discussion on quality service in the auditing profession. The problem is part of more general developments. In the first part of my paper I shall look at some of these developments. In the second part I shall present some aspects of managing for quality in the industrial sector. In the final part we shall draw conclusions for maintaining high quality in the service industries.
B. The Definition of Quality
What do we understand by quality? An industrial standard (DIN 55350) defines quality as the capability of a unit (of product or service) to meet predetermined and clearly defined requirements. Taguchi defines quality (or rather its absence) by the amount of losses that society suffers from a delivered product.
These two definitions may help to determine the quality factors of a service. Quality is a complex measure derived from different predefined attributes of the service. In the case of computer software, Wildemann has identified reliability, avoidance of improper use, user orientation and compatibility with different hardware systems as the dominating
attributes of quality1. In the case of an audit report I venture to define reliability, validity, professionalism, clarity, and accessiblity as the characteristics of quality.
The requirements or quality characteristics are derived from customer needs. They may have become qualified in toto or in part. They may change over time. It is important to recognize that quality service is defined by the customer and not by law.
It has become customary in the auditing profession to distinguish between the quality of services not directly related with a particular contract and the quality of these services rendered under a specific contract. In the first instance quality requirements may be defined by the state, by the trade organizations, and by the producer of the service. In the latter case it is always the customer himself who defines the required quality in the contract.
C. General Trends in Quality Service
With this definition of quality service we can now look at some general trends in quality requirements. Three trends may be distinguished in this context.
1. A change in the risk tolerance of society
2. A change in the quality requirements of products and services 3. A change in the attitude towards the cost of quality
We shall take up these trends in turn.
I. Changing Risk Tolerance
In the 19th century the customer had to bear the risk of product failure. Damages from proper and improper use of a product were not normally reimbursed by industry. This was maybe necessary to motivate industrial firms to make technical innovations and to launch them in the market-place. Even today, many firms operate on the basis of the slogan: "The best test for a product is the market-place!" However, society no longer accepts this attitude. Product-liability has dramatically shifted the burden of losses from products of poor quality. The producer is now held responsible. Litigation has driven quality standards of physical products up, safety standards for production have been established, e.g. in the pharmaceutical industry. People have become less fault-tolerant with new products and services.
1 Wildemann, Horst: Strategien zur Qualitätssicherung - Japanische Ansätze und ihre Übertragbarkeit auf deutsche Unternehmen, in: Zeitschrift für Betriebswirtschaft, 1982, p. 1043.
H. Changing Quality Requirements
At the same time quality requirements have undergone significant changes. Products have become what may be termed "sophisticated products". They are technically highly complex. Their use has to be carefully explained to the customer. The services rendered to the customer by a product have increased in number and scope. Just look at the desk calculator a CPA used 40 years ago and the desk calculator or laptop that he uses today.
In 1960 one could beat an IBM 650 with a slide-rule for quality of the sequential matrix inversions necessary for solving a linear programming problem, today slide-rules are no longer in use. One has argued that the software component in modern products has constantly increased. The know-how component in each hardware product has become of ever greater importance. The ratio of human capital to real capital has shifted towards the human capital side. Software embedded in hardware has increased in value and importance for the quality of a product.
In the services a similar trend can be observed. The professional and the scientific components in the services rendered to industry have increased constantly and have contributed significantly to the dynamics of the industry related service industries in the areas of investment, employment, and profitability.
HI. Changing Price Elasticity of Quality
In the chemical industry the scientific inputs have always been important. The chemical companies have always considered application services as being part of their marketing efforts. They have been a major determinant of competitiveness for several decades now. However, the chemical industry was the first also to notice a change in the willingness of its customers to pay for these services rendered. When in the 70's global competition took on a new dimension as a consequence of rising energy costs and floating exchange rates, price sensitivity for the quality of services rose significantly.
Customers began to take these services for granted and were no longer willing to pay for them. IBM started to charge its customers separately for services like software packages, maintaining the equipment, analyses for new configurations in the data processing system of a company.
Under the pressure from competition the philosophy in industry changed radically.
After-sales service had become too expensive. Therefore industry shifted to pre-sales services. The products and services were planned very carefully and extensively in order to make the products and services easy to apply and easy for the customer to use.
Ease of handling became a major determinant of competitiveness in industry. This required careful planning and design of new products. Careful product planning made it possible in some industries even to leave the assembly of the products to the customer, who came to be called a "prosumer". Good examples are the furniture business and the model building industry that produces kits with all the parts of model planes, model ships and model cars to be put together by the consumer.
Figur© 1: General Trends in Quality Service
1: Changing Risk Tolerance
=> Safer, more sophisticated products 2: C hanging Quality Requirements
=> more professional know-how,
more service com ponents in physical products
3: Changing Price Elasticity
=> more customer utility, more
and higher quality service a t no extra cost
A similar trend may be observed in the auditing services. Computer aided auditing helped to reduce the time for auditing financial reports.
The general shifts may be summarized as shown in Figure 1.
IV. Consequences
These changes have already had significant consequences. Three major consequences may be distinguished.
1. Setting Quality Standards 2. Professionalization of Services 3. Automation of Services
1. Setting Quality Standards
The pressure of customers for more services at no extra cost created a moral hazard situation. In cases were the quality of the service cannot be easily observed (hidden information), there is temptation to reduce quality. Professional services in particular are of this kind. Legal advisors, consultants, market researchers, medical doctors and CPAs all render services of a quality which cannot be easily ascertained by the client.
Therefore, in order to meet cost pressures from clients and from competitors, the service firm may try to lower the quality of this service in order to remain price-competitive.
Of course, this results in a price competition with decreasing service quality. The auditing profession has tried to cope with this problem by passing a price list for auditing services. The anti-trust problems involved in making such a price list accepted standard in the profession are another matter. However, these price lists do not really solve the problem. They result in indirect price competition. Working time on audits is reduced. Therefore, such price lists have to be accompanied by quality standards in order to define minimum service quality. The legislators and the chambers of certified public auditors have specified minimum standards of service quality. This consequence is not only restricted to the auditing profession. The European Commission is presently considering to establish minimum quality standards for all products sold in Europe.
This is, of course, the wrong approach. It drives up the cost of products and services and establishes a quality audit bureaucracy. It does not necessarily improve quality at the lowest cost obtainable.
The correct approach is to generate quality competition. Quality competition is workable only if quality can be communicated to the market. Advertising has in fact shifted towards stressing quality rather than price. Quality competition for professional services requires the freedom to advertise for quality. The ban on advertising for
Figure 2: C onsequences of P rice and Q u a lity C o m p e titio n
Q u a lit y
o - o T r a d e - o f f b e tw e e n c o s t and Q u a lit y 1 P r ic e C o m p e titio n
2 Q u a lit y S ta n d a rd s 3 Q u a lit y C o m p e titio n
services by the auditing firms should lilted. I l requires also, however, eliminating the risk of exploiting the incomplete information of the client about the quality of the service rendered. Drastic sanctions for those firms that exploit a moral hazard situation would be the price for permitting advertising in the professions.
Figure 2 shows the different consequences of competitive pressures on quality or products and services. We shall deal with three aspects of quality competition in the following sections.
2. Professionalization of Services
The traditional approach to quality competition is in the services to professionalize the production of services. The costs of professionalization are borne by the state because the state pays for an academic education of future auditors. This shifts input cost from the firm to the tax payer. The quality of the service (input quality) is assumed to be a function of the quality of the service rendered to the customer (output quality).
Professionalization also means that the sanction for low quality services is shifted from the firm to the individual. The individual member of the auditing profession may be ousted from the profession. This is a highly effective system which in general sets the right inducements to improve the service quality.
3. Automation of Services
By now it is a widely accepted view that the human being is anything but a faultless worker. In gothic cathedrals and in oriental carpets the little faults of human handicraft are considered a token of originality if not of quality. In modern hightech products and complex services, faulty products are intolerable. Therefore, the consequence of the customers' insistence on utmost quality have resulted in the automation of production processes in order assure top quality. This is a general trend in industry. It can be observed in the services also. In the services there may be a trade-off between professionalization and automation at least to some degree. Therefore, in the auditing profession, automation started where the professionalization was less developed. In the meantime, automation of auditing procedures has spread to Europe as well. Of course, automation may also result in lower costs. Improving quality at lower cost is the quality strategy marked "3" in Figure 2.
D. Lessons from Industrial Quality Control
We now turn to industrial quality control and identify those lessons from recent developments that may be applied to improve quality service in the service industries.
Four lessons may be distinguished:
1. An analytic approach to quality maintenance is better than a heuristic approach 2. A value-added approach to quality management is better than an integration
approach
3. Process control is more efficient than control of the final product 4. Self-control is less expensive than control by others
I. From Heuristic to Analytic Quality Management
The traditional approach to quality control in industry has been to sample the final product or the intermediate products at various stages in the production process and to control the sample for quality. In order to avoid the excessive costs of such control systems, industry first applied scientific methods to quality control. Sequential sampling was one such scientific technique which resulted in drastic cost reductions without lowering standards for accepting the quality of the products. The next step was to carefully analyse all the weak spots in the production process in order to determine the causes of inadequate product quality. Quality planning was introduced to rigorously eliminate these weak spots.
H. From Integration to Value-Added Control
The philosophy in industry, particularly in the United States, has traditionally been to vertically integrate for higher quality products. Justification for integration is provided again by the moral hazard problem of incomplete information on the quality of intermediate products purchased in the market. In the automobile industry, Ford Motor Company is a good example of full integration. In the early 20th century the Dearborn plant of Ford Motor Company was fully integrated: it produced steel, it produced tires and it produced the final product. In Germany, the automobile manufacturers integrate their quality management systems back into the supply industry and establish rigorous quality norms like Ford's Q 101 standard and reserve the right to send their quality inspectors to make sure that these quality standards are adhered to.
Integration has proved to be a very costly system of quality management. The trend now is towards lower value-added by outsourcing. This is efficient only if the firm can trust its suppliers to deliver top quality. Supplier and customer agree on a system of quality management and thereby eliminate quality inspection upon delivery of the intermediate product to the producer of the final product.
In auditing, German firms at first insisted on auditing subsidiaries also when auditing the consolidated statement even though the auditor of the subsidiary had already made his report. Today, the auditor only tests the auditing systems and procedures of the auditor of the subsidiary. Also, there was intensive discussion in the auditing profession in the 60's about the extent to which the results of the internal control audits of the audited firm could be used in the auditing services of a CPA firm to reduce workload
and fees. Again in the early days of this discussion it was assumed that the certified public accountant deviated from accepted auditing standards if he accepted internal audits without probing into the internal auditing system and without at least sampling its results. Today with the advancement of automated control procedures the certified public accountant relies to a greater extent on the results of the internal audits without acting irresponsibly.
HI. From Product Control to Process Control
In industry quality control moved from sampling to one-hundred-percent-control in order to guarantee zero defects in deliveries. One-hundred-percent end control of the product before shipping to the customer is very expensive. Therefore, quality control shifted from product control to process control. Failure analysis at each stage of the production process was automated. Faulty products were immediately eliminated at each stage of the production process. The thrust of this shift from product control to process control was, however, more dramatic: Its objective was to analyse the causes for inadequate production and to eliminate them all together. The principle of the internal customer was introduced. Each stage of the production process was made responsible to deliver to the next stage a "product" which is as good in quality as it should be if delivered to a customer of the company.
This is of course a lesson of great importance for the auditing profession. Each worksheet of the audit of a particular figure in the financial statements has to meet the same quality standards as the final auditor's report. The auditor, who audits the accounts payable delivers his "product" to the auditor of the contingent liabilities, and his worksheet should meet all the quality requirements of the auditor of the contingent liabilities.
IV. From Control by Inspectors to Self-Control
Formerly quality philosophy held it that the producing and the controlling functions should be clearly separated. This philosophy neglected the adverse selection phenomenon. Setting up a quality controller function changes the behaviour of the producer. The quality is controlled, not produced. The producer does not strive for maximum quality, but for maximum output. Faulty products are passed on to the next stage in the production process and may be rejected by the quality inspectors. This adverse selection drove the costs for quality control up to the point where the philosophy had to be changed. Now each producer is responsible for the quality of his performance. Self-control is less costly than control by quality inspectors. Zero defects programs motivate each worker to make sure he does not hand on faulty products.
Quality circles exert enormous pressure on the individual not to slip in his endeavours to guarantee top quality in performing his function.
Figur© 3: Th© Magic Triangle of Quality Strategy
CPA Audit ---► Client
◄ --- Expectations ---
Litigation
Figur© 4: Risk Strategies and Service Quality
Losses
M oney an d Professional Im age
General A udit
C ontract Conditions on Product Liability
Compulsory Insurance Quality M anagem ent A dditional Voluntary System
Insurance
Outside Control Inside Control
'Peer Review' Professional Audits Courts
▼
Quality Planning Quality M anagem ent Post A udit Quality Control
This shift in the industrial quality control system may not be directly applicable to the auditing firms. However, I venture to say that the costs of post-audit controls like report control and occasional post-audit reviews can be reduced if self-control is significantly improved. Automated control procedures for the individual auditor are evidence of this trend in many CPA firms.
E. Improving Service Quality - A Challenge for Public Auditors
Improving service quality in the auditing profession has become a major challenge for CPAs and CPA firms. There are strategic and operational aspects to meeting this challenge.
I. Strategic Aspects
Any strategy consists of two parts: A decision on the strategic objectives and a decision on the ways to meet these objectives.
The strategic objectives of quality management in an auditing firm are set within what Staudt has called the "magic triangle of the quality strategy": The state, the client, the firm2. Figure 3 shows the magic triangle. In general, quality expectations of the client exceed the auditing standards issued by the state or by the self-regulatory bodys working on behalf of or with the consent of the state.
The CPA has to decide on the strategy how to cope with the risk of litigation for not meeting quality standards and expectations. Three strategic approaches to this problem can be distinguished. Figure 4 illustrates them. It seems evident that risk shifting and risk insurance are no longer viable strategies for making sure that the client gets top- quality service. Risk avoidance is the dominant strategy.
The strategic instruments of risk avoidance may be derived from a quality portfolio. The portfolio was first developed by Scharrer for industrial quality control3. It is adapted here to quality strategies in the auditing profession. Figure 5 shows the matrix. The idea behind this matrix is that quality service has a rational and an emotional component. It takes professional knowledge and personal commitment to produce top-quality service in industry as well as in the services. Therefore, service quality requires both: A high rational component and a highly emotional component. It is obvious from Figure 5, that the public accountant can no longer rely on legal clauses and professional quality
2 Staudt, Erich, und Horst Hinterwäller: "Von der Qualitätssicherung zur Qualitätspolitik - Konzeption einer integralen unternehmerischen Qualitätspolitik", in: Zeitschrift für Betriebswirtschaft, 1982, p. 1000.
3 Scharrer, Erich: "Qualität - Ein betriebswirtschaftlicher Faktor", in: Zeitschrift für Betriebswirtschaft, 1991, p.695, esp. p.712.
standards if he wants to render top quality service to his client. He has to devise a system of quality management that mobilizes the professional expertise of each and every employee and that commits him emotionally to the quality objectives of the firm.
This ideal strategy is called here "integrated quality management".
Finally, a quality service strategy has to take the cost of quality maintenance into consideration. We have argued that total cost of rendering quality services decreases when emphasis is laid on quality planning and not so much on quality control. Now we look at the relative importance of different stages in the quality management process.
Figure 6 gives cost accrual curves for different service quality strategies. Figure 6 suggests that there is a trade-off between prevention of not meeting quality objectives and paying for damages resulting from low-quality service. It suggests also that quality management system B is more efficient than system A. With B great efforts are taken to plan quality carefully and to think in advance of all the potential weaknesses in the auditing process. Strategy B also places great emphasis on the recruiting of highly professional and emotionally committed staff. And finally, it relies heavily on self
control and reduction of post-audit control. Under strategy B, many of the employees now occupied with report review are assigned to auditing teams with clients. And yet, as is evident from Figure 6, losses from litigation can be almost completely avoided under this strategy.
II. Operational Aspects
This takes us to the operational aspects of maintaining service quality. Three aspects have to be distinguished:
1. The Organization of an Integrated Quality Management System 2. The Definition of the Criteria for Quality Management
3. The Methods for Service Quality Management
Since this overview does not attempt to be a handbook for maintaining quality service in the auditing profession, the third aspect will not be treated here. Rather, two specific points, which relate to the criteria for quality management will be taken up because practical experience and theoretical interest have been concentrated on these two aspects for many years.
1. The Organization of Integrated Quality Management
Organization of integrated quality management means defining the competences for establishing quality objectives and assuring that the objectives are met in the auditing operation.
F ig u re 5: S tr a te g y P o r tfo lio fo r Q u a lity S e rv ic e
r a t io n a l c o m p o n e n t
H ig h Low
TQC - T o ta l Q u a lit y C o n t r o l S y s te m
IQ M - In te g r a të d Q u a lit y M a n a g e m e n t S y s te m A,B - S t r a t e g y P o in ts
C o s t
Figure 6: C ost A ccru a l o f Q u a lity S tra te g ie s (p e rce n t, cum ulative)
1 0 0
A u d itin g P ro c e s s
t-
Quality objectives are defined by top management of the CPA firm. Quality management and quality monitoring are two functions that are assigned to a new function in CPA firms, called quality controlling. Quality controlling is a support staff that plans the quality control system, develops the methods for quality management and receives feedback from quality control for analysis. Quality management is the job of each audit group. Figure 7 is a graphic representation of the organization of the quality function in a CPA firm.
It may be noted that the organization chart of Figure 7 does not indicate a separate internal staff "report review" nor does it show a separate "post-audit control department". On the other hand there is a strong quality controller that implements the quality philosophy and makes the quality objectives set by top management operational.
The quality controller monitors the quality management process which is assigned to each line-employee. Members from controlling as well as from the line organization work together in task groups on quality improvement projects.
2. The Definition of Quality Objectives
The quality objectives reliability, validity, professionalism, clarity and accessibility have to be transformed into operational measures. Figure 8 shows which quality criteria may be associated with the quality objectives. Also, Figure 8 shows the legal basis, if there is one, for the quality criteria. It should be noted that the decision on the size of the samples taken in auditing a financial statement is left to the auditor under the general clause of responsibility for his audit and that be criterion of conservatism in auditing and in particular in risk analysis and valuation is also left to the individual CPA or to top management of a CPA firm to decide. In my experience, conservatism is the most important quality criteria. Conservatism, however, is hard to communicate in written form. Board members are, therefore, well advised to require the presence of the auditors at the board meeting that deals with the annual report and to inquire carefully whether all the risks associated with the business have been carefully accounted for in the financial statements. German law requires auditors also to take part in the annual shareholders' meeting but it does not require auditors to answer the questions by the shareholders. In my opinion it would be better to restrain shareholders by law from asking questions about the firm's involvement in Apartheid South Africa but to permit shareholders to ask questions of the firms' auditors. -This would definitely improve the accessibility of the auditors and consequently their quality service. After all, it is the shareholders responsibility to elect the company's auditors.
Two criteria are of particular interest to me. I would, therefore, like to comment on publishing in professional journals as a criterion for quality service and to take up the issue of independence as a criterion of a quality of an auditor's service. I would thereby like to draw attention to wider definition of dependence.
Figur© 7: Organization of Integrated Quality Management
Outside Directors Consultants
Figure 8: Quality Objectives and Criteria
Objectives Criteria Basis
Reliability Independence
Punctuality
§ 319 HGB
§§ 43, 49 WPO
§ 120 AktG
§ 170 AktG
Validity Size of Samples
Conservatism in Valuation
"Whistle Blowing" §321 Abs. 2 HGB Professionalism Hiring
Publications
Teaching in Training Programs Service in Professional Organizations
§§ 8, 15 WPO
§ 59 WPO Clarity Ratio analysis
Risk analysis
§ 243 Abs. 2 HGB
Accessibility Audit Report Auditors
§ 170 AktG
§ 171 AktG
§ 176 AktG
3. Publications in Professional Journals
Quality service in the auditing profession has its basis in a thorough professional training at the university level. Professional training is research based. Professional service continues to be research based. Many members of the auditing profession seem to forget this after they have left the university. They no longer consult the scientific journals but limit their attention to their specific auditing journals. Publishing in these journals or in other relevant professional journals is not commonly considered to be a criterion of quality service. Therefore, only a minority of the members of the auditing profession writes and publishes professional articles. In the twenty years that I served on the board of "Treuarbeit" I have consistently tried to stimulate interest in contributing to the quality of the profession by publishing articles on controversial issues in auditing. On my suggestion the board has received quarterly reports on articles published by employees of the firm and on papers presented to professional conferences. And yet, it was only a minority, and it has been only a minority of the professionally trained employees that could be motivated to constantly think about improving professionalism, quality standards and quality service in the auditing profession in publications. However, I insist on publishing being a very important criterion for quality service in auditing. Too many auditors seem to be of the opinion that quality service is a synonym of complying with the law and the statutes of the audited company. Too few auditors have learned that quality service means meeting the client's expectations for economic analysis of his business, of identifying changes and of pointing out potential adverse consequences if considered material. In my opinion professional publications should become a prerequisite for promoting public accountants to senior management positions. This would produce competition for better quality within the accounting firm and, maybe, eventually result in more competition between accounting firms for better quality service.
4. Independence
Independence seems to be clearly defined in § 319 HGB (German Commercial Law). A CPA firm is not independent if one of its board members serves on the boad of a company that is audited by the CPA firm (§319, section 3, No. 5 HGB).
Now let us assume that we have a situation as shown in Figure 9.
The definition of independence given in the Commercial Law rules out an audit of company X by the CPA firm. It does not rule out, however, auditing of company Y and Z. We define CPA as dependent on X of the first degree, as dependent on Y of the second degree, and as dependent on Z of the third degree.
Figur© 9: Dependence and Independence
Firm All audits Degree of Dependence Unconnected Centrality
2 3 4 5 6
1. KPMG 94 3 27 37 10 0 17 0,0
2. Schitag 37 1 5 11 8 1 11 127,25
3. Treuhand Vereinigung
35 - - - - - 35 0,0
4. Treuarbeit 33 11 8 5 3 1 5 20,93
5. BDO Deutsche Waren treuhand
28 4 8 8 5 0 3 14,33
6. Süddeutsche Treuhand
13 - - - - - 13 0,0
7. Treuhand AG Rheinland
3 - - - - - 3 0,0
8. Revisions- u.
Beratungs AG
2 2 - - - - 0 0,0
9. Dr. Lange &
Partner
1 - - - - - 1 0,0
We have analysed 372 German industrial corporations and 14 major German CPA firms on the basis their 1989 financial statements4. These nine firms and their subsidiaries audit 246 of these 386 firms. If one accepts the view that a firm is central in such a network of interlocking directorates as shown in Figure 9 if it serves as a link in the communication line between two and more companies, one can compute a measure of centrality for each CPA firm. The basic idea behind this measure is to identify the ability to control and to influence the information flow in the network. Only five of the nine CPA firms have interlocking directorates with other auditing firms. Of course, dependence of the second degree is the most interesting case. If it takes six links to establish an information flow, one will certainly not talk about having control over the information flow in the communication channel. Of course, there is no dependence of degree one, because this case is ruled out by German law.
Obviously, KPMG follows a strategy of electing board members that differs strikingly from the strategy followed by Treuarbeit. KPMG has only one board member that has three links of length (W. Kühborth). Treuarbeit has three board members with a total of eleven links of length (Nawrath, Gester, Albach). We will not go into detail here. It may suffice to say that the higher the centrality of a person in a network of board members, the more difficult it is for a CPA firm to meet the legal requirement of independence and the higher is the probability of becoming dependent of higher degrees if a CPA firm elects this person to its board.
4 I am grateful to my assistant Amo Pfannschmidt for collecting the data and carrying out the computations.
F. Conclusion
In conclusion it seems fair to say that the German CPA firms meet the quality requirements of annual audits. More qualifications seem in order with respect to valuation assignments and consulting. Massive complaints about quality service have been voiced with respect to the auditing of the Deutschmark-opening statements in the new states of the Federal Republic of Germany. Here lack of qualified personnel, unfamiliarity with the complex problems of auditing formerly state-owned firms, and time pressures have resulted in major quality problems. This has posed very serious problems for the boards of the audited companies. CPA firms should have staffed the audit teams with their best auditors. These auditors seem to have been indispensable or unwilling to serve in the new states. This resulted in adverse staffing and a serious quality gap. Small and medium sized firms seem to have been less exposed to these problems. Medium and small CPA firms have won the competition for quality service in the new states.
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