Audit Quality Differences Among Auditors: The Case of Hong Kong

1.6%.
Under the requirements of HKAS 36, 
goodwill balance acquired in a business 
combination is subject to impairment testing 
whether the value of goodwill is immaterial 
compared with the values on the balance 
sheet. So the firms with failure of disclosure 
method used were judged not to comply with 
the disclosure requirements of the HKAS 36. 
However, based on only this analysis, it is not 
possible to reach a robust conclusion as to the 
possible variation in quality by audit firm.
The next analytical technique used was to 
compare the reported value of goodwill on the 
consolidated financial statements with the sum 
of the amounts of goodwill allocated to defined 
CGUs of reporting sample firms. As set out in 
Table 5, the majority of firms fully complied 
with the disclosure requirements, accounting 
for 75% of the total sample (in this case it was 
possible to have matched data between value 
of goodwill on the balance sheet and the sum 
of goodwill allocated to CGUs). In only three 
Table 4: Method used for determining recoverable amount of CGUs
Method Employed Deloitte E&Y KPMG PWC Others Totaln=63 n=58 n=30 n=76 n=37 n=264
Fair value 2 1 3 1 1 8
Value-in-use 58 52 26 64 34 234
Mixed method 2 1 - 4 - 7
No effective disclosure 1 4 1 7 2 15
Proportions of auditees where no effective disclosure 1.6% 6.9% 3.3% 9.2% 5.4% 5.7%
Journal of Economics and Development Vol. 17, No.1, April 201586
cases belonging to clients of Deloitte, E&Y and 
KPMG that goodwill value allocated partially 
to defined CGUs and discrepancies between 
goodwill value and the sum of goodwill 
allocated to CGU were immaterial.2
There were 63 cases (about 24% of the final 
sample), which provided no effective disclosure 
relating to goodwill allocation to defined CGUs. 
Clients of E&Y failed to disclose the effective 
disclosure pertaining to goodwill allocation to 
CGUs with the highest percentage of 32.8%. 
Followed by clients of non-Big4 auditors, PWC 
and KPMG were at 29.7%, 26.3% and 23.3%, 
respectively, and with clients of Deloitte at the 
lowest percentage in total, 9.5%.
From an audit firm identity, there was 
little evidence of cross-sectional variation in 
practice. In the first two analytical procedures 
applied to the sample data, however, it appeared 
that Deloitte’s clients had the lowest percentage 
of non-compliant levels, whereas clients of 
remaining auditors had insignificant variation 
of non-compliant levels with the accounting 
standard. The next analysis procedure produces 
more evidence of compliant levels of audit firm 
clients relating to CGU aggregation, which is 
set out in Table 6.
Table 6 reveals that clients of non-big 
4 auditors (other auditors) have a greater 
tendency to define fewer CGUs than business 
segments or report no meaningful disclosure of 
CGU definition than other clients of big 4 firms, 
especially Deloitte. According to the content of 
paragraph 80, each CGU or groups of CGUs to 
which the goodwill is so allocated will present 
the lowest level within the entity, and will not 
be larger than a segment of the company. So, 
clients of all audit firms violated the provision 
with different levels.
The data show that about 81% of other 
auditors defined fewer CGUs than business 
segments or provided no effective disclosure 
Table 5: CGU allocation compliance by auditors
Sectors Deloitte E&Y KPMG PWC Others Totaln=63 n=58 n=30 n=76 n=37 n=264
Fully compliant 56 38 22 56 26 198
Ostensibly compliant 1 1 1 - - 3
Non-compliant 6 19 7 20 11 63
Proportion of firms where non-compliant 9.5% 32.8% 23.3% 26.3% 29.7% 23.9%
Table 6: Business segments and CGU aggregation by auditors
Number of firms 
Deloitte E&Y KPMG PWC Others
n=63 n=58 n=30 n=76 n=37
CGU > Segments 8 7 4 12 3
CGU = Segments 18 7 3 16 4
CGU < Segments 32 28 16 33 20
No Effective Disclosure 5 16 7 15 10
Proportion of firms where CGUs < segments or no effective disclosure 58.7% 75.9% 76.7% 63.2% 81.1%
Journal of Economics and Development Vol. 17, No.1, April 201587
relating to the relationship between number of 
CGUs and number of business segments. In 
contrast, this happened in only 59% of Deloitte 
clients, with PWC, KPMG and E&Y clients at 
about 63%, 77% and 76%, respectively. This 
suggests a higher risk of CGU aggregation 
belonging to non-big 4 audit clients than that in 
clients of Big 4 firms, especially Deloitte.
The same pattern exists when calculating 
the ratios of CGUs to business segments and 
then stratifying and classifying under audit 
firm identity, which is illustrated in Table 7. 
Specifically, clients of other auditors have the 
lowest percentage of ratios of CGUs to business 
segments higher than 1. This suggests that these 
clients can potentially conceal impairment, and 
therefore prevent detection and overestimate 
earnings.
Other techniques of analytical procedure are 
employed for identifying an audit firm’s quality 
Table 7: Ratio of CGUs to business segments
Number of firms Deloitte E&Y KPMG PWC Othersn=63 n=58 n=30 n=76 n=37
No Effective Disclosure 5 16 7 15 10
CGU : Segment is between 0.00 - 0.50 25 24 13 21 18
CGU : Segment is between 0.51-0.99 7 4 3 12 2
CGU : Segment = 1 18 7 3 16 4
CGU : Segment is between 1.01-1.50 2 2 1 3 -
CGU : Segment>1.50 6 5 3 9 3
Mean CGU : Segment ratio 0.88 0.93 0.87 0.95 0.85
Median CGU : Segment ratio 0.67 0.50 0.50 0.75 0.50
Minimum CGU: Segment ratio 0.14 0.11 0.20 0.17 0.13
Maximum CGU : Segment ratio 5.00 8.00 4.50 4.00 5.00
% CGU : Segment > 1.01 12.7% 12.1% 13.3% 15.8% 8.1%
Table 8: Analysis of discount rates used to test impairment4
(Value in use and mixed method used only)
Number of firms Deloitte E&Y KPMG PWC Others n=60 n=53 n=26 n=68 n=34 
Multiple explicit discount rate (n=31) 11 8 2 8 2 
Single explicit discount rate (n=162) 44 36 16 39 27 
Range of discount rates (n=20) 2 4 3 6 5 
No disclosure (n=28) 3 5 5 15 - 
Proportion of firms where no disclosure 5.0% 9.4% 19.2% 22.1% 0.0% 
Minimum discount rate 5.00% 3.10% 5.00% 2.60% 4.68% 
Maximum discount rate 22.36% 23.70% 25.90% 20.00% 20.00% 
Median discount rate 10.00% 10.00% 10.88% 10.44% 10.78% 
Mean discount rate 11.26% 9.68% 10.79% 10.93% 11.48% 
Journal of Economics and Development Vol. 17, No.1, April 201588
of discount rate disclosure for estimating CGU 
recoverable amount. As presented in Table 
8, clients of PWC provided less effective 
disclosure pertaining to discount rates than 
clients of the remaining big four auditors and 
non-big four auditors, particularly.
The data also shows that clients of audit 
firms employed unusually low discount rates.3 
Specifically, PWC clients adopted a rate of 
2.6%, through to clients of E&Y at 3.1%, 
other audit firm clients at 4.68% and clients 
of Deloitte and KPMG at 5%. Applying lower 
mean discount rates in the model of discounted 
cash flow would result in overestimating present 
values (recoverable amounts), consequently 
reducing the chance of recognising impairment 
expenses in the accounting period, and 
increasing accounting profit recognised in the 
consolidated financial statements. However, 
there is little evidence of finding meaningful 
cross-sectional variation explained by audit 
firm identity.
A scrutiny of data to growth rates is 
employed in the discounted cash flow model 
for estimating recoverable amount of each 
CGU. Table 9 illustrates a different pattern 
in comparison with the pattern shown in 
the discount rate disclosure in practice. The 
highest percentage of non-compliance with 
the disclosure requirements belongs to clients 
of other auditors, accounting for about 71%, 
followed by clients of Deloitte, PWC, KPMG 
and E&Y at about 70%, 68%, 65% and 62% 
respectively.
Average estimated growth rates employed 
by other auditor clients (about 11.5%) were 
higher than that chosen by big 4 auditor clients, 
particularly E&Y (about 9.7%). Using higher 
growth rates in the model of discounted cash 
flow, other things being equal, would increase 
the determined recoverable amount of CGU 
assets, and reduce the chance of recognising 
goodwill impairment expenses, and increase 
the possibility of reporting accounting profit in 
a given year. 
In addition, some clients of audit firms 
employed longer period than the prescription 
in the accounting standard, but no explanations 
Table 9: Analysis of growth rates used to test impairment5
Number of firms Deloitte E&Y KPMG PWC Othersn=60 n=53 n=26 n=68 n=34
Multiple explicit growth rate (n=15) 5 4 2 3 1
Single explicit growth rate (n=56) 11 16 7 14 8
Range of growth rates (n=8) 2 - - 5 1
No disclosure (n=162) 42 33 17 46 24
Proportion of firms where no disclosure 70.0% 62.3% 65.4% 67.6% 70.6%
Minimum growth rate 0.00 0.00 0.50 0.00 0.00
Maximum growth rate 26.76 12.00 8.00 15.6 21
Median growth rate 2.75 3.90 5.00 3.40 3.00
Mean growth rate 3.40 3.29 4.94 3.99 6.13
Mean forecast period (years)6 6.89 5.74 6.82 5.61 7.37
Journal of Economics and Development Vol. 17, No.1, April 201589
existed in the note-forms of financial statements. 
On the whole, the non-compliance levels 
pertaining to disclosing long-term growth rates 
in the clients of every category of auditors were 
very high.
5. Conclusion
This research is conducted to find evidence 
which might reveal variations in audit quality 
among auditors (Deloitte, E&Y, KPMG, PWC 
and non-Big 4 auditors). The methodology 
applied in this study focussed on the nature and 
quality of disclosures in relation to goodwill 
impairment testing process under HKAS 36 - 
Impairment of Assets.
The research is based on accumulated 
evidence obtained from the sample of listed 
firms in Hong Kong for the third year after 
HKFRS implementation, including HKAS 
36. By testing the method adopted, CGU 
aggregation and variables of the discounted 
cash flow model, the low compliance levels 
and poor disclosure quality relating to goodwill 
impairment belong to clients of all audit firms. 
It appears that the levels of non-compliance and 
poor disclosure quality pertaining to goodwill 
impairment of other audit firm clients were 
higher than that of Big 4 audit firm clients.
Out of the Big 4 audit firms and non-Big 4 
audit firms, clients of Deloitte were judged, on 
the whole, to be the best practice disclosure 
bearing on goodwill impairment testing 
process. Meanwhile, clients of E&Y, KPMG, 
PWC and other audit firms were evaluated 
to have substantial variations of practice 
disclosures relating to method employed, CGU 
aggregation and discount rates and growth 
rates.
Evidently, the extent of compliance levels 
with HKFRS including HKAS 36 is likely 
to be related to the probability of detecting 
and reporting material misstatements in the 
accounting system of an auditee. Variations in 
disclosure of goodwill impairment of auditees 
are likely to be the result of audit quality 
variation. So evidence collected in this research 
may contribute to the literature by supporting 
the proposition that audit quality of big 4 
auditors is seen to be higher than that of non-
big 4 auditors and the quality of an audit among 
Big 4 audit firms is not homogeneous as long 
accepted before, but is subject to variation. 
Further research on variations in audit quality 
among audit firms when compliance levels and 
disclosure quality of goodwill impairment in 
the time series is identified and discussed.
Notes:
1. As to which, see HKAS 36, Paragraph 134.
2. Materiality is determined by reference to the dollar value of the reconciliation gap compared against 
the dollar value of total goodwill balance of the firm.
3. This judgment is based on the long-run sovereign risk-free rate in jurisdictions such as the United 
States at levels in excess of 5%, and in Australia at 6%.
4. Of the 264 sample firms, 234 used the method of value in use and 7 applied the mixed method 
(combination of the value in use and fair value). Table 8 does not consist of two outliers by checking 
Histogram and Boxplot. Shell Electric Mfg (Holdings) Co., Ltd., client of other auditor, used a single 
discount rate of 35% and Uni-Bio Science Group Ltd., client of other auditor, applied a range of 
Journal of Economics and Development Vol. 17, No.1, April 201590
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