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MAJ
22,6

The impact of codes of ethics

and experience on auditor
judgments

566

Gary Pflugrath
School of Accounting, University of New South Wales, Australia

Nonna Martinov-Bennie
Discipline of Accounting, The University of Sydney, Australia, and

Liang Chen
School of Accounting, University of New South Wales, Australia
Abstract
Purpose The purpose of this study is to investigate the impact of the presence of a code of ethics on
the quality of auditors judgments, within the context of the new International Standard on Quality
Controls 1 (ISQC1).
Design/methodology/approach A sample of 112 professional accountants and auditing students
was employed to investigate the effect of the presence of a code of ethics (operationalised as the
presence vs absence of an organisational code of conduct) on the quality of audit judgments, pertaining
to an inventory writedown, using a 2 2 full factorial between-subjects experimental design.
Findings The results of this study indicate that the presence of a code of ethics has a positive
impact on the quality of the judgments made by professional accountants, but not on students. This
suggests that it is the code of ethics, in the context of greater general experience that leads to higher
quality of judgments.
Practical implications The results suggest that the requirements of ISQC1 are relevant to the
quality control of accounting firms and have potential to positively impact the quality of audit
performance.
Originality/value This is the first paper to examine the impact of the presence of a code of ethics
within an audit context. It is the first time that the interactive effects of the code of ethics and technical
competency, which together form an integral part of standard-setters quality control standards, upon
the quality of auditor judgments has been investigated.
Keywords Ethics, Competences, Auditing, Standards
Paper type Research paper

Introduction
Recent high-profile corporate collapses, such as Enron and WorldCom, have brought into
question the status and credibility of the accounting profession, especially auditors, with
allegations of accountants violations of public trust (Chan and Leung, 2006, p. 436).
In 1999, Steve Samek, Country Managing Partner, USA, for Arthur Andersen, talking
about the firms independence and ethical standards, noted that The day Arthur
Managerial Auditing Journal
Vol. 22 No. 6, 2007
pp. 566-589
q Emerald Group Publishing Limited
0268-6902
DOI 10.1108/02686900710759389

The authors would like to acknowledge the support of the Institute of Chartered Accountants in
Australia for assistance during this study, as well as colleagues at the University of New South
Wales and The University of Sydney, and participants and discussant at the 2006 AFAANZ
Conference, for their comments and feedback on the paper.

Andersen loses the publics trust is the day we are out of business. While all of the major
accounting firms have been implicated with different corporate collapses and accounting
scandals, it is Andersen which has since ceased to exist. A consequence of these apparent
violations has been increased government intervention in the regulation of the profession
(Chan and Leung, 2006).
In an aim to restore public confidence, regulators have embarked on a number of
measures, including the introduction of new quality control standards (e.g. International
Standard on Quality Controls 1 (ISQC1, 2005)) for accounting firms, which prescribe both
ethical and technical requirements. The importance of possessing both technical and
ethical competency is well illustrated by the alleged role of auditors in a number of these
recent high-profile corporate collapses, and highlights the point that auditors need to be
technical and ethical experts when auditing financial reports (Gaa, 1994). This study
aims to investigate the impact of one aspect of the ethical environment (i.e. the code of
ethics) on the quality of auditors judgments, within the context of the new ISQC1.
The International Auditing and Assurance Standards Board (IAASB) has recently
introduced ISQC1[1], which aims to help firms establish a system of quality control for
audits and reviews of historical financial information as well as other assurance and
related services engagements. The standard applies to all members[2] of the
International Federation of Accountants (IFAC) and requires all firms to have policies
and processes in place to ensure their human resources are both technically and
ethically competent (ISQC1, p. 36). The purpose of the standard is to improve auditor
performance and audit quality by strengthening the ethical environment. Given the
significant burden upon firms to comply with ISQC1 mandatory changes, there is need
for timely research on this standard.
The only relevant study to date (Booth and Schulz, 2004) appears to provide
support for ISQC1s recommendations, by finding that an overall strong ethical
environment can significantly reduce the tendency of managers to continue failing
investments. As Booth and Schulz (2004) is a management accounting study, the
applicability of this study to the auditing field is limited. Further research on the
ethical environment within an auditing context is therefore warranted.
The current study examines the impact that the presence (vis-a`-vis absence) of a
firms code of ethics has on the quality of auditor judgment. The firms code of
ethics is chosen as the proxy for the ethical environment given that organisational
codes of ethics have been made mandatory by ISQC1 for all accounting firms.
Moreover, previous studies on codes of ethics have determined that the codes can
affect auditors ethical judgment (Jones et al., 2003; Herron and Gilbertson, 2004);
however, none has extended this to consider the effect on auditors overall audit
judgment. Therefore, it is unclear how codes of ethics may affect audit judgments.
Participants (professional accountants and undergraduate auditing students)
assuming the role of a senior auditor, were required to make inventory-writedown
judgments. Audit quality of the participants judgment was assessed by two measures:
(1) The likelihood of the subject discussing the audit issue with a supervisor
(likelihood).
(2) The difference in the inventory adjustment amount that the subject believes to
be technically appropriate under the accounting standards, and the adjustment
amount that would be recommended to the supervisor (difference).

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Participants are expected to be positively impacted by the presence of a firms code of

ethics (Douglas et al., 2001; Booth and Schulz, 2004) and therefore make higher quality
audit judgments (i.e. less susceptible to clients preferences resulting in smaller
differences) than those not in the presence of a code. Also, based on prior research
(Noreen, 1988; Siegel et al., 1995; Wotruba et al., 2001), it is expected that participants
possessing greater general auditing experience (i.e. professional accountants) will also
make higher quality judgments.
The interaction between general auditing experience (operationalised by auditor
rank, and measured in terms of months of experience) and the presence (vis-a`-vis
absence) of a code of ethics was also investigated to determine whether the level
of experience impacts professional accountants in a manner which leads them to
react differently to the presence of the code than students.
The results provide some support for the predictions that both the presence
(vis-a`-vis absence) of a code of ethics, and greater general auditing experience, have a
positive impact on audit judgment quality. While the presence of a code of ethics had
no significant impact on the participants awareness of the importance of the audit
issue[3], it significantly enhanced the quality of the judgments of professional
accountants, who recommended a smaller inventory writedown difference than
students, and professional accountants not in the presence of the code[4]. Students were
not significantly impacted by the presence of a code of ethics. This suggests that the
presence (vis-a`-vis absence) of a firms code of ethics affects auditors judgment
performance only on the condition of increased general auditing experience. One aspect
of greater general auditing experience includes exposure to codes of ethics in a
professional work environment (Wotruba et al., 2001), and this may be a possible driver
of the difference between the quality of judgments made by professional accountants
and students.
Overall, the results support the standard setters belief that the ethical environment
(specifically, the code of ethics) is an important factor in improving audit quality and
provide empirical support for ISQC1s requirements. The results also suggest that
accounting firms may be able to improve the quality of auditors judgment
performance by timely training and exposure of their employees to organisational
codes of conduct and professional ethical principles.

Theory and hypothesis development

Audit quality has been defined in a number of ways in accounting research. DeAngelo
(1981, p. 186) defines audit quality as the market-assessed joint probability that a
given auditor will both (a) discover a breach in the clients accounting system, and
(b) report the breach. Other definitions have related the quality of an audit to:
.
the audits ability to reduce noise and bias and improve fineness in accounting
data (Wallace, 1980);
.
the probability that an auditor will not issue unqualified reports for statements
containing material error (Lee et al., 1999);
.
the accuracy of the information reported by auditors (Titman and Trueman,
1986; Beatty; 1989; Davidson and Neu, 1993); and

the degree to which the audit conforms to applicable legal and professional
standards (Aldhizer et al., 1995; Tie, 1999; Krishnan and Schauer, 2001; Francis,
2004).

Given that an audit is the product of individual auditor judgments, the different
definitions of audit quality, to varying degrees, all encompass the notion of auditor
competency (Watkins et al., 2004). In this study, auditor competency (equivalent to
auditor expertise) is defined as the degree to which an auditor can apply, and comply
with, the professional standards (i.e. auditing standards and the professions code of
ethics). Thus, auditor competency is conceptualised as possessing both technical and
ethical dimensions, and audit quality is determined by both technical and ethical factors.
Ethical environment (code of ethics)[5]
This study investigates how the strength of the ethical environment, as proxied by an
organisations code of ethics, impacts upon the quality of auditor judgment.
Libby and Luft (1993) suggest that the audit environment is a determinant of
decision-making performance. Since, the ethical environment is a subset of the audit
environment and auditors carry out their work in a value-laden environment (Dienhart,
1995), organisational factors of the ethical environment may improve auditor judgment
by helping individuals determine (i) issue(s) organisational members consider to be
ethically pertinent and (ii) the criteria they use to understand weigh and resolve these
issues (Cullen et al., 1989, p. 51).
Prior research examining the ethical environment surrounding auditors is limited,
with the majority of ethical auditing studies focusing on individual ethical
development and reasoning, and only on the ethical dimension of auditors
judgments (Jones et al., 2003). To date, there has been only one accounting study
that examined the ethical environment as a whole. Booth and Schulz (2004) conducted
an experimental study investigating the effect the strength of an ethical environment
has on managers economic decisions, as well as its interaction with the level of agency
problem. Booth and Schulz (2004) varied the strength of the ethical environment
between strong and weak by providing information on six of the eight ethical
environmental factors considered by the Independent Commission Against Corruption
(ICAC) in 1998[6]. The study found that a stronger ethical environment had a direct
effect on managers project evaluation judgments, with managers under the stronger
environment making decisions more aligned with the interests of their organisation
under both the presence and absence of agency-problem conditions.
In relation to the specific factors of the ethical environment, studies on codes of
ethics have dominated the ethical accounting and auditing literature. Codes of ethics
are important since they implicitly set limits for unethical behaviour and are intended
to offer guidance in ambiguous situations. Codes of ethics can perform several
organisational functions, such as making explicit the ethical values that were
previously unstated or unclear, alert employees as to what actions are unethical and
unpunishable, and help firms shift accountability of actions from the organisation to
the individual (Gellerman, 1989).
Survey studies have established that codes of ethics are thought to be relevant and
important to organisations and their employees (Martinov, 2004; Lamberton et al.,
2005). Lamberton et al. (2005) found that US firms that were more ethically concerned

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were more likely to possess a code of ethics and 90 per cent of the surveyed managers
believed codes of ethics to be an important factor in resisting unethical behaviour.
This echoes the earlier findings of Siegel et al. (1995), where surveyed internal auditors
thought of the professions code of ethics as a tool of ethical guidance, whose
effectiveness increased as the auditors gained experience.
Brief et al. (1996) specifically examined the effect the presence of a firms code of
conduct[7] had on the frequency of fraudulent-financial reporting by executives and
financial controllers and found no significant results. The subjects were given seven
role plays requiring a decision of whether or not to misrepresent their firms financial
statements and found the occurrence of fraudulent reporting to be high regardless of
the presence (vis-a`-vis absence) of a code of ethics. The lack of positive relationship
between the presence of a code of ethics and individuals ethical behaviour is also
reported by Laczniak and Inderrieden (1987) and Pater and Van Gils (2003). Laczniak
and Inderrieden (1987) found the presence and endorsement of a firms code of ethics to
have little impact on the behaviour of managers (MBA students), and Pater and
Van Gils (2003) reported a negative relationship between management consultants
ethical behaviour and their organisations possession of a written code of ethics.
In contrast, studies by Adams et al. (1995) and Barnett and Vaicys (2000) report
findings that the presence of a code of ethics has a positive impact on ethical behaviour.
Adams et al. (1995) surveyed certified practising accountants (CPAs) as to their
personal beliefs and ethical actions they would take for three scenarios relating to
confidentiality. The majority of the CPAs would follow the CPA code of professional
conduct when asked to resolve ethical dilemmas, even when the code might not reflect
their own personal beliefs. This may be interpreted as a potential limitation of codes of
ethics as they hinder the development of ethical reasoning of auditors (Jones et al.,
2003), but compliance with codes of ethics should not be regarded as a negative
consequence as codes are implicitly designed to create ethical behaviour which
conform to a pre-determined set of ethical values. This is suggested by Barnett and
Vaicys (2000), who found marketeers to be likely to engage in behaviour that is
considered ethical from an organisational though not personal level when there is an
organisational code of ethics.
The results of research to date on the code of ethics and its impact on the ethical
dimension of auditors judgment are mixed, with no clear indication of how a code of
ethics, as part of the ethical environment, may impact auditors judgments. The mixed
findings may be due to the lack of distinction made by prior studies between the
presence, and the reinforcement, of a code of ethics. The reinforcement of a code of
conduct was found to be significant on the judgment of managers (Booth and Schulz,
2004), while an earlier study found no impact if the code was just presented without
reinforcement (Brief et al., 1996). Furthermore, no auditing research to date has
addressed the effect of the presence and reinforcement of a code of ethics on auditors
overall judgment quality, despite explicit acknowledgment that auditor judgment
comprises both ethical and technical dimensions.
The aim of standard-setters is to improve audit quality through an enhanced-ethical
environment. This aim, supported by the several research findings, suggests that the
presence of the code of ethics will have a positive impact on the quality of judgment.
This is because a code of ethics can act as an ethical framework, and help ensure
individuals will behave within organisational and social expectations. Thus, it is

expected that the presence of a code of ethics will have a favourable impact on the
quality of auditors judgments:
H1. The presence of a code of ethics will elicit higher quality auditor judgments.
Technical competency (general-auditing experience)
Technical competency is an individual ability and has been shown to be an important
determinant of decision-making performance and judgment quality. Based on research to
date, common proxies for technical competency are experience (general and task-specific)
and knowledge. General-auditing experience has been found to be positively related to
auditors judgment performance when complexity of the audit task is taken into
consideration (Abdolmohammadi and Wright, 1987; Libby and Tan, 1994; Shelton, 1999;
Lin et al., 2003). For low-complexity tasks with well-defined routine solutions (i.e.
structured tasks), auditors need to only exercise minimal judgment, and in such
situations, general auditing experience is not a significant determinant of performance.
However, for more complex tasks requiring greater exercise of judgment (i.e.
semi-structured and unstructured tasks), experience can improve performance by
providing the necessary skills and/or knowledge required to complete these tasks
(Anderson and Wright, 1988; Bonner and Lewis, 1990; Anderson and Maletta, 1994).
Furthermore, task-specific experience has been shown to be able to provide additional
improvement to the quality of auditors judgments for semi-structured and
unstructured tasks (Bonner and Lewis, 1990; Pincus, 1991; Libby and Tan, 1994;
Wright, 2001; OReilly et al., 2004).
The other major determinant of technical competency is knowledge (Bonner and
Lewis, 1990; Libby and Luft, 1993; Tan and Libby, 1997). Knowledge has been
found to be a stronger explanatory factor of performance than experience because
experience tends to impact indirectly on performance through knowledge (Libby
and Luft, 1993; Libby and Tan, 1994). Task-specific knowledge is particularly
helpful in semi-structured and unstructured-audit tasks (Bonner, 1990; Bonner and
Lewis, 1990).
The task used in this study is a semi-structured task, for which higher quality
judgments would be expected from those participants who have greater levels of
general-auditing experience within a work environment. Also, it is a task that all
participants would be expected to be able to complete, from a technical perspective.
With this in mind, we have operationalised-technical competency as general auditing
experience. Task-specific experience and task-specific knowledge have been measured
to provide further insight into possible reasons for any significant differences, and to
confirm the assumption that all participants are technically competent in terms of the
requirements of the task. Therefore, it is posited that greater general-auditing
experience will impact positively upon the quality of auditors judgments:
H2. Greater general-auditing experience will elicit higher quality auditor
judgments.
Interaction between the code of ethics and general auditing experience
While a stronger ethical environment may be created by the presence of a code of
ethics, there has been no research examining the relationship between the ethical
environment and technical competency (general-auditing experience).

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Libby and Luft (1993) suggest that there are two types of interaction between an
environmental factor and performance an environmental factor may alter the
requirements of the task (i.e. the ability, knowledge and/or effort required) and/or
alter the amount or allocation of effort that decision makers are willing to employ to
fulfil those requirements (i.e. changes motivation). In the first instance, a stronger
ethical environment would impose additional guidelines by which the auditors must
abide, so that their judgments are based on technical and ethical considerations. In the
second instance, a stronger ethical environment may increase the effort auditors are
willing to expend on judgment-making, due to such concerns as accountability and
risk.
General-auditing experience is expected to be the dominant factor in determining
auditor performance in a semi-structured task, such as the task employed in this study,
because semi-structured tasks provide limited alternative choices under accounting
and auditing standards. This may restrict the permissible technical and ethical options
available to the auditor.
However, Noreen (1988) suggests that ethical codes of conduct will only be
effective if they are bilaterally internalised by individuals as the monitoring of
breaches of codes is difficult and costly. Furthermore, Siegel et al. (1995) suggest that
the effectiveness of a code of ethics as a tool for ethical guidance, improves as
auditors gained experience. Wotruba et al. (2001) proposes a positive relationship
between content familiarity of codes of ethics and their usefulness to managers.
Familiarity with good corporate governance practices (including the existence of
codes of ethics) in organisational settings leads to a higher level of internalisation,
whether it be consciously or unconsciously. These results are contrasted with studies
pertaining to those people who do not have a high level of audit experience; namely
students. Fulmer and Cargile (1987) note that while exposing students to professional
codes of conduct within their accounting courses leads them to perceiving ethical
issues more frequently, it has no significant impact on their actions. Furthermore,
Wynd and Mager (1989) reported that students attitudes towards ethical decisions do
not significantly change after having undertaken a business ethics course. Indeed, in
discussing ethics education, Armstrong et al. (2003) make the point that students
behaviour is unlikely to change simply through exposure to ethical issues, albeit a
necessary part of the process.
Consistent with these findings, the following hypothesis is posited:
H3. The presence of the code of ethics will have a significantly greater favourable
impact on the quality of auditor judgments for professional accountants than
auditing students (i.e. in the presence of greater audit experience).
Research method
A 2 2 full factorial between-subjects design was used to test the hypotheses. Two
independent variables were:
(1) general auditing experience of the subjects (high or low); and
(2) the presence of a code of ethics (presence or absence).
The design yielded four experimental cells.

Participants
The study had two groups of participants, auditing students and accounting
professionals. The participants (120 in total)[8] were randomly allocated to
experimental cells.
Auditing students were chosen as subjects, as prior studies have used this group to
proxy for low-level auditing experience when studying auditors technical competency
and performance (Krogstad et al., 1984; Abdolmohammadi and Wright, 1987;
Anderson and Wright, 1988; Marchant, 1989; Bonner and Lewis, 1990; Libby and
Frederick, 1990; Tubbs, 1992; Anderson and Maletta, 1994; OReilly et al., 2004). In
addition, their familiarity with codes of conduct within the work environment context
is much less that that of professional accountants. Depending on the extent to which
professional accountants have internalised and are familiar with the codes of conduct,
the impact of the presence (vis-a`-vis absence) of a code of conduct is expected to differ
between the students and professional accountants. The students were in the final
stages of an auditing and assurance course when the experiment was administered.
The majority of students (51 of 60) had no practical auditing experience, and on
average, the students had less than one month of general-auditing experience and
virtually no task-specific experience. However, importantly for this study, students
had the necessary task-specific knowledge to complete the task (Table I), and
throughout their studies had been exposed to ethical professional requirements,
including their importance and relevance in an auditing context. Recent studies
suggest that exposure to ethics and ethical instruction does make students more
sensitised to ethical issues, thus more readily being able to perceive ethical issues than
if they have not received such instruction (Armstrong et al., 2003; Allen et al., 2005).
Professional accountants were selected to proxy for high general-auditing
experience, based on prior studies employing audit tasks similar to the current
study (Krogstad et al., 1984; Pincus, 1991). This group comprised both auditors and
non-auditors who had been attending the final focus session in the Institute of
Chartered Accountants in Australia program (CA program)[9], with a minimum of two
Auditing students
Experience
General auditing experience (months)
Mean (standard deviation)
0.5583 (2.3937)
Range
0-18
N
60
Inventory writedown task-specific experience1
Mean (standard deviation)
0.0667 (0.2516)
Range
0-1
N
60
Task-specific knowledge
Independent knowledge score (out of 10)
Mean (standard deviation)
6.1667 (1.7288)
Range
2-10
N
60

Professional accountants

Total

20.4600 (25.3588)
0-96
52

9.6045 (19.7810)
0-96
112

0.9615 (1.35425)
0-4
52

0.4821 (1.0309)
0-4
112

6.3269 (1.2323)
4-10
52

6.2411 (1.5142)
2-10
112

Notes: aThe response was measured by categories; 0, nil experience; 1, dealt with 1-3 times; 2, dealt
with 4-6 times; 3, dealt with 7-9 times; and 4, dealt with 10 or more times

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Table I.
Participants. Panel A:
descriptive statistics for
participants technical
competency proxies

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years accounting experience. A majority of these participants were seniors, with an

average of 20 months general-auditing experience, being significantly greater than that
of auditing students (Table I). In addition, the professional accountants have greater
inventory writedown task-specific experience than students (mean 0.9615 vs
0.0667, respectively, based on a five-point scale measuring the number of times they
had dealt with the particular type of issue being examined).
Both participant groups achieved a similar task-specific knowledge score (6.3269 for
accountants, 6.1667 for students, out of a maximum of 10), indicating that both groups
have sufficient technical knowledge to undertake the inventory writedown case, which
strengthens the ability of the experiment to discern the impact that the code is having
on judgments. All participants were volunteers and no incentives were given.
Research instrument
The research instrument is an adapted version of the Babyboomers Inc. case (Cohen
and Trompeter, 1997) tailored by Martinov (2004) for the Australian-auditing context.
The case is suitable for students and professional accountants, and is reflective of the
business environment of public accounting. The audit issue in the case study deals
with a potential material writedown of inventory. Prior research (e.g. Reckers and
Wong-On-Wing, 1991) has identified write off of stock and stock obsolescence issues to
be judgment based.
The case material consists of a background description of the client, including
key-financial information[10], details of an audit issue involving potential material
writedown of inventory, and two proposals for the treatment of this inventory, which
had been discussed with the client. The background information also included audit
materiality of $2.5 million to ensure consistent interpretation of the materiality of the
potential writedown adjustment by subjects. All writedown adjustments based on the
two proposals (other than the clients current treatment of nil writedown) are material.
Pilot testing
The research instrument was tested and reviewed by three senior audit practitioners
and an accounting academic. All three practitioners are technical directors/consultants
for their respective organisations, with two also managing audit engagements in
addition to their technical role. The accounting academic was an ex-audit manager
with seven years of experience in a Big-4 firm. Questions were asked to elicit responses
as to the realistic nature and relevance of the background information and clarity of the
instructions and the questionnaire. Two audit research academics later reviewed the
revised instrument as an additional quality check.
Independent variables
There are two independent variables:
(1) The existence of the code of ethics is manipulated by varying the
presence/absence of an organisational code of conduct. The code of conduct
used was based upon the Joint Code of Professional Conduct of the ICAA and
CPA Australia (Joint Code of Professional Conduct), which is the official code
recognised by the AUASB[11].

(2) General auditing experience of the participants is operationalised firstly by

audit rank auditing student or professional accountant. It is also measured by
the length of the auditing experience (months).
Four additional variables were measured. The first variable is the subjects
task-specific experience with inventory writedown (months); and the second, task
specific knowledge (ten multiple choice questions, qualitatively similar to those
employed by previous audit expertise studies such as Bonner and Lewis (1990)). These
were measured in order to assess that all subjects had the requisite technical
knowledge to complete the task.
The last two variables were measured as prior studies found these to be significant in
affecting judgment performance. These variables include the subjects assessment of the
risk of material misstatement in relation to the given inventory account (seven-point
Likert scale). Prior studies suggest that inexperienced auditors and students tend to be
more risk-averse relative to experienced auditors (Anderson and Wright, 1988;
Anderson and Maletta, 1994). Also, Martinov (2004) found risk assessments to explain
much of the variation in auditor judgment (partners and managers) in the Babyboomers
Inc. case utilised in this study. Finally, ethical awareness of the participants was also
measured as prior studies found this variable to moderate the effect of codes of conduct
on auditor behaviour (Cohen et al., 1993; Harrington, 1996).
Dependent variables
The quality of auditors judgment is measured by two dependent variables:
(1) The likelihood that the participant would bring the inventory writedown issue
to the supervisors attention (Likelihood measured on a seven-point Likert
scale, ranging from 1 Highly Unlikely to 7 Highly Likely). Competent
auditors should bring this issue to the attention of their supervisor because an
adjustment to the inventory valuation is a significant audit issue and could
have potential material impact on the financial statements. Furthermore,
technically competent auditors would realise from the given financial
information that the minimal adjustment required ($2.6 million) was beyond
the materiality threshold ($2.5 million).
(2) The difference between the inventory writedown amount that the participant
believes to be technically appropriate under AASB (2005) 102 Inventories and
the amount that would be recommended to the supervisor in light of clients
preference for nil writedown (Difference ranging from $0 million to plus or
minus $15 million). Expert consensus opinion suggests that no difference
should be found between the appropriate and recommended adjustment
amounts. Of particular concern are judgments where the recommended
adjustment is less than what the subject believed was technically appropriate, as
this would suggest reduced audit quality according to DeAngelos (1981)
definition[12].
Procedure
This experiment used an in-basket approach similar to that employed by Brief et al.
(1996) who examined the impact a code of conduct has on fraudulent reporting in a
managerial context.

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Participants were randomly assigned to one of two relevant cells (presence/absence

of the code) and given a package containing a set of instructions, two envelopes, case
material and a questionnaire with two separate parts. The instructions asked
participants to assume the role of an audit senior, who was about to go on leave. They
were also told that prior to their return from leave; an audit on which they are currently
working would be signed off (i.e. Babyboomers Inc.).
Participants were instructed to go through their in-tray in the short amount of time
they had before their departure. The in-tray consisted of a number of documents: the
Babyboomers Inc. case; a brief one page memorandum containing amended
definitions of ethical principles (reproduced from the Code of Professional Conduct,
Section B) contained in the firms code of conduct (for participants in the presence of
code cells); and two filler items[13] (an expenses reimbursement form and an internal
memorandum discussing the firms Christmas party). The filler items were used to
create a sense of realism and to disguise the experimental manipulations (Ueker et al.,
1981; Connelly et al., 2004). Subjects were not required to make an immediate response
to any of the items except for the Babyboomers Inc. case. This provided the subjects
the choice of whether to respond to the items in the in-tray, which helped to enhance the
realism of the study. Schwartz (2001) found that the majority of employees in four large
corporations only skimmed through their firms code of conduct, with only a few
having read the entirety of the document. Therefore, strong emphasis on the code of
conduct would have been inappropriate, giving greater support for the in-basket
approach that has been adopted.
In practice, senior auditors are often faced with time deadline pressure (Solomon
and Brown, 1992; Kelley et al., 1999); therefore, to mimic this pressure and enhance
realism, all participants were informed that the tasks should take no more than
15-20 min of their time. This was to create a realistic urgency for the completion of the
tasks, with subjects required to balance the need for competent completion of tasks and
the upcoming leave. The majority of the participants did complete the task within
15 min, with time spent by participants ranging from 10 to 20 min.
The questionnaire was organised into two parts. Part one contained the
Babyboomers Inc. case, the code of conduct and the filler items. Following the
completion of Part one, the material and questionnaire were sealed in an envelope. Part
two elicited subjects demographic information, including their general and
task-specific auditing experiences. Subjects level of knowledge of inventory
valuation and their ethical awareness[14] were also measured. A manipulation check
question was asked.
Results
The three hypotheses are discussed in terms of each dependent variable. The results
are presented in Tables II-IV. Panel A of these tables shows the descriptive statistics
including the mean, standard deviation and the number of participants. Panel B shows
the results of the ANOVAs, while Panel C in Tables III and IV show the results of
contrasts analyses.
Likelihood of discussing the inventory writedown
The results of ANOVA (Table II, Panel B) show a significant main effect for auditor
rank (F 4.837, p 0.039), with professional accountants more likely to discuss the

Sum of squares
0.200
7.897
0.008
1.028
36.239
6.148

Students
Mean (standard deviation)
5.232 (1.317)
5.334 (1.229)
5.292 (1.256)
df
1
1
1
1
21
7

N
25
35
60
F
0.111
4.387
0.004
0.522
0.877
0.878

Level of auditing position

Professional accountants
Mean (standard deviation)
5.786 (1.371)
5.854 (1.485)
5.817 (1.411)
P
0.740
0.039 *
0.947
0.472
0.620
0.870

N
28
24
52

Total
Mean (standard deviation) N
5.525 (1.361)
53
5.546 (1.352)
59
5.536 (1.350)
112

Notes: *Significant at the 5 per cent level. Description of variables SUBJ_GR, subjects auditing rank, either an auditing student or a professional
accountant; GEN_EXP, subjects length of general auditing experience; CODE, the presence (vis-a`-vis absence) of a code of conduct

Presence of code
Absence of code
Total
Panel B: ANOVA results
Source of variation (R2 0.039)
CODE
SUBJ_G
SUBJ_GR *CODE
CODE
GEN_EXP
GEN_EXP *CODE

Panel A: descriptive statistics

Ethical environment
Code of conduct

The impact of
codes of ethics
and experience
577

Table II.
Likelihood of
discussing the issue
(what is the likelihood of
the auditor discussing
this issue with the
supervisor before going
on leave? 0, highly
unlikely; 7, highly likely)

Table III.
Difference between
inventory writedown
believed to be technically
appropriate, and amount
of writedown
recommended
(recommended inventory
writedown less
technically appropriate
inventory writedown 0,
no difference; 15, increase
in suggested amount;
215, decrease in
suggested amount)
N
25
35
60

Level of auditing position

Professional accountants
Mean (standard deviation)
2 0.536 (1.875)
2 2.429 (4.779)
2 1.410 (3.615)

P
0.021 *

P
0.314
0.107
0.165
0.016 *
0.046 *
0.488

N
28
24
52

Total
Mean (standard deviation) N
21.724 (3.231)
53
22.536 (4.609)
59
22.120 (4.168)
112

Notes: *Significant at the 5 per cent level. Description of variables SUBJ_GR, subjects auditing rank, either an auditing student or a professional
accountant; GEN_EXP, subjects length of general auditing experience; CODE, the presence (vis-a`-vis absence) of a code of conduct; athe interaction term
remains insignificant when outliers are removed, and when they are winsorised to twice the size of the standard deviation

Presence of code
Absence of code
Total
Panel B: ANOVA results
Source of variation (R2 0.050)
Sum of squares
df
F
CODE
17.332
1
1.021
SUBJ_GR
44.751
1
2.639
SUBJ_GR *CODEa
33.068
1
1.950
CODE
95.143
1
6.027
GEN_EXP
566.735
21
1.710
GEN_EXP *CODE
102.793
7
0.930
Panel C: contrasts analysis contrast of professional accountants in presence of code with other three cells
Value of contrast
df
T
Assume equal variance
26.3426
108
2 2.344

Students
Mean (standard deviation)
22.912 (4.586)
22.609 (4.558)
22.740 (4.533)

578

Panel A: descriptive statistics

Ethical environment
Code of conduct

MAJ
22,6

Students
Mean (standard deviation)
2.992 (4.532)
2.951 (4.338)
2.968 (4.382)
df
F
P
1
1.369
0.245
1
3.225
0.075 *
1
1.496
0.224
1
6.612
0.012 *
21
1.735
0.042 *
7
1.031
0.416
in presence of code with other three cells
df
t
P
108
2.436
0.016 *

N
25
35
60

Level of auditing position

Professional accountants
Mean (standard deviation)
N
0.679 (1.827)
28
2.513 (4.734)
24
1.525 (3.567)
52
Total
Mean (standard deviation)
1.770 (3.546)
2.773 (4.468)
2.298 (4.071)
N
53
59
112

Notes: *Significant at the 5 per cent level. Description of variables, SUBJ_GR, subjects auditing rank, either an auditing student or a professional
accountant; GEN_EXP, subjects length of general auditing experience, CODE, the presence (vis-a`-vis absence) of a code of conduct; athe interaction term
remains insignificant when outliers are removed, and when they are winsorised to twice the size of the standard deviation

Presence of code
Absence of code
Total
Panel B: ANOVA results
Source of variation (R2 0.055)
Sum of squares
CODE
22.035
SUBJ_GR
51.904
SUBJ_GR *CODEa
24.075
CODE
98.077
GEN_EXP
540.458
GEN_EXP *CODE
107.023
Panel C: contrasts analysis contrast of professional accountants
Value of contrast
Assume equal variance
6.4202

Panel A: descriptive statistics

Ethical environment
Code of conduct

The impact of
codes of ethics
and experience
579

Table IV.
Absolute value of the
difference between
inventory writedown
believed to be technically
appropriate and amount
of writedown
recommended
(Recommended inventory
writedown less
technically appropriate
inventory writedown 0,
no difference; 15,
difference in suggested
amount)

MAJ
22,6

580

issue with the supervisor (mean 5.817) than the auditing students (mean 5.292).
This provides partial support for H2. However, the presence (vis-a`-vis absence) of the
code of conduct had no significant effect on judgment (F 0.111, p 0.740).
Therefore, H1 is not supported.
Other main (i.e. general-auditing experience) and interaction effects tested were not
significant. Participants assessment of the risk of material misstatement (F 3.176,
p 0.078) was significant, with participants more likely to discuss the issue with the
supervisor if they assess the risk of material misstatement to be high.
Difference between the technically appropriate and recommended inventory
writedown[15]
Figure 1 shows that the majority of subjects did not reduce or increase the technically
appropriate inventory writedown amount when they provided a recommendation to
the supervisor (i.e. difference is zero). However, for the majority of participants who
made adjustments the difference was negative (i.e. the recommended writedown was
less than what they believe to be technically appropriate).
The ANOVAs (Table III, Panel B) report a significant main effect for the presence
(vis-a`-vis absence) of a code of conduct (F 6.027, p 0.016), when general-auditing
experience is measured in terms of length of experience (rather than operationalised by
auditor rank), with subjects in the presence of the code having a smaller difference in
judgments (mean 2 1.592) than those without the presence of a code
(mean 2 2.579). This provides partial support for H1. General-auditing experience
was also significant (F 1.710, p 0.046), with a smaller difference between the two

80

Count

60

40

20

0
00
4.
00
2.
00
1.
00
0.
0
.9
0
0
.0
1
0
.0
2
0
.5
2
0
.0
3
0
.5
3
0
.0
5
0
.0
7
0
.5
7
0
.0
8
0
.0
9 0
0
0.
1 0
0
1.
1 0
0
4.
1 0
4
4.

Figure 1.
Frequency of differences
between inventory
writedown believed to be
technically appropriate
and recommended

Difference between the 'recommended' and technically

'appropriate' writedown amounts

judgments for more experienced subjects, providing support for H2. General-auditing
experience, operationalised as auditor rank, was not significant.
While the interaction between auditor rank and the presence/absence of the code did
not show as being significant using ANOVA, descriptive statistics (Table III, Panel A)
highlight that the differences for professional accountants in the presence of a code
vary greatly from the other three cells. As discussed in Buckless and Ravenscroft
(1990), contrasts analysis is a more appropriate form of analysis than ANOVA, when
the results (and hence expected interactions) are in the form hypothesised (and shown)
in this study. Contrasts analysis (Table III, Panel C) shows that these differences
(mean 2 0.536) are significantly smaller than the differences reported for the other
three cells (t 2 2.344; p 0.021). This supports H3. Refining the analysis in order to
compare individual cells shows that the differences reported by professional
accountants in the presence of the code, are significantly smaller than the differences
reported by:
.
professional accountants in the absence of a code (F 3.735, p 0.059); and
.
auditing students in the presence of a code (F 6.343, p 0.015).

The impact of
codes of ethics
and experience
581

This is shown graphically at Figure 2.

Absolute values of the difference between the technically appropriate amount
and the recommended judgments were also analysed. Absolute values were
calculated because both positive and negative differences were found in the data, and
when analysed, the positive and negative differences would have cancelled each other.
ANOVAs (Table IV, Panel B) report a significant main effect for the presence (vis-a`-vis
absence) of a code of conduct (F 6.612, p 0.012), when general-auditing experience
is measured in terms length of experience (rather than operationalised by auditor rank),

"Difference" between judgments

('recommended' minus technically
'appropriate')

0.50

Presence
(absence) of Code
Absence of Code
Presence of Code

1.00

1.50

2.00

2.50

3.00
Auditing Students Proffessional Accountants
Proffessional Accountants and Students

Figure 2.
Means of differences
between inventory
writedown believed to be
technically appropriate
and amount of writedown
recommended

MAJ
22,6

582

thereby providing partial support for H1. Furthermore, there was a significant main
effect for auditor rank (F 3.225, p 0.075) and the general auditing experience
(F 1.735, p 0.042), providing strong support for H2. In general, the results suggest
that general-auditing experience improves the quality of auditors judgments, with
professional accountants (mean 1.525) reporting smaller differences than
auditing students (mean 2.968).
Consistent with the previous discussion on differences contrasts analysis
(Table IV, Panel C) shows that the absolute values of differences reported for
professional accountants in the presence of a code (mean 0.679) are significantly
smaller than for the other three cells (t 2.436; p 0.16). Specifically, they are
smaller than the differences reported for professional accountants in the absence
of a code (F 3.589, p 0.064), and those reported for auditing students in
the presence of a code (F 6.183, p 0.016) (Figure 3). These results support H3.
Therefore, the presence of a code improved the judgment quality of the professional
accountants, but had little impact on the students, who had similar results in both the
presence and absence of the code (Tables III and IV, Figures 2 and 3).
Additional analysis
Auditors and non-auditors. Using only the data from the professional accountants, the
judgments of auditors (n 24) and non-auditors were compared (n 28). For the
judgment on the likelihood of discussion of the audit issue, there were no significant
differences between the two groups. The presence (vis-a`-vis absence) of a code of
conduct and its interactions with general-auditing experience was not significant.
For the difference dependent variable, the code of conduct had a significant main
effect (F 4.480, p 0.040) on judgment. The average difference in judgments was
smaller for non-auditors for both treatments, but was not significant. The results of the
analysis of the absolute differences are qualitatively the same. This indicates that the
presence of the code of ethics has a favourable impact on the judgments of professional
accountants, regardless of whether they are audit, or non-audit, professionals.

Figure 3.
Means of absolute value of
differences between
inventory writedown
believed to be technically
appropriate and amount of
writedown recommended

Abosulte value of "difference" between

judgments ('recommended' minus
technically 'appropriate')

3.00
Presence
(absence) of Code
Absence of Code
Presence of Code

2.50

2.00

1.50

1.00

0.50
Auditing Students

Proffessional Accountants

Proffessional Accountants and Students

Big 4 and Non-Big 4. To test whether participants from Big 4 firms provide better
quality audit judgments than those from Non-Big 4 firms, the professional accountants
group was divided into the Big 4 (n 30) and Non-Big 4 (n 16). There was no
significant main or interaction effect for the likelihood variable.
The results for the difference variable in the presence of the code was significantly
smaller than those not in the presence of the code (F 5.612, p 0.023). A similar
result is reported for the absolute value of differences (F 5.594, p 0.023). This is
consistent with the results shown for the previous analysis of audit, and non-audit,
professionals. Furthermore, there was a marginally significant interaction between the
code of conduct and the accounting firm (F 2.927, p 0.094) for the absolute
difference variable. This result appears to be driven by the much larger differences
for Non-Big 4 participants in the absence of a code[16].
Treatment of the code of conduct
The research instrument also asked participants who received a code of conduct how
they dealt with the code. There were no significant correlations (using one-tailed
Pearson correlations) between the use of the code and the difference variable for all
participants. However, there was a significant correlation ( p 0.041) for professional
accountants, but none for students. This suggests that the greater attention paid to the
code by professional accountants may contribute to the improvement in judgment
quality.
Discussion and conclusion
The aim of this study was to examine whether the presence (vs absence) of code of
ethics has an impact on audit quality. This was motivated by the recent introduction of
the new ISQC1, which requires all accounting firms to implement policies and
processes to ensure employees technical and ethical competence. Professional
accountants and auditing students (as proxies for high and low general-auditing
experience) were asked to make a number of audit judgments in relation to an
inventory writedown task, with aggressive client preferences already indicated. The
results of the current study suggest that the presence (vis-a`-vis absence) of a code of
conduct can improve the quality of auditors judgments.
The presence (vis-a`-vis absence) of a code of conduct had no significant effect on the
participants decision on the likelihood of discussing the inventory writedown with a
supervisor. Rather, the quality of this auditor judgment was explained by the
general-auditing experience of the subjects (auditing rank) and the subjects
assessment of risk of material misstatement. The professional accountants were
significantly more aware of the seriousness of the audit issue and thus were more likely
to discuss the issue. Furthermore, high-risk assessments were associated with greater
likelihood of discussion.
However, the presence of a code of ethics appears to have a significant influence on
the audit judgments of professional accountants. The professional accountants were
sensitive to the presence (vis-a`-vis absence) of a code, whereby the difference between
the recommended and appropriate inventory writedown was significantly smaller for
judgments made in the presence of the code. In contrast, auditing students appear to be
generally unaffected by the presence of a code. Furthermore, the presence of the code
appears to significantly improve the judgments made by those with greater

The impact of
codes of ethics
and experience
583

MAJ
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584

general-auditing experience. These differences in effects may be due to differences in

the degree of familiarity that professional accountants and auditing students (and also
those with greater general auditing-experience, and those without such experience)
have with codes of ethics (Wotruba et al., 2001), as the work environment of the
professional accountants would provide them with significantly greater contact with
codes of ethics than the work and study environment of the auditing students.
Overall, these results support the findings of Booth and Schulz (2004), and
contradict the arguments of Dillard and Yuthas (2001) who argue that codes of ethics
are only marketing tools used to legitimise organisations and cannot influence
individual behaviour.
Additional analyses of the judgments of the professional accountants suggest that
both auditors and non-auditors are equally affected by the presence (vis-a`-vis absence)
of a code of conduct. Both groups had significantly smaller differences between the
technically appropriate and the recommended inventory writedown amounts when
in the presence of a code of conduct. When the professional accountants are partitioned
into Big 4 and Non-Big 4 groups, both groups reacted positively to the presence of a
code, with those in the presence of a code having on average a smaller difference
between judgment amounts than those not in the presence of a code. There was an
interaction between the code of conduct and audit firm type, as Non-Big 4 accountants
had on average a larger difference between the two judgment amounts than Big 4
accountants in the absence of a code of conduct[17]. This is consistent with prior
research that uses Big 4 as a proxy for higher audit quality. Big 4 firms are likely to
have stronger ethical environments in terms of the presence of formal codes of conduct
and relevant training, resulting in increased familiarity of codes for staff within a Big 4
firm. In turn, this leads to a presumption of higher quality judgments in the absence of
the code for participants from Big 4 firms, compared to those from the Non-Big 4 firms.
Overall, the results of the study provide support for the introduction of written
codes of conduct at the firm level, as required by ISQC1. The fact that auditing
students, unlike the professional accountants, were not affected by the presence
(vis-a`-vis absence) of a code of conduct suggests that the usefulness of codes of conduct
depends upon users familiarity with such codes. Therefore, accounting firms
interested in improving audit quality should consider formally exposing their
employees to codes of conduct through formal training, as well as audit aids such as
the inclusion of checklists and/or audit program steps on all engagements. Tertiary
education auditing courses, and CA and CPA programs, should also consider
broadening students exposure to codes of conduct by strengthening the emphasis on
ethical principles and their significance in the auditing process.
The findings of this study must be considered in the light of the following
limitations. Firstly, the use of an experimental design reduces the external validity of
the study as not all information normally considered by auditors was presented in the
case study. However, the internal validity of the study is strengthened by the
experimental method and by use of an existing research instrument (developed by
Cohen and Trompeter (1997), adapted to, and tested in, the Australian auditing context
by Martinov (2004)). Secondly, the study did not control for firm-specific differences
(e.g. training, decision tools and audit approach) which may influence the judgment
performance of the professional accountants (Bonner, 1990). Differences in corporate
cultures between firms may impact upon the judgments made by professional

accountants, for as noted by Chen et al. (1997), what is perceived as being correct or
moral is often defined by the environment within which decisions are made. A final
limitation relates to the independent-knowledge test used to measure task-specific
knowledge, which had to be created specifically for this study. However, the test is
similar to those used in previous studies measuring task-specific knowledge (Bonner
and Lewis, 1990; Libby and Tan, 1994; Tan and Libby, 1997), and had been pilot tested.
This appears to be the first study to date to examine the effect the presence of a code
of ethics has on the quality of auditors judgments. Given the significant findings of
this study, future research into other factors of the ethical environment suggested by
ISQC1 (e.g. leadership and management influence) could be explored. Another avenue
of research is to extend the current study and investigate the impact of reinforcement,
in addition to the presence, of a code of conduct on auditors judgment quality.
Previous studies have suggested that reinforcement of codes of conduct by firms may
produce additional significant effects (Laczniak and Inderrieden, 1987; Brief et al.,
1996). Lastly, similar studies could be undertaken for a wider range of auditing
experience, such as audit managers and partners.
Notes
1. This standard has been incorporated by the Australian Auditing and Assurance Standards
Board (AUASB) into the revised Auditing Professional Statement (APS) 5 Statement of
Quality Control of Firms effective 31 December 2005. The Accounting Professional and
Ethical Standards Board (APESB) was established by CPA Australia and the Institute of
Chartered Accountants in January 2006. The first standard issued by the Board, APES110,
was entitled Code of Ethics for Professional Accountants. Its contents cover the key
aspects of ISQC1 and APS5.
2. IFAC members include CPA Australia, The Institute of Chartered Accountants in Australia,
National Institute of Accountants in Australia, and New Zealand Institute of Chartered
Accountants.
3. The technical competency of the participants as measured by auditor rank had a positive
impact on the likelihood of participants discussing the audit issue with a supervisor (i.e.
professional accountants are more likely to discuss the issue than the auditing students).
General-auditing experience did not have a significant impact on the likelihood of discussion
of the issue with supervisor.
4. Additional separate analyses of the impact of the presence (vis-a`-vis absence) of a code of
ethics on the individual-audit judgments of the technically correct inventory writedown
amount and the amount to be recommended to the supervisor were performed. The results
were not significant.
5. In line with discussion with accounting firms and the latest standards, the term Code of
Conduct is used more often than the term Code of Ethics and as such we have used the
former in the research instrument and in aspects of the general discussion in this paper. We
have continued to use the term Code of Ethics as it relates to (and is described in) the
academic research on this topic.
6. The six factors are mission and values, leadership and management influence, peer group
influence, procedures, rules and codes of ethics, ethics training, and rewards and sanction.
These factors are chosen because they directly relate to the creation and operation of an
ethical environment (Booth and Schulz, 2004).
7. Codes of ethics at the organisation level are generally referred to as codes of conduct.

The impact of
codes of ethics
and experience
585

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586

8. Five participants failed the manipulation check and three participants omitted to complete
one or more of the dependent variables, resulting in a final adjusted sample of 112. The
sample size also varies between the tests as some of the participants in the final sample of
112 did not complete all of the questions in the instrument. Only their completed answers
were used for the relevant analyses.
9. The candidates were attending the final focus session in their final CA module (integrative or
CAI module) and had already successfully completed all the technical modules in the CA
program, including the Financial Reporting and Audit and Assurance (FRA) module.
10. Financial information provided was actual and forecasted sales, gross margin, profit before
tax, net profit, inventory balance and selected ratios, and industry inventory turnover ratio.
11. Joint Code of Professional Conduct of the Institute of Chartered Accountants in Australia and
Certified Practicing Accountants Australia, Melbourne, 2005
12. DeAngelo (1981) had defined audit quality as the market-assessed joint probability that an
auditor can (a) discover the breach; and (b) report the breach. By analogy, the individual
auditors judgment quality relies on the auditors being technically competent and neutral to
all influences (e.g. client preference).
13. Each item was stapled separately and the order of presentation was randomised in the
instrument.
14. The order of the ethical orientation questions was not randomised but the poles of some
questions were switched.
15. Individual analysis was carried out for the two judgments the technically appropriate
inventory writedown amount and the recommended inventory writedown amount. The
independent variables were not significant, though individual ethical awareness is positively
significant for the recommended writedown amount judgment.
16. These results should be read with caution, given the small size of some of the cells being
analysed.
17. These results should be read with caution, given the small size of some of the cells being
analysed.
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Corresponding author
Gary Pflugrath can be contacted at: g.pflugrath@unsw.edu.au
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