Principles‐Based versus Rules‐Based Auditing Standards: The Effect of the Transition from AS2 to AS5

The transition from a rules‐based auditing standard ( AS2 ) to a principles‐based auditing standard ( AS5 ) provides a context to assess how such a change impacts audit outcomes. Under a rules‐based auditing standard, audit processes are relatively uniform, unscaleable and include significant redundancy. Under a principles‐based auditing standard, audit effort can be directed to where risk is greatest; audits are scalable and can be customized. We find that the post‐ SOX shedding of risky clients by the Big 4 meant that non‐Big 4 clients were more likely than Big 4 clients to disclose material internal control weaknesses ( MICWs ) when assured under AS2 . This gap narrowed significantly following the transition to AS5 , when risk‐based customized audits were possible which benefited Big 4 firms to a greater extent than non‐Big 4 firms.