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  • Jennifer M Mueller-Phillips
    An Examination of Partner Perceptions of Partner Rotation:...1
    research summary posted October 10, 2013 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.05 Impact of SOX, 04.0 Independence and Ethics, 04.08 Impact of SEC Rules Changes/SarbOx, 11.0 Audit Quality and Quality Control, 11.04 Industry Experience 
    Title:
    An Examination of Partner Perceptions of Partner Rotation: Direct and Indirect Consequences to Audit Quality
    Practical Implications:

    The findings of this study shed light on the perceived benefits and detriments of the five versus seven year partner rotation requirements.  The results highlight the potential unintended consequences of implementing the accelerated rotation including a reduction in partner quality of life and auditor independence and audit quality. 


    For more information on this study, please contact Brian Daugherty. 
     

    Citation:

    Daugherty, B., D. Dickins, R. Hatfield, and J. Higgs.  2012.  An Examination of Partner Perceptions of Partner Rotation:  Direct and Indirect Consequences to Audit Quality. Auditing: A Journal of Practice & Theory 31 (1): 97-114. 

    Keywords:
    Sarbanes-Oxley; audit partner rotation; auditor independence; audit quality; quality of life.
    Purpose of the Study:

    This study examines practicing audit partner perceptions regarding the mandatory partner rotation and cooling off periods.  Specifically, the authors investigate how recently enacted and stringent rules might negatively impact auditor quality of life leading to deterioration in audit quality.  As a result of the Sarbanes-Oxley Act of 2002 (SOX), the US moved from a seven-year rotation with a two-year cooling-off period to a five-year rotation and five-year cooling-off period.  This change in standard provides the authors the opportunity to investigate the perceptions of partner that have worked under both standards.

    Design/Method/ Approach:

    The authors conducted in-depth semi-structured interviews with seven practicing audit partners.  Most of these partners were managing partners from various geographic locations.  Based on those interviews, the authors developed a model of the effects of mandatory rotation and created a field survey that was completed by 370 audit partners.  Collection of survey results occurred prior to May 2011. 

    Findings:

    The audit partners in the study believed that rotation generally improved independence which has a positive impact on audit quality.  However, partners also expressed that accelerated rotation reduced client-specific knowledge and had a negative impact on audit quality.  Partners suggested that the accelerated rotation and extended cooling-off period imposed by SOX has increased the need to relocate if the partner wishes to remain in the same industry.  As a result partners often choose to gain new industry experience and stay in the same location, rather than to relocate.  This decision maintains the partner quality of life, but possibly at the expense of industry depth and to the detriment of overall audit quality.  Partners also discussed a two to three-year new-client familiarization process, resulting in an increase in the amount of time that engagements suffer from “start-up efficacy”.  In sum, although the partners view rotation in general as a means to improve independence, they believe the accelerated rotation imposed by SOX may actually result in a reduction in independence and possibly audit quality.

    Category:
    Audit Quality & Quality Control, Independence & Ethics, Standard Setting
    Sub-category:
    Impact of SEC Rules Changes/SarBox, Impact of SOX, Industry Experience
  • Jennifer M Mueller-Phillips
    Spatial Competition in Local Audit Markets and the Fallout...
    research summary posted May 30, 2017 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.06 Impact of PCAOB, 03.0 Auditor Selection and Auditor Changes, 11.0 Audit Quality and Quality Control, 11.11 Impact of Firm and External Inspection Programs 
    Title:
    Spatial Competition in Local Audit Markets and the Fallout on Deloitte from the 2007 PCAOB Censure
    Practical Implications:

    The results from this study demonstrate that product differentiation in the form of market leadership and industry specialization may not provide a firm the power to mitigate the adverse consequences of a PCAOB censure.

    Citation:

    Boone, J. P., I. K. Khurana, and K. K. Raman. 2017. Spatial Competition in Local Audit Markets and the Fallout on Deloitte from the 2007 PCAOB Censure. Auditing, A Journal of Practice and Theory 36 (21): 1-19.

    Keywords:
    PCAOB; Big 4 auditors; local audit markets; spatial competition
    Purpose of the Study:

    The 2007 PCAOB censure on Deloitte regarding a pharmaceutical client in California caused the firm to suffer both audit fee and client losses. The objective of the paper is to determine whether auditor market power in a local area overrides the audit quality issues resulting from a censure. Specifically, authors investigate the effects of the censure on Deloitte’s ability to retain existing clients (or, switching risk) and potential loss of audit fees. The initial assumption is that auditor-client alignment and auditor-closest-competitor distance can help create differentiation among the Big 4 and this would lead to lower audit fee and client losses for a particular metropolitan area. Researchers looked at specific market specialization and geographic areas to analyze the effects on Deloitte. 

    Design/Method/ Approach:

    The research evidence was collected from 2008-2010, the period after the censure. There were 65 local audit markets used within the sample. Each of these markets had a minimum of 6 to a maximum of 1,662 clients observed. Deloitte-client alignment for the individual local audit markets was based on Deloitte’s expertise in the client’s industry, measured according to whether Deloitte is the national leader in the industry (top fee earner), an industry specialist (significant fee earner), or a local audit market leader (top fee earner locally). Deloitte-closest-competitor distance measures Deloitte’s implied differentiation and reputation. It was calculated by comparing the distance between the firm’s fee market share and its closest competitor both at the national level and in the local market.

    Findings:

    The overall finding is that audit quality issues override auditor market power and that differentiation does not provide Big 4 firms market power against adverse regulatory action.

    The authors specifically find that:

    • Deloitte’s audit fee losses were concentrated in the pharmaceutical industry. However, the majority of client losses were not limited to one geographical area or industry.
    • In all cases observed, the results indicate that Deloitte’s leadership or specialty engagements suffered client loss risk odds that were not different from that of its non-leader or non-specialty engagements.
    • Evidence with respect to Deloitte-closest-competitor distance suggests that there was no difference in client loss risk across the local audit market areas.
    Category:
    Audit Quality & Quality Control, Auditor Selection and Auditor Changes, Standard Setting
    Sub-category:
    Impact of Firm & External Inspection Programs, Impact of PCAOB
  • Jennifer M Mueller-Phillips
    Current Practices and Challenges in Auditing Fair Value...
    research summary posted April 19, 2017 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards 
    Title:
    Current Practices and Challenges in Auditing Fair Value Measurements and Complex Estimates: Implications for Auditing Standards and the Academy
    Practical Implications:

    This study provides a more in-depth understanding of current audit practices related to auditors’ use of substantive approaches outlined in AS 2502. These results provide several important new insights, including more clearly distinguishing between auditors’ use of pricing services and valuation specialists and factors that drive this decision, as well as provide additional insights regarding differences in the use of valuation specialists for financial and nonfinancial FVMs. Finally, the results shed new light on whether audit challenges differ for financial versus nonfinancial FVMs.

    Citation:

    Glover, S. M., M. H. Taylor, and Y. Wu. 2017. Current Practices and Challenges in Auditing Fair Value Measurements and Complex Estimates: Implications for Auditing Standards and the Academy. Auditing: A Journal of Practice and Theory 36 (1): 63 – 84.

    Keywords:
    auditing fair value measurements and other complex estimates, pricing services, valuation specialists, financial fair value measurements, nonfinancial fair value measurements.
    Purpose of the Study:

    The subjectivity inherent in estimating future events, coupled with the potential high degree of measurement uncertainty, makes auditing fair value measurements and other complex estimates challenging for auditors. Because of this difficulty, auditors frequently rely on valuation specialists; however, the PCAOB has voiced criticisms as a result of such reliance. To provide a more complete picture of current practices and challenges encountered when auditing complex FVMs, this study has three primary objectives:

    • To obtain deeper insights into auditors’ use of substantive approaches to audit FVMs given criticisms of auditors’ substantive approaches
    • To provide improved understanding of auditors’ use of pricing services and valuation specialists (in-house and third-party) when auditing complex FVMs
    • To further explore challenges auditors encounter when auditing FVMs by distinguishing between financial versus nonfinancial FVMs and investigating how auditors respond when they encounter problems with management’s valuation expertise and knowledge
    Design/Method/ Approach:

    The authors employ a field-based survey that provides a channel for practitioners to openly express their opinions and views. 

    Findings:
    • The authors find that auditors are likely to use the first substantive approach (i.e., test management’s assumptions and underlying data) when auditing typical or lower-risk estimates, but as audit risk and complexity increase, they are more likely to use a combination of approaches.
    • The authors find that, despite AS 2502 allowing auditors to use management’s assumptions when developing an independent estimate, the results indicate that auditors typically opt instead to use the audit team’s own assumptions to derive independent estimates.
    • The authors find that a greater percentage of audit partners report using third-party valuation specialists to develop independent estimates for financial FVMs than for nonfinancial FVMs.
    • The authors find that a majority of the participants believe that challenges differ between financial and nonfinancial FVMs and the key reason is the lack of observable market information for nonfinancial FVMs. 
    Category:
    Standard Setting
    Sub-category:
    Changes in Audit Standards
  • Jennifer M Mueller-Phillips
    A Field Survey of Contemporary Brainstorming Practices
    research summary posted February 20, 2017 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards, 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment, 06.07 SAS No. 99 Brainstorming – process, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism, 10.0 Engagement Management, 10.03 Interaction among Team Members 
    Title:
    A Field Survey of Contemporary Brainstorming Practices
    Practical Implications:

    Understanding that auditors allocate greater resources to fraud brainstorming when engagement risk is significant fosters brainstorming of a superior caliber corresponds to stronger regulatory compliance.  Auditors report that engagement teams are holding fraud brainstorming sessions earlier in the audit, document more detailed risk assessments, plan more specific procedures, and retain more documentation.  These characteristics contribute to adequately addressing increased PCAOB regulatory scrutiny.  Additionally, brainstorming sessions are highly regarded when they occur in a face-to-face fashion and are attended by multiple levels of firm personnel—whether that is “core” or “non-core” professionals.  Fraud brainstorming sessions are executed less mechanically (as determined by PCAOB inspectors) by using fewer checklists and increase the amount of time auditors prepare for brainstorming sessions.  

    Citation:

    Dennis, S. A., and K. M. Johnstone. 2016. A Field Survey of Contemporary Brainstorming Practices. Accounting Horizons 30 (4): 449–472. 

    Keywords:
    audit planning; engagement risk; field survey; fraud brainstorming; professional skepticism
    Purpose of the Study:

    The purpose of this study is to further understand current fraud brainstorming practices minding regulatory climate and its impression of brainstorming practices.  The authors seek to understand the auditing profession’s existing framework to effectively brainstorm by evaluating audit team characteristics; attendance and communication; structure, timing, effort; and brainstorming quality.  Fraud brainstorming environment is considered with respect to client characteristics; particularly, inherent, fraud, and engagement risks, and if the client is publicly traded or privately held.  The authors refer to the characteristics as “partitions”.  The partitions allow the study to better examine how each characteristic effects the deployment of resources in response to risk levels and trading status. 

                The study poses further exploration into the implementation of Statement of Auditing Standards No. 99 and its effect on fraud brainstorming practices.  Particularly addressing the Public Company Accounting Oversight Board’s report suggesting auditing professionals were “mechanically” addressing fraud-related auditing standards.  SAS 99 sought to blend experienced audit professionals—those with greater client experience—with less-seasoned auditors to brainstorm how a fraud could occur specific to the client.  As part of the brainstorming framework, the study seeks to understand if senior-level auditors (partners and managers) and seniors and staff members, along with “non-core” professionals, cultivate meaningful brainstorming sessions. 

    Design/Method/ Approach:

    The authors collected field data from audits conducted between March 2013 and January 2014, per a survey of 77 audit engagements.  Information pertaining to the client, audit team, and brainstorming sessions were called upon in the survey.  The majority (93 percent) of observations were obtained by two Big 4 firms—7 percent from one non-Big 4 global firm.  Each engagement’s partner received instructions for the distribution of the survey to lead managers and lead seniors on the respective engagement while the partner withheld that the survey was for research purposes.  A total of 75 managers and 73 seniors participated.  

    Findings:
    • Surveyed auditors rarely interacted with engagements where fraud in financial reporting was identified.
    • When fraud risk and inherent risk are both elevated for a particular engagement, perceived professional skepticism is also elevated.
    • Risk-based resource deployment is consistent when considering high- versus low-risk clients—particularly, when inherent risk is elevated, audit team size is also greater.
    • Public clients cultivate larger audit teams where managers and seniors have more client experience.
    • With respect to contributions made at brainstorming sessions, the audit partner and manager make the greatest contributions along with forensic specialists and audit seniors.  Interestingly, when fraud brainstorming is more important with respect to the engagement, seniors make lower relative contributions. 
    • Media richness theory is robustly at work with respect to attendance patterns at brainstorming sessions.  Specifically, when engagement risk is elevated, staff and seniors are more likely to attend face-to-face. 
    • Fraud brainstorming sessions are most commonly open-discussion (86 percent) where the session is held during the planning stage of the engagement (87 percent).
    • Results propose that audit partners are open-minded to suggestions made during fraud brainstorming.
    • Fraud risk assessments appear to be independent from brainstorming tactics; however, when inherent risk is elevated and if the client is public versus private, audit teams exert more effort.  
    Category:
    Auditing Procedures - Nature - Timing and Extent, Engagement Management, Risk & Risk Management - Including Fraud Risk, Standard Setting
    Sub-category:
    Auditors’ Professional Skepticism, Changes in Audit Standards, Fraud Risk Assessment, Interaction among Team Members, SAS No. 99 Brainstorming – process
  • Jennifer M Mueller-Phillips
    The Effects of Critical Audit Matter Paragraphs and...
    research summary posted February 16, 2017 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.06 Impact of PCAOB, 12.0 Accountants’ Reports and Reporting, 12.05 Changes in Reporting Formats 
    Title:
    The Effects of Critical Audit Matter Paragraphs and Accounting Standard Precision on Auditor Liability
    Practical Implications:

    These results provide new insight into conflicting results in contemporaneous studies that investigate the relationship between CAMS and auditor liability. The results will also be informative to the PCAOB and SEC because they highlight a potential unintended consequence of the proposed audit reporting model and reinforce the importance of the two oversight bodies considering the relationship between their regulatory actions. 

    Citation:

    Gimbar, C., B. Hansen and M. E. Ozlanski. 2016. The Effects of Critical Audit Matter Paragraphs and Accounting Standard Precision on Auditor Liability. The Accounting Review 91 (6): 1629 – 1646.

    Keywords:
    PCAOB, audit reporting, auditor litigation, critical audit matter (CAMs), and accounting standard precision
    Purpose of the Study:

    The PCAOB is currently considering substantial changes to the audit reporting model that would require auditors to disclose critical audit matters (CAMs) in the audit report. CAMs discuss areas of the audit that required a significant amount of professional judgment to evaluate appropriately or that posed the most difficulty in obtaining and evaluating evidence. Although this additional disclosure is expected to increase the information content of the audit report for investors, several interest groups have expressed concerns that CAMs will also increase the audit profession’s liability risks. In addition, the SEC, FASB and IASB have the potential to make sweeping changes to accounting standards in the coming years. These changes have the potential to significantly impact assessments of auditor liability. The purpose of this study is to investigate how jurors’ perceptions of auditor liability are affected by CAMs, accounting standard precision, and the interaction between CAMs and accounting standard precision. 

    Design/Method/ Approach:

    The authors use an experiment in which participants, acting the role of jurors, evaluate auditor liability for an alleged misstatement of financial statements due to inaccurate lease reporting and the subsequent bankruptcy of an audit client.  Following the experiment, the authors use mediation analysis to provide additional evidence regarding participants’ decision making underlying the hypothesized and observed significant association between auditor liability under precise accounting standards and both related and unrelated CAMs. 

    Findings:
    • The authors find that when no CAM is present, the participants have a lower propensity to issue verdicts against the auditor when the client’s accounting conforms to a precise standard than under an imprecise standard with the same accounting treatment.
    • The authors find that under precise standards and an accounting treatment that meets the letter of the law, both related and unrelated CAMs increase auditor liability.
    • The authors observe an interaction between standard precision and CAMs such that CAMs increase auditor liability by a lesser amount under imprecise standards than precise standards.
    • The authors find that, under precise accounting standards, related CAMs increase jurors’ assessments of the auditor’s control over financial reporting, and this increased level of perceived control mediates the relationship between related CAMs and jurors’ assessments of the auditor’s liability.
    • The authors find that unrelated CAMs are significantly associated with a decrease in participants’ evaluation of the audit performed, and this result mediates the relationship between unrelated CAMs and auditor liability under precise standards. 
    Category:
    Accountants' Reporting, Standard Setting
    Sub-category:
    Changes in Reporting Formats, Impact of PCAOB
  • Jennifer M Mueller-Phillips
    Do Income Tax-Related Deficiencies in Publicly Disclosed...
    research summary posted September 13, 2016 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.06 Impact of PCAOB, 09.0 Auditor Judgment, 09.12 Impact of potential post-audit review - e.g., PCAOB, internal firm inspections 
    Title:
    Do Income Tax-Related Deficiencies in Publicly Disclosed PCAOB Part II Reports Influence Audit Client Financial Reporting of Income Tax Accounts?
    Practical Implications:

     While many studies examine how the Part I inspection report or the PCAOB inspection process as a whole impact the auditor and audit committee decision making, the research on the impact of Part II reports is limited. Furthermore, the PCAOB is publicly issuing Part II inspection reports with greater frequency; thus, an understanding of how the failed remediation of Part II reports influences the audit firm and its clients is of importance to a number of parties.

    Citation:

     Drake, K. D., N. C. Goldman, and S. J. Lusch. 2016. Do Income Tax-Related Deficiencies in Publicly Disclosed PCAOB Part II Reports Influence Audit Client Financial Reporting of Income Tax Accounts? The Accounting Review 91 (5): 1411-1439.

    Keywords:
    PCAOB inspections, auditor scrutiny, valuation allowances, and uncertain tax benefits
    Purpose of the Study:

    The Public Company Accounting Oversight Board (PCAOB) is responsible for overseeing the quality of external audits through a rigorous inspection process that examines both audit engagements and audit firm quality control processes. At the completion of their review, the PCAOB issues their findings to the inspected audit firm via inspection reports. This led the authors to investigate whether a change in auditor scrutiny over income tax accounts, prompted by the failed remediation of a PCAOB Part II inspection report, results in changes in client financial reporting of income taxes. Utilizing the unique situation of Deloitte & Touche LLP’s 2007 Part II inspection report, which identifies concerns about the firm’s quality controls with respect to the audit procedures performed on income tax accounts, the authors delve into whether the failed remediation and subsequent public disclosure of the report led to observable changes in financial reporting for income tax accounts among Deloitte’s client.  

    Design/Method/ Approach:

    The authors focus on the time period beginning with Deloitte’s 2007 Part II report, which was issued privately to Deloitte on May 19, 2008 and ending with the remediation period on May 18, 2009. The sample chosen was annually inspected audit firms between 2006 and 2012. The authors also investigate which components of the annual UTB reconciliation drive the changes in the total UTB balance.

    Findings:
    • The authors find that an increase in auditor scrutiny over income tax accounts in response to PCAOB Part II findings is associated with changes in financial reporting of income tax accounts.
    • The authors find that the changes implemented by Deloitte result in an increase in reported valuation allowances and an increase in the reserve for uncertain tax positions among its clients.
    • The authors find that the UTB result is not driven by changes in tax avoidance but is driven but increases in the reserve related to current-year and prior-year positions.
    • The authors do not find that additional auditor scrutiny influences the income tax accounts when examining non-tax related Part II reports. This suggests that the effect the authors identify is in response to the specific deficiencies identified in the Part II report rather than a general reaction to failing the remediation of a Part II report. 
    Category:
    Auditor Judgment, Standard Setting
    Sub-category:
    Impact of PCAOB, Impact of potential post-audit review (e.g. PCAOB - internal firm inspections)
  • Jennifer M Mueller-Phillips
    Did the PCAOB’s Restrictions on Auditors’ Tax Services Imp...
    research summary posted September 13, 2016 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.06 Impact of PCAOB, 04.0 Independence and Ethics, 04.03 Non-Audit Services 
    Title:
    Did the PCAOB’s Restrictions on Auditors’ Tax Services Improve Audit Quality?
    Practical Implications:

     This study serves the purpose of examining the PCAOB’s role as overseer of public company auditing, while separating from previous studies by targeting the PCAOB’s restrictions on auditors’ tax services, which have not been examined in the past. This study also examines whether APTS pose a threat to audit quality but again differentiates itself from previous literature by focusing on only the tax services that the PCAOB chose to ban and by utilizing the difference-in-differences design to address the limitation of the cross-sectional approach utilized by other studies in the past. After reviewing these findings, it is possible that the PCAOB restrictions did not fully accomplish their objective.

    Citation:

     Lennox, C. S. 2016. Did the PCAOB’s Restrictions on Auditors’ Tax Services Improve Audit Quality? The Accounting Review 91 (5): 1493-1512.

    Keywords:
    PCAOB, audit quality, and auditors’ tax services.
    Purpose of the Study:

    In 2005, the Permanent Subcommittee on Investigations of the U.S. Senate reported that audit firms were selling potentially abusive or illegal tax-planning strategies to audit clients and their top executives on a contingent fee basis. This concerned regulators for many reasons; consequently, the PCAOB adopted three new rules to address these potential threats to audit quality. First, Rule 3521 reaffirms the ban on contingent fees that existed under Rule 302 of the American Institute of Certified Public Accountants’ Code of Professional Conduct. Second, Rule 3522 bars audit firms from selling aggressive tax services to audit clients. Finally, Rule 3523 forbids audit firms from selling tax services to executives in a financial reporting role. These three rules became effective from October 31, 2006 onward. The PCAOB stated that the rules were intended to improve audit quality, and, by extension, the quality of financial reporting. The purpose of this study is to test whether the restrictions met this objective.

    Design/Method/ Approach:

    Because audit quality is not directly observable the author focuses on accounting misstatements, both misstatements that are tax-related and other types, and the issuance of going-concern opinions. The author separates companies into groups based upon the reduction of APTS purchases between July 26, 2005 and October 31, 2006. He then compares the differences in misstatements and going-concern opinions between the treatment and control groups and tests whether these differences change after the PCAOB imposed the restrictions on auditors’ tax services. 

    Findings:
    • The author finds that in the period before the restrictions, there is no difference in the incidence of going-concern opinions between the treatment and control companies; however, the treatment companies are more likely than the control companies to have accounting misstatements and tax-related misstatements. This supports the premise of regulators that the treatment companies had lower-quality auditing before the restrictions were introduced. 
    • The author finds no significant changes in misstatements, tax-related misstatements, or going-concern opinions subsequent to the APTS restrictions after using a difference-in-differences research design. In fact, the treatment companies continue to have significantly more accounting misstatements and more tax-related misstatements in the period subsequent to the APTS restrictions.
    • The author finds large and highly significant reductions in APTS fees when the restrictions were introduced. 
    Category:
    Independence & Ethics, Standard Setting
    Sub-category:
    Impact of PCAOB, Non-audit Services
  • Jennifer M Mueller-Phillips
    The Association Between Audit Partner Rotation and Audit...
    research summary posted August 31, 2016 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.05 Impact of SOX, 05.0 Audit Team Composition, 05.03 Partner Rotation 
    Title:
    The Association Between Audit Partner Rotation and Audit Fees: Empirical Evidence from the Australian Market
    Practical Implications:

     The results of the study have important implications for regulators, auditors, and companies. In recent years, audit partner rotation has increased due to mandatory rotation legislation in Australia and has led to increased monetary and social costs. This study identifies the extent to which auditors pass on these costs and the relative bargaining power between an audit firm and a client, which varies across different segments of the market. This study also makes several contributions to existing literature. Specifically, this study informs the debate on the costs and benefits of audit partner rotation by focusing on the financial costs of partner rotation in the form of increased audit fees. Further, this study extends prior research that examines the impact of mandatory and voluntary partner rotation and the association between audit fees and partner rotation in different market segments. In addition, this study informs policy makers and regulators on whether and in which context the costs of audit partner rotation are passed on to clients as increased audit fees.

    Citation:

     Stewart, J., P. Kent and J. Routledge. 2016. The Association Between Audit Partner Rotation and Audit Fees: Empirical Evidence from the Australian Market. Auditing, A Journal of Practice and Theory 35 (2): 181-197.

    Keywords:
    Audit partner rotation, audit fees, voluntary partner rotation, mandatory partner rotation, audit markets
    Purpose of the Study:

     Audit partner rotation has become an accepted practice in many jurisdictions as a means of enhancing audit independence. Both regulators and professional bodies believe that greater auditor independence should lead to improved audit quality and hence improved financial reporting quality. A number of studies have examined the benefits of partner rotation in terms of its impact on audit quality, but these studies have produced mixed results and the benefits of the practice have been questioned. Given the concern that audit partner rotation may not improve audit quality, it is appropriate to consider the impact of partner rotation on audit costs and whether any increased costs are passed on to the client. This study seeks to examine the direct relation between audit fees and partner rotation using data from Australia where mandatory partner rotation after 5 years was introduced in 2006.

    Design/Method/ Approach:

     The authors used a sample of publicly traded companies selected from those listed on the Australian Securities Exchange (ASX) in 2007 for this study. Details of audit partner rotation and financial and nonfinancial data were then collected from Morningstar DatAnalysis, Connect 4 Annual Reports Collection, or company annual reports for the years 2007-2010. The authors used this information to evaluate the relation between audit partner rotation and audit fees in the year of rotation and the two years post rotation. The impact of audit partner rotation was examined as either mandatory or voluntary. The data was also examined based on stratification into three groups: large global clients, mid-level clients, and small local clients.

    Findings:

    The results indicate that audit fees are higher in the year of partner rotation and the higher fees persist in the first year post rotation and, to a lesser extent, in the second year post rotation. Further, the results indicate the following:

    • Higher audit fees are associated with both mandatory and voluntary rotations in the year of rotation and with voluntary rotation in the first year post rotation.
    • Stratification of the sample shows that mandatory and voluntary rotations are associated with higher audit fees for the large global segment but only voluntary rotation is associated with higher audit fees for the small local segment. No association between audit fees and rotation was found for the mid-level market segment. 
    Category:
    Audit Team Composition, Standard Setting
    Sub-category:
    Audit Partner Rotation, Impact of SOX
  • Jennifer M Mueller-Phillips
    Standards of Innovation in Auditing
    research summary posted August 30, 2016 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting 
    Title:
    Standards of Innovation in Auditing
    Practical Implications:

    This paper claims that the ultimate challenge for innovation that the auditing profession needs to contemplate is whether it has the confidence and commitment to revise its own business models and to reconfigure its traditional modes of delivery and organization regarding the provision of statutory financial audits. After looking at the experience of BRA, innovation has the highest chance of success if it comes with a willingness both to develop the scope of the audit and to accept variation in aspects of the delivery of the audit. It is important to exercise responsible professionalism and recognize that there is value in audit beyond its codification, standardization, and commodification. 

    Citation:

    Curtis, E., C. Humphrey, and W. S. Turley. 2016. Standards of Innovation in Auditing. Auditing: A Journal of Practice and Theory 35 (3): 75-98.

    Keywords:
    audit methodologies, international standard setting and regulation, business risk auditing, audit scope, audit firms, and audit profession
    Purpose of the Study:

    The term “business risk auditing” has been widely used to refer to a broad strand of similarly motivated methodological developments in a number of the major international firms in the mid- to late- 1990s. Despite variations between firms, there was a common emphasis on the need to consider client business risk and the related strategic and other controls as a fundamental part of the audit process, rather than focusing more narrowly on financial statement risk. The developments in the firms were seen by standard setters and regulators as representing a common generic trend of development in methodology, leading to the consideration of revisions in auditing standards, which is how the term BRA is applied.  The premise of BRA was based on the notion that audit failures typically arose from a failure on the part of auditors to identify and address client business risk in the course of their audit rather than from failures in the application of detailed testing procedures. The underlying motivation for this paper was to consider the capacity for innovation in auditing in light of the experiences of attempts to incorporate BRA in ISAs.

    Design/Method/ Approach:

    Analysis spans the period from 1998 to 2004. The authors examined documentation from the JWG, minutes of the IAPC/IAASB and U.S. Auditing Standards Board meetings. They also conducted in-depth interviews with key participants from every stage of the standard-setting process. 

    Findings:
    • The authors’ analysis has shown that the primary innovative features of BRA had been diluted over a year before the Enron case broken and well before the passing of the Sarbanes-Oxley Act in 2002.
    • The authors’ empirical analysis has shown that BRA was an innovation that the profession established but also significantly helped to limit.
    • The authors find that the inspection-based review and control procedures instigated by professional audit firms themselves can outweigh the number related to independent public inspections.
    • The authors find that the rise of integrated reporting and the resulting focus on the longer-term sustainability of the business is likely to stimulate such a renewed demand for a form of auditing that makes analysis of business risk central to the assurance process.
    • The authors find that BRA was made vulnerable because of a lack of sufficient numbers of suitably skilled staff, caused in turn by the way in which auditing firms are organized, and a business model in which a high proportion of the work is undertaken by relatively junior staff. 
    Category:
    Standard Setting
  • Jennifer M Mueller-Phillips
    Does Recent Academic Research Support Changes to Audit...
    research summary posted July 18, 2016 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.01 Changes in Reporting Formats, 01.02 Changes in Audit Standards 
    Title:
    Does Recent Academic Research Support Changes to Audit Reporting Standards?
    Practical Implications:

    This study reviews academic literature to not only offer insights into how well recent audit reporting initiatives gives users the information they need to understand the audit, but also suggest future research that academics can perform to help standard setters improve the auditor’s report.  The authors argue that (1) disclosure of the audit partner’s name does close the information gap, (2) disclosures related to auditor independence and tenure only partially closes the information gap, and (3) auditor commentary on going concerns does not close the information gap; however, not enough is known about how well either (4) disclosure of critical or key audit matters or (5) assurance on other information in the audit report closes the information gap.  These insights may be of interest to stakeholders in the standard setting process who wish to evaluate the success of currently enacted audit reporting initiatives and the potential costs and benefits of proposed audit reporting initiatives.

    Citation:

    Bédard, J., P. Coram, R. Espahbodi, and T.J. Mock. 2016. Does Recent Academic Research Support Changes to Audit Reporting Standards?. Accounting Horizons 30 (2): 255-275.

    Keywords:
    audit reporting model, audit report, auditing, information gap.
    Purpose of the Study:

    Regulators interested in improving the informativeness of the auditor’s report have recently proposed/required new disclosures to be made by the auditor to help information users better understand the audit.  Academic researchers studied whether these new disclosures fulfill their intended purpose and/or have unintended consequences.  The purpose of this study is to synthesize the academic literature related to the new disclosures in order to identify (1) whether the benefits of specific new disclosures outweigh the costs, (2) whether further changes to the auditor’s report are needed, and (3) where more research is needed to better understand the effects of the new disclosures.  Thus, this study serves as a means of communicating the findings of academic research to standard setters in order to enable academics to better fulfill their information-gathering role in the standard setting process.

    Design/Method/ Approach:

    The author perform a review of the academic literature relevant to PCAOB, IAASB, and U.K. FRC audit reporting initiatives, specifically focusing on (1) disclosure of critical or key audit matters, (2) assurance on other information in the audit report, (3) auditor commentary on going concerns, (4) disclosure of audit partner name, and (5) disclosures related to auditor independence and tenure.  They obtain research published, posted online, or presented at conference(s) from 2007 through mid-2015, but mostly after 2011.

    Findings:
    • Not enough is known about how well disclosure of critical or key audit matters gives users the information they need to understand the audit.
      • Experimental evidence suggests that Critical Audit Matters (CAMs) disclosed in the auditor’s report may (1) draw users’ attention to areas discussed in the CAMs, (2) scare some nonprofessional investors away from companies with CAMs, (3) influence auditor liability and legal damages in unintended ways, (4) and discourage auditors from bringing problems to the attention of passive audit committees.  Furthermore, experimental evidence suggests that (1) the impact of additional disclosure from the auditor upon users may vary depending upon management disclosures and (2) managers may be reluctant to share information about accounting estimates with auditors who are required to make additional disclosures about these estimates.
      • Preliminary archival evidence from the U.K. is mixed in terms whether CAMs have a positive association with audit fees and audit quality, but suggests CAMs have no relationship with financial statement’s informativeness. 
      • Research about the French justifications of assessments disclosure suggests that they are generally boilerplate and uninformative, and they have no impact on audit quality (after the year of implementation).
      • Archival research from the U.S. on the effect of explanatory language on unqualified audit reports suggests that (1) some types of explanatory language provide information about financial reporting quality and (2) non-going concern explanatory language can increase/decrease disagreement among investors.
      • A review of stakeholder responses to the IAASB’s proposed audit reporting initiatives suggests that stakeholders generally approved of the changes, but had differing opinions of how much change was needed.
    • There is no evidence available about whether assurance on other information in the audit report gives users the information they need to understand the audit.
    • Auditor commentary on going concerns appears to not give users the information they need to understand the audit.
      • Although most studies find the going concern audit reports useful, one study finds them not incrementally valuable when they merely focus users’ attention on management’s going concern disclosures.
    • Disclosure of the audit partner’s name does give users the information they need to understand the audit.
      • Although some studies provide mixed evidence about whether disclosing the audit partner’s name increases audit quality, other studies suggest that (1) different audit partners are associated with different levels of audit quality and (2) the restatement history of the audit partner may scare off some potential investors.  However, higher audit fees appear to be the cost of disclosing this useful information.
    • Disclosures related to auditor independence and tenure give users some of the information they need to understand the audit.
      • Although a review of prior research suggests no link between non-audit services (NAS) and auditor independence, a recent study found that total NAS fees are associated with higher (lower) audit quality for issuers (non-issuers).
      • Although a review of prior research does not find decreased audit quality for firms with longer audit firm tenure, a recent study suggests that long audit firm tenure is only associated with decreased audit quality for audits of non-issuers.
    Category:
    Standard Setting
    Sub-category:
    Changes in Audit Standards, Changes in Reporting Formats

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