Whether or not the ISA should be adopted by the United States is a greatly contested topic. This study is helpful for regulators and standard-setting boards in the United States about the potential effects of the adoption of ISA and mandatory audit rotation for the United States. This information is also applicable for other countries when making these decisions as well.
Simunic, Dan A., M. Ye, and P. Zhang. 2017. “The Joint Effects of Multiple Legal System Characteristics on Auditing Standards and Auditor Behavior”. Contemporary Accounting Research 34.1 (2017): 7.
This paper examines the impacts of legal characteristics and auditing standards on audit behavior. Then based on this information the authors determine what the optimal auditing standards would be under different legal regimes. The two legal characteristics examined are vagueness in interpreting audit standards by courts and the expected damage award size in lawsuits against auditors for a failed audit. In recent years there has been a large number of countries adopting the International Standards on Auditing (ISA). Specifically, this study addresses whether or not ISA can be applied efficiently for all countries, and whether or not it adds value to the country that adopts the standards.
The authors begin the analysis by determining the audit quality based on auditing standards and the legal system by using a single-period auditing model with risk-neutral players. After that the optimal auditing standards which maximize audit quality for a specific legal system were determined. The effect of auditor rotation on audit quality was found by adding contingent fees into the model.
Overall, the authors find that audit quality is affected by both auditing standards and characteristics of legal systems. The optimal audit standards for a particular country also change depending on the legal system.
Specifically, the authors find:
In regards to ISA the authors find:
http://commons.aaahq.org/groups/e5075f0eec/summary
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.
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.
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:
The authors employ a field-based survey that provides a channel for practitioners to openly express their opinions and views.
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.
Dennis, S. A., and K. M. Johnstone. 2016. A Field Survey of Contemporary Brainstorming Practices. Accounting Horizons 30 (4): 449–472.
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.
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.
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.
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.
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.
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.
This paper played the vital role of beginning the conversation on privacy audit standards. From this starting point, more research can be done on the effectiveness of privacy audits, issues with privacy audits, differences in effectiveness between various audit providers, whether more extensive regulation tends to increase or decrease the use of international best practice in privacy audits, studying the causes and effects of privacy breaches in other research methodologies, and the effect of privacy audit fees on privacy audits, just to name a few.
Toy, A. and D.C. Hay. 2015. Privacy Auditing Standards. Auditing: A Journal of Practice and Theory 34(3): 181-199.
Privacy of personal information has been an issue of rising importance in the 21st century, especially after the revelations by Edward Snowden regarding the collection of certain data about telephone and Internet activities of ordinary citizens. Also, action by regulators has resulted in the imposition of fines based on privacy violations, which has led to privacy audits becoming increasingly implemented as a response to privacy problems. This paper examines the extent of convergence of the standards used in privacy audits conducted by various privacy auditors. It is the position of the authors that generally accepted criteria would improve the usefulness of privacy audits because users would be able to assess the relevance of privacy audits to entities that operate across different countries and to compare the audits with privacy audits in other countries; furthermore, if consistent standards are not developed it would fall on the user to adjust his or her understanding of the findings in the audit report based on a range of technical differences between standards used in different privacy audit reports. Within this paper, the authors suggest a set of fundamental principles for information privacy that could serve as suitable criteria for privacy audits.
To illustrate the need for consistency among privacy audits, the authors assess 30 privacy auditing reports in five countries and examine the consistency among them and their consistency with the fundamental principles the authors are proposing.
The findings of this study have important implications for practice. Although prior research has suggested that an audit judgment rule may improve audit quality, findings from this research suggest that audit quality may decrease. This is seen indirectly by the audit committee members’ belief that accounting estimates become less conservative and due diligence decreases when there is an audit judgment rule. However, this was not directly tested, and future research is needed to determine whether audit judgment rules are beneficial or not.
Kang, Y.J., A.J. Trotman, and K.T. Trotman. 2015. The effect of an Audit Judgment Rule on audit committee members’ professional skepticism: The case of accounting estimates. Accounting, Organizations and Society 46: 59-76.
The purpose of this study is to examine how a proposed audit judgment rule impacts the professional skepticism of the members of an audit committee. Prior research has suggested that an audit judgment rule be implemented that requires courts and inspectors to not second-guess auditors’ reasoned judgments when they are made in good faith and in a rigorous manner. Currently, the concern is that auditors are engaging in defensive auditing and fearful of using innovative approaches to auditing accounting estimates. By examining the audit committees’ reaction to the proposed rule, the researchers are able to examine how audit committees believe this change impacts audit quality and how it impacts the behavior of the audit committee.
Data for this paper was collected prior to March 2015 by using an experiment with audit committee members from Australia. All participants had been on an audit committee in the past, and on average they had been on audit committees for 10.33 years.
With the introduction of the audit judgment rule, there was an increase in perceived accountability in ensuring the reasonableness of the financial statements from the audit committee members. This was due to a belief that accounting estimates become less conservative and due diligence decreases. This increase in perceived accountability did not necessarily lead the audit committee members to act more professionally skeptical by asking more probing questions. However, the audit committee was more comfortable when they used innovative techniques in developing their accounting estimates. This was due to a belief that innovation leads to improved audit quality. Additional analysis demonstrates that former audit partners showed greater skepticism (by asking more probing questions) than other audit committee members.
This discussion emphasizes significant caution when interpreting the results of the study. Mainly, it is unclear if results of the study can generalize to the broader public company market in the US. Furthermore, if the results are misinterpreted (i.e., individual auditors are not systematically aggressive but, instead, high quality auditors are systematically assigned the riskiest clients) then regulation requiring audit partner identification could actually have overall negative effects on overall audit quality.
Kinney, W.R. 2015. Discussion of “Does the Identity of Engagement Partners Matter? An Analysis of Audit Partner Reporting Decisions”. Contemporary Accounting Research 32 (4):1479-1488.
The author reviews the paper's content, analyzes its predictive validity, and discusses its multiple implications. He provides constructive suggestions for improvements. Based on predictive validity analysis, the author concludes that engagement partner assignment strategy is an important and acknowledged omitted variable that affects the study's internal validity via both the independent variable (partner's prior performance measure) and the dependent variable (borrower's cost of debt capital). The omission also affects construct validities and, if audit firms are applying a plausible assignment strategy, then interpretation of the study's main results would be reversed. Finally, the lack of a standards intervention noted by the authors and the extreme size and other differences between audits of Swedish private companies and U.S. public companies impair external validity and generalization to the U.S. intervention.
This article is a discussion.
The discussion emphasizes the following points:
Auditor aggressive/conservative reporting style may be a systematic audit partner attribute and non-randomly distributed across engagements. Particular market participants (in this case, lenders) appear to recognize and price these differences in reporting style. While the particular mechanism through which these different reporting styles occur is not possible to determine, the results suggest the importance of individual audit partners in influencing audit reporting decisions. Therefore, current regulations in both the US and EU to identify the individual partner’s identity could potentially offer valuable information to market participants.
Knechel, W. R., A. Vanstaelen, and M. Zerni. 2015. Does the Identity of Engagement Partners Matter? An Analysis of Audit Partner Reporting Decisions. Contemporary Accounting Research 32 (4):1443-1478.
Current debate exists as to whether requiring individual auditor identification would enhance audit quality and, if so, whether investors understand and respond to these differences. This study provides empirical evidence to support the assertions that:
This study is especially relevant given both the EU’s decade old requirement to disclosure of audit engagement partner and the recent, similar PCAOB requirement that US audit partners do the same.
The authors use archival methods. They acquired panel data between 2001 – 2008 of the total clienteles of individual Big 4 audit partners of statutory audits for small, private companies in Sweden. This excludes non-Big 4 auditors and joint auditors.
In general, the frequency of Type I and II reporting errors is correlated over time for an individual partner both (1) across time for the same client and (2) between clients. As such, aggressive or conservative accounting appears to be a systematic partner attribute. Regarding investors, they appear to understand that partner reporting style is systematic across time and between clients and penalize firms audited by partners with a history of aggressive reporting via higher interest rates, lower credit ratings, and higher credit/insolvency risk. These results are, generally, economically significant.
More specific results include:
This study suggests that audit workpaper documentation decisions can significantly influence juror negligence verdicts and damage awards in cases where the auditor faces litigation. This is a particularly important finding for audit firms as this is an aspect of the litigation process that the auditor can directly control prior to facing litigation by considering how jurors might perceive this information when designing documentation procedures.
Backof, A. G. 2015. The Impact of Audit Evidence Documentation on Jurors’ Negligence Verdicts and Damage Awards. The Accounting Review 90 (6): 2177-2204.
During litigation proceedings, audit workpaper documentation represents a key piece of evidence supporting the quality of audit work because these documents are not only presented to jurors and scrutinized by experts during the trial, but are also available for juror review during deliberations. Because of its prominence during trials, the method and information contained in audit workpaper documentation has the potential to influence juror negligence verdicts and damage awards. This study examines how variation in audit documentation decisions related to the linkage of specific audit procedures performed to risks of misstatement for individual-level accounts, along with the inclusion of facts inconsistent with the auditor’s professional judgment influenced subsequent juror decisions. In particular, the study addresses the following research objectives:
The research evidence was collected utilizing a group of participants whose characteristics mimicked that of an average jury pool. Participants listened to a 28-minute audio recording of a negligence lawsuit, and then received a written transcript of the trial along with copies of the audit workpapers entered into evidence during the trial. Participants were instructed to assume the role of a juror in order to evaluate whether the audit firm was negligent and to determine an appropriate level of damages to assess the audit firm.
The study results are important to regulators and audit practitioners as they show the differential audit quality for participating auditors used in issuer audits. The results show that audit quality declines when audit engagements use participating auditors that are not experienced in auditing SEC issuers. This indicates that public disclosure of the principal and participating auditors in the audit report can provide useful information to evaluate audit quality.
Dee, C.C., A. Lulseged, and T. Zhang. 2015. Who Did the Audit? Audit Quality and Disclosures of Other Audit Participants in PCAOB Filings. The Accounting Review 90 (5): 1939-1967.
The Public Company Accounting Oversight Board (PCAOB) introduced in 2011 and re-proposed in 2013, an auditing standard that would require audit reports of SEC issuers to disclose participants in the audit other than the principal auditor. The PCAOB introduced the proposal to provide investors with full disclosure of the participants in the audit process, including affiliated firms of international audit firm networks. The underlying assumption of the proposed standard is that participating auditor involvement may negatively effect audit quality. However, using a participating auditor may not effect audit quality due to the market pressure on the principal auditor to maintain high audit quality. The authors investigate whether the proposed standard would provide market participants with additional information to evaluate audit quality.
The paper addresses whether there is a difference in audit quality between issuer audits with and without participating auditors. Using publicly available PCAOB filings, the authors identify an issuer sample that uses a participating auditor and a control sample that does not. The use of PCAOB filings allows the authors to identify participating auditors with limited experience in serving as a principal auditor for an issuer audit. The authors believe these auditors have a higher likelihood of low audit quality. If audit quality is not reduced using this auditor population, there is lower likelihood that audit quality reductions would occur in an expanded auditor sample. However, if audit quality is reduced, it would provide evidence that the proposed standard would benefit market participants in assessing audit quality.
The authors employ an archival research methodology in this study and obtain PCAOB Form 2 filings from 2010-2012 to identify the sample. The study includes an experimental sample (use a participating auditor) and a control sample (does not use a participating auditor). To assess differences in audit quality, the authors use four proxies: cumulative abnormal returns, earnings response coefficients, discretionary accruals, and audit fees.