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  • The Auditing Section
    The Influence of Client Importance on Juror Evaluations of...
    research summary posted May 9, 2012 by The Auditing Section, tagged 04.0 Independence and Ethics, 04.02 Impact of Fees on Decisions by Auditors & Management 
    Title:
    The Influence of Client Importance on Juror Evaluations of Auditor Liability
    Practical Implications:

    The results of this study are useful for understanding what factors affect jurors’ decisions regarding whether, and to what extent, an auditor should be held responsible for audit failure. These results should be of interest to audit firms and their respective attorneys when making litigation decisions regarding whether to settle or pursue a jury trial.

    Citation:

    Brandon, D. M. and J. M. Mueller. 2006. The Influence of Client Importance on Juror Evaluations of Auditor Liability. Behavioral Research in Accounting 18: 1-18.

    Keywords:
    client importance, auditor liability, juror evaluations, punitive, compensatory
    Purpose of the Study:

    Previous research suggests that there is a common perception that auditor independence is impaired by an economically important client (i.e. a client whose audit fees represent a large proportion of gross revenues). Evidence also suggests that client importance may even lead to a higher incidence of litigation against the auditor. For example, jurors may be more likely to blame and punish the  auditor if they perceive that the auditor had intentions or motives, such as profitability or client retention, to act in favor of the client.  This paper examines whether client importance is significantly related to juror evaluations of responsibility and blame as well as auditor liability and damage awards. 

    Design/Method/ Approach:

    The authors collected data from 187 undergraduate students enrolled in economics and introductory business courses. Participants reviewed a litigation case against the auditor of a bankrupt toy company for incorrectly providing a favorable audit report prior to the bankruptcy filing. Half of the participants reviewed a case which indicated that the client represented approximately 60% of the office revenues and half reviewed a case where the client represented approximately 2% of the office revenues.

    Findings:
    • The authors find that when an auditor is involved in litigation associated with an audit client that is financially more important to the auditor, participants evaluated the auditor as less objective, more blameworthy, and more deserving of punishment. A
    • Although, the authors do find that client importance significantly affects jurors’ liability assessments, the relationship can largely be attributed to independence perceptions. Thus, the authors conclude that client importance marginally affects punitive damage awards but does not influence compensatory damage awards.
    Category:
    Independence & Ethics
    Sub-category:
    Impact of Fees on Decisions by Auditors & Managmeent
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  • The Auditing Section
    Revitalizing Accounting Ethics Research in the...
    research summary posted May 7, 2012 by The Auditing Section, tagged 04.0 Independence and Ethics, 04.04 Moral Development and Individual Ethics Decisions 
    Title:
    Revitalizing Accounting Ethics Research in the Neo-Kohlbergian Framework: Putting the DIT into Perspective
    Practical Implications:

    The findings of this paper are of importance for firms that are interested in accountants’ ethical and moral judgment. This paper provides a thorough and broad review on the usefulness of the Defining Issues Test (DIT). In addition, the authors propose a theoretical framework for research using the DIT. The authors suggest that ethical research should consider more components of ethical issues, such as moral sensitivity, moral judgment, moral motivation, and moral character. These findings and suggestions can help accounting firms in improving the ethical performance of accountants.

    Citation:

    Bailey, C. D., I. Scott, and S. J. Thoma.  2010.  Revitalizing Accounting Ethics Research in the Neo-Kohlbergian Framework: Putting the DIT into Perspective. Behavioral Research in Accounting 22 (2): 1-26.

    Keywords:
    Ethical judgment; ethical behavior; defining issues test; Kohlberg; Rest’s Four-Component Model
    Purpose of the Study:

    The Defining Issues Test of moral judgment (DIT and DIT-2) has been widely used in the ethics-related research in accounting and auditing in the past. Yet recently, some of the pioneers and influential thinkers in accounting ethics research feel that the DIT has outlived its usefulness or has been proven to be flawed as a measure of the ethical judgment of accounting professionals. Since there is considerable disagreement over the status and future of research using DIT as a measure of ethical judgment, the primary purpose of this study is to provide a thorough and broad review of the DIT-related accounting ethics research.

    Findings:
    • Neo-Kohlbergian theory  suggests that moral judgment develops through a series of stages, beginning with self-interest (pre-conventional), proceeding through a respect for society’s conventions and laws (conventional), and ultimately, in some people, developing to the highest level of postconventional (principled) reasoning.  
    • The DIT has been used to assess the moral development in professional schools. While Neo-Kohlbergian theory and the DIT is widely accepted, there are controversies associated with the theories.
    • The authors present a “Framework for research using the DIT”, as a way to organize research under the Neo-Kohlbergian theory.
    Category:
    Independence & Ethics
    Sub-category:
    Moral Development and Individual Ethics Decisions
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  • The Auditing Section
    Independence Threats, Litigation Risk, and the Auditor’s D...
    research summary posted May 4, 2012 by The Auditing Section, tagged 04.0 Independence and Ethics, 04.02 Impact of Fees on Decisions by Auditors & Management, 09.0 Auditor Judgment, 09.04 Going Concern Decisions, 12.0 Accountants’ Reports and Reporting, 12.01 Going Concern Decisions 
    Title:
    Independence Threats, Litigation Risk, and the Auditor’s Decision Process
    Practical Implications:

    This study is important for audit firms and audit regulators, as it provides a more complete picture of how threats to auditor independence and litigation risk affect auditor performance. Rather than just focusing on the auditor’s final decision, this study demonstrates that the above incentives affect auditors through their evaluation of information during the decision process. Therefore, firms and regulators may be interested in research that specifically addresses processing biases. This research advocates using decision aids, such as artificial neural networks, to attenuate processing bias. Accountability-inducing controls, like those promoted by audit documentation standards, are unlikely to achieve this goal. Further, reviews conducted by individuals within the same firm are less likely to detect process bias. Review by independent parties, such as an audit committee, would likely be more effective.

    Citation:

    Blay, A.D. 2005. Independence Threats, Litigation Risk, and the Auditor’s Decision Process. Contemporary Accounting Research 22 (4): 759-789.

    Keywords:
    Auditor independence, auditor reporting, decision process, going concern, motivated reasoning
    Purpose of the Study:

    The preservation of auditor independence is a concern of audit regulators. The Sarbanes-Oxley Act of 2002 attempts to minimize the economic bond between the auditor and the client, but cannot completely eliminate it. Litigation risk is often proposed as a safeguard to mitigate independence threats. Prior studies about auditor independence focus solely on auditors’ final reporting choices, but this paper addresses auditors’ judgment and decision-making process as well. Particularly, this paper investigates whether independence threats (high versus low) and litigation risk (high versus low) influence auditors’ evaluation of information and their subsequent reporting choices. 

    The author expects that when high threats to auditor independence are present, auditors will be more supportive of the client-preferred position (unqualified opinion) both during the decision process and in the final reporting decision.  However, when high litigation risk is present, the author expects auditors will be less supportive of the client-preferred position. 

    These expectations are derived from the psychology literature on directional goals and motivated reasoning. Directional goals arise when an individual is dependent on a particular decision outcome. Though accurate judgment should be the auditor’s ultimate goal, the literature on motivated reasoning suggests that, as long as the conclusion is justifiable, individuals will evaluate information consistent with a desired conclusion. Thus, economic incentives associated with independence threats and litigation risk are likely to affect not just the auditor’s final decision, but also his/her evaluation of information during the decision process.

    Design/Method/ Approach:

    The research evidence was collected in the early-2000s (pre-SOX). Audit managers from three Big-4 firms participated in the experiment.  Participants completed a simulated task involving a hypothetical manufacturing client where they assessed the initial likelihood of going-concern, searched for informational cues, and reassessed the likelihood of going-concern. As informational cues were obtained, auditors also assessed whether the cues provided positive or negative support for the client’s going concern.

    Findings:
    • The author finds that auditors facing greater threats to independence will be more supportive of an unqualified opinion (client-preferred) when:
      • Assessing initial information,
      • Evaluating additional information cues,
      • Making a final report choice.  
    • The author finds that auditors facing higher litigation risk will be less supportive of an unqualified opinion (client-preferred) only when:
      • Evaluating additional information cues,
      • Making a final reporting choice  
    • The author finds that both threats to independence and litigation risk affect final report choice completely through their influence on the auditor’s evaluation of additional information cues. Thus, it appears that independence threats and litigation risk lead to information processing bias, as opposed to an up-front choice bias. 
    • The author finds that when both threats to independence and litigation risk are high, auditors gather additional information cues and spend more time evaluating evidence.  Further, there is no significant difference in final reporting choice when independence threats and litigation risk are low, supporting regulators’ claim that litigation risk offsets independence threats.
    Category:
    Independence & Ethics, Auditor Judgment, Accountants' Reporting
    Sub-category:
    Impact of Fees on Decisions by Auditors & Managmeent, Going Concern Decisions, Going Concern Decisions
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  • The Auditing Section
    Auditors’ Identification with their Clients and its Effect o...
    research summary posted April 16, 2012 by The Auditing Section, tagged 04.0 Independence and Ethics, 04.09 Individual & Team Conduct - e.g., premature signoff, underreporting hours, 09.0 Auditor Judgment 
    Title:
    Auditors’ Identification with their Clients and its Effect on Auditors’ Objectivity
    Practical Implications:

    The results of this study are important for audit firms to consider in designing their independence training sessions.  It is important to encourage audit employees to gain familiarity and knowledge with their clients to increase the overall quality of the audit.  However, if increased familiarity results in audit employees identifying more with their clients as opposed to the audit firm, it can cause a decrease in independence and objectivity.  The results of this study indicate that experienced auditors and auditors with a greater sense of identification with the CPA profession are less likely to “give-in” to their clients.  Audit firms should focus on instilling a sense of duty to the audit firm and the CPA profession early on in their training sessions. 

    Citation:

    Bamber, E.M. and V.M. Iyer. 2007. Auditors’ Identification with their Client and its Effect on Auditors’ Objectivity. Auditing: A Journal of Practice and Theory 26 (2): 1-24.

    Keywords:
    Auditor objectivity, auditor independence, client identification, professional identification, and social identity theory
    Purpose of the Study:

    Recently there has been increased regulatory focus on auditor independence and objectivity.  In a 2000 exposure draft, the Independence Standards Board identified auditors’ familiarity with the client as one of five threats to auditor independence.  The underlying concern expressed by regulators is that certain relationships (“close ties”) between the auditor and the client are inappropriate because they impair auditors’ objectivity in performing the audit, which in turn contributes to perceived audit failures.  This paper addresses this concern by investigating whether auditors unconsciously/unknowingly jeopardize their independence and objectivity based on their relationship with their clients.  Below are three objectives that the authors address in their study: 

    • Examine the extent to which auditors begin to identify more with their clients as opposed to their audit firms (e.g. employer).  Causes include years spent on the client engagement, client importance, and client image.  An example, not included in the
      article, would be auditors that serve Fortune 500 clients for many years.  Given the demands of these clients, the auditor will likely spend the majority of their year at the client site, rarely going to the audit firm office.  Given this, it is possible that the auditor will begin to identify and adopt the culture of the client opposed to the audit firm. 
    • Examine outcomes of auditors’ identification with their clients.  Specifically, the authors evaluate whether auditors that identify more with their client are more likely to “give-in” to client pressures and allow the client to take aggressive accounting positions.  
    • Examine other factors that might increase or decrease the effect of client identification on the likelihood that the auditor will give-in to client pressure.  These include client size, firm tenure with the client, auditor experience, and auditor’s identification with the CPA profession. 
    Design/Method/ Approach:

    The authors collected their evidence via research questionnaires mailed to AICPA members employed as auditors at Big 5 audit firms in the early 2000s time period.  Survey participants were asked questions about client identification, professional identification, and client image and then were asked to perform a case that dealt with auditors’ behavior in an audit conflict situation. 

    Findings:
    • The authors find that auditors do identify with their clients, although there is significant variability across auditors’ level of client identification and, on average, client identification is lower than professional identification.  
    •  The authors find that auditors that have greater identification with their client are more likely to agree with the client-referred position regarding a materiality issue and not recommend recording an adjustment for unrecorded liabilities.  However, the authors find that auditors that have more experience and greater identification with the CPA profession are less likely to agree with the client preferred position.  The authors interpret these results as support for recent efforts by regulators and  accounting firms to emphasize the tone at the top and to push professional values down the firm hierarchy.  
    • The authors find that increases in client size and audit firm tenure do not appear to increase the likelihood that the audit firm will give-in to theclient-preferred position. 
    Category:
    Independence & Ethics, Auditor Judgment
    Sub-category:
    Individual & team conduct (e.g. premature signoff - underreporting hours), Auditors’ Professional Skepticism
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  • The Auditing Section
    A Test of the Selection-Socialization Theory in Moral...
    research summary posted May 7, 2012 by The Auditing Section, tagged 04.0 Independence and Ethics, 04.04 Moral Development and Individual Ethics Decisions 
    Title:
    A Test of the Selection-Socialization Theory in Moral Reasoning of CPAs in Industry Practice
    Practical Implications:

    The results of this study are useful for understanding what factors are influential in the moral development of CPAs. Practitioners should consider the results of this study when making hiring and promotion decisions. Results may also be informative to the development of ethical training programs.

    Citation:

    Abdolmohammadi, M. J. and D. L. Ariail. 2009. A Test of the Selection-Socialization Theory in Moral Reasoning of CPAs in Industry Practice. Behavioral Research in Accounting 21 (2): 1-12.

    Keywords:
    moral development; defining issues test (DIT), selection-socialization, Inverted-U
    Purpose of the Study:

    Past research on the moral reasoning of Certified Public Accountants (CPAs) has indicated that the the moral reasoning of CPAs in public accounting appears to increase from the senior to manager level but then decrease from the manager to the partner level (referred to as an Inverted-U Phenomenon). This phenomenon is consistent with Selection-Socialization Theory, which predicts that individuals at superior levels (e.g. partners) often promote employees with attributes similar to their own. This paper examines the existence of this phenomenon by collecting information on the moral development of CPAs in both industry and public practice.

    Design/Method/ Approach:

    The authors collected data (sometime prior to 2009) from 273 practicing CPAs. To measure their moral development, participants were asked to fill out the Defining Issues Test (DIT). The DIT is a generic instrument commonly used in research to determine an individual’s moral development within six stages. The six stages range from low levels of moral reasoning, characterized by self-interest, to higher levels characterized, by law abidance and adherence to universal principles of justice and human rights.

    Findings:
    • The authors do not find significant differences in the moral reasoning between accountants of different rank and thus, no evidence of the Inverted-U Phenomenon suggested by prior research.
    • The authors also did not find differences in moral reasoning between CPAs in industry and those in public practice.
    • Although there is no indication that gender or ethical training affects CPAs’ moral reasoning, the authors do find that CPAs with graduate degrees scored higher in moral reasoning than those with only undergraduate degrees and that politically moderate or liberal CPAs scored higher than conservatives.
    Category:
    Independence & Ethics
    Sub-category:
    Moral Development and Individual Ethics Decisions
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  • The Auditing Section
    A Reexamination of Behavior in Experimental Audit Markets:...
    research summary posted May 4, 2012 by The Auditing Section, tagged 04.0 Independence and Ethics, 04.02 Impact of Fees on Decisions by Auditors & Management, 04.04 Moral Development and Individual Ethics Decisions 
    Title:
    A Reexamination of Behavior in Experimental Audit Markets: The Effects of Moral Reasoning and Economic Incentives on Auditor Reporting and Fees
    Practical Implications:

    These findings suggest that auditors with lower moral reasoning scores (i.e., who tend to cooperate with close allies, but tend to be less cooperative with other parties) might in some cases better adhere to the profession’s duties.  Auditors with higher moral reasoning scores (i.e., who tend to view norms and rules as flexible and interpret them depending on a situation) are more likely to depart from auditing conventions and cooperate with others to their mutual benefit.  There have been similar findings, i.e. contrary to what we might expect in relation to moral reasoning, in other research settings.

    Citation:

    Schatzberg, J. W., G. R. Sevcik, B. P. Shapiro, L. Thorne, and R. S. O. Wallace. 2005. A reexamination of behavior in experimental audit markets: The effects of moral reasoning and economic incentives on auditor reporting and fees. Contemporary Accounting Research 22 (1): 229-264.

    Keywords:
    Audit fee, auditor reporting, cooperation, moral reasoning
    Purpose of the Study:

    In this study, the authors examine how “moral reasoning” (as measured by a commonly-used test) affects auditor reporting under different economic incentives, in an experimental setting.  In the audit of the financial statements process, cooperation between auditors and managers is important so that sufficient evidential matter can be obtained. The authors examine whether auditors are more or less likely to cooperate with management, based on the level of moral reasoning, and penalties for mis-reporting. 

    Design/Method/ Approach:

    The authors assign participants to either a “higher” or “lower” moral reasoning group based on each participant’s “higher” or “lower” score on a commonly-used moral reasoning test.  A lower score on the moral reasoning test indicates that the participant is focused on what is good for him or her whereas a higher score indicates the individual considers what is best for society.  Although not specifically stated in the study, the data appears to have been collected prior to 2005.  The participants used in this study were recruited from MBA classes.  Participants had to consider whether they would truthfully report a “low” outcome, or report “high” even though the outcome was low (i.e. cooperate with management), which would harm investors but economically benefit the participants.  The authors varied the level of penalty for misreporting to observe how this changes behavior. 

    Findings:
    • Moral reasoning and the economic penalty both significantly affected reporting behavior.  The smaller the economic penalty for misreporting the more frequently the participants tended to misreport.
    • As the economic penalty increased, truthful reporting increased.
    • When auditors engaged in “cooperative reporting behavior” (saying outcome was high when it was really low), managers tended to respond with cooperative contracting behavior (rewarding auditor participants).  Such cooperative contracting behavior was more frequent in higher moral reasoning groups, which is contrary to what we might expect (we would expect higher moral reasoning groups to report truthfully more often as opposed to less often). 
    Category:
    Independence & Ethics
    Sub-category:
    Impact of Fees on Decisions by Auditors & Managmeent, Moral Development and Individual Ethics Decisions
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  • The Auditing Section
    Does “Political Bias” in the DIT or DIT-2 Threaten Val...
    research summary posted May 9, 2012 by The Auditing Section, tagged 04.0 Independence and Ethics, 04.04 Moral Development and Individual Ethics Decisions 
    Title:
    Does “Political Bias” in the DIT or DIT-2 Threaten Validity in Studies of CPAs?
    Practical Implications:

    The results of this study are important for understanding the implications of previous studies which have used the Defining Issues Test (DIT) or its later version the DIT-2 to measure the ethical reasoning and moral development of CPAs. The authors note that determining whether there is a true correlation between political orientation and the DIT P score is an intriguing debate that remains unsettled. The authors suggest that political belief should not be ignored and should be considered by researchers and included as a control variable in future studies to prevent misleading results.

    Citation:

    Bailey, C. D., T. J. Phillips and S. B. Scofield. 2005. Does “Political Bias” in the DIT or DIT-2 Threaten Validity in Studies of CPAs? Behavioral Research in Accounting 17 (1): 23-42.

    Keywords:
    DIT, DIT-2, political bias, ethical reasoning, cognitive-developmental perspective
    Purpose of the Study:

    The DIT and the DIT-2 are tests commonly used by researchers to measure individual cognitive moral development or ethical reasoning ability. Individuals taking the DIT are presented with a series of ethical dilemmas and asked to choose the ethical argument which they view to be the most compelling. Individuals are then assigned a P score, which represents their level of ethical reasoning – a higher score indicating a higher level of reasoning. However, the DIT and the DIT-2 have been criticized as being seriously influenced by political belief. The purpose of this study is to examine whether political position explains a significant amount of variation in individuals’ P scores.

    Design/Method/ Approach:

    The authors collected responses from 741 CPAs taking the short-form DIT in 1995 and 261 taking the DIT-2 in 2001. Participants were also asked to respond to a conservatism scale which measured their political beliefs as either politically “liberal,” “conservative” or “other.”

    Findings:
    • The authors find that political orientation is in fact significantly correlated with the DIT P score and somewhat with the score generated by the DIT-2.
    • However, the authors note that the strength of the relationship between political orientation and P scores is encouragingly small and may mean that the correlation is not a cause for concern for previous research. They do not claim to settle the debate, however, and encourage use of political orientation as a control variable in the future.
    Category:
    Independence & Ethics
    Sub-category:
    Moral Development and Individual Ethics Decisions
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