The results of this study are important for both regulators and auditors alike.  Despite auditor concerns that a requirement to disclose CAMs would increase litigation risk, the results of this study indicate that they may actually reduce, or at the very least, have no effect on litigation risk.  This is the case even when the subsequently identified misstatement is not related to the risks documented in the CAM.  Furthermore, standard setters should take comfort in these findings as they weigh the potential benefits of adopting a CAM disclosure requirement because the results indicate that the implementation of CAMS would not increase the risk of litigation to auditors. 

Brasel, K., M. M. Doxey, J. H. Grenier, and A. Reffett. 2016. Risk Disclosure Preceding Negative Outcomes: The Effect of Reporting Critical Audit Matters on Judgments of Auditor Liability.  The Accounting Review 91 (5): 1345-1362.

The PCAOB has proposed a change to the standard audit reporting model to include the disclosure of critical audit matters (CAMs).  While there is evidence that investors support additional auditor disclosures like CAMs, many other stakeholders oppose the implementation of a requirement to produce such ex ante risk disclosures.  The opposition, which includes audit firms, academics, and attorneys, assert that this type of requirement would increase litigation against auditors.

However, CAMs require disclosure of increased risk prior to a subsequently revealed misstatement.  This feature of the proposed disclosure also makes it possible that CAMs may reduce litigation risk because jurors will view the plaintiff as being forewarned of an increased risk.  To the extent that jurors view a misstatement as having been more foreseeable to the plaintiff, this study predicts that jurors will experience less negative affect when considering plaintiff losses because the plaintiff was forewarned.  Below are two objectives the authors address in their study:

• Examine whether auditors face increased litigation risk when auditors disclose a CAM that is related to a subsequently revealed misstatement.
• Examine whether auditors face increased litigation risk when auditors disclose a CAM that is unrelated to a subsequently revealed misstatement.

The authors conducted an experiment with jury-eligible participants to examine their research questions.  The study included four different disclosure conditions: (1) control – no mention of CAMs, (2) disclosure of a CAM related to the subsequently revealed misstatement, (3) disclosure of a CAM that is unrelated to the misstatement, (4) an explicit statement that the auditors did not identify any CAMs.  Additionally, two different types of misstatements were examined to determine whether the type of misstatement affected the jurors’ propensity to find the auditor negligent: (1) an overstatement of inventory, (2) an understatement of an environmental restoration liability.  Participants read a case study about an audit that failed to detect a material financial statement fraud and then assessed auditor negligence.

• When auditors failed to detect an overstatement of inventory, participants were less likely to find the auditor negligent when the auditor disclosed a related CAM, relative to both when there was no mention of CAMs and to when the auditor explicitly stated that there were no CAMs.  However, when auditors failed to detect the understatement of the client’s environmental restoration liability, participants were neither more nor less likely to find the auditors negligent when the auditor disclosed a related CAM.  This difference in outcomes was due to participant perceptions that the understatement of the client’s environmental restoration liability was more foreseeable than the inventory misstatement in the control condition thereby reducing the impact of the CAM.
• Disclosing a CAM that was unrelated to the undetected misstatement did not affect jurors’ auditor liability judgments relative to current reporting standards.  However, disclosure of an unrelated CAM did reduce jurors’ negligence assessments relative to a condition in which the auditor explicitly stated there were no CAMs.

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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.  

• 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.  

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These results imply that risk assessment approach can have a significant effect on the assessed risk of material misstatement and, thus, on audit program decisions that influence audit effectiveness and efficiency. The existence of assertion framing effects may directly affect the level of professional skepticism and audit effectiveness and efficiency. Both studies indicate that when belief-based assessments are transformed into probabilities, the difference from the direct probability assessments of risk is not significant; thus, obtaining belief-based assessments might make obtaining probability assessments redundant and also has the advantage of providing explicit assessments of ambiguity. 

Mock, T. J. and H. Fukukawa. 2016. Auditors’ Risk Assessments: The Effects of Elicitation Approach and Assertion Framing. Behavioral Research in Accounting 28 (2): 75 – 84. 

The primary purpose of this experimental study is to replicate a previous study conducted by the authors, who examine the effects of “risk assessment elicitation approach” and “assertion framing” on auditors’ risk assessments. They find that auditors’ risk assessments differ in some important ways and that auditors’ risk assessments are influenced by assertion framing. However, the generalizability of these findings may be limited due to the use of Japanese practitioners as subjects. This study investigates U.S. practitioners in an attempt to corroborate the previous findings.

            The study focuses on two important factors that are found to affect auditors’ risk assessment judgments in the prior study: the risk assessment elicitation approach and the framing of financial statement assertions being audited. 

This study is an experimental replication of Fukukawa and Mock 2011. The risk assessment elicitation approach is manipulated by using scales based on either probability theory or the theory of belief functions. 

• The authors find that both experimental results show significant “risk assessment approach” effects in the expected directions.
• The authors find considerable evidence of significant “assertion framing” effects.
• The authors find that the two risk elicitation approaches result in significantly different risk assessments.
• The authors find that auditors’ assessed risks are higher; they seem to be more risk-sensitive and exhibit a higher level of professional skepticism when an assertion is stated in a negative way than in a positive way.
• The authors find that while probability-based risk assessments are higher than belief-based assessments and lower than plausibility assessments, the differences between the two approaches are not significant when the belief-based assessments are transformed into probabilities using a newly proposed method. 

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This paper incorporates important organizational theory into the fraud literature by reporting the presence of an instrumental climate when fraud is being perpetrated within an organization. Internal auditors and those charged with governance could adapt this climate measure as a red flag for potential fraud. 

Murphy, P. R. and C. Free. 2016. Broadening the Fraud Triangle: Instrumental Climate and Fraud. Behavioral Research in Accounting 28 (1): 41-56.

Many papers focus on investigating organizations in which management’s tone exemplifies high ethical standards, combined with a climate that support and encourages ethical behavior in an effort to examine if this organization is less vulnerable to fraud. However, this paper takes a different approach. It examines the “flip side” of organizations, those that are associated with fraud instead of those associated with preventing fraud. By doing this, the authors also hope to delve into the effectiveness of the fraud triangle. For years, the fraud triangle has been the dominant fraud framework but recently it has been called into question for its narrow interpretation and lack of comprehensiveness. Thus, the goal of this research is not only to identify an organizational climate that exists in the presence of fraud but also to broaden the interpretation of the fraud triangle by explicitly identifying fraud triangle elements related to such a climate. 

The authors created and administered a survey to three groups of individuals having fraud experience: (1) prisoners who are incarcerated for committing fraud within an organization, (2) individuals who audited or investigated fraud within an organization, and (3) individuals who witnessed fraud within their organization. 

• The authors find that 39 percent of the respondents agreed or strongly agreed that an instrumental climate was present when fraud occurred within the organization.
• The authors find that an instrumental climate is significantly associated with a malevolent work environment and social incentives and pressures.
• The authors find that the use of externally oriented rationalizations are very common with instrumental climates, especially the claim of helping the company.
• The authors find that an instrumental climate is not associated with conventional attitude variables (prior history of white-collar crime, character, ethical values of the perpetrator), internally oriented rationalizations (minimizing or ignoring the consequences of the fraud, or entitlement) or individual greed or need. 

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 Implications for the practicing audit community are developed from the findings that less experienced auditors are susceptible to the information choice effect. In situations where litigation risk is low (high) and the auditor has less experience, auditors place greater (lower) significance on information given to them by an external party than information they sought out themselves. More experienced auditors are not subject to the information choice effect. Additionally, more experienced auditors are confident in judgments based on information sought themselves, even in a setting with elevated litigation risk. The results of this study may interest audit clients providing information to auditors, auditors reviewing the work of less (more) experienced colleagues, auditors performing a critical self-review, and regulators reviewing the work of auditors.

 Smith, S. D., W. B. Tayler, and D. F. Prawitt. 2016. The Effect of Information Choice on Auditors' Judgments and Confidence. Accounting Horizons 30 (3): 393–408.

During the course of an audit, auditors choose what information they need to search for; however, they obtain both sought and unsought information.  These auditors must then use the information obtained to make judgements and decisions that ultimately lead to an audit opinion.  Thus, the weight auditors place on the information obtained when making judgements and the auditors’ confidence in those judgements has important implications for audit quality.  The authors of this paper investigate whether it matters if information is gotten by the auditor or given to the auditor.  Understanding that the way in which information is received affects information processing, the authors examine how the auditors’ receipt of additional sought or unsought information impacts the auditors’ judgment and confidence in that judgement given judgements with different levels of importance (e.g., high vs. low litigation risk) and auditors with different levels of experience (e.g., high vs. low).

Evidence was obtained during the 2010’s through an experiment using 136 auditors as participants.  Participants read a case and evaluated the likelihood of obsolescence in inventory.  The researchers manipulated the (1) choice to acquire relevant information (i.e., given a choice or not given a choice) and (2) litigation risk levels (i.e., high or low).  Furthermore, they measured auditor experience, and classified participants as more or less experienced based on number of years in public accounting.

• In the high litigation setting, sought information is weighed more heavily than unsought information.  This result appears to be driven by auditor experience.  Specifically, when auditor experience is low and litigation risk is high, sought information is weighed more heavily than unsought information.
• In the low litigation setting, sought information is weighed less heavily than unsought information.  This result appears to be driven by auditor experience.  Specifically, when auditor experience is low and litigation risk is low, information is weighed less heavily than unsought information.
• Auditor confidence in their judgment of inventory obsolescence was greater when they chose to obtain additional information than when they were just given the additional information.  This result appears to be driven by auditor experience.  Specifically, more experienced auditors had greater confidence after obtaining sought information than unsought information.  This results also appears to depend on the litigation level.  In the high litigation setting, more experienced auditors had greater confidence after obtaining sought information than unsought information.

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