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  • Jennifer M Mueller-Phillips
    Auditor Mindsets and Audits of Complex Estimates.
    research summary posted July 22, 2015 by Jennifer M Mueller-Phillips, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism, 11.0 Audit Quality and Quality Control 
    Title:
    Auditor Mindsets and Audits of Complex Estimates.
    Practical Implications:

    The study provides new direction for improving audits of complex estimates, and it adds to growing evidence that improved critical thinking, rather than increased doubt or increased demand for evidence, is key to improving audit quality. The authors show that changing auditors’ mindsets through a brief intervention allows them to make better use of the evidence that they have. The study demonstrated how a simple mindset intervention can improve audit quality, and thus, potentially improve financial reporting quality, when complex estimates are important to the financial statements. The authors expect that a deliberative mindset can help other decision makers, including investors and managers, make higher quality decisions by improving their critical analysis of a complete set of information.

    Citation:

    Griffith, E. E., Hammersley, J. S., Kadous, K., & Young, D. 2015. Auditor Mindsets and Audits of Complex Estimates. Journal Of Accounting Research 53 (1): 49-77.

    Keywords:
    accounting estimates, audit quality, fair value, professional skepticism, mindset
    Purpose of the Study:

    Complex accounting estimates, including fair values, impairments, and valuation allowances, are increasingly important to financial statements. However, auditors experience significant difficulty in auditing complex estimates, suggesting that audit quality may be low in this area. Some of these difficulties can be attributed to high levels of uncertainty about valuations given volatile financial markets and innovative securities. However, others arise from problems with auditor judgment and the audit process. Analysis of PCAOB inspection reports for the largest accounting firms reveals that fair value measurements, including impairments and other estimates, are among the most frequently cited accounts for auditor errors and that, while other audit deficiencies have decreased over time, deficiencies involving fair values and impairments have not. Chief among auditors’ judgment problems associated with auditing complex estimates are that auditors fail to adequately test the data and assumptions underlying management’s estimates and fail to notice and incorporate into their analyses inconsistencies among the assumptions, other internal data, and external conditions.

    In this paper, the authors examine whether and how changing auditors’ mindsets can improve audits of estimates, thereby enhancing audit quality in this important area. Mindsets are the set of judgment criteria and cognitive processes and procedures that produce a disposition or readiness to respond in a certain manner. Mindsets are not merely a template or framework for approaching a particular type of task; they represent a more global readiness to respond in a particular way.

    Design/Method/ Approach:

    The authors test their hypotheses in an experiment in which they manipulate mindset between participants at three levels (deliberative mindset, implemental mindset, and control). They obtained 94 usable responses from experienced audit seniors who participated while attending national or local training sessions sponsored by their firms. Participants come from three Big 4 firms and their audit experience ranges from 30 to 72 months. Seventy-eight percent are CPAs. The evidence was gathered prior to February 2014.

    Findings:
    • Auditors in the deliberative mindset condition assess the client’s biased fair value as less reasonable than do auditors in the control and implemental mindset conditions.
    • Auditors in the deliberative mindset condition are also more likely to choose a next action step that reflects more urgent concern that the fair value is unreasonable.
    • Deliberative mindset condition auditors’ explanations for their decisions are more likely to include the seeded issues and more valid issues with the estimate, generally, than are those of other auditors.
    • Additional analyses demonstrate that auditors in the deliberative mindset condition are not less trusting of management in general; rather, they target the specific assumptions with seeded errors. They also evaluate evidence about the appropriateness of the aggressive discount rate more critically than do auditors in other conditions.
    • Identification of the seeded inconsistencies and more critical evaluations of the appropriateness of the discount rate jointly fully mediate the relationship between the deliberative mindset condition and the assessed reasonableness of the fair value.
    • The deliberative mindset facilitates identification of the seeded issues and critical analysis of the discount rate, which increase concern about the reasonableness of the fair value.
    Category:
    Audit Quality & Quality Control, Auditing Procedures - Nature - Timing and Extent
    Sub-category:
    Auditors’ Professional Skepticism
  • The Auditing Section
    Auditors’ Assessment and Incorporation of Expectation P...
    research summary posted April 16, 2012 by The Auditing Section, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 09.0 Auditor Judgment, 09.03 Adequacy of Evidence 
    Title:
    Auditors’ Assessment and Incorporation of Expectation Precision in Evidential Analytical Procedures
    Practical Implications:

    The results of this study suggest that auditors’ precision assessments may not be well calibrated for relevant precision factors. Thus, auditors may benefit from additional guidance indicating the factors that should be considered for assessing the precision of analytical
    procedures.  Furthermore, audit firms might want to consider integrating some of the findings of this study into future training sessions and/or decision aids that would assist auditors in improving their precision calibration. An insensitivity to important precision factors may lead to over-reliance on analytical procedures, negatively affecting audit effectiveness. Because the allowance for loan losses is an estimate, the results of this study provide insight into factors that could influence the potential effectiveness of audits of estimates. Understanding how auditors evaluate analytical procedure precision for estimates is particularly critical in that analytical procedures may be the only source of assurance for testing these accounts.

    Citation:

    McDaniel, L.S. and L.E. Simmons. 2007. Auditors’ assessment and incorporation of expectation precision in evidential analytical
    procedures. Auditing: A Journal of Practice & Theory 26(1): 1-18.

    Keywords:
    Analytical procedures, precision, expectations, substantive test, audit evidence
    Purpose of the Study:

    The precision with which auditors form expectations during analytical procedures is important. The precision of an expectation is a measure of the closeness of the developed expectation to the actual amount and refers to the quality of the expectation, and thus, the quality of the analytical procedure. Professional standards clearly indicate that auditors should be able to form more precise expectations for accounts that are more predictable (income statement relationships generally are more predictable than balance sheet relationships) and when the information related to the account is more disaggregated (i.e., detailed). However, the Public Oversight Board’s (POB) Panel on Audit Effectiveness has found evidence that auditors rely on analytical procedures that do not provide the desired level of assurance, suggesting possible difficulty in assessing precision. To address this finding by the POB, this study investigates auditors’ abilities to assess expectation precision and incorporate their assessments into judgments related to substantive analytical procedures, as required by professional standards. A first step toward developing more effective guidance is obtaining a better understanding of why auditors sometimes fail to effectively apply analytical procedures. As such, the authors aim to answer the following two questions: 

    • To what extent do auditors’ precision assessments reflect the level of account predictability and the level of detail of the data used to form expectations? 
    • To what extent are auditors’ judgments consistent with their precision assessments? According to professional standards, the following judgments should be consistent with auditors’ precision assessments:

    (1)   The level of assurance expected by auditors to be provided by the analytical procedure.

    (2)   The range of the difference between the expected and recorded amount.

    (3)   The likelihood that the difference between the expected and recorded amount is due to misstatement versus non-isstatement causes.

    Design/Method/ Approach:

    The authors gathered their data experimentally at a firm training event for audit seniors and above (the training event occurred sometime during or prior to 2005). The participants were asked to review workpapers which included analytical procedures for two different accounts – the allowance for loan losses (a less predictable account) and interest income (a more predictable account). The expectations for the analytical procedures documented in the workpapers were either based on more or less detailed information. After reviewing the analytical procedures, auditors were asked to assess the precision and the level of assurance provided, provide an expectation range for the account balance, and judge the amount of difference between the expected and recorded amount due to misstatement.

    Findings:
    • Overall, auditors assess precision higher when the data forming the expectation are disaggregated (i.e., more detailed) versus aggregated (i.e., less detailed). 
    • Auditors also assess precision higher for the more predictable account (interest income) versus the less predictable account (the allowance for loan losses). 
    • Auditors’ precision assessments for the allowance for loan losses are not significantly different between the disaggregated and aggregated analytical procedures. This finding suggests that in assessing the precision of analytical procedures for less predictable accounts, auditors do not consider the effects of data aggregation. 
    • The results also show that for both accounts auditors judge the level of assurance obtained from the analytical procedures consistent with their precision assessments (i.e., higher assessed precision corresponds with a higher level of assurance).  
    • Counter to the authors’ expectations, auditors’ precision assessments were not related to their judgments of the range of differences between the expected and recorded amounts or the likelihood of misstatement.
    Category:
    Auditing Procedures - Nature - Timing and Extent, Auditor Judgment
    Sub-category:
    Adequacy of Evidence
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  • The Auditing Section
    Auditors’ Assessment and Incorporation of Expectation P...
    research summary posted April 13, 2012 by The Auditing Section, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 09.0 Auditor Judgment, 09.03 Adequacy of Evidence 
    Title:
    Auditors’ Assessment and Incorporation of Expectation Precision in Evidential Analytical Procedures
    Practical Implications:

    The results of this study suggest that auditors’ precision assessments may not be well calibrated for relevant precision factors. Thus, auditors may benefit from additional guidance indicating the factors that should be considered for assessing the precision of analytical
    procedures.  Furthermore, audit firms might want to consider integrating some of the findings of this study into future training sessions and/or decision aids that would assist auditors in improving their precision calibration. An insensitivity to important precision factors may lead to over-reliance on analytical procedures, negatively affecting audit effectiveness. Because the allowance for loan losses is an estimate, the results of this study provide insight into factors that could influence the potential effectiveness of audits of estimates. Understanding how auditors evaluate analytical procedure precision for estimates is particularly critical in that analytical procedures may be the only source of assurance for testing these accounts.

    Citation:

    McDaniel, L.S. and L.E. Simmons. 2007. Auditors’ assessment and incorporation of expectation precision in evidential analytical procedures. Auditing: A Journal of Practice & Theory 26(1): 1-18.

    Keywords:
    Analytical procedures, precision, expectations, substantive test, audit evidence
    Purpose of the Study:

    The precision with which auditors form expectations during analytical procedures is important. The precision of an expectation is a measure of the closeness of the developed expectation to the actual amount and refers to the quality of the expectation, and thus, the quality of the analytical procedure. Professional standards clearly indicate that auditors should be able to form more precise expectations for accounts that are more predictable (income statement relationships generally are more predictable than balance sheet relationships) and when the information related to the account is more disaggregated (i.e., detailed). However, the Public Oversight Board’s (POB) Panel on Audit Effectiveness has found evidence that auditors rely on analytical procedures that do not provide the desired level of assurance, suggesting possible difficulty in assessing precision. To address this finding by the POB, this study investigates auditors’ abilities to assess expectation precision and incorporate their assessments into judgments related to substantive analytical procedures, as required by professional standards. A first step toward developing more effective guidance is obtaining a better understanding of why auditors sometimes fail to effectively apply analytical procedures. As such, the authors aim to answer the following two questions: 

    • To what extent do auditors’ precision assessments reflect the level of account predictability and the level of detail of the data used to form expectations? 
    • To what extent are auditors’ judgments consistent with their precision assessments? According to professional standards, the following judgments should be consistent with auditors’ precision assessments:

    (1)   The level of assurance expected by auditors to be provided by the analytical procedure.

    (2)   The range of the difference between the expected and recorded amount.

    (3)   The likelihood that the difference between the expected and recorded amount is due to misstatement versus nonmisstatement causes.

    Design/Method/ Approach:

    The authors gathered their data experimentally at a firm training event for audit seniors and above (the training event occurred sometime during or prior to 2005). The participants were asked to review workpapers which included analytical procedures for two different accounts – the allowance for loan losses (a less predictable account) and interest income (a more predictable account). The expectations for the analytical procedures documented in the workpapers were either based on more or less detailed information. After reviewing the analytical procedures, auditors were asked to assess the precision and the level of assurance provided, provide an expectation range for the account balance, and judge the amount of difference between the expected and recorded amount due to misstatement.

    Findings:
    • Overall, auditors assess precision higher when the data forming the expectation are disaggregated (i.e., more detailed) versus
      aggregated (i.e., less detailed). 
    • Auditors also assess precision higher for the more predictable account (interest income) versus the less predictable account (the allowance for loan losses). 
    • Auditors’ precision assessments for the allowance for loan losses are not significantly different between the disaggregated and aggregated analytical procedures. This finding suggests that in assessing the precision of analytical procedures for less predictable accounts, auditors do not consider the effects of data aggregation. 
    • The results also show that for both accounts auditors judge the level of assurance obtained from the analytical procedures consistent with their precision assessments (i.e., higher assessed precision corresponds with a higher level of assurance). 
    • Counter to the authors’ expectations, auditors’ precision assessments were not related to their judgments of the range of differences between the expected and recorded amounts or the likelihood of misstatement.
    Category:
    Auditing Procedures - Nature - Timing and Extent, Auditor Judgment
    Sub-category:
    Adequacy of Evidence
    Home:
    home button
  • Jennifer M Mueller-Phillips
    Auditors’ Consideration of Material Income-Increasing v...
    research summary posted April 28, 2014 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.06 Earnings Management, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.06 Earnings Management – Detection and Response, 11.0 Audit Quality and Quality Control, 11.09 Evaluation of Evidence 
    Title:
    Auditors’ Consideration of Material Income-Increasing versus Material Income-Decreasing Items during the Audit Process
    Practical Implications:

    The results of this study suggest that auditors spend a greater effort on analyzing income-increasing items compared to income-decreasing items. They also suggest that auditors compensate for greater risk associated with income-increasing items by requiring greater verification of such items. Because of the limitations placed on the results of this study due to the specific context of the experiment, future research should try and examine such differences in auditors’ decision-making processes.

    For more information on this study, please contact Naman K. Desai.
     

    Citation:

    Desai, N. K., and G. J. Gerard. 2013. Auditors’ Consideration of Material Income-Increasing versus Material Income-Decreasing Items during the Audit Process. Auditing 32 (2).

    Keywords:
    accruals; auditing; conservatism; memory; risk
    Purpose of the Study:

    The purpose of this study is to examine whether auditors’ consideration of material items, as evidenced by recognition memories, is influenced by the direction of material items. During the gathering of audit evidence, auditors come across evidence in support of material items that affect earnings in a positive or negative manner. Because earnings can be managed upward or downward depending on management’s objectives and incentives, auditors should be sensitive to both material increasing and deceasing items. Prior research indicates that auditors face greater litigation risk for non-detection of fraudulent income-increasing items compared to income-decreasing items. Therefore, the expectation is that auditors will spend greater cognitive effort evaluating material income-increasing items, resulting in superior memories for such items.

    Design/Method/ Approach:

    The experimental design is a 2 x 2 mixed design with data collected using a signal detection theory paradigm. The participants were randomly assigned to treatments. A total of 60 experienced auditors (all CPAs) participated in the experiment. The participants had an average of 9.83 years of auditing experience. The minimum experience was two years and the maximum was 19 years. The experiment was conducted on site during firm training sessions. 

    Findings:
    • Auditors’ memories for income-increasing items are significantly greater than that for income-decreasing items when auditors are not asked to form expectations about the future effects of the items.
    • This difference above is not observed when auditors are asked to form expectations about future effects of each item.
    • Auditors are less likely to refer back to the work papers to verify the accuracy of income-decreasing items compared to income-increasing items.
       
    Category:
    Audit Quality & Quality Control, Auditing Procedures - Nature - Timing and Extent, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Earnings Management – Detection and Response, Earnings Management, Evaluation of Evidence
  • Jennifer M Mueller-Phillips
    Auditors’ Professional Skepticism: Neutrality versus P...
    research summary posted July 28, 2015 by Jennifer M Mueller-Phillips, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism 
    Title:
    Auditors’ Professional Skepticism: Neutrality versus Presumptive Doubt.
    Practical Implications:

    Presumptive doubt has a greater effect on auditors’ skeptical judgments when client risks are higher than does neutrality. In particular, auditors with higher levels of presumptive doubt exhibit pronounced skeptical judgments and decisions in the higher control environment risk setting.

    Since the findings indicate inversed RIT is a better predictor of desired auditor skeptical judgments, this measure warrants further consideration in practice to develop adequate recruitment, staffing, and training guidance. Also a consideration for practice and future research is whether quality control processes, such as audit reviews, mitigate cases where auditors lack sufficient individual skepticism.

    Citation:

    Quadackers, L., Groot, T., & Wright, A. 2014. Auditors' Professional Skepticism: Neutrality versus Presumptive Doubt. Contemporary Accounting Research 31 (3): 639-657.

    Keywords:
    auditor independence, professional ethics, neutrality, professional skepticism
    Purpose of the Study:

    Professional skepticism is considered to be an essential element of the financial statement audit, as reflected in professional auditing standards and the audit methodologies of international audit firms. Analyses of fraud-related U.S. Securities and Exchange Commission (SEC) cases conclude that a lack of sufficient professional skepticism is often cited as the reason that auditors fail to detect material misstatements. While there is no universally accepted definition of professional skepticism, two perspectives have emerged in the current literature and auditing standards: neutrality and presumptive doubt.

    • Neutrality refers to a perspective in which the auditor assumes no bias in management’s representations.
    • Presumptive doubt represents an auditor’s attitude in which some level of dishonesty or bias by management is assumed, unless evidence indicates otherwise.

    Importantly, there is a lack of consensus on which of these two perspectives of skepticism is most appropriate for audit practice. The purpose of this study is to examine the relationship between auditors’ skeptical perspective (neutrality and presumptive doubt) and auditor skeptical judgments and decisions across client risk settings (higher versus lower control environment risk). Neutrality is measured by the Hurtt Professional Skepticism Scale (HPSS; Hurtt 2010), and presumptive doubt is measured by the inverse of the Rotter Interpersonal Trust Scale.

    Design/Method/ Approach:

    All of the participants come from one Big 4 firm. There were 96 participants in the experiment: 25 partners, 41 managers, and 27 seniors (3 participants did not provide staff-level information). On average, the auditors had 15.36 years general auditing experience and 14.75 years of experience with conducting analytical procedures. The number of participants was relatively balanced across the two control environment risk conditions. The evidence was collected prior to September of 2014.

    Findings:

    The results of this study show that inversed RIT (Rotter’s Interpersonal Trust Scale), a trait measure of presumptive doubt, is more closely associated with auditors skeptical judgments than HPSS (Hurtt Professional Skepticism Scale), a trait measure of neutrality. This relationship particularly holds when control environment risks are higher and, thus, the risk of material misstatement is of particular concern. Since auditing standards direct greater skepticism in a higher-risk setting than in a lower-risk setting, this finding suggests that inversed RIT is more likely to reflect the desired skepticism than HPSS. This result suggests that the presumptive doubt perspective of professional skepticism is more predictive than neutrality of auditor skeptical judgments and decisions in higher-risk situations.

    There is no normative solution to the case, so it is not possible to determine which skepticism measure is more closely related to optimal judgments and decisions.

    Category:
    Auditing Procedures - Nature - Timing and Extent
    Sub-category:
    Auditors’ Professional Skepticism
  • Jennifer M Mueller-Phillips
    Auditors’ Reactions to Inconsistencies between Financial a...
    research summary posted November 10, 2014 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.01 Substantive Analytical Review – Effectiveness 
    Title:
    Auditors’ Reactions to Inconsistencies between Financial and Nonfinancial Measures: The Interactive Effects of Fraud Risk Assessment and a Decision Prompt
    Practical Implications:

    The findings suggest that auditors need improvement in the use of NFMs when performing substantive analytical procedures. Also, the findings of this study suggest that a relatively simple and efficient prompt regarding the use of NFMs can improve auditor substantive testing in the important area of revenue recognition. The evidence suggests that auditors are more likely to respond appropriately to a prompt when fraud risk is assessed at high levels. This demonstrates that decision-makers should carefully assess the level of fraud risk that will result in the desired behavior from in-charge senior auditors.

    For more information on this study, please contact Joe Brazel (jfbrazel@ncsu.edu).

    Citation:

    Brazel, J. F., K. L. Jones, and D. F. Prawitt. 2014. Auditors' Reactions to Inconsistencies between Financial and Nonfinancial Measures: The Interactive Effects of Fraud Risk Assessment and a Decision Prompt. Behavioral Research in Accounting 26 (1): 131-156.

    Keywords:
    Analytical procedures, audit, fraud risk, nonfinancial measures
    Purpose of the Study:

    Professional standards, auditing texts, and prior research suggest that external auditors can use nonfinancial measures (NFMs) to verify their clients’ reported financial information. These sources also suggest that an inconsistency between a company’s financial performance and related NFMs represents a potential red flag for financial statement fraud. However, recent research indicates that auditors’ attention to NFMs is insufficient to detect inconsistencies between financial data and NFMs. This paper addresses this concern by investigating factors that affect auditors’ use of NFMs when auditing financial statement data. Specifically, the paper investigates whether auditors’ reliance on NFMs and development of revenue expectations are affected by the following factors:

    • The consistency/inconsistency of NFMs and related financial data
    • The use of a prompt to encourage auditors to use NFM to calculate a revenue expectation
    • The level of fraud risk assessed during planning

    The authors motivate their hypotheses using the Heuristic-Systematic Model from the psychology literature. This model suggests that the contextual features of a judgment affect how an individual processes information. The authors use this theory to suggest that auditors who are prompted to use NFMs might be more likely to use NFMs to set revenue expectations under high fraud risk compared to low fraud risk.

    Design/Method/ Approach:

    The research evidence used in this study was gathered in 2009. In this study, the authors use in-charge senior auditors from a Big 4 firm to complete two experimental tasks. In both experiments, the participants were given access to client information and were asked to develop an expectation for a client’s revenue balance.  The second experiment introduces an NFM prompt and manipulates fraud risk.

    Findings:
    • The authors find that a minority of auditors use NFMs as an information source for performing analytical procedures and report that auditors do not increase their reliance on NFMs when the NFMs point to a fraud red flag in revenue figures.
    • The authors find that the presence of high fraud risk alone does not affect the auditors’ NFM reliance or revenue expectations.
    • The authors find that auditors are more likely to rely on NFMs and question the client’s revenues balance when prompted about how NFMs can be used to develop a revenue expectation.
    • The influence of the prompt on auditor reliance on NFMs and account balance expectations is stronger when fraud risk is assessed as high.
    Category:
    Auditing Procedures - Nature - Timing and Extent, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Fraud Risk Assessment, Substantive Analytical Review – Effectiveness
  • Jennifer M Mueller-Phillips
    Audits of Complex Estimates as Verification of Management...
    research summary posted October 19, 2015 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.01 Use of Specialists e.g., financial instruments, actuaries, valuation, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism, 09.0 Auditor Judgment, 09.03 Adequacy of Evidence, 09.12 Impact of potential post-audit review - e.g., PCAOB, internal firm inspections, 11.0 Audit Quality and Quality Control, 11.05 Training and General Experience, 11.09 Evaluation of Evidence 
    Title:
    Audits of Complex Estimates as Verification of Management Numbers: How Institutional Pressures Shape Practice.
    Practical Implications:

    Based on the interviews and problems identified, the authors conjecture that potentially suboptimal auditing methods are being used to evaluate complex estimates which are an important and growing part of the financial statements. This may be negatively impacting audit quality. More specifically, auditors over-rely on management estimates because they lack the knowledge and incentives to behave otherwise. This possibility has direct consequences for auditor professional skepticism because increasing professional skepticism may be less effective unless auditors are also given the requisite knowledge to properly use it. These problems are reinforced by auditing standards and regulators which generally outline/criticize the current auditing methods without suggesting new or better ones.  

    Citation:

    Griffith, E., J. Hammersley, and K. Kadous. 2015. Audits of Complex Estimates as Verification of Management Numbers: How Institutional Pressures Shape Practice. Contemporary Accounting Research 32 (3): 833-863.

    Keywords:
    Complex Estimates, Subjectivity, Institutional Theory, Valuation Specialists, Professional Skepticism, Interviews
    Purpose of the Study:

    Complex estimates are increasingly important to financial statements and of growing concern to both regulators and investors. While auditors have well-established procedures for auditing more objective account balances (i.e., valued at historical cost), little is known about the process auditors use to evaluate more subjective, complex estimates. This article conducts interviews with experienced audit personnel to determine how auditors evaluate such estimates, determines the problems with such approaches, and uses “institutional theory” to theorize the reason such problems exist and persist. The authors consider the influence of both audit firms themselves and regulators (i.e., information from PCAOB inspection reports) on auditors’ complex estimate audit procedures.

    Design/Method/ Approach:

    The authors conducted semi-structured phone interviews with experienced audit personnel. Participants are from 6 large accounting firms with at least manager level experience. Interviews were conducted between October and November 2010. The authors analyzed the audit process steps discussed by participants for complex estimates and coded these steps according to the PCAOB auditing standards related to accounting estimates (AU 342 and 328).  For steps that could not be appropriately classified into ones discussed by the auditing standards, the authors developed additional classifications.

    Findings:

    While auditing standards allow for different approaches to evaluating complex estimates (e.g., testing management process, preparing independent estimate, etc.), the authors find that auditors usually just test management’s process (i.e., verifying inputs such as historical cost, understanding who and how estimate is generated, testing controls surrounding process, and testing sensitivity of assumptions used).  

    Based on institutional theory, the authors theorize two key reasons that auditors mainly use management process verification when auditing complex estimates instead of other (potentially more creative and skeptical) approaches. The reasons are:

    • Both audit firm policies and professional standards generally emphasize management process verification techniques over other potential techniques. Additionally, regulators (i.e., PCAOB) reinforce/encourage this behavior because inspection findings largely focus on problems with auditing management’s process instead of suggesting alternative, superior auditing methods.
    • Audit firms employ valuation specialists who have the necessary knowledge to more critically analyze complex estimates. This fact means that financial statement auditors generally do not have the necessary knowledge to critically analyze management’s models or develop an independent expectation. When auditors do use such specialists, they over-rely on their work.
    • Given the lack of guidance regarding complex estimates, firms tend to use practices that have been previously legitimized. For auditing of complex estimates, verification (which works well to audit less subjective accounts) is used to audit more subject complex estimates. Auditing standards also mainly emphasize verification.
    • Given inspection pressures, firms find it safer and more legitimate to mimic each other’s policies and procedures for auditing complex estimates instead of develop new ones.
    Category:
    Audit Quality & Quality Control, Audit Team Composition, Auditing Procedures - Nature - Timing and Extent, Auditor Judgment
    Sub-category:
    Adequacy of Evidence, Auditors’ Professional Skepticism, Evaluation of Evidence, Impact of potential post-audit review (e.g. PCAOB - internal firm inspections), Sustainability ServicesTraining & General Experience, Use of Specialists (e.g. financial instruments – actuaries - valuation)
  • Jennifer M Mueller-Phillips
    Behavioral implications of big data’s impact on audit j...
    research summary posted September 11, 2015 by Jennifer M Mueller-Phillips, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 08.09 Impact of Technology on Audit Procedures, 09.0 Auditor Judgment 
    Title:
    Behavioral implications of big data’s impact on audit judgment and decision making and future research directions.
    Practical Implications:

    The authors outline potential pitfalls in the use of big data noted in auditing and psychology literature. Specifically, they focus on areas in which auditor decision making may be negatively influenced. They note that big data may lead to inefficient and/or incorrect decisions resulting from having too much information, not being able to determine what is relevant to the decision, not finding correct patterns in the data/finding incorrect patterns, and having data which may be too ambiguous to be used effectively. They then outline potential solutions to these problems, such as having decision aids, fitting the task to the system to auditor experience level, and providing contextual (“big picture”) training.

    Citation:

    Brown-Liburd, H., H. Issa, and D. Lombardi. 2015. Behavioral implications of big data’s impact on audit judgment and decision making and future research directions. Accounting Horizons 29(2): 451-468.

    Keywords:
    Big data, audit judgment, data analytics, information processing weaknesses
    Purpose of the Study:

    Big datahigh-volume, high-velocity, and high-variety information assets that demand cost-effective, innovative forms of information processing for enhanced insight and decision makinghas been the new trendy topic in the future of auditing. This paper outlines potential implications on the actions of the auditor resulting from the use of big data, specifically drawing from literature on psychology and auditing.

    Design/Method/ Approach:

    This paper summarizes the current literature in psychology and auditing specifically to bring to light potential issues resulting from incorporation of big data in auditing. No data is used and no analyses are performed.

    Findings:

    The authors find four primary areas where research in auditing and psychology indicate potential negative effects of big data on audit performance, specifically in auditor judgment and decision making:

    • Auditors may make inefficient decisions, struggle to differentiate relevant information, struggle to identify relationships between detail and overall trends, and disregard large portions of information (information overload).
    • Auditors may make poorer decisions due to the excess of irrelevant information innate in big data. They may be unable to filter relevant information from the noise, thus being less efficient in analyzing data and potentially using irrelevant information in decision making (information relevance).
    • The sheer magnitude of data to analyze may force auditors to become worse at recognizing patterns, applying knowledge to the audit task, weighting evidence, or extrapolating patterns into longer times series (pattern recognition).
    • Auditorsif they have a low tolerance for ambiguitymay neglect information once a simple solution or response is identified, potentially ignoring relevant but more complex information (ambiguity).

    The authors then provide examples of solutions to these problems, such as 1) providing decision models 2) having inexperienced auditors use expert systems (requires minimal auditor interpretation) 3) provide auditors with more contextual experience and training so they can interpret patterns in big data 4) leverage predictive models that can indicate areas of increased risk.

    Category:
    Auditing Procedures - Nature - Timing and Extent, Auditor Judgment
    Sub-category:
    Impact of Technology on Audit Procedures Confirmation – Process and Evaluation of Responses
  • Jennifer M Mueller-Phillips
    Behind the Numbers: Insights into Large Audit Firm Sampling...
    research summary posted July 27, 2015 by Jennifer M Mueller-Phillips, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 08.02 Sample Selection – use of statistical sampling 
    Title:
    Behind the Numbers: Insights into Large Audit Firm Sampling Policies.
    Practical Implications:

    Given the limited evidence on firms’ sampling policies after Sarbanes-Oxley, these findings contribute to the current literature on audit sampling and provide insights into sampling policies and procedures that are important for researchers, educators, regulators, and practitioners to better understand the application of audit sampling in the current audit environment. This study provides evidence on current sampling practices and identifies important differences in sampling policy among the largest audit firms. Responses represent firm policy, and although the sampling experts indicate that they believe that firm guidance is followed in the field, actual sampling practices may vary.

    Citation:

    Christensen, B. E., Elder, R. J., & Glover, S. M. 2015. Behind the Numbers: Insights into Large Audit Firm Sampling Policies. Accounting Horizons 29 (1): 61-81.

    Keywords:
    audit misstatements, audit sampling, materiality, statistical sampling
    Purpose of the Study:

    This study addresses a number of research questions regarding the current state of audit sampling. Audit sampling is a fundamental audit testing procedure. Over the last two decades there have been significant changes in audit approaches, including strategic systems auditing in the 1990s and federally mandated audits of internal control over financial reporting for large public companies as a result of the Sarbanes-Oxley Act of 2002 (SOX). Revisions to audit approaches have the potential to change the nature and extent of audit sampling techniques used by accounting firms. For instance, the requirement to audit internal control over financial reporting has necessarily increased the extent and importance of tests of controls, many of which are performed using sampling. Additionally, the Public Company Accounting Oversight Board (PCAOB) has identified sampling as an area needing more emphasis, and inspection reports have identified multiple issues regarding audit sampling, including small and non-representative samples and incorrect or lack of error projection, among others.

    The study focuses on the policies in place at the firms and not necessarily how these policies are implemented in the field. However, due in part to internal firm and federal oversight, discussions with firm experts indicate that audit teams are expected to comply with firm sampling guidance. 

    Design/Method/ Approach:

    The survey asked respondents a number of open-ended questions regarding sampling policies and practices currently in place at the Big 4 and two other international accounting firms. The authors worked in coordination with the participating firms. A version was sent by email in Spring 2013 to one of the Big 4 firms for completion and feedback, after which some additional clarifications were made before distributing electronically to the other firms.

    Findings:
    • The sampling methods differ significantly among the largest auditing firms; while some emphasize statistical methods, others use nonstatistical methods.
    • Firms frequently use different inputs to these sampling models, thus resulting in relatively different sample sizes.
    • The authors find variation in the planned level of expected error, and they also find differences in error projection methods used and how firms respond to identified errors and misstatements.
    • Sampling approaches and parameters within most firms are identical for large public and smaller private companies despite the likely differences in business and engagement risk.
    • Some firms have significantly changed their approach to revenue testing due to PCAOB inspections, relying more heavily on substantive testing using sampling than other substantive testing such as analytical procedures.
    • Some firms have significantly changed their approach to revenue testing due to PCAOB inspections, relying more heavily on substantive testing using sampling than other substantive testing such as analytical procedures.
       
    Category:
    Auditing Procedures - Nature - Timing and Extent
    Sub-category:
    Sample Selection – use of statistical sampling
  • Jennifer M Mueller-Phillips
    Between a Rock and a Hard Place: A Path Forward for Using...
    research summary posted June 15, 2016 by Jennifer M Mueller-Phillips, tagged 08.0 Auditing Procedures – Nature, Timing and Extent 
    Title:
    Between a Rock and a Hard Place: A Path Forward for Using Substantive Analytical Procedures in Auditing Large P&L Accounts: Commentary and Analysis
    Practical Implications:

    The results of this study are important because the authors believe that the reduction in the use of appropriately rigorous substantive analytical procedures could diminish overall audit quality, and that the utilization of their approach could keep this from occurring. 

    Citation:

    Glover, S.M., D.F. Prawitt, and M.S. Drake. 2015. Between a Rock and a Hard Place: A Path Forward for Using Substantive Analytical Procedures in Auditing Large P&L Accounts: Commentary and Analysis. Auditing: A Journal of Practice and Theory 34 (3): 161-179.

    Keywords:
    substantive analytical procedures, revenue testing, materiality, and audit evidence
    Purpose of the Study:

    Substantive analytical procedures (SAPs) have been one of the common substantive procedures applied to income statement accounts for decades; however, there is a growing trend for public company auditors to forego substantive analytical procedures on large income statement accounts due to criticisms from regulatory inspectors that such procedures are not capable of providing useful substantive evidence. This paper hopes to comment on the concern that discouraging the application of appropriately rigorous substantive analytical procedures may diminish overall audit quality. The authors consider whether rigorous substantive analytical procedures can be designed to provide useful evidence at moderate and low levels of assurance for large income statement accounts even when the significant-difference threshold exceeds overall materiality. It is the belief of the authors that such procedures can provide strong evidence that financial statements are free of massive fraud or unintentional misstatement, and that the moderate or low assurance obtained by such procedures can be combined with assurance from other audit procedures to yield high overall assurance. The authors hope to illustrate how to achieve moderate or low assurance and explain how their approach is consistent with auditing theory and auditing standards. Overall, the primary purpose of this paper is to raise awareness of a practice concern and resulting trend that may have negative effects on audit quality and to provide thought leadership on how the profession may be able to leverage the benefits of SAPs.

    Design/Method/ Approach:

    Public company revenue data and analyst forecast errors are used to illustrate the practical difficulties and inherent limitations of seeking high assurance from a substantive analytical procedure. Possible ways to conceptualize thresholds are outlined and public company data is used to demonstrate the use of substantive analytical procedures to provide moderate or low assurance.

    Findings:
    • The authors find that audit theory, the audit risk model, and recent auditing standards suggest that, when combined with other audit procedures, substantive analytical procedures can provide useful complementary evidence when they provide only moderate or low assurance.
    • The authors find that little or no guidance exists regarding what constitutes moderate or low assurance when conducting the types of substantive analytical procedures that are typically used in practice.
    • Analysis suggests that if auditors can improve expectations via disaggregation, then substantive analytical procedures should be able to be developed to provide some assurance that revenue and other large income statement accounts are fairly stated.
    Category:
    Auditing Procedures - Nature - Timing and Extent

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