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  • Jennifer M Mueller-Phillips
    Do auditor judgment frameworks help in constraining...
    research summary posted November 14, 2016 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 09.09 Impact of Consultation on Judgments, 09.12 Impact of potential post-audit review - e.g., PCAOB, internal firm inspections 
    Title:
    Do auditor judgment frameworks help in constraining aggressive reporting? Evidence under more precise and less precise accounting standards
    Practical Implications:

    By examining the cognitive impact of the different judgment frameworks, this study provides academics, practitioners, and regulators with important insight into why counterfactual reasoning and a structured thought process differentially enhance auditors’ professional skepticism. 

    Citation:

    Backof, A. G., E. M. Bamber and T. D. Carpenter. Do auditor judgment frameworks help in constraining aggressive reporting? Evidence under more precise and less precise accounting standards. Accounting, Organizations and Society 51: 1-11. 

    Keywords:
    auditing, accounting standard precision, judgment frameworks, psychological distance, and abstract mindsets.
    Purpose of the Study:

    Auditors are being called on to exercise substantially more professional judgment during the financial reporting process due in part to the global trend towards less precise accounting standards; consequently, the Advisory Committee on Improvements to Financial Reporting (CIFiR) recommended that the Public Company Accounting Oversight Board (PCAOB) develop guidelines on how the PCAOB plans to evaluate the reasonableness of judgments made based on PCAOB auditing standards. Although the PCAOB has not yet done this, audit firms have developed their own judgment frameworks based on CIFiR’s identification of key components underlying reasonable accounting judgments. Further, the Center for Audit Quality (CAQ) recently published a professional judgment resource that audit firms can use to enhance their professional judgment process. This study examines how alternative specification of these judgment frameworks affect auditors’ constraint of management’s aggressive financial reporting under accounting standards that differ in their level of precision.

    Design/Method/ Approach:

    The authors conduct an experiment using a 2 x 4 factorial design to investigate these issues. A number of audit managers and partners from a Big 4 accounting firm participated in a case requiring them to audit management’s lease classification decision. The setting is created to be on where auditors stand to benefit from a well-reasoned judgment process that includes the consideration of alternatives and focuses auditors on the big picture economics rather than the transactional details.  

    Findings:
    • The authors find that the judgment frameworks are more effective under less precise standards. In particular, the pro/con framework based on CIFiR’s recommendation to consider the “pros and cons for reasonable alternatives” effectively enhances auditors’ skepticism of aggressive reporting under less precise standards, but not more precise standards.
    • The authors’ evidence suggests that both the pro/con why framework and pro why framework lead to an even greater reduction in auditors’ allowance of aggressive reporting under less precise standards; however, only the pro why framework curbs aggressive reporting under more precise accounting standards. 
    Category:
    Auditor Judgment
    Sub-category:
    Impact of Consultation on Judgments, Impact of potential post-audit review (e.g. PCAOB - internal firm inspections)
  • Jennifer M Mueller-Phillips
    Does Disclosure of Conflict of Interest Increase or Decrease...
    research summary posted August 31, 2016 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.01 Use of Specialists e.g., financial instruments, actuaries, valuation, 09.0 Auditor Judgment, 09.09 Impact of Consultation on Judgments 
    Title:
    Does Disclosure of Conflict of Interest Increase or Decrease Bias?
    Practical Implications:

     Valuators’ judgment and decision making is currently unexplored. This study provides preliminary evidence on how valuators act in the presence of conflict of interest, and the need for conflict disclosures. The results of this study have implications for public accounting firms to the extent that they provide either fairness opinions and associated valuation judgments or are involved in some audit aspects related to mergers/acquisitions. This study contributes to accounting and psychology literature on conflict of interest disclosures and is the first study to test the biasing effects of conflict disclosure specifically targeting professionals performing familiar tasks. Further, this study extends existing literature of the topic by documenting that bias arising from disclosure of conflict of interest depends on whether the conflict of interest is aligned or misaligned with the client’s interest. This study provides the first evidence that disclosure of conflict of interest causes bias in Client-Aligned, but not in a Client-Misaligned, conflict of interest setting.

    Citation:

     Jamal, K., E. Marshall and H. Tan. 2016. Does Disclosure of Conflict of Interest Increase or Decrease Bias? Auditing: A Journal of Practice and Theory 35 (2): 89-99.

    Keywords:
    Conflict of interest, disclosure, bias, auditor independence, valuation, client advocacy, nature of conflict
    Purpose of the Study:

     Professional valuators are increasingly called upon to supply inputs that form part of the financial statements and the audit report. However, criticisms of potential conflicts of interest relating to valuators’ reports abound. One concern is that professional valuators provide expert opinions in circumstances where they are required to act in the public interest, yet are hired and paid by a client who has self interest in the outcome of the valuator’s report. This study seeks to investigate, in a valuation setting involving professional valuators, the efficacy of disclosure in curbing biases stemming from conflict of interest. Further, this study investigates whether the effect of disclosure of conflict of interest depends on the nature of the conflict of interest—specifically, whether the conflict of interest is aligned with or threatens the current client’s (seller or auditor’s) interest.

    Design/Method/ Approach:

     The authors recruited 90 experts with business valuation experience and sent these participants research instruments via courier mail. On average, participants had 13.3 years of work experience, 6.7 years of work experience in business valuation, and had worked on 38 valuation engagements. These individuals were asked to make a valuation judgment in the context of a larger fairness opinion engagement on the sale of a subsidiary. Conflict of interest was manipulated as either Client-Aligned (valuators’ interest aligned with auditors) or Client-Misaligned (valuators’ interest aligned with audit client). The results were also examined in the presence and absence of disclosure (No Disclosure, Disclosure).

    Findings:

     The study resulted in the following conclusions. • In a Client-Aligned conflict situation, disclosure of conflict of interest induces bias toward the current client (auditor), and does not produce the intended result of reducing or preventing bias. • In a Client-Misaligned conflict of interest setting where the valuator has potential future business opportunities with the buyer (audit client), the authors found evidence that valuation estimates are still biased toward the current client (auditor), regardless of disclosure. • In the Client-Aligned conflict situation, disclosure magnified bias. In contrast, in the client-misaligned conflict setting, disclosure of conflict of interest did not cause any incremental bias.

    Category:
    Audit Team Composition, Auditor Judgment
    Sub-category:
    Impact of Consultation on Judgments, Use of Specialists (e.g. financial instruments – actuaries - valuation)
  • The Auditing Section
    Effects of Technical Department’s Advice, Quality A...
    research summary posted May 7, 2012 by The Auditing Section, tagged 09.0 Auditor Judgment, 09.09 Impact of Consultation on Judgments 
    Title:
    Effects of Technical Department’s Advice, Quality Assessment Standards, and Client Justifications on Auditors’ Propensity to Accept Client-Preferred Accounting Methods
    Practical Implications:

    The results of this study are important for audit firms to consider when outlining best practices for their technical department.  They highlight the role and limitations of in-house consultation and advice in enhancing auditors’ decisions, and suggest that the nature of advice sought by, and presented to, auditors matters. Technical advice that merely reduces ambiguity may not be sufficient to counteract auditors’ bias toward accepting client-preferred methods. In fact, such advice could lead to an unintended consequence of bolstering auditors’ support for client-preferred methods. Explicit recommendations to use the most appropriate methods and reference to QAS should be included as well.

    Citation:

    Ng, T.B. and P. G. Shankar. 2010. Effects of Technical Department’s Advice, Quality Assessment Standards, and Client Justification on Auditors’ Propensity to Accept Client-Preferred Accounting Methods. The Accounting Review 85 (5): 1743-1761.

    Keywords:
    Advice, quality assessment, justification, auditor judgment
    Purpose of the Study:

    Current standards require auditors to discuss with listed companies’ audit committees their judgments about the appropriateness or quality, not just acceptability, of the accounting principles and estimates in audited financial statements. The spirit of such standards advocates for the use of the most appropriate accounting method. However, prior research suggests that auditors continue to accept client-preferred methods, even when they may not be the most appropriate. This paper investigates whether the effectiveness of quality assessment standards (QAS) is weakened or strengthened by: 

    • Advice from the audit firm’s technical department. Both the presence and type of advice should impose reasonableness constraints on auditors’ tendency to accept client-preferred accounting methods.
    • The strength of client justification for their preferred accounting methods. Strong client justifications are more likely to persuade auditors, so the combined effect of QAS and advice from the audit firm’s technical department should be higher in these circumstances. 

    The authors derive their expectations from the psychology literature pertaining to motivated reasoning. The theory of motivated reasoning suggests that auditors with pro-client directional goals are likely to support their client-preferred method within reasonableness constraints, (i.e., as long as it is justifiable).

    Design/Method/ Approach:

    The research evidence was collected in the mid-2000s. Audit seniors, supervisors, and managers from two Big 4 firms in Singapore participated in the experiment. Auditors completed a simulated task involving the decision to accept the client-preferred method of accounting for an ambiguous sales contract. In the first stage, the authors randomly assign participants to one of four possible conditions, where QAS is present or absent, and client justification strength is strong or weak.  In the second stage, participants within each of these four conditions were randomly provided with two types of technical advice, with an explicit recommendation or without. At the end of both stages, participants made several judgments about the case, including whether to accept the client-preferred method.

    Findings:
    • The authors find that auditors’ propensity to accept the client-preferred method in the absence of technical advice (stage 1) is significantly influenced by client justification strength, but not by the presence of QAS.
    • The authors find that auditors’ propensity to accept the client-preferred method is reduced by the presence of QAS only when client justification is strong and explicit technical advice is provided (stage 2).
    • Subsequent analysis suggests that auditors strategically use technical advice to increase support for the client-preferred method unless QAS is present, explicit technical advice is provided, and client justification is strong.
    Category:
    Auditor Judgment
    Sub-category:
    Impact of Consultation on Judgments
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  • Jennifer M Mueller-Phillips
    Effects of Technical Department’s Advice, Quality A...
    research summary posted March 16, 2015 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 09.09 Impact of Consultation on Judgments, 11.0 Audit Quality and Quality Control 
    Title:
    Effects of Technical Department’s Advice, Quality Assessment Standards, and Client Justifications on Auditor’s Propensity to Accept Client-Preferred Accounting Methods
    Practical Implications:

    “These findings demonstrate the complementary roles that professional standards and the audit firms’ technical departments play in enhancing the quality of auditor’s decisions, and indicate that the nature of advice matters.” Furthermore, as asserted in its concluding remarks, this study highlights, “the role and limitations of in-house consultation and advice in enhancing auditors’ decisions, and suggests that the nature of advice sought by, and presented to, auditors matters.”

    For more information on this study, please contact Terence Bu-Peow Ng.

    Citation:

    Ng, T.B. and P. G. Shankar. 2010. Effects of Technical Department’s Advice, Quality Assessment Standards, and Client Justification on Auditors’ Propensity to Accept Client-Preferred Accounting Methods. The Accounting Review 85 (5): 1743-1761.

    Keywords:
    Advice, quality assessment, justification, auditor judgment
    Purpose of the Study:

    This study references “reasonableness constraints” in reference to the theory of motivated reasoning which suggests that individuals are prone to biased reasoning in favor of a directional goal. This study investigates, “whether the effect of an SAS No. 90-like standard requiring auditor assessment of the quality, not just the acceptability, of a client’s accounting methods (QAS) on auditors’ decisions is contingent on the presence and/ or nature of advice and strength of the client’s justification for its preferred accounting method.”

    Design/Method/ Approach:

    Participants were audit seniors, supervisors, and managers from two Big 4 firms in Singapore. This study involved an experiment that was performed in two stages. In stage one, no hypothetical advice is provided from the firm’s technical department as QAS (absent or present) and client justification (weak or strong) are manipulated. In stage two, hypothetical advice is provided as QAS, client justification strength, and advice nature (with or without an explicit recommendation) are manipulated. 

    Findings:
    • In the absence of advice, QAS does not affect auditors’ decision, regardless of client justification strength.
    • In the presence of advice from technical department, the presence of QAS, “significantly reduces auditors’ propensity to accept the client-preferred method, but only when the advice explicitly recommends the use of the most appropriate method and the client’s justification is strong.”  
    Category:
    Audit Quality & Quality Control, Auditor Judgment
    Sub-category:
    Impact of Consultation on Judgments
  • Jennifer M Mueller-Phillips
    Group judgment and decision making in auditing: Past and...
    research summary posted February 17, 2016 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.09 Group Decision-Making, 09.0 Auditor Judgment, 09.09 Impact of Consultation on Judgments, 09.11 Auditor judgment in the workpaper review process 
    Title:
    Group judgment and decision making in auditing: Past and future research.
    Practical Implications:

    The insights highlighted in this paper from research on audit groups/teams inform one’s understanding of how best to design group interactions between auditors within the firm and with professionals outside the audit firm, including management, audit committees, and inspectors. These insights are important given the criticism audit firms have faced from regulators and inspectors over the past decade and the multi-person setting present in auditing. Further, while a large literature exists on single-person decision-making, these studies may not generalize to multi-person settings. The review also highlights the need for continued research in this area and the importance audit practitioner involvement with future research efforts.

    Citation:

    Trotman, K., T. Bauer, and K. Humphreys. 2015. Group judgment and decision making in auditing: Past and future research. Accounting, Organizations and Society 47: 56-72.

    Keywords:
    Review process, brainstorming, consultation
    Purpose of the Study:

    This paper examines experimental research on audit groups/teams. The paper focuses on three main areas: 1) the hierarchical review process, 2) brainstorming as part of the fraud detection planning process, and 3) consultation within firms. The authors define research on audit groups/team as those papers where two or more individuals within the audit firm interact with one another face-to-face, electronically, or where on person prepares/reviews working papers for another. In addition to summarizing research to date in each of the three areas, the authors suggest directions for future research within the three areas as well as future research on within-firm group interactions. These areas include shared mental models, audit team diversity, and interactions with groups outside the audit firm, such as audit committees.

    Design/Method/ Approach:

    The paper summarizes research on group audit JDM experimental studies published in Accounting, Organizations, and SocietyContemporary Accounting ResearchJournal of Accounting Research, and The Accounting Review from 1970 through 2015. Relevant working papers are also discussed.

    Findings:

    Note: Given the breadth of this review paper, only select subsections are summarized below.

    • Hierarchical review process:
      • What performance gains result from the review process?
        • The review process generally improves audit effectiveness.
        • However, it is not always effective as biases may not be mitigated by the review process, such as the recency effect.
      • Alternative forms of the review process: Includes research on comparing reviews with and without discussion, specialized versus all-encompassing reviews, and electronic versus face-to-face reviews.
      • Effects of the preparer on the review process:  
        • Studies investigate the attributes of the preparer and the effects of preparer stylization on the review process.  
        • Overall, preparer attributes and stylization have a significant impact on the review process.
    • Brainstorming:
      • Face-to-face interacting versus nominal brainstorming: Nominal groups generate more unique ideas than face-to-face interacting groups, due to process losses (e.g., production blocking) occurring in the face-to-face interacting context.
      • Interacting face-to-face brainstorming compared to alternate brainstorming formats: While unstructured face-to-face brainstorming is the most common method used by audit firms, other methods (e.g., providing guidelines or instructions) outperform this unstructured method with respect to the quantity of fraud risks identified and fraud hypotheses generated.
      • Electronic brainstorming:  
        • Positive consequences of electronic brainstorming include minimizing production blocking and evaluation apprehension, however social loafing is a potential negative consequence.
        • Evidence supports the claim that electronic brainstorming is superior to face-to-face interaction, however as with non-electronic brainstorming, nominal electronic brainstorming outperforms interacting electronic brainstorming.
    • Consultation within firms:
      • Willingness to follow consulting advice: Auditors tend to incorporate advice received, however receiving advice can increase the tendency to follow aggressive client preferences.
      • Willingness to seek consulting advice: In general, auditors are more likely and willing to consult when related risk is high.
    Category:
    Audit Team Composition, Auditor Judgment
    Sub-category:
    Auditor judgment in the workpaper review process, Group Decision-Making, Impact of Consultation on Judgments
  • Jennifer M Mueller-Phillips
    How Do Auditors Weight Informal Contrary Advice? The Joint...
    research summary posted September 14, 2015 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 09.09 Impact of Consultation on Judgments, 09.10 Prior Dispositions/Biases/Auditor state of mind 
    Title:
    How Do Auditors Weight Informal Contrary Advice? The Joint Influence of Advisor Social Bond and Advice Justifiability.
    Practical Implications:

    By treating worse justified advice as though it were better justified advice, auditors are likely to overestimate the defensibility of their conclusions that are based on this advice. It also is worrisome that specialists appear to defensively resist well-justified, contrary advice from stronger social bond advisors. In response to a stronger social bond advisor’s better justified advice, specialists assess advisor competence to be higher and they assess the advice itself to be of higher quality, but they assign relatively low weight to the advice. This inconsistency implies that specialists may have difficulty accepting good advice even when they recognize its high quality.

    Citation:

    Kadous, K., J. Leiby, and M. E. Peecher. 2013. How Do Auditors Weight Informal Contrary Advice? The Joint Influence of Advisor Social Bond and Advice Justifiability. Accounting Review 88 (6): 2061-2087.

    Keywords:
    advice, audit quality, auditor judgment, fair value, social bond, true heuristic
    Purpose of the Study:

    Auditors regularly seek informal advice, including additional information, recommendations, and alternative perspectives about their initial judgments, from other auditors. Audit firms encourage advice seeking to enhance professional skepticism and improve professional judgment. Existing theory and evidence provide contrasting viewpoints. On the one hand, auditors recognize that following contrary advice can enhance the justifiability, or defensibility, of their judgments on ill-structured audit tasks such as determining the acceptability of management’s accounting policies. On the other hand, people generally discount contrary advice in nonauditing contexts, and auditors are prone to motivated reasoning.

    The authors expect that auditors’ willingness to use contrary advice is a joint function of their social bond with their advisor and advice justifiability. Social bond refers to auditors’ subjective sense of interpersonal closeness or connectedness toward their advisor. The authors examine the influence of advice justifiability on advice weighting for three reasons.

    • The justifiability of a recommendation is a reasonable proxy for advice quality in the ill-structured tasks that auditors frequently encounter, such as assessing the reasonableness of a fair value.
    • A common explanation for individuals’ general tendency to discount advice in everyday contexts is that while they can easily access reasons for their own opinions, they have far less ability to access reasons for their advisor’s recommendations.
    • The authors examine the influence of advice justifiability across both weaker and stronger levels of advisor social bond because theory predicts an interaction of advice justifiability and social bond for auditors’ advice weighting.
    Design/Method/ Approach:

    88 audit seniors from a Big 4 firm completed the experimental task at a national training session. Their audit experience ranged from 30 to 96 months, with a mean (standard deviation) experience of 39 months (10 months). The evidence was gathered prior to August 2010.

    Findings:

    The authors find that non-specialist auditors rely on the predicted trust heuristic. When advice comes from a stronger social bond advisor, they weight it relatively heavily and do not differentiate better from worse justified advice. Non-specialists also fail to objectively assess the quality of advice, and they optimistically assess specific attributes of advice coming from stronger social bond advisors, inaccurately equating better and worse justified advice. They do this even though they are able to distinguish advice justifiability and weight the advice accordingly when it comes from a weaker social bond auditor.

    In contrast, specialists do not rely on a trust heuristic in weighting advice, but they weight advice inconsistently with their own assessments of its quality. Specialists put less weight on better justified advice despite assessing its quality to be higher when it comes from a stronger social bond advisor. This inconsistency appears defensive in nature. The authors find that contrary advice has promise for reducing auditors’ motivated reasoning in that auditors significantly weight it in each condition. Informal contrary advice helps auditors to see an alternative point of view.

    Category:
    Auditor Judgment
    Sub-category:
    Impact of Consultation on Judgments, Prior Dispositions/Biases/Auditor state of mind
  • Jennifer M Mueller-Phillips
    If You Want My Advice: Status Motives and Audit...
    research summary posted February 16, 2017 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.01 Use of Specialists e.g., financial instruments, actuaries, valuation, 09.0 Auditor Judgment, 09.09 Impact of Consultation on Judgments 
    Title:
    If You Want My Advice: Status Motives and Audit Consultations About Accounting Estimates
    Practical Implications:

    The finding that higher decision authority can have negative audit quality implications is relevant to audit firm policies, which often vest substantial authority in consultants, and to the ongoing debate over standards for the use of specialists. This and other findings also suggest that it may be beneficial to advocate lower decision authority. Finally, the findings can inform audit firm policies that require consultation with knowledgeable persons, as well as standard-setters and regulators whose responsibilities to provide guidance on using consultation to conduct more effective audits of financial statement estimates. 

    Citation:

    Knechel, W. R. and J. Leiby. 2016. If You Want My Advice: Status Motives and Audit Consultations About Accounting Estimates. Journal of Accounting Research 54 (5): 1331 – 1364. 

    Purpose of the Study:

    Financial reports contain many complex accounting estimates that require significant auditor judgment and can increase the risk of material misstatements. Auditors often struggle to maintain the requisite knowledge and questioning mindset necessary to effectively assess these estimates. Little is known about how the efficacy of consultation and the conditions under which consultants provide advice that might improve the audit of estimates. Consultation in auditing is pervasive and has substantial potential benefits, thus the availability of useful advice is often a necessary condition to improve the audit of estimates. In this study, the authors examine two properties of advice that are likely to help improve auditor judgment on accounting estimates: contrariness and precision. Contrariness refers to the degree to which a consultant’s advice differs from the advice-seeker’s own opinion, and precision refers to the narrowness of the range of options presented by a consultant to an advice seeker, that is, reducing the range of possible outcomes to be considered. 

    Design/Method/ Approach:

    The authors conduct an experiment with a number of audit managers and senior managers from a U.S. accounting firm. The authors manipulate status motives by priming auditors with a brief story prior to the task in which they act as a consultant to another auditor regarding the discount rate a client uses to estimate the fair value of a securitized asset. 

    Findings:
    • The authors find that a consultant’s recommendations are influenced by specialized knowledge and decision authority conditional on their status motives.
      • More specifically, when status motives are active, consultants with higher specialized knowledge are more precise but less contrary than those with lower knowledge.
    • The authors find that consultants recommend changes to the end of the range that is further from management’s preference, thus this increased precision is unlikely to influence the evaluation and ultimate quality of the estimate.
    • The authors find that precision decreases with higher decision authority and increases only when decision authority is lower and status motives are active. 
    Category:
    Audit Team Composition, Auditor Judgment
    Sub-category:
    Impact of Consultation on Judgments, Use of Specialists (e.g. financial instruments – actuaries - valuation)
  • Jennifer M Mueller-Phillips
    Resolving Audit Engagement Challenges through Communication
    research summary posted September 10, 2013 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 09.09 Impact of Consultation on Judgments 
    Title:
    Resolving Audit Engagement Challenges through Communication
    Practical Implications:

    This study documents successful resolutions to actual self-identified audit challenges. Auditors can use this information to be proactive in minimizing future audit challenges and resolving any challenges that do arise in a timely manner. Additionally, the list of unresolved challenges can aid firms in making wise client acceptance decisions as unresolved challenges represent potential liability.

    Citation:

    Bobek, D.D., B.E. Daughtery, and R.R. Radtke.  2012.  Resolving Audit Engagement Challenges through Communication.  Auditing: A Journal of Practice and Theory. (31) 4:21–45.

    Keywords:
    challenge resolution, auditor-client interaction, auditor communication
    Purpose of the Study:

    This study was designed to examine the role of communication in real world audit settings and determine how auditors most frequently and effectively use communication to resolve audit issues.

    Design/Method/ Approach:

    The authors sent out experimental questionnaires to 1,289 audit professionals and received 197 usable responses.

    Findings:

    The authors find that communication between audit team members and direct communication with the client are the most common methods of resolving issues on an engagement. By contrast, the authors also find that intra-firm communication with employees not on the audit team does not appear to be a commonly used method of resolving issues related to the engagement.

    Category:
    Auditor Judgment
    Sub-category:
    Impact of Consultation on Judgments
  • Jennifer M Mueller-Phillips
    The Audit of Fair Values and Other Estimates: The Effects of...
    research summary posted November 10, 2014 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 09.09 Impact of Consultation on Judgments, 09.11 Auditor judgment in the workpaper review process 
    Title:
    The Audit of Fair Values and Other Estimates: The Effects of Underlying Environmental, Task, and Auditor-Specific Factors
    Practical Implications:

    The paper gives practitioners, policy makers, and researchers a framework for considering audit of FVOEs. In considering environmental, task, and auditor-specific factors that individually and interactively affect auditors’ judgments, one may better analyze observed practice deficiencies and contribute to practitioners’ and regulators’ understanding of their likely causes and potential remedies.

    The framework is also valuable in identifying and evaluating the merit of future research topics. Central to the goal of developing research that will improve audits of FVOEs is the deliberate consideration of important interactions among the environmental, task, and person-specific factors involved in the development and audit of FVOEs. Identifying the important interactions among these factors allows researchers to better design studies that evaluate ways to improve the quality of audited FVOEs. Conducting practice-relevant research within the three-factor framework will help researchers, practitioners, and regulators better communicate their perspectives on issues surrounding audits of FVOEs.

    For more information on this study, please contact Gregory E. Sierra.

    Citation:

    Bratten, B., L. M. Gaynor, L. McDaniel, N. R. Montague & G. E. Sierra. 2013. The audit of fair values and other estimates: The effects of underlying environmental, task, and auditor-specific factors. Auditing: A Journal of Practice and Theory 32(Supplement 1): 7-44.

    Keywords:
    fair value, estimates, audit judgment, audit deficiencies.
    Purpose of the Study:

    Based on inspections that report numerous deficiencies, the PCAOB has been concerned that auditors are not sufficiently prepared for the challenges faced in evaluating fair value and other estimates (FVOEs). The authors’ purpose is to organize the discussion on the sources of audit deficiencies related to FVOEs. First, the authors use the theoretical framework established by Bonner (2008)[1] to organize the challenges of auditing FVOEs in practice. The framework examines auditor judgment through an analysis of three critical and interactive factors of the judgment process—the environment, the task, and the person. Second, with consideration of the PCAOB-identified practice areas with direct implications for the audits of FVOEs, the authors develop and present future research lines of inquiry. The research lines of inquiry take into account the important interactions among the three framework factors, as they believe empirical evidence within these lines will help identify potential sources of, and remedies for, observed audit deficiencies.

     

    [1] Bonner, S. E. 2008. Judgment and Decision Making in Accounting. Upper Saddle River, NJ: Pearson Prentice Hall.

    Design/Method/ Approach:

    The authors analyze the possible sources for observed practice deficiencies by evaluating extant archival and experimental research and organize the discussion of FVOE audit around the Bonner (2008) three-factor judgment framework, which includes the environment, the task, and the person. The authors place the research in the context of the three factors (environment, task, and person) and their interactions. No data is tested. However, the authors do note that 42 percent of the deficiencies in the PCAOB’s August and September 2011 inspection reports are related to FVOEs.

    Findings:

    Regulators have attributed auditor characteristics, such as lack of valuation knowledge and lack of professional skepticism, to observed audit deficiencies. However, the authors’ evaluation of the literature within the three-factor framework demonstrates that not only are environmental uncertainties important but complexities in the task of auditing FVOEs are also important to consider in understanding auditor judgment. In short, whether auditor characteristics are the fundamental driver of audit deficiencies related to FVOEs is unclear. The authors also identify gaps in the research literature on audit of FVOEs and use the three-factor framework to organize research lines of inquiry. Given the paucity of research specifically targeted toward the audits of FVOEs, the authors identify 11 specific, empirical research lines of inquiry focused on  understanding the possible underlying sources of PCAOB-observed audit deficiencies. These suggestions for future research address unanswered questions that would benefit practice.  

    Category:
    Auditor Judgment
    Sub-category:
    Impact of Consultation on Judgments, Prior Dispositions/Biases/Auditor state of mind
  • Jennifer M Mueller-Phillips
    The Effect of the Strictness of Consultation Requirements on...
    research summary posted October 22, 2013 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment, 09.0 Auditor Judgment, 09.09 Impact of Consultation on Judgments 
    Title:
    The Effect of the Strictness of Consultation Requirements on Fraud Consultation
    Practical Implications:

    In cases where fraud risks are high or time pressures are severe, auditors are more likely to consult a fraud specialist regarding the presence of fraud indicators when the requirement to do so is mandatory and the advice received is binding.  The authors indicate that a strict requirement is more likely to cause auditor compliance with the policy than a more lenient policy that merely suggests consultation and where the advice from the specialist is nonbinding.  Additionally, the auditors’ perceptions of fraud risks increased when a more strict consultation policy was in place which may indicate that the mere presence of a strict policy increases assessed fraud risks.

    For more information on this study, please contact Anna Gold.
     

    Citation:

    Gold, A., W.R. Knechel, and P. Wallage. 2011.The Effect of the Strictness of Consultation Requirements on Fraud Consultation. The Accounting Review 87 (3): 925-949.

    Keywords:
    auditing standards; consultation requirement; consultation propensity; deadline pressure; fraud; fraud risk.
    Purpose of the Study:

    This study addresses how auditors comply with a standard or policy given varying engagement and client characteristics and the strictness of the policy in question.  Specifically, the authors conduct two experiments to determine:

    • The propensity of an auditor to consult a fraud specialist when fraud risks exist and there is either a strict policy in place or a more lenient policy in place.
    • The propensity of an auditor to consult a fraud specialist when significant time pressures exist and there is either a strict policy in place or a more lenient policy in place. 

    Under the strict consultation condition, if fraud indicators are present the auditor is required to consult the fraud specialist and the advice received must be obeyed.  Under the lenient consultation condition, if fraud indicators are present it is merely suggested that the auditor consult a specialist and the advice received is nonbinding.

    The first experiment examines the strictness of the consultation policy where fraud indicators are manipulated to either be present or absent, thus creating a high fraud risk and low fraud risk condition.  The second experiment examines the strictness of the consultation policy where the audit completion deadline is either several days or many months away, thus creating a high time pressure and low time pressure condition.

    Design/Method/ Approach:

    163 Dutch audit partners and managers from 3 of the Big 4 accounting firms participated in the study.  Subjects were randomly assigned to the two experiments and to the conditions in the experiments.  80 auditors participated in experiment 1 and 83 auditors participated in experiment 2.  The auditors were provided with a hypothetical audit engagement scenario based on their inclusion in one of the treatment conditions described above and were asked to assume the role of audit partner.  After reviewing their case materials auditors indicated their propensity to seek consultation from a fraud specialist.  Data were collected in 2007.

    Findings:
    • The strictness of the consultation policy is positively associated with auditors’ propensity to seek consultation, but only in instances where fraud risks are high.  That is, when fraud risks exist, a strict, binding policy about consultation with a fraud specialist is more likely to result in an auditor consulting a specialist than if the consultation is merely suggested and the advice received is not binding.  The authors indicate that the managers used in this experiment may primarily be driving this finding, noting that the managers were more likely to seek consultation when fraud risks were high.
    • Deadline pressure is positively related to an auditor’s propensity to seek consultation when the consultation policy is strict but only moderately so.  That is, the auditor’s likelihood of consulting a fraud specialist under a strict consultation policy is only marginally greater when deadline pressure is strong as opposed to weak.
    • Auditors expressed an increased assessment of perceived fraud risk under the strict consultation policy compared to the more lenient policy.  This may indicate that the mere presence of a strict policy about consulting a fraud specialist causes auditors’ fraud risk assessments to go up.
       
    Category:
    Auditor Judgment, Risk & Risk Management - Including Fraud Risk, Standard Setting
    Sub-category:
    Fraud Risk Assessment, Impact of Consultation on Judgments

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