Auditing Section Research Summaries Space
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research summary posted July 29, 2015 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.08 Impact of SEC Rules Changes/SarbOx, 06.0 Risk and Risk Management, Including Fraud Risk, 06.06 Earnings ManagementTitle:Audit Market Concentration and Auditor Tolerance for Earnings Management.Practical Implications:Given that auditor concentration is an important topic that has seen relatively little empirical research, this study contributes to the literature by providing more complete evidence on the relation between auditor concentration and audit quality. Concentration reduced the opportunity for Big 4 clients to switch auditors particularly given the new auditor independence requirements following the 2002 Sarbanes-Oxley Act. Reduced choice is seen as increasing auditor entrenchment and complacency, and potentially contributing to a more lenient and less skeptical audit for clients.
Citation:Boone, J. P., I. K. Khurana, and K.K. Raman. 2012. Audit Market Concentration and Auditor Tolerance for Earnings Management* Audit Market Concentration and Auditor Tolerance for Earnings Management. Contemporary Accounting Research 29 (4): 1171-1203.
- 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 EvidenceTitle:Auditors’ Consideration of Material Income-Increasing versus Material Income-Decreasing Items during the Audit ProcessPractical 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).
- research summary posted September 14, 2015 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.06 Earnings Management, 12.0 Accountants’ Reports and Reporting, 12.03 Restatements, 13.0 Governance, 13.01 Board/Audit Committee Composition, 13.05 Board/Audit Committee OversightTitle:Board Interlocks and Earnings Management Contagion.Practical Implications:
The evidence on the firm-to-firm spread of financial reporting behavior via board networks contributes to a little-studied area in accounting that should be important. The authors contribute to the corporate governance literature by offering evidence that contagion effects vary with board positions. They show that board supervision of management is important for ensuring high-quality financial reporting and that board linkages affect the success of this supervision. Regulators concerned about improving financial reporting quality should consider the board connectivity of companies.
Citation:Chiu, P. C., S. H. Teoh, and F. Tian. 2013. Board Interlocks and Earnings Management Contagion. Accounting Review 88 (3): 915-944.
- research summary posted September 15, 2015 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 02.02 Client Risk Assessment, 06.0 Risk and Risk Management, Including Fraud Risk, 06.06 Earnings ManagementTitle:CEO Equity Incentives and Audit Fees.Practical Implications:
According to the authors, stock options and restricted stocks are important components in CEO compensation. This study shows that auditors do perceive greater audit risk due to CEO equity compensation adjust pricing decisions accordingly. Auditors appear more concerned about CEO’s incentives to increase a company’s risky behavior so as to the CEO’s equity based compensation as opposed to increasing stock price specifically. As a CEO’s vega (i.e. change in value of a manager’s equity portfolio due to a change in stock return volatility) increases, a manager becomes less risk averse and more willing to engage in risky behavior such as earnings management. This study offers additional insights into the cost/benefits of equity based compensation.
Citation:Kim, Y., H. Li, and S. Li. 2015. CEO Equity Incentives and Audit Fees. Contemporary Accounting Review 32 (2): 608-638.
- research summary posted November 5, 2014 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.06 Earnings ManagementTitle:Client Risk Management: A Pecking Order Analysis of Auditor Response to Upward Earnings Management RiskPractical Implications:
Earnings management has received significant attention in the business press and from regulators and investors. Auditors are expected to constrain earnings management and, more generally, to enhance the quality of financial reporting. The passage of the 2002 SOX Act has substantially increased the legal liability for auditors and, therefore, has influenced their mindset toward conservative reporting. The results of this study show how auditors respond to earnings management risk via audit pricing and client retention decisions in a sequential way. The type of strategies that auditors employ varies with the level of earnings management risk. If the trade-off between return and risk is acceptable, auditors are willing to retain clients that engage in upward earnings management by charging higher audit fees. However, if the risk exceeds an acceptable level, auditors will choose to resign. The study provides evidence that a pecking order of auditors’ strategies exists in response to various risk levels in the post-SOX period.
For more information on this study, please contact Gopal Krishnan.
Citation:Krishnan, G., L. Sun, Q. Wang, and R. Yang. 2013. Client Risk Management: A Pecking Order Analysis of Auditor Response to Upward Earnings Management Risk. Auditing: A Journal of Practice and Theory 32 (2): 147-170.
- research summary posted April 17, 2014 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.06 Earnings Management, 14.0 Corporate Matters, 14.01 Earnings Management, 14.05 Earnings Targets and Management BehaviorTitle:Discontinuities and Earnings Management: Evidence from Restatements Related to Securities LitigationPractical Implications:
The results of this study provide important evidence to the earnings management literature. Recent studies provide several plausible alternative explanations for the discontinuities in earnings distributions near earnings benchmarks. Though the findings of this study cannot readily be extrapolated to a broader sample of firms, the authors found evidence that firms commit less egregious earnings management in order to meet earnings benchmarks. This study is therefore important in considering whether earnings management plays a role in the discontinuities in various earnings distributions documented by prior studies.
For more information on this study, please contact Dain C. Donelson.
Citation:Donelson, D. C., J. M. McInnis, and R. D. Mergenthaler. 2013. Discontinuities and Earnings Management: Evidence from Restatements Related to Securities Litigation. Contemporary Accounting Research 30 (1).
- research summary posted April 17, 2014 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment, 06.06 Earnings ManagementTitle:Dividend Policy at Firms Accused of Accounting FraudPractical Implications:
The results of this study greatly contribute to the literature on the relation of earnings quality to dividends. Companies that report fraudulent financial statements have caused significant problems for financial markets and economies, and additional research in this are remains vital. The evidence found in this paper is consistent with the notion that dividend-paying firms are less likely to engage in fraud because they know they cannot maintain their same dividend policies if earnings are fraudulent. Fraud firms cannot keep pace with non-fraud firms in terms of dividend policy and fraud firms’ dividends are less related to earnings that are non-fraud firms.
For more information on this study, please contact Judson Caskey.
Citation:Caskey, J., and M. Hanlon. 2013. Dividend Policy at Firms Accused of Accounting Fraud. Contemporary Accounting Research 30 (2).
- research summary posted October 20, 2015 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.02 Impact of Fees on Decisions by Auditors & Management, 06.0 Risk and Risk Management, Including Fraud Risk, 06.06 Earnings Management, 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations, 11.0 Audit Quality and Quality ControlTitle:Do Abnormally High Audit Fees Impair Audit Quality?Practical Implications:
The study provides useful insight into current regulatory debates on the auditor’s economic dependence on the client and increases understanding to the reasons why previous research provides mixed evidence on the association between various fee metrics and the extent of earnings management. If the association between abnormal fees and the magnitude of discretionary accruals is conditioned on the sign of abnormal fees, examining the association without reference to the sign of abnormal fees most likely leads to observations of insignificant associations, as also reported in most previous studies. This study’s findings suggest that future research on similar issues should take into account the asymmetric nonlinearity in the fee-quality relation.
Citation:Choi, J. H., J. B. Kim, and Y. Zang. 2010. Do Abnormally High Audit Fees Impair Audit Quality? Auditing: A Journal of Practice & Theory 29 (2): 115-140.
- research summary posted October 22, 2013 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, 08.04 Auditors’ Professional Skepticism, 10.0 Engagement Management, 10.04 Interactions with Client ManagementTitle:Do changes in audit actions and attitudes consistent with increased auditor scepticism deter aggressive earnings management? An experimental investigationPractical Implications:
- Regulators and standard setters have been concerned that we do not know which audit actions most likely detect fraud. An understanding of what audit procedures are likely to discourage managers from committing fraud is valuable.
- Specifically, the study shows that changes in the nature and extent of audit procedures combined with increased skepticism via critical inquiry are helpful in deterring potentially fraudulent behavior.
- Similar changes in audit procedures also affect management’s judgment about the ethicality of potentially fraudulent behavior.
Citation:Chen, Q., K. Kelly, and S. Salterio. 2012. Do changes in audit actions and attitudes consistent with increased auditor scepticism deter aggressive earnings management? An experimental investigation. Accounting, Organizations and Society 37 (2): 95-115.
- research summary posted April 17, 2014 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.06 Earnings Management, 14.0 Corporate Matters, 14.05 Earnings Targets and Management BehaviorTitle:Earnings Smoothing Activities of Firms to Manage Credit RatingsPractical Implications:
This paper provides fresh empirical evidence on long-term financial reporting strategies that managers use to impact perceptions of credit risk. It is among the first to examine reporting strategies in a setting where companies with stronger incentives to manage earnings to affect debt ratings can be identified. The authors find evidence that earnings smoothing activities appear to be affectively employed by managers to improve firm credit ratings.
For more information on this study, please contact Boochun Jung.
Citation:Jung, B., N. Soderstrom, and Y. S. Yang. 2013. Earnings Smoothing Activities of Firms to Manage Credit Ratings. Contemporary Accounting Research 30 (2).
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- 01.0 Standard Setting
- 01.01 Changes in Reporting Formats
- 01.02 Changes in Audit Standards
- 01.03 Impact of New Accounting Pronouncements
- 01.04 Impact of 404
- 01.05 Impact of SOX
- 01.06 Impact of PCAOB
- 01.07 Impact of SEC Actions
- 02.0 Client Acceptance and Continuance
- 02.01 Audit Fee Decisions
- 02.02 Client Risk Assessment
- 02.03 Management Integrity Assessments
- 02.04 Predecessor Auditor Factors
- 02.05 Business Risk Assessment - e.g., industry, IPO, complexity
- 02.06 Resignation Decisions
- 03.0 Auditor Selection and Auditor Changes
- 03.01 Auditor Qualifications
- 03.02 Dismissal Decisions – impact of restatements, disagreements, fees, mergers
- 04.0 Independence and Ethics
- 04.01 Scope of Services
- 04.02 Impact of Fees on Decisions by Auditors & Management
- 04.03 Non-Audit Services
- 04.04 Moral Development and Individual Ethics Decisions
- 04.05 Ethics and Consultation
- 04.06 Reporting Ethics Breaches – Self & Others
- 04.07 Audit Firm Rotation
- 04.08 Impact of SEC Rules Changes/SarbOx
- 04.09 Individual & Team Conduct - e.g., premature signoff, underreporting hours
- 05.0 Audit Team Composition
- 05.01 Use of Specialists e.g., financial instruments, actuaries, valuation
- 05.02 Industry Expertise – Firm and Individual
- 05.03 Partner Rotation
- 05.04 Staff Hiring, Turnover and Morale
- 05.05 Diversity of Skill Sets e.g., Tenure and Experience
- 05.06 Qualifications of Engagement Quality Reviewers
- 05.07 Impact of 150-hour requirement
- 05.08 Impact of Office Size
- 05.09 Group Decision-Making
- 05.10 Impact of Diversity - e.g., gender - on Group Decision Making
- 06.0 Risk and Risk Management, Including Fraud Risk
- 06.01 Fraud Risk Assessment
- 06.02 Fraud Risk Models
- 06.03 Failure Risk Models
- 06.04 Management Integrity
- 06.05 Assessing Risk of Material Misstatement
- 06.06 Earnings Management
- 06.07 SAS No. 99 Brainstorming – process
- 06.08 SAS No. 99 Brainstorming – effectiveness
- 06.09 Litigation Risk
- 06.10 Impact of office size
- 07.0 Internal Control
- 07.01 Scope of Testing
- 07.02 Assessing Material Weaknesses
- 07.03 Reporting Material Weaknesses
- 07.04 Assessing Remediation of Weaknesses
- 07.05 Impact of 404 on Fees and Financial Reporting Quality
- 08.0 Auditing Procedures – Nature, Timing and Extent
- 08.01 Substantive Analytical Review – Effectiveness
- 08.02 Sample Selection – use of statistical sampling
- 08.03 Conclusions Based on Samples
- 08.04 Auditors’ Professional Skepticism
- 08.05 Evaluating Accruals/Detection of Abnormal Accruals
- 08.06 Earnings Management – Detection and Response
- 08.07 Interim Testing Procedures – Nature, Timing and Extent
- 08.08 Projecting Interim Testing Conclusions Year End
- 08.09 Impact of Technology on Audit Procedures
- 08.10 Confirmation – Process and Evaluation of Responses
- 08.11 Reliance on Internal Auditors
- 09.0 Auditor Judgment
- 09.01 Audit Scope and Materiality Judgments
- 09.02 Documentation Specificity
- 09.03 Adequacy of Evidence
- 09.04 Going Concern Decisions
- 09.05 Failure Risk Models
- 09.06 Adequacy of Disclosure
- 09.07 GAAP Departures
- 09.08 Evaluation of Errors – Statistical and Non-statistical
- 09.09 Impact of Consultation on Judgments
- 09.10 Prior Dispositions/Biases/Auditor state of mind
- 09.11 Auditor judgment in the workpaper review process
- 09.12 Impact of potential post-audit review - e.g., PCAOB, internal firm inspections
- 09.13 Recognition vs. Disclosure
- 10.0 Engagement Management
- 10.01 Budgeting and Audit Time Management
- 10.02 Materiality and Scope Decisions
- 10.03 Interaction among Team Members
- 10.04 Interactions with Client Management
- 10.05 Interactions with Audit Committee Members
- 10.06 Audit Fees and Fee Negotiations
- 11.0 Audit Quality and Quality Control
- 11.01 Supervision and Review – Effectiveness
- 11.02 Engagement Quality Review – Processes and Effectiveness
- 11.03 Management/Staff Interaction
- 11.04 Industry Experience
- 11.05 Training and General Experience
- 11.06 Working Paper Review – Conduct, Biases and Predispositions
- 11.07 Attempts to Measure Audit Quality
- 11.08 Proxies for Audit Quality
- 11.09 Evaluation of Evidence
- 11.10 Impact of Quality Reviewers
- 11.11 Impact of Firm and External Inspection Programs
- 11.12 Impact of National Office on Auditor Decisions
- 11.13 Partner incentive schemes
- 12.0 Accountants’ Reports and Reporting
- 12.01 Going Concern Decisions
- 12.02 Quarterly Reviews
- 12.03 Restatements
- 12.04 Investigations
- 12.05 Changes in Reporting Formats
- 12.06 Consequences of Adverse 404 Opinions
- 12.07 Attestation Services
- 13.0 Governance
- 13.01 Board/Audit Committee Composition
- 13.02 Board/Financial Experts
- 13.03 Board/Audit Committee Tenure
- 13.04 Board/Audit Committee Compensation
- 13.05 Board/Audit Committee Oversight
- 13.06 Board/Audit Committee Processes
- 13.07 Internal auditor role and involvement in controls and reporting
- 14.0 Corporate Matters
- 14.01 Earnings Management
- 14.02 Corporate Whistle Blowers
- 14.03 Interim Reporting
- 14.04 MD and A Language/Signaling
- 14.05 Earnings Targets and Management Behavior
- 14.06 CFO Tenure and Experience
- 14.07 Executive Compensation
- 14.08 Press Release Language and Signaling
- 14.09 CEO Tenure and Experience
- 14.10 CEO Compensation
- 14.11 Audit Committee Effectiveness
- 15.0 International Matters
- 15.01 Audit Partner Identification by Name
- 15.02 IFRS Changes – Impacts
- 15.03 Audit Partner Rotation
- 15.04 Audit Firm Rotation
- 15.05 Sustainability Services