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  • Jennifer M Mueller-Phillips
    An Examination of Partner Perceptions of Partner Rotation:...1
    research summary posted October 10, 2013 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.05 Impact of SOX, 04.0 Independence and Ethics, 04.08 Impact of SEC Rules Changes/SarbOx, 11.0 Audit Quality and Quality Control, 11.04 Industry Experience 
    Title:
    An Examination of Partner Perceptions of Partner Rotation: Direct and Indirect Consequences to Audit Quality
    Practical Implications:

    The findings of this study shed light on the perceived benefits and detriments of the five versus seven year partner rotation requirements.  The results highlight the potential unintended consequences of implementing the accelerated rotation including a reduction in partner quality of life and auditor independence and audit quality. 


    For more information on this study, please contact Brian Daugherty. 
     

    Citation:

    Daugherty, B., D. Dickins, R. Hatfield, and J. Higgs.  2012.  An Examination of Partner Perceptions of Partner Rotation:  Direct and Indirect Consequences to Audit Quality. Auditing: A Journal of Practice & Theory 31 (1): 97-114. 

    Keywords:
    Sarbanes-Oxley; audit partner rotation; auditor independence; audit quality; quality of life.
    Purpose of the Study:

    This study examines practicing audit partner perceptions regarding the mandatory partner rotation and cooling off periods.  Specifically, the authors investigate how recently enacted and stringent rules might negatively impact auditor quality of life leading to deterioration in audit quality.  As a result of the Sarbanes-Oxley Act of 2002 (SOX), the US moved from a seven-year rotation with a two-year cooling-off period to a five-year rotation and five-year cooling-off period.  This change in standard provides the authors the opportunity to investigate the perceptions of partner that have worked under both standards.

    Design/Method/ Approach:

    The authors conducted in-depth semi-structured interviews with seven practicing audit partners.  Most of these partners were managing partners from various geographic locations.  Based on those interviews, the authors developed a model of the effects of mandatory rotation and created a field survey that was completed by 370 audit partners.  Collection of survey results occurred prior to May 2011. 

    Findings:

    The audit partners in the study believed that rotation generally improved independence which has a positive impact on audit quality.  However, partners also expressed that accelerated rotation reduced client-specific knowledge and had a negative impact on audit quality.  Partners suggested that the accelerated rotation and extended cooling-off period imposed by SOX has increased the need to relocate if the partner wishes to remain in the same industry.  As a result partners often choose to gain new industry experience and stay in the same location, rather than to relocate.  This decision maintains the partner quality of life, but possibly at the expense of industry depth and to the detriment of overall audit quality.  Partners also discussed a two to three-year new-client familiarization process, resulting in an increase in the amount of time that engagements suffer from “start-up efficacy”.  In sum, although the partners view rotation in general as a means to improve independence, they believe the accelerated rotation imposed by SOX may actually result in a reduction in independence and possibly audit quality.

    Category:
    Audit Quality & Quality Control, Independence & Ethics, Standard Setting
    Sub-category:
    Impact of SEC Rules Changes/SarBox, Impact of SOX, Industry Experience
  • Jennifer M Mueller-Phillips
    Firm versus Partner Measure of Auditor Industry Expertise...
    research summary posted October 10, 2013 by Jennifer M Mueller-Phillips, tagged 11.01 Supervision and Review – Effectiveness, 11.02 Engagement Quality Review – Processes and Effectiveness, 11.04 Industry Experience, 11.07 Attempts to Measure Audit Quality, 11.08 Proxies for Audit Quality 
    Title:
    Firm versus Partner Measure of Auditor Industry Expertise and Effects on Auditor Quality
    Practical Implications:

    The findings of this study imply that firm level expertise impacts audit quality but has a greater impact in conjunction with office level or partner level expertise. Similarly, concurring auditors have a greater impact on audit quality when their abilities are paired with those of a lead or signing partner. This study implicitly emphasizes the importance in cooperation and the sharing of intellectual resources among partners in Big 4 firms considering that expertise is not homogeneous across a firm. Additionally, this study has implications on what could result if the Public Company Accounting Oversight Board in the United States decided to require an engagement partner’s signature on the audit report.

    For more information on this study, please contact Hsin-Yi Chi.
     

    Citation:

    Chi, H., and C. Chin. Firm versus partner measures of auditor industry expertise and effects on auditor quality.  Accounting: A Journal of Practice and Theory 30 (2): 201-229.

    Keywords:
    individual partner industry expertise; discretionary accruals; modified audit opinion; audit quality.
    Purpose of the Study:

    This study explores the relationship between Big 4 audit quality and auditor expertise with respect to both the individual partners and the audit firm. The authors used accruals analysis as well as analysis of audit opinions to assess audit quality. To take the study a step further, an examination of the possible existence of differential audit quality between signing auditors whether lead or concurring partners was also performed. An office level perspective was used and deemed appropriate under the assumption that auditor expertise is permanently tied to individual professionals and their client knowledge which cannot be readily captured and distributed across the firm offices; additionally, the individual practice office is the decision-making unit of the firm when it comes to specific clients.

    To accomplish their purpose, first the authors studied whether audit industry expertise is driven by firm expertise, individual partner expertise, or a combination of both. They also studied whether the association between audit quality and industry expertise of the signing auditor specialist was more or less prominent for the lead auditor or the concurring auditor. One would expect that the lead partner generally would exhibit a more prominent association with audit quality than concurring audit specialists because it is the lead partner who is actively engaged with daily audit proceedings; this study aims to discover if that is truly the case. The study assesses the effectiveness of an individual partner-level and firm-level auditor specialists in enhancing audit quality as well as provides evidence regarding industry expertise homogeneity between individual partners within the same firm.  
     

    Design/Method/ Approach:

    The evidence for this study was collected from Taiwanese publicly listed companies audited by the Big 4 firms from 1983 to 2004. Financial data, audit opinions data, and auditor names were obtained from the Taiwan Economic Journal. Taiwan was the chosen location for this evidence because the audit report in Taiwan contains two signing auditor names as well as the firm name. 

    Findings:
    • Both firm-level industry expertise alone and partner- level industry expertise alone are associated with lower accruals. However, a combination of the two creates an effect above and beyond either level of expertise in isolation; therefore, differential discretionary accruals due to industry expertise are driven by a combination of firm and partner expertise.
    • Differential accruals due to industry expertise of signing are primarily driven by the lead auditor rather than the concurring auditor.
    • The differential likelihood of the issuance of a modified audit opinion is primarily attributable to signing auditor specialists and partner-level expertise.
    • Firm level specialists alone are not associated with a higher likelihood of issuing a modified audit opinion. Instead, firm level specialists along with signing auditor specialists create effects above and beyond those observed with auditor specialists alone.
    • Clients of lead signing auditor specialists have smaller accruals and are more likely to receive a modified audit opinion relative to those of non-specialists  whether the auditor specialists works alone or with a concurring auditor specialist.
    • Concurring auditor specialists alone are not associated with higher audit quality.
    • Industry expertise is not homogeneous across individual auditors within the same audit firm in Taiwan.
       
    Category:
    Audit Quality & Quality Control
    Sub-category:
    Attempts to Measure Audit Quality, Engagement Quality Review – Processes & Effectiveness, Industry Experience, Proxies for Audit Quality, Supervision & Review – Effectiveness
  • Jennifer M Mueller-Phillips
    Auditor Differentiation, Mitigating Management Actions, and...
    research summary posted October 10, 2013 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 09.04 Going Concern Decisions, 11.0 Audit Quality and Quality Control, 11.04 Industry Experience 
    Title:
    Auditor Differentiation, Mitigating Management Actions, and Audit-Reporting Accuracy for Distressed Firms
    Practical Implications:

    SAS No. 59 requires auditors to evaluate the adequacy and feasibility of management’s plans to mitigate financial distress.  The results of this study show that industry specialization improves auditors’ ability to more accurately evaluate management’s initiatives and the likelihood of going-concern issues.  Though BRA methodology was not shown to improve reporting accuracy, the implementation of the methodology was limited to only two firms at the time of the study.     This study suggests the importance of auditor specialization in improving reporting accuracy which can impact the approach audit clients take in obtaining an auditor. 

    For more information on this study, please contact Liesbeth Bruynseels.
     

    Citation:

    Bruynseels, L., W.R. Knechel, and M. Willekens. 2011. Auditor differentiation, mitigating management actions, and audit-reporting accuracy for distressed firms. Auditing: A Journal of Practice & Theory 30 (1): 1-20.

    Keywords:
    audit reporting, going-concern, management plans, audit methodology, auditor industry specialization
    Purpose of the Study:

    Since auditors are required to evaluate the adequacy of management plans to mitigate financial distress, when bankruptcies occur that were not preceded by a going-concern report, the audit report is perceived to lack quality.   This study investigates whether enhanced industry knowledge (auditor specialization) or an increased focus on business risk auditing methodologies improves audit-reporting accuracy.  These are the two areas of focus because:

    • Prior research has shown that industry specialization produces higher audit quality.
    • A new audit approach defined as “business risk auditing” (BRA) forces an auditor to determine whether the client’s strategic objectives are being met and to assess the likelihood of going-concern issues.  BRA is embedded in international auditing standards (ISA 315) and proposed standards by the PCAOB to require the auditor to assess a client’s business environment and risks in the audit.  Recent studies have shown that BRA can lead to more efficient and effective audits.

    Recent research has also indicated that information obtained about the client’s strategic plans to mitigate financial distress can have a significant impact on the likelihood that an auditor will issue a going-concern report.  Therefore, this paper examines the impact of auditor specialization and auditor risk methodology on audit-reporting accuracy in the setting of financially distressed firms in which managers take initiatives to reduce this distress.

    Design/Method/ Approach:
    • The data consists of U.S. public companies from manufacturing industries that declared bankruptcy between 1999-2002.
    • Auditor specialization is measured based on audit firm market share within a particular industry.
    • Two of the Big 5 firms in the study implemented the BRA methodology. Therefore, only audits conducted by these two firms are considered to have employed BRA methodology.
    • The authors also report if a company in the sample had a significant strategic or operating initiative reported in its 10-Ks as a sign of management’s actions to mitigate financial distress.
       
    Findings:
    • For companies that subsequently declared bankruptcy:
      • Specialist auditors were more likely than non-specialists to issue a going-concern opinion even when management had undertaken strategic turnaround initiatives.
      • Audit firms that used a BRA methodology were less likely to issue a going-concern opinion if the client had undertaken operating initiatives to mitigate financial distress.
      • All auditors, irrespective of type, were less likely to issue a going-concern opinion when the client had plans to raise cash in the short-term.

    Contrary to the authors’ expectations, the reporting accuracy of BRA auditors is reduced when a client implements short term operating initiatives to reduce financial distress.  Specialist auditors correctly interpret the information contained in management’s strategic long-term initiatives and more accurately signal the potential for a future bankruptcy by issuing a going-concern report. 

    Category:
    Audit Quality & Quality Control, Auditor Judgment
    Sub-category:
    Going Concern Decisions, Industry Experience
  • Jennifer M Mueller-Phillips
    Industry- versus Task-Based Experience and Auditor...
    research summary last edited September 26, 2013 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual, 11.0 Audit Quality and Quality Control, 11.04 Industry Experience 
    Title:
    Industry- versus Task-Based Experience and Auditor Performance
    Practical Implications:

    The results of this study are important for audit firms to consider when staffing their engagements, particularly for mid-tier accounting firms.  The authors note that firms may want to consider allocating non-specialist staff among a few different industries. According to their research, there appears to be benefits due to the industry experience regardless of whether they have task-related experience.  This allows for non-specialist auditors to continue gaining task-based experiences while expanding their industry-based experiences. 

    For more information on this study, please contact Robyn Moroney.
     

    Citation:

    Moroney, R., and P. Carey. 2011. Industry- versus Task-Based Experience and Auditor Performance. Auditing: A Journal of Practice & Theory 30 (2):1-18.

    Keywords:
    Audit quality; industry-based experience; task-based experience
    Purpose of the Study:

    Prior research has shown that both industry-related experience and task-related experience improve auditor performance.  This is important because, other than training, experience is the main opportunity for an auditor to gain knowledge and improve their audit performance.  In these earlier studies, researchers focused on either task-based experience or industry-based experience.  This allows researchers to find that task-based experiences improve performance or industry-based experience improves performance but not which one is more important.  Since auditors gain industry experience by working on audit tasks for clients within an industry and vice versa, the relative importance of each has not been evaluated.  The purpose of this study is to make comparisons about whether industry-based or task-based experience is more important in the performance of non-specialist auditors.  It also seeks to determine whether continued experiences within one industry continues to increase auditor performance or if it levels out.

    Design/Method/ Approach:

    The authors collected evidence from their experiment prior to January 2009.  The authors use a sample of non-specialist auditors (including senior associates, managers, and partners) from 8 non-Big 4 accounting firms.  Participants completed two cases, one with a research and development expenditure in the manufacturing industry and another case involving investments in the superannuation (pension fund) industry.  Answers from 5 questions about each case resulted in a performance rating based on comparison of the participant’s answers to the “correct” answer as provided by an expert panel.

    Findings:
    • The authors find that industry-based experience is relatively more important than task-based experience in non-specialist auditors.
    • The authors find performance due to industry-based experience increases quickly.  As auditors spend higher percentages of their annual time in a particular industry their performance scores increase noticeably between the 0% category and the 1-10% category and again between the 1-10% category and 11-20% category. 
    • The authors also find that the impact of industry-based experience levels out once auditors spend approximately 20% of their annual time in that industry. 
       
    Category:
    Audit Quality & Quality Control, Audit Team Composition
    Sub-category:
    Industry Expertise – Firm and Individual, Industry Experience
  • The Auditing Section
    The Influence of Audit Firm Specialization on Analysts’ F...
    research summary last edited May 25, 2012 by The Auditing Section, tagged 11.0 Audit Quality and Quality Control, 11.04 Industry Experience, 14.0 Corporate Matters, 14.05 Earnings Targets and Management Behavior 
    Title:
    The Influence of Audit Firm Specialization on Analysts’ Forecast Errors
    Practical Implications:

    The results of this study suggest that industry specialist auditors help constrain management’s tendency to manipulate earnings to achieve certain earnings thresholds.  These results do appear weaker when limiting the analysis to the post-SOX period, which could reflect the significant changes to the auditing market that occurred during and after 2002, but the post-SOX analysis is subject to limited data availability.

    Citation:

    Payne, J. 2008. The Influence of Audit Firm Specialization on Analysts’ Forecast Errors. Auditing: A Journal of Practice & Theory 27 (2): 109-136.

    Keywords:
    auditor specialization; analysts’ forecast error; audit quality
    Purpose of the Study:

    The prior literature shows that analysts’ forecasts provide information to financial market participants.  Also, it shows that managers have incentives to meet or beat analysts’ forecasts because failure to do so could result in negative stock price reactions, reduced compensation, costly legal actions, or all of the above.  However, managers also have incentives to reduce reported earnings down to analysts’ forecasted amount if earnings were to exceed the forecasted amount and establishing accrual reserves would allow  management to more easily meet future earnings expectations.  Therefore, the amount of analyst forecast error (i.e., the difference between the consensus analyst forecast and actual earnings) provides a proxy for management’s use of earnings manipulation activities.

    Prior literature also shows that higher quality auditors constrain management’s earnings manipulation activities, including their use of total and discretionary accruals.  Additionally, prior literature examines and shows a decreased level of reported earnings that just meet or beat analysts’ forecasts when the companies are audited by city-specific auditor specialists, as well as reduced analyst forecast errors for quarterly periods that are subject to financial statement audit requirements versus review requirements (i.e., the 4th quarter versus quarters 1 through 3).  However, the purpose of this paper is to fill a void in the literature and examine the impact of higher audit quality, as proxied by industry specialist auditors, on managements’ use of accruals when management has specific incentives to manipulate earnings (up or down) towards a predetermined target level.

    Design/Method/ Approach:

    To isolate industry specialization, the author examines U.S. publicly traded companies who are audited by Big N firms during the period of 1989-2005.  The author measures managements earnings manipulation by modeling  the absolute value of analyst forecast error and reported earnings exceeding analysts’ forecasts by exactly 1 cent.  Differential audit quality is based on measures for auditor specialization as proxied by the auditor’s industry market share, audit firm portfolio market share, and a combined indicator of those two measures.  The author examines both measures in the pre- and post- SOX period.

    Findings:
    • The results indicate that absolute analyst forecast errors are greater for companies audited by industry specialist auditors. 
    • Companies audited by industry specialist auditors are less likely to just meet or beat analysts’ earnings forecasts.
    • There is no difference with respect to the period absolute analyst forecast errors analysis in the pre- or post-SOX period.
    • The negative association between auditor specialists and companies that just meet or beat analysts’ earnings forecasts is weaker during the post-SOX period.
    Category:
    Audit Quality & Quality Control, Corporate Matters
    Sub-category:
    Industry Experience, Earnings Targets & Management Behavior
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