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  • Jennifer M Mueller-Phillips
    A Decade after Sarbanes-Oxley: The Need for Ongoing...
    research summary posted July 21, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.06 Impact of PCAOB 
    Title:
    A Decade after Sarbanes-Oxley: The Need for Ongoing Vigilance, Monitoring, and Research.
    Practical Implications:

    This paper provides views on many areas within the auditing profession that would benefit from further research and analysis, as well as opportunities for research that could be useful to the PCAOB as it considers current and future regulatory priorities.

    Citation:

    Franzel, J. M. 2014. A Decade after Sarbanes-Oxley: The Need for Ongoing Vigilance, Monitoring, and Research. Accounting Horizons 28 (4): 917-930. 

    Keywords:
    auditing quality, audit research, PCAOB, Public Company Accounting Oversight Board, Sarbanes-Oxley Act
    Purpose of the Study:

    After more than a decade since passage of the Sarbanes-Oxley Act and the creation of the Public Company Accounting Oversight Board (PCAOB), it is appropriate and necessary to ask questions about the present state of audit quality and evaluate the impact and effectiveness of PCAOB’s oversight programs. Written from the viewpoint of a current PCAOB Board member and former Managing Director of the U.S. Government Accountability Office (GAO), this paper discusses the warning signs of serious auditing problems in the years preceding the Act, and the role that the GAO played in analyzing those risks and calling for greater oversight of the accounting profession’s auditing public companies.

    Design/Method/ Approach:

    This paper provides the perspective of the author, a current PCAOB Board member, on the major issues debated during the development and passage of the Sarbanes-Oxley Act, specifically related to the oversight of the auditing profession and the creation of the PCAOB.

    Findings:

    The interrelated nature of corporate governance, accounting and financial reporting, the auditing of financial statements, and oversight of the accounting profession call on all stakeholders to work vigilantly to ensure the integrity of each aspect of this system. All participants need to be alert to warning signs and red flags and respond appropriately to maintain integrity and the public trust. Failure in any of these areas places a strain on the entire system and could threaten the capital markets and greater economic well-being. The successful functioning of this system also relies on academic researchers. The academic community plays a key role in this system of vigilance by conducting research and analysis, monitoring the strengths and weaknesses of the system at any given time, evaluating performance, across the financial system, studying the impact of specific actions, and generating recommendations for change. In addition, success of the entire system relies on educators preparing future members of the profession to successfully assume and carry out their responsibilities in maintaining integrity and public trust, while protecting investors and the public interest.

    Category:
    Standard Setting
    Sub-category:
    Impact of PCAOB
  • Jennifer M Mueller-Phillips
    A Field Survey of Contemporary Brainstorming Practices
    research summary posted February 20, 2017 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards, 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment, 06.07 SAS No. 99 Brainstorming – process, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism, 10.0 Engagement Management, 10.03 Interaction among Team Members 
    Title:
    A Field Survey of Contemporary Brainstorming Practices
    Practical Implications:

    Understanding that auditors allocate greater resources to fraud brainstorming when engagement risk is significant fosters brainstorming of a superior caliber corresponds to stronger regulatory compliance.  Auditors report that engagement teams are holding fraud brainstorming sessions earlier in the audit, document more detailed risk assessments, plan more specific procedures, and retain more documentation.  These characteristics contribute to adequately addressing increased PCAOB regulatory scrutiny.  Additionally, brainstorming sessions are highly regarded when they occur in a face-to-face fashion and are attended by multiple levels of firm personnel—whether that is “core” or “non-core” professionals.  Fraud brainstorming sessions are executed less mechanically (as determined by PCAOB inspectors) by using fewer checklists and increase the amount of time auditors prepare for brainstorming sessions.  

    Citation:

    Dennis, S. A., and K. M. Johnstone. 2016. A Field Survey of Contemporary Brainstorming Practices. Accounting Horizons 30 (4): 449–472. 

    Keywords:
    audit planning; engagement risk; field survey; fraud brainstorming; professional skepticism
    Purpose of the Study:

    The purpose of this study is to further understand current fraud brainstorming practices minding regulatory climate and its impression of brainstorming practices.  The authors seek to understand the auditing profession’s existing framework to effectively brainstorm by evaluating audit team characteristics; attendance and communication; structure, timing, effort; and brainstorming quality.  Fraud brainstorming environment is considered with respect to client characteristics; particularly, inherent, fraud, and engagement risks, and if the client is publicly traded or privately held.  The authors refer to the characteristics as “partitions”.  The partitions allow the study to better examine how each characteristic effects the deployment of resources in response to risk levels and trading status. 

                The study poses further exploration into the implementation of Statement of Auditing Standards No. 99 and its effect on fraud brainstorming practices.  Particularly addressing the Public Company Accounting Oversight Board’s report suggesting auditing professionals were “mechanically” addressing fraud-related auditing standards.  SAS 99 sought to blend experienced audit professionals—those with greater client experience—with less-seasoned auditors to brainstorm how a fraud could occur specific to the client.  As part of the brainstorming framework, the study seeks to understand if senior-level auditors (partners and managers) and seniors and staff members, along with “non-core” professionals, cultivate meaningful brainstorming sessions. 

    Design/Method/ Approach:

    The authors collected field data from audits conducted between March 2013 and January 2014, per a survey of 77 audit engagements.  Information pertaining to the client, audit team, and brainstorming sessions were called upon in the survey.  The majority (93 percent) of observations were obtained by two Big 4 firms—7 percent from one non-Big 4 global firm.  Each engagement’s partner received instructions for the distribution of the survey to lead managers and lead seniors on the respective engagement while the partner withheld that the survey was for research purposes.  A total of 75 managers and 73 seniors participated.  

    Findings:
    • Surveyed auditors rarely interacted with engagements where fraud in financial reporting was identified.
    • When fraud risk and inherent risk are both elevated for a particular engagement, perceived professional skepticism is also elevated.
    • Risk-based resource deployment is consistent when considering high- versus low-risk clients—particularly, when inherent risk is elevated, audit team size is also greater.
    • Public clients cultivate larger audit teams where managers and seniors have more client experience.
    • With respect to contributions made at brainstorming sessions, the audit partner and manager make the greatest contributions along with forensic specialists and audit seniors.  Interestingly, when fraud brainstorming is more important with respect to the engagement, seniors make lower relative contributions. 
    • Media richness theory is robustly at work with respect to attendance patterns at brainstorming sessions.  Specifically, when engagement risk is elevated, staff and seniors are more likely to attend face-to-face. 
    • Fraud brainstorming sessions are most commonly open-discussion (86 percent) where the session is held during the planning stage of the engagement (87 percent).
    • Results propose that audit partners are open-minded to suggestions made during fraud brainstorming.
    • Fraud risk assessments appear to be independent from brainstorming tactics; however, when inherent risk is elevated and if the client is public versus private, audit teams exert more effort.  
    Category:
    Auditing Procedures - Nature - Timing and Extent, Engagement Management, Risk & Risk Management - Including Fraud Risk, Standard Setting
    Sub-category:
    Auditors’ Professional Skepticism, Changes in Audit Standards, Fraud Risk Assessment, Interaction among Team Members, SAS No. 99 Brainstorming – process
  • Jennifer M Mueller-Phillips
    A Former PCAOB Board Member Looks to the Past...and to the...
    research summary posted July 21, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.06 Impact of PCAOB 
    Title:
    A Former PCAOB Board Member Looks to the Past...and to the Future.
    Practical Implications:

    Bill Gradison believes that an appropriate and effective way to protect the investor would be to share its wealth of data with protections of confidentiality with outside group, especially of those in academia, to foster research that might shed light on the importance of investor protection and how best to protect investors in the future.

    Citation:

    Gradison, B. 2014. A Former PCAOB Board Member Looks to the Past...and to the Future. Accounting Horizons 28 (4): 931-935.

    Keywords:
    auditing standards, Public Company Accounting Oversight Board
    Purpose of the Study:

    The Public Company Accounting Oversight Board (PCAOB) is still a relatively new entity, compared with most government agencies. The author of this paper, Bill Gradison, was a Founding Member of the PCAOB with many insights on the workings and challenges of the Board. The world has changed since 2002 when Sarbanes-Oxley became law with almost unanimous Congressional support. It would be most unlikely to be passed into law today. Thus, the Board not only has the challenge and the responsibility to carry out its Congressional mandate but also to champion the cause of investor.

    Design/Method/ Approach:

    Bill Gradison, a Founding Member of the Board, shares his perspectives on the work of the PCAOB during its early years.

    Findings:

    The five major challenges facing the Board as of January 2011.

    1. Current inability to conduct inspections in the EU, Switzerland, and China;
    2. Major changes in accounting standards;
    3. New authority to inspect and if necessary discipline auditors of broker-dealers;
    4. Ongoing recruiting challenges; and
    5. Fee pressures being experienced by public company auditors.
    Category:
    Standard Setting
    Sub-category:
    Impact of PCAOB
  • Jennifer M Mueller-Phillips
    A Perspective on the PCAOB - Past and Future.
    research summary posted July 21, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.05 Impact of SOX, 01.06 Impact of PCAOB 
    Title:
    A Perspective on the PCAOB - Past and Future.
    Practical Implications:

    The quality of the firm performing the audit is important but must be viewed through the perspective of a specific engagement team and a specific set of circumstances. Information supplied by the PCAOB is one component of the evaluation of the likelihood that an engagement team will perform a quality audit and of specific areas of audit practice where deficiencies have been identified. In the end, however, issues of independence, auditor rotation, industry competence, attention to the work, and all the other important aspects of audit quality must be monitored by the audit committee at the engagement level in the context of the specific engagement.

    Citation:

    Wedemeyer, P. D. 2014. A Perspective on the PCAOBPast and Future. Accounting Horizons 28 (4): 937-947.

    Keywords:
    internal auditing, auditing standards, PCAOB, Sarbanes-Oxley
    Purpose of the Study:

    The passage of Sarbanes-Oxley (SOX), the creation of the Public Company Accounting Oversight (PCAOB), and subsequent developments have substantially increased the political visibility of auditors and audits of financial statements. These same events have substantially decreased the role of the auditing profession in establishing audit standards and standards of audit performance; auditing is now an industry regulated primarily by persons who are not professional auditors. The perceived interest of each of the parties involved in the political process is often in conflict with those of any, or all, of the other parties.

    The author’s primary concern is the quality of the audit performed on a specific engagement.

    Design/Method/ Approach:

    This paper summarizes and synthesizes information on the PCAOB and its effect on the business model of an audit firm.

    Findings:

    SOX requirements for PCAOB inspections of audit firms substantially increased the possibility that an audit will be subsequently evaluated despite the absence of identified errors in audited financial statements. The SOX requirement for an auditor's opinion on internal controls over financial reporting (ICFR) immediately increased audit costs. The net effect of these changes has been to increase the cost of audits, particularly as a result of increased review, other quality control activities, and the performance of audits of ICFR, where required. In return, the quality of audits in terms of compliance with audit standards has improved significantly. However, the business models of audit firms and the processes for education and certification of accountants have remained substantially unchanged and are major influences on the quality of audits.

    Category:
    Standard Setting
    Sub-category:
    Impact of PCAOB, Impact of SOX
  • Jennifer M Mueller-Phillips
    A Post-SOX Examination of Factors Associated with the Size...
    research summary posted October 31, 2013 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.05 Impact of SOX, 05.0 Audit Team Composition, 05.04 Staff Hiring, Turnover and Morale, 13.0 Governance, 13.01 Board/Audit Committee Composition 
    Title:
    A Post-SOX Examination of Factors Associated with the Size of Internal Audit Functions
    Practical Implications:

    This study provides insights that should be useful for CAEs and boards of directors (or audit committees) in discussions related to (1) internal audit philosophy regarding its potential contributions to an organization, (2) alternative staffing models, (3) resource allocation, and (4) embracement of audit technology. The study could also help guide external auditors’ evaluation of client internal audit functions. The authors find that the mission of internal audit functions differs from organization to organization. Additionally, the results suggest that internal audit functions used for leadership development purposes (i.e., a rotational staffing strategy) are larger, presumably because the staff have less experience and staff are rotating in and out of the department more frequently. Finally, these findings help illustrate the importance of internal audit proving that it is ‘‘value added’’ to the organization. Management and audit committees are often looking for more than financial statement compliance, and those internal audit functions that have responded to these greater needs are rewarded with more resources, likely because they are perceived to deliver more value.

    For more information on this study, please contact Karla Johnstone.
     

    Citation:

    Anderson, U. L., M. H. Christ, K. M. Johnstone, and L. E. Rittenberg. 2012. A Post-SOX Examination of Factors Associated with the Size of Internal Audit Functions. Accounting Horizons 26(2): 167-191

    Keywords:
    Internal Audit; resource allocation; budgeting; staffing.
    Purpose of the Study:

    Internal auditing is a key element of an organization’s governance, risk management, and internal control structure. However, many organizations struggle to know if the investments they make in the internal audit function are appropriate and use size benchmarking data (e.g., firm assets, revenues, number of employees) to determine if internal audit is appropriately sized. However, benchmark data fails to incorporate other factors that influence internal audit size such as the effectiveness and efficiency of an internal audit function, the scope of the internal audit mission, or internal audit objectives and staffing strategies. Therefore, the objectives of the study include the following:

    • Develop and test a conceptual model that articulates the factors associated with internal audit size in the contemporary post-SOX era. The model includes four determinants of internal audit size: (1) audit committee characteristics, (2) internal audit characteristics and mission, (3) assurance activities performed by others (including internal audit outsourcing providers and assurance provided by other functions within the organization), and (4) organization characteristics.
    • Conduct an examination using contemporary post-SOX data in order to extend earlier related research on internal audit sizing by considering a variety of previously unexamined characteristics that differentiate internal audit functions from one another.
    • Examine the state of internal audit staffing in the post-SOX environment.
       
    Design/Method/ Approach:

    The authors collected data with which to test their model by first conducting field interviews with a variety of chief audit executives across a broad range of industries. The authors then distributed a survey to chief audit executives that are members of the Institute of Internal Auditors. The survey includes questions related to each of the four determinants of internal audit size (as mentioned above), as well as internal audit size based on number of internal audit personnel. The field interviews were conducted between August 2006 to November 2006 and the survey was conducted from August 2007 and October 2008.

    Findings:

    The authors find that internal audit size is positively associated with:

    Audit Committee Characteristics:

    • the size of the audit committee;
    • the frequency of audit committee meetings with the CAE
    • audit committee review and approval of the internal audit budget.

    Internal Audit Characteristics and Mission:

    • CAE tenure in the organization;
    • performance of IT auditing;
    • the use of a staffing model in which internal audit is used for rotational leadership development
    • the use of sophisticated audit technology.

    Organization Characteristics:

    • the total assets of the organization
    • the number of foreign subsidiaries that the organization possesses.


    Further, the authors find that internal audit size is inversely associated with:

    Internal Audit Characteristics and Mission:

    • the percent of audit staff designated as Certified Internal Auditors.

    Internal Audit Activities Performed by Others:

    • the extent of internal audit activities outsourced to a third party.
    Category:
    Audit Team Composition, Governance, Standard Setting
    Sub-category:
    Board/Audit Committee Composition, Impact of SOX, Staff Hiring - Turnover & Morale
  • Jennifer M Mueller-Phillips
    A Summary of Research on External Auditor Reliance on the...
    research summary posted February 16, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.05 Impact of SOX, 07.0 Internal Control 
    Title:
    A Summary of Research on External Auditor Reliance on the Internal Audit Function
    Practical Implications:

    Regulators should draft regulations and oversee the profession in such a way that reflects an understanding of the complex environment in which practitioners are making reliance decisions. Standard setters, both domestic and international can learn from the cultural and jurisdictional nuances of different countries, which will facilitate appropriate internal audit reliance as corporations continue to have multi-national presences. Practitioners can benefit from the study by utilizing the review to improve upon their reliance decision frameworks.

    For more information on this study, please contact Chad Stefaniak.

    Citation:

    Bame-Aldred, C. W., D. M. Brandon, W. F. Messier, Jr., L. E. Rittenberg, and C. M. Stefaniak. 2013. A Summary of Research on External Auditor Reliance on the Internal Audit Function. Auditing: A Journal of Practice and Theory 32 (Supplement 1): 251-286

    Keywords:
    external audit; internal audit; reliance on the internal audit function; audit judgments.
    Purpose of the Study:

    The Public Company Accounting Oversight Board (PCAOB) requested a synthesis of existing research on the external auditor’s reliance of the internal audit function. Auditing Standard No. 5 (AS5) allows external auditors to rely on the internal audit function under certain criteria. This paper synthesizes post Sarbanes-Oxley research (2004 – 2012) that examines external auditor reliance of the internal audit function. The research reviewed pertains to:

    1. The influence of environmental factors on internal auditor reliance (i.e., Regulatory Environment and Governance and Client Management Characteristics),
    2. The impact of internal audit specific factors on reliance (i.e., Competence, Objectivity, and Work Quality),
    3. The nature and extent of the external auditor’s reliance, and
    4. The outcome effects of external auditor reliance on the internal auditor (i.e., Audit Efficiency, Fees, Financial Statement Quality, and Litigation).

    The research examined is limited and does not fully address the PCAOB’s inquiries, specifically jurisdictional limitations on internal audit reliance and overall threshold limitations on internal audit reliance. This paper identifies gaps in the research and proposes a series of research questions aimed at closing these gaps.

    Design/Method/ Approach:

    The review included current and proposed U.S. and international auditing standards, academic literature and selected practitioner research related to the nature of internal audit work, and the external auditor’s reliance on this work. Based on this review, the paper includes a proposed summation model and organizing framework to help capture the various factors in the reliance decision. This organizing framework is used to present the synthesis of the relevant research, identify gaps in the research and propose research questions aimed at closing these gaps. In addition, the relevant papers are summarized for ease of understanding. This summary includes the methodology, the objective of the research project, the sample (if applicable), the results of each study, and a cross-reference to the proposed research questions. 

    Findings:
    • The environment (i.e., the regulatory environment and governance and client characteristics) in which external auditors must make a reliance decision is complex – involving several factors that must be considered simultaneously. The evolving set of global auditing standards further complicates the reliance decision process.
    • Researchers have made some progress in understanding the influence of external auditors’ evaluations of internal auditor quality factors (i.e., competence, objectivity, and work performance); however, very little is known about how, and to what extent, external auditors are evaluating internal audit quality factors.
    • Research notes that the nature and extent of external auditors’ reliance on internal auditors is influenced by account risk, inherent risk, and internal audit sourcing (e.g., outsourced, co-sourced, or in-house). How the external auditors choose task environments (e.g., revenue recognition versus payroll) and the types of tests to rely upon within these task environments is not completely understood.
    • There are several unaddressed issues in the current research. These include:
      • Research examining the influence of continuous monitoring on the reliance decision
      • Research examining the reliance decision for integrated audits of public companies, specifically the audit of internal control over financial reporting.
      • Research examining the evolving nature of the internal audit function.
    Category:
    Internal Control, Standard Setting
    Sub-category:
    Impact of SOX
  • Jennifer M Mueller-Phillips
    A Test of the Auditor Reliability Framework Using Lenders’ J...
    research summary posted February 24, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 04.0 Independence and Ethics, 04.08 Impact of SEC Rules Changes/SarbOx 
    Title:
    A Test of the Auditor Reliability Framework Using Lenders’ Judgments
    Practical Implications:

    The results of this study indicate that banning the provision of both non-audit and audit services by a single firm likely increased perceptions of auditor independence, but did not significantly effect overall judgments of reliability or the extent to which financial statement users incorporate financial statement information into their decision process. Additionally, results of this study indicate that companies who have audits performed by auditors who are perceived to possess greater integrity, expertise and independence likely enjoy reduced costs of borrowing.

    For more information on this study, please contact F. Todd DeZoort.

    Citation:

    DeZoort, F.T., T. Holt, and M.H. Taylor. 2012. A test of the auditor reliability framework using lenders’ judgments. Accounting, Organizations and Society 37 (8): 519-533.

    Purpose of the Study:

    The purpose of this study is to test the relationship between financial statement users’ perceptions of auditor expertise, integrity, independence and objectivity and overall assessments of auditor reliability. Previous research suggests that perceptions of auditor reliability are critical to perceptions of financial statement reliability. This study directly tests that assertion and also investigates the relationship between perceptions of financial statement reliability and subsequent reliance on disclosed financial information. 

    Design/Method/ Approach:

    Data for this study was collected via a survey of commercial lenders belonging to the Risk Management Association prior to 2012. The survey yielded 187 responses and required participants to review financial information for a hypothetical company. Participants responded to several questions about their perceptions of the company’s auditors, the financial statements and overall risk as a potential applicant for a commercial loan.

    Findings:

    This study investigates the relationship between financial statement users’ perceptions of auditor expertise, integrity, independence and objectivity and makes the following observations:

    • Perceptions of auditor integrity are positively correlated with perceptions of auditor independence, expertise, objectivity and reliability
    • Perceptions of auditor expertise are positively correlated with perceptions of auditor objectivity
    • Perceptions of auditor independence are positively correlated with perceptions of objectivity
    • Perceptions of auditor objectivity are positively correlated with perceptions of auditor reliability.

    This study also investigates how perceptions of auditor reliability influence financial statement users’ interpretation and use of financial statement information.

    • Perceptions of auditor reliability are positively correlated with perceptions of financial statement reliability
    • Perceptions of financial statement reliability are negatively correlated with judged risk of default on a commercial loan

    Finally, manipulating whether or not the auditor provided non-audit services in addition to performing the financial statement audit had the following effects:

    • Negatively impacted perceptions of auditor independence, objectivity and reliability
    • Did not statistically impact perceptions of auditor integrity, expertise, financial statement reliability or default risk
    Category:
    Independence & Ethics, Standard Setting
    Sub-category:
    Impact of SEC Rules Changes/SarBox
  • Jennifer M Mueller-Phillips
    Accelerated filing deadlines, internal controls, and...
    research summary posted October 20, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.07 Impact of SEC Actions, 12.0 Accountants’ Reports and Reporting, 12.03 Restatements 
    Title:
    Accelerated filing deadlines, internal controls, and financial statement quality: The case of originating misstatements.
    Practical Implications:

    Given the significant amount of concern regarding the reliability of financial statement reporting under new filing deadlines (movement from 90 days to 75 days in 2003 and then to 60 days in 2006), the authors provide evidence which shows the concern was valid but only temporarily. The authors use originated misstatements to indicate the beginning of a misstatement, showing that accelerated filers experienced higher likelihood of misstatements after the first acceleration, however large accelerated filers did not experience such a change in response to the second acceleration. Additionally, implementation of SOX appears to have increased reliability with fewer originated misstatements upon implementation.

    Citation:

    Boland, C. M., S. N. Bronson, C. E. Hogan. 2015. Accelerated filing deadlines, internal controls, and financial statement quality: The case of originating misstatements. Accounting Horizons 29 (3) 297-331.

    Keywords:
    Accelerated filing, financial statement restatements, Sarbanes-Oxley Act, filing lags, internal controls
    Purpose of the Study:

    The authors investigate whether Government regulationspecifically through changes in filing deadlines and implementation of the Sarbanes Oxley Act (SOX)influence the origination of financial statement misstatements. They specifically focus on the origination of misstatements to determine if firms sacrificed relevance and reliability to comply with accelerated filing dates.

    Design/Method/ Approach:

    The analyses use a sample of 17,216 firm-year observations from 12/15/2002 to 12/14/2007. The authors run a regression analysis predicting the likelihood of a restatement for accelerated filers and large accelerated filers relative to non-accelerated filers. The model incorporates controls for other known determinants of changes in likelihood of restatement.

    Findings:

    The authors find:

    • Accelerated filers had a higher likelihood of a misstatement following the filing deadline shift from 90 to 75 days.
    • Accelerated filers had a reduced likelihood of a misstatement following implementation of SOX.
    • Large accelerated filers did not experience a change in likelihood of a misstatement following the filing deadline shift from 75 to 60 days.

    The results suggest that the concerns of filers and their auditors regarding the potential for lower-quality information resulting from accelerated filing was valid, although only temporarily. In the long run, companies were able to file reports in a timelier manner without a corresponding increase in the likelihood of misstatement.

    Category:
    Accountants' Reporting, Standard Setting
    Sub-category:
    Impact of SEC Actions, Restatements
  • Jennifer M Mueller-Phillips
    Agency problems, accounting slack, and banks’ response to p...
    research summary posted July 21, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.03 Impact of New Accounting Pronouncements 
    Title:
    Agency problems, accounting slack, and banks’ response to proposed reporting of loan fair value.
    Practical Implications:

    The results should be considered in the context of due process for setting accounting standards and for legislating financial regulation. The study suggests that bank representatives writing negative comment letters have motives to resist accounting standards that result in reduced accounting slack and increased transparency. As one would expect, these motives and patterns of financial-reporting behavior are not mentioned in the comment letters. Instead, the negative letters submitted by responding bank representatives cite conceptual reasons for resisting proposals intended to increase financial reporting transparency. The results suggest that the processing of comment-letters should explicitly include consideration of letter-writer motivations, and weigh carefully the stated reasons for support or opposition against letter-writer incentives and potentially divergent facts.

    Citation:

    Hodder, L. D., & Hopkins, P. E. 2014. Agency problems, accounting slack, and banks’ response to proposed reporting of loan fair values. Accounting, Organizations & Society, 39 (2): 117-133.

    Keywords:
    fair value accounting, bank loans, financial statements, FASB
    Purpose of the Study:

    In May 2010, the United States (US) Financial Accounting Standards Board (FASB) issued an Exposure Draft (ED) that proposes greatly expanding fair value recognition for most financial instruments, including long-term receivables, such as bank loans. Responses received by the FASB during the ED’s comment period were overwhelmingly negative and particularly concentrated within the banking industry; specifically, the FASB received 2971 comment letters in response to the ED, with over 85% from bank representatives and banking trade organizations. Through the end of 2011, this is one of the highest comment-letter volumes in response to any single FASB-issued public-comment discussion document. Because of the large volume of negative letters received from bank representatives, the FASB withdrew the proposal in January 2011. This study seeks to understand the factors systematically associated with bank representatives’ decisions to submit comment letters.

    Despite the many changes proposed in the ED, the vast majority of letters submitted by commercial-bank representatives addressed only one issue: opposition to the proposed reporting of loans at fair value. Given the large, uniform, and narrowly focused response that was concentrated in the banking industry, this suggests that responding bank representatives perceived an economic threat from the FASB’s ED and its proposal to change current accounting for loans.

    Design/Method/ Approach:

    The authors use logistic regression analysis to test the determinants of differential bank comment-letter writing. The primary sample consists of all private and public commercial banks with necessary financial data in the periods covered by the tests. The authors collect financial statement data from publicly available regulatory filings. The authors include quarterly data spanning 2001Q1 through 2011Q4. The sample includes 5,289 unique banks. From the FASB’s web site, the authors collect all 2,971 comment letters submitted.

    Findings:

    The authors provide evidence suggesting that bank representatives’ objections to the ED are motivated less by stated conceptual concerns and more by self-interest. The incurred loss model for accounting for loan losses makes available accounting slack that can be used to manage capital and earnings. The finding that banks historically using accounting slack are more likely to oppose the ED suggests that the FASB’s fair value proposal is perceived to decrease available accounting slack related to loans. In the analysis of transparency-related motives, banks submitting comment letters opposing the loan-reporting provisions of the ED are:

    1. More likely to elect to participate in the new optional, supplemental, fixed-price deposit insurance and debt guarantee programs offered by the FDIC,
    2. Less likely to have nonguaranteed outside creditors and
    3. Less likely to obtain financial statement audits of their non-regulatory GAAP financial statements.

    These results are consistent with bank managers and shareholders affiliated with lobbying banks benefitting from the lower agency costs that accompany government guarantees of indebtedness and the lower levels of external monitoring that otherwise would be provided by unguaranteed debt holders and by auditors.
     

    Category:
    Standard Setting
    Sub-category:
    Impact of New Accounting Pronouncements
  • 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

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