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  • 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
    An Examination of the Credence Attributes of an Audit
    research summary posted October 15, 2013 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards, 09.0 Auditor Judgment, 09.10 Prior Dispositions/Biases/Auditor state of mind, 11.0 Audit Quality and Quality Control 
    Title:
    An Examination of the Credence Attributes of an Audit
    Practical Implications:

    At its core, the theory proposed by the authors assumes that auditors are economic agents who provide a valuable service and can be expected to behave rationally to maximize their profits. Strategic behaviors such as under-auditing, over-auditing, or overbilling would be unobservable by an auditee in many instances. The possibility of such behaviors has important implications for the level of assurance over financial reports and can potentially affect the efficient allocation of capital resources. One of the goals of this study was to analyze how the credence aspect of audits could influence important policy decisions. Regulation may play a powerful role in mitigating the credence nature of auditing, e.g., PCAOB inspections. However, regulation can be a double-edged sword if it increases the incentive or opportunity for auditors to behave strategically. Therefore, auditors can take the theories and models presented in this study to evaluate their firms for potential profit maximizing biases that may negatively impact audit quality and efficiency. Policy makers could also use these theories and models to evaluate how new auditing policies might influence auditors’ incentives and behaviors.

    For more information on this study, please contact W. Robert Knechel.
     

    Citation:

    Causholli, M., and W. R. Knechel. 2012. An Examination of the Credence Attributes of an Audit. Accounting Horizons 26(4): 631-656.

    Keywords:
    Credence attributes; audit quality; audit efficiency.
    Purpose of the Study:

    The purpose of this study was to expand the understanding of the economics of auditing and audit markets by using the theory of credence goods as the basis for explaining auditors’ incentives. The idea of a credence good or service is that (1) the seller of the good or service is an expert who both recommends and provides a level of service to the buyer; (2) buyers of credence goods or services cannot assess how a service is a delivered and must rely on a seller’s recommendation; and (3) buyers cannot assess how well the service was performed. The authors suggest that the external audit is a credence good which provides auditors with incentives to under-audit, over-audit or overcharge their clients.

    Design/Method/ Approach:

    The authors take a purely theoretical approach to study the perspective of an audit as a credence good. The authors rely on prior research of credence goods and on the principles of Game Theory to help explain auditors’ incentives to under-audit, over-audit or overcharge clients and predict auditors’ behaviors under certain scenarios. The authors use theoretical decision trees to describe an auditor’s possible strategies for bidding for an audit, and for executing the audit. The authors also describe examples of prior auditing research that present results that support the author’s credence theory.

    Findings:

        The authors propose that if an audit is a credence good, the auditee cannot determine any of the levels of audit effort that define the auditor’s decisions. This creates information asymmetry between the auditor and auditee both before and after the audit because the auditee cannot be sure of the true level of assurance that is necessary before the audit, and the auditee cannot be sure of the true level of assurance that is gained as a consequence of the audit. The information asymmetry goes in favor of the auditor, who can act strategically to under-audit and earn greater profits because the auditee has imperfect information about the auditor’s work and the level of assurance gained by the auditor’s efforts.

     The authors also propose that there are disciplining mechanisms in the market for audit services that are in place to mitigate an auditor’s incentive to behave strategically such as an auditee’s direct knowledge, audit firm reputation and size, professional regulation, legal liability, and competition between audit firms. However, while these mechanisms may be in place, an auditor facing low penalties or risk of detection may be more likely to consider strategic actions. In environments with weak courts or regulation, auditors have more incentives to act strategically and expect to reap superior profits as a result. Similarly, changes in regulations or other structural changes in the audit market can induce changes in the incentives for auditors to behave strategically. Overall, disciplining mechanisms facilitate the operation of audit markets even though they may not completely resolve the information (credence) problem.
     

    Category:
    Audit Quality & Quality Control, Auditor Judgment, Standard Setting
    Sub-category:
    Changes in Audit Standards, Prior Dispositions/Biases/Auditor state of mind
  • Jennifer M Mueller-Phillips
    An Inductive Typology of Auditing Research
    research summary posted March 4, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards 
    Title:
    An Inductive Typology of Auditing Research
    Practical Implications:

    This study has certain limitations that could be tackled in future research: in particular, the sample is based on published articles from 25 journals, therefore neglecting other journals and “grey literature”. However, this inductive typology could be further applied to present a structured framework of auditing research, and to analyze trends and emerging issues in comparative and/or longitudinal studies, research reports, and the like. Future investigations of the way research themes emerge and evolve should certainly contribute to a better understanding of auditing research.

    For more information on this study, please contact Cedric Lesage.

    Citation:

    Lesage, C. and H. Wechtler. 2011. An Inductive Typology of Auditing Research. Contemporary Accounting Research 29 (2): 487-504. 

    Keywords:
    typology; auditing research theme
    Purpose of the Study:

    A global picture of a specific complex domain in social sciences can be provided by typologies. Despite the usefulness and subsequent applications of the typologies proposed in past research, there are four concerns. First, the SK typology is arguably less efficient for structuring auditing research knowledge 30 years later. Second, the studies cited earlier concerned either a single journal, or a single period. Third, previous typologies are concept-driven rather than data-driven classifications. Fourth, they are practice-oriented rather than research-oriented. Taking these main concerns into consideration, the authors implement the study with the purpose to propose an updated, inductive, and comprehensive typology of auditing research. 

    Design/Method/ Approach:

    The study covers 25 main journals over all their years of publication from 1926 to 2005, and uses a computer-based content analysis of the abstracts of 3,143 selected articles. The authors first investigate how the identified keywords have changed since 1926, highlighting three key periods; then they provide a comprehensive typology of 16 major themes in auditing research, with the relative importance, significant keywords and periods, and the main contributory journals presented for each scheme. After that, the authors analyze trends in the popularity of each research theme over time and examine the contribution of individual journals to each theme.

    Findings:

    Compared with previous studies, this study’s typology is the first to be data-driven and covers the whole period between 1926 and 2005, comprising 3,143 auditing research articles. As a result, this new typology of auditing research themes provides a more representative picture of actual academic production than existing typologies, which are all based on a predefined practitioner’s structure. As an illustration, the authors have applied it to analyze trends in research themes and the most contributory journals to auditing research.

    Category:
    Standard Setting
    Sub-category:
    Changes in Audit Standards
  • Jennifer M Mueller-Phillips
    Audit Partner Tenure and Cost of Equity Capital
    research summary posted May 28, 2014 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards, 05.0 Audit Team Composition, 05.03 Partner Rotation 
    Title:
    Audit Partner Tenure and Cost of Equity Capital
    Practical Implications:

    Prior research suggests that the length of auditor-client relationship affects audit quality, and, therefore, the integrity and information risk associated with a clients’ financial reporting. This study attempts to examine the effects of audit engagement partner tenure and rotation on investors’ perceptions. The results of this study raise important questions for future research. It is not known to what extent investors or analysts are aware of the audit partner’s identity or pay attention to audit partner tenure. If investors or analysts do not consider partner tenure, future research may identify omitted variables that have the same nonlinear relationship with the ex ante cost of capital that we observe for non-Big 4 audit partner tenure.  

    Citation:

    Azizkhani, M., G. S. Monroe, and G. Shailer. 2013. Audit Partner Tenure and Cost of Equity Capital. Auditing 32 (1).

    Keywords:
    audit partner rotation; audit partner tenure; cost of capital; financial reporting credibility
    Purpose of the Study:

    Recent proposals by the PCAOB suggest that audit firms should be required to identify the name of the engagement partner in the audit report. The proposals suggest that this provides useful information to investors by allowing investors to identify audit partner tenure and rotation. Professional accounting bodies and regulators have long been concerned that long auditor-client relationships impair audit quality. The PCAOB, however, has noted that other commenters do not believe disclosure of partner identity will provide meaningful information to investors. This study investigates the usefulness of disclosing partner identity by exploring whether audit partner tenure and partner rotation are informative to investors, as indicated by the ex ante cost of equity capital.

    Design/Method/ Approach:

    The authors tested the relationship between client-specific ex ante cost of equity capital and audit partner tenure using two models. The client-specific ex ante cost of equity capital was estimated using the price-earnings ratio divided by the short-term earnings growth rate. Auditor tenure was tested using raw, long transform, and quadratic terms. The authors also used two-stage regressions to address the potential for Big 4 selection bias. The sample was selected for all Australian-domiciled companies listed on the Australian Stock Exchange during the 1995-2005 time period. 

    Findings:
    • Partner tenure has a nonlinear relation with the ex ante cost of equity capital for non-Big 4 audit engagements prior to the introduction of partner rotation requirements.
    • Imputed gains from partner tenure appear similar to the imputed gains of having a Big 4 auditor.
    • Partner rotation is associated with increased ex ante cost of equity capital.  
    Category:
    Audit Team Composition, Standard Setting
    Sub-category:
    Changes in Audit Standards, Partner Rotation
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  • Jennifer M Mueller-Phillips
    Balancing the Costs and Benefits of Auditing and Financial...
    research summary posted March 30, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards, 01.03 Impact of New Accounting Pronouncements, 01.04 Impact of 404 
    Title:
    Balancing the Costs and Benefits of Auditing and Financial Reporting Regulation Post-SOX, Part I: Perspectives from the Nexus at the SEC
    Practical Implications:

    The results of this study are important because they illuminate the impact of new accounting rules on standard setters and companies abiding by these rules (in this case, the specific context was the implementation process related to SOX Section 404). The study suggests that a number of steps are required in order to perfect the guidance. It is important to understand the meaning and intentions behind authoritative literature in order to follow it. The observations suggest that the process for implementing new guidance has room for change, yet has evolved over time to increase effectiveness. The findings are specific to the implementation for assessment and auditing of internal controls for public companies.

    For more information on this study, please contact Zoe-Vonna Palmrose (zv.palmrose@marshall.usc.edu).

    Citation:

    Palmrose, Z.-V. 2010. Balancing the Costs and Benefits of Auditing and Financial Reporting Regulation Post-SOX, Part I: Perspectives from the Nexus at the SEC. Accounting Horizons 24 (2):313-326.

    Purpose of the Study:

    Sarbanes-Oxley (SOX) Section 404 adds requirements for disclosures discussing management’s assessment of internal controls. Zoe-Vonna Palmrose served as the Deputy Chief Accountant for Professional Practice in the Office of the Chief Accountant. From August 2006 to July 2008, Palmrose observed the effects of SOX Section 404 on practice. The paper describes her observations related to:

    • The purpose of SOX Section 404.
    • Initial implementation efforts related to SOX Section 404.
    • Improvements for the implementation of SOX Section 404. These improvements primarily focus on the cost-benefit for smaller companies that had to report under SOX Section 404.
    • Overall cost-benefit effect on SOX Section 404 filers.
    Design/Method/ Approach:

    The author collected data through personal experiences from August 2006 through July 2008. She observed and recorded information related to SOX Section 404 during her time as the Deputy Chief Accountant in the Professional Practice Group.

    Findings:
    • The author finds that SOX Section 404 does not require a company to implement adequate internal controls because previous standards released in 1977 already accomplished that objective. Instead, SOX Section 404 requires disclosure of management’s assessment of the adequacy of its internal controls. The assessment is based on whether the internal controls can provide reasonable assurance about the reliability of the financial statements. SOX Section 404 does not allow management to disclose that its internal controls are effective if it determines material misstatements exist in the financial statements. The guidance also requires that a registered PCAOB auditor opines on management’s assessment of internal controls.
    • The author finds that the problems associated with the initial implementation of SOX Section 404 arose because it was issued from the top down. Few companies were reporting on internal controls before SOX required public companies to do so. The author observes that AS No. 2 was initially poorly suited for reporting on internal controls because it was difficult to determine the respective responsibilities of the auditor and management. In June 2006, the PCAOB clarified the standard in response to this confusion.
    • The author finds that the PPG aided the amendment to AS No. 2, accomplished in AS No. 5. Furthermore, an open meeting between the SEC and the PCAOB was primarily held to discuss how to make management and the auditor’s responsibilities more effective with respect to the responsibilities of each party.
    • The author finds that deferring implementation of SOX Section 404 for smaller public companies allowed the implementation flaws to be discovered before smaller companies were harmed.
    • The author finds that audit fees rose in order to compensate for the added work for the auditors. Cost-benefit relationships were analyzed in order to determine the effectiveness of the work to be completed.
    Category:
    Standard Setting
    Sub-category:
    Changes in Audit Standards, Impact of 404, Impact of New Accounting Pronouncements
  • Jennifer M Mueller-Phillips
    Big Data in Accounting: An Overview.
    research summary posted September 21, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.01 Changes in Reporting Formats, 01.02 Changes in Audit Standards, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.09 Impact of Technology on Audit Procedures, 09.0 Auditor Judgment 
    Title:
    Big Data in Accounting: An Overview.
    Practical Implications:

    The availability of Big Data will precipitate substantive changes in accounting education, research, and practice. In education, in particular accounting and auditing, the use of Big Data will increase the statistical and IT content in curricula, probably breaking the current set of limitations represented in the CPA exam. Research in the more traditional fields in accounting, such as capital markets research, will benefit from dimensional increases in data availability and will be conditional on improvements of the researcher’s skill sets in areas such as modeling, statistics, and text mining. Practice, in particular internal audit departments, will be the leading facilitator of accounting Big Data usage, while attempting to keep abreast or in sync with the developments in corporate data utilization in fields like marketing, supply chain, and customer services.

    Citation:

    Vasarhelyi, M. A., A. Kogan, and B. M. Tuttle. 2015. Big Data in Accounting: An Overview. Accounting Horizons 29 (2): 381-396.

    Keywords:
    analytics, audit judgment, enterprise data ecosystem, reporting, standards, storage
    Purpose of the Study:

    The term Big Data is fairly new but seems to be applied in almost every area of human activity at the moment. It is not defined in the rigorous meaning of the word, and it is usually used under the assumption that the readers understand it at the intuitive level. The reason for this popularity is the exponentially growing amount of information made available by developments in computing and telecommunications technology, particularly the Internet and environmental sensing. This paper sheds light on the meaning of Big Data in the accounting and auditing domains.

    Design/Method/ Approach:

    This article is a commentary.

    Findings:
    • The definition of Big Data is conditional on the environment being used.
    • Processing needs are nonlinear with the size of data. Even small datasets may be computationally difficult if models are complex.
    • There is a progressive extension of the feasible dataset. Inclusion of sources is mainly an economic and legal issue and not one of feasibility.
    • Newly included data structures contain a wide set of not previously determined/used parameters, which by themselves may be informational.
    • Extended, nontraditional data sources may substantively change the domains of accounting and auditing.
    • Linkages of traditional extended data, as found in ERPs, to new sources of data may provide very strong confirmatory evidence for economic activity.
    • Accounting, auditing, and management extensions into Big Data usage overlap and present powerful opportunities in the next decade but also the re-conceptualization of functions in an age of computer intelligence and automation.
    Category:
    Auditing Procedures - Nature - Timing and Extent, Auditor Judgment, Standard Setting
    Sub-category:
    Changes in Audit Standards, Changes in Reporting Formats, Changes in Reporting Formats, Impact of Technology on Audit Procedures Confirmation – Process and Evaluation of Responses
  • Jennifer M Mueller-Phillips
    Commentaries on Big Data's Importance for Accounting and...
    research summary posted September 21, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards 
    Title:
    Commentaries on Big Data's Importance for Accounting and Auditing.
    Practical Implications:

    This set of commentaries presents a strong challenge to the accounting and auditing profession. Perhaps the greatest risk is the slow pace of adjustment of auditors and accountants to the new realities of Big Data/business analytics, which most accounting firms today would agree is absolutely essential to managing and maintaining competitive advantage. Academics, as educators, certainly must revamp their accounting and auditing curricula to provide the necessary skills for Big Data in the accounting and auditing profession. Researchers, too, have a responsibility to analyze Big Data datasets and to generate results that would better understand the contribution of Big Data for operations and decision making, and how the benefits of Big Data might flow to firm managers, company stakeholders, and the public at large.

    Citation:

    Griffin, P. A., and A. M. Wright. 2015. Commentaries on Big Data's Importance for Accounting and Auditing. Accounting Horizons 29 (2): 377-379.

    Keywords:
    management control, accounting standards, Big Data
    Purpose of the Study:

    The commentaries in this forum on Big Data confront one of the profession’s most pressing challenges. How should the accounting profession respond to Big Data? Big Data and business analytics now permeate almost all aspects of major companies’ decision making and business strategies. A large U.S. company, for example, might process a billion data elements every day to understand its competitive environment. Moreover, by its very nature, Big Data cannot avoid running head-on into the traditional systems of accounting and auditing that have served the profession so well in the past.

    This issue presents eight commentaries by expert academics and business professionals, who have studied and thought much about the core issues and challenges. Collectively, these commentaries not only define and frame the important issues for accounting and auditing but, also, they identify many feasible, yet difficult, pathways forward, wherein Big Data and traditional accounting and auditing might meld to better serve firms, stakeholders, and the public. These commentaries also identify controversies within the field that imply hard choices. At minimum, the expectation is that these commentaries will stimulate a healthy discussion on the topic among students, academics, and professionals. In this way, they will also serve a key aim of this journalto bridge the gap between theory and practice.

    Design/Method/ Approach:

    This article is a commentary.

    Findings:
    • Vasarhelyi, Kogan, and Tuttle (2015) argue strongly that Big Data matters fundamentally because it changes radically what the profession means by information.
    • Warren, Moffat, and Byrnes (2015) continue this theme but focus mostly on behaviors internal to the firm. Big Data will affect the design and operation of management control systems, they contend, by helping identify behaviors correlated with specific goal outcomes, which would prompt formulation of new performance measures.
    • Krahel and Titera (2015), on the other hand, offer a more sobering hypothesis, contending that current accounting and auditing standards, which emphasize presentation, aggregation, and sampling, are headed in the wrong direction. They state, Aggregation and arbitrary allocations made on static, paper-based financial statements are artifacts of a bygone era of high transmission costs and slow data collection speeds.”
    • Several commentaries discuss how Big Data will change auditing.
    • Brown-Liburd, Issa, and Lombardi (2015) also raise challenges for the auditing profession, but these relate more to its behavioral repercussions; in particular, how Big Data might affect the quality of auditors’ judgments.
    • Zhang, Yang, and Appelbaum (2015) develop their views around the four Vs of Big Datavolume, velocity, variety, and veracity.
    Category:
    Standard Setting
    Sub-category:
    Changes in Audit Standards
  • Jennifer M Mueller-Phillips
    Consequences of Big Data and Formalization on Accounting and...
    research summary posted September 21, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.01 Changes in Reporting Formats, 01.02 Changes in Audit Standards, 10.0 Engagement Management, 10.02 Materiality and Scope Decisions 
    Title:
    Consequences of Big Data and Formalization on Accounting and Auditing Standards.
    Practical Implications:

    In light of cost reductions in data generation, storage, retrieval, and transmission, the inherent compromises within the paper paradigm are of little benefit. Users are entitled to more in-depth, granular values that they can manipulate, drilling down and up for more or less detail where needed. Financial reporting standards that govern presentation and arbitrary aggregation must likewise give way to rules regarding the limits and frequency of data transmission, as well as the quality of those data. 

    Audit standards must change as well. Error detection and risk quantification are no longer sufficient targets, but must be seen as small components of an audit of broader scope. The deep analysis of tremendous volumes of data and potentially thousands of exception reports necessitates a different paradigm of reporting and assurance. The role of auditing standards, far from being diminished in the face of increasing automation, must shift from governing sampling procedures to embracing the broader, deeper data availability and analysis of the modern era in an effort to create a better, more thorough audit.

    Citation:

    Krahel, J. P., and W. R. Titera. 2015. Consequences of Big Data and Formalization on Accounting and Auditing Standards. Accounting Horizons 29 (2): 409-422.

    Keywords:
    accounting standards, auditing standards, Big Data, continuous audit, materiality
    Purpose of the Study:

    The level, breadth, and quality of externally presented financial information have always represented a compromise between the preparer’s cost and the user’s benefit. While preparer costs vis-a`-vis data collection and transmission have decreased significantly, the compromises made in the paper-based era have persisted, creating a set of anachronistic accounting practices that, in the authors’ view, unfairly handicaps statement users. A similar effect can be observed in auditing practices. While data availability and standardization have increased, audit standards continue to focus on sampling and other practices indicative of a low-information environment. This paper will address the problems that result from such anachronisms, present a set of axes along which accounting and auditing standards must evolve, describe the avenues through which such changes can be accomplished, and discuss the new paradigm from academic and practical perspectives.

    Design/Method/ Approach:

    This article is a commentary.

    Findings:
    • Accounting and reporting standards must adapt to deal with the frequent (possibly even continuous) transmission of granular data, not only their presentation in the aggregate.
    • Such standards need to consider addressing company-specific data, as well as macro-level data that may be important to the analysis of a company’s financial condition. They also need to consider enhancing historical reporting to include other data elements that may enable predictive analysis by users.
    • Auditing standards must address situations where data are abundant, not only where data are sparse. The concept of materiality in relation to a company’s financial statements, taken as a whole, needs to be reevaluated.
    • Auditing standards must also do more to address the concept of process auditing. When data are available on a continuous basis, the processes generating those data must be continuously assured. Internal and external auditor competencies must be broadened to include more advanced types of data analytics. 
    • All parties along the financial reporting value chain must recognize the latent value in unstructured and semi-structured data.
    • Care must be taken to minimize the expectations gap between users and auditors in the face of increasing data and analytical capacity. A user’s role (and responsibility), which could change, must also be considered.
    Category:
    Engagement Management, Standard Setting
    Sub-category:
    Changes in Audit Standards, Changes in Reporting Formats, Changes in Reporting Formats, Materiality & Scope Decisions
  • Jennifer M Mueller-Phillips
    Current Practices and Challenges in Auditing Fair Value...
    research summary posted April 19, 2017 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards 
    Title:
    Current Practices and Challenges in Auditing Fair Value Measurements and Complex Estimates: Implications for Auditing Standards and the Academy
    Practical Implications:

    This study provides a more in-depth understanding of current audit practices related to auditors’ use of substantive approaches outlined in AS 2502. These results provide several important new insights, including more clearly distinguishing between auditors’ use of pricing services and valuation specialists and factors that drive this decision, as well as provide additional insights regarding differences in the use of valuation specialists for financial and nonfinancial FVMs. Finally, the results shed new light on whether audit challenges differ for financial versus nonfinancial FVMs.

    Citation:

    Glover, S. M., M. H. Taylor, and Y. Wu. 2017. Current Practices and Challenges in Auditing Fair Value Measurements and Complex Estimates: Implications for Auditing Standards and the Academy. Auditing: A Journal of Practice and Theory 36 (1): 63 – 84.

    Keywords:
    auditing fair value measurements and other complex estimates, pricing services, valuation specialists, financial fair value measurements, nonfinancial fair value measurements.
    Purpose of the Study:

    The subjectivity inherent in estimating future events, coupled with the potential high degree of measurement uncertainty, makes auditing fair value measurements and other complex estimates challenging for auditors. Because of this difficulty, auditors frequently rely on valuation specialists; however, the PCAOB has voiced criticisms as a result of such reliance. To provide a more complete picture of current practices and challenges encountered when auditing complex FVMs, this study has three primary objectives:

    • To obtain deeper insights into auditors’ use of substantive approaches to audit FVMs given criticisms of auditors’ substantive approaches
    • To provide improved understanding of auditors’ use of pricing services and valuation specialists (in-house and third-party) when auditing complex FVMs
    • To further explore challenges auditors encounter when auditing FVMs by distinguishing between financial versus nonfinancial FVMs and investigating how auditors respond when they encounter problems with management’s valuation expertise and knowledge
    Design/Method/ Approach:

    The authors employ a field-based survey that provides a channel for practitioners to openly express their opinions and views. 

    Findings:
    • The authors find that auditors are likely to use the first substantive approach (i.e., test management’s assumptions and underlying data) when auditing typical or lower-risk estimates, but as audit risk and complexity increase, they are more likely to use a combination of approaches.
    • The authors find that, despite AS 2502 allowing auditors to use management’s assumptions when developing an independent estimate, the results indicate that auditors typically opt instead to use the audit team’s own assumptions to derive independent estimates.
    • The authors find that a greater percentage of audit partners report using third-party valuation specialists to develop independent estimates for financial FVMs than for nonfinancial FVMs.
    • The authors find that a majority of the participants believe that challenges differ between financial and nonfinancial FVMs and the key reason is the lack of observable market information for nonfinancial FVMs. 
    Category:
    Standard Setting
    Sub-category:
    Changes in Audit Standards
  • Jennifer M Mueller-Phillips
    Discussion of “Does the Identity of Engagement Partners M...
    research summary posted January 20, 2016 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards, 01.03 Impact of New Accounting Pronouncements, 05.0 Audit Team Composition, 05.05 Diversity of Skill Sets e.g., Tenure and Experience, 12.0 Accountants’ Reports and Reporting, 12.01 Going Concern Decisions, 15.0 International Matters, 15.01 Audit Partner Identification by Name 
    Title:
    Discussion of “Does the Identity of Engagement Partners Matter? An Analysis of Audit Partner Reporting Decisions”.
    Practical Implications:

    This discussion emphasizes significant caution when interpreting the results of the study. Mainly, it is unclear if results of the study can generalize to the broader public company market in the US. Furthermore, if the results are misinterpreted (i.e., individual auditors are not systematically aggressive but, instead, high quality auditors are systematically assigned the riskiest clients) then regulation requiring audit partner identification could actually have overall negative effects on overall audit quality.

    Citation:

    Kinney, W.R. 2015. Discussion of “Does the Identity of Engagement Partners Matter? An Analysis of Audit Partner Reporting Decisions”. Contemporary Accounting Research 32 (4):1479-1488.

    Keywords:
    auditor attributes, reporting style, auditor identification, audit quality, going concern opinion, Type I error, Type II error, credit risk, insolvency risks, statutory audits
    Purpose of the Study:

    The author reviews the paper's content, analyzes its predictive validity, and discusses its multiple implications. He provides constructive suggestions for improvements. Based on predictive validity analysis, the author concludes that engagement partner assignment strategy is an important and acknowledged omitted variable that affects the study's internal validity via both the independent variable (partner's prior performance measure) and the dependent variable (borrower's cost of debt capital). The omission also affects construct validities and, if audit firms are applying a plausible assignment strategy, then interpretation of the study's main results would be reversed. Finally, the lack of a standards intervention noted by the authors and the extreme size and other differences between audits of Swedish private companies and U.S. public companies impair external validity and generalization to the U.S. intervention.

    Design/Method/ Approach:

    This article is a discussion.

    Findings:

    The discussion emphasizes the following points:

    • KVZ (the reviewed paper’s authors Knechel, Vanstraelen and Zerni) main analyses are for statutory (not financial statement) audits of small, private, Swedish companies. Therefore, these results may have more limited generalizability. 
    • KVZ use publically available data for private companies without considering the significant amount of private information available to private lenders and audit firms.
    • KVZ acknowledge and cannot rule out a potential competing hypothesis whereby audit firms follow a “best partner to riskiest engagements” strategy. In this case, the highest quality partners may appear to have the most aggressive reporting strategy because that partner serves riskier clients with harder to predict bankruptcy risk. To confirm/disconfirm this competing hypothesis occurs, KVZ could ask audit firm management to describe their audit partner assignment strategies and rank a sample of partners accordingly. This information could be correlated with KVZ’s reporting style measures.    
    • Regulators, academics, and popular/business press articles may be similarly over-generalizing KVZ’s results. Furthermore, misinterpretation of results could have the ill-effects of high quality audit partners being assessed as low quality. This false characterization may lead high quality auditors to refuse to audit riskier clients where their skills are most needed. As such, any interpretations of KVZ’s results should proceed with much caution.
    Category:
    Accountants' Reporting, Audit Team Composition, International Matters, Standard Setting
    Sub-category:
    Audit Partner Identification by Name, Changes in Audit Standards, Diversity of Skill Sets (e.g. Tenure & Experience), Going Concern Decisions, Impact of New Accounting Pronouncements

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