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  • Jennifer M Mueller-Phillips
    The Joint Effects of Multiple Legal System Characteristics...
    research summary posted June 22, 2017 by Jennifer M Mueller-Phillips, tagged 01.02 Changes in Audit Standards, 15.04 Audit Firm Rotation 
    Title:
    The Joint Effects of Multiple Legal System Characteristics on Auditing Standards and Auditing Behavior
    Practical Implications:

    Whether or not the ISA should be adopted by the United States is a greatly contested topic. This study is helpful for regulators and standard-setting boards in the United States about the potential effects of the adoption of ISA and mandatory audit rotation for the United States. This information is also applicable for other countries when making these decisions as well.

    Citation:

    Simunic, Dan A., M. Ye, and P. Zhang. 2017. “The Joint Effects of Multiple Legal System Characteristics on Auditing Standards and Auditor Behavior”. Contemporary Accounting Research 34.1 (2017): 7.

    Purpose of the Study:

    This paper examines the impacts of legal characteristics and auditing standards on audit behavior. Then based on this information the authors determine what the optimal auditing standards would be under different legal regimes. The two legal characteristics examined are vagueness in interpreting audit standards by courts and the expected damage award size in lawsuits against auditors for a failed audit. In recent years there has been a large number of countries adopting the International Standards on Auditing (ISA). Specifically, this study addresses whether or not ISA can be applied efficiently for all countries, and whether or not it adds value to the country that adopts the standards. 

    Design/Method/ Approach:

    The authors begin the analysis by determining the audit quality based on auditing standards and the legal system by using a single-period auditing model with risk-neutral players. After that the optimal auditing standards which maximize audit quality for a specific legal system were determined. The effect of auditor rotation on audit quality was found by adding contingent fees into the model.

    Findings:

    Overall, the authors find that audit quality is affected by both auditing standards and characteristics of legal systems. The optimal audit standards for a particular country also change depending on the legal system.

    Specifically, the authors find:

    • In situations where the expected damages are low, the audit standards are not able to increase audit quality. This is also true for a vague interpretation of audit standards by the courts. Simply adopting a set of rules, such as the ISA, does not determine audit quality.
    • Mandatory auditor rotation can improve audit quality and is more beneficial in countries that have tough and vague auditing standards.

    In regards to ISA the authors find:

    • In places that already have similar standards and legal systems, such as Canada, ISA can be effectively implemented.
    • However, in countries that have a weak legal system, such as China, it is not likely the adoption of ISA will affect audit quality.
    • It is hypothesized by the authors that due to the litigious legal environment of the United States the adoption of ISA would decrease audit quality. 
    Category:
    International Matters, Standard Setting
    Sub-category:
    Changes in Audit Standards
    Home:

    http://commons.aaahq.org/groups/e5075f0eec/summary

  • 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
    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
    Does Recent Academic Research Support Changes to Audit...
    research summary posted July 18, 2016 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.01 Changes in Reporting Formats, 01.02 Changes in Audit Standards 
    Title:
    Does Recent Academic Research Support Changes to Audit Reporting Standards?
    Practical Implications:

    This study reviews academic literature to not only offer insights into how well recent audit reporting initiatives gives users the information they need to understand the audit, but also suggest future research that academics can perform to help standard setters improve the auditor’s report.  The authors argue that (1) disclosure of the audit partner’s name does close the information gap, (2) disclosures related to auditor independence and tenure only partially closes the information gap, and (3) auditor commentary on going concerns does not close the information gap; however, not enough is known about how well either (4) disclosure of critical or key audit matters or (5) assurance on other information in the audit report closes the information gap.  These insights may be of interest to stakeholders in the standard setting process who wish to evaluate the success of currently enacted audit reporting initiatives and the potential costs and benefits of proposed audit reporting initiatives.

    Citation:

    Bédard, J., P. Coram, R. Espahbodi, and T.J. Mock. 2016. Does Recent Academic Research Support Changes to Audit Reporting Standards?. Accounting Horizons 30 (2): 255-275.

    Keywords:
    audit reporting model, audit report, auditing, information gap.
    Purpose of the Study:

    Regulators interested in improving the informativeness of the auditor’s report have recently proposed/required new disclosures to be made by the auditor to help information users better understand the audit.  Academic researchers studied whether these new disclosures fulfill their intended purpose and/or have unintended consequences.  The purpose of this study is to synthesize the academic literature related to the new disclosures in order to identify (1) whether the benefits of specific new disclosures outweigh the costs, (2) whether further changes to the auditor’s report are needed, and (3) where more research is needed to better understand the effects of the new disclosures.  Thus, this study serves as a means of communicating the findings of academic research to standard setters in order to enable academics to better fulfill their information-gathering role in the standard setting process.

    Design/Method/ Approach:

    The author perform a review of the academic literature relevant to PCAOB, IAASB, and U.K. FRC audit reporting initiatives, specifically focusing on (1) disclosure of critical or key audit matters, (2) assurance on other information in the audit report, (3) auditor commentary on going concerns, (4) disclosure of audit partner name, and (5) disclosures related to auditor independence and tenure.  They obtain research published, posted online, or presented at conference(s) from 2007 through mid-2015, but mostly after 2011.

    Findings:
    • Not enough is known about how well disclosure of critical or key audit matters gives users the information they need to understand the audit.
      • Experimental evidence suggests that Critical Audit Matters (CAMs) disclosed in the auditor’s report may (1) draw users’ attention to areas discussed in the CAMs, (2) scare some nonprofessional investors away from companies with CAMs, (3) influence auditor liability and legal damages in unintended ways, (4) and discourage auditors from bringing problems to the attention of passive audit committees.  Furthermore, experimental evidence suggests that (1) the impact of additional disclosure from the auditor upon users may vary depending upon management disclosures and (2) managers may be reluctant to share information about accounting estimates with auditors who are required to make additional disclosures about these estimates.
      • Preliminary archival evidence from the U.K. is mixed in terms whether CAMs have a positive association with audit fees and audit quality, but suggests CAMs have no relationship with financial statement’s informativeness. 
      • Research about the French justifications of assessments disclosure suggests that they are generally boilerplate and uninformative, and they have no impact on audit quality (after the year of implementation).
      • Archival research from the U.S. on the effect of explanatory language on unqualified audit reports suggests that (1) some types of explanatory language provide information about financial reporting quality and (2) non-going concern explanatory language can increase/decrease disagreement among investors.
      • A review of stakeholder responses to the IAASB’s proposed audit reporting initiatives suggests that stakeholders generally approved of the changes, but had differing opinions of how much change was needed.
    • There is no evidence available about whether assurance on other information in the audit report gives users the information they need to understand the audit.
    • Auditor commentary on going concerns appears to not give users the information they need to understand the audit.
      • Although most studies find the going concern audit reports useful, one study finds them not incrementally valuable when they merely focus users’ attention on management’s going concern disclosures.
    • Disclosure of the audit partner’s name does give users the information they need to understand the audit.
      • Although some studies provide mixed evidence about whether disclosing the audit partner’s name increases audit quality, other studies suggest that (1) different audit partners are associated with different levels of audit quality and (2) the restatement history of the audit partner may scare off some potential investors.  However, higher audit fees appear to be the cost of disclosing this useful information.
    • Disclosures related to auditor independence and tenure give users some of the information they need to understand the audit.
      • Although a review of prior research suggests no link between non-audit services (NAS) and auditor independence, a recent study found that total NAS fees are associated with higher (lower) audit quality for issuers (non-issuers).
      • Although a review of prior research does not find decreased audit quality for firms with longer audit firm tenure, a recent study suggests that long audit firm tenure is only associated with decreased audit quality for audits of non-issuers.
    Category:
    Standard Setting
    Sub-category:
    Changes in Audit Standards, Changes in Reporting Formats
  • Jennifer M Mueller-Phillips
    Privacy Auditing Standards
    research summary posted June 15, 2016 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards 
    Title:
    Privacy Auditing Standards
    Practical Implications:

    This paper played the vital role of beginning the conversation on privacy audit standards. From this starting point, more research can be done on the effectiveness of privacy audits, issues with privacy audits, differences in effectiveness between various audit providers, whether more extensive regulation tends to increase or decrease the use of international best practice in privacy audits, studying the causes and effects of privacy breaches in other research methodologies, and the effect of privacy audit fees on privacy audits, just to name a few.

    Citation:

    Toy, A. and D.C. Hay. 2015. Privacy Auditing Standards. Auditing: A Journal of Practice and Theory 34(3): 181-199.

    Keywords:
    privacy audits, information privacy, data protection, international comparability, and assurance services
    Purpose of the Study:

    Privacy of personal information has been an issue of rising importance in the 21st century, especially after the revelations by Edward Snowden regarding the collection of certain data about telephone and Internet activities of ordinary citizens. Also, action by regulators has resulted in the imposition of fines based on privacy violations, which has led to privacy audits becoming increasingly implemented as a response to privacy problems. This paper examines the extent of convergence of the standards used in privacy audits conducted by various privacy auditors. It is the position of the authors that generally accepted criteria would improve the usefulness of privacy audits because users would be able to assess the relevance of privacy audits to entities that operate across different countries and to compare the audits with privacy audits in other countries; furthermore, if consistent standards are not developed it would fall on the user to adjust his or her understanding of the findings in the audit report based on a range of technical differences between standards used in different privacy audit reports. Within this paper, the authors suggest a set of fundamental principles for information privacy that could serve as suitable criteria for privacy audits.

    Design/Method/ Approach:

    To illustrate the need for consistency among privacy audits, the authors assess 30 privacy auditing reports in five countries and examine the consistency among them and their consistency with the fundamental principles the authors are proposing. 

    Findings:
    • The authors find that of the 30 audit reports analyzed, two applied four of the suitable fundamental privacy principles.
    • Sixteen of the audit reports did not apply any of the fundamental privacy principles, which could be due to legitimate reasons for the scope of these audits due to the legal mandate within a particular country to conduct a privacy audit.
    • The fundamental principles of Legitimacy and Respect for Context were not used as criteria in any of the audit reports.
    • Although some standards embody aspects of the fundamental principle of Respect for Context, the broad definition of this principle as a fundamental principle is not captured in its entirety by the national legislation in any of the countries from which audit reports were sourced.
    • Overall, there has been a significant divergence between standards used by different privacy audits.
    Category:
    Standard Setting
    Sub-category:
    Changes in Audit Standards
  • Jennifer M Mueller-Phillips
    The effect of an Audit Judgment Rule on audit committee...
    research summary posted February 17, 2016 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism, 13.0 Governance, 13.05 Board/Audit Committee Oversight 
    Title:
    The effect of an Audit Judgment Rule on audit committee members’ professional skepticism: The case of accounting estimates.
    Practical Implications:

    The findings of this study have important implications for practice. Although prior research has suggested that an audit judgment rule may improve audit quality, findings from this research suggest that audit quality may decrease. This is seen indirectly by the audit committee members’ belief that accounting estimates become less conservative and due diligence decreases when there is an audit judgment rule. However, this was not directly tested, and future research is needed to determine whether audit judgment rules are beneficial or not.

    Citation:

    Kang, Y.J., A.J. Trotman, and K.T. Trotman. 2015. The effect of an Audit Judgment Rule on audit committee members’ professional skepticism: The case of accounting estimates. Accounting, Organizations and Society 46: 59-76.

    Keywords:
    audit judgment rule, professional skepticism
    Purpose of the Study:

    The purpose of this study is to examine how a proposed audit judgment rule impacts the professional skepticism of the members of an audit committee. Prior research has suggested that an audit judgment rule be implemented that requires courts and inspectors to not second-guess auditors’ reasoned judgments when they are made in good faith and in a rigorous manner. Currently, the concern is that auditors are engaging in defensive auditing and fearful of using innovative approaches to auditing accounting estimates. By examining the audit committees reaction to the proposed rule, the researchers are able to examine how audit committees believe this change impacts audit quality and how it impacts the behavior of the audit committee.

    Design/Method/ Approach:

    Data for this paper was collected prior to March 2015 by using an experiment with audit committee members from Australia. All participants had been on an audit committee in the past, and on average they had been on audit committees for 10.33 years.

    Findings:

    With the introduction of the audit judgment rule, there was an increase in perceived accountability in ensuring the reasonableness of the financial statements from the audit committee members. This was due to a belief that accounting estimates become less conservative and due diligence decreases. This increase in perceived accountability did not necessarily lead the audit committee members to act more professionally skeptical by asking more probing questions. However, the audit committee was more comfortable when they used innovative techniques in developing their accounting estimates. This was due to a belief that innovation leads to improved audit quality. Additional analysis demonstrates that former audit partners showed greater skepticism (by asking more probing questions) than other audit committee members.

    Category:
    Auditing Procedures - Nature - Timing and Extent, Governance, Standard Setting
    Sub-category:
    Auditors’ Professional Skepticism, Board/Audit Committee Oversight, 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
  • Jennifer M Mueller-Phillips
    Does the Identity of Engagement Partners Matter? An Analysis...
    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:
    Does the Identity of Engagement Partners Matter? An Analysis of Audit Partner Reporting Decisions.
    Practical Implications:

    Auditor aggressive/conservative reporting style may be a systematic audit partner attribute and non-randomly distributed across engagements. Particular market participants (in this case, lenders) appear to recognize and price these differences in reporting style. While the particular mechanism through which these different reporting styles occur is not possible to determine, the results suggest the importance of individual audit partners in influencing audit reporting decisions. Therefore, current regulations in both the US and EU to identify the individual partner’s identity could potentially offer valuable information to market participants.

    Citation:

    Knechel, W. R., A. Vanstaelen, and M. Zerni. 2015. Does the Identity of Engagement Partners Matter? An Analysis of Audit Partner Reporting Decisions. Contemporary Accounting Research 32 (4):1443-1478.

    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:

    Current debate exists as to whether requiring individual auditor identification would enhance audit quality and, if so, whether investors understand and respond to these differences. This study provides empirical evidence to support the assertions that:

    1. Reporting style (i.e. consistently conservative or aggressive reporting) is an individual partner attribute that systematically differs between partners.  
    2. Investors understand and respond to these differences when assessing a company’s risk.

    This study is especially relevant given both the EU’s decade old requirement to disclosure of audit engagement partner and the recent, similar PCAOB requirement that US audit partners do the same.

    Design/Method/ Approach:

    The authors use archival methods. They acquired panel data between 2001  2008 of the total clienteles of individual Big 4 audit partners of statutory audits for small, private companies in Sweden. This excludes non-Big 4 auditors and joint auditors.

    Findings:

    In general, the frequency of Type I and II reporting errors is correlated over time for an individual partner both (1) across time for the same client and (2) between clients. As such, aggressive or conservative accounting appears to be a systematic partner attribute. Regarding investors, they appear to understand that partner reporting style is systematic across time and between clients and penalize firms audited by partners with a history of aggressive reporting via higher interest rates, lower credit ratings, and higher credit/insolvency risk. These results are, generally, economically significant.

    More specific results include:  

    • Predictive ability of both accruals and cash flows on future OCFs are lower when prior reporting errors of either Type have previously occurred.
    • Prior aggressive reporting results in lower persistence of current accrual estimates.  
    • Type I (Type II) reporting errors are negatively (positively) associated with abnormal accruals.
    • Conservative accrual reporting is positively (negatively) associated with Type I (Type II) reporting errors in all settings. Aggressive accrual reporting is positively (negatively) associated with Type II (Type I) reporting errors in low-risk settings.  
    • Clients of partners with aggressive reporting style have higher implicit interest rates, lower credit ratings, higher assessed insolvency risk, and lower Tobin’s Q. Conservative reporting styles has no effect on these credit measures.  
    • Past partner reporting style differentially affects market reaction to a new Going Concern Opinion.
    • Past partner Type II reporting errors has an economically marginally-significant effect on insolvency risk.
    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, Going Concern Decisions, Impact of New Accounting Pronouncements
  • Jennifer M Mueller-Phillips
    The Impact of Audit Evidence Documentation on Jurors’ N...
    research summary posted January 19, 2016 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards, 09.0 Auditor Judgment, 09.02 Documentation Specificity 
    Title:
    The Impact of Audit Evidence Documentation on Jurors’ Negligence Verdicts and Damage Awards.
    Practical Implications:

    This study suggests that audit workpaper documentation decisions can significantly influence juror negligence verdicts and damage awards in cases where the auditor faces litigation. This is a particularly important finding for audit firms as this is an aspect of the litigation process that the auditor can directly control prior to facing litigation by considering how jurors might perceive this information when designing documentation procedures.

    Citation:

    Backof, A. G. 2015. The Impact of Audit Evidence Documentation on Jurors’ Negligence Verdicts and Damage Awards. The Accounting Review 90 (6): 2177-2204.

    Keywords:
    audit documentation, auditor liability, culpable control model, damage awards
    Purpose of the Study:

    During litigation proceedings, audit workpaper documentation represents a key piece of evidence supporting the quality of audit work because these documents are not only presented to jurors and scrutinized by experts during the trial, but are also available for juror review during deliberations. Because of its prominence during trials, the method and information contained in audit workpaper documentation has the potential to influence juror negligence verdicts and damage awards. This study examines how variation in audit documentation decisions related to the linkage of specific audit procedures performed to risks of misstatement for individual-level accounts, along with the inclusion of facts inconsistent with the auditor’s professional judgment influenced subsequent juror decisions. In particular, the study addresses the following research objectives:

    • Whether the inclusion of the auditor’s consideration of alternative accounting treatments in workpaper documentation influences juror perceptions of the foreseeability of the misstatement.
    • Whether the inclusion of documentation which directly links account-level risks of misstatement to specific audit procedures performed increases the juror’s evaluations of auditor intentions to conduct a quality risk-based audit.  
    • Whether differences in workpaper documentation influence juror evaluations of auditor negligence and subsequent damage assessments.
    Design/Method/ Approach:

    The research evidence was collected utilizing a group of participants whose characteristics mimicked that of an average jury pool. Participants listened to a 28-minute audio recording of a negligence lawsuit, and then received a written transcript of the trial along with copies of the audit workpapers entered into evidence during the trial. Participants were instructed to assume the role of a juror in order to evaluate whether the audit firm was negligent and to determine an appropriate level of damages to assess the audit firm.

    Findings:
    • Jurors assess the likelihood of auditor negligence as higher when the auditor includes in their workpaper documentation facts inconsistent with their professional judgments. This is the case because jurors assess the misstatement as more foreseeable when this information is available in the workpaper documentation.  
    • When the workpaper documentation includes direct links between identified account-specific risks of misstatement and specific audit procedures performed, jurors do not view auditor’s intentions to conduct a quality risk-based audit as higher. Subsequently, jurors do not view the auditor’s likelihood of negligence to be lower when this information is included in workpaper documentation.
    • Workpaper documentation which includes direct links between identified account-specific risks of misstatement and specific audit procedures performed does not significantly influence the amount of damages awarded by jurors when facts inconsistent with the auditor’s professional judgments are not additionally included in the documentation. However, when this additional information is present, jurors award lower damages when the documentation does include direct links between identified account-specific risks of misstatement and specific audit procedures performed.
    Category:
    Auditor Judgment, Standard Setting
    Sub-category:
    Changes in Audit Standards, Documentation Specificity
  • Jennifer M Mueller-Phillips
    Who Did the Audit? Audit Quality and Disclosures of Other...
    research summary posted October 19, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards, 11.0 Audit Quality and Quality Control 
    Title:
    Who Did the Audit? Audit Quality and Disclosures of Other Audit Participants in PCAOB Filings.
    Practical Implications:

    The study results are important to regulators and audit practitioners as they show the differential audit quality for participating auditors used in issuer audits. The results show that audit quality declines when audit engagements use participating auditors that are not experienced in auditing SEC issuers. This indicates that public disclosure of the principal and participating auditors in the audit report can provide useful information to evaluate audit quality.  

    Citation:

    Dee, C.C., A. Lulseged, and T. Zhang. 2015. Who Did the Audit? Audit Quality and Disclosures of Other Audit Participants in PCAOB Filings. The Accounting Review 90 (5): 1939-1967.

    Keywords:
    PCAOB, audit quality, earnings quality, other audit participants
    Purpose of the Study:

    The Public Company Accounting Oversight Board (PCAOB) introduced in 2011 and re-proposed in 2013, an auditing standard that would require audit reports of SEC issuers to disclose participants in the audit other than the principal auditor. The PCAOB introduced the proposal to provide investors with full disclosure of the participants in the audit process, including affiliated firms of international audit firm networks. The underlying assumption of the proposed standard is that participating auditor involvement may negatively effect audit quality.   However, using a participating auditor may not effect audit quality due to the market pressure on the principal auditor to maintain high audit quality. The authors investigate whether the proposed standard would provide market participants with additional information to evaluate audit quality.

    The paper addresses whether there is a difference in audit quality between issuer audits with and without participating auditors. Using publicly available PCAOB filings, the authors identify an issuer sample that uses a participating auditor and a control sample that does not. The use of PCAOB filings allows the authors to identify participating auditors with limited experience in serving as a principal auditor for an issuer audit. The authors believe these auditors have a higher likelihood of low audit quality. If audit quality is not reduced using this auditor population, there is lower likelihood that audit quality reductions would occur in an expanded auditor sample. However, if audit quality is reduced, it would provide evidence that the proposed standard would benefit market participants in assessing audit quality.   

    Design/Method/ Approach:

    The authors employ an archival research methodology in this study and obtain PCAOB Form 2 filings from 2010-2012 to identify the sample. The study includes an experimental sample (use a participating auditor) and a control sample (does not use a participating auditor). To assess differences in audit quality, the authors use four proxies: cumulative abnormal returns, earnings response coefficients, discretionary accruals, and audit fees.

    Findings:
    • The authors find that cumulative abnormal returns are significantly negative in the one, two, and three days after the public disclosure of a participating auditor for the experimental sample. For the control sample, the cumulative abnormal returns are not significantly different from zero. This finding shows that the initial disclosure of the participating auditor is informative to the market.
    • In the earnings response coefficient analysis, the market valuation of earnings surprises decreases in the quarters subsequent to the public disclosure of the participating auditor. 
    • When evaluating discretionary accruals, the authors find that performance-adjusted discretionary accruals are higher for the experimental sample issuers when compared to the control sample. 
    • Using audit fees as a measure of audit quality, the results did not show a reduction in audit fees for the experimental sample issuers compared to the control sample.
    • Overall, the results show that the public disclosure of SEC issuer engagements with participating auditors provides the market with information that is beneficial in assessing audit quality.  
       
    Category:
    Audit Quality & Quality Control, Standard Setting
    Sub-category:
    Changes in Audit Standards

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