Auditing Section Research Summaries Space

A Database of Auditing Research - Building Bridges with Practice

This is a public Custom Hive  public

Posts

  • 1-10 of 10
  • 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
    Are Revisions to SFAS No. 5 Needed?
    research summary posted February 19, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.03 Impact of New Accounting Pronouncements 
    Title:
    Are Revisions to SFAS No. 5 Needed?
    Practical Implications:

    The findings generally support FASB (2008) Exposure Draft assertions that there is often insufficient timely information about litigation available to users. Specifically, the authors find that in an unexpectedly large proportion of the cases they investigate, companies do not disclose lawsuits until a loss occurs. The authors also find a relatively high incidence of companies not providing estimated losses or ranges of losses prior to resolution. For a substantial number of cases, accruals for estimated losses are not made (or are at least not disclosed) prior to the realization of the loss. Further, the authors find a relatively high degree of disclosure of the items called for in the FASB’s (2008) Exposure Draft, suggesting that users already demand at least some of them.

    For more information on this study, please contact Ray J. Pfeiffer.

    Citation:

    Desir, R., K. Fanning, and R. Pfeiffer. 2010. Are revisions to SFAS No. 5 needed? Accounting Horizons 24 (4): 525-545.

    Purpose of the Study:

    Setting financial reporting standards, like most regulatory activities, requires decision-making under uncertainty.  In a typical standard-setting issue, standard setters receive information — typically in the form of (often unsupported) assertions — that there is some deficiency in existing Generally Accepted Accounting Principles.  For those alleged deficiencies that exceed a threshold, the Board and Staff of the FASB initiate a standard-setting project.  In their work on projects, Board and Staff members must make difficult judgments about the nature of guidance likely to resolve the deficiency while anticipating any indirect consequences of the contemplated new guidance.

    Empirical academic research has the potential to play a useful role in the standard setting process to the extent that it can be used to reduce the inherent uncertainty facing Board members. Ex ante empirical evidence is particularly desirable because it enhances the likelihood that new guidance is actually warranted and that any new guidance achieves its intended purpose.

    This paper reports the findings of an example of such ex ante empirical research.  The issue in question is the allegation that firms tend to provide insufficient and insufficiently timely disclosures of contingent legal obligations.  This assertion was an explicit part of the rationale underlying the FASB’s Exposure Draft, “Disclosure of Loss Contingencies” (FASB 2008b).  This paper has two intended contributions:  (1) to report the findings of empirical research about the extent of the alleged insufficient disclosure problem; and (2) to serve as an example of how empirical academic research can be informative to the FASB Board and Staff.

    Design/Method/ Approach:

    The authors assembled a representative random sample of unfavorable settlements and adjudications of lawsuits in firms’ 10-Q and 10K filed during the first half of 2007. For each resolved lawsuit, the authors coded characteristics of the disclosure in the period of resolution as well as in all prior periods where disclosure existed prior to resolution. The descriptive evidence of litigation-related disclosure was from financial statement notes and required SEC disclosures in the 10K or 10-Q. 

    Findings:
    • The authors find that firms did not disclose 7.8% of the lawsuits in their sample in the quarter immediately preceding resolution, or in any period prior to resolution.
      • Twenty percent of the cases involving large losses (i.e., greater than 5% of pretax income) and 14% of the cases involving core operations fail to disclose the lawsuit in the quarter prior to resolution, suggesting this non-disclosure is not driven by lawsuits involving small dollar amounts or that are unrelated to core operations.
    • The authors find that firms provided estimates of the loss or range of possible loss (or explicitly stated that an estimate could not be made) in only 47.1% of the resolved lawsuits in their sample.
    • The authors find that companies accrue for such losses (or at least disclose that an accrual has been made) in 60.8% of cases.
      • For those cases that are larger (i.e., greater than 5% of pretax income) the accrual rate is 55%. For those cases related to core operations, the accrual rate is 59.1%, suggesting larger losses and losses related to core operations are not necessarily accrued more often.
    • The authors find a relatively high degree of disclosure of the items called for in the FASB’s (2008) Exposure Draft.
    Category:
    Standard Setting
    Sub-category:
    Impact of New Accounting Pronouncements
  • 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
    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
    Fair Value Measurements and Audit Fees: Evidence from the...
    research summary posted March 1, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.03 Impact of New Accounting Pronouncements, 11.0 Audit Quality and Quality Control, 11.04 Industry Experience 
    Title:
    Fair Value Measurements and Audit Fees: Evidence from the Banking Industry
    Practical Implications:

    Overall, the results support concerns expressed by some observers that greater use of fair value measurements for financial instruments will trigger increased audit fees. We believe our results validate the compliance cost concerns expressed by some preparers (i.e. higher audit fees), and provide interesting and timely evidence relevant to the ongoing debate regarding the increased use of fair value measurements for financial instruments (FASB 2010; ABA2010).

    For more information on this study, please contact Michael Ettredge.

    Citation:

    Ettredge, M. L., Xu, Y., & Yi, H. S. (2014). Fair value measurements and audit fees: evidence from the banking industry. Auditing: A Journal of Practice & Theory 33(3): 33-58.

    Keywords:
    audit fees, fair value measurements, FAS 157, ASC 820, banks
    Purpose of the Study:

    This study examines the association between audit fees and the proportions of fair-valued assets held by the sample of public U.S. bank holding companies. Motivated by claims that fair-valued assets are unusually difficult to audit (Bratten et al., 2013), we explore

    • whether audit fees are positively associated with the proportions of bank assets that are fair-valued, and whether this relation is more evident for the least verifiable (Level 3) fair-valued assets. 
    • whether auditors who are bank industry specialists charge more or less than other auditors to audit banks and, in particular, to audit fair-valued bank assets.

    Consistent with the view that audit risk and effort increase with the extent of fair-valued assets, we provide evidence that auditors charge more for higher proportions of assets held in the form of fair-valued assets. Furthermore, within fair-valued assets, the positive association between logged audit fees and the proportions of total assets that are fair-valued using Level 3 inputs is greater than its positive association with the proportions of total assets that are fair-valued using Level 1 or Level 2 inputs. We believe our results validate the compliance cost concerns expressed by some preparers (i.e. higher audit fees), and provide interesting and timely evidence relevant to the ongoing debate regarding the increased use of fair value measurements for financial instruments (FASB 2010; ABA2010). 

    Design/Method/ Approach:

    Our data cover the years 2008-2011 with 299 unique banks for our main tests.

    Findings:

    The paper documents that

    • the proportions of fair-valued assets held by banks are positively associated with audit fees.
    • The positive association between audit fees and the proportions of total assets that are fair-valued using Level 3 inputs is greater than its positive association with the proportions of total assets that are fair-valued using Level 1 or Level 2 inputs.
    • We also document that bank specialist auditors charge lower audit fees to bank clients on average, suggesting cost efficiencies passed to clients as lower fees. However, bank expert auditors charge more for auditing the proportions of total assets that are fair-valued. 
    Category:
    Audit Quality & Quality Control, Standard Setting
    Sub-category:
    Impact of New Accounting Pronouncements, Industry Expertise – Firm and Individual
  • Jennifer M Mueller-Phillips
    Investors’ Response to Revelations of Prior Uncorrected M...
    research summary posted April 1, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.03 Impact of New Accounting Pronouncements, 09.0 Auditor Judgment, 09.01 Audit Scope and Materiality Judgments, 11.0 Audit Quality and Quality Control, 12.0 Accountants’ Reports and Reporting, 12.05 Changes in Reporting Formats 
    Title:
    Investors’ Response to Revelations of Prior Uncorrected Misstatements
    Practical Implications:

    The results of this study are important in realizing the investor’s perception of audit quality as it relates to SAB No. 108 disclosures. Investors respond negatively to the quantification of prior period misstatement disclosures. The investor also distinguishes between misstatements that are waived by previous auditors and misstatements waived in the current year. Investors react negatively to misstatements that are disclosed in the current year. The investors also react to the importance of the client as it relates to the misstatements that are waived. Investors understand and react to the correlation between client importance, waived misstatements, and client retention. The results are important to understand that investors react to disclosures made under SAB No. 108.

    Citation:

    Omer, T. C., M. K. Shelley, and A. M. Thompson. 2012. Investors' Response to Revelations of Prior Uncorrected Misstatements. AUDITING: A Journal of Practice & Theory 31 (4):167-192.

    Keywords:
    materiality decisions; Staff Accounting Bulletin No. 108; client importance; audit quality; misstatements.
    Purpose of the Study:

    Staff Accounting Bulletin (SAB) No. 108 requires the disclosure of prior-period waived misstatements as well as the use of multiple methods of quantifying misstatements. The rollover method quantifies misstatement on a current year income statement effect, while the iron curtain method quantifies misstatement based on the balance sheet effect. The two methods can differ in terms of the resulting misstatement amounts. The authors of this study examine:

    • Investor responses to the new disclosures under SAB No. 108. Previously waived misstatements that were deemed immaterial by one quantifying method, but then deemed material by the other must now be disclosed.
    • Investor responses to misstatements waived by a predecessor auditor compared to misstatements waived by a current year auditor.
    • Investor perceptions of audit quality based on the new disclosures.
    • Whether client importance is a factor in relation to SAB No. 108 disclosures. 
    Design/Method/ Approach:

    The authors identified 420 firms that disclosed misstatements under SAB No. 108 using EDGAR and Morningstar Document Research. Of these firms, a sample of 272 firms were chosen to complete market return tests on the data. Multivariate regression analysis was employed on firm disclosures from filings made after November 15, 2006. 

    Findings:
    • The authors find that investors respond negatively to SAB No. 108 disclosures. The findings provide evidence that the information affects how the investor views the financial statement information and biases perceptions of audit quality.
    • The authors find that cumulative abnormal returns exist in relation to misstatements initially waived by current auditors. The findings suggest that investors react negatively to waived misstatements by auditors in the current year. Investors distinguish these misstatements from those of waived misstatements by predecessor auditors.
    • The authors find a negative trend of cumulative abnormal returns associated with the investor’s perception of client importance. The findings suggest that investors react according to the perception that misstatements are waived for important clients in order to retain their business. 
    Category:
    Accountants' Reporting, Audit Quality & Quality Control, Auditor Judgment, Standard Setting
    Sub-category:
    Audit Scope & Materiality Judgements, Changes in Reporting Formats, Changes in Reporting Formats, Impact of New Accounting Pronouncements
  • Jennifer M Mueller-Phillips
    The Impact of SFAS 133 on Income Smoothing by Banks through...
    research summary posted September 14, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.03 Impact of New Accounting Pronouncements 
    Title:
    The Impact of SFAS 133 on Income Smoothing by Banks through Loan Loss Provisions.
    Practical Implications:

    This study provides evidence on how SFAS 133 affected reporting behavior. While it is not possible to directly assess the extent to which banks might have used LLP to offset hedge ineffectiveness prior to SFAS 133, a variety of tests in this study collectively indicate that bank managers increase their reliance on discretionary LLP to counteract the undesirable effects of SFAS 133’s recognition requirements. The effects of SFAS 133 go beyond derivatives; SFAS 133 also altered the information content of a non-derivative financial statement component (i.e., LLP) and the pricing of that component in equity markets. The findings are particularly timely given the recent exposure draft on accounting for financial instruments.

    Citation:

    Kilic, E., G. J. Lobo, T. Ranasinghe, and K. Sivaramakrishnan. 2013. The Impact of SFAS 133 on Income Smoothing by Banks through Loan Loss Provisions. Accounting Review 88 (1): 233-260.

    Keywords:
    derivatives, hedging, income smoothing, loan loss provisions, SFAS 133
    Purpose of the Study:

    This study examines the impact of SFAS 133, Accounting for Derivative Instruments and Hedging Activities, on the reporting behavior of commercial banks and the informativeness of their financial statements. SFAS 133 changed accounting for derivatives substantially by forcing recognition of (1) all hedging derivatives at their fair values, and (2) any hedge ineffectiveness in income as it occurs. As a result, the hedging derivative gains/losses recognized in income by derivative user banks almost quadrupled following the adoption of SFAS 133, with as much as 20 percent of those gains/losses arising from ineffective hedging. Clearly, hedge ineffectiveness increases income volatility because gains and losses from hedges and hedged items are not offsetting.

    SFAS 133 would arguably inhibit the use of derivatives in smoothing income. This possibility raises at least two interesting research questions regarding the impact of SFAS 133 on the reporting behavior of managers, and the consequent impact on the informativeness of financial statements. In particular:

    1. Did firms using derivative instruments for hedging significantly alter their reporting behavior post-SFAS 133?
    2. Notwithstanding any changes in reporting behavior, by enacting SFAS 133, did the FASB achieve its intended purpose of making financial statements more transparent to users?
    Design/Method/ Approach:

    The authors obtain bank holding company financial data and derivative data from 10-K filings and FR Y-9C filings, and share price data from the CRSP data files. They restrict the pre-SFAS 133 sample period to fiscal years 1998, 1999, and 2000, and the post-SFAS 133 sample period to fiscal years 2001, 2002, and 2003. The authors use a final sample of 105 derivative-user banks. The sample of non-user banks includes 139 publicly traded banks that do not use hedging derivatives during the sample period.

    Findings:
    • Banks likely to be more affected by SFAS 133 achieved a greater degree of income smoothing from offsetting LLP following its adoption.
    • The positive association between discretionary LLP and market returns is significantly lower in the post-SFAS 133 period compared to the pre-SFAS 133 period for affected banks than for unaffected banks and for non-user banks.
    • The informativeness of LLP deteriorated for these banks subsequent to SFAS 133 (i.e., the association of LLP with future loan defaults and contemporaneous stock returns became weaker).
    • The authors do not find evidence that SFAS 133 altered the informativeness of hedging derivative gains/losses for bank holding companies. 
    • This study reinforces the notion that the efficacy of a given regulation cannot be assessed on a standalone basis without giving due consideration to its unintended consequences.
    Category:
    Standard Setting
    Sub-category:
    Impact of New Accounting Pronouncements
  • Jennifer M Mueller-Phillips
    The Strategic Effects of Auditing Standard No. 5 in a...
    research summary posted June 15, 2016 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.03 Impact of New Accounting Pronouncements, 06.0 Risk and Risk Management, Including Fraud Risk, 06.02 Fraud Risk Models 
    Title:
    The Strategic Effects of Auditing Standard No. 5 in a Multi-Location Setting
    Practical Implications:

     This paper examines how the auditor’s evaluation of internal control impacts substantive testing in a two-location setting with correlated internal control strengths. When control strengths are independent, internal control strength pairings have no effect on the manager’s probability choice to commit fraud or on the auditor’s substantive test effort. This study shows how the manager’s opportunity to commit fraud and informational characteristics of internal control tests impact the manager’s probability choice of fraud and the auditor’s choice of substantive test effort.

    Citation:

    Patterson, E.R. and J.R. Smith. 2016. The Strategic Effects of Auditing Standard No. 5 in a Multi-Location Setting. Auditing: A Journal of Practice and Theory 35 (1): 119-138. 

    Keywords:
    strategic auditing, multi-location auditing, and internal control testing
    Purpose of the Study:

    Auditing Standard No. 5, An Audit of Internal Control over Financial Reporting that is Integrated with an Audit of Financial Statements, provides guidance in the required audit of internal controls. The purpose of AS 5 is to reduce the burden of SOX-required control tests by integrating them into a risk-based approach to auditing. From an internal control perspective, fraud risk is considered to increase as controls weaken because weaker controls create an opportunity for a manager to commit fraud. However, the auditor’s risk assessments and resulting audit strategy must include anticipation of the manager’s strategic behavior, which depends on conjectures about the auditor’s strategy. This paper examines how a manger’s knowledge of internal control strengths and weaknesses across different locations affects the auditor’s testing strategy and the manager’s propensity to commit fraud. 

    Design/Method/ Approach:

    A two-stage model is created in which a manager oversees two locations and has the opportunity to commit fraud in either of the two locations alone, or at both locations simultaneously. Three situations are considered: no internal control testing, minimal internal control testing, and full internal control testing. 

    Findings:
    • The authors find that in their setting, the manager has a greater opportunity for fraud when he observes weak controls in both locations because this allows him to choose fraud in any of the locations, including choosing fraud in both locations at once.
    • The authors find that an increased opportunity to commit fraud does not always correspond to an increased fraud risk when the control risks are correlated because correlation alters the auditor’s perception of where fraud opportunities most likely occur, which leads to the manager choosing the probability of fraud for each control strength pairing.
    • The authors find that the average amount of substantive test effort decreases when the auditor tests controls while audit risk is unaffected; thus, control testing has the potential to reduce expected audit costs without negatively affecting audit risk. 
    Category:
    Risk & Risk Management - Including Fraud Risk, Standard Setting
    Sub-category:
    Fraud Risk Models, Impact of New Accounting Pronouncements
  • Jennifer M Mueller-Phillips
    Waves of Global Standardization: Small Practitioners’ R...
    research summary posted June 15, 2016 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.03 Impact of New Accounting Pronouncements 
    Title:
    Waves of Global Standardization: Small Practitioners’ Resilience and Intra-Professional Fragmentation within the Accounting Profession
    Practical Implications:

     At the empirical level, this analysis brings the impact of global standardization on local communities of small accounting practitioners to the fore. The authors have found that accounting and auditing research has neglected both small practitioners and the impact of resilience in accounting and auditing research. At the theoretical level, this paper is the first to mobilize the notion of resilience in accounting and auditing research. It is the hope of the authors that this study will lead to a qualitative study of the formation of small practitioners’ habitus – how they are socialized in taking up the role of docile actors who tend to be obedient to their profession’s formal authorities, highly skilled in technical thinking, and not too demanding in terms of requiring justifications.

    Citation:

    Durocher, S., Y. Gendron, and C. Picard. 2016. Waves of Global Standardization: Small Practitioners’ Resilience and Intra-Professional Fragmentation within the Accounting Profession. Auditing: A journal of Practice and Theory 35 (1): 65-88. 

    Keywords:
    globalization, intra-professional fragmentation, professional resilience, small practitioners, and standardization
    Purpose of the Study:

    As the forces of globalization prompt more and more countries to open their doors to foreign investment and as businesses themselves expand across borders, both the public and private sectors are increasingly recognizing the benefits of having a commonly understood financial reporting framework supported by strong globally accepted auditing standards.  These processes of globalization may seem beneficial and unproblematic from the view point of the standard setters, but that is not necessarily the case if one considers the small practitioners’ view point.  Despite being the majority of all practicing accountants, small practitioners often do not have the time or ability to send representatives to work in the administration of professional bodies or on special projects that inevitably set the standards of the profession.  These facts led the authors to their primary objective in writing this article.  The primary objective of this study is to examine how small practitioners, in the field of accountancy, perceive and react to the global standardization agenda.  This study also examines how globalization discourses are constructed and rendered practical in localities.  

    Design/Method/ Approach:

    The authors conducted 25 semi-structured interviews with 31 participants between December 2009 and July 2011. To generate variation, practitioners having up to 39 years of experience working in firms of various sizes were interviewed. 

    Findings:
    • Small practitioners almost unanimously believe that professional standards excessively reflect the context of large public companies audited by large accounting firms.
    • Small practitioners believe that most users of financial statements do not use or understand many footnote disclosures.
    • Many practitioners complain about having to fill out many irrelevant checklists and admit to their clients that useless information must be included in the clients’ financial statements.
    • One of the authors’ key findings is global standardization intensifying the extent of fragmentation within the accountancy community.
    • The authors find that, at the field level, global standards exacerbate the cleavage between large and small accounting firms.
    Category:
    Standard Setting
    Sub-category:
    Impact of New Accounting Pronouncements

Filter by Type

Filter by Tag