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.

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. 

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.  

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. 

• 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.

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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.

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.

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.

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.

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.

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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.

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.

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.

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.

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.
 

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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).

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.

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.

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.

• 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.

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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.

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

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.

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. 

• 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.

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