Auditing Section Research Summaries Space

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  • Jennifer M Mueller-Phillips
    Fraud Risk Awareness and the Likelihood of Audit Enforcement...
    research summary posted October 12, 2016 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.09 Litigation Risk, 12.0 Accountants’ Reports and Reporting, 12.01 Going Concern Decisions 
    Title:
    Fraud Risk Awareness and the Likelihood of Audit Enforcement Actions
    Practical Implications:

     This paper sheds light on the implications of a going concern opinion, specifically in the context of litigation against the auditor. While prior research has established that a going concern opinion reduces the likelihood of shareholder litigation in bankruptcy proceedings, this study shows that going concern opinions potentially open up the auditor to increased SEC litigation if the financial statements are found to be fraudulent. The authors suggest this should be taken into consideration when auditors are determining the extent of necessary documentation for fraud risk assessment, especially when the client is likely receiving a going concern opinion.

    Citation:

     Eutsler, J., E.B. Nickell, S.W. Robb. 2016. Fraud Risk Awareness and the Likelihood of Audit Enforcement Action. Accounting Horizons 30 (3): 379-392.

    Purpose of the Study:

     The authors aim to examine whether documented awareness of fraud risk affects the likelihood of SEC enforcement action against the auditor in cases of undetected fraud. They acknowledge that financial distress provides incentive for fraudulent activity, and therefore consider the possibility that a going concern represents information that may affect SEC assessment of the auditor’s fraud risk assessment. This study aims to address concern that regulator investigation of audited fraudulent financials may be biased by economic factors or other information that was unknown at the time of the audit. This concern contradicts prior research, which shows that going concern opinions deter litigation against auditors when the client subsequently goes bankrupt.

    Design/Method/ Approach:

     The authors review Accounting and Auditing Enforcement Releases (AAERs) issued by the SEC for companies alleged to have engaged in fraudulent activity between January 1995 and August 2012. They identify 314 instances of alleged fraud, of which 34 received a going concern opinion and 54 had auditor-involved sanctions.

    Findings:

     The authors find that awareness of fraud risk—specifically noting a going concern issue—exposes the auditor to additional scrutiny of regulators when the financials are subsequently found to be fraudulent. Additionally, this paper points out an interesting contrast in the implications of a going concern opinion. Prior research has shown that auditors are less likely to be sued when a client with a going concern opinion subsequently goes into bankruptcy; however, the results in this paper show that auditors giving a going concern opinion are more likely to be sued when those financial statements are subsequently found to be fraudulent.

    Category:
    Accountants' Reporting, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Going Concern Decisions, Litigation Risk
  • Jennifer M Mueller-Phillips
    Are Juries More Likely to Second-Guess Auditors Under...
    research summary posted August 31, 2016 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.09 Litigation Risk, 12.0 Accountants’ Reports and Reporting, 12.04 Investigations, 15.0 International Matters, 15.02 IFRS Changes – Impacts 
    Title:
    Are Juries More Likely to Second-Guess Auditors Under Imprecise Accounting Standards?
    Practical Implications:

     The results of this study have implications for regulatory agencies and standard-setting bodies. As regulators contemplate whether to mandate IFRS and standard setters determine the level of implementation guidance for new standards, the litigation consequences of standard precision are an important consideration. Further, these results highlight the importance of regulators developing ways for jurors to evaluate audit judgments under imprecise standards, especially in industries and areas without precise industry reporting norms. Prior discussion on this issue has focused on how professional judgment frameworks are necessary to protect auditors and their clients from second guessing. This study suggests that judgments frameworks, if effective, may help protect auditors who make conservative judgments and also help hold auditors accountable for overly aggressive judgments.

    Citation:

     Kadous, K., and M. Mercer. 2016. Are Juries More Likely to Second-Guess Auditors Under Imprecise Accounting Standards? Auditing: A Journal of Practice and Theory 35 (2): 101-117.

    Keywords:
    audit litigation, standard precision, principles versus rules, second-guessing, jury decision making, IFRS
    Purpose of the Study:

    U.S. Generally Accepted Accounting Principles (GAAP) are generally viewed as more precise than International Financial Reporting Standards (IFRS) in that the former tend to contain more detail about implementation and compliance than the latter. Convergence efforts between U.S. GAAP and IFRS are on going, and have led to greater imprecision in U.S. accounting standards in areas such as lease accounting and revenue recognition. These imprecise standards require increased professional judgment by managers and auditors, which has led to concern that the adoption of less precise standards will result in more second-guessing of auditor judgments by juries and thus greater legal liability. This study seeks to address this concern and examines whether juries are more likely to second-guess auditors’ judgments under an imprecise accounting standard compared to a precise accounting standard. 

    Design/Method/ Approach:

    The authors recruited undergraduate students enrolled in introductory accounting courses at a large university as participants for this study. Two administrations were conducted with the students who participated in a simulated case that lasted 45 minutes during their accounting lab session. Participants acted as jurors in an auditor negligence case involving revenue recognition and were given information related to SFAS No. 66 (Real Estate) to help in their evaluation. The authors manipulated the precision of the accounting guidance as either precise or imprecise. The aggressiveness of the client’s reporting choice was manipulated as either aggressive or conservative.  

    Findings:

    The results of this experiment suggest that auditors’ fear about second-guessing by juries under imprecise accounting standards is warranted. Under an imprecise standard, conservative accounting choices are more likely to be called into question and result in negligence verdicts, ex post.

    • When the client’s reporting is conservative, there appears to be more second guessing of auditor judgments under an imprecise standard compared to a precise standard.
    • When the auditor allows aggressive client reporting, there appears to be less second guessing of auditor judgments under an imprecise standard compared to a precise standard.

    These findings indicate that rather than being overly harsh, juries appear to be overly lenient when auditors allow aggressive accounting under an imprecise standard. A lack of precision appears to make it more difficult for juries to identify whether an auditor’s judgment was reasonable or unreasonable. 

    Category:
    Accountants' Reporting, International Matters, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    IFRS Changes – Impacts, Investigations, Litigation Risk
  • Jennifer M Mueller-Phillips
    The Effect of Client Lies on Auditor Memory Resistance and...
    research summary posted August 30, 2016 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism 
    Title:
    The Effect of Client Lies on Auditor Memory Resistance and False Memory Acceptance
    Practical Implications:

      These results have important implications for audit practice, as the author shows that the specific techniques used by auditors to gather evidence for building knowledge structures are essential to resisting client influence. This paper also shows that in spite of the responsibility of understanding complex business environments and any resulting indicators, evidence finds that even experienced decision makers have difficulty learning in dynamically complex environments. Improving judgment and decision making in these settings requires enhancing auditors’ development of systems-based mental models.

    Citation:

    Brewster, B. 2016. The Effect of Client Lies on Auditor Memory Resistance and False memory Acceptance. Auditing: A Journal of Practice and Theory 35 (3): 33-50.

    Keywords:
    misinformation effect, memory errors, business risk, and analytical procedures.
    Purpose of the Study:

    Professional auditing standards direct auditors to critically evaluate and verify all client-provided information, in the hope that auditors will resist any client lies that cannot be directly corroborated. Traditional psychology research supports this conjecture because warning individuals about the ambitions of communicators typically bolsters resistance via a suspicious mindset. However, the author believes that features of the audit environment create scenarios in which the auditor is susceptible to client lies, especially blatantly incorrect ones. In particular, if auditors are unable to refute client lies through existing evidence-related memories, they will succumb to a memory error called the misinformation effect. If correct, this would mean that after exposure to a client lie, an auditor’s cognitive processing is tainted, and he/she would gravitate toward the client-provided false memories instead of his/her own true evidence-based memories when subsequently retrieving related information. As a result, the author examines the conditions that moderate auditor resistance toward and susceptibility to believing client-provided lies. 

    Design/Method/ Approach:

    The author completed a study with professional auditors from an international accounting firm with an average work experience of 44 months. He asked them to complete an experimental task, holding one group static and allowing the other to be dynamic. 

    Findings:
    • The author finds no significant differences between dynamic or static KPI understanding type conditions when participants evaluated their comprehension of the industry overview and the tutorial.
    • The author finds that auditors who develop poorly constructed memories of industry-related evidence will favor falsely implanted client communication more than their own real memories during recall.
    • The author finds that the data shows that auditors with better developed, more rigid, and more accessible memories are resistant to favoring falsely implanted client communication more than their own memories and are more likely to identify the client-provided falsehood.
    • The author finds that those who succumbed to the misinformation effect were equally as confident in their own real memories as the auditors who resisted.
    • The author’s findings are consistent with prior research that speculated that auditors with insufficient mental models regarding complex evidence are more likely to have their knowledge manipulated by the client.
    Category:
    Auditing Procedures - Nature - Timing and Extent, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Auditors’ Professional Skepticism
  • Jennifer M Mueller-Phillips
    The Role of Account Subjectivity and Risk of Material...
    research summary posted July 18, 2016 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.05 Assessing Risk of Material Misstatement, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.11 Reliance on Internal Auditors 
    Title:
    The Role of Account Subjectivity and Risk of Material Misstatement on Auditors’ Internal Audit Reliance Judgments
    Practical Implications:

    This paper suggests that the relationship between account subjectivity and usage of internal audit depends on the relative risk of misstatement.  This complex relationship has not been shown in academic literature, nor is it highlighted in audit standards.  More specifically, at lower levels of risk of misstatement, increases in subjectivity have no influence on the reliance of internal audit.  At moderate risk levels the extent of internal audit reliance increases with subjectivity of the account.  At high levels of misstatement internal audit reliance decreases with account subjectivity.  This study provides insight into the decision criteria for internal audit reliance and highlight where internal audit usage maybe more prevalent, as well as were further audit guidance may be beneficial.

    Citation:

    Bhattacharjee, S., M.J. Maletta, K.K. Moreno. 2016. The Role of Account Subjectivity and Risk of Material Misstatement on Auditors’ Internal Audit Reliance Judgments. Accounting Horizons 30 (2): 225-238.

    Keywords:
    Internal audit; account subjectivity; material misstatement risk
    Purpose of the Study:

    Reliance on Internal Audit has become an important element of the external audit.  Use of Internal Audit can play a significant role in reducing audit costs without sacrificing audit quality.  However, the extent of usage of Internal Audit has been shown to be influenced by inherent risk, control risk, and the subjectivity of audit tasks.  This paper looks at the interaction between risk assessment and subjectivity to provide insight into the complexities associated with the usage of internal audit.  The authors aim to dive deeper into the analysis of internal audit usage, expanding on the dichotomous “low or high risk” assessment by investigating moderate risk scenarios.  By analyzing these relationships with a field-based questionnaire, the authors present documentation of how real decisions are based on a complex assessment of the role of internal auditors.

    Design/Method/ Approach:

    The authors conducted a field-based questionnaire using 68 auditors from a Big 4 firm.  These auditors were located in the U.S., but came from different geographic areas.  They have an average experience of 46 months and represented 15 different industry specializations.  The auditors were asked to choose one public company client and respond to questions regarding demographic information, client characteristics, external audit team characteristics, client misstatement risk, account subjectivity, client internal audit structure, and external audit assessment of internal audit usage.

    Findings:
    • The authors find that auditors’ reliance decisions involve an interaction between material misstatement risk and account area subjectivity. 
    • The authors find that incremental increases in account subjectivity have no effect on extent of internal audit reliance when misstatement risk is assessed at lower levels.  At moderate levels of misstatement risk, however, account subjectivity is positively associated with use of internal auditors.  This suggests that moderate misstatement risk creates opportunities for auditors to benefit from increasing internal audit utilization without offsetting impairments to audit effectiveness.  At higher levels of misstatement risk, incremental increases in account subjectivity have a negative association with external audit usage.
    Category:
    Auditing Procedures - Nature - Timing and Extent, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Assessing Risk of Material Misstatement, Reliance on Internal Auditors
  • 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
    Facilitating Brainstorming: Impact of Task Representation on...
    research summary posted May 31, 2016 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.09 Group Decision-Making, 06.0 Risk and Risk Management, Including Fraud Risk, 06.08 SAS No. 99 Brainstorming – effectiveness, 09.0 Auditor Judgment 
    Title:
    Facilitating Brainstorming: Impact of Task Representation on Auditors’ Identification of Potential Frauds
    Practical Implications:

    The results of this study are important due to the requirement of members of the audit engagement team to identify potential fraud. The results of this study identify a method of improving auditor performance of identifying potential frauds at both the individual brainstorming stage and the subsequent group brainstorming stage. Because the effectiveness of the group brainstorming session is dependent on the quality and quantity of inputs from the individual auditor brainstorming sessions, the present study suggests a simple intervention regarding task representation to improve the performance of these inputs. Specifically, auditors considering potential fraud categories (e.g., revenue recognition, inventory, etc.) one by one, as opposed to all at once, identify a greater quantity and quality of potential frauds. By improving both the individual and group brainstorming stages, auditors are less likely to overlook potential fraud.

    Citation:

    Chen, W., A. S. Khalifa, and K. T. Trotman. 2015. Facilitating brainstorming: Impact of task representation on auditors’ identification of potential frauds. Auditing: A Journal of Practice & Theory 34 (3): 1-22.

    Keywords:
    Brainstorming; task representation; fraud identification; fraud risk assessments
    Purpose of the Study:

    Members of audit engagement teams are required by auditing standards to discuss the client’s susceptibility to potential frauds, usually referred to as “brainstorming.” The purpose of this study is to examine individual auditor brainstorming prior to the brainstorming session of the group. The specific preparation stage prior to a group brainstorming session is an important input to the group session itself and may alter the effectiveness of the subsequent group brainstorming session. The authors of the study predict that a sequential unpacking approach (consideration of fraud categories one by one) to identifying potential fraud improves the quantity and quality of potential frauds identified at both the individual brainstorming stage and the group brainstorming stage.

    Design/Method/ Approach:

    The experimental evidence was collected prior to 2013 at either the Melbourne or the Sydney office of a Big 4 firm in Australia. The experimental design was a 2 x 1 between-subjects design with task representation manipulated as sequential unpacking (categories considered one by one) or simultaneous unpacking (categories considered at once). Auditor participants included seniors, assistant managers, and managers with an overall average of 4.83 years of audit experience.

    Findings:
    • The authors find that sequential unpacking improves auditor performance at the individual brainstorming stage compared to simultaneous unpacking.
    • The authors find that auditors in the sequential unpacking treatment tend to distribute identified potential frauds across categories more evenly than those in the simultaneous unpacking treatment.
    • The authors find the benefits of sequential unpacking to extend beyond individual brainstorming to the group brainstorming session.
    • The authors find that the perceived likelihood of fraud is lower for auditors in the sequential unpacking treatment than those in the simultaneous unpacking treatment.
    Category:
    Audit Team Composition, Auditor Judgment, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Group Decision-Making, SAS No. 99 Brainstorming – effectiveness
  • Jennifer M Mueller-Phillips
    Auditing Related Party Transactions: A Literature Overview...
    research summary posted March 31, 2016 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment, 13.0 Governance 
    Title:
    Auditing Related Party Transactions: A Literature Overview and Research Synthesis.
    Practical Implications:

    In this paper, the authors link academic research and other pertinent literature to issues raised in the PCAOB briefing paper on auditing related party transactions. Overall, the authors believe that the findings in academic research and the significance of related party transactions in recent prominent fraud cases are consistent with the PCAOB’s reconsideration of auditing of related party transactions.

    Citation:

    Gordon, E. A., E. Henry, T. J. Louwers, and B. J. Reed. 2007. Auditing Related Party Transactions: A Literature Overview and Research Synthesis. Accounting Horizons 21 (1): 81-102.

    Keywords:
    related party transactions, arm’s length transactions, corporate governance, financial disclosure
    Purpose of the Study:

    Related party transactions are difficult to audit for a number of reasons.  

    • Related parties and transactions warranting examination may be difficult to identify.
    • Auditors must rely on management to provide detailed information on related parties and related party transactions.
    • Despite the increased internal control requirements imposed by the Sarbanes-Oxley Act of 2002, internal controls have difficulty tracking related party transactions. This difficulty arises because of the wide variety of parties and types of transactions and because some transactions may not be given accounting recognition, e.g., receipt of free services from a related party.

    The authors examine research relevant to auditing related party transactions to contribute to the PCAOB project on this topic and to provide other policy makers, auditors, and academics with an overview of relevant literature. Specifically, they report on the challenges associated with the identification, examination, and disclosure of related party transactions. Additionally, they address issues and research evidence related to nondisclosure and reliance on management assertions, risk assessment, materiality, fraud detection, the effect of related party transactions on corporate governance, and international auditing issues.

    Design/Method/ Approach:

    To prepare PCAOB Standing Advisory Group (SAG) members for discussion of these issues, the PCAOB staff prepared a briefing paper posing 13 broad questions for consideration by the SAG. The authors contribute to the PCAOB project by reviewing pertinent literature and providing appropriate insights from academic research relevant to auditing related party transactions. They highlight instances where existing research addresses the questions raised in the briefing paper. 

    Findings:

    The primary conclusions from the literature review are:

    • The definition of related parties varies across regulatory bodies.
    • Related party transaction disclosures are present in the Securities and Exchange Commission (SEC) filings of most publicly held companies.
    • While listed as a fraud risk factor in authoritative literature, related party transactions do not appear to be more common in companies committing fraud than in companies in which no fraud has been detected. Accordingly, but in opposition to authoritative guidance, survey research indicates that the presence of related party transactions alone does not appear to significantly increase external auditors’ client risk assessments.
    • Although related party transactions in isolation may not be a significant indicator of fraud, when fraud does exist, the presence of related party transactions is one of the top reasons cited for audit failures. The willingness of auditors to tolerate greater misstatement in footnotes may help partially explain this apparent contradiction.
    • Related party transactions should be assessed in the context of the company’s overall governance structure, particularly given the importance of managements’ assertions about the existence and nature of these transactions.
    • Related party transactions often impact the corporate governance of the company by creating gray directors, i.e., directors who are neither insiders nor totally independent of the company. Whether gray directors differentially impact a board’s monitoring effectiveness may depend on the specific board committee (audit, compensation) or may depend on the specific type of gray director.
    Category:
    Governance, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Fraud Risk Assessment
  • Jennifer M Mueller-Phillips
    Financial Statement Fraud: Insights from the Academic...
    research summary posted March 31, 2016 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment 
    Title:
    Financial Statement Fraud: Insights from the Academic Literature.
    Practical Implications:

    The research summarized above will provide valuable input to the accounting profession and standard-setters, and there are several areas in which additional research is needed. Despite existing auditing standards and authoritative guidance on an auditor’s responsibility for discovering and reporting financial statement fraud, there remains an expectation gap between what investors believe the auditor’s responsibility should be in detecting financial fraud and what auditors are willing to assume as responsibility in this area.

    Citation:

    Hogan, C. E., Z. Rezaee, J. A. Riley, and U. K. Velury. 2008. Financial Statement Fraud: Insights from the Academic Literature. Auditing: A Journal of Practice & Theory 27 (2): 231-252.

    Keywords:
    audit planning, audit procedures, financial statement fraud, fraud detection, fraud triangle, high-risk audit areas
    Purpose of the Study:

    Over the past several decades, a significant amount of academic research has been focused on fraud in general and financial statement fraud in particular. These studies address the trends, determinants, and consequences of financial fraud, as well as the responsibility for preventing, detecting, and remediating that fraud. To facilitate the development of auditing standards and to inform regulators of insights from the academic auditing literature, the Auditing Section of the American Accounting Association (AAA) has decided to develop a series of literature syntheses for the Public Company Accounting Oversight Board (PCAOB). The authors summarize relevant academic research findings and to offer insights and conclusions relevant to academics, standard setters, and practitioners. They discuss the characteristics of firms committing financial statement fraud, as identified in the literature, and research related to the fraud triangle. The authors then discuss research related to the procedures and abilities of auditors to detect fraud, and how fraud risk assessments impact audit planning and testing. In addition, they discuss several “high risk” areas and other issues as identified by the PCAOB. 

    Design/Method/ Approach:

    Statement on Auditing Standards (SAS) No. 99, Consideration of Fraud in a Financial Statement Audit, states that three conditions are generally present when fraud occurs. These conditions collectively are known as the fraud triangle. The authors reviewed the academic findings related to the presence of these conditions in cases of financial statement fraud. This helps provide a basis for understanding the development of the questionnaires and checklists in SAS No. 82 and SAS No. 99.

    Findings:

    The primary conclusions from the review of the literature on fraudulent financial reporting are as follows.

    • There is a significant amount of literature on the characteristics of fraud firms, providing support for the fraud triangle classifications and the list of “red flags” used in both SAS No. 82 and SAS No. 99.
    • Evidence on the usefulness of checklists as a fraud detection tool is mixed. While there is some research that supports the use of checklists as a decision tool, there is more evidence that suggests the use of checklists is dysfunctional in that auditors fail to expand their thinking beyond the checklist.
    • Research supports a need by auditors to align management incentives to the types of risks that should be evaluated as high.
    • There is evidence that suggests auditors do not make significant adjustments to audit plans as a result of higher fraud risk assessments.
    • Research supports further exploration into the use of additional fraud detection tools such as regression analysis, the use of nonfinancial information, digital analysis, and neural network models.
    • Research supports the identification of revenue recognition, significant or unusual accruals, and related parties as areas with increased risk of fraudulent financial reporting activity.
    Category:
    Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Fraud Risk Assessment
  • Jennifer M Mueller-Phillips
    Client business models, process business risks and the risk...
    research summary posted March 22, 2016 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.05 Assessing Risk of Material Misstatement 
    Title:
    Client business models, process business risks and the risk of material misstatement of revenue.
    Practical Implications:

    The study provides evidence on the extent to which auditors can implement the theory of business risk auditing, including the linkages between business strategies, business models, assessment of process-level business risks and the RMM of revenue. The study provides new insights on the ability of auditors to use non-financial information effectively to assess process-level business risks and relate them to RMM of revenue. The study also provides evidence that staff auditors can distinguish between many of the subtle and important business risk implications of the two different types of business strategies  product differentiation and operational excellence.

    Citation:

    Wright, W. F. 2016. Client business models, process business risks and the risk of material misstatement of revenue. Accounting, Organizations and Society 48: 43-55.

    Keywords:
    Business risk auditing, risk-based auditing, risk assessment, analytic procedures, strategic management, business models
    Purpose of the Study:

    This study examines the theory of business risk auditing. Regulators, researchers, and practitioners indicate the importance of understanding the operation of a client’s business and its competitive environment to achieve an effective audit. A valid understanding of a company’s objectives and strategies and those related to the business risks is necessary to interpret results from analytical procedures and engage in effective professional skepticism for management’s assertions. The author focuses process-level (instead of entity-level) business risk assessment and tests for relationships between risk assessments given differing business strategies (product differentiation versus operational excellence) and the fundamental operating processes of a manufacturing firm. Process-specific business risks are important because they can cause misstatements and can cause entity-level business risks.

    Design/Method/ Approach:

    Experimental data was collected from accounting Masters students, a few weeks prior to their graduation. Evidence was collected prior to August 15, 2014. The participants read an introduction on auditor’s risk assessment context then a case describing a client’s strategic orientation, prevailing conditions and competition in the industry, details on the operation of each of the client’s five primary business processes, and the client’s current unaudited financial results with audited results from prior years. Participants provided judgments on which business strategy applied, assessed the performed and associated business risk of each of the five processes, and reported three risk of material misstatement (RMM) assessments.

    Findings:

    Overall, participants indicate business risk and RMM judgments that reflect significant understanding of the subtleties of business risk assessment. Specifically:

    • Participants provided process-specific business risk judgments consistent with RMM judgments for the critical processes of the product differentiation strategy.  
    • The process-specific judgments of business risk link the judgments related to the production process performance and the RMM of revenue.
    • When the three product generation processes were performing less well, participants correctly assessed the highest RMM of revenue.
    Category:
    Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Assessing Risk of Material Misstatement
  • Jennifer M Mueller-Phillips
    Construal instructions and professional skepticism in...
    research summary posted February 17, 2016 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.05 Assessing Risk of Material Misstatement, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism, 09.0 Auditor Judgment, 09.02 Documentation Specificity, 11.0 Audit Quality and Quality Control, 11.09 Evaluation of Evidence 
    Title:
    Construal instructions and professional skepticism in evaluating complex estimates.
    Practical Implications:

    The findings of this study have important implications for practice. Given the concern from the PCAOB regarding auditors’ lack of professional skepticism, this paper finds a mechanism to increase and improve the level of professional skepticism. In addition, the technique the author finds (providing high-level construal instructions) to auditors is “simple to use, inexpensive, and can easily be tailored for a firm’s specific needs or language

    Citation:

    Rasso, J.T. 2015. Construal instructions and professional skepticism in evaluating complex estimates. Accounting, Organizations and Society 46: 44-55.

    Keywords:
    professional skepticism, material misstatement, auditor judgment
    Purpose of the Study:

    The purpose of this study is to examine whether instructing auditors to create summaries of their audit findings during evidence evaluation in a broad/abstract manner (creating high-level construals) increases professional skepticism. Theoretical research suggests that using these high-level construals (or interpretations) helps individuals to process and understand numerous pieces information. The author suggests that this method could help auditors to ‘see the big picture’, which could help identify patterns in the evidence or possible material misstatements. Then, auditors may be more willing to gather and evaluate additional evidence to test for these potential problems.

    Design/Method/ Approach:

    Data for this paper was collected prior to April 2015 by using a computerized experiment. Auditors were used as participants in the study, and they averaged 5.4 years of audit experience (ranging from staff auditor to partner). In addition, ninety percent of the auditors had audited fair value estimates in the past.

    Findings:

    Auditors that were given documentation instructions to create high-level construals were more likely to exert professional skepticism compared to auditors given low-level construals (identifying specifically how an estimate could be fairly stated or misstated) or auditors given no instructions. Specifically, they spent more time collecting and evaluating audit evidence, collected more evidence, and rated the risk of the fair value estimate higher. These findings suggest that auditors using the high-level construal instructions process the information from their findings better and recognize a need to gather more evidence when given an incomplete amount of evidence. In addition, when evidence suggests that the fair value is overstated, auditors given the high-level construal instructions are more likely to realize the high risk.

    Category:
    Audit Quality & Quality Control, Auditing Procedures - Nature - Timing and Extent, Auditor Judgment, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Assessing Risk of Material Misstatement, Auditors’ Professional Skepticism, Documentation Specificity, Evaluation of Evidence

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