Auditing Section Research Summaries Space

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  • The Auditing Section
    Auditor Risk Assessment; Insights from the Academic...
    research summary posted April 12, 2012 by The Auditing Section, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment, 06.05 Assessing Risk of Material Misstatement, 06.08 SAS No. 99 Brainstorming – effectiveness 
    Title:
    Auditor Risk Assessment; Insights from the Academic Literature
    Practical Implications:

    This article provides a very informative summary of current research related to the risk assessment process that supports the audit.  By outlining both general audit risk insights as well as fraud risk insights, the authors provide a clear and informative summary that should be of use to any audit firm attempting to better understand the current theoretical and practical research related to this emerging area.  Finally, by utilizing the PCAOB questions, the discussion also provides insights directly relevant to the current regulatory process.

    Citation:

    Allen, R.D., D.R. Hermanson, T.M. Kozloski, and R.J. Ramsay. 2006.  Auditor Risk Assessment: Insights from the Academic Literature.  Accounting Horizons 20(2): 157-177.

    Keywords:
    Risk assessment; PCAOB risk assessment project; industry specialization, fraud risk assessment; audit risk model.
    Purpose of the Study:

    This paper summarizes insights from academic literature related to risk assessment in financial statement audits project.  Using the February 16, 2005 PCAOB Standing Advisory Group (SAG) briefing paper on risk assessments as the organizing framework, the authors provide a literature review of topics related to: business risk, inherent risk, control risk, fraud risk, linking risk assessment to subsequent testing, and the audit risk model. 

    Design/Method/ Approach:

    The authors organize the auditor risk assessment literature review around the PCAOB briefing paper’s ten questions.  While cknowledging that fraud risk is integral to the overall audit risk, the uthors separate audit risk and fraud risk in their responses to further acknowledge he special problems in identifying, assessing, and responding to fraud isk.  Therefore, for each question, the authors discuss general audit risk assessment issues first, followed by those ssues specific to fraud risk assessments.

    Findings:
    • While using a business process focus in assessing client risks appears to be an advantage in the audit, additional guidance for using this approach may be helpful to address the diverse approaches utilized by the firms.  Decision aids and analytical procedures may increase effectiveness.
    • Industry expertise and specialization are critical to effective risk assessment.
    • Considering fraud risks separately from misstatements due to error, brainstorming and strategic thinking about management’s efforts to commit and conceal fraud all enhance fraud risk assessment effectiveness.
    • Systems dynamics, a methodology for studying and managing complex feedback systems, may provide auditors a framework to assess potential risk.  Authors suggest further examination of this and models in other fields for use in the audit process would be beneficial.
    • Auditor fraud risk assessments may not be well calibrated to the presence of risk factors.  Evidence on the effectiveness of fraud risk decision aids is mixed.
    • Inherent risk assessments (a) often are not meaningfully applied to each assertion; (b) may be decreasing over time, possibly to promote audit efficiency; and, (c) sometimes are combined with control risk into one risk factor.
    • While auditors may respond to global factors (e.g., management integrity, corporate governance) during micro-level risk assessments, proper weighting of global factors is challenging in a fraud context.
    • Testing of and reliance on internal controls have increased markedly in recent years.
    • Limited research suggests subsequent audit testing is weakly positively related to assessed risks, thus supporting efforts to improve linkages.
    • While the audit risk model appears to be sound as a conceptual tool, there are some significant limitations as a mathematical equation. In particular, it does not consider the blurring of inherent risk and control risk, the risk of incorrect rejection, the quality of evidence, or inconsistencies that may exist with actual auditor judgments.

     

    Category:
    Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Fraud Risk Assessment, Assessing Risk of Material Misstatement, SAS No. 99 Brainstorming – effectiveness
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  • The Auditing Section
    Attention to Evidence of Aggressive Financial Reporting and...
    research summary posted May 7, 2012 by The Auditing Section, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism, 09.0 Auditor Judgment, 09.10 Prior Dispositions/Biases/Auditor state of mind 
    Title:
    Attention to Evidence of Aggressive Financial Reporting and Intentional Misstatement Judgments: Effects of Experience and Trust
    Practical Implications:

    The results of this study are important for audit firms to consider when making audit personnel assignments in order to take advantage of individual traits and experiences.  Audit firms may benefit from audit team structures that include members with varying levels of trust and varying levels of prior fraud experience.  Diversifying audit team composition may improve fraud detection while maintaining audit efficiency. 

    Citation:

    Rose, J.M. 2007. Attention to evidence of aggressive financial reporting and intentional misstatement judgments: Effects of experience and trust. Behavioral Research in Accounting 19(1): 215-229.

    Keywords:
    aggressive reporting; experience; fraud; skepticism; trust
    Purpose of the Study:

    Auditors face increased pressure to detect and prevent fraud and increased responsibilities to maintain professional skepticism as a result of SAS No. 99.  Yet their ability to do so may be constrained by their individual traits or experiences.  Previous research has not sufficiently addressed auditors’ ability to detect potentially fraudulent reporting or auditors’ judgment concerning misstatements and has not evaluated auditor characteristics that can influence attention to evidence of aggressive reporting. 
    This paper investigates the following factors:  

    • Whether professional skepticism increases auditors’ attention to evidence of aggressive reporting. 
    • Whether dispositional trust affects auditor’s critical evaluation of audit evidence.  Dispositional trust is a personality trait which affects professional behavior by influencing the degree to which an individual believes that people are typically trustworthy or that they will personally benefit by trusting others.
    • Whether fraud-specific audit experience results in the development of knowledge structures that are useful for the detection of potentially fraudulent and aggressive reporting practices. 
    Design/Method/ Approach:

    The authors collected their evidence using a simulated task completed by practicing auditors from Big 4 and national accounting firms with an average of 3.6 years of experience.  Participants were given background information along with 45 pieces of audit evidence for a hypothetical audit client, and told that they were performing workpaper reviews for the client. Then, participants were asked to perform a surprise free recall of the information. Finally, participants were asked to make a judgment on the likelihood that the client’s financial statements were intentionally misstated.  Participants were assigned to either a higher or lower level of client-related skepticism and aggressive or non aggressive individual audit evidence items.

    Findings:
    • The authors find that increased skepticism is associated with increased attention to aggressive reporting, and as a result, increased belief that intentional misstatement has occurred.
    • Less trusting auditors appear to pay more attention to evidence of aggressive reporting than do more trusting auditors.  
    • The authors find that prior fraud-specific experience positively influences auditor’s judgments of intentional misstatement.  Prior fraud experience may allow auditors to develop fraud-based explanations for aggressive reporting and develop knowledge structures that include potential indicators of fraud. 
    Category:
    Risk & Risk Management - Including Fraud Risk, Auditing Procedures - Nature - Timing and Extent, Auditor Judgment
    Sub-category:
    Fraud Risk Assessment, Auditors’ Professional Skepticism, Prior Dispositions/Biases/Auditor state of mind
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  • The Auditing Section
    Are the Reputations of the Large Accounting Firms Really...
    research summary posted April 23, 2012 by The Auditing Section, tagged 03.0 Auditor Selection and Auditor Changes, 03.01 Auditor Qualifications, 06.0 Risk and Risk Management, Including Fraud Risk, 06.09 Litigation Risk 
    Title:
    Are the Reputations of the Large Accounting Firms Really International?
    Practical Implications:

    This study provides an important implication for audit firms in maintaining their worldwide brand name reputation. The results suggest that, for global audit firms, the damage to auditor reputation in one country may spill over and cause concern among investors about the quality of their services in other countries. Further, the damage to reputation is greater where the demand for auditing and assurance is higher.

    Citation:

    Cahan, S. F., D. Emanuel, and J. Sun. 2009. Are the Reputations of the Large Accounting Firms Really International? Evidence from the Andersen-Enron Affair.  Auditing: A Journal of Practice and Theory 28 (2):  199-226. 

    Keywords:
    Auditor reputation, international audit markets, Arthur Andersen, Enron, auditor selection and auditor changes
    Purpose of the Study:

    The Big 4 accounting firms market themselves as global firms that deliver a uniform level of service across countries. While such a global reputation helps build worldwide demand for high-quality audits, it also creates risks if service quality becomes questionable in one of the countries in which a firm operates. Questionable audit practices in one of the countries, especially in the home jurisdiction, may  raise doubts as to whether sub-standard audits also occur in other countries. 

    This study examines whether the damage to the name brand of Arthur Andersen following the Andersen-Enron scandal in the U.S. spilled over into other countries. The study focuses on two key event dates leading up to Andersen’s demise: (1) January 10, 2002, when Andersen announced it had shredded documents related to the Enron audit, and (2) February 4, 2002, when Enron’s board released the Powers report that was critical of Andersen and when Andersen announced the establishment of an Independent Oversight Board (IOB) to investigate the firm’s audit policies and procedures. This study investigates the market reaction to Andersen’s clientele base around these two dates to determine whether: 

    • the events caused investors to reassess the reputation of Andersen’s non-U.S. audit units. 
    • investors’ reevaluation of Andersen’s reputation is more pronounced in cases where there is a higher demand for audit quality or credible financial statements. 
    • the effect is due to the perceived assurance or insurance value of an audit. The assurance value relates to an auditor’s ability to communicate with investors about the overall quality of client financial statements, while the insurance value relates to an auditor’s legal and financial liability for an audit failure.
    Design/Method/ Approach:

    The authors use data on publicly-traded companies audited by Arthur Andersen in 2001 to examine whether there is a negative market reaction to Andersen’s non-U.S. clients around the two event dates discussed above.

    Findings:
    • The authors document that an adverse market reaction to Andersen’s clients exists in non-U.S. countries, which suggests that the damage to Andersen’s reputation and audit quality in the U.S. spilled over to other countries.  
    • The market reaction is more negative in countries where there is a greater demand for high-quality auditing and credible financial reporting. More specifically, more-pronounced adverse market reactions are observed in common law (compared to code law) countries where investor protection is higher, ownership is more dispersed, and conflicts of interest between owners and managers are more likely to occur. 
    • The authors find that the market reaction for the shredding event is more negative for Andersen’s non-U.S., cross-listed clients than for Andersen’s non-U.S., non-cross-listed clients. This suggests that the shredding event may have been anticipated by the U.S. market as triggering lawsuits against Andersen and reducing its ability to pay for possible legal claims. 
    • The authors also report a similar market reaction for Andersen’s non-U.S., cross-listed clients and Andersen’s U.S. clients, suggesting similar levels of perceived audit quality across Andersen as a whole.
    Category:
    Auditor Selection and Auditor Changes, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Auditor Qualifications (e.g. size - industry expertise), Litigation Risk
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  • The Auditing Section
    Differences in Industry Specialist Knowledge and Business...
    research summary posted May 7, 2012 by The Auditing Section, tagged 02.0 Client Acceptance and Continuance, 02.05 Business Risk Assessment - e.g., industry, IPO, complexity, 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual, 06.0 Risk and Risk Management, Including Fraud Risk, 06.05 Assessing Risk of Material Misstatement 
    Title:
    Differences in Industry Specialist Knowledge and Business Risk Identification and Evaluation
    Practical Implications:

    The findings in this study are not intended to undermine the benefits of specialization in generic industries. Rather, they serve to highlight the importance and impact that specializing across differing industries has on auditor knowledge and experience.  From a
    practical perspective, the results of this study provide audit firms insights into the possible effects experience from industries of varying complexity has on auditors’ abilities to evaluate audit risks.  The results highlight the challenges in simply grouping industry specialists homogeneously, as the benefits accruing to specialists may vary depending on the nature and complexity of the industry.

    Citation:

    Moroney, R., and R. Simnett. 2009.  Differences in Industry Specialist Knowledge and Business Risk Identification and Evaluation.  Behavioral Research in Accounting 21(2): 73-89.

    Keywords:
    Behavioral decision theory; industry specialization; business risks
    Purpose of the Study:

    Prior literature has reported that auditors who are considered industry specialists outperform non-specialists on tasks within their area of expertise.  Noting that not all industries are the same, the authors build on this prior literature to examine the relative performance gains between auditors specializing in a complex (pension fund) industry vs. generic (manufacturing) industry.  Below are the primary objectives that the authors address in their study: 

    • The authors argue that the nature of a complex industry causes a specialist to possess a more developed sub-specialty knowledge base compared to his/her counterpart specializing in a generic industry.  In response, it is believed that the complex industry specialist will outperform the generic industry specialist in identifying appropriate business risks, within their respective industries.
    • The authors additionally examine information-gathering attributes. Specifically, they argue that complex industry specialists will 1) list more appropriate information sources, 2) list more appropriate evidence gathering processes, and 3) will list more appropriate accounts and related assertions when compared to generic industry specialist auditors.
    Design/Method/ Approach:

    An experiment, which uses Big 4 auditors ranging in experience from 2 to 27 years, is conducted. The average experience levels of the auditors are 5.2 and 4.6 years, respectively, for the complex and generic industry specialists. This data was collected in Australia, prior to 2009. Two expert panels of Big 4 industry specialists (one from each industry) were involved in the development of the experimental materials.  

    Findings:
    • Complex industry specialists (i.e., pension fund auditors) were able to list relatively more business risks when working in their industry than generic industry specialists (i.e., manufacturing auditors) were able to in their respective industry.
    • Complex industry specialists, working in their industry, were able to list a greater number of appropriate information sources and appropriate evidence gathering processes, compared to their generic industry peers. However, they were not able to list a greater number of accounts or related assertions.
    Category:
    Client Acceptance and Continuance, Audit Team Composition, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Business Risk Assessment (e.g. industry - IPO - complexity), Industry Expertise – Firm and Individual, Assessing Risk of Material Misstatement
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  • The Auditing Section
    Discussion of: “The Importance of Account Relations when R...
    research summary posted May 7, 2012 by The Auditing Section, 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, 08.01 Substantive Analytical Review – Effectiveness 
    Title:
    Discussion of: “The Importance of Account Relations when Responding to Interim Audit Testing Results”
    Practical Implications:

    Bedard’s (2006) discussion of Vandervelde (2006) reinforces the fact that auditors do incorporate the relationships among accounts in their responses to increases in misstatement risk.  He also suggests that it is important to consider how this pattern maps to auditors’ risk assessments at the financial statement assertion level.  His discussion emphasizes that in response to fee pressure, auditors may shift planned audit hours between accounts (i.e., from low risk areas to high risk areas), rather than increasing overall planned audit hours.  Finally, despite Bedard’s (2006) caveat that this result could be due to auditor self-presentation concerns or a change in the mix of audit procedures that does not result in increased hours, it is important to note that auditors do not appear to reduce planned audit hours in response to fee pressure – and that this could reflect auditors’ cognizance of the heightened importance that investors and the market currently placed on the role of auditing.

    Citation:

    Bedard, J. 2006. Discussion of: “The Importance of Account Relations when Responding to Interim Audit Testing Results”. Contemporary Accounting Research. 23(3): 823 – 831.

    Keywords:
    Account relations, audit planning, interim evidence, profit pressure, auditing procedures - nature, timing, and extent
    Purpose of the Study:

    This study is a conference discussion of Vandervelde (2006).  The purpose of the discussion is to critically analyze the motivation, hypotheses, experimental design, results, and implications of Vandervelde (2006).  Please see the summary of Vandervelde (2006) for further details.  

    The discussant first reviews research on risk-based auditing. The discussant believes that Vandervelde (2006) is studying an important aspect of the audit by examining how auditors incorporate relationships between accounts in their audit testing. Regarding Vandervelde’s (2006) predictions, the discussant believes that Vandervelde’s (2006) hypotheses could more accurately reflect the mathematical model’s predictions. The following points illustrate the primary differences between the expectations in Vandervelde (2006) and Bedard (2006).

    • In response to Vandervelde’s (2006) prediction that the increase in planned audit hours as the severity of the problem increases is greater for related vs. unrelated accounts, the discussant observes auditors may compensate for increased hours in higher risk areas of the audit with decreased hours in lower risk areas of the audit, which explains why prior studies find that auditors do not always respond to risk.  
    • Contrary to Vandervelde (2006), the discussant suggests that the increase in planned audit hours for low-relatedness accounts is not mitigated by fee pressure; rather there is a decline in planned audit hours, which is heightened by fee pressure.
    Design/Method/ Approach:

    The discussant reviews and provides suggestions for Vandervelde’s (2006) motivation, hypotheses, experimental design, and results.  The discussant also integrates Vandervelde (2006) in the context of prior research and suggests avenues for future research.

    Findings:
    • The discussant observes that Vandervelde’s (2006) findings suggest that auditors do consider the relationship between accounts, as planned audit hours increase for accounts related to the account where the problem was discovered and do not materially change for nonrelated accounts. 
    • The discussant states that Vandervelde’s (2006) finding that profit pressure does not influence auditors’ response to increases in risk is consistent with the market scrutiny on audit quality spurring audit firms to decrease emphasis on profit pressure.  However the discussant also observes that this finding could have been an artifact of the experimental design of the study, as auditors may have been reluctant to show that they are affected by profit pressure.  Further, this result suggests that auditors may change the mix of audit procedures for an account to address increases in risk, rather than changing the planned hours for that account.   
    • The discussant suggests that it could be informative to examine how auditors react to risks at the assertion level, rather than the account level. He suggests that accounts can be classified as “derived” vs. “generating transactions”, which can assist in mapping to assertions.  In Vandervelde’s (2006) context, the purchases account would be classified as “generating transactions”, while accounts payable and inventory are classified as “derived” (from purchases on account/disbursements and purchases/sales, respectively).  Thus, loss of documents would suggest issues with the completeness assertion for purchases, accounts payable and inventory.  The loss of documents should prompt an auditor to adjust audit procedures related to completeness, but not other assertions.
    Category:
    Risk & Risk Management - Including Fraud Risk, Auditing Procedures - Nature - Timing and Extent
    Sub-category:
    Assessing Risk of Material Misstatement, Substantive Analytical Review – Effectiveness
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