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  • Jennifer M Mueller-Phillips
    Inferring Remediation and Operational Risk from Material...
    research summary posted June 22, 2017 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 14.0 Corporate Matters 
    Title:
    Inferring Remediation and Operational Risk from Material Weakness Disclosures
    Practical Implications:

    This study makes important contributions regarding management’s disclosure of material weakness deficiencies. Currently, only audit-related risks are required to be addressed in material weakness deficiency disclosures. However, this study indicates that nonprofessional investors also take non-audit-related risks into consideration when making a financial reporting risk assessment. Managers do have the discretion to provide information about non-related audit risks through nonaudited disclosures. The authors suggest that in doing so managers can mitigate investors’ negative reaction the material weakness from lack of communication.

    Citation:

    Asare, S. K., and A. M. Wright. 2017. Inferring Remediation and Operational Risk from Material Weakness Disclosures. Behavioral Research In Accounting

    Keywords:
    material weakness; financial reporting risk; mediation analysis; investors’ judgments
    Purpose of the Study:

    Material weakness disclosures, entity-level and account-specific, have a negative impact on nonprofessional investors financial reporting risk assessments. The authors define financial reporting risk as “an investor’s exposure to loss as a result of relying on audited financial reports generated from an ineffective ICOFR” for the purpose of the study. Prior studies have indicated that nonprofessional investors assess a higher financial reporting risk for entity-level material weakness disclosures compared to account-specific. Broadly, the primary purpose of this study is to examine audit-related and non-audit-related risks in explaining the relationship between the type of material weakness and the investor financial reporting risk assessment. The audit-related risks are as follows:

    • Information risk is the pre-audit potential for financial misstatements due to the material weakness.
    • Verification risk is the auditor’s ability to audit around the material weakness.

     

    The non-audit-related risks are as follows:

    • Remediation risk is management’s ability to remediate the weakness.
    • Operational risk is management’s loss of operational effectiveness do to the material weakness.

     

    Special attention in this paper is given to the relational effects between non-audit-related risks resulting from material weakness disclosures and nonprofessional investors financial reporting risk assessment.

    Design/Method/ Approach:

    The 181 participants in the study were all nonprofessional investors. Each participant received the following from a hypothetical company: general financial information, an audit report, and an adverse opinion on ICOFR, either on an entity-level or account-specific material weakness. Then participants were asked to evaluate the investment’s attractiveness and respond to several questions involving audit-related and non-audit-related risks. The authors used mediation analysis to evaluate the results. 

    Findings:

    The authors find the following:

     

    • The type of material weakness has a direct effect on information, verification, remediation, and operational risks. Nonprofessional investors consider entity-level material weaknesses as presenting higher audit-related and non-audit related risks compared to account-specific material weaknesses.
    • Subsequently, these higher audit-related and non-audit related risks directly cause the nonprofessional investor’s assessment of financial reporting risk to increase.
    • Thus, non-audit-related risks from material weaknesses do in fact have an impact on a nonprofessional investor’s financial reporting risk assessment.
    Category:
    Corporate Matters, Risk & Risk Management - Including Fraud Risk
    Home:

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

  • Jennifer M Mueller-Phillips
    Risk Disclosure Preceding Negative Outcomes: The Effects of...
    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, 12.05 Changes in Reporting Formats 
    Title:
    Risk Disclosure Preceding Negative Outcomes: The Effects of Reporting Critical Audit Matters on Judgments of Auditor Liability
    Practical Implications:

    The results of this study are important for both regulators and auditors alike.  Despite auditor concerns that a requirement to disclose CAMs would increase litigation risk, the results of this study indicate that they may actually reduce, or at the very least, have no effect on litigation risk.  This is the case even when the subsequently identified misstatement is not related to the risks documented in the CAM.  Furthermore, standard setters should take comfort in these findings as they weigh the potential benefits of adopting a CAM disclosure requirement because the results indicate that the implementation of CAMS would not increase the risk of litigation to auditors. 

    Citation:

    Brasel, K., M. M. Doxey, J. H. Grenier, and A. Reffett. 2016. Risk Disclosure Preceding Negative Outcomes: The Effect of Reporting Critical Audit Matters on Judgments of Auditor Liability.  The Accounting Review 91 (5): 1345-1362.

    Keywords:
    audit litigation, audit report, negligence, liability, critical audit matters, disclosure
    Purpose of the Study:

    The PCAOB has proposed a change to the standard audit reporting model to include the disclosure of critical audit matters (CAMs).  While there is evidence that investors support additional auditor disclosures like CAMs, many other stakeholders oppose the implementation of a requirement to produce such ex ante risk disclosures.  The opposition, which includes audit firms, academics, and attorneys, assert that this type of requirement would increase litigation against auditors.

    However, CAMs require disclosure of increased risk prior to a subsequently revealed misstatement.  This feature of the proposed disclosure also makes it possible that CAMs may reduce litigation risk because jurors will view the plaintiff as being forewarned of an increased risk.  To the extent that jurors view a misstatement as having been more foreseeable to the plaintiff, this study predicts that jurors will experience less negative affect when considering plaintiff losses because the plaintiff was forewarned.  Below are two objectives the authors address in their study:

    • Examine whether auditors face increased litigation risk when auditors disclose a CAM that is related to a subsequently revealed misstatement.
    • Examine whether auditors face increased litigation risk when auditors disclose a CAM that is unrelated to a subsequently revealed misstatement.
    Design/Method/ Approach:

    The authors conducted an experiment with jury-eligible participants to examine their research questions.  The study included four different disclosure conditions: (1) control – no mention of CAMs, (2) disclosure of a CAM related to the subsequently revealed misstatement, (3) disclosure of a CAM that is unrelated to the misstatement, (4) an explicit statement that the auditors did not identify any CAMs.  Additionally, two different types of misstatements were examined to determine whether the type of misstatement affected the jurors’ propensity to find the auditor negligent: (1) an overstatement of inventory, (2) an understatement of an environmental restoration liability.  Participants read a case study about an audit that failed to detect a material financial statement fraud and then assessed auditor negligence.

    Findings:
    • When auditors failed to detect an overstatement of inventory, participants were less likely to find the auditor negligent when the auditor disclosed a related CAM, relative to both when there was no mention of CAMs and to when the auditor explicitly stated that there were no CAMs.  However, when auditors failed to detect the understatement of the client’s environmental restoration liability, participants were neither more nor less likely to find the auditors negligent when the auditor disclosed a related CAM.  This difference in outcomes was due to participant perceptions that the understatement of the client’s environmental restoration liability was more foreseeable than the inventory misstatement in the control condition thereby reducing the impact of the CAM.
    • Disclosing a CAM that was unrelated to the undetected misstatement did not affect jurors’ auditor liability judgments relative to current reporting standards.  However, disclosure of an unrelated CAM did reduce jurors’ negligence assessments relative to a condition in which the auditor explicitly stated there were no CAMs.
    Category:
    Accountants' Reporting, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Changes in Reporting Formats, Changes in Reporting Formats, Litigation Risk
  • Jennifer M Mueller-Phillips
    Evaluating the Intentionality of Identified Misstatements:...
    research summary posted January 12, 2017 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment 
    Title:
    Evaluating the Intentionality of Identified Misstatements: How Perspective Can Help Auditors in Distinguishing Errors from Fraud
    Practical Implications:

    This study contributes by providing evidence regarding a type of reasoning process that appears to help auditors assess the risk that a misstatement identified during audit fieldwork was caused intentionally. In addition to considering fraud risks at the company level, auditors should also consider fraud risks that are specific to an operating location or individual manager. By considering a client manager’s perspective, auditors presumably gain insight into whether the manager perceived misstating to be personally beneficial and reasonably easy to perpetrate and conceal, assisting in the evaluation of the manager’s intentions. 

    Citation:

    Hamilton, E. L. 2016. Evaluating the Intentionality of Identified Misstatements: How Perspective Can Help Auditors in Distinguishing Errors from Fraud. Auditing: A Journal of Practice and Theory 35 (4): 57 – 78.

    Keywords:
    perspective taking, fraud risk, fraud detection, misstatement, and audit quality.
    Purpose of the Study:

    Although auditors are responsible for detecting misstatements arising from either error or fraud, the auditing standards require very different audit responses when a misstatement is believed to be the result of an intentional act. Specifically, auditors are instructed to perform additional audit procedures, reassess overall fraud risk and the integrity of management, and communicate potential concerns to the audit committee if they suspect intentional misstatement; thus, if the auditors fail to recognize and respond to information indicating a misstatement was caused intentionally, then audit quality may be impaired. The author uses this study to investigate whether auditors who consider the perspective of the manager responsible for a misstatement’s occurrence are more sensitive to circumstances indicating the misstatement was intentional. 

    Design/Method/ Approach:

     The author creates an experiment utilizing auditor participants at the manager level and above with a case describing an identified misstatement that resulted from the actions of a client manager and ask them to assess the likelihood that it was caused intentionally. 

    Findings:
    • The author finds that auditors who considered the client manager’s perspective, compared to those who did not, assessed the misstatement as significantly more likely to be intentional, but only when such increased skepticism was warranted.
    • The author finds that, while auditors who considered manager’s perspective assessed the misstatement’s intentionality higher in the high-fraud-risk condition than in the low-fraud-risk condition, auditors who did not consider the manager’s perspective assessed the misstatement’s intentionality the same regardless of whether the circumstances surrounding the misstatement were indicative of high or low fraud risk.
    • The author finds that auditors who consider management’s perspective respond to the identified misstatement more appropriately. 
    Category:
    Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Fraud Risk Assessment
  • Jennifer M Mueller-Phillips
    A Field Survey of Contemporary Brainstorming Practices
    research summary posted February 20, 2017 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards, 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment, 06.07 SAS No. 99 Brainstorming – process, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism, 10.0 Engagement Management, 10.03 Interaction among Team Members 
    Title:
    A Field Survey of Contemporary Brainstorming Practices
    Practical Implications:

    Understanding that auditors allocate greater resources to fraud brainstorming when engagement risk is significant fosters brainstorming of a superior caliber corresponds to stronger regulatory compliance.  Auditors report that engagement teams are holding fraud brainstorming sessions earlier in the audit, document more detailed risk assessments, plan more specific procedures, and retain more documentation.  These characteristics contribute to adequately addressing increased PCAOB regulatory scrutiny.  Additionally, brainstorming sessions are highly regarded when they occur in a face-to-face fashion and are attended by multiple levels of firm personnel—whether that is “core” or “non-core” professionals.  Fraud brainstorming sessions are executed less mechanically (as determined by PCAOB inspectors) by using fewer checklists and increase the amount of time auditors prepare for brainstorming sessions.  

    Citation:

    Dennis, S. A., and K. M. Johnstone. 2016. A Field Survey of Contemporary Brainstorming Practices. Accounting Horizons 30 (4): 449–472. 

    Keywords:
    audit planning; engagement risk; field survey; fraud brainstorming; professional skepticism
    Purpose of the Study:

    The purpose of this study is to further understand current fraud brainstorming practices minding regulatory climate and its impression of brainstorming practices.  The authors seek to understand the auditing profession’s existing framework to effectively brainstorm by evaluating audit team characteristics; attendance and communication; structure, timing, effort; and brainstorming quality.  Fraud brainstorming environment is considered with respect to client characteristics; particularly, inherent, fraud, and engagement risks, and if the client is publicly traded or privately held.  The authors refer to the characteristics as “partitions”.  The partitions allow the study to better examine how each characteristic effects the deployment of resources in response to risk levels and trading status. 

                The study poses further exploration into the implementation of Statement of Auditing Standards No. 99 and its effect on fraud brainstorming practices.  Particularly addressing the Public Company Accounting Oversight Board’s report suggesting auditing professionals were “mechanically” addressing fraud-related auditing standards.  SAS 99 sought to blend experienced audit professionals—those with greater client experience—with less-seasoned auditors to brainstorm how a fraud could occur specific to the client.  As part of the brainstorming framework, the study seeks to understand if senior-level auditors (partners and managers) and seniors and staff members, along with “non-core” professionals, cultivate meaningful brainstorming sessions. 

    Design/Method/ Approach:

    The authors collected field data from audits conducted between March 2013 and January 2014, per a survey of 77 audit engagements.  Information pertaining to the client, audit team, and brainstorming sessions were called upon in the survey.  The majority (93 percent) of observations were obtained by two Big 4 firms—7 percent from one non-Big 4 global firm.  Each engagement’s partner received instructions for the distribution of the survey to lead managers and lead seniors on the respective engagement while the partner withheld that the survey was for research purposes.  A total of 75 managers and 73 seniors participated.  

    Findings:
    • Surveyed auditors rarely interacted with engagements where fraud in financial reporting was identified.
    • When fraud risk and inherent risk are both elevated for a particular engagement, perceived professional skepticism is also elevated.
    • Risk-based resource deployment is consistent when considering high- versus low-risk clients—particularly, when inherent risk is elevated, audit team size is also greater.
    • Public clients cultivate larger audit teams where managers and seniors have more client experience.
    • With respect to contributions made at brainstorming sessions, the audit partner and manager make the greatest contributions along with forensic specialists and audit seniors.  Interestingly, when fraud brainstorming is more important with respect to the engagement, seniors make lower relative contributions. 
    • Media richness theory is robustly at work with respect to attendance patterns at brainstorming sessions.  Specifically, when engagement risk is elevated, staff and seniors are more likely to attend face-to-face. 
    • Fraud brainstorming sessions are most commonly open-discussion (86 percent) where the session is held during the planning stage of the engagement (87 percent).
    • Results propose that audit partners are open-minded to suggestions made during fraud brainstorming.
    • Fraud risk assessments appear to be independent from brainstorming tactics; however, when inherent risk is elevated and if the client is public versus private, audit teams exert more effort.  
    Category:
    Auditing Procedures - Nature - Timing and Extent, Engagement Management, Risk & Risk Management - Including Fraud Risk, Standard Setting
    Sub-category:
    Auditors’ Professional Skepticism, Changes in Audit Standards, Fraud Risk Assessment, Interaction among Team Members, SAS No. 99 Brainstorming – process
  • Jennifer M Mueller-Phillips
    State Liability Regimes within the United States and Auditor...
    research summary posted February 16, 2017 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.09 Litigation Risk, 09.0 Auditor Judgment, 09.04 Going Concern Decisions 
    Title:
    State Liability Regimes within the United States and Auditor Reporting
    Practical Implications:

    These results imply that auditors are more likely to render modified GC opinions for clients subject to regimes that hold auditors liable to a larger class of third parties and impose joint-and-several liability for third-party damages, both of which reflect greater liability exposure. The higher incidence of GC opinions accompanying stronger state-level litigation threats could reflect higher audit quality, but it could also stem from excessively conservative auditors protecting their interests by avoiding costly civil lawsuits, which could undermine audit quality in some circumstances. 

    Citation:

    Anantharaman, D., J. A. Pittman, and N. Wans. 2016. State Liability Regimes within the United States and Auditor Reporting. The Accounting Review 91 (6): 1545 – 1575.

    Keywords:
    auditor litigation risk, state common law, and going-concern opinions
    Purpose of the Study:

    The authors of this study analyze the relation between state regimes governing auditor liability and auditors’ propensity to modify their opinion to express uncertainty on financially distressed clients’ ability to continue as a going concern.  Extant research implies that auditors have strong incentives to conduct high-quality audits in order to reduce the litigation examining consequences stemming from an alleged audit failure; however, the bulk of this research focuses on auditor liability arising under federal statutory laws, not state laws. This study delves into the issue of state laws, including if and to what extent litigation exposure under state common law affects auditors’ reporting decisions. 

    Design/Method/ Approach:

    A previous study developed a state-level score that captures third-party liability standards, which the authors of this study rely on to measure auditor litigation exposure stemming from third-party liability standards. To evaluate variation in liability-sharing standards across states, the authors closely read the relevant law to construct a state-level index that identifies whether each state follows a joint-and-several approach or a proportional approach to liability sharing. The authors assign to each client firm the highest of the liability indices dependent on the states in which the firm does business, and they measure audit outcomes with the propensity to issue going-concern (GC) opinions to financially distressed clients. 

    Findings:
    • The authors find that auditors are significantly more likely to issue a GC opinion to clients from states applying:
      • A more expansive third-party liability standard, or
      • The joint-and-several liability (JSL) rule for apportioning damages among defendants.
    • The authors find that liability regimes primarily affect auditor reporting for clients that are inherently more likely to be sued, reinforcing the conclusion that state-level liability regimes matter more when litigation exposure is higher.
    • The authors find some suggestive evidence that the higher expected legal costs arising from state-level liability regimes have a stronger impact on Big 4 auditors that are more sensitive to litigation threats. 
    Category:
    Auditor Judgment, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Going Concern Decisions, Litigation Risk
  • Jennifer M Mueller-Phillips
    Auditors’ Risk Assessments: The Effects of Elicitation A...
    research summary posted February 16, 2017 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.05 Assessing Risk of Material Misstatement 
    Title:
    Auditors’ Risk Assessments: The Effects of Elicitation Approach and Assertion Framing
    Practical Implications:

    These results imply that risk assessment approach can have a significant effect on the assessed risk of material misstatement and, thus, on audit program decisions that influence audit effectiveness and efficiency. The existence of assertion framing effects may directly affect the level of professional skepticism and audit effectiveness and efficiency. Both studies indicate that when belief-based assessments are transformed into probabilities, the difference from the direct probability assessments of risk is not significant; thus, obtaining belief-based assessments might make obtaining probability assessments redundant and also has the advantage of providing explicit assessments of ambiguity. 

    Citation:

    Mock, T. J. and H. Fukukawa. 2016. Auditors’ Risk Assessments: The Effects of Elicitation Approach and Assertion Framing. Behavioral Research in Accounting 28 (2): 75 – 84. 

    Keywords:
    auditors’ risk assessment, belief functions, probability, assertion framing, and skepticism.
    Purpose of the Study:

    The primary purpose of this experimental study is to replicate a previous study conducted by the authors, who examine the effects of “risk assessment elicitation approach” and “assertion framing” on auditors’ risk assessments. They find that auditors’ risk assessments differ in some important ways and that auditors’ risk assessments are influenced by assertion framing. However, the generalizability of these findings may be limited due to the use of Japanese practitioners as subjects. This study investigates U.S. practitioners in an attempt to corroborate the previous findings.

                The study focuses on two important factors that are found to affect auditors’ risk assessment judgments in the prior study: the risk assessment elicitation approach and the framing of financial statement assertions being audited. 

    Design/Method/ Approach:

    This study is an experimental replication of Fukukawa and Mock 2011. The risk assessment elicitation approach is manipulated by using scales based on either probability theory or the theory of belief functions. 

    Findings:
    • The authors find that both experimental results show significant “risk assessment approach” effects in the expected directions.
    • The authors find considerable evidence of significant “assertion framing” effects.
    • The authors find that the two risk elicitation approaches result in significantly different risk assessments.
    • The authors find that auditors’ assessed risks are higher; they seem to be more risk-sensitive and exhibit a higher level of professional skepticism when an assertion is stated in a negative way than in a positive way.
    • The authors find that while probability-based risk assessments are higher than belief-based assessments and lower than plausibility assessments, the differences between the two approaches are not significant when the belief-based assessments are transformed into probabilities using a newly proposed method. 
    Category:
    Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Assessing Risk of Material Misstatement
  • Jennifer M Mueller-Phillips
    Real Earnings Management: A Threat to Auditor Comfort?
    research summary posted January 12, 2017 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.04 Management Integrity, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.06 Earnings Management – Detection and Response 
    Title:
    Real Earnings Management: A Threat to Auditor Comfort?
    Practical Implications:

    Given that REM often causes significant auditor discomfort, the authors’ paper provides broader REM and auditor comfort-related questions pertaining to the effects of management’s focus on short-term results, the extent to which REM is a problem that can or needs to be fixed, and the possibility that REM is a gateway to more serious forms of accounting manipulation. 

    Citation:

    Commerford, B. P., D. R. Hermanson, R. W. Houston, and M. F. Peters. 2016. Real Earnings Management: A Threat to Auditor Comfort? Auditing: A Journal of Practice and Theory 35 (4): 39 – 56. 

    Keywords:
    real earnings management, auditor, comfort, rationality, emotions, and body senses
    Purpose of the Study:

    The authors address two overarching questions that have not received very much attention to date. First, “To what extent does real earnings management (REM) affect auditor comfort?” Second, “What strategies do auditors rely on in trying to reach a state of comfort when the client engages in REM?” Auditing standards that relate to REM are vague and limited and, despite evidence showing that REM is becoming increasingly common, little research considers auditors’ perceptions of REM and how they respond to it. The authors wish to fill this void by writing this paper. 

    Design/Method/ Approach:

    The authors conduct in-depth interviews with experienced auditors to examine how auditors respond to an emerging issue in the post-SOX period, the increasing use of real earnings management to achieve financial reporting objectives. 

    Findings:
    • The authors find that auditors are aware of REM and often identify it through formalized audit protocols, including analytical procedures, discussions with management, ad/or their knowledge of the business.
    • The authors find that formal audit procedures play a role in identifying sources of discomfort but also find references to body senses and the use of emotive language related to feelings of discomfort.
    • The authors find that most of the interviewees have concerns about REM, largely because they believe it indicates management’s desire to meet short-term targets, implying poor management tone, which could signal other, less acceptable earnings management methods. 
    Category:
    Auditing Procedures - Nature - Timing and Extent, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Earnings Management – Detection and Response, Management Integrity
  • Jennifer M Mueller-Phillips
    Broadening the Fraud Triangle: Instrumental Climate and...
    research summary posted November 15, 2016 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment, 06.02 Fraud Risk Models 
    Title:
    Broadening the Fraud Triangle: Instrumental Climate and Fraud
    Practical Implications:

    This paper incorporates important organizational theory into the fraud literature by reporting the presence of an instrumental climate when fraud is being perpetrated within an organization. Internal auditors and those charged with governance could adapt this climate measure as a red flag for potential fraud. 

    Citation:

    Murphy, P. R. and C. Free. 2016. Broadening the Fraud Triangle: Instrumental Climate and Fraud. Behavioral Research in Accounting 28 (1): 41-56.

    Keywords:
    organizational climate, instrumental climate, fraud, fraud triangle, rationalization
    Purpose of the Study:

    Many papers focus on investigating organizations in which management’s tone exemplifies high ethical standards, combined with a climate that support and encourages ethical behavior in an effort to examine if this organization is less vulnerable to fraud. However, this paper takes a different approach. It examines the “flip side” of organizations, those that are associated with fraud instead of those associated with preventing fraud. By doing this, the authors also hope to delve into the effectiveness of the fraud triangle. For years, the fraud triangle has been the dominant fraud framework but recently it has been called into question for its narrow interpretation and lack of comprehensiveness. Thus, the goal of this research is not only to identify an organizational climate that exists in the presence of fraud but also to broaden the interpretation of the fraud triangle by explicitly identifying fraud triangle elements related to such a climate. 

    Design/Method/ Approach:

    The authors created and administered a survey to three groups of individuals having fraud experience: (1) prisoners who are incarcerated for committing fraud within an organization, (2) individuals who audited or investigated fraud within an organization, and (3) individuals who witnessed fraud within their organization. 

    Findings:
    • The authors find that 39 percent of the respondents agreed or strongly agreed that an instrumental climate was present when fraud occurred within the organization.
    • The authors find that an instrumental climate is significantly associated with a malevolent work environment and social incentives and pressures.
    • The authors find that the use of externally oriented rationalizations are very common with instrumental climates, especially the claim of helping the company.
    • The authors find that an instrumental climate is not associated with conventional attitude variables (prior history of white-collar crime, character, ethical values of the perpetrator), internally oriented rationalizations (minimizing or ignoring the consequences of the fraud, or entitlement) or individual greed or need. 
    Category:
    Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Fraud Risk Assessment, Fraud Risk Models
  • Jennifer M Mueller-Phillips
    Client business models, process business risks and the risk...
    research summary posted November 14, 2016 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.05 Business Risk Assessment - e.g., industry, IPO, complexity, 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 importance of understanding the operation of a client’s business and its competitive environment to achieve an effective audit is well-known. More specifically, the PCAOB requires that an auditor understand the company’s objectives and strategies and those related business risks that might reasonably be expected to result in risks of material misstatement. Valid understanding also is necessary to both interpret results from analytical procedures and to engage in effective professional skepticism for management’s assertions. The author’s results reveal a previously unreported level of understanding of process-oriented business risks and their association with the RMM of revenue for essentially new staff auditors. 

    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, analytical procedures, strategic management, and business models.
    Purpose of the Study:

    There are undeniable benefits for financial auditors to understand a client’s business strategy, strategic objectives and critical business processes, as well as understanding the business risks of a client’s business model during the reporting period. In fact, an inadequate understanding of business risks can result in an audit failure. While business risk auditing continues to be a central framework for auditing, whether auditors can achieve the necessary in-depth understanding of the business risks generated by different strategies and business models remains unclear.  Current research tests for understanding of the theory of business risk auditing, but this author tests the premise that informed graduate students acting as surrogates for staff auditors will understand and implement in their judgments the process risk implications of different business strategies and business models. This should prove important because the existing literature indicates inconsistent results on auditor’s ability to conduct an effective strategic analysis. 

    Design/Method/ Approach:

    The author conducted a 2x2 randomized between subjects design. The participants were all accounting Masters students who were a few weeks from their graduation. These participants were presented with an array of facts, until ultimately deciding which business strategy applied and assessing the performance and the associated business risk of each of the five processes of the case. 

    Findings:
    • The author finds that, with a few exceptions, surrogates for entry-level auditors made the subtle yet important distinctions among process-level business risks given the requirements of two different business strategies.
    • The author finds that the participants were able to report risk assessments for the critical Production process such that the indirect effect of process-specific business risk mediated the direct relationship between judgments of process performance and the RMM of revenue.
    • The author finds that the participants were able to make the distinction between the two different business strategies and could correctly indicate that there is no significant difference in the RMM of revenue for the two strategies when product generation performance was relatively high and business risk was relatively low. 
    Category:
    Client Acceptance and Continuance, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Assessing Risk of Material Misstatement, Business Risk Assessment (e.g. industry - IPO - complexity)
  • Jennifer M Mueller-Phillips
    The Effect of Information Choice on Auditors’ Judgments a...
    research summary posted October 12, 2016 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.05 Diversity of Skill Sets e.g., Tenure and Experience, 06.0 Risk and Risk Management, Including Fraud Risk, 06.09 Litigation Risk, 09.0 Auditor Judgment, 09.10 Prior Dispositions/Biases/Auditor state of mind, 11.0 Audit Quality and Quality Control, 11.09 Evaluation of Evidence 
    Title:
    The Effect of Information Choice on Auditors’ Judgments and Confidence
    Practical Implications:

     Implications for the practicing audit community are developed from the findings that less experienced auditors are susceptible to the information choice effect. In situations where litigation risk is low (high) and the auditor has less experience, auditors place greater (lower) significance on information given to them by an external party than information they sought out themselves. More experienced auditors are not subject to the information choice effect. Additionally, more experienced auditors are confident in judgments based on information sought themselves, even in a setting with elevated litigation risk. The results of this study may interest audit clients providing information to auditors, auditors reviewing the work of less (more) experienced colleagues, auditors performing a critical self-review, and regulators reviewing the work of auditors.

    Citation:

     Smith, S. D., W. B. Tayler, and D. F. Prawitt. 2016. The Effect of Information Choice on Auditors' Judgments and Confidence. Accounting Horizons 30 (3): 393–408.

    Keywords:
    information choice, litigation risk, confidence, experience, judgment impact
    Purpose of the Study:

    During the course of an audit, auditors choose what information they need to search for; however, they obtain both sought and unsought information.  These auditors must then use the information obtained to make judgements and decisions that ultimately lead to an audit opinion.  Thus, the weight auditors place on the information obtained when making judgements and the auditors’ confidence in those judgements has important implications for audit quality.  The authors of this paper investigate whether it matters if information is gotten by the auditor or given to the auditor.  Understanding that the way in which information is received affects information processing, the authors examine how the auditors’ receipt of additional sought or unsought information impacts the auditors’ judgment and confidence in that judgement given judgements with different levels of importance (e.g., high vs. low litigation risk) and auditors with different levels of experience (e.g., high vs. low).

    Design/Method/ Approach:

    Evidence was obtained during the 2010’s through an experiment using 136 auditors as participants.  Participants read a case and evaluated the likelihood of obsolescence in inventory.  The researchers manipulated the (1) choice to acquire relevant information (i.e., given a choice or not given a choice) and (2) litigation risk levels (i.e., high or low).  Furthermore, they measured auditor experience, and classified participants as more or less experienced based on number of years in public accounting.

    Findings:
    • In the high litigation setting, sought information is weighed more heavily than unsought information.  This result appears to be driven by auditor experience.  Specifically, when auditor experience is low and litigation risk is high, sought information is weighed more heavily than unsought information.
    • In the low litigation setting, sought information is weighed less heavily than unsought information.  This result appears to be driven by auditor experience.  Specifically, when auditor experience is low and litigation risk is low, information is weighed less heavily than unsought information.
    • Auditor confidence in their judgment of inventory obsolescence was greater when they chose to obtain additional information than when they were just given the additional information.  This result appears to be driven by auditor experience.  Specifically, more experienced auditors had greater confidence after obtaining sought information than unsought information.  This results also appears to depend on the litigation level.  In the high litigation setting, more experienced auditors had greater confidence after obtaining sought information than unsought information.
    Category:
    Audit Quality & Quality Control, Audit Team Composition, Auditor Judgment, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Diversity of Skill Sets (e.g. Tenure & Experience), Evaluation of Evidence, Litigation Risk, Prior Dispositions/Biases/Auditor state of mind

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