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  • Jennifer M Mueller-Phillips
    Auditor Tenure and Going Concern Opinions for Bankrupt...
    research summary posted April 19, 2017 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 09.04 Going Concern Decisions 
    Title:
    Auditor Tenure and Going Concern Opinions for Bankrupt Clients: Additional Evidence
    Practical Implications:

    This study should be of particular interest because the findings represent evidence concerning the relationship between auditor tenure and audit failures. The tenure effect, which is pronounced in the early years, is particularly important to the non-Big 4 sample because approximately 75 percent of non-Big 4 clients in the author’s sample have auditor tenures of four years or less. This short tenure, coupled with association between tenure and Type II errors suggest the adverse impact of short tenure is concentrated in the non-Big 4 sample. With this in mind, the findings of this paper may help to inform the continuing debate regarding the possible adverse effects of long auditor tenure. 

    Citation:

    Read, W.J., and A. Yezegel. 2016. Auditor Tenure and Going Concern Opinions for Bankrupt Clients: Additional Evidence. Auditing: A Journal of Practice and Theory 35 (1): 163-179.

    Keywords:
    going concern opinions, Type II errors, and auditor tenure
    Purpose of the Study:

    Regulators and lawmakers in the U.S. periodically express concerns about a possible association between auditor tenure length and audit failure. The authors define audit failure as a bankrupt company not receiving a going concern modified audit opinion prior to bankruptcy, a Type II reporting error.  Geiger and Raghunandan began investigating this relationship in the early 2000’s; however, the authors of this study hope to extend this investigation in the three following ways:

    • Studies have shown that audit reporting companies in financial distress changed following the enactment of the Sarbanes-Oxley Act of 2002 and related legislature and media scrutiny of the auditing profession; ergo, a closer examination of more recent data would be a worthwhile measure.
    • The previous study did not examine differences between Big 4 and non-Big 4 audit firms, and studies show that there are significant differences between Big 4 and non-Big 4 auditors, including going concern decisions.
    • The previous study assumed and tested for a linear relationship between auditor tenure and audit reporting failures; however, more recent data leads the authors to allow the association between auditor tenure and audit quality to be nonlinear. 
    Design/Method/ Approach:

    The authors examine prior audit reports for a sample of 401 U.S. publicly held companies that filed for bankruptcy during the period 2002-2008. A quadratic model was used to control for potential nonlinearity in the relationship between audit tenure and audit reporting.

    Findings:
    • The authors did not find evidence of a significant relation between auditor tenure and going concern opinions issued by Big 4 firms to their subsequently bankrupt clients.
    • The authors did find evidence indicating a higher likelihood of Type II errors for non-Big 4 auditors in the early years of an audit; however, this relation weakens and after approximately year four of the engagement, the authors begin to observe no statistical association between tenure length and Type II errors for non-Big 4 auditors, either.
    • The authors’ results from the endogeneity analysis are consistent with their primary conclusions that non-Big 4 audit firms are more likely to make Type II reporting errors compared to Big 4 firms during the initial years of an audit engagement.
    • The authors find that long auditor tenure, of itself, is not associated with Type II reporting errors. 
    Category:
    Auditor Judgment
    Sub-category:
    Going Concern Decisions
  • Jennifer M Mueller-Phillips
    Investigating Inspection Risk: An Analysis of PCAOB...
    research summary posted April 19, 2017 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 09.12 Impact of potential post-audit review - e.g., PCAOB, internal firm inspections, 11.0 Audit Quality and Quality Control, 11.11 Impact of Firm and External Inspection Programs 
    Title:
    Investigating Inspection Risk: An Analysis of PCAOB Inspections and Internal Quality Reviews
    Practical Implications:

    This paper complements and extends the limited extant research on inspection risk by clearly defining the construct and providing empirical evidence consistent with its existence and impact on auditors’ planning decisions. The authors contend that while auditors may perceive that PARs do not influence effort or fees, both PARs likely cause auditors, perhaps unconsciously, to increase effort and fees. 

    Citation:

    C. M. Stefaniak, R. W. Houston, and D. B. Brandon. 2017. Investigating Inspection Risk: An Analysis of PCAOB Inspections and Internal Quality Reviews. Auditing: A Journal of Practice and Theory 36 (1): 151 – 168.

    Keywords:
    inspection risk, audit quality, PCAOB inspections, and internal quality reviews
    Purpose of the Study:

    The authors report the results of an experiment that examines how auditor anticipation of the two primary external and internal post-audit reviews (PAR), specifically, U.S. Public Company Accounting Oversight Board (PCAOB) inspections or public accounting firms’ internal quality reviews (IQRs), affects auditors’ perceptions of overall engagement risk, as well as effort and pricing decisions. The authors define inspection risk as “the risk that an auditor or audit firm will suffer harm as a result of a PAR.” Although the current PAR regime has been in place for over ten years, there is little empirical evidence concerning whether, and to what extent, anticipating a PAR impacts auditor behavior, and whether the effects of anticipating a PCAOB inspection or IQR differ. IQRs also remain largely uninvestigated, despite researchers beginning to investigate external PCAOB reviews. 

    Design/Method/ Approach:

    To investigate how PAR salience affects auditors’ judgments and decisions, the authors conduct a 1 x 3 between-subjects experiment using a number of high-level auditors as participants. They manipulate PAR salience as PCAOB inspection salient, IQR salient, or no explicit expectation of a PAR. 

    Findings:
    • The authors find that PAR salience yields greater perceived overall engagement risk, even after controlling for traditional engagement risk-related factors, implying that auditors perceive inspection risk as incremental to these factors.
      • In addition, increased PAR salience results in greater audit effort and fees, consistent with an inspection risk component.
    • The authors find that both PARS yield higher fees, with the higher fees attributable only to greater effort, rather than an “inspection risk premium.”
    • PCAOB inspection results are more visible than IQRs, and partners perceive that PCAOB inspections can yield greater negative consequences for themselves and their firms; therefore, the authors find that PCAOB inspection salience involves larger increases in perceived overall engagement risk and audit effort than does IQR salience.
      • However, the authors do not find differences in audit fees between PCAOB and IQR salience. 
    Category:
    Audit Quality & Quality Control, Auditor Judgment
    Sub-category:
    Impact of Firm & External Inspection Programs, Impact of potential post-audit review (e.g. PCAOB - internal firm inspections)
  • Jennifer M Mueller-Phillips
    If You Want My Advice: Status Motives and Audit...
    research summary posted February 16, 2017 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.01 Use of Specialists e.g., financial instruments, actuaries, valuation, 09.0 Auditor Judgment, 09.09 Impact of Consultation on Judgments 
    Title:
    If You Want My Advice: Status Motives and Audit Consultations About Accounting Estimates
    Practical Implications:

    The finding that higher decision authority can have negative audit quality implications is relevant to audit firm policies, which often vest substantial authority in consultants, and to the ongoing debate over standards for the use of specialists. This and other findings also suggest that it may be beneficial to advocate lower decision authority. Finally, the findings can inform audit firm policies that require consultation with knowledgeable persons, as well as standard-setters and regulators whose responsibilities to provide guidance on using consultation to conduct more effective audits of financial statement estimates. 

    Citation:

    Knechel, W. R. and J. Leiby. 2016. If You Want My Advice: Status Motives and Audit Consultations About Accounting Estimates. Journal of Accounting Research 54 (5): 1331 – 1364. 

    Purpose of the Study:

    Financial reports contain many complex accounting estimates that require significant auditor judgment and can increase the risk of material misstatements. Auditors often struggle to maintain the requisite knowledge and questioning mindset necessary to effectively assess these estimates. Little is known about how the efficacy of consultation and the conditions under which consultants provide advice that might improve the audit of estimates. Consultation in auditing is pervasive and has substantial potential benefits, thus the availability of useful advice is often a necessary condition to improve the audit of estimates. In this study, the authors examine two properties of advice that are likely to help improve auditor judgment on accounting estimates: contrariness and precision. Contrariness refers to the degree to which a consultant’s advice differs from the advice-seeker’s own opinion, and precision refers to the narrowness of the range of options presented by a consultant to an advice seeker, that is, reducing the range of possible outcomes to be considered. 

    Design/Method/ Approach:

    The authors conduct an experiment with a number of audit managers and senior managers from a U.S. accounting firm. The authors manipulate status motives by priming auditors with a brief story prior to the task in which they act as a consultant to another auditor regarding the discount rate a client uses to estimate the fair value of a securitized asset. 

    Findings:
    • The authors find that a consultant’s recommendations are influenced by specialized knowledge and decision authority conditional on their status motives.
      • More specifically, when status motives are active, consultants with higher specialized knowledge are more precise but less contrary than those with lower knowledge.
    • The authors find that consultants recommend changes to the end of the range that is further from management’s preference, thus this increased precision is unlikely to influence the evaluation and ultimate quality of the estimate.
    • The authors find that precision decreases with higher decision authority and increases only when decision authority is lower and status motives are active. 
    Category:
    Audit Team Composition, Auditor Judgment
    Sub-category:
    Impact of Consultation on Judgments, Use of Specialists (e.g. financial instruments – actuaries - valuation)
  • 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
    Joint Impact of Materiality Guidance and Justification...
    research summary posted February 16, 2017 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 09.01 Audit Scope and Materiality Judgments 
    Title:
    Joint Impact of Materiality Guidance and Justification Requirement on Auditors’ Planning Materiality
    Practical Implications:

    The features that the authors examine, guidance structure and need of justification, vary among the Big 4 public accounting firms, and the authors show that variations in these features result in systematic differences in auditors’ planning materiality judgments. They specifically show that in circumstances where auditors’ reliance on structured guidance is inappropriate, a justification requirement can mitigate this dysfunctional effect. 

    Citation:

    Audsabumrungrat, J., S. Pornupatham, and H. Tan. 2016. Joint Impact of Materiality Guidance and Justification Requirement on Auditors’ Planning Materiality. Behavioral Research in Accounting 28 (2): 17 – 27. 

    Keywords:
    planning materiality, structured guidance, and justification.
    Purpose of the Study:

    The authors of this study investigate whether the requirement to document a justification can overcome auditors’ overreliance on decision aids in a context where their use can lead to dysfunctional outcomes. They examine this issue in a planning materiality setting because planning materiality influences the effectiveness of the overall audit process. The decision aid they examine in this study relates to structured guidance to be used in materiality assessments. Public accounting firms have developed structured guidance to assist their staff in making planning materiality judgments and to increase judgment consistency within the firms, but variations exist in the use of such guidance. They also examine justification, which is the need to provide a rationale or reason to support one’s decisions. 

    Design/Method/ Approach:

    The authors test their prediction experimentally with audit managers from three Big 4 public accounting firms in Thailand. They employ a planning materiality assessment setting where merely following the steps documented in the structured guidance without making adjustments for client-specific factors can lead to less conservative materiality assessments. 

    Findings:
    • The authors find that audit managers make less conservative and less appropriate planning materiality assessments in the presence of structured materiality guidance, but this detrimental effect is mitigated by the need to justify their judgments.
    • Participants’ materiality assessments across all conditions are higher than that made by the expert panel, suggesting that participants are not making overly low assessments that have efficiency implications. 
    Category:
    Auditor Judgment
    Sub-category:
    Audit Scope & Materiality Judgements
  • Jennifer M Mueller-Phillips
    The Impact of Estimate Source and Social Pressure on...
    research summary posted February 16, 2017 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 09.03 Adequacy of Evidence 
    Title:
    The Impact of Estimate Source and Social Pressure on Auditors’ Fair Value Estimate Choices
    Practical Implications:

    To the auditors’ knowledge this study is the first to examine the joint effect of social pressure and estimate source. By examining the joint effect of these two factors, they identify the boundary conditions under which the effect of estimate source holds. The results of this study indicate that auditors perceive advice to be more acceptable when it is from a superior than when it is from a peer. Further, when advice is received from a peer, auditors in this study indicate that the advice is more likely to be weighed against other evidence than when the same advice is received from a supervisor. 

    Citation:

    Brink, A. G., F. Tang, and L. Yang. 2016. The Impact of Estimate Source and Social Pressure on Auditors’ Fair Value Estimate Choices. Behavioral Research in Accounting 28 (2): 29 – 40. 

    Keywords:
    social pressure, fair value estimates, experiment, auditor judgment.
    Purpose of the Study:

    This paper empirically examines how estimate source interacts with social influence pressure to affect auditors’ judgments of fair value estimates.  This research is motivated by growth in the use of fair value accounting practices in recent years and concern over the usefulness of reported fair values. Because of the subjectivity and judgment that is inherent in fair value estimation, evaluating fair value estimates poses a significant challenge to auditors and it is important to understand factors influencing auditors’ judgment in the selection and reporting of fair value estimates. While fair value accounting practices are of international concern, particular emphasis has been placed on whether emerging economies, such as China, are effectively implementing the fair value components of accounting standards. 

    Design/Method/ Approach:

    The authors conduct an experiment with Chinese auditor participants to investigate how auditors’ choices regarding the investigation of a subjective fair value estimate are influenced by the source of a fair value estimate and social pressure. 

    Findings:
    • The authors find that social influence pressure moderate the effect of estimate source.
      • Specifically, Chinese auditors’ risk assessments and judgments regarding whether the auditor will investigate further are not significantly influenced by information about the fair value estimate’s source when a supervisor advises the use of the questionable estimate.
      • However, when a peer gives the auditor the same advice, the source of the estimate has a significant impact on auditor judgments. 
    Category:
    Auditor Judgment
    Sub-category:
    Adequacy of Evidence
  • Jennifer M Mueller-Phillips
    Do auditor judgment frameworks help in constraining...
    research summary posted November 14, 2016 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 09.09 Impact of Consultation on Judgments, 09.12 Impact of potential post-audit review - e.g., PCAOB, internal firm inspections 
    Title:
    Do auditor judgment frameworks help in constraining aggressive reporting? Evidence under more precise and less precise accounting standards
    Practical Implications:

    By examining the cognitive impact of the different judgment frameworks, this study provides academics, practitioners, and regulators with important insight into why counterfactual reasoning and a structured thought process differentially enhance auditors’ professional skepticism. 

    Citation:

    Backof, A. G., E. M. Bamber and T. D. Carpenter. Do auditor judgment frameworks help in constraining aggressive reporting? Evidence under more precise and less precise accounting standards. Accounting, Organizations and Society 51: 1-11. 

    Keywords:
    auditing, accounting standard precision, judgment frameworks, psychological distance, and abstract mindsets.
    Purpose of the Study:

    Auditors are being called on to exercise substantially more professional judgment during the financial reporting process due in part to the global trend towards less precise accounting standards; consequently, the Advisory Committee on Improvements to Financial Reporting (CIFiR) recommended that the Public Company Accounting Oversight Board (PCAOB) develop guidelines on how the PCAOB plans to evaluate the reasonableness of judgments made based on PCAOB auditing standards. Although the PCAOB has not yet done this, audit firms have developed their own judgment frameworks based on CIFiR’s identification of key components underlying reasonable accounting judgments. Further, the Center for Audit Quality (CAQ) recently published a professional judgment resource that audit firms can use to enhance their professional judgment process. This study examines how alternative specification of these judgment frameworks affect auditors’ constraint of management’s aggressive financial reporting under accounting standards that differ in their level of precision.

    Design/Method/ Approach:

    The authors conduct an experiment using a 2 x 4 factorial design to investigate these issues. A number of audit managers and partners from a Big 4 accounting firm participated in a case requiring them to audit management’s lease classification decision. The setting is created to be on where auditors stand to benefit from a well-reasoned judgment process that includes the consideration of alternatives and focuses auditors on the big picture economics rather than the transactional details.  

    Findings:
    • The authors find that the judgment frameworks are more effective under less precise standards. In particular, the pro/con framework based on CIFiR’s recommendation to consider the “pros and cons for reasonable alternatives” effectively enhances auditors’ skepticism of aggressive reporting under less precise standards, but not more precise standards.
    • The authors’ evidence suggests that both the pro/con why framework and pro why framework lead to an even greater reduction in auditors’ allowance of aggressive reporting under less precise standards; however, only the pro why framework curbs aggressive reporting under more precise accounting standards. 
    Category:
    Auditor Judgment
    Sub-category:
    Impact of Consultation on Judgments, Impact of potential post-audit review (e.g. PCAOB - internal firm inspections)
  • 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
  • Jennifer M Mueller-Phillips
    Do Income Tax-Related Deficiencies in Publicly Disclosed...
    research summary posted September 13, 2016 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.06 Impact of PCAOB, 09.0 Auditor Judgment, 09.12 Impact of potential post-audit review - e.g., PCAOB, internal firm inspections 
    Title:
    Do Income Tax-Related Deficiencies in Publicly Disclosed PCAOB Part II Reports Influence Audit Client Financial Reporting of Income Tax Accounts?
    Practical Implications:

     While many studies examine how the Part I inspection report or the PCAOB inspection process as a whole impact the auditor and audit committee decision making, the research on the impact of Part II reports is limited. Furthermore, the PCAOB is publicly issuing Part II inspection reports with greater frequency; thus, an understanding of how the failed remediation of Part II reports influences the audit firm and its clients is of importance to a number of parties.

    Citation:

     Drake, K. D., N. C. Goldman, and S. J. Lusch. 2016. Do Income Tax-Related Deficiencies in Publicly Disclosed PCAOB Part II Reports Influence Audit Client Financial Reporting of Income Tax Accounts? The Accounting Review 91 (5): 1411-1439.

    Keywords:
    PCAOB inspections, auditor scrutiny, valuation allowances, and uncertain tax benefits
    Purpose of the Study:

    The Public Company Accounting Oversight Board (PCAOB) is responsible for overseeing the quality of external audits through a rigorous inspection process that examines both audit engagements and audit firm quality control processes. At the completion of their review, the PCAOB issues their findings to the inspected audit firm via inspection reports. This led the authors to investigate whether a change in auditor scrutiny over income tax accounts, prompted by the failed remediation of a PCAOB Part II inspection report, results in changes in client financial reporting of income taxes. Utilizing the unique situation of Deloitte & Touche LLP’s 2007 Part II inspection report, which identifies concerns about the firm’s quality controls with respect to the audit procedures performed on income tax accounts, the authors delve into whether the failed remediation and subsequent public disclosure of the report led to observable changes in financial reporting for income tax accounts among Deloitte’s client.  

    Design/Method/ Approach:

    The authors focus on the time period beginning with Deloitte’s 2007 Part II report, which was issued privately to Deloitte on May 19, 2008 and ending with the remediation period on May 18, 2009. The sample chosen was annually inspected audit firms between 2006 and 2012. The authors also investigate which components of the annual UTB reconciliation drive the changes in the total UTB balance.

    Findings:
    • The authors find that an increase in auditor scrutiny over income tax accounts in response to PCAOB Part II findings is associated with changes in financial reporting of income tax accounts.
    • The authors find that the changes implemented by Deloitte result in an increase in reported valuation allowances and an increase in the reserve for uncertain tax positions among its clients.
    • The authors find that the UTB result is not driven by changes in tax avoidance but is driven but increases in the reserve related to current-year and prior-year positions.
    • The authors do not find that additional auditor scrutiny influences the income tax accounts when examining non-tax related Part II reports. This suggests that the effect the authors identify is in response to the specific deficiencies identified in the Part II report rather than a general reaction to failing the remediation of a Part II report. 
    Category:
    Auditor Judgment, Standard Setting
    Sub-category:
    Impact of PCAOB, Impact of potential post-audit review (e.g. PCAOB - internal firm inspections)
  • Jennifer M Mueller-Phillips
    Does Disclosure of Conflict of Interest Increase or Decrease...
    research summary posted August 31, 2016 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.01 Use of Specialists e.g., financial instruments, actuaries, valuation, 09.0 Auditor Judgment, 09.09 Impact of Consultation on Judgments 
    Title:
    Does Disclosure of Conflict of Interest Increase or Decrease Bias?
    Practical Implications:

     Valuators’ judgment and decision making is currently unexplored. This study provides preliminary evidence on how valuators act in the presence of conflict of interest, and the need for conflict disclosures. The results of this study have implications for public accounting firms to the extent that they provide either fairness opinions and associated valuation judgments or are involved in some audit aspects related to mergers/acquisitions. This study contributes to accounting and psychology literature on conflict of interest disclosures and is the first study to test the biasing effects of conflict disclosure specifically targeting professionals performing familiar tasks. Further, this study extends existing literature of the topic by documenting that bias arising from disclosure of conflict of interest depends on whether the conflict of interest is aligned or misaligned with the client’s interest. This study provides the first evidence that disclosure of conflict of interest causes bias in Client-Aligned, but not in a Client-Misaligned, conflict of interest setting.

    Citation:

     Jamal, K., E. Marshall and H. Tan. 2016. Does Disclosure of Conflict of Interest Increase or Decrease Bias? Auditing: A Journal of Practice and Theory 35 (2): 89-99.

    Keywords:
    Conflict of interest, disclosure, bias, auditor independence, valuation, client advocacy, nature of conflict
    Purpose of the Study:

     Professional valuators are increasingly called upon to supply inputs that form part of the financial statements and the audit report. However, criticisms of potential conflicts of interest relating to valuators’ reports abound. One concern is that professional valuators provide expert opinions in circumstances where they are required to act in the public interest, yet are hired and paid by a client who has self interest in the outcome of the valuator’s report. This study seeks to investigate, in a valuation setting involving professional valuators, the efficacy of disclosure in curbing biases stemming from conflict of interest. Further, this study investigates whether the effect of disclosure of conflict of interest depends on the nature of the conflict of interest—specifically, whether the conflict of interest is aligned with or threatens the current client’s (seller or auditor’s) interest.

    Design/Method/ Approach:

     The authors recruited 90 experts with business valuation experience and sent these participants research instruments via courier mail. On average, participants had 13.3 years of work experience, 6.7 years of work experience in business valuation, and had worked on 38 valuation engagements. These individuals were asked to make a valuation judgment in the context of a larger fairness opinion engagement on the sale of a subsidiary. Conflict of interest was manipulated as either Client-Aligned (valuators’ interest aligned with auditors) or Client-Misaligned (valuators’ interest aligned with audit client). The results were also examined in the presence and absence of disclosure (No Disclosure, Disclosure).

    Findings:

     The study resulted in the following conclusions. • In a Client-Aligned conflict situation, disclosure of conflict of interest induces bias toward the current client (auditor), and does not produce the intended result of reducing or preventing bias. • In a Client-Misaligned conflict of interest setting where the valuator has potential future business opportunities with the buyer (audit client), the authors found evidence that valuation estimates are still biased toward the current client (auditor), regardless of disclosure. • In the Client-Aligned conflict situation, disclosure magnified bias. In contrast, in the client-misaligned conflict setting, disclosure of conflict of interest did not cause any incremental bias.

    Category:
    Audit Team Composition, Auditor Judgment
    Sub-category:
    Impact of Consultation on Judgments, Use of Specialists (e.g. financial instruments – actuaries - valuation)

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