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  • Jennifer M Mueller-Phillips
    Construal instructions and professional skepticism in...
    research summary posted February 17, 2016 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.05 Assessing Risk of Material Misstatement, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism, 09.0 Auditor Judgment, 09.02 Documentation Specificity, 11.0 Audit Quality and Quality Control, 11.09 Evaluation of Evidence 
    Title:
    Construal instructions and professional skepticism in evaluating complex estimates.
    Practical Implications:

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

    Citation:

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

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

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

    Design/Method/ Approach:

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

    Findings:

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

    Category:
    Audit Quality & Quality Control, Auditing Procedures - Nature - Timing and Extent, Auditor Judgment, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Assessing Risk of Material Misstatement, Auditors’ Professional Skepticism, Documentation Specificity, Evaluation of Evidence
  • Jennifer M Mueller-Phillips
    The Impact of Audit Evidence Documentation on Jurors’ N...
    research summary posted January 19, 2016 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards, 09.0 Auditor Judgment, 09.02 Documentation Specificity 
    Title:
    The Impact of Audit Evidence Documentation on Jurors’ Negligence Verdicts and Damage Awards.
    Practical Implications:

    This study suggests that audit workpaper documentation decisions can significantly influence juror negligence verdicts and damage awards in cases where the auditor faces litigation. This is a particularly important finding for audit firms as this is an aspect of the litigation process that the auditor can directly control prior to facing litigation by considering how jurors might perceive this information when designing documentation procedures.

    Citation:

    Backof, A. G. 2015. The Impact of Audit Evidence Documentation on Jurors’ Negligence Verdicts and Damage Awards. The Accounting Review 90 (6): 2177-2204.

    Keywords:
    audit documentation, auditor liability, culpable control model, damage awards
    Purpose of the Study:

    During litigation proceedings, audit workpaper documentation represents a key piece of evidence supporting the quality of audit work because these documents are not only presented to jurors and scrutinized by experts during the trial, but are also available for juror review during deliberations. Because of its prominence during trials, the method and information contained in audit workpaper documentation has the potential to influence juror negligence verdicts and damage awards. This study examines how variation in audit documentation decisions related to the linkage of specific audit procedures performed to risks of misstatement for individual-level accounts, along with the inclusion of facts inconsistent with the auditor’s professional judgment influenced subsequent juror decisions. In particular, the study addresses the following research objectives:

    • Whether the inclusion of the auditor’s consideration of alternative accounting treatments in workpaper documentation influences juror perceptions of the foreseeability of the misstatement.
    • Whether the inclusion of documentation which directly links account-level risks of misstatement to specific audit procedures performed increases the juror’s evaluations of auditor intentions to conduct a quality risk-based audit.  
    • Whether differences in workpaper documentation influence juror evaluations of auditor negligence and subsequent damage assessments.
    Design/Method/ Approach:

    The research evidence was collected utilizing a group of participants whose characteristics mimicked that of an average jury pool. Participants listened to a 28-minute audio recording of a negligence lawsuit, and then received a written transcript of the trial along with copies of the audit workpapers entered into evidence during the trial. Participants were instructed to assume the role of a juror in order to evaluate whether the audit firm was negligent and to determine an appropriate level of damages to assess the audit firm.

    Findings:
    • Jurors assess the likelihood of auditor negligence as higher when the auditor includes in their workpaper documentation facts inconsistent with their professional judgments. This is the case because jurors assess the misstatement as more foreseeable when this information is available in the workpaper documentation.  
    • When the workpaper documentation includes direct links between identified account-specific risks of misstatement and specific audit procedures performed, jurors do not view auditor’s intentions to conduct a quality risk-based audit as higher. Subsequently, jurors do not view the auditor’s likelihood of negligence to be lower when this information is included in workpaper documentation.
    • Workpaper documentation which includes direct links between identified account-specific risks of misstatement and specific audit procedures performed does not significantly influence the amount of damages awarded by jurors when facts inconsistent with the auditor’s professional judgments are not additionally included in the documentation. However, when this additional information is present, jurors award lower damages when the documentation does include direct links between identified account-specific risks of misstatement and specific audit procedures performed.
    Category:
    Auditor Judgment, Standard Setting
    Sub-category:
    Changes in Audit Standards, Documentation Specificity
  • Jennifer M Mueller-Phillips
    The Effects of Auditors’ Accessibility to “Tone at the Top...
    research summary posted February 24, 2015 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.04 Management Integrity, 09.0 Auditor Judgment, 09.02 Documentation Specificity 
    Title:
    The Effects of Auditors’ Accessibility to “Tone at the Top” Knowledge on Audit Judgments
    Practical Implications:

    The results of the study identify two points where decision aids are likely to be successful in improving audit quality—when developing a mental representation of the “tone at the top” and/or when establishing a preliminary assessment of control environment effectiveness. Although developing an understanding of the client’s “tone at the top” requires retrieval of positive evidence supportive of “tone at the top” effectiveness, the process of doing so may undermine auditors’ efforts at incorporating negative evidence into their mental representations. Structuring decision aids, working papers, and reviews to ensure that the relatively abundant positive “tone at the top” information does not suppress the negative information would alleviate a favorable bias in the auditors’ “tone at the top” mental representations. This is critical given that “tone at the top” mental representations permeate subsequent audit decision making.  

    For more information on this study, please contact Regan Schmidt.

    Citation:

    Schmidt, R.N. 2014. The effects of auditors’ accessibility to “tone at the top” knowledge on audit judgments. Behavioral Research in Accounting 26 (2): 73-96.

    Keywords:
    auditor, tone at the top, control environment, knowledge, mental representation, interference, decision aid
    Purpose of the Study:

    Auditors must evaluate the “tone at the top” due to its pervasive impact on the client’s financial reporting practices and the auditors’ reliance on internal controls. However, few studies have examined how audit evidence unique to the “tone at the top” impacts audit judgments. The prior research has noted that, even in organizations that experience fraud, evidence for assessing “tone at the top” effectiveness tends to comprise a higher proportion of positive evidence supporting “tone at the top” effectiveness and a lower proportion of negative evidence supporting “tone at the top” ineffectiveness. There is also a concern expressed in auditing standards regarding the lack of documentary evidence relevant to assessing “tone at the top” effectiveness. Lacking such documentation, auditors must rely on their memory processes when evaluating “tone at the top” effectiveness. This study investigates whether the approach auditors use when accessing their memory of audit evidence influences their evaluations of “tone at the top” effectiveness and subsequent audit judgments.

    Design/Method/ Approach:

    The experimental research evidence was collected in 2008. The study participants were auditors with approximately two years of audit experience on average. Participants read the background information of the client company and were provided with 50 unchanging “tone at the top” information items (i.e., evidence). The study then manipulated how participants recalled the evidence from memory. Participants subsequently provided a preliminary assessment of the effectiveness of the control environment, a plausibility assessment of management’s explanation for differences noted in preliminary analytical procedures, and fraud risk assessments. 

    Findings:
    • Holding the underlying evidence of the “tone at the top” constant, auditors who recall positive evidence supportive of “tone at the top” effectiveness prior to negative evidence develop more favorable “tone at the top” mental representations as compared to auditors who recall negative evidence prior to positive evidence. Accordingly, retrieving the abundant positive “tone at the top” evidence from memory may suppress accessibility to the negative “tone at the top” evidence.
    • The auditors’ “tone at the top” mental representation significantly impacts the auditors’ control environment assessment, as well as subsequent audit judgments including the auditors’ reliance on client management’s explanation in analytical procedures and fraud assessments. Mediation analyses document that the control environment assessment mediates the relationship between the auditors’ “tone at the top” mental representation and subsequent audit judgments.
    • This study clarifies the results of prior research that documented audit judgments were not sensitive to “tone at the top” information. By examining intervening cognitive processes, the results of this study provides an insight to suggest that, in prior studies, when auditors were making their audit judgments, the “tone at the top” evidence was not accessible (i.e., the negative “tone at the top” evidence was inhibited from the mental representation).
    Category:
    Auditor Judgment, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Documentation Specificity, Management Integrity
  • Jennifer M Mueller-Phillips
    Audit Partner Evaluation of Compensating Controls: A Focus...
    research summary posted February 16, 2015 by Jennifer M Mueller-Phillips, tagged 07.0 Internal Control, 07.02 Assessing Material Weaknesses, 09.0 Auditor Judgment, 09.02 Documentation Specificity 
    Title:
    Audit Partner Evaluation of Compensating Controls: A Focus on Design Effectiveness and Extent of Auditor Testing
    Practical Implications:

    The results of this study are important for audit firms to consider when audit partners are evaluating the level of precision in a compensating control. The evidence indicates that the partner’s knowledge of the existence of a material weakness unrelated to a compensating control being evaluated results in partners preferring a more precise compensating control and requiring more audit testing. Furthermore, this has implications for the efficiency of the audits as control-related decisions are potentially being influenced by inappropriate factors.

    For more information on this study, please contact Audrey Gramling, Ed O’Donnell, or Scott D. Vandervelde. 

    Citation:

    Gramling, A., E. O’Donnell, and S.D. Vandervelde. 2010. Audit Partner Evaluation of Compensating Controls: A Focus on Design Effectiveness and Extent of Auditor Testing. Auditing: A Journal of Practice & Theory 29 (2): 175-187.

    Keywords:
    audit partner judgments, compensating controls, halo effects, internal control over financial reporting, material weakness
    Purpose of the Study:

    The assessment of internal control over financial reporting is a mandatory requirement of auditors for large publicly traded companies. The assessment made by the auditors on the severity of any identified control deficiencies has a significant impact on external reporting. To assess the severity of a deficiency, auditors should consider the effect of any compensating controls. However, auditors’ prior knowledge has been a primary influence on their subsequent judgments during the assessment of this severity. Also knowledge of risk factors not directly related to the compensating control influences audit partner judgments’.

    This paper addresses the concern of the influence of this prior knowledge on the evaluation of compensating controls by investigating two factors:

    • Level of precision needed in a compensating control for it to be assessed as effectively designed
    • Extent of evidence needed for auditor testing of the operating effectiveness of the compensating control

                The authors motivate their expectations based on the psychology literature discussing halo effects. Halo effects occur when knowledge that has no diagnostic implications for a specific judgment still influences that judgment. In an audit setting, halo effects can result in auditors interpreting judgment-specific evidence to be consistent with global knowledge about the client, instead of evaluating that evidence based on its diagnostic implications relative to the judgment at hand.

    Design/Method/ Approach:

    The research evidence was collected in June 2007. The authors use a simulated task to examine whether information about overall risks influences audit partners’ judgments related to a compensating control that has been implemented within a specific client process. Participants have an average experience level of 20.91 years. The minimum number of years of experience is 10 and maximum number of years of experience is 35. Participating audit partners were asked to assume the role of an engagement partner on an integrated audit. 

    Findings:
    • Audit partners who knew of an unrelated material weakness required testing of a greater percentage of the revenue subject to the compensating control than partners who knew there were no other material weaknesses.
    • Differences in inherent risk did not significantly influence any of the dependent variables (assessment of the control design effectiveness, and the extent of evidence necessary for testing the operating effectiveness of that compensating control).
    Category:
    Auditor Judgment, Internal Control
    Sub-category:
    Assessing Material Weaknesses, Documentation Specificity
  • Jennifer M Mueller-Phillips
    The Interplay of Interpersonal Affect and Source Reliability...
    research summary posted May 26, 2014 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.05 Assessing Risk of Material Misstatement, 09.0 Auditor Judgment, 09.02 Documentation Specificity, 09.10 Prior Dispositions/Biases/Auditor state of mind 
    Title:
    The Interplay of Interpersonal Affect and Source Reliability on Auditors' Inventory Judgments
    Practical Implications:
    • A negative emotional feeling toward a lower competence client contact can result in more conservative judgments and the documentation of more items indicative of increased risk. This would likely result in inefficiencies due to increased testing because risk is perceived to be higher than it would be in an unbiased setting.
    • A positive affective reaction toward a lower competence client led to similar inventory obsolescence ratings and the documentation of more items indicative of decreased obsolescence than a higher competence source. This would likely result in lowered audit effectiveness due to decreased testing because risk is perceived to be lower than it would be in unbiased setting. Additionally, it would be hard for reviewers to remedy this error because the work papers would also have a bias toward lower risk evidence items.
    Citation:

    Bhattacharjee S., K.K. Moreno, T. Riley. 2012. The Interplay of Interpersonal Affect and Source Reliability in Auditors’ Inventory Judgments. Contemporary Accounting Research 29 (4): 1087-1108.

    Purpose of the Study:

    This study investigates how the likability and competence of a client contact may influence auditors’ risk judgments, specifically, in this case, related to inventory obsolescence. Prior literature had established that auditors place greater reliance on information obtained from more highly competent sources. However, little research had considered the role of emotional factors in evidence persuasiveness judgments. Auditors likely believe that they are able to make professional judgments that are independent of emotional feelings about the client. To the extent this is not true, the profession may be interested to know what the effects are and how they can be mitigated if necessary to produce higher quality judgments.

    Design/Method/ Approach:

    This experiment was conducted prior to Winter 2012 when it was published. Participants completed a hypothetical case study in which they assessed the risk of inventory obsolescence during preliminary audit planning after reading company background information and summary unaudited financial information. The participants for this study were 174 auditors from large and regional audit firms where 71.3% held the rank of staff or associate and 28.7% held the rank of senior associate or senior.

    Findings:

    The results of this study show that the influence of client contact personality characteristics on audit judgments depends upon the level of competence that person displays. When the client contact was perceived to be highly competent then emotion or feelings of like/dislike toward the client did not influence participants’ ratings about the likelihood of an inventory obsolescence problem. However, when the client is less competent:

    • Positive emotion reduces judgments of how likely inventory obsolescence is compared to when client is more competent
    • Neutral emotion increases judgments of how likely inventory obsolescence is compared to when client is more competent
    • Negative emotion increases judgments of how likely inventory obsolescence is compared to when client is more competent to an even greater extent than neutral emotion

    Finally, the results show that these judgments influence whether the evidence documented in the work papers contain more items that indicate higher risk of obsolescence or more items that indicate a lower risk of obsolescence. 

    Category:
    Auditor Judgment, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Assessing Risk of Material Misstatement, Documentation Specificity, Prior Dispositions/Biases/Auditor state of mind
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  • Jennifer M Mueller-Phillips
    Documentation Requirements and Quantified versus Qualitative...
    research summary posted September 19, 2013 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.05 Assessing Risk of Material Misstatement, 09.0 Auditor Judgment, 09.02 Documentation Specificity, 09.12 Impact of potential post-audit review - e.g., PCAOB, internal firm inspections 
    Title:
    Documentation Requirements and Quantified versus Qualitative Audit Risk Assessments
    Practical Implications:

    This study should be of interest to both regulators and audit firms.  In the future, standard setters should consider how natural human behavior may result in unintended consequences.  By considering psychology, standard setters may be able to write the standards in a way to minimize those potential consequences or at least be aware of the risks. 
        This study should also be of interest to audit firms because current auditing standards are neutral with respect to whether audit documentation of risk assessments are performed quantitatively or qualitatively.  This implies that either option is adequate and treats the potential costs as minor.  As risk assessments that are more lenient in nature tend to lead to fewer audit procedures and less substantive evidence, the costs may be more than inconsequential. 

    For more information on this study, please contact M. David Piercey.
     

    Citation:

    Piercey, M. D. 2011. Documentation Requirements and Quantified versus Qualitative Audit Risk Assessments. Auditing: A Journal of Practice & Theory 30 (4):223-248.

    Keywords:
    quantitative versus qualitative audit risk assessments; elastic re-definition; documentation requirements
    Purpose of the Study:

    The purpose of this study is to examine whether there are any potential unintended consequences that result from Auditing Standard No. 3 (AS3) – Audit Documentation, which requires auditors to document most judgments.  The intent of AS3 is to improve documentation so that it is easier to inspect the firms’ working papers and understand what was done and why.  The expectation is that due to the increased potential scrutiny from reviewers (e.g., PCAOB review or litigation) the added documentation will cause auditors to improve their judgments and increase their levels of objectivity and professional skepticism.   
    This study looks at auditor risk assessments, which, according to the standard, can be documented quantitatively (i.e., using numerical assessments) or qualitatively (i.e., using worded assessments).  The author is concerned that if an auditor has a preference to arrive at a conclusion that is client-preferred and more lenient, the added documentation requirements will cause auditors to be even more lenient than if they were not required to meet these new documentation requirements.  This would be contrary to what one would expect given the potential risk of the firm opening itself up to liability in the event of review or litigation.
     

    Design/Method/ Approach:

    The author conducted an experiment including auditors of all ranks from 2 large accounting firms and senior accounting students prior to May 2011.  The experiment manipulated two factors (documentation requirements and response mode).  Participants were asked perform a risk assessment of material misstatement in one of three ways (one of which is quantitative and two are qualitative).  Then participants were told whether or not their assessment was going to be documented (or not) in the working papers and thus be subject to potential PCAOB review.  

    Findings:
    • The author finds that when auditors are required to document risk assessments and assess risk in qualitative terms, they are more apt to be even more lenient when they have pressures to provide a client-preferred assessment.  The qualitative terms seem to allow auditors to rationalize the more lenient judgments.
    • When using quantitative assessments, the author does not find similar results.  There is no difference in these judgments regardless of whether auditors are required to document their judgments in working papers or not.
    • These findings are not unique to auditors.  Humans, in general, assess risk differently when they are doing so with words instead of numbers. 
       
    Category:
    Auditor Judgment, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Assessing Risk of Material Misstatement, Documentation Specificity, Impact of potential post-audit review (e.g. PCAOB - internal firm inspections)
  • The Auditing Section
    The Effect of Documentation Structure and Task-Specific...
    research summary posted May 7, 2012 by The Auditing Section, tagged 07.0 Internal Control, 07.02 Assessing Material Weaknesses, 09.0 Auditor Judgment, 09.02 Documentation Specificity 
    Title:
    The Effect of Documentation Structure and Task-Specific Experience on Auditors’ Ability to Identify Control Weaknesses
    Practical Implications:

    The authors find that experienced component reviewers react differently to their preparers’ assessments/documentation than their counterparts in the supporting or balanced documentation conditions. Implicit results of the study also indicate that audit firms should consider how workpaper documentation is structured when assessing control weaknesses.

    Citation:

    Agoglia, C. P., Beaudoin, C., and Tsakumis, G. T. 2009. The Effect of Documentation Structure and Task-Specific Experience on Auditors’ Ability to Identify Control Weaknesses. Behavioral Research in Accounting 21(1): 1-17.

    Keywords:
    Review process; control environment; fraud assessment; control weakness;
    Purpose of the Study:

    Recent high-profile audit failures prompted Congress and standard-setting bodies to pass regulations emphasizing and expanding the auditor’s role in fraud detection (e.g., the Sarbanes-Oxley Act of 2002 and Statement on Auditing Standards No. 99). These new regulations require auditors to assess and issue an opinion on the effectiveness of clients’ internal controls. The intended purpose of these regulations is to help ensure adequate controls are in place to deter fraud from occurring or to detect any fraud that occurs. This paper examines how auditors assess fraud and the impact that experience assessing fraud has on members of a firm’s review team. In particular, the authors focus on the effect of workpaper documentation structure on the audit review team’s ability to identify significant control weaknesses. Below are two objectives that the authors address in their study: 

    • Workpaper documentation. Auditors typically document their assessments in audit working papers. Accuracy and completeness of documentation, which may come in varying forms, is important as the working papers could be used in the event of litigation (e.g. with the Enron scandal, a lack of proper audit documentation was key in making convictions). 
      Insufficient documentation by auditors can flow through the review process and negatively impact review team judgments. Consequently, it is important to consider factors that may improve review team performance in such settings.
    • Auditor experience. Academic research and practical anecdotal evidence indicate task-specific experience (e.g. performing audits) often improves auditors’ judgments. Task-specific experience provides the opportunity for the development of enhanced knowledge structures, which can improve auditors’ decision-making effectiveness. As such, auditors’ (reviewers’) experience performing (reviewing) internal control assessments (what the authors refer to as task-specific experience) could influence his/her effectiveness in identifying control weaknesses that present opportunities for fraud.
    Design/Method/ Approach:

    The authors collected their evidence via research questionnaires presented to practicing auditors from large international accounting firms in the early 2000s time period. One-half the participants were randomly assigned as workpaper preparers and the other half workpaper reviewers. Participants were provided a case containing control environment evidence for a hypothetical client, which was based on an actual firm that had experienced fraud. Preparers were asked to compile documentation regarding the client’s control environment and to identify control environment weaknesses. They were asked to structure their workpaper documentation using one of three assigned documentation structures:

    • “Supporting Documentation” – preparers provide evidence supporting their conclusions;
    • “Balanced Documentation” – preparers document important positive and negative evidence of the control environment;
      and
    • “Component Documentation” – preparers document important positive and negative information for components of the control environment.  

    Preparers were then asked questions regarding their assessment (likelihood) of specific fraud risk factors being present in the audit client’s control environment. 

    A reviewer was paired with each preparer and provided the same client background as preparers.  They reviewed the preparer’s fraud assessment workpaper documentation (documented in one of the three ways, noted above) and then were asked to assess the likelihood of specific fraud risk factors present in the audit client’s control environment.

    Findings:
    • The authors finds that preparers using the component documentation structure are less effective at identifying control weaknesses (i.e., inappropriately assessed control weaknesses more favorably) than those using either the supporting or balanced documentation structures.
    • Preparers using component method of documentation also had lower quality of workpaper documentation.
    • The authors find that task-specific experience mitigates the effect of documentation structure on auditor fraud risk judgments.
    • The authors find that experienced preparers are less influenced by component documentation structure than their less experienced counterparts.
    • The authors find that reviewers with greater experience appear to be better able to overcome judgment difficulties encountered by their preparers.
    Category:
    Internal Control, Auditor Judgment
    Sub-category:
    Assessing Material Weaknesses, Documentation Specificity
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  • The Auditing Section
    The Influence of Documentation Specificity and on...
    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, 06.08 SAS No. 99 Brainstorming – effectiveness, 09.0 Auditor Judgment, 09.02 Documentation Specificity 
    Title:
    The Influence of Documentation Specificity and on Auditors’ Fraud risk Assessments and Evidence Evaluation Decisions
    Practical Implications:

    This study provides important insights into the fraud assessment process. The most common method of risk assessment is to create summary fraud risk memos. However, the PCAOB recommends that auditors make documentation more specific in their assessments of fraud risk. This study suggests that when auditors receive specific documentation of fraud risks, alone, their fraud related judgments improve. However, the study provides evidence that when a more specific fraud risk memo is prepared and auditors are also reminded about the possibility of fraud (i.e., primed) that assessments of fraud actually decline. This is a significant finding considering that it is common in practice for auditors to be reminded about the possibilities of fraud, as a way to increase auditors’ awareness of fraud risk.

    Citation:

    Hammersley, J.S., E.M. Bamber, and T.D. Carpenter. 2010.  The influence of documentation specificity and priming on auditors’ fraud risk assessments and evidence evaluation decisions.  The Accounting Review 85 (2): 547-571.

    Keywords:
    audit documentation; evidence evaluation; fraud risk; priming; Support Theory; auditor judgment
    Purpose of the Study:

    The authors investigate the effect of fraud planning discussions on subsequent fraud risk assessments, issue identification, and collection of additional evidence.  The PCAOB has expressed concern that auditors have a mindset that is too compliance-oriented and insufficiently fraud-oriented, especially during the evidence evaluation stage of an audit.  One suggested method of increasing fraud awareness is to increase documentation around fraud risks in the planning stage of the audit.  This study seeks to increase  nderstanding about the impact of increased fraud awareness in the planning of an audit.  Specifically, this study addresses the following questions:

    • How does the level of specificity of the documentation of the fraud-related discussion prepared in the audit planning stage influence initial fraud risk assessments and subsequent evidence  evaluation?
    • How does reminding an auditor of previously identified fraud risks impact his/her fraud mindset and influence subsequent judgments?

    Much of the research is based on Support Theory, which predicts that a person will evaluate the likelihood of an event by evaluating the support for the underlying components of the events rather than assessing the probability of the event itself.

    Design/Method/ Approach:

    Audit seniors participated in this experiment.  The experiment took place prior to 2008 and was completed over two sessions.  During the first session, participants: read a case with key information regarding a client; listed 3 risks that would be raised at a fraud brainstorming session; watched a short video of the brainstorming session; read a briefing memo that outlined the planning decisions; and assessed preliminary client business risk.

    In the second session, participants: received a summary of findings from completed audit work; listed important fraud risks (in one condition); reviewed and evaluated summary workpapers; and assessed final client business risk. 

    Findings:
    • Auditors who reviewed memos that listed specific fraud risks, initially assessed fraud higher than those that reviewed summary fraud risk memos.
    • Documenting specific risks in the planning stage fraud-risk memo causes auditors to assess fraud risk higher even after evidence evaluation.
    • Auditors who review summary memos, assess fraud risk higher if they are reminded about the possibilities of fraud (i.e., primed), compared to if they are not reminded (i.e., unprimed).  Auditors who review specific memos, assess fraud risk higher if they are not reminded about the possibilities of fraud, compared to if they are reminded.
    • Auditors not reminded about the possibilities of fraud and provided a specific memo will identify more issues than those provided a summary memo. However, there is no difference in the amount of additional evidence each group requests.
    • When provided a summary memo, auditors reminded about the possibilities of fraud identify more issues and request more evidence than auditors not reminded.
    • When provided a specific memo, auditors reminded about the possibilities of fraud identify fewer issues and request less evidence than auditors who are provided the summary memo and are not reminded.
    Category:
    Risk & Risk Management - Including Fraud Risk, Auditor Judgment
    Sub-category:
    Fraud Risk Assessment, SAS No. 99 Brainstorming – effectiveness, Documentation Specificity
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  • The Auditing Section
    Accountability and auditors’ materiality judgments: The e...
    research summary posted May 3, 2012 by The Auditing Section, tagged 09.0 Auditor Judgment, 09.01 Audit Scope and Materiality Judgments, 09.02 Documentation Specificity, 09.11 Auditor judgment in the workpaper review process, 10.0 Engagement Management, 10.02 Materiality and Scope Decisions, 10.03 Interaction among Team Members 
    Title:
    Accountability and auditors’ materiality judgments: The effects of differential pressure strength on conservatism, variability, and effort.
    Practical Implications:

    Firms should consider the levels of accountability pressure and situations where they use them and consider how different levels of pressure may impact performance.  Higher levels of accountability pressure may increase effectiveness and increase the likelihood of finding material misstatements. 

    On the other hand, increased effectiveness and time spent due to higher levels of accountability pressure may cause inefficiencies and result in unnecessary effort.  Firms should evaluate the costs and benefits for their situations. 

    The authors note that this study only looks at the effect of accountability pressure from an unknown partner.  In the real world, auditors have accountability pressures from many levels such as other superiors, clients, regulators, and audit committees. 
    Further, the auditor may have assessed things differently if they knew the partner that was performing their review.

    Citation:

    DeZoort, T., P. Harrison, and M. Taylor. 2006.  Accountability and auditors’ materiality judgments: The effects of differential pressure strength on conservatism, variability, and effort.  Accounting, Organizations, and Society 31 (4-5):  373-390. 

    Keywords:
    Audit Judgment; Audit Materiality; accountability pressure; materiality judgment
    Purpose of the Study:

    The purpose of this study is to look at how four different levels of accountability pressure (i.e. how their decisions would be reviewed) affect auditor conservatism, variability, and effort in tasks related to materiality.

    Design/Method/ Approach:

     The authors performed a computerized experiment using a final sample of auditors from five public accounting firms.  Participants were managers, staff and senior associates.   Participants were asked to review client background information, financial information, and a proposed audit adjustment for the Allowance for Doubtful Accounts balance.  Participants were asked to provide a planning materiality amount for the engagement and a materiality judgment regarding the proposed audit adjustment.  The auditors were put into one of four levels of accountability pressure:

    • Anonymity –judgment decision and responses were anonymous
    • Review –audit partner review but no feedback provided
    • Justification – participants provide written justification, which was reviewed but no comments provided
    • Feedback –formal feedback from partner about performance provided  

    In addition, about half of the participants received a “planning materiality decision aid,” which provided a range of planning materiality values.

    Findings:
    • For higher levels of accountability pressure strength (i.e. justification and feedback) judgments regarding planning materiality and proposed audit adjustments were more conservative and less variable.  In addition, higher level participants spent more time on the tasks, provided longer explanations and included more qualitative factors than those in lower levels, which suggest a higher level of effort.
    • Planning materiality decision aids reduced planning materiality variation across the various pressure levels, particularly for those in the lower accountability pressure groups.  
    Category:
    Auditor Judgment, Engagement Management
    Sub-category:
    Audit Scope & Materiality Judgements, Documentation Specificity, Auditor judgment in the workpaper review process, Materiality & Scope Decisions, Interaction among Team Members
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  • The Auditing Section
    The Effect of Alternative Types of Review on Auditors’ P...
    research summary posted May 2, 2012 by The Auditing Section, tagged 09.0 Auditor Judgment, 09.02 Documentation Specificity, 09.11 Auditor judgment in the workpaper review process, 11.0 Audit Quality and Quality Control, 11.06 Working Paper Review – Conduct, Biases and Predispositions 
    Title:
    The Effect of Alternative Types of Review on Auditors’ Procedures and Performance
    Practical Implications:

    The results of this study are important for audit firms to consider when designing their audit review process.  Though the initial reason for using interactive review was to increase efficiency and enhance training, the results of this study show that the use of interactive review can potentially increase audit effectiveness.  The anticipation of an interactive review enhanced auditors’ efforts toward more cognitively demanding, conclusion-oriented audit procedures.  At the same time, the type of review anticipated had no effect on the performance of the mechanical steps in the audit program (both groups performed well in the mechanical, documentation-oriented audit steps).

    Citation:

    Payne, E. A., R. J. Ramsay, and E. M. Bamber. 2010.  The Effect of Alternative Types of Review on Auditors’ Procedures and Performance.  Auditing: A Journal of Practice & Theory 29 (1): 207-220.

    Keywords:
    audit review process; review formats; interactive review; written review; auditor judgment
    Purpose of the Study:

    Audit review is a primary means of audit quality control and auditor training.  Given the significant amount of total audit hours allocated to review, audit firms are constantly examining ways to increase both the effectiveness and the efficiency of review.  Traditionally, reviewers examine documentation, prepare written review comments, and then either meet with the preparer face-to-face or provide the written notes to the preparer to be addressed.  An alternative approach that has gained in popularity is a real-time interactive review.  In this type of review, reviewers do not prepare written review notes prior to the review.  Instead, the reviewer sits down with the preparer and the review is done face-to-face with the file reviewer.  The interaction generates the written comments for the preparer to follow-up rather than written comments being prepared in advance.  Given the unique features of an interactive review, the purpose of this study is to examine how preparers’ anticipation of this type of review (as compared to a review with written notes) affects their performance of audit procedures and, in turn, audit effectiveness.  Specifically, the study examines the following:

    • Whether auditors anticipating an interactive review will more thoroughly perform the more cognitively demanding, conclusion-oriented steps of an audit program than auditors anticipating receipt of written review notes.
    • Whether auditors anticipating an interactive review will perform the more mechanical, documentation-oriented steps of the audit program differently than auditors anticipating receipt of written reviewnotes.
    • If performance on the conclusion-oriented steps of an audit program is positively related to conceptual error identification.
    • If performance on the documentation-oriented steps of an audit program is positively related to mechanical error detection.
    Design/Method/ Approach:

    The research evidence is collected prior to November 2008.  The authors use a group of staff- and senior-level auditors from three international accounting firms to complete a simulated audit task involving completing a test of internal controls for write-offs of accounts receivable.  Half of the participants were told they would receive written review notes and half of the participants were told they would be asked to meet face-to-face with a manager in an interview format to discuss/review the participant’s work. 
    All participants then performed mechanical, documentation-oriented procedures, conceptual, conclusion-oriented procedures, prepared a summary memo, and performed test of controls.  Completion of the procedures would allow them to identify two misstatements in the audit support and one fraud red flag.

    Findings:
    • Auditors anticipating an interactive review performed a more thorough examination of the audit evidence in the conceptual, conclusion-oriented audit steps than auditors anticipating a written review notes.
    • Auditors anticipating both types of reviews performed similarly in the mechanical, documentation-oriented audit steps.
    • A more thorough review of the audit evidence in the demanding, conclusion-oriented steps of an audit program is positively associated with (1) the identification of the fraud red flag (as predicted) and (2) detections of mechanical errors (not predicted).  To clarify, auditors who performed better in the conclusion steps of an audit program were more likely to identify the fraud red flag and the misstatements.
    • Performance of the mechanical, documentation-oriented audit steps is positively associated with detections of mechanical errors.  To clarify, auditors who performed better in the documentation steps of an audit program were more likely to identify the misstatements.
    Category:
    Auditor Judgment, Audit Quality & Quality Control
    Sub-category:
    Documentation Specificity, Auditor judgment in the workpaper review process, Working Paper Review – Conduct - Biases & Predispositions
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