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  • Jennifer M Mueller-Phillips
    Audit Sampling Research: A Synthesis and Implications for...
    research summary posted December 1, 2014 by Jennifer M Mueller-Phillips, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 08.02 Sample Selection – use of statistical sampling, 08.03 Conclusions Based on Samples, 09.0 Auditor Judgment, 09.08 Evaluation of Errors – Statistical and Non-statistical 
    Title:
    Audit Sampling Research: A Synthesis and Implications for Future Research
    Practical Implications:

    Although little research evidence exists on the effectiveness of audit sampling, auditors should consider the effectiveness of audit sampling compared to other sources of evidence, and the use of statistical compared to nonstatistical sampling for both tests of controls and tests of details to develop the most effective and efficient sampling plans. Auditors that use nonstatistical sampling techniques should evaluate procedures to determine whether sample sizes and evaluation of results are comparable to sample sizes and conclusions reached using statistical methods. Auditors also often fail to project sample misstatements and explicitly consider sampling risk; auditor performance in the evaluation of samples is enhanced with the use of standardized sampling templates.

    For more information on this study, please contact Randy Elder, rjelder@syr.edu.

    Citation:

    Elder, R. J., A. D. Akresh, S. M. Glover, J. L. Higgs, and J. Liljegren.  2013. Audit sampling research: A synthesis and implications for future research. Auditing: A Journal of Practice & Theory 32 (Supplement 1): 99-129

    Keywords:
    Audit sampling, audit evidence, post-SOX environment
    Purpose of the Study:

    While research has influenced auditing standards for audit sampling, academic research provides limited insights into the current use of audit sampling. We synthesize relevant research based on a sampling decision framework and suggest areas for additional research. Important judgments include determining:

    • Does sampling apply
    • What type of sampling to apply (e.g., attribute or monetary sampling)
    • Whether to use statistical or nonstatistical techniques, including appropriate inputs to determine sample size and evaluate results
    • Consideration of environmental factors such as regulation, litigation, competition, culture, and technology 
    Design/Method/ Approach:

    We first design a framework of the audit sampling process based on existing auditing standards and guidance. We then review relevant literature for each step in the audit process. A fairly extensive literature exists on some sampling issues, such as determination of sample size and projection of misstatements found in the sample. An extensive, but generally dated literature also exists on various statistical sampling techniques. However, limited evidence exists for many issues related to audit sampling.

    Findings:

    Auditing standards and guidance on audit sampling have not changed significantly since SAS No. 39 (1981) and the first Audit Sampling Accounting and Auditing Guide (AICPA 1983). However, a review of the literature suggests there have been major changes in sampling practices over the last three decades. Key findings from previous research include:

    • Limited research evidence exists on the extent of the use of statistical and nonstatistical sampling for tests of controls and tests of details, and how use of these methods has changed over time or across client characteristics or other environmental factors.
    • Little research evidence also exists as to the effectiveness of audit sampling relative to other audit procedures or the effectiveness of nonstatistical audit sampling relative to statistical audit sampling in providing sufficient audit evidence.
    • When auditors select samples statistically (e.g., randomly) and evaluate the results nonstatistically, research suggests they may be prone to decision biases.
    • Auditors often underestimate risks in order to minimize the extent of testing in tests of details, which could potentially compromise audit effectiveness.
    • Several studies find that auditors may not consistently project sample misstatements as required by auditing standards, which could lead to incorrect acceptance of accounting populations. However, more recent research suggests that when decision aids such as templates are used, auditors do usually project misstatements observed in the sample to the population.  
    Category:
    Auditing Procedures - Nature - Timing and Extent, Auditor Judgment
    Sub-category:
    Conclusions Based on Samples, Evaluation of Errors - Statistical and Non-statistical, Sample Selection – use of statistical sampling
  • The Auditing Section
    Auditors’ Decisions on Audit Differences that Affect S...
    research summary posted April 16, 2012 by The Auditing Section, tagged 09.0 Auditor Judgment, 09.01 Audit Scope and Materiality Judgments, 09.08 Evaluation of Errors – Statistical and Non-statistical, 10.0 Engagement Management, 10.02 Materiality and Scope Decisions 
    Title:
    Auditors’ Decisions on Audit Differences that Affect Significant Earnings Thresholds
    Practical Implications:

    The results of this study are important for auditors to consider when making materiality judgments.  The evidence indicates that auditors are more likely to overlook the qualitative importance of adjustments that affect a client’s ability to meet or beat analysts’ forecasts.  Furthermore, findings suggest that auditors are more lenient with subjective audit differences.  The study suggests that providing auditors with guidance on qualitative materiality may improve materiality judgments, but it does not completely alleviate the differences among the earnings benchmarks. 

    Citation:

    Ng, T.B. 2007. Auditors’ Decisions on Audit Differences that Affect Significant Earnings Thresholds. Auditing: A Journal of Practice and Theory 26 (1): 71-89.

    Keywords:
    materiality, audit adjustments, earnings management, thresholds, auditor judgments, guidance
    Purpose of the Study:

    Companies have economic incentives to meet or beat certain earnings benchmarks such as the prior year’s earnings, analysts’ forecasts, and positive earnings.  As a result, even small audit differences may be qualitatively material if they allow the client to meet or beat one or more of those benchmarks. However, the SEC and the IAASB both recently recognized that auditors may need further guidance on dealing with small but qualitatively material misstatements, and the SEC issued the Staff Accounting Bulletin 99 in response.  This paper provides evidence on this issue by investigating whether auditors’ propensity to book an adjustment is influenced by: client earnings benchmarks; subjectivity of the audit difference; and the availability of authoritative guidance.

    Design/Method/ Approach:

    The research evidence was collected prior to January 2005.  The author uses a sample of senior and manager auditors from the Singapore offices of the Big 4 firms to complete a simulated task involving the decision to waive or book an audit adjustment.  Participants were each assigned to two scenarios, both involving an audit adjustment that would cause the client to miss one of three earnings benchmarks.  One of the scenarios involved a subjective audit adjustment while the other involved an objective audit adjustment.  In a follow-up experiment, the author used the same methodology, but provided the auditors with materiality guidance from SAB 99.

    Findings:
    • The authors find that among the three earnings benchmarks, auditors are most likely to require an adjustment for differences that cause positive unadjusted earnings to become negative (profitability benchmark). 
    • Auditors are least likely to require adjustments that prevent clients from meeting analysts’ forecasts. 
    • The authors find that when auditors are more likely to require an adjustment when the audit difference is objective versus subjective, regardless of any earnings benchmark effect.
    • The authors also find that providing auditors with SAB 99 materiality guidance increases the likelihood that auditors will require small but qualitatively material items to be booked.  However, auditors are still more likely to require adjustments for audit differences that affect the profitability benchmark than the other two benchmarks.
    Category:
    Auditor Judgment, Engagement Management
    Sub-category:
    Audit Scope & Materiality Judgements, Evaluation of Errors - Statistical and Non-statistical, Materiality & Scope Decisions
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  • Jennifer M Mueller-Phillips
    Field Data on Accounting Error Rates and Audit Sampling
    research summary posted February 19, 2015 by Jennifer M Mueller-Phillips, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 08.02 Sample Selection – use of statistical sampling, 08.04 Auditors’ Professional Skepticism, 09.0 Auditor Judgment, 09.08 Evaluation of Errors – Statistical and Non-statistical 
    Title:
    Field Data on Accounting Error Rates and Audit Sampling
    Practical Implications:

    This study provides several important practice implications. First, prior research on audit sampling that relied on the assumption of relatively large error rates may not provide useful guidance for post-SOX audit sampling populations. Second, auditing educators, regulators, and standard setters benefit from an updated understanding of how auditors apply audit sampling guidance in auditing standards when using audit sampling in the field. For example, knowing the relatively high compliance (compared with prior periods) with requirements in auditing standards should impact the way audit sampling is taught in universities and firm trainings, how peer and federal inspectors address audit sampling issues, as well as the need for further clarity of auditing standards. Auditors also benefit as they consider the sampling techniques and input assumptions that will produce the most effective and efficient sampling plans. Specifically, an important implication of our study is related to the impact of standardized sampling templates. The firm in this study mandated the use of such templates, which contributed to levels of explicit consideration of error projection, sufficiency of sample sizes, and of sampling risk in planning and evaluating sample testing.

    For more information on this study, please contact Steve Glover.

    Citation:

    Durney, M., R. J. Elder, and S. M. Glover. 2014. Field data on accounting error rates and audit sampling. Auditing: A Journal of Practice and Theory 33 (2): 79-110

    Keywords:
    Sampling, error rates, error projection, sampling risk
    Purpose of the Study:

    Prior research has examined error characteristics of accounting populations. Many studies investigating audit sampling techniques rely on assumptions concerning the error characteristics of accounting populations. Prior research studies examining auditor performance when using audit sampling have reported:

    • Decreasing sample sizes for tests of details.
    • Auditors frequently fail to project sample errors.
    • Auditors do not consider sampling risk when projecting sample errors.

    These studies involve data from periods preceding the events resulting in the Sarbanes–Oxley Act (hereafter, SOX). Much has happened since SOX, including a renewed focus on audit quality, new auditing and accounting standards, and the creation of the PCAOB. Using proprietary post-SOX data from a large accounting firm, the authors report on:

    • Error rates in populations subject to audit sampling.
    • Auditor compliance with auditing standards with regards to error projection, sample size, and consideration of sampling risk.
    Design/Method/ Approach:

    Data for the study is comprised of the results of 160 different sampling applications from a large auditing firm in 2005 and 2006. The sampling applications were applied across a range of financial statement accounts including accounts receivable, inventory, loans, expenses, plant additions, and revenues. All the tests were substantive tests of details and meant to be representative of the population.

    Findings:

    The authors find the following:

    • Error rates in populations subject to audit sampling are significantly lower in magnitude and frequency than researchers have traditionally assumed.
    • Significantly larger sample sizes and higher error projection rates than reported in previous studies using pre-SOX data.
    • Explicit consideration of sampling risk by auditors.
    Category:
    Auditing Procedures - Nature - Timing and Extent, Auditor Judgment
    Sub-category:
    Conclusions Based on Samples, Evaluation of Errors - Statistical and Non-statistical, Sample Selection – use of statistical sampling
  • The Auditing Section
    Priming/Reaction-Time Evidence of the Structure of...
    research summary posted May 2, 2012 by The Auditing Section, tagged 09.0 Auditor Judgment, 09.08 Evaluation of Errors – Statistical and Non-statistical 
    Title:
    Priming/Reaction-Time Evidence of the Structure of Auditors’ Knowledge of Financial Statement Errors
    Practical Implications:

    The study has implications for audit planning and practice that are not specifically discussed in the paper.  First, the study provides some support for a seemingly obvious position that seniors/managers are more efficient in identifying financial statement errors than audit staff.  Second, the study shows that when auditors are given time to freely sort errors (e.g., when the errors have already been identified in the audit), they prefer to classify the errors by audit objective.  This finding is somewhat counterintuitive, given that auditors’ knowledge is primarily structured around transaction cycles.  The authors suggest that this finding may be attributed to auditors thinking about the causes of errors when sorting through errors, which would correspond more directly to audit objectives than to transaction cycles.    

    Citation:

    Coyne, M. P., S. F. Biggs, and J. S. Rich. 2010. Priming/Reaction-Time Evidence of the Structure of Auditors’ Knowledge of Financial Statement Errors. Auditing: A Journal of Practice and Theory 29(1):99-123.

    Keywords:
    financial statement errors; knowledge structure; cue sorting method; primary organizing dimension of knowledge structure; reaction time method; audit objective; transaction cycle.
    Purpose of the Study:

    Research into how knowledge of financial statement errors is organized in auditors’ memory has an important practical goal to improve decision making in auditing contexts.  Prior research has concluded that auditors structure their knowledge of financial statement errors primarily around audit objectives.  This stream of research has typically used cue sorting method, and it has been believed that other research methods would reach the same conclusions regarding how auditors structure their knowledge of financial statement errors.  

    However, the cue sorting method has one important limitation for studying memory structure. The act of sorting cues requires a participant to develop sorting strategies and make conscious choices about sorting cues into categories. These sorting strategies and choices may or may not be representative of the structure or organization of the knowledge in participants’ memory.  For example, an auditor may decide to sort financial statement errors alphabetically, which is an unlikely organization of the auditor’s knowledge.  The purpose of this study is to determine if the finding that auditor knowledge of financial statement errors is organized primarily around audit objectives can be replicated with the priming/reaction time method.  This method is often preferred in psychological research for studying the structure of knowledge in memory.

    Design/Method/ Approach:

    Coyne et al. collect their evidence via an experiment with audit staff, seniors, and managers as participants.  In this experiment auditors complete a task designed to assess how financial statement errors are organized in auditors’ memory.  The task is completed by each auditor initially using the method used in prior research (the free sort method), and then using the method preferred in psychological research for studying the structure of knowledge in memory (the priming/reaction time method).  The free sort method requires the auditors to sort 35 financial statement errors into groups of “audit differences that go together.”  In the priming/reaction time method, Coyne et al. measure participants’ speed of recognition of several financial statement error descriptions as audit objectives or transaction cycle primes. The experiments were conducted in the early 2000’s time period.

    Findings:
    • Coyne et al. find that when auditors use the free sort method, the results of prior research are generally replicated.  That is, auditors sort errors in a way that indicates that they structure their knowledge of financial statement errors primarily around audit objectives.
    • Coyne et al. find that seniors’/managers’ average financial error recognition speed in the priming/reaction time method are significantly faster than the audit staff’s average recognition speed. 
    • Coyne et al. find that all auditors’ speed of financial statement error recognition is faster when they are primed to think of transaction cycles, than when they are primed to think of audit objectives.  This effect is especially pronounced for seniors/managers.  Thus, Coyne et al. find that seniors’/managers’ speed of financial error recognition is significantly faster when they are primed to think of transaction cycles than audit objectives.    
    • In a supplemental analysis, Coyne et al. find that seniors/managers are marginally more accurate than staff, and are significantly more accurate than staff with transaction cycle primes.  This finding further supports the study’s conclusion that seniors/managers organize their knowledge about financial statement errors around transaction cycles. 
    • In a supplemental analysis, Coyne et al. find that staff are more accurate with transaction cycle primes than audit objective primes.  This finding provides some evidence that staff may organize errors around transaction cycles, and no evidence that staff organize errors around audit objectives.   
    Category:
    Auditor Judgment
    Sub-category:
    Evaluation of Errors - Statistical and Non-statistical
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  • Jennifer M Mueller-Phillips
    The Impact of Client and Misstatement Characteristics on The...
    research summary posted November 12, 2014 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 09.08 Evaluation of Errors – Statistical and Non-statistical 
    Title:
    The Impact of Client and Misstatement Characteristics on The Disposition of Proposed Audit Adjustments
    Practical Implications:

    The findings suggest that the frequency of waived audit adjustments dramatically declined right after accounting scandals and passage of the Sarbanes-Oxley Act, suggesting the regulatory environment led to changes in auditor-client resolution of proposed adjustments. Further, repeat adjustments are often waived, perhaps because this sets a precedent making it difficult to withstand client objections.  Finally, auditors are more likely to waive reclassification entries than those impacting income, suggesting an implicit belief that these types of adjustments are less important to users even though reclassifications could impact various widely used ratios.

    For more information on this study, please contact Jennifer Joe.

    Citation:

    Joe, J., Wright, A., and S. Wright. 2011. The Impact of Changes in the Reporting Environment and Client and Misstatement Characteristics on the Disposition of Proposed Audit Adjustments. Auditing: A Journal of Practice & Theory (May): 103-124.

    Keywords:
    Proposed adjustments; waiving audit adjustments; auditor-client relationship; resolution of audit adjustments.
    Purpose of the Study:

    We present evidence on the resolution of proposed audit adjustments during a unique time period, immediately following several US financial scandals and surrounding calls for reforms in auditing and financial reporting, which culminated in the passage of the Sarbanes-Oxley Act (SOX).  During this period auditors and their clients faced increased scrutiny from investors and regulators.  In addition, auditors had to contend with changed incentives, a new external regulator (i.e., the PCAOB) and upcoming annual PCAOB inspections. We extend prior studies by considering a broader range of factors potentially impacting the resolution of proposed adjustments including the effect of client tenure, strength of internal controls, and repeat adjustments. 

    Design/Method/ Approach:

    Data on 458 proposed adjustments are obtained from the working papers of a sample of 163 audit engagements conducted during 2002 by a Big 4 firm. The desired data are abstracted directly from the working papers by a partner or manager through an instrument. 

    Findings:

    We find that 24.2% of proposed adjustments were subsequently waived. Audit adjustments are more likely to be waived for clients with whom the audit firm has had a longer relationship, although the pattern does not reflect favoring such clients. We also find that adjustments are more likely to be waived for repeat adjustments. 

    Category:
    Auditor Judgment
    Sub-category:
    Evaluation of Errors - Statistical and Non-statistical

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