Auditing Section Research Summaries Space

A Database of Auditing Research - Building Bridges with Practice

This is a public Custom Hive  public

Posts

  • The Auditing Section
    A Comparison of Auditor and Client Initial Negotiation...
    research summary posted May 4, 2012 by The Auditing Section, tagged 09.0 Auditor Judgment, 09.10 Prior Dispositions/Biases/Auditor state of mind, 10.0 Engagement Management, 10.04 Interactions with Client Management 
    Title:
    A Comparison of Auditor and Client Initial Negotiation Positions and Tactics
    Practical Implications:

    This study provides a more complete examination of auditor-client pre-negotiation decisions and negotiation tactics when confronted with an ambiguous accounting issue.  Because auditors and clients approach conflict resolution and make negotiation decisions in very different ways, the results should be of interest to auditors. 

    Citation:

    Bame-Aldred, C. W. and T. Kida. 2007. A Comparison of Auditor and Client Initial Negotiation Positions and Tactics. Accounting, Organizations, and Society 32 (6): 497-511.

    Keywords:
    Auditor-client negotiation, revenue recognition, financial reporting.
    Purpose of the Study:

    Auditors must work with clients when forming their financial reporting decisions and the two parties may encounter situations where their reporting goals are different.  This conflict can compel the auditor and client to enter into formal or informal negotiations.  Various studies have previously examined auditor-client negotiation behavior, but none have directly compared the negotiation decisions of auditors and clients when faced with the same negotiation context. As such, the overall purpose of the study is to further examine the negotiation behavior of auditors and clients when facing an ambiguous revenue recognition issue.  Negotiation behavior will ultimately have an impact on the firm’s financial reporting decisions. Below are the objectives that the authors address in their study: 

    • Examine the degree of flexibility inherent in auditor and client initial negotiation positions.
    • Examine whether auditors and clients accurately perceive the other party’s initial positions.
    • Examine the types of negotiation tactics auditors and clients are likely to use. 
    Design/Method/ Approach:

    The authors collected their evidence via research questionnaires mailed to auditors at national CPA firms and experienced financial managers at various companies during the Spring and Summer of 2002.  The auditor participants included partners, senior managers, and managers.  The financial managers included CFOs, controllers, accounting managers, and analysts from 38 different companies.  Participants read summary financial information, a description of the auditor-client relationship, and a scenario about the proper amount of revenue recognition in a specific conflict scenario.  Participants were asked questions about their initial negotiation positions, their range of acceptable amounts, their perceptions of the other party’s positions and limits, the importance of certain revenue recognition issues, and the likelihood of using specific types of negotiation tactics.

    Findings:
    • Auditors and clients differ in their desired recognition amounts, thus establishing the need for negotiation to resolve this conflict. 
    • Auditor solution sets (i.e., the revenue recognition amounts between their reporting goal and their limit) were about half as large as client solution sets, indicating considerably less flexibility by auditors during the negotiation process. 
    • Auditors’ and clients’ had overlapping solution sets, indicating that a negotiated settlement should still be quickly attainable for most auditor-client negotiations.
    • Clients’ perceptions were significantly more accurate than auditors’ perceptions about the other party’s goals and limits of recognition amounts.  Auditors appear to overestimate clients’ actual reporting goals and limits.
    • Auditors considered issues supporting higher revenue recognition (e.g., missing the analysts’ earnings estimates and management incentive bonus) as less important than clients.  Clients thought that consistency with existing revenue recognition methods and increased earnings variability were more important issues than did auditors.  However, auditors and clients considered issues supporting lower revenue recognition to be equally important.
    • Tactics:
      • The highest rated tactic by both auditors and clients was problem-solving (i.e., to provide substantial rationale for their solution to persuade the other party to change their mind). 
      • Both auditors and clients agreed they should try to get information about the other party’s preferences and that they would try to appear as if they would not back down from their initial position. 
      • The lowest rated tactic by both auditors and clients was to threaten to qualify the opinion (by auditors) or to threaten to terminate the relationship (by clients). 
      • Clients were more likely than auditors to use a tactic of bid high / concede later and a tactic of attempting to trade-off certain issues. 
      • Overall, auditors were less likely to use tactics that could be interpreted as appearing inconsistent with their professional responsibilities.
    Category:
    Auditor Judgment, Engagement Management
    Sub-category:
    Prior Dispositions/Biases/Auditor state of mind, Interactions with Client Management
    Home:
    home button
  • Jennifer M Mueller-Phillips
    A Field Survey of Contemporary Brainstorming Practices
    research summary posted February 20, 2017 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards, 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment, 06.07 SAS No. 99 Brainstorming – process, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism, 10.0 Engagement Management, 10.03 Interaction among Team Members 
    Title:
    A Field Survey of Contemporary Brainstorming Practices
    Practical Implications:

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

    Citation:

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

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

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

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

    Design/Method/ Approach:

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

    Findings:
    • Surveyed auditors rarely interacted with engagements where fraud in financial reporting was identified.
    • When fraud risk and inherent risk are both elevated for a particular engagement, perceived professional skepticism is also elevated.
    • Risk-based resource deployment is consistent when considering high- versus low-risk clients—particularly, when inherent risk is elevated, audit team size is also greater.
    • Public clients cultivate larger audit teams where managers and seniors have more client experience.
    • With respect to contributions made at brainstorming sessions, the audit partner and manager make the greatest contributions along with forensic specialists and audit seniors.  Interestingly, when fraud brainstorming is more important with respect to the engagement, seniors make lower relative contributions. 
    • Media richness theory is robustly at work with respect to attendance patterns at brainstorming sessions.  Specifically, when engagement risk is elevated, staff and seniors are more likely to attend face-to-face. 
    • Fraud brainstorming sessions are most commonly open-discussion (86 percent) where the session is held during the planning stage of the engagement (87 percent).
    • Results propose that audit partners are open-minded to suggestions made during fraud brainstorming.
    • Fraud risk assessments appear to be independent from brainstorming tactics; however, when inherent risk is elevated and if the client is public versus private, audit teams exert more effort.  
    Category:
    Auditing Procedures - Nature - Timing and Extent, Engagement Management, Risk & Risk Management - Including Fraud Risk, Standard Setting
    Sub-category:
    Auditors’ Professional Skepticism, Changes in Audit Standards, Fraud Risk Assessment, Interaction among Team Members, SAS No. 99 Brainstorming – process
  • The Auditing Section
    A Review and Integration of Empirical Research on...
    research summary posted April 13, 2012 by The Auditing Section, tagged 09.0 Auditor Judgment, 09.01 Audit Scope and Materiality Judgments, 10.0 Engagement Management, 10.02 Materiality and Scope Decisions 
    Title:
    A Review and Integration of Empirical Research on Materiality: Two Decades Later
    Practical Implications:

    The results of the studies documented in this review suggest that there is a great deal of variability in the approaches taken by firms for establishing materiality. Such differences in materiality methods can affect both the effectiveness and efficiency of audits. For example, if firms differ in how they allocate materiality to financial statement accounts, then the scope of the work could differ across audits with similar characteristics. Auditors also appear to differ in terms of the factors they consider for determining the materiality of internal control weaknesses, suggesting that auditors may need more structured criteria to make materiality judgments about internal control weaknesses. Materiality judgments are influenced by authoritative guidance, suggesting that standard setters and audit firms have the ability to influence auditors’ materiality judgments by providing auditors with specific guidance.

    Citation:

    Messier, Jr., W.F., N. Martinov-Bennie, and A. Eilifsen. 2005. A review and integration of empirical research on materiality: Two decades later. Auditing: A Journal of Practice and Theory 24 (2): 153-187.

    Keywords:
    Materiality, materiality bases, quantitative, qualitative materiality factors
    Purpose of the Study:

    Materiality has been and continues to be a topic of importance for auditors. There has recently been renewed interest in the concept of materiality, motivated by concerns at the Securities and Exchange Commission, and the Auditing Standards Board and as evidenced by the Sarbanes-Oxley Act and the issuance of proposed standards on materiality by the International Auditing and Assurance Standards Board. Additionally, new guidance has been issued recently in response to some of the materiality concerns, including Staff Accounting Bulletin (SAB) No. 99, Statements on Auditing Standards (SAS) No. 89, and SAS No. 90.  Due to the continued importance of understanding the concept of materiality, this paper reviews and integrates the empirical research on materiality since 1982. Based on the review of the literature, the authors suggest some implications of this research for audit practice and research.

    Design/Method/ Approach:

    This paper reviews the literature related to materiality that has been published since 1982. The authors divide their discussion of the research into archival studies and experimental studies. Archival studies use audit firm manuals, data from auditor working papers, or published financial statement data and auditor reports to examine materiality decisions. Experimental studies examine materiality judgments and decision-making of financial statement users, auditors and others (e.g., judges/lawyers).

    Findings:

    Archival Studies: The primary findings from archival studies are categorized based on whether they were obtained from auditor-related sources (e.g., auditor working papers) or public sources (e.g., financial statements).  

         Auditor Related Sources (i.e., firm manuals and working papers)

    • There appear to be differences in the way firms establish planning materiality as well as differences in the extent of guidance provided by firms for setting planning materiality and tolerable misstatement.
    • Auditor judgment plays a significant role in setting planning materiality
    • Some version of income continues to be the major factor in determining the materiality of a misstatement (e.g., misstatement as a percent of net revenue). 

         Public Sources (i.e., financial statements, disclosures, and auditors’ reports)

    • Public sources also indicate that income continues to be the most significant factor in auditors’ materiality and disclosure decisions. This is the case regardless of the type of reporting item or disclosure in question.
    • Similarly, the choice to modify the auditor’s report seems consistent with traditional effects of the item on income. 

         Experimental Studies:

    • Experimental studies find that net income continues to be the most important factor in determining the materiality of misstatements, consistent with the findings of archival research. A number of studies find that the second most important materiality factor is the effect of the misstatement on a company’s earnings trend.
    • A number of qualitative factors were found to affect materiality decisions, including the auditors’ perceptions of management
      and management’s integrity, audit committee effectiveness, audit firm culture and whether a misstatement will be recognized in the financial statements or the footnotes.
    • Materiality judgments vary by experience and firm type. Experience appears to lead to greater consensus in materiality judgments and greater scrutiny of materiality judgments relating to discretionary, non-routine transactions.
    Category:
    Auditor Judgment, Engagement Management
    Sub-category:
    Audit Scope & Materiality Judgements, Materiality & Scope Decisions
    Home:
    home button
  • Jennifer M Mueller-Phillips
    Abnormal Audit Fees and Restatements
    research summary posted October 20, 2014 by Jennifer M Mueller-Phillips, tagged 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations, 12.0 Accountants’ Reports and Reporting, 12.03 Restatements 
    Title:
    Abnormal Audit Fees and Restatements
    Practical Implications:

    The conclusion that audit fees are associated with the risk of audit failure may impact auditors as they face pressure to reduce audit fees. Auditors should consider this risk based on the client’s position as well as trying to minimize risk related to audit fee reductions. Similarly, client’s audit committee should consider the trade-off between current fees and the risk of restatement. With the changes that SOX introduced, regulators should review how changes in audit fees affects the quality of financial statements over time.

     

     

    For more information on this study, please contact Dr. David Hurtt.

    Citation:

    Alan I. Blankley, David N. Hurtt, and Jason E. MacGregor. 2012. Abnormal Audit Fees and Restatements. Auditing: A Journal of Practice & Theory: 31 (1): 79-96.

    Keywords:
    Restatements, audit fees, audit quality
    Purpose of the Study:

    Overall, this paper investigates whether there is a relationship between audit fees and subsequent financial statement restatements. The authors investigated whether audit firms charged more for audit services prior to a restatement compared to non-restatement clients. Past research finds that this relationship has a positive correlation. However, the authors revisited this relationship for the post-SOX period based on multiple factors:

     

    • The relationship of audit fees to future restatements is unclear since high fees may increase restatement probability due to independence issues, while low fees may increase the probability of future restatement because they potentially reflect lower levels of service or effort.
    • SOX affects the auditor-client relationship through changes such as partner rotation and prohibiting some non-audit services provided to audit clients. Research revealed a shift in firms increasing pricing for risk.
    • With the recent economic downturn, companies trying to decrease audit fees could be focusing on cutting cost instead of focusing on the quality of the financial statements.
    • Past research was inconclusive on the relationship between future restatements and audit fees because of the time frame studied as well as the omission of an internal control strength variable.

     

    Finding a clear relationship between audit fees and future restatements could have implications in how auditors, audit committees, and regulators view audit fees in a post-SOX business environment. As a result, the study could impact fee negotiations from the standpoint of audit quality.

    Design/Method/ Approach:

    Audit fee and restatement data was collected from Audit Analytics for the 2002 through 2009 period. The authors used two statistical models to study the association audit fees may have with future restatements. First, using an audit fee model based on prior research, the authors derived the abnormal or unusual audit fee after controlling for audit risk, client complexity, internal control strength and other influences on fees. In the second model, the authors tested a robust logistic regression model where the variable of interest was the abnormal audit fee derived from the first model. 

    Findings:
    • The authors find that abnormal audit fees are negatively associated with the probability of future financial statement restatements.
    • When audit fees are noticeably high, the likelihood of restatement is low. When audit fees are noticeably low, the likelihood of restatement is high.
    • When audit fees are abnormally low, there may be pressure for auditors to maintain the profitability of the engagement by minimizing hours to complete the audit.
    • This relationship is robust when the model included or excluded a variety of internal control and restatement variables.
    Category:
    Accountants' Reporting, Engagement Management
    Sub-category:
    Audit Fees & Fee Negotiations, Restatements
  • 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
    Home:
    home button
  • Jennifer M Mueller-Phillips
    Are All Industry Specialist Auditors the Same?
    research summary posted October 13, 2015 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.01 Use of Specialists e.g., financial instruments, actuaries, valuation, 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations, 11.0 Audit Quality and Quality Control 
    Title:
    Are All Industry Specialist Auditors the Same?
    Practical Implications:

    The results have implications on two fronts. First, the findings indicate that auditors pursue different production and pricing strategies in different segments of the market, suggesting that the Big 4 audit firms respond to the competitive pressures in each submarket. Second, the evidence raises questions about the construct validity of market share-based measures of industry specialization, which have been used extensively in the literature. The evidence suggests that auditors who obtain a large market share by auditing a large proportion of the industry sector may actually do so by producing lower quality, lower cost audits. As such, these auditors are not acting as true specialists in the sense of using specialized training and knowledge to raise the quality of the audit performed.

    Citation:

    Cahan, S. F., D. C. Jeter, and V. Naiker. 2011. Are All Industry Specialist Auditors the Same? Auditing: A Journal of Practice & Theory 30 (4): 191-222.

    Keywords:
    audit fees, audit quality, auditor market share, industry specialization, market segmentation, product differentiation
    Purpose of the Study:

    Auditor industry specialization continues to attract considerable attention in the literature. This may reflect the importance that clients place on industry specialization, e.g., 80 percent of companies viewed industry expertise or specialization as being an important factor in choosing an auditor. Most commonly, archival studies identify industry specialist auditors using a market share-based measure where a significant share, or an industry leading share, of the industry’s audit fees is used to designate specialists. However, a market share-based measure is problematic because market share depends jointly on the proportion of clients audited and the average size of those clients. For example, it is possible to attain a large industry market share by auditing a few relatively large clients in an industry or many relatively small ones. The question the authors examine is as follows: Are industry specialists who obtain a high market share in disparate ways similar in terms of product (audit) quality and price (audit fees)?

    Design/Method/ Approach:

    The authors begin with all client-years from 2003 through 2007 with requisite data available from Compustat and Audit Analytics. For the audit fee sample, the data requirement to compute the control variables results in a final sample of 9,565 client-year observations. For the discretionary accruals model, the additional data requirements needed to estimate discretionary accruals and the control variables for Equation (3) result in a final sample of 9,396 client-year observations. Sixty-one industries are represented by observations in both the audit fee and discretionary accruals samples. 

    Findings:

    The authors find evidence of higher (lower) audit quality when the auditor attains a high market share by auditing a lower (higher) proportion of clients in the industry. Combined, the findings suggest that industry specialists who gain market share by auditing a small proportion of clients in an industry pursue a product differentiation strategy, offering a higher quality, but more costly, audit. On the other hand, those specialists who gain market share by auditing a large proportion of clients follow a cost minimization strategy, competing on price and sacrificing quality. The authors do not find any evidence that the Big 4 operates as a tight oligopoly either in the overall audit market or within industry markets, whether defined at the national or local level. In summary, the results suggest that not all industry specialists are the same.

    Category:
    Audit Quality & Quality Control, Audit Team Composition, Engagement Management
    Sub-category:
    Audit Fees & Fee Negotiations, Use of Specialists (e.g. financial instruments – actuaries - valuation)
  • Jennifer M Mueller-Phillips
    Are Fraud Specialists Relatively More Effective than...
    research summary posted July 22, 2015 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.01 Use of Specialists e.g., financial instruments, actuaries, valuation, 06.0 Risk and Risk Management, Including Fraud Risk, 06.01 Fraud Risk Assessment, 10.0 Engagement Management, 10.01 Budgeting and Audit Time Management 
    Title:
    Are Fraud Specialists Relatively More Effective than Auditors at Modifying Audit Programs in the Presence of Fraud Risk?
    Practical Implications:

    Although both auditors and fraud specialists added non-standard procedures to the audit program, auditors cut the budgets for some standard procedures, making room in the overall audit budget for non-standard additional procedures. In contrast, fraud specialists added standard procedures, but they were not more effective than those selected by auditors, and also provided less budget room for those procedures. The involvement of fraud specialists in planning an audit engagement where fraud risk is present is likely to lead to additional audit effort and cost, possibly without commensurate benefit. However, considering the potential consequences to the auditor of undiscovered fraud, it may be cost-effective to include additional non-standard procedures in an audit program if they improve the probability of discovering a fraud.

    Citation:

    Boritz, J. E., Kochetova-Kozloski, N., & Robinson, L. 2015. Are Fraud Specialists Relatively More Effective than Auditors at Modifying Audit Programs in the Presence of Fraud Risk? Accounting Review 90 (3): 881-915.

    Keywords:
    audit planning, audit procedures, fraud, specialists
    Purpose of the Study:

    Since the passage of Statement on Auditing Standards (SAS) 99 and the Sarbanes-Oxley Act of 2002, policy-makers and regulators have promulgated additional guidance aimed at improving auditors’ performance in assessing and responding to fraud risks of audit clients. Auditors are expected to address fraud risk through the design of their audit methods and programs and by involving specialists. The authors study whether fraud specialists are relatively more effective than auditors in designing an audit program that will address elevated fraud risk. The goal is to examine whether the expertise of fraud specialists can directly contribute to planning the nature and extent of audit procedures, and whether the mix of procedures that such specialists recommend is likely to be more effective and efficient than the procedures proposed by auditors in a setting where ex ante fraud risk is rated at above a low level. By directly examining fraud specialists’ recommendations for an audit plan under conditions of an elevated fraud risk, the authors seek to clarify whether there are benefits in requesting fraud specialists to participate in audit program design.

    Design/Method/ Approach:

    Participants completed an audit case based on an actual company that had issued fraudulent financial statements. Thirty-two fraud specialists and sixteen auditors completed the case  On average, the fraud specialists were 41 years old, had 12 years of specialized fraud-related experience, and six years of auditing experience. The auditors were, on average, 36 years old, had 13.25 years of auditing experience, but no specialized fraud experience. The evidence was gathered prior to November 2010.

    Findings:
    • In a situation with elevated fraud risk, fraud specialists did not select more procedures from a standard audit program than financial statement auditors; nor were the selected procedures more effective than those selected by auditors. This suggests that the benefits of involving fraud specialists in audit planning do not lie in their ability to identify more effective standard audit procedures.
    • When the risk of fraud is other than low, the fraud specialists proposed more additional procedures than did auditors, and the specialist-proposed additional procedures were marginally more effective, but significantly less efficient, than the additional procedures proposed by auditors. This suggests that involving fraud specialists in audit planning can carry benefits for engagements where fraud risk is not low by helping to identify a larger set of effective procedures than even very experienced auditors are able to do.
    • Fraud specialists increased time budgets to reflect the additional effort that they proposed via extensive non-standard procedures. However, although they proposed significantly more additional procedures than did auditors, their proposed time budget increases for those procedures were significantly lower than adjustments proposed by the auditors. 
    Category:
    Audit Team Composition, Engagement Management, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Budgeting & Audit Time Management, Fraud Risk Assessment, Use of Specialists (e.g. financial instruments – actuaries - valuation)
  • The Auditing Section
    Audit Fees at U.S. Non-Profit Organizations
    research summary posted May 2, 2012 by The Auditing Section, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations 
    Title:
    Audit Fees at U.S. Non-Profit Organizations
    Practical Implications:

    This study identifies relationships between attributes specific to non-profit organizations (see above) and external audit fees, and it has practical implications for non-profit organizations as well as auditors in negotiating audit fees.  The audit fee model can be useful for non-profit organizations that seek to benchmark their audit fees.  Additionally, this study shows that non-profits with higher quality internal oversight are willing to incur additional costs for monitoring by external auditors. Further, this study shows that Big 4 auditors earn a premium for their services in the non-profit sector (similar to the for-profit sector).

    Citation:

    Vermeer, T. E., K. Raghunandan, and D. A. Forgione. 2009.  Audit Fees at U.S. Non-Profit Organizations.  Auditing: A Journal of Practice and Theory 28 (2): 289-303.

    Keywords:
    Non-profit organizations, auditing, liquidity, audit committees, benchmarking
    Purpose of the Study:

    The purpose of this study is to examine audit fee determinants for non-profit organizations.  The study examines audit fee determinants applicable to all businesses, as well as non-profit specific attributes that are associated with audit fees.                   

    This study is motivated by recent scandals and governance failures in non-profit organizations (United Way, New Era Philanthropy, and American Cancer Society), which have led to increased scrutiny and regulations over these organizations and have resulted in increased external audit requirements.  Given the significant differences between non-profit organizations and for-profit businesses  culture, organizational structure, financial needs, accounting rules, financial reporting, financial statement users, and audit risk environment), the role of auditing can be significantly different for non-profit organizations.  Despite the economic significance of these organizations, little is known about determinants of audit fees for non-profit organizations.  

    This study uses survey data from large non-profit organizations to determine whether the following factors impact audit fees at non-profit organizations: 

    • Complexity, including size and asset composition
    • Need for resources, including donor contributions, external debt, and single audit requirements (federal awards)
    • Monitoring mechanisms, including internal audit and audit committee
    • Control variables, including financial stress, Big 4 auditor, industry, and non-audit fees
    Design/Method/ Approach:

    The authors obtained data on fiscal 2002 and 2003 audit fees and background information from surveys sent to chief financial officers of the largest non-profit organizations per GuideStar, Inc. Financial data are obtained from the GuideStar database. The authors used these data to examine the relationship between audit fees and the factors listed above. 

    Findings:
    • Traditional determinants of for-profit audit fees appear to have a similar impact on audit fees for non-profit organizations.
    • Larger asset size and greater complexity are associated with higher audit fees.
    • Non-profits in poorer financial condition pay higher audit fees.
    • Greater debt leads to higher audit fees.
    The Big 4 audit fee premium also exists for non-profit clients. 
    • Non-profit organizations with a single audit incur higher audit fees. 
    • Audit fees are lower for non-profits in regulated industries (healthcare and education). 
    • Monitoring by external auditors complements, rather than substitutes for, other internal monitoring mechanisms such as audit committees and internal auditing departments. This is evidenced by the following:
      • Higher quality audit committees (i.e., audit committees being fully independent, having at least one CPA or other financial expert, and meeting at least twice per year) are associated with higher audit fees.
      • The presence of internal auditing is associated with higher audit fees.

    The authors argue this suggests that non-profits with quality internal oversight are willing to incur additional costs for monitoring by external auditors. 

    • Greater non-audit fees as a percentage of total fees leads to lower audit fees.  This suggests that the joint provision of audit and non-audit services may lead to increased efficiencies in auditing.
    Category:
    Client Acceptance and Continuance, Engagement Management
    Sub-category:
    Audit fee decisions, Audit Fees & Fee Negotiations
    Home:
    home button
  • Jennifer M Mueller-Phillips
    Audit Hours and Unit Audit Price of Industry Specialist...
    research summary posted June 2, 2016 by Jennifer M Mueller-Phillips, tagged 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations, 11.0 Audit Quality and Quality Control, 11.04 Industry Experience 
    Title:
    Audit Hours and Unit Audit Price of Industry Specialist Auditors: Evidence from Korea
    Practical Implications:

    The existing research is unclear about the mechanism behind the higher audit fees charged by the industry specialist auditors (ISAs). The fee premium can be explained either by higher audit hours or by higher audit fees per hour. Using Korean data, this study provides direct evidence of the source of the ISA fee premium. The results show ISAs spend more audit hours while charge lower unit price than non-ISAs, which indicates the ISA fee premium mainly comes from additional audit work performed by ISAs. One limitation of this study is the authors cannot differentiate the two potential explanations for the low unit price: cost savings arising from economies of scale or additional work performed by cheap audit labor.

    Citation:

    Bae, G. S., S. U. Choi, and J. H. Rho. 2016. Audit Hours and Unit Audit Price of Industry Specialist Auditors: Evidence from Korea. Contemporary Accounting Research 33(1): 314-340.

    Keywords:
    Industry specialist auditors; Audit effort; Audit fee premium; Audit quality
    Purpose of the Study:

    Prior audit research documents the total audit fees charged by industry specialist auditors (ISAs) are higher than those charged by non-industry specialist auditors (non-ISAs). There are different explanations of this finding. Some argue ISAs charge higher fees for more audit work they conduct. Others argue ISAs charge higher fees because they have greater bargaining power over client. This paper is to explore the source of audit fee premiums associated with ISAs. In particular, the authors compare total audit hours and audit price per hour between similar audit engagements of ISAs and non-ISAs. By decomposing total audit fees into total audit hours and audit price per hour, the authors would at least identify one source of the ISA audit fee premium. A higher total audit hours spent by ISAs would imply ISAs exert greater audit effort and their audit quality is higher. In contrast, a higher audit price per hour charged by ISAs would imply ISAs can extract market power rents or expertise rents from their clients. 

    Design/Method/ Approach:

    The sample comprises audit engagements of Korea listed companies from 2000 to 2010. In Korea, audit hours are required to be disclosed in the companies’ annual reports. The authors first compare total audit fees and total audit hours between audit engagements of ISAs and non-ISAs, controlling for other engagement characteristics. Next, they compare the unit audit prices charged by ISAs and non-ISAs.

    Findings:
    • Consistent with prior research, the authors find ISAs charge significantly higher audit fees than non-ISAs.

     

    • Further, the authors find the higher audit fees are driven by additional audit hours spent by ISAs, which implies ISAs make more audit efforts than non-ISAs.

     

    • They also find the audit price per hour charged by ISAs is significantly lower than that charged by non-ISAs.  They argue the lower unit price of ISAs could be either due to the benefit of economies of scale shared with clients or due to more audit work completed by low-pay junior auditors.   

     

     

    • Supporting the argument that extra audit hours are translated into higher audit quality, the authors find ISAs are positively associated with higher accounting quality.

     

    • The authors find consistent results when they limit their analysis within audit engagements of Big 4 accounting firms. Moreover, similar results exist when audit engagements are separate into large client group and small group and when the ISAs have dominant market shares. These findings refute the argument that the ISA fee premium is a result of superior bargaining power. 
    Category:
    Audit Quality & Quality Control, Engagement Management
    Sub-category:
    Audit Fees & Fee Negotiations
  • Jennifer M Mueller-Phillips
    Audit Partner Tenure and Audit Planning and Pricing.
    research summary posted October 20, 2015 by Jennifer M Mueller-Phillips, tagged 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations, 15.0 International Matters, 15.03 Audit Partner Rotation 
    Title:
    Audit Partner Tenure and Audit Planning and Pricing.
    Practical Implications:

    This study provides the first evidence using U.S. data on the relationships between audit planning and pricing and audit partner tenure. Importantly, the results speak to the requirement in SOX Section 203 that audit partners on public clients rotate every five years. The second set of results concerns changes in auditor risk responsiveness during the period 2002 to 2003. Because there are very few longitudinal studies of engagement effort that feature a consistent sample of clients over time, this study contributes to understanding of changes in audit firms’ risk responsiveness.

    Citation:

    Bedard, J. C., and K. M. Johnstone. 2010. Audit Partner Tenure and Audit Planning and Pricing. Auditing: A Journal of Practice & Theory 29 (2): 45-70.

    Keywords:
    audit effort, audit partner tenure, audit pricing, risk management, rotation
    Purpose of the Study:

    This paper investigates the association between audit engagement partner tenure and audit planning and pricing. Limitations on partner tenure for public company engagements exist in many developed countries. For instance, in the U.S., the AICPA’s SEC Practice Section has long had a professional requirement that audit partners of public clients be rotated at least once every seven years. Section 203 of the Sarbanes-Oxley Act (SOX) codifies a partner tenure limitation for public companies into law, and reduces the period to five years. Proponents of frequent partner rotation argue that the auditor’s independence and objectivity suffer from long tenure with the client, which may result in lower audit quality, and that the fresh perspective of a new partner is thereby beneficial. However, many in the auditing profession maintain that mandatory partner rotation causes unnecessary costs, and may in fact impair audit quality. This position is derived from concerns that while client information is stored in the workpapers, each new engagement partner faces a certain amount of information asymmetry due to less history of client interaction.

    Design/Method/ Approach:

    The data includes client characteristics and plans for audit engagements of publicly traded companies to be conducted during 2002 and 2003, gathered by the participating audit firm in support of its client continuance decisions. The final sample size is well over 500. The models consider 20022003 risk assessments and audit planning/pricing decisions for the firm’s continuing public clients in 2002, i.e., those that the firm audited in 2001 and prior years.

    Findings:
    • The level of planned effort does not differ for clients having longer versus shorter tenure partners.
    • Engagements with longer partner tenure have significantly higher realization rates, suggesting that client demand for services of those partners and associated reduction in fee pressure enables a greater return on their engagements.
    • Results reveal that relative to the prior year engagement of the client, audit effort increases in the year of the partner change.
    • Planned realization rates decline in the year of the partner rotation.
    • In combination, the results suggest that tightening the term of mandatory partner rotation from seven to five years removes a service valued by clients.
    • Levels of risks related to financial reporting quality, management integrity, and internal controls are positively associated with the levels of planned effort in 2002.
    • Changes in assessments of financial reporting risk, management integrity risk and internal control risk are positively associated with changes in planned effort from 2002 to 2003.
    • Overall, the authors conclude that from 2002–2003, the firm’s risk response was strong in 2002, and further increased in 2003. This change was more predominant in effort rather than unit pricing, which has positive implications for audit quality.
    Category:
    Engagement Management, International Matters
    Sub-category:
    Audit Fees & Fee Negotiations, Audit Partner Rotation

Filter by Type

Filter by Tag