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  • Jennifer M Mueller-Phillips
    Are Juries More Likely to Second-Guess Auditors Under...
    research summary posted August 31, 2016 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.09 Litigation Risk, 12.0 Accountants’ Reports and Reporting, 12.04 Investigations, 15.0 International Matters, 15.02 IFRS Changes – Impacts 
    Title:
    Are Juries More Likely to Second-Guess Auditors Under Imprecise Accounting Standards?
    Practical Implications:

     The results of this study have implications for regulatory agencies and standard-setting bodies. As regulators contemplate whether to mandate IFRS and standard setters determine the level of implementation guidance for new standards, the litigation consequences of standard precision are an important consideration. Further, these results highlight the importance of regulators developing ways for jurors to evaluate audit judgments under imprecise standards, especially in industries and areas without precise industry reporting norms. Prior discussion on this issue has focused on how professional judgment frameworks are necessary to protect auditors and their clients from second guessing. This study suggests that judgments frameworks, if effective, may help protect auditors who make conservative judgments and also help hold auditors accountable for overly aggressive judgments.

    Citation:

     Kadous, K., and M. Mercer. 2016. Are Juries More Likely to Second-Guess Auditors Under Imprecise Accounting Standards? Auditing: A Journal of Practice and Theory 35 (2): 101-117.

    Keywords:
    audit litigation, standard precision, principles versus rules, second-guessing, jury decision making, IFRS
    Purpose of the Study:

    U.S. Generally Accepted Accounting Principles (GAAP) are generally viewed as more precise than International Financial Reporting Standards (IFRS) in that the former tend to contain more detail about implementation and compliance than the latter. Convergence efforts between U.S. GAAP and IFRS are on going, and have led to greater imprecision in U.S. accounting standards in areas such as lease accounting and revenue recognition. These imprecise standards require increased professional judgment by managers and auditors, which has led to concern that the adoption of less precise standards will result in more second-guessing of auditor judgments by juries and thus greater legal liability. This study seeks to address this concern and examines whether juries are more likely to second-guess auditors’ judgments under an imprecise accounting standard compared to a precise accounting standard. 

    Design/Method/ Approach:

    The authors recruited undergraduate students enrolled in introductory accounting courses at a large university as participants for this study. Two administrations were conducted with the students who participated in a simulated case that lasted 45 minutes during their accounting lab session. Participants acted as jurors in an auditor negligence case involving revenue recognition and were given information related to SFAS No. 66 (Real Estate) to help in their evaluation. The authors manipulated the precision of the accounting guidance as either precise or imprecise. The aggressiveness of the client’s reporting choice was manipulated as either aggressive or conservative.  

    Findings:

    The results of this experiment suggest that auditors’ fear about second-guessing by juries under imprecise accounting standards is warranted. Under an imprecise standard, conservative accounting choices are more likely to be called into question and result in negligence verdicts, ex post.

    • When the client’s reporting is conservative, there appears to be more second guessing of auditor judgments under an imprecise standard compared to a precise standard.
    • When the auditor allows aggressive client reporting, there appears to be less second guessing of auditor judgments under an imprecise standard compared to a precise standard.

    These findings indicate that rather than being overly harsh, juries appear to be overly lenient when auditors allow aggressive accounting under an imprecise standard. A lack of precision appears to make it more difficult for juries to identify whether an auditor’s judgment was reasonable or unreasonable. 

    Category:
    Accountants' Reporting, International Matters, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    IFRS Changes – Impacts, Investigations, Litigation Risk
  • Jennifer M Mueller-Phillips
    Are There Adverse Consequences of Mandatory Auditor...
    research summary posted July 27, 2015 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 15.0 International Matters, 15.04 Audit Firm Rotation 
    Title:
    Are There Adverse Consequences of Mandatory Auditor Rotation? Evidence from the Italian Experience.
    Practical Implications:

    The consequences of mandatory rotation appear to be (1) higher audit fees, and (2) lower-quality audited earnings following rotation (which is consistent with the evidence in non-mandatory settings). The authors conclude with some conjectures on how the negative effects of mandatory rotation observed in Italy might be even greater in countries with larger audit markets and larger clients, such as the United States and other European Union countries, which should give regulators pause. Another unintended consequence of mandatory rotation in the United States would be to reduce an audit firm’s industry expertise. A rotation rule in the United States and other large economies could disrupt the market and fundamentally change the way accounting firms are organized for the delivery of audits. 

    Citation:

    Cameran, M., Francis, J. R., Marra, A., & Pettinicchio, A. 2015. Are There Adverse Consequences of Mandatory Auditor Rotation? Evidence from the Italian Experience. Auditing: A Journal of Practice & Theory 34 (1): 1-24.

    Keywords:
    audit fees, audit market regulation, auditor rotation, earning quality
    Purpose of the Study:

    Mandatory auditor rotation was recently proposed for the European Union and is also under consideration in the United States. On April 24, 2013, the Legal Affairs Committee approved a proposal for a 14-year rotation rule. However, the full European Parliament has not yet acted on the recommendation. At the heart of the case for mandatory rotation is the belief that bad things can happen when auditors have long tenure. On the other hand, it may be the case that bad things do happen in the short-tenure setting due to a learning curve effect. Short tenure occurs when there is a change in auditor and there is evidence that earnings quality is lower during the first few engagement years, which is consistent with a learning curve on new audits.

    There has been little research into either the benefits or costs of rotation in a true mandatory setting that could inform intelligent policy making. Given the existing body of evidence, it appears the European Commission is advocating a major change to the audit market that is not supported by extant research. Even worse, the Commission could cause lower quality audits since there would be more frequent auditor changes under a mandatory rotation rule and, therefore, more frequent audits with short tenure and potentially lower quality. This paper helps fill this gap by examining Italy, where mandatory rotation of auditors has been required since 1975, and examines potential negative consequences of mandatory audit firm rotation.

    Design/Method/ Approach:

    The sample is comprised of 204 publicly listed companies in Italy audited by the Big 4 accounting firms over the period 20062009, resulting in 667 firm-year observations in the sample, although the specific sample size varies from test to test depending on data availability. The sample has 52 auditor changes, 36 of which are mandatory rotations (17.6 percent of firms), plus another 16 auditor changes that are voluntary (7.8 percent of firms). 

    Findings:
    • First, for the outgoing auditor, there is no evidence of lower-quality audits due to shirking in the final-year engagement. However, there is some evidence of abnormally higher fees, as the final-year fees are 7 percent higher than normal. This suggests there may some opportunistic pricing, since the authors find no evidence of abnormally higher audit effort in the final-year engagement. The PCAOB report does not identify this as a negative consequence, but the evidence suggests it adds to the cost of mandatory rotation.
    • Second, for the incoming auditor, audit effort (hours) is abnormally higher by 17 percent in the initial engagement, but initial fees are discounted by 16 percent relative to ongoing engagements. However, the authors also find that future audit fees following the first-year audit are abnormally higher by approximately 76 percent of first-year fees.
    • Third, the authors document that earnings quality is lower during the first three engagement years relative to later years of auditor tenure (large abnormal accruals and less timely loss recognition). On average, abnormal accruals are 36 percent larger in the first three years relative to later years of tenure.
    Category:
    Client Acceptance and Continuance, International Matters
    Sub-category:
    Audit Fee Decisions, Audit Firm Rotation
  • Jennifer M Mueller-Phillips
    Audit Fee Differential, Audit Effort, and Litigation Risk:...
    research summary posted June 26, 2017 by Jennifer M Mueller-Phillips, tagged 02.01 Audit Fee Decisions, 15.0 International Matters 
    Title:
    Audit Fee Differential, Audit Effort, and Litigation Risk: An Examination of ADR Firms
    Practical Implications:

    There are numerous factors that go into a firm’s decision to cross-list on foreign stock exchanges. One factor firms should consider regarding entrance into the U.S. stock exchange is an increase in audit fees. The evidence from this study indicates this increase can be traced back to costs from the legal environment and increased audit effort. 

    Citation:

    Bronson, Scott N., A. Ghosh, and C. E. Hogan. 2017. “Audit Fee Differential, Audit Effort, and Litigation risk: An Examination of ADR Firms”. Contemporary Accounting Research 34.1 (2017): 83.

    Purpose of the Study:

    U.S. investors rely on financial statements by foreign firms cross-listed on U.S. stock exchanges. Therefore, these financial statements must comply with accounting standards from the entity’s home country and U.S. standards. Previous studies have identified that audit fees are higher for cross-listed firms and attributed this to added litigation costs. This study examines if there are additional factors causing the audit fees to be higher for cross-listed firms. Specifically, about whether an increase in audit effort is incrementally related to price increases and if audit effort varies based on the stringency of an entity’s home country regulations. The authors presume the additional audit effort will result from the attestation of U.S. GAAP reconciliations and foreign auditor attestation of U.S. audit and independence standards.

    Design/Method/ Approach:

    The final sample consists of 36,646 observations and only includes entities audited by Big 4 firms. Compustat was used to find U.S.-based publicly traded firms, a list of foreign firms cross-listed in the United States was obtained from Bank of New York Mellon, and foreign non-cross listed publicly traded firms was listed in Worldscope and Compustat Global. The analysis was run using a regression of audit fees.

    Findings:

    The authors find the following:

    • Cross-listed firms in the United States do in fact pay significantly higher fees relative to other firms.
    • This total fee difference includes both incremental costs in legal environment and audit effort. The authors attributed 29% to 48% of this additional incremental costs as the additional audit effort required.
    • Cross-listed firms in countries with more stringent audit oversight pay a lower incremental audit fee compared to cross-listed firms in countries with more lax audit oversight.
    Category:
    Client Acceptance and Continuance, International Matters
    Sub-category:
    Audit Fee Decisions
    Home:

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

  • 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
  • The Auditing Section
    Audit Partner Tenure and Audit Quality
    research summary posted May 7, 2012 by The Auditing Section, tagged 04.0 Independence and Ethics, 04.07 Audit Firm Rotation, 05.0 Audit Team Composition, 05.03 Partner Rotation, 15.0 International Matters, 15.03 Audit Partner Rotation 
    Title:
    Audit Partner Tenure and Audit Quality
    Practical Implications:

    The results of this study are limited to the debate concerning individual audit partner rotation and do not support the argument for, or negate the prior studies that examine, audit firm rotation.  Combining the results of this study with the prior studies suggests that audit firms develop, over time, client and industry-specific knowledge that increases their ability to provide quality audits, and if quality control procedures within the firm are adequate (such as might be expected at a Big 6 firm), then rotating audit partners periodically helps maintain the auditor’s independence and objectivity while minimizing the loss of client-specific knowledge and rtise.

    Citation:

    Carey, P. and R. Simnett 2006. Audit Partner Tenure and Audit Quality. The Accounting Review 81 (3): 653-676.

    Keywords:
    audit partner tenure; audit quality; qualifications; earnings management
    Purpose of the Study:

    For many years, regulators have expressed concern regarding auditors’ extended associations with particular audit clients (i.e., long auditor tenure) and its potential impact on auditors’ independence and objectivity.  In the U.S., the AICPA Practice Section mandated in the 1970’s that audit partners rotate off their client after a seven year period.  The Sarbanes-Oxley Act of 2002 decreased this period to five years for public company engagements.  Outside the U.S., countries following international accounting standards and the Code of Ethics implemented by the International Federation of Accountants, as well as the United Kingdom and Australia, adopted similar standards by the early 2000’s due to the perceived “familiarity threat” associated with long auditor tenure.  Two of the arguments for mandatory rotation are that long auditor tenure 1) results in personal relationships with the client that could impair, consciously or subconsciously, the auditor’s independence, and 2) weakens the auditor’s ability to critically evaluate the client’s assertions.  However, to date, there is little empirical evidence to support these
    arguments.

    Due to data limitations, previous studies examining auditor tenure tend to focus on tenure of the audit firm as a whole.  Contrary to regulators’ perceptions, those studies tend to find that audit quality actually deteriorates in the early years after a change in the client’s audit firm, which is attributed to the “learning curve” effect, and that higher audit quality is associated with longer audit firm tenure, which is consistent with the audit firm developing more knowledge and familiarity with the client and industry as time progresses.  Based on their actions, regulators appear convinced that the potential benefits associated with auditor rotation are greater than the potential risks.  Therefore, the purpose of this study is to further examine whether long auditor tenure contributes to decreased audit quality in a setting where individual audit partners can be identified for particular audit clients.

    Design/Method/ Approach:

    The authors rely on data for Australian-domiciled companies publicly traded on the Australian Stock Exchange in 1995.  The authors accumulate auditor tenure information through 1997.

    The authors proxy for audit quality using three different measures: 1) the auditor’s propensity to issue a going-concern opinion; 2) the client’s reporting of abnormal working capital accruals; and 3) the extent to which key earnings targets are just beaten or missed.  Using the results of prior studies and the arguments and policies provided by regulators, the authors examine the association between audit quality and three measures of auditor tenure: less than two years, three to seven years, and greater than seven years.

    Findings:
    • For going-concern opinions, the authors find that longer audit partner tenures do decrease the individual auditors’ propensity to issue such an opinion.  Sensitivity analyses for this test suggest that these results are driven by non-Big 6 audit firm partners.
    • The results of this study find no association between abnormal working capital accruals and longer audit partner tenure. 
      These findings are in contrast to a prior study that examines the Taiwanese market and does find some support for an increased association between abnormal accruals (i.e., lower earnings quality) and longer auditor tenures,
    • The results show limited evidence of fewer clients just missing earnings benchmarks (i.e., more clients beating earnings benchmarks) in cases where the audit partner has longer tenure at the client.
    Category:
    Independence & Ethics, Audit Team Composition, International Matters
    Sub-category:
    Audit Firm Rotation, Partner Rotation, Audit Partner Rotation, Audit Firm Rotation
    Home:
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  • Jennifer M Mueller-Phillips
    Auditing Without Borders.
    research summary posted October 19, 2015 by Jennifer M Mueller-Phillips, tagged 15.0 International Matters 
    Title:
    Auditing Without Borders.
    Practical Implications:

    There are two points of this essay. First, the auditing community can benefit from a more expansive view of auditing without borders, one that considers the commonalities of financial statement audits with other certification practices. Auditors and academics can both learn from and potentially contribute to other research literatures. At the same time, context is also important. That is, the community also needs to examine closely the specific contexts in which auditing and other certification practices take place. In particular the author conjectures that a major cause of the variation in audit quality (and perhaps the quality of other 3rd party certifications as well) is the specific institutional and cultural setting of a particular certification practice, and the effects that these have on the incentives and behavior of certification experts. Very little is known about these contextual effects, even for financial statement audits.

    Citation:

    Francis, J. R. 2011. Auditing Without Borders. Accounting, Organizations & Society 36 (4/5): 318-323.

    Keywords:
    audit, auditing, global markets
    Purpose of the Study:

    The studies by Jamal and Sunder (2011), Jeacle and Carter (2011), and Downer (2011) raise two interesting questions for accounting scholars: what is an audit, and what is auditing research? As illustrated by these papers, there are widespread certification activities in modern societies and the first theme of this essay is that accounting scholars can both learn from and contribute to a much broader research literature on certification and verification activities. While there are some exceptions, for the most part the accounting literature on “auditing” is quite narrow in scope, focusing almost exclusively on professional accountants, financial statement audits by licensed auditors and the related regulatory regimes. Thus the essay’s title “Auditing without Borders” is an appeal to expand the thinking about auditing as a more generalizable activity, and a way of enriching understanding of financial statement audits while at the same time contributing to a broader scholarship on certification and verification processes. Even though auditing can be conceptualized as part of a more generalizable activity, the second theme the author takes up at the end of the essay is that context also matters and is very important in understanding specific certification practices. The author defines “auditing” very broadly as any 3rd party certification by an expert, or more simply certification, and begins with a brief excursion into the wider world of certification activities.

    Design/Method/ Approach:

    This article is an editorial.

    Findings:

    One way of thinking broadly about different types of certification activities is based on who does the certification. The first type is state-run certification programs in which governmental organizations conduct certifications. The second broad type of certification is state-sponsored certification programs in which the state authorizes and regulates certification activities, but the actual certifications are undertaken in the private sector with state monitoring and oversight. This is where public-company financial statement auditing is located (and also private company audits in those countries where they are mandated by law). The state licenses accountants as experts, requires that these experts certify financial statements, and the state monitors the behavior and performance of the accounting experts.

    Even for the global accounting firms, each country constitutes a unique practice and audit market. Context not only matters, it may well be critical to assessing audits. What the author suggests is the need for comparative or cross-country audit research in order to learn how the particular institutions and culture of a country affect auditing practices. When one investigates auditing a single country, be it an experiment, archival study, field study, or a discursive analysis, in essence it represents a sample of “one” in terms of national culture and institutions. To more deeply understand the role of country-specific characteristics that shape auditing practices one must directly compare two or more countries.

    Category:
    International Matters
  • Jennifer M Mueller-Phillips
    Auditor-Client Compatibility and Audit Firm Selection
    research summary posted February 27, 2017 by Jennifer M Mueller-Phillips, tagged 11.0 Audit Quality and Quality Control, 15.0 International Matters, 15.04 Audit Firm Rotation 
    Title:
    Auditor-Client Compatibility and Audit Firm Selection
    Practical Implications:

     The authors’ results may be of interest to policy makers for two important reasons. First, regulatory discussions on mandatory audit firm rotation could have implications for the cost and quality of auditing if a client is forced to switch from a compatible auditor to one that is less compatible. Second, proposals to expand the auditor’s reporting responsibilities might mitigate the loss of audit quality when similarity arises in unaudited disclosures.

    Citation:

     Brown, S. V. and W. R. Knechel. 2016. Auditor-Client Compatibility and Audit Firm Selection. Journal of Accounting Research 54 (3): 725-775.

    Purpose of the Study:

     A great number of factors affect the complicated process of a client selecting an auditor. The factors that might affect the degree of compatibility between an auditor and a client include pricing, expertise, location, interpersonal associations and the extent of agency problems in the client. Research in the past has looked into some of these attributes and how they are relevant in determining the overall quality of the resulting audit. A limited amount of research has examined alignment between clients and certain types of auditors based on factors such as the size of the audit firm or degree of industry specialization. However, there is less research on the compatibility of specific auditors and specific clients. The authors define auditor-client compatibility as the ability of the auditor to satisfy a client’s preferences, given the auditor’s own preferences, abilities and constraints. With this in mind, the authors examine the narrative disclosures included in the text-based parts of the financial statements that provide information about a company, its operations and its accounting choices. Next, they develop a unique measure of auditor-client compatibility for Big 4 firms based on the similarity of their financial disclosures rather than their financial results.

    Design/Method/ Approach:

     The authors focus on three narrative disclosures separately and together: the company’s business description, the accounting footnotes, and management discussion and analysis. They also compare the similarity of an individual client to all of the current clients within an industry of a specific auditor to generate a proxy for how well that company fits into each auditor’s client base.

    Findings:
    • The authors find that clients clustered within an industry at the audit firm level tend to have higher similarity scores when compared to clients of other auditors in the same industry and time period; this suggests that the authors’ proxy is capturing information about the compatibility between an individual client and an individual audit firm.
    • The authors find that the poorer the fit with an existing auditor, the greater the probability the client will choose to switch to a new auditor.
    • The authors find that the successor auditor is generally the non-incumbent firm that has the best relative fit.
    • The authors find that discretionary accruals are lower when auditor-client compatibility is better, suggesting higher audit quality; however, they find a higher incidence of accounting restatements when the similarity of the unaudited MD&A and client business description is high but not when the similarity of the audited footnotes is high.
    • The authors find that financially distressed firms that are more similar are less likely to receive a going concern opinion, but similarity is also associated with increased accuracy in going concern opinion reporting. 
    Category:
    Audit Quality & Quality Control, International Matters
    Sub-category:
    Audit Firm Rotation
  • Jennifer M Mueller-Phillips
    Balancing the Costs and Benefits of Auditing and Financial...
    research summary posted April 1, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.06 Impact of PCAOB, 01.07 Impact of SEC Actions, 15.0 International Matters 
    Title:
    Balancing the Costs and Benefits of Auditing and Financial Reporting Regulation Post-SOX, Part II: Perspectives from the Nexus at the SEC
    Practical Implications:

    The study provides helpful insight on auditing and financial reporting public policy issues and initiatives. The report focuses on the roles of the SEC and PCAOB in the setting of standards, convergence of standards, and the formation of a new public oversight regulating body. The author provides her personal perspective on the complications and thought processes behind many of the tasks taken on by the SEC from 2006 - 2008.

    For more information on this study, please contact Zoe-Vonna Palmrose (zv.palmrose@marshall.usc.edu).

    Citation:

    Palmrose, Z.-V. 2010. 2010. Balancing the Costs and Benefits of Auditing and Financial Reporting Regulation Post-SOX, Part II: Perspectives from the Nexus at the SEC. Accounting Horizons 24 (3):487-507.

    Purpose of the Study:

    Zoe-Vonna Palmrose served as the Deputy Chief Accountant for Professional Practice in the Office of the Chief Accountant. From August 2006 to July 2008, Palmrose observed the effects of SEC activities in the areas of auditing and financial reporting public policy during her tenure. Palmrose discusses her observations about the following areas:

    • Oversight of the PCAOB by the SEC
    • SEC Federal Advisory Committee on Improvements to Financial Reporting (CIFiR)
    • International Financial Reporting Standards (IFRS)
    • U.S. Department of the Treasury Advisory Committee on the Auditing Profession
    • Auditor Independence
    • Assessing Audit Regulation Under Sarbanes-Oxley 
    Design/Method/ Approach:

    The author relies on personal experiences from her tenure as Deputy Chief Accountant to provide insight about the topics mentioned above.

    Findings:
    • The Committee on Improvements to Financial Reporting took on an initiative to increase the usefulness of SEC reports. The improvements focused on enhancing the standards-setting process as well as the helpfulness of the standards. The committee also focused on clarifying guidance for restatements and accounting judgments. The author finds that no formal action has been taken on the committee’s recommendations.
    • During the author’s tenure, the leadership of the SEC moved from an advocating role towards IFRS and U.S. GAAP convergence to allowing U.S. companies adopt IFRS. The author noted that the possible costs associated with U.S. companies adopting IFRS standards would be high relative to the costs associated with adopting Sarbanes-Oxley.
    • The U.S. Department of the Treasury Advisory Committee on the Auditing Profession issued a report in 2008 with recommendations for audit firm governance and transparency. The report urged firms to appoint independent members with full voting power to audit firm boards and advisory boards. It also urged the PCAOB to require certain public annual reporting by large audit firms by 2010. The report recommended that the PCAOB develop key indicators of audit quality and effectiveness and require the disclosure of those indicators by audit firms. The report recommended that large audit firms file audited U.S. GAAP financial statements with the PCAOB beginning in 2011. The report also recommended that the PCAOB should monitor catastrophic risk associated with audit quality.
    • The author observes that the co-chairs of the Advisory Committee were concerned primarily with the revenues of audit firms based on type of service. The concern was focused on non-audit services revenue. The author finds that the views of the co-chairs will likely become a part of public policy discussions.
    • The author observes that the convergence of auditor independence standards is becoming very difficult. The author suggests that a compilation comparing independence rules of the SEC and PCAOB would be helpful to initiate the change and convergence of the rules. The author finds that one factor preventing convergence is that international standards use a threats and safeguards approach which is adamantly opposed by investor advocates in the U.S.
    • The author observes that the PCAOB standard setting process does not allow enough meaningful public input. The author finds that the PCAOB has failed to distinguish public company audits enough to warrant the need for auditing standards other than the IASB standards. The author notes that SEC oversight does not mean that is runs the PCAOB. The two bodies have different agendas which can create issues.
    • The author proposes that a new regulatory organization for audits of public entities be formed. The regulatory organization would be subject to SEC oversight. The regulatory organization would be funded by an audit fee surcharge.
    Category:
    International Matters, Standard Setting
    Sub-category:
    Impact of PCAOB, Impact of SEC Actions
  • Jennifer M Mueller-Phillips
    Benefits and Costs of Appointing Joint Audit Engagement...
    research summary posted May 31, 2016 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.07 Audit Firm Rotation, 05.0 Audit Team Composition, 05.03 Partner Rotation, 15.0 International Matters, 15.03 Audit Partner Rotation 
    Title:
    Benefits and Costs of Appointing Joint Audit Engagement Partners
    Practical Implications:

     The results of this study are important to understanding the potential benefits of joint engagement partner audits compared to single-partner audits. The results of this study identify an association between the type of partner audit (joint vs. single) and audit quality and audit fees. As regulators consider the association between joint audits and audit quality, the results of this study suggest there are benefits to joint-partner audits, particularly when the partners are located in the same office. Compared to single-partner audits, joint-partner audits are associated with higher audit quality. Compared to joint audit firms, joint-partner audits appear to provide the same benefits without the increased cost.

    Citation:

    Ittonen, K., and P. C. Trønnes. 2015. Benefits and costs of appointing joint audit engagement partners. Auditing: A Journal of Practice & Theory 34 (3): 23-46.

    Keywords:
    Joint auditing; engagement partners; audit quality; audit fees
    Purpose of the Study:

    Audits using joint engagement partners versus audits using a single engagement partner may produce significant benefits. The purpose of this study is to examine the relationship between joint engagement partners and audit quality and audit fees. The authors of the study predict that joint audit partners improves audit quality via benefits in knowledge and experience, consultation availability with a joint partner, and reducing client-specific knowledge lost due to partner rotation.

    Design/Method/ Approach:

    The authors use 1,345 firm-year observations from the NASDAQ OMX Exchanges in Finland and Sweden for the period 2005 to 2009.

    Findings:
    • The authors find a stronger association between joint engagement partners and higher audit quality when the partners are from the same, rather than a different, office.
    • The authors find that joint engagement partners, compared to single partners, are associated with less accruals (two proxies for audit quality).
    • The authors find a small decrease in audit fees for joint engagement partners from different offices compared to single-partner audits. The authors find no difference in audit quality. 
    Category:
    Audit Team Composition, Independence & Ethics, International Matters
    Sub-category:
    Audit Firm Rotation, Audit Partner Rotation, Partner Rotation
  • Jennifer M Mueller-Phillips
    Can Reporting Norms Create a Safe Harbor? Jury Verdicts...
    research summary posted September 19, 2013 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.09 Litigation Risk, 15.0 International Matters, 15.02 IFRS Changes – Impacts 
    Title:
    Can Reporting Norms Create a Safe Harbor? Jury Verdicts against Auditors under Precise and Imprecise Accounting Standards
    Practical Implications:

    The results of this study are important for audit firms to prepare for the adoption of IFRS and/or less precise standards under U.S. GAAP. The results indicate that a move to less precise standards will not necessarily result in more verdicts against auditors. There is only one condition in which an imprecise standard leads juries to return more verdicts against the auditor: when the client’s reporting complies with the precise standard and is inconsistent with the industry reporting norm. The results suggest that auditors can reduce this liability by ensuring that their client’s reporting is consistent with industry reporting norm.

    For more information on this study, please contact Kathryn Kadous.
     

    Citation:

    Kadous, K., and M. Mercer. 2012. Can Reporting Norms Create a Safe Harbor? Jury Verdicts against Auditors under Precise and Imprecise Accounting Standards. The Accounting Review 87 (2):565-587.

    Keywords:
    Audit litigation, principles versus rules, jury decision making, IFRS
    Purpose of the Study:

    The transition from U.S. GAAP to International Financial Reporting Standards (IFRS) has been a topic of debate among regulatory bodies, standard-setters, firms, and their auditors. IFRS tend to provide less precise guidance than current U.S. accounting standards, so their application requires more professional judgment. Auditors have expressed concern that the adoption of IFRS will result in increased legal liability. This paper addresses this concern by investigating how the level of precision in accounting standards affects jury verdicts in auditor negligence lawsuits. Based on legal studies and the psychology literature, this paper studies how the effect of accounting standard precision on jury verdicts depends on two factors:

    • The aggressiveness of the audit client’s reporting choice
    • Whether the audit client’s reporting choice is consistent with the industry reporting norm
       
    Design/Method/ Approach:

    The authors collected their evidence prior to September 2010.  They use a group of undergraduate students to act as jurors in a simulated auditor negligence case. The participants deliberate in juries of six persons. Each jury is asked to assess the auditor’s conduct and to provide a verdict.  

    Findings:
    • The authors find that effect of accounting standard precision on jury verdicts depends on both the aggressiveness of the client’s reporting choice and on the industry reporting norm. Jurors use a hierarchy of decision rules. When the accounting standard does not provide a clear decision criterion, jurors seek other decision rules such as whether the client’s accounting is consistent with the industry reporting norm. 
    • The authors find that when the client’s accounting is more aggressive and violates the precise standard, a majority of juries return verdicts against the auditor, regardless of whether the industry reporting norm is met. When the client’s reporting is less aggressive and does not violate the precise standard, juries rarely return verdicts against the auditor, regardless of whether the reporting is consistent with the industry reporting norm. 
    • The authors find that when the accounting standard is imprecise, compliance with the industry reporting norm is a stronger predictor of jury verdicts. In particular, under the imprecise standard, no juries find against the auditor for allowing the more aggressive client reporting when the reporting is consistent with the industry reporting norm; when the reporting norm is violated, about half of the juries find the auditor negligent.
       
    Category:
    International Matters, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    IFRS Changes – Impacts, Litigation Risk

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