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  • Jennifer M Mueller-Phillips
    Audit Pricing for Strategic Alliances: An Incomplete...
    research summary posted February 16, 2017 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 02.05 Business Risk Assessment - e.g., industry, IPO, complexity 
    Title:
    Audit Pricing for Strategic Alliances: An Incomplete Contract Perspective
    Practical Implications:

    This paper adds a new dimension to the research on strategic alliances by focusing on auditing rather than governance, performance, funding, or equity participation. It also identifies incomplete contracts as the driver of audit complexity, and extends the audit fee literature by documenting that the number of strategic alliances is a significant determinant of audit fees. Finally, the authors’ evidence that strategic alliances result in higher audit fees provides empirical support for the largely theoretical argument that incomplete contracts are complex. 

    Citation:

    Demirkan, S. and N. Zhou. 2016. Audit Pricing for Strategic Alliances: An Incomplete Contract Perspective. Contemporary Accounting Research 33 (4): 1625-1647.

    Purpose of the Study:

    A strategic alliance is a long-term contract between multiple firms where resources are pooled to accomplish preset objectives, creating dependence between otherwise legally independent firms. Prior research has focused on the emergence, management and survival of alliances; consequently, there is not substantial research on the relation between strategic alliances and auditing. This paper fills that void by investigating how auditors price their audit services for firms involved in strategic alliances. 

    Design/Method/ Approach:

    The authors conduct a study on the pricing of audit services for strategic alliances through compiling data and utilizing descriptive statistics.  

    Findings:
    • The authors find that the nonverifiability of information and potential agency behavior in alliances increase audit complexity, resulting in higher audit fees.
    • The authors find that auditors are less likely to issue going-concern modified opinions when there is an increase in strategic alliances; moreover, an increase in strategic alliances is associated with a reduction in bankruptcy risk as measured by Altman Z-Scores.
    • The authors find that an increase in strategic alliances is unrelated to the likelihood of financial misstatements.
    • The authors find that an increase in strategic alliances is unrelated to internal control weakness opinions. 
    Category:
    Client Acceptance and Continuance
    Sub-category:
    Audit Fee Decisions, Business Risk Assessment (e.g. industry - IPO - complexity)
  • Jennifer M Mueller-Phillips
    Auditor Resignation and Risk Factors.
    research summary posted September 21, 2015 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.02 Client Risk Assessment, 02.05 Business Risk Assessment - e.g., industry, IPO, complexity, 02.06 Resignation Decisions, 06.0 Risk and Risk Management, Including Fraud Risk, 06.09 Litigation Risk 
    Title:
    Auditor Resignation and Risk Factors.
    Practical Implications:

    This study sheds light on why auditors choose to resign from auditing particular clients. The authors find that public information about audit risk, business risk, and litigation risk as well as private information about audit risk and business risk all play a role in the auditor’s resignation decision. This is useful for audit firms and regulators to consider. 

    Citation:

    Ghosh, A. and C.Y. Tang. 2015. Auditor Resignation and Risk Factors. Accounting Horizons 29 (3): 529-549.

    Keywords:
    auditor resignations, litigation risk, audit risk, business risk
    Purpose of the Study:

    While prior research has suggested litigation risk as the main reason for auditor resignations, the competing explanations of audit risk and business risk have not been tested concurrently to discover their incremental importance. Furthermore, prior research has not been able to isolate the auditor’s private information from public information about these risks. The authors attempt to close this gap in the literature by studying whether and how much the auditor’s private information about future audit risk, business risk, and litigation risk impacts the auditor’s resignation decision.

    Design/Method/ Approach:

    The authors use data from publicly-traded companies that switched auditors during the 1999-2010 time period. First, they compare auditor resignations to auditor dismissals based on pre-switch audit risk, business risk, and litigation risk. Then they test whether auditor resignations predict post-switch audit risk (e.g. internal control problems), business risk (e.g. delisting from stock exchange), and litigation risk (e.g. class-action lawsuits).

    Findings:
    • Compared to clients from which auditors have been dismissed, clients from which auditors resigned tend to have greater litigation risk, audit risk, and business risk before the change in auditors, but greater audit risk and business risk after the change.
    • The litigation risk, business risk, and audit risk existing before an auditor chooses to resign from an engagement all impact the auditor’s resignation decision, with litigation risk having the largest impact and audit risk the smallest.
    • Clients whose auditors have resigned are more likely to experience class-action lawsuits, internal control problems, and delisting from a stock exchange.
    • Auditor resignations reveal no private information about future litigation risk.
    • Auditor resignations reveal private information about future audit risk and future business risk, especially when one of the Big 4 audit firms resigned.
    Category:
    Client Acceptance and Continuance, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Business Risk Assessment (e.g. industry - IPO - complexity), Client Risk Assessment, Litigation Risk, Resignation Decisions
  • Jennifer M Mueller-Phillips
    Business Strategy, Financial Reporting Irregularities, and...
    research summary posted April 17, 2014 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.05 Business Risk Assessment - e.g., industry, IPO, complexity, 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations 
    Title:
    Business Strategy, Financial Reporting Irregularities, and Audit Effort
    Practical Implications:

    This study provides several important contributions to the existing accounting literatures on financial reporting irregularities. The authors provide evidence that the differences in the client business risk of companies’ choice of business strategies is an underlying determinant of financial statement quality. Also, the findings provide evidence that auditors appear to recognize and adjust audit effort based on clients’ business strategies. This study is important because it identifies organizational business strategies as an important determinant of both financial reporting irregularities and audit effort based off publicly available data.

    For more information on this study, please contact Kathleen, A. Bentley.
     

    Citation:

    Bentley, K. A., T. C. Omer, and N. Y. Sharp. 2013. Business Strategy, Financial Reporting Irregularities, and Audit Effort. Contemporary Accounting Research 30 (2).

    Keywords:
    business strategies; audit effort; financial statement quality.
    Purpose of the Study:

    This study examines the effect clients’ business strategies have on the occurrence of financial reporting irregularities and the level of audit effect. Using Miles and Snow’s (1978, 2003) strategy typology, the authors attempt to provide evidence that increases the understanding of underlying determinates of financial reporting quality. They provide a measure of business strategy that requires only publicly available information and is generalizable across industries. Using these measures, this study is able to provide evidence of whether companies’ business strategies exhibit differences in the occurrences of financial reporting irregularities.

    Design/Method/ Approach:

    The authors of this study use the organizational strategy theory of Miles and Snow to develop a comprehensive measure of business strategy using publicly available data. Relying on this theory, the authors developed a discrete STRATEGY composite measure, which proxies for the organization’s business strategy. Higher STRATEGY scores represent companies with prospector strategies and lower score represent companies with defender strategies. Using logistic regression, the authors determine whether the company strategies are associated with financial reporting irregularities. Level of audit effort was determined using audit fee data. All of this data is combined and analyzed to produce overall conclusions.

    Findings:
    • Companies following a prospector strategy are more likely than companies following a defender strategy to experience financial reporting irregularities across three samples of irregularities: SEC AAERs, shareholder lawsuits related to alleged accounting improprieties, and accounting restatements.
    • The business strategy measure represents client business risk and is not a substitute for financial reporting risk.
    • Clients following prospector strategies have higher audit fee, suggesting that auditors expend greater audit effort for these clients.
    • Despite higher audit fees for prospectors, fees are not high enough to account for the riskiness of these clients.
       
    Category:
    Client Acceptance and Continuance, Engagement Management
    Sub-category:
    Audit Fees & Fee Negotiations, Business Risk Assessment (e.g. industry - IPO - complexity)
  • Jennifer M Mueller-Phillips
    Client business models, process business risks and the risk...
    research summary posted November 14, 2016 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.05 Business Risk Assessment - e.g., industry, IPO, complexity, 06.0 Risk and Risk Management, Including Fraud Risk, 06.05 Assessing Risk of Material Misstatement 
    Title:
    Client business models, process business risks and the risk of material misstatement of revenue
    Practical Implications:

    The importance of understanding the operation of a client’s business and its competitive environment to achieve an effective audit is well-known. More specifically, the PCAOB requires that an auditor understand the company’s objectives and strategies and those related business risks that might reasonably be expected to result in risks of material misstatement. Valid understanding also is necessary to both interpret results from analytical procedures and to engage in effective professional skepticism for management’s assertions. The author’s results reveal a previously unreported level of understanding of process-oriented business risks and their association with the RMM of revenue for essentially new staff auditors. 

    Citation:

    Wright, W. F. 2016. Client business, models, process business risks and the risk of material misstatement of revenue. Accounting, Organizations and Society 48: 43-55. 

    Keywords:
    business risk auditing, risk-based auditing, risk assessment, analytical procedures, strategic management, and business models.
    Purpose of the Study:

    There are undeniable benefits for financial auditors to understand a client’s business strategy, strategic objectives and critical business processes, as well as understanding the business risks of a client’s business model during the reporting period. In fact, an inadequate understanding of business risks can result in an audit failure. While business risk auditing continues to be a central framework for auditing, whether auditors can achieve the necessary in-depth understanding of the business risks generated by different strategies and business models remains unclear.  Current research tests for understanding of the theory of business risk auditing, but this author tests the premise that informed graduate students acting as surrogates for staff auditors will understand and implement in their judgments the process risk implications of different business strategies and business models. This should prove important because the existing literature indicates inconsistent results on auditor’s ability to conduct an effective strategic analysis. 

    Design/Method/ Approach:

    The author conducted a 2x2 randomized between subjects design. The participants were all accounting Masters students who were a few weeks from their graduation. These participants were presented with an array of facts, until ultimately deciding which business strategy applied and assessing the performance and the associated business risk of each of the five processes of the case. 

    Findings:
    • The author finds that, with a few exceptions, surrogates for entry-level auditors made the subtle yet important distinctions among process-level business risks given the requirements of two different business strategies.
    • The author finds that the participants were able to report risk assessments for the critical Production process such that the indirect effect of process-specific business risk mediated the direct relationship between judgments of process performance and the RMM of revenue.
    • The author finds that the participants were able to make the distinction between the two different business strategies and could correctly indicate that there is no significant difference in the RMM of revenue for the two strategies when product generation performance was relatively high and business risk was relatively low. 
    Category:
    Client Acceptance and Continuance, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Assessing Risk of Material Misstatement, Business Risk Assessment (e.g. industry - IPO - complexity)
  • The Auditing Section
    Differences in Industry Specialist Knowledge and Business...
    research summary posted May 7, 2012 by The Auditing Section, tagged 02.0 Client Acceptance and Continuance, 02.05 Business Risk Assessment - e.g., industry, IPO, complexity, 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual, 06.0 Risk and Risk Management, Including Fraud Risk, 06.05 Assessing Risk of Material Misstatement 
    Title:
    Differences in Industry Specialist Knowledge and Business Risk Identification and Evaluation
    Practical Implications:

    The findings in this study are not intended to undermine the benefits of specialization in generic industries. Rather, they serve to highlight the importance and impact that specializing across differing industries has on auditor knowledge and experience.  From a
    practical perspective, the results of this study provide audit firms insights into the possible effects experience from industries of varying complexity has on auditors’ abilities to evaluate audit risks.  The results highlight the challenges in simply grouping industry specialists homogeneously, as the benefits accruing to specialists may vary depending on the nature and complexity of the industry.

    Citation:

    Moroney, R., and R. Simnett. 2009.  Differences in Industry Specialist Knowledge and Business Risk Identification and Evaluation.  Behavioral Research in Accounting 21(2): 73-89.

    Keywords:
    Behavioral decision theory; industry specialization; business risks
    Purpose of the Study:

    Prior literature has reported that auditors who are considered industry specialists outperform non-specialists on tasks within their area of expertise.  Noting that not all industries are the same, the authors build on this prior literature to examine the relative performance gains between auditors specializing in a complex (pension fund) industry vs. generic (manufacturing) industry.  Below are the primary objectives that the authors address in their study: 

    • The authors argue that the nature of a complex industry causes a specialist to possess a more developed sub-specialty knowledge base compared to his/her counterpart specializing in a generic industry.  In response, it is believed that the complex industry specialist will outperform the generic industry specialist in identifying appropriate business risks, within their respective industries.
    • The authors additionally examine information-gathering attributes. Specifically, they argue that complex industry specialists will 1) list more appropriate information sources, 2) list more appropriate evidence gathering processes, and 3) will list more appropriate accounts and related assertions when compared to generic industry specialist auditors.
    Design/Method/ Approach:

    An experiment, which uses Big 4 auditors ranging in experience from 2 to 27 years, is conducted. The average experience levels of the auditors are 5.2 and 4.6 years, respectively, for the complex and generic industry specialists. This data was collected in Australia, prior to 2009. Two expert panels of Big 4 industry specialists (one from each industry) were involved in the development of the experimental materials.  

    Findings:
    • Complex industry specialists (i.e., pension fund auditors) were able to list relatively more business risks when working in their industry than generic industry specialists (i.e., manufacturing auditors) were able to in their respective industry.
    • Complex industry specialists, working in their industry, were able to list a greater number of appropriate information sources and appropriate evidence gathering processes, compared to their generic industry peers. However, they were not able to list a greater number of accounts or related assertions.
    Category:
    Client Acceptance and Continuance, Audit Team Composition, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Business Risk Assessment (e.g. industry - IPO - complexity), Industry Expertise – Firm and Individual, Assessing Risk of Material Misstatement
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  • The Auditing Section
    Dual-Class Shares and Audit Pricing: Evidence from the...
    research summary posted April 16, 2012 by The Auditing Section, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 02.05 Business Risk Assessment - e.g., industry, IPO, complexity 
    Title:
    Dual-Class Shares and Audit Pricing: Evidence from the Canadian Markets
    Practical Implications:

    This study provides evidence that dual class share structures increase audit risk.  In response, audit firms either increase the scope of the audit or charge a fee premium.

    Citation:

    Khalil, S., M.L. Magnan, and J.R. Cohen. 2008. Dual-Class Shares and Audit Pricing: Evidence from the Canadian Market. Auditing: A Journal of Practice & Theory 27 (2): 199-216.

    Keywords:
    audit pricing; ownership structure; dual-class shares; corporate governance
    Purpose of the Study:

    This study examines the impact that dual-class shares have on audit fees.  Dual-class shares exist when there are 2 or more classes of shares and they have disproportionate voting rights (i.e. voting rights are concentrated while the rights to the cash flows of the firm are more dispersed).  The presence of dual-class shares affects audit pricing through an increase or decrease of audit risk.  

    There are two competing hypotheses on how dual-class shares affect audit risk.  First, dual-class shares may entrench the  shareholder and thus reduce financial reporting quality. This view is known as the entrenchment perspective. Secondly, the alignment perspective posits that dual-class shares reduce audit risk because the holders (1) are poorly diversified, (2) protect their reputation and desire to pass wealth onto the next generation, and (3) manage the firm themselves. 

    The authors examine which of these competing hypotheses is dominant: dual-class shares represent increased risk to the auditor, or dual-class shares represent an effective governance mechanism (think: “tone at the top”) and therefore lower risk to the auditor.

    Design/Method/ Approach:

    The authors gather data on Canadian companies publicly traded on the Toronto Stock Exchange (TSX) for the year 2004. The authors create a ratio of ownership to control and compare audit fees for firms with a high ratio of ownership to control to firms with a low ratio using statistical techniques.

    Findings:

    Audit fees are higher for firms with dual class share structures, suggesting perceived audit risk is higher, although it is not clear whether the increase is due to increased audit effort or a risk premium. 

    Category:
    Client Acceptance and Continuance
    Sub-category:
    Audit fee decisions, Business Risk Assessment (e.g. industry - IPO - complexity)
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  • Jennifer M Mueller-Phillips
    How Do Auditors Behave During Periods of Market Euphoria?...
    research summary posted April 17, 2014 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.05 Business Risk Assessment - e.g., industry, IPO, complexity, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.04 Auditors’ Professional Skepticism, 09.0 Auditor Judgment, 09.04 Going Concern Decisions 
    Title:
    How Do Auditors Behave During Periods of Market Euphoria? The Case of Internet IPOs
    Practical Implications:

    Due to the potential for future market bubbles, the findings of this study may be of interest to audit regulators and standard setters. These finding suggest mixed conclusions regarding the Big 5’s behavior during periods of market euphoria. The presence of going concern opinions varies inversely with variables that represent client viability and auditor self-interest. Evidence that points to a decrease in the predictive value of Big 5 opinions signed during the Internet IPO bubble may also have consequences for investors.
     
    For more information on this study, please contact Andrew J. Leone.
     

    Citation:

    Leone, A. J., S. Rice, J. P. Weber, and M. Willenborg. 2013. How Do Auditors Behave During Periods of Market Euphoria? The Case of Internet IPOs. Contemporary Accounting Research 30 (1).

    Keywords:
    auditors’ opinions; going concerns; initial public offerings; online information services
    Purpose of the Study:

    The study of periods of market euphoria is a long-standing topic of interest to economists. Theorists specify conditions under which market participants and institutions cause bubbles to form. This study looks at how auditors behave during these periods of euphoric market conditions, specifically around the time of the wave of Internet companies’ IPOs in the late 1990s and early 2000s. The goal was to discover how audit decisions change with fluctuations in the external marketplace. The authors address whether auditors are maintaining their responsibility to act in the public’s best interest during these unique market conditions, and how going concern decisions of these Internet IPO companies might vary based on these conditions.

    Design/Method/ Approach:

    The authors obtained a sample of 756 Internet IPO filings from 1996 to 2000 using an online database, as well as a sample of non- Internet IPO registrants. Using descriptive statistics, the authors tested these samples for determinants that could lead auditors to shift their going concern decision criteria during euphoric market conditions.

    Findings:
    • The presence of going concern opinions varies with variables that proxy for both economic reasons and for less independence and skepticism by the Big 5.
    • Some evidence points to associations between costs to investors and a decrease in Big 5 going concern opinions during the bubble.
    • Big 5 firms were not a major cause of the Internet IPO bubble, but large audit firms did little to slow it from inflating.
       
    Category:
    Auditing Procedures - Nature - Timing and Extent, Auditor Judgment, Client Acceptance and Continuance
    Sub-category:
    Auditors’ Professional Skepticism, Business Risk Assessment (e.g. industry - IPO - complexity), Going Concern Decisions
  • Jennifer M Mueller-Phillips
    Is the Audit Fee Disclosure a Leading Indicator of...
    research summary posted October 3, 2013 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 02.02 Client Risk Assessment, 02.05 Business Risk Assessment - e.g., industry, IPO, complexity 
    Title:
    Is the Audit Fee Disclosure a Leading Indicator of Clients’ Business Risk?
    Practical Implications:

    The results of this study have very important implications regarding how stakeholders respond to the disclosed audit fee and business risk. Stakeholders could devote special attention the audit fee disclosure that is mandated by the SEC as it has the potential to reveal risk information. Additionally, the results of this study should warrant increased awareness on the part of the auditors when they price an audit because audit firms should consider what the public believes the audit fee implies about the client’s business risk.

    For more information on this study, please contact Jonathan D. Stanley.
     

    Citation:

    Stanley, J.D. 2011. Is the audit fee disclosure a leading indicator of clients’ business risk? Auditing: A Journal of Practice and Theory 30 (3): 157-179.

    Keywords:
    audit fees; audit pricing; client business risk
    Purpose of the Study:

    Client business risk is defined as the risk that an audit client’s economic condition will deteriorate in the future. This risk is critical in the auditor’s determination of the price of the audit because the client’s business risk also affects the auditor’s business risk as well as audit risk. This study aims to investigate if the audit prices, as revealed through audit fee disclosures made mandatory by the SEC in 2001, provide the public with information of a client firm’s business risk. Although the requirement to disclose audit fees was put in place with regulatory intent, it is suggested that how auditors price the audit reveals the auditor’s perception of the client’s risk which they would otherwise not be able to disclose. The existence of this relationship is examined based on the correlation between audit fees and future changes in the clients’ economic condition. The ability for auditors to foresee future changes in a client’s economic condition display a level of sophistication in auditor judgment that shines a favorable light on auditor competence as expert service providers.

    Design/Method/ Approach:

    This study was conducted using firm-year observations during the 2000-2008 time period. Proxies for client business risk such as earnings, operating cash flows, leverage, and liquidity were used to perform a principal components analysis. The financial data was obtained from Compustat and matched with information from Audit Analytics. 

    Findings:
    • A significant inverse relationship between audit fees and the one-year-ahead change in a measure of client’s operating performance exists.
    • This relationship extends more for changes up to five years ahead and is stronger for negative as opposed to positive changes in performance.
    • Audit fees reflect future changes in a client’s earnings that analysts’ forecast do not identify.
    • Little evidence was found to support the existence of a relationship between audit fees and incremental changes in clients’ solvency.
    • An insignificant relationship between audit fees and a client’s future bankruptcy status was identified.
    • Both solvency and bankruptcy are dimensions of a client’s business risk that the audit fee is unable to capture.
    • The findings suggest that audit fees reflect information that is unknown by even other sophisticated market participants.
    • The results collectively suggest that the audit fee disclosure is a leading indicator of the operating performance and business risk of a client.
       
    Category:
    Client Acceptance and Continuance
    Sub-category:
    Audit Fee Decisions, Business Risk Assessment (e.g. industry - IPO - complexity), Client Risk Assessment
  • Jennifer M Mueller-Phillips
    Relevant but Delayed Information in Negotiated Audit Fees
    research summary posted March 30, 2015 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 02.05 Business Risk Assessment - e.g., industry, IPO, complexity 
    Title:
    Relevant but Delayed Information in Negotiated Audit Fees
    Practical Implications:
    • The study is a first step in documenting the economically relevant information contained in negotiated fees.
    • The market is precluded from assimilating timely, consequential information embedded in the negotiated audit fee simply because the current mandate is to disclose the audit fee paid essentially one year after the negotiated audit fee is known by insiders.
    • The study does not address how accelerating the disclosure of audit fee information would complicate the auditor-auditee fee negotiation process, or more generally, the auditor-client relationship.

    For more information on this study, please contact Karl Hackenbrack.

    Citation:

    Hackenbrack, K., N.T. Jenkins and M. Pevzner. 2014. Relevant but delayed information in negotiated audit fees. Auditing: A Journal of Practice and Theory 33 (4): 95-117

    Keywords:
    Stock price crashes, audit fees, disclosure, client acceptance, business risk assessment
    Purpose of the Study:

    Audit fee negotiations conclude with the signing of an engagement letter, typically the first quarter of the year under audit. Yet investors do not learn of the audit fee paid until it is disclosed in the following year’s definitive proxy statement. We conjecture that negotiated audit fees impound auditors’ consequential private, client-specific knowledge about ‘‘bad news’’ events investors will learn eventually. We demonstrate that a proxy for the year-to-year change in the negotiated audit fee has an economically meaningful positive association with proxies for public realizations of ‘‘bad news’’ events that occur during the roughly 12-month period between the negotiation of the audit fee and the disclosure of the audit fee paid.

    Design/Method/ Approach:

    The approach is archival/empirical.  The sample selection process began with all available company-year observations in Audit Analytics for entities that filed either a 10-K or a definitive proxy statement during the period 2000 to 2011.  Company-years associate with first year engagements, multiple auditors, average share price less than $2.50, financial services companies and utilities were eliminated, as well as observations with incomplete data or not covered in CRSP or COMPUSTAT.  The resulting sample has 27,708 company-year observations.  All data is available from public sources.

    Findings:
    • Our analyses address whether changes in negotiated audit fees lead to public realizations of idiosyncratic risk and the consequent stock price crash.
    • Auditors appear to be aware of the buildup of company-specific bad news at the time the audit fee is negotiated and to adjust negotiated audit fees accordingly.
    • Our proxy for the change in the negotiated audit fee is positively associated with proxies for public realizations of idiosyncratic risk over the roughly 12 months between the negotiation of the audit fee and the disclosure of the audit fee paid.
    • On average, auditors negotiated a 2 to 3 percentage point increase in the audit fee in advance of a stock price crash event over and above changes necessitated by operational or structural changes in the client.
    Category:
    Client Acceptance and Continuance
    Sub-category:
    Audit Fee Decisions, Business Risk Assessment (e.g. industry - IPO - complexity)
  • Jennifer M Mueller-Phillips
    Strategic analysis and auditor risk judgments
    research summary posted March 11, 2015 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.02 Client Risk Assessment, 02.05 Business Risk Assessment - e.g., industry, IPO, complexity, 06.0 Risk and Risk Management, Including Fraud Risk, 06.05 Assessing Risk of Material Misstatement 
    Title:
    Strategic analysis and auditor risk judgments
    Practical Implications:

    The results of this study have important implications:

    • First, the results demonstrate that auditor judgments of the risk of material misstatement at the entity (financial statement) level are linked to the performance and documentation of strategic analysis of strategy positioning and the strategy implementation process
    • Second, this study provides preliminary evidence on the association between performing an analysis of the entity’s strategy implementation process and auditors’ judgments of the strength of the control environment
    • Third, the fact that auditors who performed strategic analysis did not identify a greater number of significant business and financial statement risks than auditors who did not perform strategic analysis warrants further research

    For more information on this study, please contact Natalia Kochetova-Kozloski.

    Citation:

    Kochetova-Kozloski, N., and W. F. Messier Jr. 2011. Strategic analysis and auditor risk judgments. Auditing: A Journal of Practice & Theory 30(4): 149-171.

    Keywords:
    risk assessment; strategic analysis; strategic positioning; strategy implementation.
    Purpose of the Study:

    Conducting a business risk-based audit requires the auditor to develop an understanding of the client and its environment, make risk assessments based on that knowledge, and design appropriate audit procedures to respond to those risks. A significant component of understanding the client and its environment involves conducting a strategic analysis of the client.

    The study investigates whether and how senior auditors’ strategic analysis of a client affects their identification of significant business and financial statement risks, and their risk assessments by addressing these two issues:

    • Whether strategic analysis undertaken by auditors to develop an understanding of the client’s business affects their risk identification
    • How two aspects of strategic analysis (analysis of strategic positioning and the strategy implementation process) influence auditors’ risk assessments
    Design/Method/ Approach:

    The study employed a 3 x 1 between-subjects factorial design with no strategic analysis (‘‘No SA’’) as a control condition, and analysis of strategic positioning (‘‘SA: strategic positioning’’) and analysis of strategy implementation process (‘‘SA: strategic process’’) as treatment conditions.  Experimental materials were delivered to the participants by e-mail or at a national training session. Sixty-seven (67) audit seniors from three Big 4 firms completed the experiment. The experimental materials included a cover letter, Additional Task Instructions, Risk Assessment and Audit Planning and Debriefing Questionnaire.

    Findings:

    The authors find:

    • Auditors who performed guided strategic analysis did not identify more significant business and financial statement risks than auditors who did not perform strategic analysis,
    • Senior auditors who performed strategic analysis of strategic positioning or the strategy implementation process assessed risk of material misstatement at the entity level more consistently with an expert panel than auditors who did not perform such an analysis,
    • Senior auditors’ analysis of the client’s strategy implementation process was associated with assessments of the strength of the control environment that were more consistent with the expert panel than assessments done by auditors who did not perform any strategic analysis or who performed only an analysis of strategic positioning.
    Category:
    Client Acceptance and Continuance, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Assessing Risk of Material Misstatement, Business Risk Assessment (e.g. industry - IPO - complexity), Client Risk Assessment

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