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  • Jennifer M Mueller-Phillips
    The Interplay of Interpersonal Affect and Source Reliability...
    research summary posted May 26, 2014 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.05 Assessing Risk of Material Misstatement, 09.0 Auditor Judgment, 09.02 Documentation Specificity, 09.10 Prior Dispositions/Biases/Auditor state of mind 
    Title:
    The Interplay of Interpersonal Affect and Source Reliability on Auditors' Inventory Judgments
    Practical Implications:
    • A negative emotional feeling toward a lower competence client contact can result in more conservative judgments and the documentation of more items indicative of increased risk. This would likely result in inefficiencies due to increased testing because risk is perceived to be higher than it would be in an unbiased setting.
    • A positive affective reaction toward a lower competence client led to similar inventory obsolescence ratings and the documentation of more items indicative of decreased obsolescence than a higher competence source. This would likely result in lowered audit effectiveness due to decreased testing because risk is perceived to be lower than it would be in unbiased setting. Additionally, it would be hard for reviewers to remedy this error because the work papers would also have a bias toward lower risk evidence items.
    Citation:

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

    Purpose of the Study:

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

    Design/Method/ Approach:

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

    Findings:

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

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

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

    Category:
    Auditor Judgment, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Assessing Risk of Material Misstatement, Documentation Specificity, Prior Dispositions/Biases/Auditor state of mind
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  • Jennifer M Mueller-Phillips
    The Joint Influence of the Extent and Nature of Audit...
    research summary posted September 19, 2013 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.05 Assessing Risk of Material Misstatement, 09.0 Auditor Judgment, 09.01 Audit Scope and Materiality Judgments, 11.0 Audit Quality and Quality Control, 11.09 Evaluation of Evidence 
    Title:
    The Joint Influence of the Extent and Nature of Audit Evidence, Materiality Thresholds, and Misstatement Type on Achieved Audit Risk
    Practical Implications:

    This study challenges the audit practice to think about what makes sufficient, relevant, and reliable audit evidence. It provides evidence that decreased audit risk does not always occur when materiality is lowered, an increased quantity of audit evidence is obtained, and traditional audit tests are performed. The nature and persuasiveness of the audit evidence should be evaluated in order to obtain the desired level of audit risk. 


    For more information on this study, please contact David V. Budescu.
     

    Citation:

    Budescu, D.V., Peecher, M.E and I. Solomon. 2012. The Joint Influence of the Extent and Nature of Audit Evidence, Materiality Thresholds, and Misstatement Type on Achieved Audit Risk. Auditing: A Journal of Practice and Theory 31 (2): 19-41.

    Keywords:
    Audit risk, audit evidence, fraud, error, materiality, misstatement
    Purpose of the Study:

    The role of the auditors is to provide assurance on a company’s financial statements by obtaining sufficient evidence to support the audit procedures performed.  Although there are professional and regulatory standards to guide an auditor, it is ultimately the auditor’s judgment to determine if the amount of evidence that is obtained is of the right quality and quantity to support the opinion.  Through a simulation model, the authors seek to provide evidence that an achieved audit risk is influenced jointly by the nature and extent of audit evidence, materiality, and the types of financial misstatement that may occur.  Using the audit risk model, the authors address how auditors use of the audit risk model lead to lower levels of achieved audit risk and whether fraud is the only type of misstatement where use of the audit risk model is suspect. Below are the factors that the authors assess to evaluate their influence on achieved audit risk in their study: 

    • Quantitative materiality (six levels ranging from .5-5% based on typical materiality measurement)
    • Extent of the evidence (the amount of times the auditor will evaluate a set of audit procedures.  For example, an auditor may perform analytics, inquiries, walkthroughs, and sample items to test a specific account are viewed as one “venture” at the audit evidence for the account). 
    • Nature of the evidence (third-party external evidence, internal evidence from management’s financial reporting process, or internal evidence from management’s business process)
    • Type of misstatement type (Unintentional error due to management’s random error, unintentional error due to bias in management’s judgments, or intentional error due to fraud)
       
    Design/Method/ Approach:

    The authors perform a simulation to model how achieved audit risk depends on the extent and nature of audit evidence, materiality levels, and the type of misstatements that may distort the financial statements. Specifically, they use the revenue account for purposes of their simulation.  They also manipulate four factors (the independent variables):  quantitative materiality, evidence extent, evidence nature, and misstatement type. The dependent variable is the achieved audit risk, which is measured as the probability that the auditors’ expectation for revenue departs from the true value by at least material amount. 

    Findings:
    • Increasing the extent of testing decreases the audit risk only under certain conditions (i.e. when the bias in audit evidence is less than quantitative materiality).  In certain circumstances, increasing the extent of testing may increase the audit risk (i.e. when the bias in audit evidence exceeds quantitative materiality).
    • Reducing materiality levels to perform a more precise audit may or may not enhance the effectiveness of the audit procedures.  Depending on the nature of the audit procedures and the evidence that is gathered, it may decrease or increase the audit risk.
    • Quality of the internal controls of an organization may assist an auditor to better judge the extent in which evidence from management is may be distorted or contain an intentional or unintentional misstatement.
    • In the circumstances of fraud, an auditor should supplement more traditional audit tests with tests that provide evidence that is unlikely to be biased by management (i.e. external evidence).
       
    Category:
    Audit Quality & Quality Control, Auditor Judgment, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Assessing Risk of Material Misstatement, Audit Scope & Materiality Judgements, Evaluation of Evidence
  • Jennifer M Mueller-Phillips
    The Role of Account Subjectivity and Risk of Material...
    research summary posted July 18, 2016 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.05 Assessing Risk of Material Misstatement, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.11 Reliance on Internal Auditors 
    Title:
    The Role of Account Subjectivity and Risk of Material Misstatement on Auditors’ Internal Audit Reliance Judgments
    Practical Implications:

    This paper suggests that the relationship between account subjectivity and usage of internal audit depends on the relative risk of misstatement.  This complex relationship has not been shown in academic literature, nor is it highlighted in audit standards.  More specifically, at lower levels of risk of misstatement, increases in subjectivity have no influence on the reliance of internal audit.  At moderate risk levels the extent of internal audit reliance increases with subjectivity of the account.  At high levels of misstatement internal audit reliance decreases with account subjectivity.  This study provides insight into the decision criteria for internal audit reliance and highlight where internal audit usage maybe more prevalent, as well as were further audit guidance may be beneficial.

    Citation:

    Bhattacharjee, S., M.J. Maletta, K.K. Moreno. 2016. The Role of Account Subjectivity and Risk of Material Misstatement on Auditors’ Internal Audit Reliance Judgments. Accounting Horizons 30 (2): 225-238.

    Keywords:
    Internal audit; account subjectivity; material misstatement risk
    Purpose of the Study:

    Reliance on Internal Audit has become an important element of the external audit.  Use of Internal Audit can play a significant role in reducing audit costs without sacrificing audit quality.  However, the extent of usage of Internal Audit has been shown to be influenced by inherent risk, control risk, and the subjectivity of audit tasks.  This paper looks at the interaction between risk assessment and subjectivity to provide insight into the complexities associated with the usage of internal audit.  The authors aim to dive deeper into the analysis of internal audit usage, expanding on the dichotomous “low or high risk” assessment by investigating moderate risk scenarios.  By analyzing these relationships with a field-based questionnaire, the authors present documentation of how real decisions are based on a complex assessment of the role of internal auditors.

    Design/Method/ Approach:

    The authors conducted a field-based questionnaire using 68 auditors from a Big 4 firm.  These auditors were located in the U.S., but came from different geographic areas.  They have an average experience of 46 months and represented 15 different industry specializations.  The auditors were asked to choose one public company client and respond to questions regarding demographic information, client characteristics, external audit team characteristics, client misstatement risk, account subjectivity, client internal audit structure, and external audit assessment of internal audit usage.

    Findings:
    • The authors find that auditors’ reliance decisions involve an interaction between material misstatement risk and account area subjectivity. 
    • The authors find that incremental increases in account subjectivity have no effect on extent of internal audit reliance when misstatement risk is assessed at lower levels.  At moderate levels of misstatement risk, however, account subjectivity is positively associated with use of internal auditors.  This suggests that moderate misstatement risk creates opportunities for auditors to benefit from increasing internal audit utilization without offsetting impairments to audit effectiveness.  At higher levels of misstatement risk, incremental increases in account subjectivity have a negative association with external audit usage.
    Category:
    Auditing Procedures - Nature - Timing and Extent, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Assessing Risk of Material Misstatement, Reliance on Internal Auditors
  • Jennifer M Mueller-Phillips
    The Use of Business Risk Audit Perspectives by Non-Big 4...
    research summary posted March 10, 2015 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, 06.05 Assessing Risk of Material Misstatement 
    Title:
    The Use of Business Risk Audit Perspectives by Non-Big 4 Audit Firms
    Practical Implications:

    The first implication is a call for proportionality and flexibility to adopt an audit approach that meets the client-audit firm context. SMP auditors told us that they struggle with achieving proportionality by not performing some audit procedures such as entity-level analytical procedures for smaller clients, because they feel obliged to perform these procedures to comply with documentation requirements of the auditing standards or of regulators and oversight bodies. Such experiences may result in inefficient, ‘‘check-the-box’’ audits in order to satisfy perceived documentation requirements for review purposes.

    The second implication is that standard setters should be aware that the type and/or scope of the assurance engagement might also vary by jurisdiction. For example, in a jurisdiction with a close book-tax alignment, the clients’ and users’ expectations about the type and scope of assurance may interact with the prescribed standards in shaping audit practice.

    For more information on this study, please contact Niels van Nieuw Amerongen.

    Citation:

    Van Buuren, J., C. Koch, N. v. Nieuw Amerongen, and A. M. Wright. 2014. The Use of Business Risk Audit Perspectives by Non-Big 4 Audit Firms. Auditing: A Journal of Practice and Theory 33 (3): 105-128

    Keywords:
    business risk auditing, small and medium-sized audit practices (SMPs), auditing standards, audit methodology
    Purpose of the Study:

    The purpose of this study is to examine the extent of use of business risk perspectives by Small and Medium-sized audit Practices (SMP) and to investigate the conditions and factors affecting the application of such practices. We neither focus on the degree of compliance with standards nor on the audit quality differences among audit firms. Rather, we want to document variation in practices and, in particular, the relative reliance on Business Risk Audit (BRA) forms of evidence, since current auditing standards allow great flexibility in the choice of audit approaches on an audit engagement.

    Investigating SMPs is expected to provide new insights because SMP auditors face an audit environment that is very challenging in the use of business risk perspectives. For instance, SME clients often do not have formalized entity-level controls for assessing (client) business risks. Also, clients of such firms vary considerably in size and complexity, which may affect the cost-effectiveness of various forms of BRA evidence. We examine whether business risk assessments are proportionally applied. That is, we investigate whether the extent of consideration of business risks is dependent upon cost-effectiveness in the client setting. For instance, for large clients, the complexity of the engagement likely requires a focus on business risks and entity-level evidence, while for small clients, it may be more cost-effective to primarily rely on substantive tests at the assertion-, account or cycle level. In this respect, we consider a continuum of audit approaches, ranging from a substantive-based audit approach to a full-scope business risk audit, to explain differences in the use of business risk perspectives in SMP’s audit planning.

    Design/Method/ Approach:

    To examine these issues, we use a semi-structured interview approach involving 38 highly experienced auditors in Germany and in The Netherlands. This approach allows us to gather rich, detailed data of auditors’ experiences in the field.

    Findings:

    The findings indicate limited application of business risk perspectives by SMPs. Although SMPs regularly assess business risks, they are divided in their experiences and perceptions about the usefulness of business risk perspectives and rarely apply the knowledge of business risks for analytical procedures. We also find that many SMP auditors find it challenging to rely on entity-level controls that are often informal in SMEs or that are established by an owner-manager. Our results suggest that SMP auditors more often choose a systems-based or primarily substantive audit approach, as compared to the broad BRA approach. The findings indicate that the use of business risk perspectives is driven by consideration of the tradeoff between audit effectiveness and efficiency. Auditors with larger and more complex clients apply business risk perspectives more extensively. Further, auditors identify other factors that may affect the use of a business risk audit approach, such as tax-book alignment, enforcement by audit supervisory authorities, prior working exposure to BRA through experience with Big 4 audit firms, audit client tenure, and investments in training and databases.

    Category:
    Risk & Risk Management - Including Fraud Risk, Standard Setting
    Sub-category:
    Assessing Risk of Material Misstatement, Changes in Audit Standards
  • The Auditing Section
    Transforming audit technologies: Business risk audit...
    research summary posted May 4, 2012 by The Auditing Section, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.05 Assessing Risk of Material Misstatement 
    Title:
    Transforming audit technologies: Business risk audit methodologies and the audit field
    Practical Implications:

    The findings of the study emphasize the importance of considering history when understanding how changes in the auditing profession occur (such as the emergence of the BRA, which the authors explore in this study).  Though audit firms have stated that they initially implemented BRA methodologies in response to the challenge of the “information age” and corporate clients’ assurance needs, the authors propose that BRA served as a legitimacy tool for the auditing profession, changed the identity of accounting firms, and enabled audit firms to maintain broader areas of expertise.  

    Citation:

    Robson, K., Humphrey, C., Khalifa, R., and J. Jones. 2007. Transforming audit technologies: Business risk audit methodologies and the audit field. Accounting, Organizations, and Society 32(5): 409 – 438.

    Keywords:
    Risk and Risk Management, including Fraud Risk
    Purpose of the Study:

    Drawing on theories of legitimacy, professional knowledge, and science and technology, this study seeks to understand the promotion and use of the Business Risk Audit (BRA) approach.  The authors suggest the BRA allowed audit firms to renegotiate their professional identities and status and expand their jurisdictional claims over broader areas of expertise.  The authors develop a framework of “theory for audit change” that highlights how audit firms gain and maintain legitimacy and how audit technology evolves and changes.

    Design/Method/ Approach:

    The research evidence is collected starting in 1996, and the authors utilize the major accounting firms’ publications, brochures, and websites (i.e., materials describing the BRA; a key example is a KPMG Monograph titled “Auditing Through a Strategic-Systems Lens: the KPMG Business Measurement Process” (KPMG 1997)), in concert with documentary material from professional accounting institutes and interviews with audit partners and senior managers from UK accounting firms. Within the written evidence, the authors conduct a textual analysis, examining both verbal characteristics of the language and latent meanings of the words.

    Findings:
    • The authors observe that during the late 1990s and early 2000s, audits tended to be viewed as a commodity, primarily because audit firms treated auditing as a “gateway” to providing more lucrative non-audit services. 
    • The authors argue that the legitimacy of the audit process lies within “the statutory frame in which audit requirements are embedded” and is also dependent on the association of auditor expertise with cultural codes and values such as efficiency, rationality, and science. 
    • The authors suggest that the emergence of the BRA as a technology to add value to the audit process was an attempt to increase the prestige of the audit profession and give it a new identity.  The authors link the emergence of the BRA with the increased use of more strategic and risk-based approaches taken by client managers.  Accordingly, the BRA generated a value added audit via knowledge spillovers that enabled the auditor to add value both with respect to business risks and the related accounting implications. 
    • The development of the BRA approach allowed audit services to be integrated with the “value-added” nature of the other expert services provided by public accounting firms. The depiction of audit as a value-added service is consistent with the AICPA’s attempts to characterize audit professionals as global knowledge experts.
    Category:
    Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Assessing Risk of Material Misstatement
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